Legal Environment of Business

Article explores the legal environments that directly impact today's businesses and corporations by providing an overview of the major legal realms and legal structures that impact business and business practices. The role law plays in the world of business and its implications to the business professional, as well as, the major sources of law and their intent to either control, regulate, or assist current business practices.

Keywords American Legal system; Business Law; Constitution; Procedural Law; Securities Exchange Act; Statutes; UCC

Law > The Legal Environment of Business

Overview

The legal environment of business refers to the code of conduct that defines the legal boundaries for business activity. To understand these boundaries, it is essential to first have a basic understanding of the law and how it affects businesses and business practices. The nature of business spans over a number of legal realms, all of which are continuously influenced by the needs and demands of the business community, consumers, and the government. Each has a distinct stake and voice in this vibrant legal environment.

Nature of Law

The study of the legal environment of business encompasses numerous approaches and philosophical theories. The exploration of what law is and how it is defined has been examined by numerous legal philosophers.

Legal Traditionalists

The legal traditionalists view law as a body of principles and rules that courts `utilize when deciding disputes. The traditionalist approach is steeped in the belief that the basic constructs of right and wrong are fixated even though society is continuously changing its beliefs.

Environmental Approach

The environmental approach views law as an arm of societal control that must continuously reflect the current society's moral constructs through the enforcement of rules, regulations, and laws. This approach is much broader in scope, since the law is an institution that reflects the societal need for social order.

Sociological Jurisprudence Theorists

Sociological jurisprudence theorists profess that society ultimately shapes and molds the law and the mechanisms for its enforcement. This school of thought views the legal system and the law as a means of providing an orderly, predictable system of social order, change, and legal reform.

These theories lead to similar conclusions; the primary function of law is to maintain social, political, and economic stability, while simultaneously balancing the need and ability to implement change. To accomplish this successfully, laws have been categorically classified.

Classifications of Law

To make sense out of huge body of information, laws are placed into various categories. Although a number of classifications are possible, the most useful categories utilized are:

• Substantive and Procedural
• Civil and Criminal

Basic to the understanding of these classifications are the terms right and duty.

A right is the ability of a person with the help of the law, to demand someone else to perform or to cease engaging in a certain activity.

A duty on the other hand, is a commitment placed upon a person to engage in or desist engaging in a certain activity. These two concepts are correlatives, meaning that no right can rest upon one person without a corresponding duty resting upon some other person.

Substantive Law & Procedural Law

Substantive Law

Substantive law includes all those laws that define, regulate, and create legal rights and obligations. A rule stating that promises are enforced only where each party receives something of value from the other party is part substantive law. An example of this would be business contracts and contract obligations.

Procedural Law

Procedural law, on the other hand, establishes the methods for enforcing the rights that are established by substantive law. For example, questions about how a lawsuit should begin, what papers need to be filed, which court the suit should go to, which witnesses can be called, and so on are all questions of procedural law.

Essentially, substantive law relays our rights and entitlements under the law, while procedural law delineates our legal obligations and duties that need to be undertaken to obtain the benefits of those rights.

Civil Law & Criminal Law

Civil Law

Civil law refers to the laws that define the duties existing between individuals or legal entities (meaning corporations). This body of law (better known as torts) deals with the infringement of one person or legal entity on the legally recognized rights of another. Civil law violations appear in business in numerous ways. It is the basis of employment violations, breaches of contracts, product liability and copyright infringement.

Criminal Law

Criminal law differs from civil law in that it is an act prohibited by law for the protection of the public at large. Criminal violations in business occur when individuals, in a position of authority, commit criminal actions either against individuals, the company, or the consumer.

“Under the doctrine of respondent superior, a corporation may be held criminally liable for the illegal acts of its directors, officers, employees, and agents. To hold a corporation liable for these actions, the government must establish that the corporate agent’s actions were within the scope of his/her duties and were intended, at least in part, to benefit the corporation” (Michel, 2003, p.1).

These types of criminal acts are often referred to as white collar crimes. This catch-all phrase was originally coined by Edwin Sutherland in 1939. Sutherland defined it as "a crime committed by a person of respectability and high social status in the course of his occupation." White-collar crimes usually involve fraud, bankruptcy fraud, bribery, insider trading, embezzlement, computer crime, medical crime, public corruption, identity theft, environmental crime, pension fund crime, RICO crimes, consumer fraud, occupational crime, securities fraud, financial fraud, and forgery.

Sources of Law

With a basic understanding of the classifications of law, the next question that comes to mind is what are the sources of law and where are laws found? Laws derive from federal and state constitutions, federal treaties, interstate compacts, federal and state statutes and executive orders, ordinances of municipal governments, the rules and regulations of federal and state administrative agencies, and federal and state court decisions.

The United States Constitution

The U.S. Constitution (adopted 1787, ratified 1788) is considered the "supreme law." A law in violation of the Constitution, no matter what the source, will not be enforced by the courts. Similarly, the state constitutions are supreme within their respective borders, though keep in mind that all law in the United States is subordinate to the Federal Constitution. No law, Federal or State, is valid if it is in violation of the Federal Constitution.

The U.S. Constitution also creates and limits the power of the government. Examples of the exclusive regulatory federal powers created by the US Constitution include: the power to establish laws regarding bankruptcy, to grant patents, trademarks, and copyrights, and to coin currency. One area of the US Constitution that perhaps has the greatest impact on U.S. businesses is the commerce clause contained in the Tenth Amendment. The commerce clause grants virtually complete power to the Federal Government to regulate the economy and business. This includes transportation of goods across state lines, consumer warranties and credit transactions, electronic funds transfers, residential and commercial real estate transactions, consumer and employee safety, labor relations, civil rights in employment, transactions in securities, environmental protections, and taxation.

The federal government's power to tax is subject to three limitations. First, taxes (excluding income tax) must be apportioned among the states. Second, all custom duties and excise taxes must be uniform throughout the United States. Lastly, no duties may be levied upon exports from any state. Taxes also have regulatory effects. For example, import taxes and custom duties that are meant to protect domestic industry from foreign competition and tax credits which are meant to encourage investments in favorable enterprises and disadvantage unfavorable enterprises.

Statutory Law

Statutes are enacted by Congress and the various state legislative bodies. This constitutes what is better known as statutory law.

An example of a statutory scheme that has had a tremendous impact on corporations has been the Securities Act of 1933 and The Securities Exchange Act of 1934. Both of these were enacted by congress to avoid another stock market crash like the one in 1929. Congress designed both these Acts to prohibit various forms of fraud and to stabilize the securities industry by requiring that all essential information concerning the issue of stock be made available to the investing public.

The 1933 Act is basically a disclosure statute and paper act. This means that the act permits a corporation to sell "junk" (or referred at the time as junk bonds) as long as appropriate disclosures are made through registration statements and prospectus delivery. The major aspects of the act include:

• Issuers of securities must file registration statement
• Prospectuses must be provided to all purchasers of new issues with full and fair disclosures
• Fraudulent activity in connection with underwriting and issuing of all securities is prohibited.

The Securities Exchange Act of 1934 was a further reaction by the legislature to the crash of 1929. It picks up where the Act of 1933 finished, by addressing fraudulent practices in the secondary market.

The Securities Exchange Act of 1934 has often been referred to as the People Act since it regulates all persons involved in trading securities on behalf of customers. It encompasses the regulation and registration of brokers and dealers and national security associations.

What is most fascinating about the 1934 Act are the agencies and regulations it was responsible for creating. For example, the creation of the SEC (Security and Exchange Commission), regulations of credit by the Federal Reserve Board, regulations of insider trading, and reporting requirements for issuers are all the direct result of the enactment of the Securities Exchange Act of 1934.

In the early twenty-first century, the most significant statutory scheme regulating corporations was the passage of the Sarbanes-Oxley (SOX) Act in 2002. SOX requires top management to personally certify the accuracy of financial information, boosts the oversight responsibilities of boards of directors, and prohibits the outsourcing of internal audit functions to a company's external auditor. Prawitt, Sharp & Wood (2012) find that accounting risk is more closely associated with the quality of IAF and that oursourcing all or parts of IAF to an external auditor reduced rather than exacerbated risk; however, Singer & You (2011) reported greater invester confidence following SOX and the resulting flurry of financial restatements. After the financial crisis of 2008, in which large companies failed while their executives received substantial compensation packages, the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) was passed. Dodd-Frank requires a nonbinding shareholder vote on compansation for top executives. Though a number of lawsuits were brought by shareholders after negative votes were overruled by boards, courts were inclined to dismiss cases on procedural grounds. As plaintiff switched tactics, legal expenses for companies mounted and settlements became common. By 2013, the legal environment surrounding executive compensation at public companies remained troubled (Wilkerson, 2013).

Case Law & Judicial Precedent

Courts are responsible for adjudicating alleged violations of and disagreements that arise under legal jurisdiction. The courts are responsible for interpreting the law. A courts interpretation of the law is dependent upon previous court interpretations of the law; this is referred to as the “principle of stare decisis,” or simply, precedent. Stare decisis ensures consistency and predictability in the law and in interpretation. In situations where the precedent is unfavorable to a particular case, attempts are made to differentiate the current case from the former case and decision.

It is the responsibility of the higher courts to resolve any inconsistencies in rulings; the ultimate court being The Supreme Court, whose rulings apply to all the lower federal courts. Stare decisis also applies in the various state court systems.

Stare decisis is exemplified in the case that was brought against Enron’s accounting firm Arthur Anderson. Charges of obstructing an official proceeding of the Securities and Exchange Commission was filed against the accounting firm in a Texas District Court in 2002. The jury found Arthur Anderson guilty. Anderson Corporation appealed the decision to the United States Court of Appeals for the Fifth Circuit. The fifth circuit affirmed the district court’s decision (stare decisis). Arthur Andersen v. United States, 73 U.S.L.W. 4393 (2002)]

Common Law

When there is no particular statute or provision, common law is said to exist. Common law is a collection of judicial decisions, customs, and general principles upon which federal and state courts rely. Because many state legislatures refrain from ruling on multiple contigencies, common law holds high importance, especially in contract disputes.

In response to common law, a secondary area of legal authority was developed. Beginning in the 1920's a distinguished group of judges, lawyers, and law school professors established the American Law Institute, known as the ALI. The ALI composed "restatements of the general common law of the United States, including in that term not only the law developed solely by judicial decision, but also the law that has grown from the application by the courts of statutes that were generally enacted and were in force for many years." [Wolkin, (1940) Restatements of the Law: Origin, Preparation, Availability, 21 Ohio B.A, Rept. 663] These restatements cover many important areas of common law that include: torts, contracts, agency law, property, and trusts.

Administrative Law

Administrative law is the branch of public law created by administrative agencies. It is important that we look at Administrative law, since Administrative agencies create rules, regulations, orders, and act as the primary interpreters and enforcers of business regulatory schemes like the Security and Exchange Commission, U.S. Federal Trade Commission, Equal Employment Opportunity Commission, Occupational Safety & Health Administration, and Environmental Protection Agency. They possess both judicial authority as well as executive powers. Keep in mind that Administrative agencies are created by federal, state, and local governments. When Congress enacts a statute, it often creates an administrative agency to administer the statute and creates administrative rules and procedures that reflect the agency's needs and ability to effectively operate.

Codification of Law

Codifications of law came about due to demands by the business community lobbying for uniformity in commercial transactions. These tenacious efforts led to the development of uniform business protocols. One of the best known of these codifications has been the Uniform Commercial Code; better known as the UCC. After its completion in 1952, the UCC was systematically adopted by 49 states (except Louisiana).

The NCCUSL (National Conference of Commissioners on Uniform State Laws) besides drafting the UCC also drafted more that 200 uniform laws including the Uniform Partnership Act, the Uniform Limited Partnership Act, and the Unified Probate Code. These codifications expanded and codified existing commercial transaction law; unifying the states' business legal frameworks specific to the business community's needs.

Keep in mind the impact this has had on the expanding national economy. Prior to these codifications, most states had enacted statutes dealing with branches of commercial law, resulting in great diversity among states which ultimately was detrimental to commerce on a national scale. These codifications unified commercial enterprise leading to a more effective and productive national economy.

Conclusion

The legal environments of business and the areas of existing legal precedence that touch and affect businesses and the business community on a daily basis are vast. Whether it is criminal, civil, constitutional, statutory, common, or administrative, all have a stake in business and commerce and therefore influence the business horizon as we know it today. Business professionals need to not only think and act globally, but also understand the underling legal fabric that surrounds businesses in our global economy.

Terms & Concepts

Administrative Law: Administrative law is the branch of public law created by administrative agencies. It is important that we look at Administrative law, since Administrative agencies create rules, regulations, orders, and act as the primary interpreters and enforcers of business regulatory schemes.

Case Law: The collection of reported cases that create the body of law within a certain jurisdiction.

Commerce Clause: US Constitution Article I, §8, cl. 3, which gives Congress the exclusive power to oversee commerce between states.

Common Law: The body of law derived from judicial decisions rather than from statutes or the Constitution.

Procedural Law: Defines the steps which allow for a right or duty to be judicially enforced; in conrast to law which defines the rights and duties themselves.

Securities Act: A federal or state law protecting the public by regulating the registration, offering, and trading of securities.

Securities Act of 1933: Federal law which requires public disclosure of financial and similarly vital organizational information with regard to public security offerings.

Securities Act of 1934: TThe federal law regulating the public trading of securities. This law provides for the registration and supervision of securities exchanges and brokers, and regulates exchanges and brokers, and regulates proxy solicitations.

Statute: A law passed by a legislative body.

Statutory Law: Collection of laws created through statute rather than from the constitution or judicial rulings.

Substantive Law: Law concerning personal power, rights and duties.

Uniform Commercial Code (U.C.C.): Country-wide law concerning the sale of goods, secured transaction and negotiable instruments.

Bibliography

Franklin, M.A., Rabin, R.L. (2001). Tort Law and Alternatives. New York: University Casebook Series.

Geldart, W., (1984) Introduction to English Law, 146 D.C.M. Yardley ed. 9.

Klein, W.A., Ramseyer, M.J., & Bainbridge, S.M. (2001). Business Associations. New York: University Casebook Series.

Knapp, C.L., Crystal, N.M., & Prince, H.G., (2003). Problems in Contract Law. New York: Aspen.

Michel, S.D. (2003, Nov-Dec). Corporate tax departments and the new focus on corporate criminality. The Tax Executive. Retrieved March 14, 2007, from FindArticles.com. http://findarticles.com/p/articles/mi_m6552/is_6_55/ai_n6049582/pg_1

Prawitt, D.F., Sharp, N.Y., & Wood, D.A. (2012). Internal audit outsourcing and the risk of misleading or fraudulent financial reporting: Did Sarbanes-Oxley get it wrong? Contemporary Accounting Research, 29, 1109-1136. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=84385459&site=ehost-live

Singer, Z., & You, H. (2011). The Effect of Section 404 of the Sarbanes-Oxley Act on earnings quality. Journal of Accounting, Auditing & Finance, 26, 556-589. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=66335781&site=ehost-live

Sloan, A. (2013). Are we ready for the next meltdown?. Fortune, 168, 151. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90052547&site=ehost-live

Subrin, S.N., Minow, M.L., Brodin, M.S., & Main, T.O. (2000), Civil Procedure: Doctrine, Practice, and Context. New York: Aspen.

Wilkerson, A.T. (2013). The continuing evolution of litigation regarding the say-on-pay voting requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Benefits Law Journal, 26, 75-87. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85940593&site=ehost-live

Wolkin, (1940). Preparation, Availability, Restatements of the Law: Origin. 21, Ohio B.A, Rept. 663

Suggested Reading

Arewa, O. B. (2005). Comment: Corporate governance events: legal rules, business environment and corporate culture. Case Western Reserve Law Review, 55, 545-550. Retrieved March 14, 2007, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=18622622&site=ehost-live

Dickerson, C. (2005). Ignorance of the law. InfoWorld, 27, 20. Retrieved March 14, 2007, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=16406918&site=ehost-live

Ennico, C. (2005). New year's resolutions for businesses in 2005. Enterprise/Salt Lake City, 34 , 9. Retrieved from EBSCO Online Database Regional Business News. http://search.ebscohost.com/login.aspx?direct=true&db=bwh&AN=15632179&site=ehost-live