CHAPTER 1
TODAY’S BUSINESS ENVIRONMENT: LAW AND ETHICS
Managers face an increasingly complicated world. Law is a part of the environment and it grows
ever more complex as it impacts on parts of business that saw little regulatory interference in
years past. Managers must be aware of legal issues, just as they must know something about
accounting, personnel management, and other parts of the business environment. Increasingly,
ethical issues have come to the forefront and businesses are expected to handle matters with that
in mind.
LAW AND THE KEY FUNCTIONS OF THE LEGAL SYSTEM—Many definitions can be
given to law because it is a general concept. Holmes and Cardozo provide definitions that show
that law is, generally, a set of rules that govern conduct that will be enforced by the courts. It
includes formal rules, which include what we usually refer to as law, and informal rules that
come from a society’s culture and ethics.
Improving Social Stability by Influencing Behavior—Law and the legal system define
acceptable human behavior and provide a means for controlling unacceptable behavior. To
encourage or discourage behavior the legal system needs some measure of “force”—the ability
to threaten and impose sanctions including fines and imprisonment. What is the “public interest”
varies a lot across countries. Selling dope in Amsterdam is legal; it may result in execution in
other countries.
Conflict Resolution—The law and the legal system provide a formal mechanism and structure
for the resolution of disputes–the court system. Private and public disputes may be resolved
within this formal structure of the legal system, which provides substantive and procedural rules
for conflict resolution.
International Perspective: Emerging Nations and the Law—Haiti, like other very poor
countries, does not have an effective rule of law. The more corrupt a country, such as measured
by Transparency International, the poorer it is likely to be. The Dominican Republic, which
occupies the other half of the island Haiti is on, is less corrupt and much wealthier. How to instill
an effective, accepted rule of law is not easy or well understood.
Add. Info.: Corruption, or lack of well-functioning, legitimate legal system is the major cause of
poverty. Some countries, such as Nigeria, are resource rich, but corrupt regimes have stolen
hundreds of billions of dollars in oil revenues. Other countries have greater stability, such as
Belarus, but its regime is a repressive with a command economy. Even if the Belarus regime
were not corrupt, no country can expect development when creativity and freedom of choice is
quashed. A Cuban expatriate, who ran a restaurant in Havana, reported that he was required to
produce all meals according to recipes provided by the government agency that regulates
restaurants.
Social Stability and Change—The law and the legal system must work to preserve society’s
values, customs, and traditions. The legal culture and its acceptance are important in explaining
the extent to which laws are enforced, obeyed, avoided, or abused. The law and the legal system
must provide a means through which the governing authority can bring about important changes
in acceptable behavior. Racial discrimination used to be an accepted part of the law and culture;
that has changed significantly in the last 40 years. The laws and attitudes about gay marriages are
changing now.
SOURCES OF LAW IN THE UNITED STATES—Law in the U.S. comes from a mix of
common, or judge-made law, and statutory law.
Constitutions—A constitution is a fundamental source of law. In most countries, it forms the
most fundamental source of law dictating the structure of government and limits on
governmental authority.
The U.S. Constitution—It is the oldest written constitution in force in the world, it establishes the
branches of the US government and specifies their powers. See Appendix C for full text.
State Constitutions—Specifies the structure of state governments, including their court systems,
limits on taxes, and the powers of various authorities. It may not conflict with the U.S.
Constitution.
Legislatures and Statutes—Legislatures are the key sources of statutory law. The powers of
both Congress and the state legislatures are restricted by constitutions.
United States Congress—The Congress was created by the Constitution which specifies its
various, including the powers to borrow money, declare war, and so forth. Thousands of bills are
introduced each year; about 200 are actually voted upon.
State Legislatures—State legislatures are bicameral (in two parts, typically a house and a senate)
except Nebraska. As in Congress, bills go through a committee system prior to dual house
passage and signature by governor. National Conference of Commissioners on Uniform State
Laws provides text for state statutes, such as the UCC, UPA, and other laws commonly adopted
in part or in whole.
Administrative Agencies and Regulations—Administrative agencies are typically created by
legislatures or the executive branch of the government. Agencies are delegated authority to act
on certain matters. As empowered under the applicable enabling statute, agencies pass
regulations implementing the statute. Those regulations have the same legal authority as a law
passed by a legislature. An agency may also have law enforcement authority.
The Judiciary and Common Law—Judge-made law or the common law dates to the colonial
period, and was derived from English common law. English common law began with the
establishment of the King’s Courts (Curia Regis) after 1066. The King’s Courts were an integral
part of the William the Conqueror’s efforts to unify England. They were supplemented by local
courts and church courts. Important sources of law within the judicial branch of the government
now includes (1) the judge-made common law and (2) the judicial review of agency
administrative actions and activities.
Case Law—The King’s Courts helped to develop and apply a common and uniform set of laws
throughout the country. The decisions of the courts were written down (court reporters) and then
were expected to be followed in subsequent disputes; precedent had been created. As now, judges
look to other court decisions for guidance.
Doctrine of Stare Decisis—The use of past cases (precedents) in deciding cases forms the
doctrine of stare decisis. Precedent has nearly the same force as a statute; judges are expected to
follow it.
Value of Precedent—Stare decisis promotes several functions in our legal system:
(a) Clarity and Consistency—businesses can have reasonable expectations about the future
enforcement of their agreements and the legal standards to be applied.
(b) Uniformity—encourages businesses to expand and foster economic activity when they are
confident of the legal environment as it encompasses an economic activity.
(c) Neutralize Judicial Prejudices—serves to neutralize the prejudices of individual judges by
pressuring them to follow precedent rather than their own personal biases and beliefs. Judges
who do follow precedent will likely see their decisions overturned upon appeal.
Add. Info: Overturning precedent is not a simple matter. When should it be done? Supreme
Court Justice Stevens: ‘The question whether a case should be overruled is not simply answered
by demonstrating that the case was erroneously decided and that the Court has the power to
correct its past mistakes. The doctrine of stare decisis requires a separate examination. Among
the questions to be considered are the possible significance of intervening events, the possible
impact on settled expectations, and the risk of undermining public confidence in the stability of
our basic rules of law. Such a separate inquiry is appropriate not only when an old rule is of
doubtful legitimacy … but also when an old rule that was admittedly valid when conceived is
questioned because of a change in the circumstances that originally justified it.’
Changes in Law and Society—A distinct advantage of the common law is that it changes readily
to reflect evolution in technology and social attitudes. The law adapted to the existence of e-mail,
faxes, and other methods of communication that people wish to use.
Add. Case: Hessenthaler v. Farzin (Super. Ct., Pa., 1989). Background: Farzin hired a real
estate agent to sell his property. The agent found a buyer (Hessenthaler), and informed Farzin.
Farzin sent a fax confirming acceptance. Upon seeing the full agreement, Farzin tried to make
several changes. Hessenthaler sued for specific performance. Farzin argued that a fax was not
sufficient to create a signed writing as required. The trial court found for Hessenthaler stating
that the mailgram created a binding agreement. Farzin appealed.
Decision: Affirmed. Businesses must be able to use technology such as “electronic mail, telexes
and facsimile machines in conducting their business affairs” to meet the statute of frauds
sufficient ‘writing’ requirement. The need for the sufficient ‘writing’ was to ensure that the
Add. Info: Technology, Confidentiality, and the Legal Profession—Use of the faxes and e-mails
has generated legal problems. One issue is confidentiality: (1) a message sent to the wrong
location or (2) a message sent to a central location and is seen by unintended persons. Is the
attorney-client and work-product privileges waived under these circumstances? In P&B Marina
Ltd. v. Logrande, 136 F.R.D. 50, the court held that the attorney-client privilege is waived when
confidential material is disclosed, even if disclosure is inadvertent. Faxes seen by others were
not subject to attorney-client privilege. Jurisdictions are split on disclosure (no waiver, waiver if
the parties failed to take reasonable precautions, and waiver in all circumstances). The
reasonable precautions reasoning appears to be most common. It is in the interest of the attorney
and client to at least use a legend on the cover sheet stating that the information accompanying
the cover is confidential and is intended only for use by the addressee. E-mail distribution should
be carefully controlled and secure, with an understanding of who has access to emailed
documents.
Reporting Court Cases—The Davis case in the text shows how common law rules change with
the times, as the Washington supreme court abandons a traditional liability rule. See Appendix B
for a discussion of elements of a case and how presented in text.
CASE: Davis v. Baugh Contractors—Baugh did construction work for Glacier that included
installing underground pipes that should have lasted many years. When a leak soon developed,
Glacier dug down to see what the problem was. While an employee was investigating the leak, a
Decision: Washington State Supreme Court held that the old rule, the Completion and
Acceptance Doctrine, is overturned. It is outmoded and harmful. Under the modern approach, a
Questions: 1. The court rejected the common law rule concerning completion and acceptance
that had been in effect until this decision (and ordered a new trial). What was the key reason for
that decision? How does the new rule affect liability?
Answer: The old rule had been abandoned by most states already. It was outmoded because the
complexity of construction has increased such that it is much less likely that a buyer can look at
2. A judge on the court dissented from the decision. Explaining his opposition to the decision of
the majority, he said this change in the law should have been done by the legislature in a statute,
not the court. What are the practical problems with such a view?
Answer: Legislatures rarely care to fiddle with relatively technical rules of law. Their time is
spent dealing with broader issues or ones that have an immediate political payoff. Getting
legislatures to focus on code rules can be difficult. Further, the construction industry was lined
The Executive—The president has the ability to issue executive orders—an order or regulation
issued by the president (or an administrative authority under the president’s direction) for the
purpose of interpreting, implementing, or giving administrative effect to a provision of the
Constitution or of some law or treaty.
International Sources of Law—Important sources of law include the laws of the individual
countries, treaties and trade agreements among those countries, and the rules enacted by
international organizations such as the UN, WTO and CISG. Congress must vote to approve
treaties with other nations.
Add. Info: Alternative Legal Traditions—Generally, there are three major ‘families’ of legal
systems: (1) common law, (2) civil law, and (3) religious law. They are not mutually exclusive.
The U.S. may be viewed as a common law system, but the civil and criminal codes play huge
roles. Similarly, precedents are followed in civil law countries. A summary:
Civil Law—The basic source of law are codes; most disputes are resolved by looking to a statute
or code. In contrast to the common-law systems where basic laws are developed by judges, the
codes of conduct are enacted by the government. Judges play a greater role in proceedings—
questioning witnesses and conducting the court proceedings—than their common law
counterparts. Major civil law countries include: Japan, Germany, France, Mexico, and Italy.
Religious Law—Within Islam and Judaism the law is asserted to be the word of God. Generally,
the laws affecting personal relations are derived directly from religious doctrines. The sources of
law are the religious writings—for example, the Qur’an in the Islamic legal system and the
Torah in the Jewish legal system. The commercial laws in some religious law countries have
been adapted from Western codes to assist economic development.
CLASSIFICATIONS OF LAW—The law could be classified in several ways, including: by its
source, or according to whether it could be classified as being private or public law, civil or
criminal law; or, substantive or procedural law. It is important to note that these categories are
not mutually exclusive. For example, a law could be private, civil and substantive.
Private and Public Law—Public law is concerned with the legal relationships between society
members and the government (or other) authority. Private law sets forth the legal relationships
among society members.
Civil and Criminal Law—Civil law is concerned with the rights and duties that exist among
individual society members, or between society members and the government (or other)
authority in noncriminal matters. Civil law requires that the wrongdoer be found liable by a
preponderance of the evidence. Criminal law concerns legal wrongs, or crimes, committed
against all of society. Criminal law requires that the wrongdoer be found guilty beyond a
reasonable doubt. One area of criminal law is white collar crime, particularly computer-related
crime.
Add. Case: Werner, Zaroff v. Lewis (Civ. Ct. of N.Y.C., 1992). Background: The plaintiff, a law
firm, hired Lewis to work on its computer system. When the firm made its last payment to Lewis,
he said to an attorney that if the firm had not paid he would crash the system. When the
computer reached job number 56789 the system crashed. A consultant determined that Lewis
caused the crash. The firm sued Lewis. The trial court found for the plaintiff and Lewis
appealed.
Decision. Affirmed “Members of the general public are often captives of those who have
developed the expertise needed to understand computers and computer programs, and must rely
upon those experts to act with good faith. Some people with computer expertise have utilized
International Perspective: Civil Law Systems—Most nations of the world use a code-based
system of laws rather than having part of their legal system from common law. Codes are old;
much of the code law in Europe has origins in Roman code law. So when people do business in
other countries, it must be remembered that the rules may not be the same and that terms may
have different legal meaning. Under code law, judges play a much more active role in litigation
and legal procedure is quite different, so U.S. firms in other countries must hire local counsel.
Substantive and Procedural Law—Substantive law includes common law and statutory law
that define and establish legal rights and regulate behavior. Note the importance that procedure
be followed for substantive issues to be heard. [Note that in any area of law, ignorance is no
excuse.]
Add. Case: Barcellona v. Tiffany English (5th Cir.) Background: Waiters at a TGIF restaurant
sued, contending that the policy of using tips to satisfy the employer’s obligation to pay minimum
wage violated the law. The owners asserted that they were simple farmers, ignorant of the law.
The owners were trying to avoid paying damages in addition to back wages and attorneys’ fees.
The minimum wage law provides that defendants who act in good faith and have a reasonable
basis for believing that they were not in violation can avoid damages. The lower court found for
the waiters and awarded back wages and attorney’s fees, but no damages.
Decision: The appeals court affirmed the back wage and attorneys’ fees awards but reversed as
to damages: “apathetic ignorance is never the basis of a reasonable belief.” If ignorance of the
BUSINESS ETHICS AND SOCIAL RESPONSIBILITY—Opinion polls indicate that many
believe that business is less ethical today than in years past. This may well not be so, but a part of
the decline in trust in institutions (such as Congress) in general.
Ethics, Integrity, Morality and the Law—These terms are not the same. Ethics, in business,
has to do with rules or standards of conduct and how those standards are put into practice.
Integrity means living by a moral code. Morality concerns conformity to rules of conduct in the
Business Ethics—Peter Drucker, among others, noted that business ethics and personal ethics
should not be held distinct. We should put into practice what we believe in all parts of our lives.
Political Reality—Bribes, one way or another, are required to do much business in many
countries. While the Foreign Corrupt Practices Act will be discussed in Ch. 22, the general point
Issue Spotter: OK to Grease Palms? You can quit if you do not like it, but that is the way
things are done in a number of cities in the U.S. You might try playing dumb, hoping the
inspectors will sign, figuring the new guy does not know the system, but that is not likely to last
long, and soon there may not be any permits being issued or they may delay inspection visits,
holding up construction, which is a very costly result. One person is unlikely to be able to change
such unethical practices. Contractors do not like it, but must have the permits. The heads of the
inspection departments are either in on the take, know all about it, or may be powerless to deal
with it. However, liability for making payments, even if extorted by the government inspector,
can be strict and result in criminal sanctions.
Perceptions of Ethics and Responses—Corporations face problems with public perceptions of
their honesty and with employee honesty. Corporate codes of ethics have not seemed to improve
the situation. Some studies show that corporations that make the most effort to inform employees
of ethical standards are most likely to be subject to federal regulatory investigations. Most
Americans think there is more dishonesty now than a decade ago. To stem this problem, more
companies hire ethics specialists. Talk is not enough; there must be incentives to act more
honestly.
Ethics Codes and Compliance Programs—Talking about ethics and compliance is one thing;
making it happen is another. To reduce legal punishment, more and more companies are adopting
compliance programs that meet DOJ standards. Companies that have effective programs face
lower levels of punishment under the Sentencing Guidelines.
Cyberlaw: Online Ethics and Legal Compliance
Many companies have employees take online classes in legal requirements and ethical decisions.
The advantage of such classes is that there must be positive responses to questions asked; when
people sit in classes they may not pay attention, so the online classes seem to be effective.
International Perspective: Does Regulation Improve Business Ethics?
World Bank study of business practices and legal rules indicates that corrupt countries tend to
have more regulation. Government control often gives corrupt bureaucrats greater ability to
extort. Many simple steps in business in poor countries require many more legal, bureaucratic
steps than they do in Western countries, making it all the harder for ordinary people to earn a
living.
Issue Spotter: Putting Ethics into Practice—Most larger companies have codes of ethics that
are distributed to employees. As the statements in the book indicate (that are taken from a code
of conduct of a large firm; this was given to a sales clerk employee) most employees will not
relate to the code. Nothing the ordinary employee does can relate to antitrust issues. Few are in a
position to affect decisions to grant credit or not. Such codes may be well-intended but only
matter if they are put into practice at the relevant levels within an organization.
Ethics and Corporate Social Responsibility—CSR can be very vague. Peter Drucker put it in
the contest of business leadership. Leaders must be sure the corporate mission is fulfilled.
Earning a profit for investors is socially responsible. Part of doing that means minimizing errors
that are harmful to the value of the organization over time. Google tries to incorporate this notion
with the “Don’t be evil” rule. Some companies have staffs that consider operations within the
company within the social responsibility context, as well as issues of company participation in
community activities. The Lamson case makes clear—law and ethics can be quite distinct.
CASE: Lamson v. Crater Lake Motors—Lamson was long time sales manager at a car
dealership. He advocated honest dealing with customers; no high-pressure sales tactics. The
company hired an outside marketing firm. It used techniques Lamson thought were unethical—
but they worked. He objected to the decline in ethical standards and would not cooperate with
the marketing firm. He was fired and sued, saying the company violated its own code of ethics.
Jury held for him. Employer appealed.
Decision: Reversed. There is no legal basis for a suit for wrongful discharge. It was an at-will
Questions: 1. Suppose some of the sale tactics used by RPM violated Oregon law. What could
Lamson do about it? Unless he suffered the effects of an illegal practice by making a purchase
based on such practice, he had no complaint at law. Who would know more about such practices;
those involved in putting them in place or a customer? Do you think any other car dealer would
want to hire Lamson if he went public about his complaints?
Answer: The court noted that Lamson may have had a case under Oregon law if he was told to
hide something that could involve health and safety conditions, but nothing else. Hence, while
certain sales practices are illegal, there was nothing Lamson could do about it except for what he
2. Why do you think the courts are shy to get involved in such incidents? Should the courts be
enforcers of company’s ethical practices and codes of ethics?
Answer: Codes of ethics are internal documents that usually have no legal consequence. The job
of courts is to enforce the law, not act as arbiters in cases of codes of ethics. It would be a great
Add. Case: Soldano v. O’Daniels (Calif. Ct. App., 1982) Background: A man threatened to
shoot Soldano. Another man ran into a bar and asked the bartender to call for help. The
bartender refused to call the police and refused to let the man call. Soldano was killed. Soldano’s
child sued the bartender for wrongful death. The trial court dismissed the case, stating that a
person may not be held liable for nonactions. Plaintiff appealed.
Decision: Reversed. According to the Restatement of Torts, a person does not incur a duty to act
b) the certainty of the injury is undisputed c) there is a close connection between the defendant’s
Add. Case: United States v. Stanley (S.Ct., 1987)—Stanley was a sergeant in the U.S. Army. In
1958 he volunteered to participate in a program he was told would test protective clothing in
chemical warfare. Without his knowledge, he was given doses of LSD as part of an experiment.
Later he suffered mental problems, his marriage and careers floundered. The Army revealed in
1975 that he had been given LSD. He sued the government under the Federal Tort Claims Act,
claiming that his mental problems stemmed from the drug. The trial court dismissed the case
because the federal government is not liable for harms inflicted upon military personnel during
their service. Court of Appeals affirmed and Stanley appealed to the Supreme Court.
Decision: Affirmed. The majority opinion noted that the Constitution gives Congress the power
to make rules for the armed forces. Congress could restrict the ability of military personnel to
sue the government for harms they incur during military service. Justice Brennan dissented in
Add. Case: Grimshaw v. Ford Motor—Plaintiffs were Grimshaw, a passenger, and the heirs of a
woman (Grey) who had bought a Ford Pinto that stalled on the highway. Another car hit the
Pinto, causing it to burst into flames. Gray died as a result of burns. Grimshaw suffered
extensive burns. Evidence was that Ford used cost-benefit analyses before it marketed the Pinto.
The company knew that the fuel tank design of the car was problematic, and it weighed the cost
of redesigning the tank against liability that might arise if the car was sold as is. Ford kept the
cheaper fuel tank. Plaintiffs alleged that the defendant could have included safety features on the
car to prevent the kind of accident they suffered. The jury awarded plaintiffs over $3 million in
compensatory damages and $125 million in punitive damages. The judge reduced the punitive
damages. Ford appealed.
Decision: Affirmed. The Pinto was rushed through production. Ford did not do its normal testing
with this car. Engineering decisions were dictated largely style. The fuel tank was less than a
foot from the rear of the car. It lacked many crush resistant features, making it more susceptible
to explosions upon rear ending. In crash testing, the Pinto failed to meet government
Discussion Question
It is generally true that ignorance of the law is no excuse. Citizens are deemed to have
constructive knowledge of the law. Yet, as well know as this rule is, it is surprising how often it
is proffered as an excuse. (A Westlaw search cases finds hundreds of examples). Examples
include: Deluco v. Dezi (Conn. Super) (lack of knowledge regarding the state’s usury laws is no
excuse for the inclusion of an illegal interest rate in a sales contract); and Plumlee v. Paddock
(ignorance of the fact that the subject matter of the contract was illegal was not excuse). The
courts have provided a small exception to the rule when it comes to people in lack of English
language skills. Consider Flanery v. Kuska, (defendant did not speak English was advised by a
friend that an answer to a complaint was not required); Ramon v. Dept. of Transportation, (no
English and an inability to understand the law required for an excuse); Yurechko v. County of
Allegheny, (Ignorance and with the fact that the municipality suffered no hardship in late lawsuit
filing was an excuse).
Case Questions
1. This points out that the legal system has limits. Its acceptability is dictated by legal
culture–which determines whether law will be enforced, obeyed, avoided, or abused. It is limited
by the informal rules of the society–its customs and values. One limit is the extent to which
There was a precedent for a light sentence in this case in U.S. law: U.S. v. Holmes, 20 F. Cas. 360
(No. 15383) (C.C.E.D. Pa. 1842). The case involved a sinking ocean liner. Several passengers
The British judge in the case here imposed the death penalty upon the person who survived. The
2. (answer on Internet for students) The general rule that exists now is that since the government
has ordered the posting of warning labels on cigarettes, and since the dangers of smoking are
well known, consumers have been warned and are not due compensation if they kill themselves
by smoking. The Cippoline case, since reviewed by the Supreme Court, appears to be of limited
impact since the victim was adjudged to have become addicted to cigarettes before the warning
3. The court found no liability for the manufacturers. There was no defect; the product was safe
for intended use. Safety instructions were clear; the parents let the boys ride the bikes. Anything
can be dangerous–baseballs are dangerous when they hit the head, swings are dangerous when
4. (answer on Internet for students) The Court held it a form of sex discrimination to prevent
women of child-bearing age from holding the more dangerous jobs. The company argued that it
did this to protect itself from possible liability in case of damage to babies and that the decision
5. The appeals court held it was entirely appropriate to fire Noonan and to deny him severance
benefits because he violated Staples’ Code of Ethics. The Code clearly stated what was expected
and what the consequences would be for violations. That enables the Code to have more meaning
6. The appeals court affirmed that the employer had the right to terminate the employee for
failure to be fully cooperative in the investigation of the complaint of sexual harassment that had
Ethics Questions
1. The nature of our political system forces firms to participate in the political process. Those
that fail to do so, if they are of any size, are more likely to be subject to political attack. In a
sense, firms “buy” protection by keeping a flow of contributions going, especially to incumbent
2. The high mark up suppresses the demand for fair trade goods, thereby reducing the market for
fair trade goods. If the retail prices reflected the actual additional cost, not the profit maximizing
3. The company was in a no-win situation. It was attacked by environmentalists and some locals
for “destroying” the environment, even though the pollution was acceptable. When the company
later stated it would close the plant, which as not profitable, it came under fire for destroying
jobs. It eventually upgraded the plant and kept it open, but it was never a profitable operation.
4. If ethics is to be theoretical or applied only in formal situations, then it means little.
Internet Assignment
Look at these major websites for the U.S. Code and federal court system as well as key legal
materials of the federal government: Office of Law Revision Counsel, U.S. Code:
http://uscode.house.gov/
Cornell University Law School, U.S. Code: www.4.1aw.cornell.edu/uscode/ United States
Courts: www.uscourts.gov/ United States Supreme Court: www.ussc.gov/