Business Structure

Visit the Choose Your Business Structure (Links to an external site.)Links to an external site. section of the U.S. Small Business Administration’s website.

If you were to start your own business, which business entity structure would you choose? Justify why your chosen structure is the best organizational form.

Explain the following business structures: sole proprietorship, partnership, LLC, and a corporation. In your analysis address the following for each business structure:

Steps to form

Personal liability for owners


Advantages and disadvantages

Your paper must be three to five pages (excluding title and reference pages), and it must be formatted according to APA style as outlined in the Ashford Writing Center. You must cite at least two scholarly sources in addition to the course textbook. Cite your sources in-text and on the reference page.

Starting & managing (Links to an external site.)Links to an external site. (n.d.). SBA. Retrieved from


Chapter Overview

13.1 Partnerships • Must Be Association of Two or More

Competent Persons • Must Carry On a Business • Must Be Co-Owners • Must Be for Profit • Partnership by Estoppel • Advantages and Disadvantages of Partnerships • Rights and Obligations of Partners • Dissolution and Termination of Partnerships • Limited Partnerships

13.2 Corporations • Advantages and Disadvantages of Corporations • Who’s Who in Corporations: Incorporators, Promo-

tors, Directors, Officers, and Shareholders

13.3 Limited Liability Companies

13.4 Chapter Summary • Focus on Ethics • Case Study: C&J Builders and Remodelers, LLC v.

Geisenheimer • Case Study: Malone v. Patel • Critical Thinking Questions • Hypothetical Case Problems • Key Terms

13 Learning Objectives

After studying this chapter, you will be able to:

1. Describe the main characteristics of partnerships, corporations, and LLCs.

2. Explain the advantages and disadvantages of the different business forms.

3. Discuss how partnerships operate.

4. Describe the different roles of promoters, directors, shareholders, and officers of corporations.

Business Organizations

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CHAPTER 13Section 13.1 Partnerships

One of the most fundamental decisions all businesspersons face in starting a busi-ness is how that business will be organized. Business owners must carefully weigh a number of different factors. There is no one right form, but the better informed the participants in a business are about the legal consequences of being a sole proprietorship, a partnership, a lim- ited partnership, a corporation, or an LLC, the better off they will be.

The simplest form of business orga- nization is the sole proprietorship, where a single owner owns and oper- ates the business. It has the advan- tage of being very easy, with no for- malities and no expense attached to creation. The disadvantage is that a sole proprietor has limited options for raising capital and no limits on liability for business debts; thus if the business does not fare well, the sole proprietor can face personal bankruptcy.

Beyond the sole proprietorship, there are three basic types of business organizations with which we must become familiar: the partnership, the corporation, and the limited liability company. This chapter will be devoted to exploring the unique qualities of each of these basic forms of business organization.

13.1 Partnerships

A partnership can be defined as an association of two or more competent persons to carry on a business as co-owners for profit. To help understand this definition, we will break it down and look at the individual clauses. Must Be Association of Two or More Competent Persons By competent, the law means that the partners must have contractual capacity (rather than that the people involved are actually good at what they’re doing). In a partnership, each partner is simultaneously both a principal and an agent, thus the requirement makes sense. Minors can be partners, but they can also void partnership agreements (as was dis- cussed in the chapter on contractual capacity). Anyone would therefore be wise to either require emancipation or be cautious about going into partnership with a minor.

Must Carry On a Business Partnership is more than just joint ownership; it must involve enough activity to be con- sidered operating a business. Not all joint investment, even though done with a profit motive, constitutes a partnership.

A sole proprietor is both the owner and manager of her business.


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CHAPTER 13Section 13.1 Partnerships

Example 13.1. Arielle and Bradley both chip in $50,000 and buy Blackacre, a piece of real estate. A year later, they sell Blackacre for $150,000 and split the profit equally. Arielle and Bradley are concurrent owners of Blackacre, but they are unlikely to be deemed a partnership, since they were not car- rying on a business.

To be carrying on a business, Arielle and Bradley would need to be more actively involved in their profit-making venture, rather than just passively holding on to property until they are ready to sell.

Exampe 13.2. Arielle and Bradley, emboldened by their first real estate success, decide to do land speculation full time. They both now put up $100,000 and buy six properties. They fix up the properties and sell them at a profit, and buy six more, reinvesting part of the profit and sharing in the rest equally. Arielle and Bradley are now a partnership; they are clearly carrying on a business.

Must Be Co-Owners Partners are automatically owners and managers of the business, and the law presumes equal rights unless the partners have specified otherwise.

Example 13.3. Ethan, Fabian, and Gina have formed a partnership to do public relations for corporations. Ethan puts in $10,000 in capital, and Fabian and Gina both contribute $5,000 each. Nothing is said about how they will split profits or losses. At the end of their first quarter, the firm has made $12,000 in profit. Ethan thinks that since he put in half the capital,

he should get half the profit, or $6,000. But Ethan should have taken business law! Since noth- ing was specified, he’s only entitled to a one-third share, the same as Fabian and Gina.

If the partners didn’t specify how to share a loss, the law states that they will share in the same percentage they share profits.

Must Be for Profit Note that while there can be unprofit- able partnerships, there is no such thing as a nonprofit partnership. The partners must intend to make a profit.

You will recall from the chapter on agency that agents owe their principals a fiduciary duty. This means that a partner also owes this same duty to the partnership and the other partners (along with the corresponding duty of loyalty, right to indemnification, etc.). Note that partnership law is essentially a combination of agency law and contract law,

General partners all have the right to participate in management of the business.

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CHAPTER 13Section 13.1 Partnerships

with the contract in question being the partnership agreement, whether it is express or implied from the parties’ conduct.

Partnership by Estoppel Don’t be fooled by the name; these are not real partnerships, but a situation in which to protect a third party the law holds people liable as though they had been partners. It is essentially the principle of apparent authority that you learned in agency transplanted to a partnership situation. A partnership by estoppel rests upon a holding out of partnership and reasonable reliance by the third party.

Example 13.4. Michael, who is romantically interested in Lorraine, intro- duces her as his new partner in a computer services firm to a group of cli- ents at a social function. Lorraine, flattered, smiles and goes along with it, although in fact she and Michael have never discussed going into business together. Later Lorraine, who is a recent graduate with a degree in informa- tion technology but no prior work experience in the field, agrees to work as a consultant to a company owned by one of Michael’s clients to oversee the purchase and installation of a new network system. She recommends the purchase and installation of computer equipment that is not well suited to the client’s needs, costing the client millions of dollars to subsequently cor- rect the problem. If the client sues both Lorraine and Michael, both of them will be liable for any judgment against Lorraine if the client can establish that he retained Lorraine in reliance on her being Michael’s partner.

However because there is no real partnership, Lorraine would not be liable for Michael’s business debts to people who had not been at the party and had not heard Michael say she was his partner.

Advantages and Disadvantages of Partnerships One of the advantages of the partnership form of business is that it is simple to create. All that is required is that the parties agree to carry on the business as co-owners for profit. There are no formalities, such as filing with the state. Another advantage is taxa- tion: the individual partners will be taxed on their earnings, but the business itself will not (although it must file an informational return). There is no requirement of a written agreement, although it is a very good idea, and will avoid a lot of headaches in most cases.

Example 13.5. Carla and Daniel have never discussed being partners, but they both put in cash to buy cans of soda at a discount store, along with coolers and bags of ice. They each mount a cooler on a bicycle, and sells cans of soda at a considerable markup at different locations around town. At the end of the day, they meet up and divide the profits equally. Carla and Daniel may not realize it, but they are partners.

The downside of a partnership is liability. Because each partner is an agent of the partner- ship and the other partners, he or she has the power to bind the partnership and the other partner to transactions within the scope of the partnership business. All partners have full, personal liability for these partnership obligations.

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CHAPTER 13Section 13.1 Partnerships

Example 13.6. While pedaling around town selling soda, Daniel sees that Bigbox store is having a sale on crates of soda. He contracts to buy a dozen crates for $120. Since Daniel would have either apparent or implied author- ity to buy the soda for the partnership, Carla is equally bound by this debt. If Daniel doesn’t pay the bill, Bigbox could collect the full amount from Carla personally.

Example 13.7. Meanwhile, on her way to her next location, Carla negli- gently runs over Peter. Since this is a tort within the scope of the partner- ship business, Peter could hold Daniel liable.

Liability is joint and several with those of the other partners, which means that partners may be sued together or separately for the full amount of the debt. Thus if Carla now wins $10,000 in the lottery, the partnership creditor might collect the entire amount from her (although they must first attempt to satisfy the debt from partnership assets). If creditors collect the entire debt from a single partner, that partner will be able to seek indemnifica- tion from his copartners for their equitable share of the debt. But note that if Daniel is a deadbeat with no assets to speak of, it is Carla who (literally) will pay the price, not the plaintiffs Peter or Bigbox. As a practical matter, any partnership should consider business insurance, and look carefully at its coverage. This will help to alleviate some, but not all, of the liability concerns associated with partnerships.

Rights and Obligations of Partners Remember, partners are fiduciaries, and this is probably the most important duty they have to each other and the partnership. However, there are some other rights and duties provided in partnership law.

All partners have the right to participate in managing the partnership, and unless other- wise specified, majority vote will govern partnership decisions.

Example 13.8. Back to Ethan, Fabian, and Gina, who have formed a part- nership to do public relations. Ethan puts in $10,000 in capital, and Fabian and Gina contribute $5,000 each. Fabian now proposes that they should contract with Anna, a freelance artist, for some designs for brochures. Gina thinks this is a good idea, but Ethan says that because he put more money in, he has the right to veto the contract. Ethan, who obviously should have taken business law, is wrong. His two partners can approve a contract with Anna over his objection.

When it comes to partnership property, all partners own the property as tenants in part- nership, and have a right to use the property for partnership purposes and no other purpose without full consent and disclosure from other partners. If a partner dies or otherwise leaves the partnership, the remaining partners own the property. But if the partnership terminates, the property is sold and the assets distributed, first to creditors and then to the partners.

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CHAPTER 13Section 13.1 Partnerships

Example 13.9. The PR partnership owns a van that they use for travel to trade shows and conferences. Fabian wants to take the van on a weekend camping trip. Can he do so?

The answer is no, because this would not serve the purpose of the partnership (unless Ethan and Gina are fully aware of the circumstances and choose to give their consent).

Example 13.10. Fabian dies in a motorcycle accident. The van still belongs to the remaining partners, and Fabian’s estate or heirs have no rights to it specifically, although they have a right to be paid Fabian’s share in the partnership, as the next example illustrates.

Example 13.11. After Fabian’s death, Ethan and Gina decide to wind up the partnership. The van will be sold along with the other partnership prop- erty. Once the assets are liquidated, the partnership will pay off its outside creditors, then repay any loans partners made to the business, then repay partners’ capital contributions, then distribute profits. Fabian’s estate or heirs are entitled to what would have been his share, if he had lived and the partnership had terminated.

Partnership does require unanimous consent of all partners for some types of transactions to bind the partnership. If partners’ interest will be changed, or if the partnership is to engage in a new kind of business, there must be unanimous agreement.

Example 13.12. Heinrich, Ileana, and Jessica enter into a partnership to operate a pizza parlor. After three years, Ileana wants to add new menu items that are lower in calories and carbs. Jessica thinks it’s a good idea, but Heinrich objects. Since this is a normal business decision, not entering into a new business, Ileana and Jessica can change the menu.

Example 13.13. Heinrich now proposes adding a massage parlor in the basement (so customers have something to do while they wait for their pizza). Ileana says she’s okay with it, but Jessica objects. No massage par- lor, since this is a different line of business and requires unanimous consent.

Example 13.14. Ileana thinks the business should expand, and proposes bringing Kevin in as a partner. Heinrich votes no, but Jessica says yes to Kevin. Kevin is not a partner, as this would be creating a new partnership and all must consent.

Dissolution and Termination of Partnerships A partnership dissolves whenever there is a change in membership, but it may or may not terminate (which means it is going to wind up its affairs and cease to exist). Traditionally in the law there was a presumption that a dissolution would lead to termination, which

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CHAPTER 13Section 13.1 Partnerships

made partnerships a somewhat precarious proposition, as any partner could decide to leave and force liquidation. The modern trend has favored letting the remaining partners continue to operate the business, as long as they can pay the leaving partner his propor- tionate share.

Example 13.15. Heinrich, Ileana, and Jessica are partners operating Pizza Palace. Heinrich is now tired of pizza and wants to try something new. Under the old rule, Heinrich could force Ileana and Jessica to liquidate Pizza Palace. Under the modern rule, if they can come up with the money to pay him his share of profits and surplus, they can continue to run Pizza Palace as a new partnership.

Partnerships dissolve both by act of the parties and by operation of law, in a fashion very similar to agencies.

Example 13.16. Suppose in the above example, Heinrich is dissolving in the second year of a five-year partnership agreement. Although he has the power to dissolve, he does not have the right, and his former partners can hold him liable for any damages. If, for example, Jessica and Ileana have to hire someone to take over Heinrich’s workload, they could deduct the new employee’s wages from Heinrich’s share of the business.

Limited Partnerships Unlike a general partnership, the limited partnership did not exist at common law. It is a creature of statute that owes its existence to legislation in the states that specifically allow it as a form of business organization. The main difference between general and limited partnerships is that a limited partnership makes it possible for individuals to invest in a partnership and retain limited liability for partnership losses to the extent of the amount

invested in the partnership. Like a gen- eral partnership, a limited partnership requires an agreement by two or more people to enter into a business for profit as joint owners. Some of the salient features of a limited partnership are as follows:

1. The partnership must contain at least one general partner with unlimited liability;

2. The partnership must be entered into pursuant to a written agreement as specified by statute;

3. The limited partnership agreement must be filed with the appropriate state agency (usually the secretary of state); and

4. Limited partners cannot be involved in the running of the business, but must merely be investors who share in its profits and losses to the extent of their investment.

For years, law firms traditionally operated as partnerships. More recently, some have elected to become LLCs.

Tim Barker/Associated Press

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CHAPTER 13Section 13.2 Corporations

If a limited partner becomes involved in the day-to-day operation of the business or has a voice in its management, he becomes liable as if he was a general partner and loses the protection of the limited liability offered by the limited partner status.

Example 13.17. Arielle’s Antiques is organized as a limited partnership, with Arielle as general partner and Fred as limited partner. Arielle contrib- utes $5,000 in start-up capital, and Fred puts in $20,000 in exchange for a 25 percent share of the profits. Arielle manages the business, works in the store, and supervises all employees. Fred is not actively involved in the business. Arielle fails to pay rent for the store, and the landlord sues. While Arielle is potentially personally liable, Fred is not. He stands to lose his capital contribution and share of undistributed profits to business credi- tors, but his personal assets such as his personal bank account and his car are not at risk.

Example 13.18. Arielle becomes ill and can’t work at the store for two months. Fred steps up and takes over, managing the business. Now Fred is personally liable for business debts, because he is acting like a general partner. The partnership could have hired an employee to fill in for Arielle, which would have allowed Fred to retain his limited partner status.

Limited partnerships are somewhat more stable than general partnerships, and do not automatically dissolve with changes in membership, as long as there is always at least one general and at least one limited partner.

13.2 Corporations

Like limited partnerships, the corporation did not exist at common law; it is a form of business organization that owes its existence to statutes in all states that provide guidelines for its creation and management. Unlike a partnership, the corporation is a legal entity in the eyes of the law—an artificial person that enjoys an existence apart from the individuals who own or manage it. As an entity, a corporation enjoys most of the privileges and shares in most of the responsibilities of natural persons: it can avail itself of most constitutional protections offered to natural persons and can own property in its own name, but it must also pay taxes (albeit at a lower rate than natural persons) and is subject to civil and some criminal penalties for acts it performs through its agents.

The corporation is governed primarily by the statutory guidelines of the state statute that provides for its creation. The requirements for the creation and management of a corpo- ration vary somewhat between the states, but as is usually the case, there are common threads that can be found in the corporate statutes of all states.

Advantages and Disadvantages of Corporations As noted, the corporation is legally a person, which makes it unlike a sole proprietorship (which does not exist outside of the person who owns the business), a partnership, or a limited partnership. As already mentioned , the corporation as its own person is entitled to many constitutional rights, but it cannot claim the privilege against self-incrimination

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CHAPTER 13Section 13.2 Corporations

under the Fifth Amendment (since it lacks a body to take the witness stand and a mouth to make statements with). Likewise, a person is not necessarily a citizen, and so a corpora- tion is also not entitled to vote and does not have other rights given to citizens.

Limited liability of the shareholders (who are essentially the owners) makes corporations an attractive alternative in some cases to partnerships. While the corporation itself is liable for its debts, shareholders’ personal assets are not at risk.

Example 13.19. Pizza Palace Inc. is a corporation with ten shareholders, including Danielle. A Pizza Palace delivery driver negligently runs over Tiffany, who sues the corporation and obtains a judgment of $100,000. Although Danielle’s stock holdings in Pizza Palace may be affected, she has no personal liability for the debt incurred by the operations of the company.

In order for a corporation to offer its shareholders the protection of limited liability, it must be run in accordance with the requirements under a state’s business corporation law. If the corporate form of business organization is used to defraud creditors, stockholders will lose the protection of limited liability and will be held personally liable for all debts of the corporation. Likewise stockholders can be subject to unlimited personal liability if a corporation is set up merely to insulate its owners from unlimited liability but is run as a partnership or sole proprietorship. When this is the case, courts can “pierce the corporate veil” of dummy corporations to find its owners personally liable for its debts.

Example 13.20. Barney, a contractor, sets up Gorgeous Homes, Inc., a cor- poration involved in the home remodeling business. Barney is the corpora- tion’s sole stockholder and president. He and his wife serve on the board of directors, and his wife is the corporation’s secretary. Barney and his wife never hold stockholders’ or board of directors’ meetings. All profits from the corporation go into Barney’s personal bank account, held jointly with his wife. Payments for corporate debts are made from the couple’s joint checking account.

Under the above facts, Gorgeous Homes, Inc. is basically being used to defraud credi- tors. It really has no separate existence from Barney himself. If the corporation is sued for breach of contract or a tort, a court would pierce the corporate veil and ignore the exis- tence of the corporation to hold Barney personally liable for all corporate debts.

Another advantage of the corporate form of business is potentially perpetual existence. We have already seen that partnerships are somewhat unstable: a partner can leave at any time and cause major disruption, or even termination, of the partnership. But corpora- tions can live forever, even though the management and the shareholders change with the passing years.

Formation of a corporation, however, may be considered a disadvantage, since it requires filing fairly complicated documents with the state (as well as annual reports after the corporation is created) and paying a registration fee, which can make it a costly process.

Double taxation is also one of the disadvantages of the corporate form. The corporation itself is taxed on its earnings, and the shareholders are also taxed when they receive

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CHAPTER 13Section 13.2 Corporations

dividends or sell shares at a profit. A type of corporation that avoids the double taxa- tion is the Subchapter S corporation, which has “flow through” taxation, meaning that only the shareholders are taxed on their earnings. However, there are a number of specific qualifications that must be met for S status, such as having no more than 100 stockholders, and restrictions on how corporate income is earned and types of share- holders, which mean that these corporations will be primarily smaller businesses.

Who’s Who in Corporations: Incorporators, Promotors, Directors, Officers, and Shareholders Incorporators are probably the least important people involved in corporations, since their main role is to sign the articles of incorporation (the documents submitted to the state) and they may never be heard from again. While incorporators may be people actively involved in setting up the business, they can just as easily be the secretary or paralegal who works in the law office where the papers are drawn up.

Promoters, on the other hand, are the motivating force behind creation of a corporation. It is the promoters who organize on behalf of the corporation-to-be, securing financing by making subscription contracts (agreements to buy stock) with prospective stockhold- ers, and making any arrangements necessary for the corporation to do business once it is granted life by the state (by securing its certificate of incorporation). Being a promoter is a risky business, as they are generally personally liable for preincorporation contracts unless they secure a release or waiver of some type from the other party.

Example 13.21. Peter is a promoter for the yet-to-be-formed Alpha Inc. Peter contracts for retail space for Alpha with Lisa Landlord, signing the lease “Peter, agent for Alpha Inc.” However since Alpha does not yet exist, Peter cannot in fact be its agent, and so he will be personally liable to Lisa on the contract.

The corporation only becomes liable if it adopts the contract, either by express action, such as the board of directors approving the lease, or by implied action, such as Alpha moving into Lisa’s building once it has incorporated. So is Peter now off the hook? No, the adop- tion of the corporation gives Lisa a choice of who to hold liable. If Alpha adopts, she has the choice now of suing either Alpha Inc. or Peter (but not both).

Directors are elected by the shareholders to serve a specific term, and are responsible for the broad, policy-based management of the company. They do not necessarily act as cor- porate agents, but they do owe the corporation a fiduciary duty. Officers, such as the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), are agents of the corporation and manage the regular, ongoing business of a corporation and are generally appointed by the board of directors. Directors and officers are not necessarily shareholders, although they may be if the corporate rules allow it. Shareholders are the owners of the corporation

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CHAPTER 13Section 13.3 Limited Liability Companies

who earn dividends from corporate profits, and have no right to be involved in regular management of the company, although they do retain some indirect control, through their right to elect directors. Shareholders must vote (and generally approve by a super major- ity, such as two-thirds of the outstanding shares) on changes to articles (and sometimes bylaws), fundamental corporate changes such as a merger with another company or dis- solution, and extraordinary business that is the subject of a shareholder proposal. For example, some corporations require that shareholders have a vote on executive bonus pay.

13.3 Limited Liability Companies

The first thing we need to establish about this form of business organization is that it is relatively new and there is more variation from state to state than you will find with partnerships and corporations. In some states, rather than just LLCs you may find limited liability partnerships (which are different than limited partnerships) and other variations, but we shall focus here on the essential features of a basic LLC that most states have in common.

The LLC represents an attempt to combine the best features of a partnership with the best features of a corporation. Thus LLC statutes typically feature easier formation (although filing under the statute is required) and lower filing fees, flow-through taxation where members of an LLC are taxed on their earnings but the business itself is not taxed, the stability of a corporation (a member’s leaving will not dissolve the LLC), and limited liability, where the business is liable for its debts and the people who own it are not.

At this point you may be thinking, wow, why would anyone ever be a partnership or bother with a corporation? Why even have those anymore? (And why did I just have to read all that stuff about partnerships, which are surely obsolete?) Remember, many cor- porations (which can have infinite life) have been around for decades, long before the first LLC statute was passed by the Wyoming legislature in 1977. It may be structurally impos- sible, or not worth the cost, of switching to LLC status. For partnerships, it is important to remember that many people go into business without even realizing that they are a partnership! Also, because LLC law is relatively new and in many cases state legislatures passed statutes without putting in much detail, courts have often held that where an LLC law does not cover an issue, the default setting is to partnership law. One way or another, partnership law is still relevant in today’s business world.

Although many LLCs are small businesses that in earlier years would have been partner- ships, others are very large-scale businesses such as Internet giant Google.

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CHAPTER 13Section 13.3 Limited Liability Companies

In the Media: The Business Organization of the Social Network

The 2010 film The Social Network chronicles the rise of Face- book and Mark Zuckerberg. It shows, in short, how the world’s most powerful social media site began and then morphed as a business entity.

Before Facebook there was “Facemash,” which Zuckerberg cre- ated on October 23, 2003 in his Harvard dorm, with the help of classmates Eduardo Saverin, Chris Hughes, and Dustin Mos- kovitz. It was Saverin who the film portrays as Zuckerberg’s for- mer best friend, who was eventually kicked out of Facebook and who then sued Zuckerberg. Facemash was a website that allowed Harvard students to click-vote on the hotness of side- by-side pictures of Harvard females.

As shown in The Social Network, Facemash gave way to in 2004, in a scene where Zuckerberg asks Saverin to join him in Thefacebook, offering Saverin a minority stake in the venture. But Facebook’s official timeline lists Moskovitz and Hughes as cofounders of in 2004. Regardless, that would seem to make their business a partnership. Soon thereafter, The Facebook was officially formed as a Florida Limited Liability Company (LLC)—Florida is where Saverin was from. The company moved to Palo Alto, California, in June 2004, when Sean Parker, the Napster creator, became president. In 2005, “” became “” Various series of company shares were created in the mid-2000s, as various investors such as PayPal cofounder Peter Theil and Microsoft began purchasing stakes.

By 2012, Facebook announced it was seeking to become a publicly traded corporation and was hoping to raise $5 billion in its initial public offering (IPO). After the IPO, Zuckerberg would retain 22 percent of the company and would have 57 percent of the voting stock. On May 18, 2012, Facebook went public, raising $16 billion, making it one of the largest IPOs in history. However, the Facebook IPO was by all accounts a public relations disaster, as technical glitches in the trading of the stock and its eventual significant price decline after one week of trading left securities regulators scrambling to investigate what happened, and some investors scrambling to find lawyers who filed suit against Facebook and Zuckerberg.

Since it began, Facebook has operated under a number of business organization forms. And as the Facebook saga continues to unfold, the way in which the business is organized will keep playing a silent but pivotal role in the outcomes of future court rulings and the liability of all involved.


Facebook CEO Mark Zuckerberg has seen his business organized in a number of different ways.

Paul Sakuma/Associated Press

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Section 13.4 Chapter Summary CHAPTER 13

13.4 Chapter Summary

Business owners are wise to consider the fundamental issue of organizational form before they become too deeply immersed in business operations. By default, if they do not file appropriate papers with the state, a business will be a sole proprietorship or, if more than one person is an owner, a partnership. Both of these have the disadvan- tage of unlimited liability for the owners themselves. In contrast, either a corporation or LLC has potentially limited liability, as long as the owners are careful to observe statutory formalities and do not merely treat the business form as a shield to hide behind. When it comes to raising capital, the corporation and limited partnership are generally best; for taxation purposes, an LLC is preferable. Essentially, being knowledgeable about the legal consequences of organizational forms and weighing all the factors involved when starting up a business will save businesspersons from a number of headaches in the future.

Focus on Ethics

As an American politician recently said, “Corporations are people, my friend.” While this is true from a legal standpoint, it is important to remember that the law does not always treat all people in identical fashion. Aliens are people who are often treated very differently from citizens, for example. Minors are certainly people, but the law places different rules on their ability to contract and even interprets their constitutional rights differently. Their right to free speech can be severely limited by their schools, and their freedom of movement curtailed by government curfew restrictions in a way that an adult’s rights would not be.

So does it follow that a corporation’s right to political expression should include the same right to contribute to political campaign funding that an individual person has? The Supreme Court appeared to answer the question in the affirmative when they struck restrictions on corporations in the case Citizens United v. Federal Election Commission, 558 U.S. 50 (2010). Corporations can indeed now con- tribute to individual political campaigns as an individual citizen would.

As a practical matter, however, even if a corporation itself is a disclosed donor to a political action group or campaign, it can be almost impossible to find out who is ultimately behind the corporate veil. A corporation’s stock may be held by another corporation, which may in turn be owned by another cor- poration, which may in turn be owned by another, and so on. As we discussed in this chapter, though a corporation is legally considered a person, it has no actual physical body; it operates solely through its agents, who are in fact real, living, breathing people. Thus agents of a corporation perhaps now wield more power than individual citizens do, and they can potentially do so anonymously, which brings up lots of space for ethical debate.

Questions for Discussion

1. Does it matter who spends money on U.S. political advertisements or otherwise attempts to influence elections? Do you think it affects the integrity of the political process?

2. Do you think the law should distinguish between natural persons (those with a body and a brain) and legal persons such as corporations when it comes to political spending?

3. Would it affect your perception of a political candidate if you learned that some of the nega- tive ads against his opponent were financed by a large oil company? By a Saudi Arabian sheik? By a labor union? By a foreign government? By a drug cartel?

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Section 13.4 Chapter Summary CHAPTER 13

Case Study: C&J Builders and Remodelers, LLC v. Geisenheimer

733 A.2d 193 (Conn. 1999)

Facts: In March of 1996, Charles Pageau, doing business as a sole proprietorship that went by the name C&J Builders, contracted to renovate the defendant’s summer residence. The agreement had a clause that provided for disputes to be submitted to arbitration.

In October, Pageau caused C&J to become an LLC. C&J then proceeded to renovate the defendant’s residence. In June 1997, a dispute arose regarding $87,667.12 that C&J claimed was owed on the con- tract. C&J sought arbitration. The defendants, however, claimed that the plaintiff LLC was not a party to their contract with the sole proprietorship, and, therefore, that the plaintiff was not entitled to compel the defendants to arbitrate the dispute.

Issue: Can C&J as an LLC enforce a contract made by Pageau as a sole proprietorship?

Discussion: The LLC statute in Connecticut did not specifically consider the issue of an LLC taking over a business previously operated as a sole proprietorship, but it did address what happened if a general or limited partnership converted to an LLC. The court recognized that the statute did not necessarily control the present situation, but found that the statute was still a useful point of reference. Under the statute, when a partnership business became an LLC, all property and obligations of the previous entity became those of the LLC. Furthermore, the court found that a basic purpose of the LLC statute was to facilitate a seamless transition from partnership to LLC, and that there was no reason to treat a sole proprietorship that becomes an LLC any differently.

Held: The plaintiff, C&J Builders and Remodelers, LLC, has a right to enforce the contract entered into by Pageau as a sole proprietorship, including the right to compel arbitration.

Questions for Discussion

1. In what way are partnerships and sole proprietorships different and the same? Do you agree with the court that in this case it is the similarities that are most relevant?

2. What is the purpose of LLC laws? Is it served by the court’s analysis in this case? 3. If the court had found for the defendant and taken a strict view that a contract made by one busi-

ness entity cannot be enforced by another, what would be the effect on business organizations?

Case Study: Malone v. Patel

__ S.W.3d __, 2012 WL 1142251 (Tex. App. 1st Dist.–Houston 2012)

Facts: Malone invited Patel, an Indian national, to work for Prescendo Consulting, LP (Prescendo). Patel quit his lucrative job (with an annual salary of $100,000) to work for his friend Malone for $24,000 per year. Malone orally promised Patel an equal partnership at Prescendo. Malone told Patel to sign papers indicat- ing his at-will employee status but promised to write a partnership agreement when Patel became a per- manent resident of the United States. According to Patel, Malone claimed that until Patel obtained a green card he would be unable to own equity in an American business. Patel worked for Prescendo (continued)

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Section 13.4 Chapter Summary CHAPTER 13

Case Study: Malone v. Patel (continued)

for three years, bringing in significant revenue. Patel’s salary was raised to $85,000 and eventually to $166,000, by the mutual agreement between Patel, Malone, and another person who later claimed to have been promised an equal partnership. After receiving his green card, Patel asked Malone for a written partnership agreement with an equal partnership share, but Malone objected. Patel sued Malone for the breach of contract. Malone argued that, first, there was no written partnership agreement. Second, he claimed that Patel was never a partner because numerous documents show that Malone was the only owner of Prescendo and that Patel was his at-will employee. Patel argued that the documents reflect- ing his employee status “do not conclusively prove that the parties did not agree to be equal partners.” At the trial, four witnesses testified that Malone expressed an intention to make Patel an equal partner. The trial court ruled for Patel and awarded him $495,000 in actual damages. Malone appealed.

Issues: Was there an oral agreement between Malone and Patel to be equal partners in Prescendo, and if there was one, would it trump the signed employee-at-will documents?

Discussion: In reviewing evidence in the most favorable light for the defendant, the appellate court analyzed “the totality of the known circumstances rather than reviewing each piece of evidence in isolation.” Since the law recognizes oral contracts, “the lack of a written agreement cannot conclusively establish that an oral agreement does not exist.” Though there was no evidence of Patel’s sharing in the profits, there was evidence of his right to the profits. His nominally low salary (at least at the beginning) was another proof of his partner status, as it showed he preferred to invest in the company instead of receiving a larger salary. Finally, there was evidence that Malone and Patel regularly discussed Pre- scendo’s business affairs and made collaborative decisions. The court found that Patel had a right to exercise some control over Prescendo’s executive decisions, and this cumulatively proves his status as an equal partner. Finally, the court found that Patel’s positions as an at-will employee and an equal partner were not mutually exclusive. One can be an at-will employee and still have a partner’s status. Therefore, the court concluded that Malone and Patel agreed to be equal partners in Prescendo.

Holding: The appellate court affirmed the judgment of the trial court.

Questions for Discussion

1. What was the initial agreement between Malone and Patel? Why they did not sign the part- nership agreement if they agreed to be equal partners in Prescendo?

2. Why did Patel sue Malone for the breach of contract? Why did Malone object to the equal partnership of Patel? What was Patel’s argument?

3. What was the decision of the trial court? Do you agree with it? 4. What legal principle did the appellate court use to analyze evidence? What evidence proved

Patel’s status as an equal partner? Why did Patel’s status as an at-will employee not contradict his status as an equal partner?

5. Imagine that you are an attorney, and your client, Patel, asks your legal advice with respect to his friend’s oral promise to make Patel an equal partner in a company. What would you advice Patel to do to make sure that there will be no disputes about his equal partner status?

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Section 13.4 Chapter Summary CHAPTER 13

Critical Thinking Questions

1. New restaurants are a type of business with a high failure rate: many don’t even last a year. At the same time, they are a type of business that can be something of a status symbol for their owners. Suppose Marina, a business school graduate, and Stephen, a chef, are interested in starting a new restaurant, which would aim to be a destination for the in crowd. They need at least $50,000 more than either of them can raise. Kareem, a professional athlete who earns $15 million a year, and Brooke, a supermodel, are interested in being involved, partly to establish themselves as something other than a jock and a pretty face. Discuss what busi- ness organizations might best suit the restaurant.

2. A business consultant at a seminar for realtors who also buy investment property counseled the realtors to form a different corporation or LLC for each one of their properties, in order to avoid liability. In other words, if Rihanna Realtor owns three rental properties, located at 100 Elm Street, 200 Maple Avenue, and 300 Oak Boulevard, Rihanna should have three LLCs. According to the consultant, if Peter Plaintiff slips, falls, and breaks his leg at Elm Street, he would not be able to reach the rents from Maple, or have Oak sold, to satisfy his judgment. Discuss under what circumstances the consultant would be correct, and whether it is really a practical solution.

Hypothetical Case Problems

Case 1. Carli, Donald, and Thomas are three attorneys who share office space and a receptionist. They have a sign outside the office that reads “Carli, Donald and Thomas, Attorneys at Law” and all three of them use stationary with the same heading. They do not share profits or make joint decisions about clients or refer to each other as partners. A client of Donald alleges he did an incom- petent job of representation and sues all three for damages. The client paid for Donald’s services at the time with a check made out to “Carli, Donald and Thomas,” which was deposited by Donald in his account. Carli and Thomas defend on grounds that there has never been a partnership.

A. Are the three attorneys a partnership? B. What other theory could the plaintiff use to hold all three liable? C. What recommendation would you make to the three attorneys as to how

to avoid this type of problem in the future?

Case 2. Maria, James, and Neko operate Dreamscapes, a gardening and landscape firm. All three contributed capital and they share equally in profits. They have no written agreement, nor have they filed anything with the state. Maria and James do most of the work, although occasionally Neko designs advertising materials.

A. Is this a partnership? B. Maria and Neko now want to buy a new truck for the business. James

objects. Is there authority for the truck?

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Section 13.4 Chapter Summary CHAPTER 13

C. A dissatisfied customer sues Maria, James, and Neko. Neko argues that she was a limited partner and thus cannot be held personally liable. What is the result?

D. While working on a customer’s landscape, James carelessly dumps a load of mulch on Sarah, who is injured, sues, and recovers a judgment against the business for $50,000. Sarah discovers that the assets of Dreamscapes will be inadequate to satisfy her judgment, but that Maria has a lot of money in her personal bank account, which she inherited from her great aunt. May Sarah recover the judgment from Maria? What are Maria’s rights against her partners?

Case 3. Regina is a seamstress who makes clothing to order for customers. She conducts her business out of a small boutique in Yonkers, New York, under the name of Regina’s Fashions. Business has been good over the past several years and she would like to expand by opening a second store and hiring additional employees to help her run it.

A. Compare the relative advantages and disadvantages of different business forms for Regina. What would you recommend?

B. Regina decides to form a Subchapter S corporation, mainly because her uncle the accountant has done this before and is willing to help her with it. In the meantime, Regina’s friend Lawrence offers to help her expand her business. He finds a great location for the second store and signs a lease in the name “Regina’s Fashions Inc.” However, Regina doesn’t care for the space, and tells the landlord she won’t be using it. Can the land- lord hold Regina’s Fashions Inc. liable once it incorporates? How about Lawrence?

C. Regina’s Fashions Inc. is duly incorporated and a board of directors comprising Regina, Lawrence, and Uncle Saul is elected. Regina owns 90 percent of the stock; Lawrence owns the other 10 percent. Regina is appointed CEO. She now makes a contract with Best Bank for a $50,000 loan to finance expansion, signing as “Regina, CEO, Regina’s Fashion’s Inc.” The corporation defaults on the loan. Discuss the potential liability of the corporation, Regina, Uncle Saul, and Lawrence.

Case 4. Benson and Tyler, two certified public accountants, do business as B & T, LLC. After five years, Tyler wants to quit accounting to be a professional comedian. Neither Benson and Tyler’s operating agreement nor the state’s LLC statute specifies what should happen in this situation.

A. Does Tyler have a right to quit the business? Should he be held liable for any costs Benson has as a result?

B. Will the court be more likely to use partnership law or corporate law as guideline in this situation?

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Section 13.4 Chapter Summary CHAPTER 13

corporation A business entity that is formed through application to the state, which allows shareholders limited liabil- ity. Corporations have the legal status of persons.

director A person elected by sharehold- ers to engage in broad management of a corporation.

dissolution In a partnership, any change of membership. For a corporation, termi- nation of the business entity.

dividend A share of corporate profits paid to its shareholders.

incorporator The individuals who sign the articles or charter of incorporation.

limited liability company A business organization form that is formed through application to the state, which attempts to combine the relative advantages of part- nerships and corporations.

limited partnership A business organiza- tion that can be created only by filing with the state, which must have at least one general and at least one limited partner. The limited partner or partners will not be ordinarily personally liable for the debts of the business.

officer A person appointed by the board of directors for a corporation, who acts as an agent for the corporation.

partnership An association of two or more competent persons to carry on a business as co-owners for profit. The business itself is not a legal entity.

promoter The individual who organize the creation of a corporation. Promoters gen- erally have liability for pre-incorporation contracts unless released by the third party.

shareholder An owner of a corporation; those individuals who hold stock or shares in equity in a company.

sole proprietorship A business owned and operated by a single person. The busi- ness has no separate legal existence from its owner.

Subchapter S corporation A type of corporation sanctioned by the IRS, which qualifies for single taxation.

Key Terms

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CHAPTER 11: Property: Personal, Intellectual, and Real

CHAPTER 12: Agency and Employment Law

CHAPTER 13: Business Organizations

Unit IV Property, Employment,

and Business Organizations

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Property rights are central to both law and business. Some legal philosophers go as far as saying the ultimate point of law is to protect property rights. Even if one takes a broader view of the purpose of law, there is no doubt that it plays a major role in defining different types of property and setting a framework to govern such matters as ownership and transfer. Business transactions often focus on property, whether it is leasing an office building, selling products, or preventing infringement of a trademark. In Chapter 11 we shall examine the three major categories: personal property, which includes all kinds of objects that a person can own; intellectual property, which encompasses copyrights, pat- ents, and trademarks; and real property, which is real estate.

Business relationships and organizations are also critical to understanding the modern commercial environment. In today’s complex business world, no one can operate a business completely alone. The law of agency governs any situation where one person may act on another’s behalf. Employment relationships are a type of agency, and both are the subject of Chapter 12. In Chapter 13, we look at the different types of business organizations, ranging from the ancient and simple sole proprietorships and partnerships to the much newer and more complex forms that can exist only through statute, such as corporations.

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Chapter Overview

11.1 Personal Property • Acquiring Personal Property

11.2 Intellectual Property • Patents • Copyrights • Trademarks

11.3 Real Property • Possessory Interests in Land • Nonpossessory Interests • Landlord-Tenant Law • Regulation and Real Property

11.4 Chapter Summary • Focus on Ethics • Case Study: Kelo v. City of New London, Connecticut • Case Study: Terry v. Lock • Critical Thinking Questions • Hypothetical Case Problems • Key Terms

Top Photo Corporation/Top Photo Group/Thinkstock

11 Learning Objectives

After studying this chapter, you will be able to:

1. Distinguish between personal, intellec- tual, and real property.

2. Explain how personal property is acquired.

3. Discuss the definition and significance of bailments.

4, Define different types of tenancies in real property.

5. Discuss the concept of eminent domain.

Property: Personal, Intellectual, and Real

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Introduction CHAPTER 11

The concept of property and ownership is one that has long been important in both society in general and law in particular. English philosopher and political theorist John Locke saw it as “the reason why men enter into society,” and Walter Lippmann, the American journalist, described it as “the only dependable foundation of personal lib- erty.” Some have gone so far as to say that the main reason for law is to protect property rights. Even if one does not subscribe to such a narrow purpose, there is no doubt that the law is much concerned with property and rights of ownership.

Property can be defined as the right of an individual to exclusively possess, use, and dis- pose of anything that is capable of being owned. Broadly speaking, property can be divided into three separate types: personal property, intellectual property, and real property.

Personal property is characterized by its portable nature; it can be carried from place to place. Furthermore, personal property can be either tangible or intangible. Tangible per- sonal property encompasses ownership interest in things that have a physical existence and are able to be moved, or carried, from place to place. Most property falls into this category: a car, wallet, photograph, shirt, pen, and phone are all common examples of tangible personal property. Intangible personal property, on the other hand, is personal property that by its very nature does not have a physical existence as such, but is merely a right that can be owned, as opposed to a real, tangible object. Common examples of intan- gible property include stocks and bonds.

Intellectual property, such as copy- rights, patents, and trademarks, is per- sonally owned but generally treated as a separate form of property by the law. A person who owns the copyright to a new book or patent to a new invention, for example, owns intangible property; the person may have a patent or copy- right certificate that is a tangible piece of paper, but the thing owned—the expres- sion of an idea or a new invention—is incapable of a physical existence and constitutes intangible property.

Real property constitutes land and all things permanently attached to it. What characterizes real property and distin- guishes it from tangible personal prop- erty is that it is by nature fixed and not

capable of being easily moved from one place to another. Land, buildings, and fixtures are all considered part of the real property, as are the air above land and mineral rights below the surface of the land.

Because modern business often involves all three types of property, a basic understand- ing of property law is essential for business students. A company will protect its name, its logo, and its advertising slogans through intellectual property law. The company’s factory, whether owned or leased, is governed by the law of real property. The goods the

The horse is personal property; the barns and the pasture are real property.

© Getty Images/

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CHAPTER 11Section 11.1 Personal Property

company manufactures are personal property of the business. One way or another, prop- erty law is unavoidable for almost any business.

11.1 Personal Property

Is possession nine-tenths of the law, as the old saying goes? Not really. In order to own property, title must be acquired and that depends on more than just possession. In general, property (and title) may be acquired through a few basic methods: purchase or manufacture, gifts, and, in some situations, found property.

Acquiring Personal Property The following are ways in which personal property can be transferred or acquired.

Purchase and Manufacture Purchase means that an owner contracted to buy the property; manufacture means that the owner is the person who created the property. If you build a doghouse, you own it. If you buy a premade doghouse at Pets-R-Us, you own it. But if you buy a doghouse from Ramona, who stole it from Mark’s yard, Mark still owns it, as a thief cannot pass title (a point discussed previously in Chapter 8).

Gifts A gift is a transfer of property from one person to another without consideration (if there is consideration, there is a contract instead of a gift). The giver is called the donor; the recipient is the donee. In order for a donee to legally own the property, there are three requirements:

1. The donor must intend to transfer ownership immediately to the donee; 2. The donor must deliver the property to the donee; and 3. The donee accepts the property.

Some examples will help to clarify these requirements.

Example 11.1. Michelle hands her laptop to David and says, “David, it’s yours.” Michelle has made a gift.

Example 11.2. Michelle says to David, “When I get a new laptop, you can have this one.” There is no gift. Michelle did not intend to transfer owner- ship immediately, and she did not deliver the laptop to David.

Example 11.3. Jen says to Max, “I’m giving you my car,” signs the title, and hands him the title and keys. Her statement indicates donative intent, and her providing the keys and title is adequate delivery, since she can hardly hand him the car itself. This is known as constructive delivery, and it is generally only allowed when physical delivery of the property is not feasible.

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CHAPTER 11Section 11.1 Personal Property

Example 11.4. Sarah tells Luis, “I’m giving you this diamond ring for your birthday,” and holds out the ring. Luis says, “No, I can’t accept it. It’s too expensive and I think it would look sissy on me anyway.” If Luis changes his mind and wants the ring after all, he will not be entitled to it. He did not accept the gift.

Most gifts are inter vivos, or made “during life,” meaning the donor was not expecting to die. Such gifts cannot be revoked. If Jen, in the above example, decides she needs the car after all, she is out of luck. Max now owns the car, and Jen cannot revoke the gift.

Some gifts, however, are causa mortis, meaning that the gift is made in contemplation of impending death, and these gifts are revocable.

Example 11.5. Christopher has just been informed by his doctor that he has terminal cancer. Christopher tearfully bids farewell to his girlfriend Stephanie, and also gives her his gold antique watch to remember him by. The next day, Christopher learns Stephanie had been cheating on him and decides to revoke the gift. He has the right to do so. Furthermore, if it turns out the diagnosis was a mistake and his death from cancer is not imminent, the gift is automatically revoked.

Found Property Finders keepers? The law does not often subscribe to this idea. In general, the common law favors returning found property to the owner when feasible.

Example 11.6. Cara puts her violin on the overhead rack of the bus, and forgets to retrieve it. Winton finds it. Generally Winton has no rights to this mislaid property; if Cara cannot be found, the owner of the property where it was left typically gets it, which in this case is the owner of the bus.

Example 11.7. Wesley accidentally drops his Rolex watch on the street, making it lost property. Shauna finds it. If Wesley comes forward, he gets his watch back; otherwise Shauna may keep it. But if Wesley drops the watch in Zachary’s yard and never comes forward, Zachary gets the watch even if Shauna is the one who found it.

Example 11.8. Kendra throws a painting done by her ex-boyfriend and given to her as a birthday present last year into the dumpster behind her apartment building. Daniel retrieves it from the dumpster. The painting

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CHAPTER 11Section 11.1 Personal Property

In the Media: High-Stakes Lost and Found

The law regarding lost vs. abandoned property took quite a twist (pun intended) in a Las Vegas courtroom in 2000 when a jury was asked to decide who owned a Pepsi bottle cap. Judy Richardson Yeats, who bought but did not drink from the Pepsi bottle on March 17, 1997, filed suit against Sindy Allen, who found the unopened bottle the next day. Why all the fuss over the cap from a bottle of soda? Well, that cap was 1 in 545 million Pepsi bottle caps that bore the winning $1 million prize from a contest Pepsi pro- moted to celebrate its 100th anniversary. How’s that for Las Vegas odds?

According to Ms. Yeats, she bought the Pepsi bottle at a convenience store next to the Wild Oats health food and grocery store where she worked. She took the bottle with her to work that morning but never drank it. At the end of her shift, Yeats placed the bottle on a shelf in the employee area, a place where she said she often kept her things. Later that night, Ms. Allen, who also worked at Wild Oats, found the bottle during her evening shift and, thinking it had been discarded, opened it for a drink and discovered the million-dollar cap. When Ms. Yeats heard about Ms. Allen’s amazing find, Yeats put two and two together and confronted her. Ms. Allen wouldn’t give the bottle cap back but eventually offered to split the prize with Yeats; however, Yeats rejected Allen’s offer and filed suit.

Three years later, a jury was asked to decide if Ms. Yeats abandoned the Pepsi, making Ms. Allen the rightful owner, or if Ms. Allen took possession of something that was at most mislaid, which would make her a bailee and not an owner. After an hour of deliberation, the jury ruled in favor of Ms. Yeats, in large part due to the testimony of other Wild Oats employees that Ms. Yeats—who had no receipt for her purchase—was known to keep her things where the bottle was found. The jury seemed not to be swayed by Ms. Allen’s claim that she thought the bottle was abandoned because as one juror said of the verdict, “integrity and honesty always win out.”


The common law generally prefers found property to be returned to the owner, if possible.

Donald Bowers/SuperStock

is abandoned property, and Daniel owns it. But the law does not tend to presume abandonment, so if Kendra claims it was tossed by accident, she will likely get the painting back.

In spite of the above examples, many states have enacted laws that govern found prop- erty and may have additional requirements and different results. For example, New York requires found property to be turned over to the police or the owner of the premises where the personal property was found. If the owner is not located within a stated period, the finder may then be entitled to the property.

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CHAPTER 11Section 11.1 Personal Property

Accession Another issue associated with personal property is accession, which occurs when one person through labor, materials, or both improves property belonging to another. Is the improver entitled to be paid for the work? The law usually says no, if the improver knew he had no authority to make the improvements.

Example 11.9. Ready Rentals rents a trailer to Tom, who is moving. Tom notices that the trailer has a worn tire, and buys a new one. Tom should not expect to be paid back by Ready.

But if the improver mistakenly believes he has the right to make improvements, he may be entitled to recover.

Example 11.10. Charles, while walking home from work, notices an old bicycle lying by the side of the road, near some garbage cans. He thinks that the bicycle has been abandoned by its owner, and happily takes it home. In reality, the bike belongs to Michael, who left it there while he was buying cigarettes in the convenience store next door. Charles painstakingly works on the bike and completely restores it to better-than-new condition after spending a considerable amount of time and some money to replace worn parts. Through his work, the bicycle is transformed from an old, nearly worthless clunker to a wonderful, customized English racer worth several hundred dollars. The first time that he takes it for a ride, Michael recognizes it and demands that Charles return it. Since Charles mistakenly thought the property was abandoned, Michael has to pay for the enhanced value of the bike.

Bailments A bailment is a legal relationship that arises out of the temporary transfer of the pos- session of personal property by one person to another for a specific purpose, with the understanding that the property is to be returned at some future time. There are many

businesses that are founded upon pro- viding bailments. If you take your dry cleaning to One Hour Cleaners, you are entrusting your clothes to One Hour, with the understanding that One Hour will return the clothes after cleaning them. The person who entrusts his property into the care of another is called the bailor, and the person entrusted with the property of another is called the bailee.

Example 11.11. Susan leaves her car in a parking garage where the attendant takes her keys and parks the automobile. (Susan is the bailor and the parking garage is the bailee.)

A bailment is being created here, by the owner of the car turning it over to the parking valet.

Mark Lennihan/Associated Press

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CHAPTER 11Section 11.1 Personal Property

Types of Bailments

There are basically three types of bailments:

1. bailments for the sole benefit of the bailor; 2. bailments for the sole benefit of the bailee; and 3. mutual benefit bailments.

A bailment for the sole benefit of the bailor is a gratuitous bailment in which the bailor entrusts her property to the bailee solely for her benefit without compensation.

Example 11.12. Cathy asks Jane to hold her pocketbook and coat while she goes to the restroom. The only person who receives a benefit under the arrangement is Cathy, the bailor.

A bailment for the sole benefit of the bailee results when the bailee is entrusted by the bailor with his property for the bailee’s benefit.

Example 11.13. Sam borrows a video recorder from Sandra and agrees to return it in two days. Sam, the bailee, is the only one to benefit from bor- rowing Sandra’s video recorder.

Mutual benefit bailments result when both the bailor and bailee receive some tangible ben- efit from the bailment.

Example 11.14. Susan leaves her car in a parking garage where the atten- dant takes her keys and parks the automobile. Susan receives the benefit of being able to park her car, and the garage gets $10.95 from Susan for accepting the bailment of her car.

Bailor’s and Bailee’s Rights and Duties

The bailee has the right to possess the bailed goods in accordance with the provisions of the bailment contract, along with the right to use the goods if that right is part of the bailment agreement. Unauthorized use of bailed goods can lead to liability for the tort of conversion if the goods are injured in any way because of the unauthorized use.

Example 11.15. Mark asks Tameka to take care of his motorcycle while he goes on a trip. He does not allow her the right to ride it or otherwise use it. She agrees to look after it. If Tameka sells or destroys the bike while Mark is gone, she is clearly guilty of conversion, but she is also liable to him for any unauthorized use. Thus, if she rides it without his permission, rents it out to others, or allows harm to come to it by her direct action or negli- gence, she will be liable to him for damages in tort (negligence, trespass to personal property, or conversion).

The bailee has the duty to exercise due care with regard to the bailed goods. In most states today, the standard is reasonable care under the circumstances, regardless of the type of bailment involved. The relative benefit to the parties in the bailment is a factor considered in determining what constitutes reasonable care.

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CHAPTER 11Section 11.1 Personal Property

The bailor has the right to expect that the bailee will faithfully discharge her duties under the bailment agreement and can sue the bailee under a theory of breach of contract or torts if the bailee fails to observe her responsibilities. Tort theories under which the bailor can bring suit include conversion, negligence, and replevin (an action to recover one’s prop- erty in the possession of another).

Example 11.16. Aika asks Ben to look after her pet turtle while she goes on vacation for a week. When Aika returns she learns Ben has made turtle soup of her pet. She can sue for conversion.

Example 11.17. If when Aika returns, she learns the turtle was injured by Ben’s dog and requires medical care, she can sue for negligence (assuming she can show Ben failed to exercise due care in keeping the dog away from the turtle).

Example 11.18. If, upon her return, Aika finds that Ben has fallen in love with the turtle and refuses to return it, she can sue for conversion (for its price) or replevin (to have it returned to her).

The bailor has the duty to compensate the bailee in all but gratuitous bailments and must reimburse the bailee for all expenses reasonably necessary to carry out the bailment. If, for example, Aika’s turtle in the last example falls ill while in Ben’s care through no fault of his, she must reimburse him for any reasonable medical expenses he has incurred in caring for the animal. Likewise, she must reimburse him for the reasonable cost of feeding the turtle if he demands it.

Constructive Bailments

There are situations in which the law implies a bailment, even when one does not exist by the consent of the parties. A common example is that of the finder of lost or mislaid prop- erty. Even though no actual bailment exists, since the bailor did not entrust the property to the bailee or deliver it into his care, the law treats the finder of such property as an invol- untary bailee. As such, the finder of mislaid or lost property must take reasonable care of the property until the true owner is found, until he turns it over to the police, or, until the statute of limitations for recovering lost property runs out, whichever comes first.

Disclaimers of Responsibility

Bailees may sometimes exempt themselves of all liability from harm that may come to bailed property. Conspicuously posted signs to the effect that bailees are not responsible for theft or damage to bailed property in their care, as well as standard form liability waiv- ers printed on receipts or contracts, have generally been upheld by the courts as valid as long as they are clearly visible to the bailor at the time of the bailment, and as long as the parties had comparable bargaining power. However, courts are less likely to uphold such exculpatory contracts when the bailor is a consumer than they are when the bailor and bailee are corporations or businesses that are well able to protect themselves.

Example 11.19. Tara leaves her car on a parking ramp. ABC Inc. stores goods with Warehouse Corp. Both Tara’s and ABC’s bailment contracts contain clauses saying the bailee is not liable for any damage to the property. If

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CHAPTER 11Section 11.2 Intellectual Property

both Tara’s car and ABC’s goods are damaged, Tara has a better chance of having a court disregard the exculpatory clause and impose liability on the parking ramp than ABC has of holding Warehouse liable.

11.2 Intellectual Property

Intellectual property is a form of personal property that is not tangible, but because it is regulated primarily by specific statutes rather than the common law, we shall examine it separately. There are three basic types of intellectual property: patents, copyrights, and trademarks.

Patents A patent gives an inventor the exclusive right to profit from her invention for a period of 14 years for design patents and 20 years for utility and plant patents from the date of filing the patent application. A utility patent is issued for the invention of a new and useful pro- cess, machine, manufacture, or composition of matter, or a new and useful improvement thereof. Unlike a utility patent that protects what an object or process does, a design patent protects how an object looks (e.g., shape and ornamental qualities rather than function).

Example 11.20. Imelda invents an automatic pedicure device. She would obtain a utility patent for this. The device is in the shape of a toe, com- plete with beautifully painted toenail. This aspect would be protected by a design patent.

An inventor wishing to reserve the right to exclusively use his invention needs to apply for a patent to the U.S. Patent and Trademark Office (USPTO). For an idea to be issued a patent, the inventor needs to show that the invention is both novel and useful, and sub- stantially different from any other existing patented invention. Although most inventions concern some type of physical object or new machine (such as the proverbial better mouse- trap), it is also possible to patent new chemical compositions of matter (such as a better dishwashing detergent), new plants, and even genetically engineered organisms, such as oil-eating bacteria, as well as business processes. After the maximum 20-year period for a utility patent or 14-year period for a design patent, the inventor’s right to exclusively use, license, sell, or give away the right to use his invention ends, and the invention becomes part of the public domain, and may be used by anyone without the need to obtain the inventor’s permission or pay her royalties for its use. The only way for an inventor to extend her patent beyond the 14- or 20-year period is to reapply to the patent office for a new patent, which will be issued only if the inventor can show significant improvements to her invention warranting the issuance of a new patent.

Copyrights Article I, Section 8, Clause 8 of the United States Constitution, known as the copyright clause, empowers the U.S. Congress to promote the progress of science and useful arts by securing for a limited time to authors and inventors the exclusive right to their respec- tive writings and discoveries. The idea was that without the ability to control (and profit from) their works, people might be less creative and inventive, and that would be a bad

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CHAPTER 11Section 11.2 Intellectual Property

thing for society. Congress passed the first copyright statute in 1790, with a 28-year limit on copyrights. Today the term is up to 120 years.

However, the law has also recognized that there is a public interest in having works pass into the public domain, where they are freely available without users having to pay royalties or obtain permissions. (If you ever wondered why schools have such a fondness for dead playwrights and their productions, this would be one reason.) Hence the language that copyright should be for a “limited time.” Also, the law recognizes with the fair use doctrine that there are times when it is appropriate to copy without getting the copyright holder’s permission, including using brief excerpts in reviews or commentary, teaching, and scholarship.

Copyrights protect creative works, such as a drawing, a video, a sculpture, a poem, a song, dance choreography, and the like. The idea behind the piece is not protectable; the copyright covers only the fixed form (such as the actual words or images) the creator put her idea into.

Example 11.21. Dan Brown, author of The DaVinci Code, was sued by several writers who claimed he had stolen the plot from their works. However, the court found no infringement, since copyright law does not extend to plots.

Example 11.22. Suppose a play called The Marachi Code, a humorous send- up of Dan Brown’s book, uses actual dialogue from the book in the play, without Brown’s consent. This could be copyright infringement.

For works created after January 1, 1978, copyright protection lasts throughout the author’s life and for an additional 70 years after the author’s death. Copyrights owned by companies rather than individuals (e.g., works for hire produced by authors for pub- lishers) last for 95 years from the date of publication or 120 years from the date of cre- ation, whichever comes first. During the copyright period, the author (and the author’s estate for 70 years after the author’s life) has the exclusive right to reproduce the work or to make any derivative works based on it. Authors may also be entitled to royalty payments upon public use of copyrighted works, such as the broadcasting of a song or music video over the airwaves or the public performance of a play.

An author automatically obtains a copyright to work as soon as it is fixed in some perma- nent form, such as typing it on paper, recording it, or saving it to a hard disk or remov- able storage device. Any qualifying work can be copyrighted by registering with the U.S. Copyright Office (USCO) in Washington, DC, but registration is not necessary to obtain- ing copyright protection. Until a work is registered in the USCO, however, an action for copyright infringement damages cannot be brought in federal court. Upon the expiration of the copyright period, the work is considered to be in the public domain and may be used by anyone without the permission of the author or heirs.

As modern technology has made it easier to make reproductions (sometimes indistin- guishable from the originals) of copyrighted work, new laws have been passed to address such infringement. The Digital Millennium Copyright Act will be discussed in more detail in the chapter on cyberlaw, but it is worth noting now that it significantly expanded the definition of infringement and the penalties attached to it.

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CHAPTER 11Section 11.3 Real Property

Limited fair use of copyrighted work can be made without it constituting copyright infringement for educational purposes, as well as for news reporting and literary criti- cism. To qualify as “fair use,” the portion of the copyrighted work must be relatively small and not unduly infringe of the work as a whole. For example, quoting from one page of a novel for purposes of literary criticism or copying one article from a newspaper for class- room distribution is likely to be covered under fair use. But if the amount of material used is excessive, a copyright infringement occurs. Courts in recent years have shown decreas- ing tolerance for allowing a fair use exception to copyright infringement actions, even in not-for-profit educational settings.

Trademarks A trademark is any symbol, graphic image, word, or name attached to a manufacturer’s product in order to dis- tinguish it from other similar products on the market.

Example 11.23. Coca-Cola and Coke are registered trademarks of the Coca Cola Company, as is the red and white swoosh design used on Coke cans and labels.

In order to protect a name, slogan, or other distinctive mark attached to a product, the company must register it with the USPTO. To obtain trademark protection, the name or symbol must be unique and not a generic term. Thus, while Coke is a registered trademark, the word “cola” cannot be registered as a trademark, since it is a generic name. A company can pro- tect its trademark from infringement by any other company, and infringement can occur even when the actual name is not used, if the name or style of presentation is too close to the protected trademark. A soft drink called Koke, for example, was deemed to violate the Coca Cola Company’s trademark, and you can bet that Cola-Coca would also be deemed a violation—especially if the distinctive script of the Coca Cola Company’s trademark were also used. On the other hand, Caren’s Cola would not be an infringement (unless she closely matched the script of the Coca Cola Company’s trademark.)

11.3 Real Property

Real property includes land and everything permanently fixed to the land, such as a house, trees, and the coal below the land. Real property, unlike personal property, is not movable (at least, not easily!). Note that once a tree is cut for timber, or coal is mined, it becomes personal property.

All of the designs used on these cans, as well as the name Fanta, are protected by trademarks.

Jacquelyn Martin/Associated Press

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CHAPTER 11Section 11.3 Real Property

Possessory Interests in Land

Fee Simple Absolute The law provides different ways of owning land; these are sometimes referred to as estates. The most complete form of ownership is known as fee simple absolute. The owner of land in fee simple has the right to sell it, give it away, or build on it (subject to government regulation in some cases), and on the owner’s death, the same interest goes to his heirs.

Life Estate A life estate is an ownership interest in real property that lasts only for a person’s lifetime. The owner of a life estate, called a life tenant, has many but not all of the rights of a fee simple owner during her lifetime. The tenant has the obligation to maintain the property and pay taxes on it.

Example 11.24. Tania has a life tenancy in a piece of real estate called Black- acre. When Tania dies, her heirs will have no rights to the property. Tania can give or sell the estate to Brent, but only for Tania’s lifetime. Once Tania dies, neither her estate nor Brent has any rights in Blackacre.

Example 11.25. Harry owns both an oil field and a gold mine. He deeds to his two children, Charlie and Sally, the oil field and gold mine, respectively, for their lives, with the remainder of the property to go to UNICEF, his favorite charity, upon their deaths. Throughout the past ten years, the oil field has produced 1,000 barrels of oil per day, and the gold mine has pro- duced approximately 1,000 ounces of gold per year. Charlie and Sally may continue to extract approximately 1,000 barrels of oil per day and 1,000 ounces of gold per year for their own use. If they decide to greatly increase the output during their lifetime by, for example, strip mining and sinking new wells, they will be guilty of waste and will be liable for damages to the future owner of the land—UNICEF. UNICEF will also be able to seek an injunction to stop Charlie and Sally from committing waste if it learns of their plans in time; otherwise, it can sue them for damages.

Concurrent Ownership Real estate can be owned by more than one person simultaneously, but again the law pro- vides for different types of ownership. The default setting (presumed if the parties do not specify something else) is the tenancy in common, where the parties each own an undi- vided interest in the whole property. Either party can convey their interest at any time, and upon the tenant’s death, the heirs will own the interest, which can be disconcerting to the surviving owner.

Example 11.26. Jennifer and Brad own Whiteacre as tenants in common, thus they each own 50 percent of the whole of Whiteacre (rather than Jen- nifer owning the north side, and Brad the south side, etc.). Jennifer can sell her interest to Cara, and Brad will find himself in joint ownership with someone he doesn’t know.

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CHAPTER 11Section 11.3 Real Property

However, the law does give a tenant in common the right to demand partition, which means a court will split the property and create individual ownership in a spe- cific parcel.

Another form of concurrent ownership is joint tenancy, which carries with it a right of survivorship. If Jennifer and Brad owned Whiteacre as joint tenants, upon Jenni- fer’s death, Brad will own all of Whiteacre (and White- acre will not be considered part of Jennifer’s estate, which can have important tax and administrative con- sequences and makes joint tenancy a popular feature in estate planning). An odd thing about a joint tenancy is that if Jennifer transfers her interest in the property to Matt, the joint tenancy ends and Matt and Brad will own as tenants in common (and Brad can demand partition if he doesn’t care to share with Matt).

A tenancy by the entirety is a form of ownership that still exists in some states; it applies only to married couples. A husband and wife each own the entire property and both have right of survivorship. Divorce will leave the couple as tenants in common. In other states, different laws have replaced this tenancy, such as community property laws or divorce specific statutes.

Nonpossessory Interests An easement is a property right that does not involve the right to possess the property. A common form of express easement is where a right-of-way is granted by the owner to another person.

Example 11.27. Daniel owns lakefront property. He subdivides it and builds cabins on sections that do not include lake access, and sells those lots as vacation homes. Each cabin lot comes with an easement that allows the owner to cross Daniel’s property to reach the lake, as well as the right to use the lake. Without the easement, Daniel would get a much lower price for cabins without lakefront.

Easements can also arise from implication or necessity. Suppose Daniel in the above exam- ple did not include an express easement with the lots, but did sell them with the right to use the dock. Obviously, to use the dock the new owners will have to cross Daniel’s prop- erty, so the owners of the vacation cabins will have an implied easement.

Another form of nonpossessory interest is a profit, which gives a person the right to enter land to take something from it.

Example 11.28. Valuable gold deposits are discovered under Greenacre. Tom, the owner, sells a profit to Mining Company for $100,000. Tom gets the cash, and Mining Company has the right to take the gold.

There are several different ways for this couple to jointly own their new dream house. Different types of tenancies have different legal consequences.


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CHAPTER 11Section 11.3 Real Property

Adverse Possession A strange concept in the law, adverse possession allows a person to gain ownership of another person’s property by:

• Entry and exclusive possession, • Open and notorious possession, • Continuous possession for a statutory period of time, and • A claim adverse to that of the owner.

Here is an example to illustrate the requirements.

Example 11.29. William and Wendy move into town and clear a half-acre lot in a 200-acre tract owned by John Doe, an absentee landowner who lives in another state. They build a house, plant a few crops and live in the land for 20 years, telling people that they are the owners and preventing anyone else from using the land without their permission. If the statutory period for claiming adverse possession is 20 years in the state and John learns of William and Wendy’s adverse possession 21 years later and tries to oust them from his land, will he succeed? Unfortunately for John, he is too late; the adverse possession had been open and notorious, continuous for 20 years, adverse, exclusive, and without claim or right. (Wendy and William had no legal right to claim the land when they began their adverse possession.)

In the above example, the half-acre tract that was used by the couple belongs to them by virtue of their adverse possession. Notice, however, that the remaining 199.5 acres still belong to John Doe, since the couple never treated that property as their own. Also, if John had discovered they were there during the 20-year occupation and written a letter to them—“Dear William and Wendy, I’m glad to have you as my guests, Love, John”—they would have the owner’s permission to be on the land and so the possession would not be adverse and they would not gain ownership after the 20 years.

Note that if Wendy and William lived on the land for 19 years without permission, aban- doned it for a year, and then returned for an additional 2 years, they would not have a valid claim of adverse possession; the 20-year time span must be uninterrupted.

Landlord-Tenant Law Much of the landlord-tenant relationship will be governed by their contract, or lease. Other aspects may be covered by different state or local laws, including housing codes and zoning (land use) statutes. However, despite the differences that may exist from juris- diction to jurisdiction, there are still some general rules that may be considered to be part of the law of real property.

Types of Non-Ownership Tenancies There are essentially four nonpossessory, or non-freehold, interests in land that give their holder the right to use and occupy land, but no ownership interest in it. These are the ten- ancy for years, periodic tenancy, tenancy at will, and tenancy at sufferance.

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CHAPTER 11Section 11.3 Real Property

A tenancy for years arises out of a contract that allows the tenant to occupy and use the realty for a set period of time in exchange for consideration (rent, in this case).

Example 11.30. Larry Landlord rents an apartment to Tom Tenant for $900 per month, for a period of one year.

A periodic tenancy (also known as a tenancy from term to term) continues for a specified period of time and is automatically renewed at the end of the stated period unless either the owner or tenant gives proper notice of his wish to terminate the tenancy. The most common example of this type of tenancy is a month-to-month tenancy of an apartment or a home.

Example 11.31. Tenant signs a two-year lease running from January 2010 through December 2011. In January 2012, the tenant’s lease has expired, but she stays on and tenders to the landlord the usual monthly rent and the landlord accepts it. At that time, she has entered into a periodic tenancy—one that will run from month to month until either she or the landlord gives the other notice (generally equal to the ten- ancy period, here a month) that they wish to end the arrangement.

A tenancy at will is one that can be terminated at any time by either the landlord or tenant without previous notice. Unless there is a specific understanding between the parties that they intend to enter into a tenancy at will, a periodic tenancy is assumed to exist. Therefore, if a ten- ant moves into an apartment and begins paying rent on a monthly basis, a month-to-month periodic tenancy will be presumed unless there is a specific agreement between the parties that a tenancy at will was intended.

A tenancy at sufferance comes into existence when a ten- ant lawfully in possession of rented property under a ten- ancy at will, periodic tenancy, or term tenancy remains in possession of the property without the landlord’s consent at the expiration of the tenancy. Such a tenant is, in fact, a trespasser and becomes liable to the landlord for the mar- ket value of the rental property over the period that he occupies it pending eviction proceedings by the landlord.

Tenant Rights and Responsibilities During his tenancy, a tenant is entitled to occupy property that is habitable and free from unreasonable dangerous defects. Most states, either through legislation or court decision, provide some measure of protection to tenants who are denied essential services by land- lords, or whose rental property has become uninhabitable due to the landlord’s unwilling- ness to make necessary repairs. In addition, landlords make an implied covenant of quiet enjoyment to tenants through which they warrant that the tenant will be allowed to enjoy the rented property free from outside interference that is preventable by the landlord.

The law provides for specific rights and duties of both landlords and tenants, but the lease will usually add to these automatic provisions.

age footstock/SuperStock

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CHAPTER 11Section 11.3 Real Property

Example 11.32. Larry Landlord has rented an apartment to Tom Tenant. Larry has now decided to sell the property, and wishes to show it to pro- spective buyers. Larry must give Tom reasonable notice and only enter the property during reasonable hours, or he will be violating Tom’s right of quiet enjoyment.

If a tenant gives reasonable notice to a landlord of the need for some essential service or repair, the landlord must fix the condition or the tenant will have the right to sue for con- structive eviction, which is a breach of the lease on the landlord’s end (and may entitle the tenant not only to move out, but also to sue for damages).

Example 11.33. Because of a broken pipe in the apartment, Tom now has no water. Tom immediately informs Larry, but two weeks later the pipe has not been fixed, and Larry has simply given Tom a couple of buckets and kindly pointed out an outside tap. Tom may move out, even though there are five months left on his lease, and he may sue Larry for damages.

However, if the interruption in water service was because of a problem with the municipal water main, over which Larry has no control, Larry would not be liable for damages.

Tenants also have obligations. A tenant is responsible for payment of rent when it is due, and a failure to do so is a breach of the lease and grounds for eviction. A tenant is also responsible for making minor repairs to the rental property, including unstopping clogged sinks or changing a washer in a leaky faucet. Major repairs, such as fixing broken plumb- ing inside a wall, repairing a leaky roof, or waterproofing a leaky basement, would all be the responsibility of the landlord. Where additional restrictions on the tenant’s conduct are specified in a lease, the tenant must abide by such restrictions.

Landlord’s Rights and Obligations The landlord of course has the right to the agreed-upon rent, as well as the right that the tenant return the property at the end of the lease in the same condition that she occupied it, minus acceptable wear and tear. The landlord also has the right to expect that the tenant will make minor repairs to the rental property as necessary, and can sue the tenant for waste if the tenant’s inability to make minor repairs results in damage to the rented property.

Example 11.34. Tom rents a house from Lavinia. A branch of a tree in Tom’s yard breaks off during a storm and falls across the sidewalk. Tom is expected to move the branch off the sidewalk.

Finally, the landlord has the right to expect that the tenant will notify her of any major damage to the property requiring her attention when she would not otherwise discover the damage herself. If the roof leaks, for example, the tenant must notify the landlord immediately upon discovering the condition so that she can get it fixed. If the tenant fails to notify the landlord and greater damage ensues, the tenant will be liable for the damage to the extent that a timely notification would have avoided it. The landlord can reserve to herself additional rights or place on the tenant additional duties or restrictions pursuant to specific provisions in a lease.

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CHAPTER 11Section 11.3 Real Property

In most jurisdictions today, a landlord has the obligation to keep the property in reason- able condition. Injuries suffered by tenants as a result of a landlord’s negligence in correct- ing any dangerous condition can lead to liability. There are a substantial number of cases, for example, holding landlords responsible for tenants’ injuries arising from the criminal acts of others such as muggings and rapes that might have been prevented had some rudi- mentary protective measures been in place, such as working locks on doors. In addition, the landlord has the duty to provide necessary services to his tenants, and to maintain the premises in a habitable condition; failure to live up to this duty is a breach of the implied covenant of quiet enjoyment and results in a constructive eviction of the tenant.

Regulation and Real Property Although there are many areas where the government may impose restrictions on private property, a few deserve special attention. Zoning laws are local regulations that control what use property may be put to in a designated area.

Example 11.35. The town of Sunnyvale divides the community into a com- mercial zone where stores of a certain size are permitted, a residential zone devoted to single family housing, a residential zone permitting multifam- ily housing, and an industrial zone that allows factories to be built. Larry Landlord may not build an apartment building, or convert a house he cur- rently owns to five apartment units, in the single-family housing zone.

However, zoning regulations do permit Larry to seek a variance, or exception, from the zoning board. Whether a variance will be granted depends on a number of factors, such as the hardship to Larry of not allowing the usage, the effect on the community (such as reduced parking because Larry’s apartment tenants will be hogging the curb space), and the neighbors’ reactions to the proposed variance.

Eminent domain refers to the power of the government to take private land for public use. The Fifth Amendment of the Constitution, in a section known as the Takings Clause, provides that the government must provide just compensation, which usually means a fair market price.

Example 11.36. After World War II, it became a national priority to build an interstate highway system (in part to provide for evacuation of cities in the event of a nuclear attack). In order to acquire the land necessary to build the highways, governments resorted in some cases to eminent domain. If owners of needed land refused to sell, the government would condemn the property, meaning that a court proceeding would determine the amount the government would have to pay the owner.

We will examine eminent domain in more detail in the Kelo v. City of New London case at the end of this chapter.

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Section 11.4 Chapter Summary CHAPTER 11

11.4 Chapter Summary

Property rights are a central focus of most legal systems, and in the U.S. the law has established three separate types of property—personal, intellectual, and real estate—that are granted protection. Personal property consists of portable objects that can be transported, and it can be acquired through several methods, including pur- chase, manufacture, and gifts. Intellectual property is intangible, such as copyrights, patents, and trademarks, and is largely protected by specific federal statutes. Real prop- erty is land and things attached to the land, such as a building. Like personal property, real property can be transferred by a number of different methods, including purchase and inheritance; perhaps more unusually, it can also be acquired through adverse pos- session. Ownership of real property is typically more complicated than that of personal or intellectual property, since the law provides for different forms of ownership, which carry different rights. Although ownership of property is of central importance, the law also addresses issues such as usage by owners and non-owners alike.

Focus on Ethics

Copyright law seeks to balance the rights of those who create artistic works with that of the public in having such works be available. There is often considerable disagreement in whether Congress has accommodated both interests adequately.

Questions for Discussion

1. Much of the time congressional action to increase copyright protection has been in response to lobbying by the Motion Picture Association of America (MPAA) or the Recording Industry Association of America (RIAA), which spend millions of dollars to protect their members’ inter- est. On the other hand, the “public” tends to have no lobby to represent its interest in limiting copyright and preserving fair use. Does this seem fair?

2. Do you believe that copyright law is necessary to preserve creativity? Without it, would writ- ers cease to write, or artists stop painting? Would movies cease to be made?

3. Studios put millions of dollars into making movies and television programs, yet many can be downloaded for free (illegally) on the Internet. Often, the same shows are available for a charge, from a legal source. Do you ever take advantage of free, illegal downloads? Do you think you are acting ethically or unethically?

4. The “fair use” doctrine allows works to be used in parodies or satires to some extent. In a case involving rap group 2LiveCrew (who were also involved in a famous obscenity case, mak- ing them possibly the only music artist to be more famous for lawsuits than anything else), the Supreme Court held that their use of the Roy Orbison song “Pretty Woman” in their own, satirical version, was fair use. On the other hand, artist Jeff Koons lost a copyright infringe- ment case, after he used an Art Rogers photograph, “Puppies,” in his sculpture, “String of Pup- pies.” The sculpture was found to be a parody of society’s values, rather than Rogers’ photo, and this was not fair use. If the law is so unpredictable, does the fair use doctrine serve its purpose? Do you think it is ethical for an artist to use another’s work as an ingredient?

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Section 11.4 Chapter Summary CHAPTER 11

Case Study: Kelo v. City of New London, Connecticut

545 U.S. 469 (2005)

Facts: The economically depressed city of New London decided to redevelop a riverfront area known as Fort Trumbull. The plan called for a waterfront hotel and store, condos, and a research facility to be built. While many of the owners of the lots needed for the plan chose to sell to the city, Susette Kelo and several others refused to sell. They claimed that the city was attempting to use eminent domain for private, rather than public use, and thus violated the Takings Clause of the Constitution.

Issue: Does such a use of eminent domain violate the Takings Clause?

Discussion: A majority of the Supreme Court noted that while the government may not take one per- son’s property to merely give it to another person, the government can use eminent domain to transfer property from one private party to another if future use by the public is the purpose of the taking. One example is where land is condemned to lay rail tracks; the railroads themselves were owned by private companies, just as New London’s plan contemplated action by private developers rather than by the city itself. Even though the condemned land would not necessarily be open to use by the general public (as is the case when property is taken for use as a park or road), the majority of the court found that the city had a carefully formulated plan that it believes will provide appreciable benefits to the community, includ- ing new jobs and increased tax revenue. The city was endeavoring to coordinate a variety of commercial, residential, and recreational uses of land, with the hope that they will form a whole greater than the sum of its parts, and the plan thus served a public purpose and was justified under the Takings Clause.

Holding: for New London. The condemnation of Kelo’s and the other plaintiffs’ property was not a violation of the Takings Clause.

Questions for Discussion

1. Four justices dissented to (disagreed with) the majority’s ruling. Justice Sandra Day O’Connor wrote in her dissent that the majority’s definition of public use was so broad as to realistically not exclude any takings, since almost any private use could in the future generate some inci- dental benefit to the public. Which view do you agree with?

2. What is the basic purpose of allowing condemnation? Was it served here? 3. Is the development plan in this case similar to the taking of land to create a railway? Why or

why not? 4. Although the ruling in Kelo meant the Constitution did not prevent the taking, the court did indi-

cate that state legislatures, if they so chose, could limit the power of eminent domain. If you were a member of your state’s legislature, would you vote in favor of or against such a proposed law?

5. After Kelo and her neighbors had their homes condemned, the state and city spent about $78 million dollars bulldozing the site and preparing for the development. Four years later, the site was still standing empty—no hotel, no conference center, no condos. Furthermore, Pfizer Corporation, the giant pharmaceutical company whose research facility was supposed to be enhanced by the development, decided to close its research and development headquarters in New London. Is this relevant to the legal reasoning in the Kelo decision? Or is it just an example of hindsight being 20/20?

Susette Kelo’s house was taken from her through eminent domain in a highly controversial case.

© 2005 Getty Images/Spencer Platt

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Section 11.4 Chapter Summary CHAPTER 11

Case Study: Terry v. Lock

343 Ark. 452 (Ark. 2001)

Facts: While remodeling a motel owned by Lock, Terry and Stocks discovered above the ceiling tile in room 118 a cardboard box containing old currency with the face value of $38,310. Terry gave the box to Lock, who was present during the discovery. Later Terry and Stocks filed a complaint in a chancery court (a chancery, or equity, court has jurisdiction in cases where a legal remedy cannot be obtained in common law courts) asking for a temporary restraining order and an injunction to prevent Lock from spending the money. They also asked for a court order that Lock pay them all the money or to hold it in trust for them. The chancery court issued a temporary restraining order requiring Lock to deposit the found money with the court’s registry. Later, the chancery court characterized the found money as “mislaid property” and ruled that Lock’s interest as the owner of the premises is superior to the inter- est of Terry and Stocks as finders of the money. Terry and Stocks appealed, arguing that the found box was not “mislaid property” but “lost property,” “abandoned property,” or “treasure trove.”

Issue: Was the cardboard box that contained a large amount of old currency and that was found in the ceiling in a motel “mislaid property”?

Discussion: The appellate court examined the four categories of found property: (a) abandoned property—“thrown away or its possession is voluntarily forsaken by the owner”; (b) lost property— “unintentionally separated from the dominion of its owner”; (c) mislaid property—“intentionally put into a certain place and later forgotten”; (d) treasure trove—“any gold or silver in coin, plate, or bullion, whose owner is unknown, found concealed in the earth or in a house or other private place, but not lying on the ground.” Analyzing the facts of the present case, the appellate court agreed with the chancery court that the found money “was intentionally placed where it was found for its security, in order to shield it from unwelcome eyes.” Thus, it was mislaid property. Though the bills in the box were old, they were not antique, which is required for the classification of money as treasure trove. Therefore, the appellate court concluded that the found money belonged to Lock, the owner of the premises where it was discovered.

Holding: The appellate court affirmed the judgment of the chancery court.

Questions for Discussion

1. Why did Terry and Stocks file a complaint in a chancery court against Lock? What is a chancery court?

2. After initially issuing the temporary restraining order, how did the chancery court characterize the found money?

3. What did Terry and Stocks argue in their appeal? 4. What are the four categories of found property as classified by the appellate court? Why did

the court reach the conclusion it did regarding who owned the money? 5. Do you agree with the current legal principle that the finder of the mislaid property does not

have any rights to the property? Do you think that the finder of the mislaid property should be awarded a certain percentage of the value of the found property? While thinking about your answer, realize that the $38,310 that Mr. Terry and Mr. Stock found in the ceiling of the motel room was not put there by Mr. Lock, who was later declared the rightful owner. It was put there by whoever was in that room and, likely for an urgently needful reason, decided to hide the money. But because Lock was the owner of the motel, and because the person who put the money there never came back to claim it, Lock was the beneficiary of the doctrine of mislaid property.

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Section 11.4 Chapter Summary CHAPTER 11

Critical Thinking Questions

1. Engagement rings are an item of personal property where legal rules of owner- ship may differ from state to state. Many simply regard the ring as a gift, no dif- ferent than the box of candy on Valentine’s Day or the silk tie given at Christmas. In these states, if the man has given the ring to his intended, she now owns the ring, regardless of whether the engagement is broken and they never get mar- ried. Other states take a more businesslike view of the transaction, treating it as something similar to a down payment. In Pennsylvania, for example, if the mar- riage doesn’t take place, the ring must be returned to the giver. The reason the marriage failed to occur doesn’t matter. Which approach would you favor? If you were a judge in a state that had not decided the issue, would you treat it as a gift, a conditional transfer, or something else?

2. Suppose you and your roommate are tired of renting apartments. Your dating lives are lousy, your marriage prospects seem dim. The two of you decide to buy a house together. Analyze the advantages and disadvantages of the different type of real property tenancies. Which seems best for your situation?

3. Harley-Davidson, the motorcycle manufacturer, once sought to trademark the sound of their engines. Paris Hilton, hotel heiress, wanted to trademark the phrase “it’s hot.” Do you think such things should be given exclusive protection?

Hypothetical Case Problems

Case 1. Marge rents a car from the ZYX Rental Co. The rental agreement states that Marge may use the automobile for 24 hours anywhere within the state of Arizona, but that she cannot take the car out of the state due to insurance regulations.

A. What type of bailment is this? B. I f Marge drives to Nevada and gets into a wreck with a hit-and-run

driver, will she be liable for the damages to the auto rental company? If so, under what theory or theories may the rental company sue her?

C. Marge parks in a Carson City garage and is given a ticket that has a liabil- ity waiver printed on its back. If the car is damaged, what factors would a court consider in deciding whether the waiver is valid or not?

Case 2. Socialite and famous party girl London Hyatt, after being described by a tabloid magazine as “Hottie Tottie,” decides that she should market a line of clothing under that name.

A. What form of intellectual property would London get in order to protect the name Hottie Tottie?

B. May London use the cartoon of her that appeared in the magazine as her logo?

C. If London and Cathy Chemist develop a new perfume as part of London’s merchandise line, what should they do to protect the formula?

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Section 11.4 Chapter Summary CHAPTER 11

Case 3. Fred and Barney own homes on adjacent lots. Over a period of 20 years, Fred, with Barney’s permission, parks his car on Barney’s land. After 20 years of putting up with Fred’s car on his property, Barney tires of the arrangement and informs Fred that he may no longer park the car there.

A. What would be the legal term for Fred’s right to use Barney’s land for the last 20 years?

B. If Fred refuses to stop using Barney’s land to park his car, what remedies, if any, are open to Barney?

C. Can Fred claim a right to Barney’s land through adverse possession? Explain.

D. Would Fred have a valid claim of adverse possession if he continues to use Barney’s land for an additional 20 years after Barney tells him not to?

Key Terms

accession Where one person improves another’s property and is entitled to compensation.

bailment A legal relationship that arises out of the temporary transfer of the pos- session of personal property by one person to another for a specific purpose, with the understanding that the property is to be returned at some future time.

easement A right of way, or nonposses- sory interest in real property.

eminent domain The power of govern- ment to take private property for public use, after notice and compensation to the owner.

estate An ownership interest in real property.

fee simple absolute The most complete form of property ownership, in which the owner has the right to sell it, give it away, build on it (subject to government regula- tion in some cases), and, on the owner’s death, the same interest goes to his heirs.

intangible personal property Personal property that does not have a physical existence, such as stocks.

intellectual property Patents, copyrights, and trademarks; intangible property that represents specific rights rather than an object.

joint tenancy A form of concurrent own- ership of real estate between two or more persons, that carries with it the right of survivorship.

life estate An ownership interest in real property that lasts only for a person’s lifetime.

personal property Property that is movable.

profit A nonpossessory right that allows someone to take something from another’s real property.

real property Real estate; land or things attached to the land.

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Section 11.4 Chapter Summary CHAPTER 11

tangible personal property Ownership interest in things that have a physical exis- tence and are able to be moved, or carried, from place to place.

tenancy by the entirety A form of owner- ship that applies only to married couples. A husband and wife each own the entire property and both have right of survivor- ship. Divorce will leave the couple as ten- ants in common.

tenancy in common A form of concur- rent ownership between multiple people in which each person owns an undivided right in the whole property and can con- vey this right to another person.

zoning law Regulation by state or local authorities that limits the use of real property.

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