is where the claim against the manager has no legal basis. These claims are cheaply dismissed. The second tier of cost is where the claim against the manager has an inadequate factual basis. These claims require much more work to defeat. Where a claim has a legal and has a factual basis, the manager faces the greatest amount of cost and should prepare for trial. Chapter 2 puts those risks into context using the Federal Rules of Civil Procedure.
Determining whether a claim has a legal or a factual basis is the subject of Chapters 3–8. Chapter 3 deals with claims that result from personal injuries or tort law. The law selected for this chapter comes from the Second Restatement of Torts except where it has been superseded by the Third Restatement of Torts. While not the law of any particular jurisdiction, the Restatements provide approaches to determining liability that are nonetheless generally applicable.
In this chapter, Ronald Coase sets a chain of events in motion that gets managers to rethink whether being able to recover for an injury is good for society in the first place. A proof using game theory explains that different kinds of injuries should have different kinds of remedies and some should have no remedy at all.
Chapter 3 can be viewed as covering liability in the absence of an agreement. Chapter 4 deals with liability in the presence of an agreement. In particular, service agreements are treated in detail based on the law found in the Second Restatement of Contracts. Returning to Michael Porter’s model, virtually all American businesses either buy or sell services. This chapter discusses identifying and mitigating risks when one party fails to perform in a service contract. Contract provisions are discussed to encourage parties to perform in order to limit risk involved in transactions with venders and customers.
Chapter 5 continues the discussion of Chapter 4, but deals with contracts for the sale of goods instead of contracts for services. The law here resides in Article 2 of the Uniform Commercial Code. The major difficulty in goods contracts is not so much that one party simply doesn’t perform, but rather that the goods are of a different quality than negotiated. With regard to Porter’s model, it is much easier to use restrictive provisions in sales contracts than services contracts. When resources can be pooled and controlled, it is difficult for other market participants to compete against the manager’s firm.
Chapter 6 deals with the situation of protecting against default. This takes a more holistic look at risk as described in Article 9 of the Uniform Commercial Code. It is rare that a creditor would allow a debtor to undertake a project where the potential downside is losing everything. Collateral is a way to solve that problem and spread risk. Being able to turn inventory quickly is a large competitive advantage within an industry. Creditors want a system where their risk is very low before they are willing to help a debtor’s business. Those transactions are considered in detail in Chapter 6.
Chapter 7 turns inward to the operation of the firm as a whole and asks a very common question in business, “Should I hire an employee or an independent contractor?” Fortunately, our protagonist, Ronald Coase, has a Nobel prize winning answer to that question. The rights and duties between principals and agents are known as Agency law, and the Third Restatement of Agency provides a legal basis for this chapter.
Chapter 8 culminates the book by showing how the principals of Agency law evolve when principals join together to form firms. Partnerships are discussed using the Uniform Partnership Act. Limited Partnerships are discussed using the Uniform Limited Partnership Act. Limited Liability Companies are discussed using the Uniform Limited Liability Company Act. Corporations are discussed using the Revised Model Business Corporation Act. The rights and duties between owners of all of these businesses are considered in detail.
While the rights and duties between business owners vary considerably, the most common reason that one business entity or another is selected has to do with tax treatment. In particular, owners need to make decisions as to whether election under Subchapter S is wise. Chapter 8 integrates legal environment principals of corporate rights and duties with the regulatory environment of taxation in order to provide a comprehensive landscape for business entity selection. Hopefully by the end of this book, the reader will have a better framework for recognizing and allocating risk in routine business transactions.
Throughout the book the following features provide a way to navigate the material presented
“Game on!” is a game theory application of common law principles.
“Getting real” provides a practical application of the adjacent material.
“Under the microscope” explains the microeconomic (or macroeconomic) underpinnings of a legal rule.
“Case Problems” are scenarios that are based on real cases that are answered in an appendix to the text.
1Michael H. Porter, How Competitive Forces Shape Strategy, Harv. Bus. Rev. (March–April 1979) available at: https://hbr.org/1979/03/how-competitive-forces-shape-strategy.
Chapter ONE
Introduction to Microeconomics
The introduction explained that the task of the manager in the legal environment is to identify and qualify risk. This chapter focuses simply on a model for qualifying all kinds of risks. That model is based on economic theory.
Economics is choice in the presence of scarcity. A resource is scarce when there is less of it than can provide for all possible needs. Managers often deal with this problem because scarcity necessarily requires a decision of how to use resources. That decision is complicated because managers have desires to both help themselves and to help others, which would seem to create a paradox as to how scarce resources should be utilized. Adam Smith questioned that paradox by arguing that by following their own self-interests, economic agents frequently serve society as well.
Cooperation
Most managers realize that when they are able to cooperate with peers, subordinates and supervisors, the organization is most productive. This is true for the economy on the whole as well.
Cooperation is greatly responsible for the development of more affordable and desirable products and services; in a society where each individual can rely on others to provide the majority of products and services, one can focus on perfecting their own wares. By doing so, they are able to sell more, as the desirability and affordability of their merchandise is greater than that of competitors’, in the process benefitting both themselves in the form of higher prosperity and society as a whole with cheaper, better, or more abundant goods.
The Production Possibilities Frontier
The manager in the example below has two employees that need direction. Cara is working on one plot of land and Bob is working on another plot of land. The manager can direct Cara and Bob to produce apples, peaches or some combination of these. Cara and Bob have a limited ability to produce
