Business Law in California

Chapter 1

LAW AND BUSINESS

INTRODUCTION

In order to better understand what business law includes, we need to examine the various components of the U.S. legal system. This chapter will illustrate how its elements are combined to provide the law governing business.

DEFINITIONS

Before examining the U.S. legal system, certain terms should be defined. A law is a pronouncement from a legislature which provides parameters for conduct in society. It is synonymous with the term statute. A regulation is also a pronouncement which provides guidelines for societal conduct. However, it is issued by an agency rather than by a legislature.

CIVIL LAW V. COMMON LAW

The law that any legislative body may enact can broadly be separated between civil law and common law. Civil law, modeled after the Roman legal system, tries to set down all possible laws concerning all possible situations at one time. Common law, on the other hand, is most concerned with precedent. The concept of precedent deals with solving current problems utilizing past solutions. U.S. common law is derived from England’s legal system.

Both methods of formulating law are used in the United States. Common law, though, is by far the most predominant. Because of its intent, common law can more effectively deal with the contemporary problems of society. It doesn’t have to try and anticipate what problems might occur.

LAW FORMATION

As indicated above, governmental legislatures can institute a law. However, there are many other ways of establishing laws on both the federal, state and local levels.

(I) The Federal Level

(A) The Constitution of the United States- Law in the United States comes from a variety of sources. The supreme law of the land is the U.S. Constitution. It provides the basic framework for our governmental, legislative, and judicial systems as well as providing for basic rights for all citizens. It supersedes all law that may come from any other source.

While the Constitution does not have a specific set of codified laws dealing exclusively with business law, it nonetheless does have impact in the area. For example, the rights of entrepreneurs and customers are guaranteed by the Bill of Rights. These rights are included in the first ten amendments to the Constitution.

(B) The legislative branch- The bulk of national law comes from the United States Congress, which is comprised of the House of Representatives and the Senate. The Congress is by far the most powerful legislative body in America. Besides passing laws, Congress also has the power of appropriating funds for fulfilling various governmental obligations.

Much of business law is initiated at the federal level. Notable examples of applicable laws are the federal antitrust laws, the Bankruptcy Code, and the Limited Uniform Partnership Act.

(C) The executive branch- The executive branch enacts law in a slightly different manner than its legislative counterpart. The President can issue executive orders. While not as prevalent or pervasive as statutes, executive orders do carry legal status.

In the area of business law, the executive branch does not play a major role.

(D) The judicial branch- When the United States first formed into a nation, they didn’t have a set of codified laws as we have today. The courts served the purpose of resolving conflicts and setting precedents which would assist in how similar future conflicts should be handled. The legislature could then recognize the need for a law covering the problem dealt with. In the future, the courts would not only have a precedent but also a law with which to render a verdict.

It should be noted that not all decisions provide a valuable precedent. Sometimes, the legislature may pass a law that deals with the problem in a different manner. In this case, the court still played an important role in that it presented the need for the law. Judges are not bound to follow a precedent just as legislatures are not bound. The tradition of common law is an unwritten one.

Presently, there are volumes upon volumes of laws on the books. The courts play the important role of interpreting the intent of those laws. The intent may not always be clear. Because our society is constantly changing, new conflicts are continually arising. The courts then revert back to presenting the need for formal legislation. In any case, the vast majority of statutes on the books today came about because the courts had to deal with a new problem not previously covered by law. The legislature then formalized the resolution to the problem.

Thus, the role of the judicial branch in the formation of law is two-fold. It serves the functions of presenting the need for a law and interpreting an existing law.

(E) The agencies- Agencies do not pass laws. Rather, they provide regulations for the fulfillment of statutes enacted by Congress. Federal agencies play a part in shaping business law by passing certain business regulations.

(II) The State Level

(A) Legislative authority- The U.S. Constitution allows the individual states to enact laws covering their citizens. This authority is provided by the Bill of Rights to the Constitution. It states that, The powers not delegated to the United States by the Constitution nor prohibited to it by the states are reserved to the states respectively or to the people. This concept of limited self-rule by the individual states is called federalism.

The rationale behind federalism was to ensure that the states did not lose all of their governing power over themselves. This concept of a decentralized government allows the individual states to tailor their laws to fit their own unique needs.

As indicated above, the scope of the states’ authority to legislate has certain limitations. They cannot exceed their delegated power. In addition, they cannot contradict federal statutes.

The concept of federalism provides the foundation for self-rule. The explicit authority to enact and enforce laws on the state level is provided by the concept of police power of the state. Specifically, police power is the authority of the state to enact legislation within federal and state constitutional limitations in order to ensure the safety, health, morals and general welfare of the people of the state.

(B) Mechanisms for law formation- The greatest contributor of statutes on the state level is the state legislature. Its function is similar to its federal counterpart. Some of the statutes in the area of business law come from the California Legislature. They cover such topics as the legal constraints of certain business forms, property law, the Statute of Frauds, and the Statute of Limitations. They are contained in California Codes such as the Civil Code, the Code of Civil Procedures, the Corporations Code, the Government Code, and the Health and Safety Code. As stated before, the laws that the State of California passes must not contradict the Federal Constitution, any federal law or the Constitution of California.

State agencies play an important role in providing guidelines for the business community. These agencies issue regulations which assist companies in complying with the various laws. Of particular importance to real estate agents is the California Department of Real Estate. The principal office is located at 1719 24th Street, Sacramento.

(III) The Local Level

Local governments are given very little power with which to legislate laws in comparison to the federal or state levels. The areas which they are authorized to legislate include laws such as zoning ordinances and building codes. However, since these considerations are vital to any business, they do have an impact.

TYPES OF LAW

Law can be broken down into many categories. The distinction between civil law and common law lies in how a law is formulated. For our purposes, a more important distinction exists in discriminating between the different types of law.

The two broad types of law are public law and private law. Public law is concerned with disputes in which at least one party is the government. Private law, on the other hand, deals with conflicts between two private citizens.

Public law is the most visible form of law to the average person. The principal fields of public law are administrative law, criminal law, constitutional law, labor law, tax law and trade regulations. Administrative law deals with the powers of the different sections of the government, except the judicial and legislative, that affect private interests. Criminal law is concerned with felony and misdemeanor crimes. Constitutional law studies the determinations of the United States Supreme Court that have interpreted the U.S. Constitution. Labor law affects workers because of their employment relationship. Tax law covers the taxation of private individuals and groups. Trade regulations control the marketplace and are designed to encourage competition and protect the rights of all parties through such measures as antitrust laws, patents, and copyrights.

Private law can be divided into business enterprises, commercial law, contract law, family law, and tort law. The law of business enterprises actually is subdivided into such areas as individual proprietorship law, partnership law, and most notably, corporate law. Commercial law deals with, as the preamble of the Uniform Commercial Code states, Certain commercial transactions in or regarding personal property and contracts and other documents concerning them. Contract law deals with enforcing agreements between consenting parties. Family law covers the relationship between spouses and between parent and child. Tort law deals with civil wrongs, other than breach of contract, where a conflict exists with commercial or social advantage, person, reputation or property.

BUSINESS LAW

Business law does not originate from one, primary source. Rather, it evolves from many sources and encompasses many different types of law. Business law is a composite of the various components of our legal and political systems. As such, this book will examine many diverse sources of laws, regulations and applicable concepts.

(I) Infractions of Business Law

There are a myriad of possible infractions of law in the United States. However, only a select few of them apply to business law. They can be divided into business torts and business crimes.

(A) Business torts- As a reminder, a tort is a civil wrong, independent of a contract, which results from a breach of a legal duty. The following activities would be considered as business torts.

1. Negligence - This results when a wrong results from not exercising reasonable care.

2. Fraud - This occurs when an injury results from a misrepresentation of a material fact. Fraud can be constructive or actual. Constructive fraud contains no intent to defraud. Actual fraud contains such an intent.

3. Defamation - This is a communication to a third party that injures the name or reputation of another party. Written defamation is called libel. Oral defamation is called slander.

4. Invasion of privacy - This occurs when there is the unlawful disclosure of damaging facts concerning another party.

5. Nuisance - This is the unnecessary interference with a person’s use and enjoyment of property.

6. Conversion - This is the unreasonable interference with a person’s control over property.

7. Unfair competition - This action unduly grants a competitive edge to a single business.

NOTE: There are other types of torts. The ones mentioned above are most closely associated with business law.

(B) Business crimes- A crime is a wrong which is punishable through governmental means. The following activities would be considered as business crimes.

1. Embezzlement - This occurs when a party entrusted with the property of another misappropriates that property.

2. Larceny - This results when a person physically takes the property of another with the intention of permanently depriving the owner of possession.

3. Forgery - This involves the falsification of any legal document.

4. Gross negligence - This is the failure to exercise even the slightest degree of care when performing an activity. While slight negligence and ordinary negligence are infractions of tort law, gross negligence is a criminal offense.

NOTE: There are other types of crimes. The ones mentioned above are most closely associated with business crimes.

ENFORCEMENT OF LAW

There is an elaborate court system which is designed to deal with all possible types of legal infractions. The judicial structure can be logically divided into the federal courts and the state courts.

(I) Federal Courts

There are three types of federal courts. They include federal district courts, U.S. courts of appeal, and the U.S. Supreme Court. Federal district courts are known as trial courts. They are granted original jurisdiction in the following types of legal cases.

1. Ones involving a federal question.

2. Ones involving a diversity of state citizenship where the value in the dispute exceeds $10,000.

3. Ones initiated under federal statutes.

U.S. courts of appeal are known as federal appellate courts. There is a federal appellate court for each judicial circuit. The United States is divided into eleven such circuits. U.S. courts of appeal hear appeals of decisions made by federal district courts. They also deal with most appeals of decisions rendered by federal administrative agencies.

The highest court in the country is the U.S. Supreme Court. Because of its unique position of power, it is composed of a Chief Justice and eight Associate Justices. The court has original jurisdiction over a small portion of cases. Normally, however, the court is petitioned by a concerned party to issue a writ of certiorari. This requires a lower court to send a case to the Supreme Court for review.

(II) State Courts

The state court structure is composed of trial courts, intermediate appellate courts, and highest appellate courts. State trial courts have original jurisdiction in cases involving the state court system. The jurisdiction can be limited or unlimited. The notable example of a limited jurisdiction trial court is the small claims court.

Intermediate appellate courts hear appeals on decisions rendered by the state trial courts. They are designed to relieve some of the caseload from the highest appellate court.

The highest appellate court is called by several titles. In California, it is known as the State Supreme Court. The Court renders the final decision in most appealed cases. An exception to this occurs if a federal constitutional question exists. In this case, the U.S. Supreme Court may be petitioned.

LEGAL TERMINOLOGY

Before examining the specific areas of business law, an understanding of appropriate legal terminology is necessary. You may be a party in a legal action in the future. To better protect your business, the following terms should be studied.

1. Plaintiff - The party who initiates a suit. The person is also known as the petitioner.

2. Defendant - The party who is subject to a suit. The person is also known as the respondent.

3. Pleadings - The required forms to initiate court action.

4. Complaint - The plaintiff’s initial pleading.

5. Motion - A request for action by a court.

6. Deposition - A statement made under oath.

7. Lis pendens - A pending lawsuit.

8. Decision - The final judgment of the court.

9. Opinion - The rationale for a decision.

10. Verdict - Final outcome of a case.

THE REAL ESTATE BUSINESS ENVIRONMENT

Any company must exist in the business environment. It is imperative that you fully understand this environment. It will enable you to better apply the various principles of business law.

The primary aspect of the real estate business environment is the financing of property. It does not take place in a vacuum. Many factors interact together. These conditions comprise the real estate business environment. The reader should keep in mind that this environment is not static.

A HISTORICAL PERSPECTIVE

Real estate financing has been around for many years. However, its early formation was very unfavorable for the borrower. Prior to the Great Depression, the borrower traditionally only obtained a loan for an approximate period of five years. Interest payments were made periodically. The entire principal amount was due in a lump sum at the end of the loan period. Even in a good economy, this system provided problems for the borrower.

With the advent of the disastrous economic crisis of 1929, borrowers could no longer meet these extreme loan conditions. Mass foreclosures resulted. As is always the case, neither party benefited from this situation. The borrower had no home in which to live in. The lender, on the other hand, was stuck with property that was of little value. Property values became depressed. In addition, consumers could no longer afford to purchase property because of the mass unemployment.

To counteract this problem, the Federal Government instituted many programs. Of major significance was the formation of the Federal Housing Administration (FHA). Under it, fixed-rate loans were made for periods up to 40 years in duration. Principal and interest payments were paid monthly with no balloon payment.

To counteract the unprecedented withdrawal of funds that accompanied the start of the Depression, the Federal Deposit Insurance Corporation (FDIC) and the Federal Savings and Loan Insurance Corporation (FSLIC) were created. They provided stability for the financial institutions by insuring the funds of individual depositors. This sense of security helped restore the depositors’ confidence in the institutions.

With this renewed confidence, the financial environment stabilized. Consumers could afford to borrow the capital to buy property. As a result, housing construction increased. After World War II, the demand for housing became phenomenal.

Conditions were very conducive to expansion. Several credit crunches appeared from time to time. However, the market always seemed to recover. Growth in housing construction continued.

Finally, in the 1970s, the credit crunch became very severe. Depositors were withdrawing their funds from regular savings accounts earning low interest and reinvesting their capital in high-yield investments. This practice is known as disintermediation. In an effort to keep the investors’ capital, institutions were forced to offer higher interest rates on their savings accounts. At the same time, borrowers were still paying the same low, fixed rate that was assured to them years before. The institutions were losing money. Many of them went out of business. Those that managed to survive encountered a lack of working capital with which to loan.

In an effort to remain viable and profitable in an ever changing economy, several changes occurred in the policies and procedures of lenders. Many different types of loan packages were developed that could be altered to accommodate changes in the market. These packages, which will be detailed later, include such innovations as the variable rate loan and the graduated payment plan. Also, the nature of the loan instruments has been changed. This will also be examined later.

Methods of Financial Exchange

Throughout history, different societies have used different methods of financial exchange. The most basic form is commodity money. It uses items such as animal skins, tobacco and tea. Conversely, symbolic money uses items that have extrinsic value. They do not necessarily have value in and of themselves. However, their value is accepted by all in the society. Examples of symbolic money include shells, precious stones and coins.

The United States uses the symbolic method of financial exchange. In the system, four types of symbolic money are used. They include coins, paper currency, demand deposits and credit.

Coins make up approximately two percent of our total money supply. The coin system includes the penny, nickel, dime, quarter, half-dollar, silver dollar, and Susan B. Anthony dollar. Half-dollars and silver dollars are seldom used by the public. The Susan B. Anthony dollar was issued for only a short time. It is no longer made because it resembled a quarter too closely. This caused confusion.

Paper money constitutes approximately 20 percent of our total money supply. Paper bills are essentially promissory notes that are issued by the Federal Reserve. Contrary to popular opinion, our paper money is not backed by gold. In

1933, the United States went off the gold standard. While each paper dollar is backed with a small portion of gold, its main protection is the confidence of the American people. Without it, the dollar would fall dramatically and not be universally honored.

Demand deposits are negotiable instruments drawn against checking accounts. They are commonly called checks. Demand deposits constitute approximately 78 percent of our total money supply. They play an integral role in our current society. The use of demand deposits should continue to grow as we gravitate toward a coinless and paperless money society.

The final method of financial exchange is the use of credit. This method of exchange is not considered a part of the nation’s money supply. Instead, it is a supplement to the money supply.

Like demand deposits, the use of credit has increased tremendously over the years. This trend is vividly illustrated in Figure 1-1.

With the credit system, a seller forwards products or services to a party who does not have the capital to afford the entire amount at that time. The seller relies upon the promise of the buyer to repay the debt in the future. Often, the buyer will have to show the ability to pay the debt with his or her employment record. In addition, a buyer normally must demonstrate a propensity for paying credit obligations with a favorable credit history.

The concept of credit is a critical element in the practice of mortgage lending. Financial lenders forward capital to borrowers that allows them to buy property. The lenders extend this credit even though the borrower cannot presently afford to pay the entire obligation. Their inherent risks are rewarded with the payment of interest by the borrower. To lower their risk, real estate lenders usually require collateral. Collateral is anything of value that a borrower pledges as security on a loan. It guarantees that the lender will not suffer a complete financial loss in case of a loan default on the part of the borrower.

National Mortgage Market

As with any economic market, the national mortgage market is comprised of supply and demand. Without a supply of mortgage money, there would be no mortgage market. Conversely, without a demand for mortgage money, there would be no mortgage market.

(I) Mortgage Money Supply

There are many ways that money becomes a part of the mortgage money supply. However, the predominant source is savings of depositors. The depositors are usually only concerned with maximizing their return on their money. To pay this return, the entities which receive these deposits loan the deposited funds out to borrowers. The initial depositors may be unaware that their capital is helping to supply the money for the national mortgage market.

Figure 1-1

TRENDS IN CREDIT USAGE (IN BILLIONS OF DOLLARS)

* - Preliminary statistics

Note - Figures have been rounded.

Sources: United States League of Savings Associations, Federal Reserve Board

(II) Mortgage Money Demand

Demand is generated from three main sources. They include construction loans, sales financing, and refinancing.

Construction loans are necessary to assist the builder in buying the property and constructing the buildings. A major party who utilizes this type of loan is the subdivider. The loan can be made in installments or as a lump sum. The amount of the loan can be based upon a guaranteed price or on a cost-plus price basis.

Mortgage demand is normally thought of as sales financing. With sales financing, a buyer is loaned a portion of the total purchase price of a piece of property. Licensees will be most familiar with this type of mortgage money demand.

Refinancing is a prevalent source of demand. Refinancing refers to the practice of financing property which was not previously financed or to renew or extend existing financing. It has traditionally been associated with raising needed money by tapping into the equity of a person’s property. With the decline of the fixed-rate mortgage, borrowers are facing the problem of altering mortgage terms in order to not default on payments. This is due to problems such as increased interest charges on adjustable rate mortgages and accelerated payments on graduated payment plans.

The demand for mortgage money has continued to increase over the years. According to the Federal Reserve Board, in 1960, the total amount of outstanding mortgage loans for all properties was $208.9 billion. This included residential, commercial and farm properties. In 1970, the total amount was $473.1 billion. By 1980, the total amount skyrocketed to $1.4 trillion. While some of the increase can be attributed to inflation, it does not provide an adequate reason. A better rationale is that the demand for mortgage money is greater than before.

External Forces Affecting the Mortgage Market