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Case Study Ethic Question

Read the case of Woolley v. Hoffman-LaRoche, Inc. listed below: If the employer had required employees to sign a document indicating that they had read and understood the requirements of the employment manual would that change the analysis in the case? Explain your reasoning. Case Study, reference content and further instructions listed below.

Topic 2 Case Study

Unilateral Contract and At-Will Employment

Woolley v. Hoffmann-La Roche, Inc.

491 A.2d 1257 (N.J. 1985)

Wilntz, C. J.

Plaintiff, Richard Woolley, was hired by defendant, Hoffmann-La Roche, Inc., in October 1969, as an Engineering Section Head in defendant’s Central Engineering Department at Nutley. There was no written employment contract between plaintiff and defendant. Plaintiff began work in mid-November 1969. Sometime in December, plaintiff received and read the personnel manual on which his claims are based.

[The company’s personnel manual had eight pages;] five of the eight pages are devoted to “termination.” In addition to setting forth the purpose and policy of the termination section, it defines “the types of termination” as “layoff,” “discharge due to performance,” “discharge, disciplinary,” “retirement” and “resignation.” As one might expect, layoff is a termination caused by lack of work, retirement a termination caused by age, resignation a termination on the initiative of the employee, and discharge due to performance and discharge, disciplinary, are both terminations for cause. There is no category set forth for discharge without cause. The termination section includes “Guidelines for discharge due to performance,” consisting of a fairly detailed procedure to be used before an employee may be fired for cause. Preceding these definitions of the five categories of termination is a section on “Policy,” the first sentence of which provides: “It is the policy of Hoffmann-La Roche to retain to the extent consistent with company requirements, the services of all employees who perform their duties efficiently and effectively.”

In 1976, plaintiff was promoted, and in January 1977 he was promoted again, this latter time to Group Leader for the Civil Engineering, the Piping Design, the Plant Layout, and the Standards and Systems Sections. In March 1978, plaintiff was directed to write a report to his supervisors about piping problems in one of defendant’s buildings in Nutley. This report was written and submitted to plaintiff’s immediate supervisor on April 5, 1978. On May 3, 1978, stating that the General Manager of defendant’s Corporate Engineering Department had lost confidence in him, plaintiff’s supervisors requested his resignation. Following this, by letter dated May 22, 1978, plaintiff was formally asked for his resignation, to be effective July 15, 1978.

Plaintiff refused to resign. Two weeks later defendant again requested plaintiff’s resignation, and told him he would be fired if he did not resign. Plaintiff again declined, and he was fired in July.

Plaintiff filed a complaint alleging breach of contract.…The gist of plaintiff’s breach of contract claim is that the express and implied promises in defendant’s employment manual created a contract under which he could not be fired at will, but rather only for cause, and then only after the procedures outlined in the manual were followed. Plaintiff contends that he was not dismissed for good cause, and that his firing was a breach of contract.

Defendant’s motion for summary judgment was granted by the trial court, which held that the employment manual was not contractually binding on defendant, thus allowing defendant to terminate plaintiff’s employment at will. The Appellate Division affirmed. We granted certification.

The employer’s contention here is that the distribution of the manual was simply an expression of the company’s “philosophy” and therefore free of any possible contractual consequences. The former employee claims it could reasonably be read as an explicit statement of company policies intended to be followed by the company in the same manner as if they were expressed in an agreement signed by both employer and employees.…

This Court has long recognized the capacity of the common law to develop and adapt to current needs.…The interests of employees, employers, and the public lead to the conclusion that the common law of New Jersey should limit the right of an employer to fire an employee at will.

In order for an offer in the form of a promise to become enforceable, it must be accepted. Acceptance will depend on what the promisor bargained for: he may have bargained for a return promise that, if given, would result in a bilateral contract, both promises becoming enforceable. Or he may have bargained for some action or nonaction that, if given or withheld, would render his promise enforceable as a unilateral contract. In most of the cases involving an employer’s personnel policy manual, the document is prepared without any negotiations and is voluntarily distributed to the workforce by the employer. It seeks no return promise from the employees. It is reasonable to interpret it as seeking continued work from the employees, who, in most cases, are free to quit since they are almost always employees at will, not simply in the sense that the employer can fire them without cause, but in the sense that they can quit without breaching any obligation. Thus analyzed, the manual is an offer that seeks the formation of a unilateral contract—the employees’ bargained-for action needed to make the offer binding being their continued work when they have no obligation to continue.

The unilateral contract analysis is perfectly adequate for that employee who was aware of the manual and who continued to work intending that continuation to be the action in exchange for the employer’s promise; it is even more helpful in support of that conclusion if, but for the employer’s policy manual, the employee would have quit. See generally M. Petit, “Modern Unilateral Contracts,” 63 Boston Univ. Law Rev. 551 (1983) (judicial use of unilateral contract analysis in employment cases is widespread).

…All that this opinion requires of an employer is that it be fair. It would be unfair to allow an employer to distribute a policy manual that makes the workforce believe that certain promises have been made and then to allow the employer to renege on those promises. What is sought here is basic honesty: if the employer, for whatever reason, does not want the manual to be capable of being construed by the court as a binding contract, there are simple ways to attain that goal. All that need be done is the inclusion in a very prominent position of an appropriate statement that there is no promise of any kind by the employer contained in the manual; that regardless of what the manual says or provides, the employer promises nothing and remains free to change wages and all other working conditions without having to consult anyone and without anyone’s agreement; and that the employer continues to have the absolute power to fire anyone with or without good cause.

Reference 1- 4

Reference 1

The Law, Sales, and Marketing v 1.0

Chapter 8

Introduction to Contract Law

LEARNING OBJECTIVES

After reading this chapter, you should understand the following:

Why and how contract law has developed

What a contract is

What topics will be discussed in the contracts chapter of this book

What the sources of contract law are

How contracts are classified (basic taxonomy)

8.1 General Perspectives on Contracts

LEARNING OBJECTIVES

Explain contract law’s cultural roots: how it has evolved as capitalism has evolved.

Understand that contracts serve essential economic purposes.

Define contract.

Understand the basic issues in contract law.

The Role of Contracts in Modern Society

Contract is probably the most familiar legal concept in our society because it is so central to the essence of our political, economic, and social life. In common parlance, contract is used interchangeably with agreement, bargain, undertaking, or deal. Whatever the word, the concept it embodies is our notion of freedom to pursue our own lives together with others. Contract is central because it is the means by which a free society orders what would otherwise be a jostling, frenetic anarchy.

So commonplace is the concept of contract—and our freedom to make contracts with each other—that it is difficult to imagine a time when contracts were rare, when people’s everyday associations with one another were not freely determined. Yet in historical terms, it was not so long ago that contracts were rare, entered into if at all by very few: that affairs should be ordered based on mutual assent was mostly unknown. In primitive societies and in feudal Europe, relationships among people were largely fixed; traditions spelled out duties that each person owed to family, tribe, or manor. People were born into an ascribed position—a status (not unlike the caste system still existing in India)—and social mobility was limited. Sir Henry Maine, a nineteenth-century British historian, wrote that “the movement of the progressive societies has…been a movement from status to contract.”Sir Henry Maine, Ancient Law (1869), 180–82. This movement was not accidental—it developed with the emerging industrial order. From the fifteenth to the nineteenth century, England evolved into a booming mercantile economy, with flourishing trade, growing cities, an expanding monetary system, the commercialization of agriculture, and mushrooming manufacturing. With this evolution, contract law was created of necessity.

Contract law did not develop according to a conscious plan, however. It was a response to changing conditions, and the judges who created it frequently resisted, preferring the imagined quieter pastoral life of their forefathers. Not until the nineteenth century, in both the United States and England, did a full-fledged law of contracts arise together with, and help create, modern capitalism.

Modern capitalism, indeed, would not be possible without contract law. So it is that in planned economies, like those of the former Soviet Union and precapitalistic China, the contract did not determine the nature of an economic transaction. That transaction was first set forth by the state’s planning authorities; only thereafter were the predetermined provisions set down in a written contract. Modern capitalism has demanded new contract regimes in Russia and China; the latter adopted its Revised Contract Law in 1999.

Contract law may be viewed economically as well as culturally. In An Economic Analysis of Law, Judge Richard A. Posner (a former University of Chicago law professor) suggests that contract law performs three significant economic functions. First, it helps maintain incentives for individuals to exchange goods and services efficiently. Second, it reduces the costs of economic transactions because its very existence means that the parties need not go to the trouble of negotiating a variety of rules and terms already spelled out. Third, the law of contracts alerts the parties to troubles that have arisen in the past, thus making it easier to plan the transactions more intelligently and avoid potential pitfalls.Richard A. Posner, Economic Analysis of Law (New York: Aspen, 1973).

The Definition of Contract

As usual in the law, the legal definition of contract is formalistic. The Restatement (Second) of Contracts (Section 1) says, “A contract is a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty.” Similarly, the Uniform Commercial Code says, “‘Contract’ means the total legal obligation which results from the parties’ agreement as affected by this Act and any other applicable rules of law.”Uniform Commercial Code, Section 1-201(11). As operational definitions, these two are circular; in effect, a contract is defined as an agreement that the law will hold the parties to.

Most simply, a contract is a legally enforceable promise. This implies that not every promise or agreement creates a binding contract; if every promise did, the simple definition set out in the preceding sentence would read, “A contract is a promise.” But—again—a contract is not simply a promise: it is a legally enforceable promise. The law takes into account the way in which contracts are made, by whom they are made, and for what purposes they are made. For example, in many states, a wager is unenforceable, even though both parties “shake” on the bet. We will explore these issues in the chapters to come.

Overview of the Contracts Chapter

Although contract law has many wrinkles and nuances, it consists of four principal inquiries, each of which will be taken up in subsequent chapters:

Did the parties create a valid contract? Four elements are necessary for a valid contract:

Mutual assent (i.e., offer and acceptance), Chapter 9 “The Agreement”

Real assent (no duress, undue influence, misrepresentation, mistake, or incapacity), Chapter 10 “Real Assent”

Consideration, Chapter 11 “Consideration”

Legality, Chapter 12 “Legality”

What does the contract mean, and is it in the proper form to carry out this meaning? Sometimes contracts need to be in writing (or evidenced by some writing), or they can’t be enforced. Sometimes it isn’t clear what the contract means, and a court has to figure that out. These problems are taken up in Chapter 13 “Form and Meaning”.

Do persons other than the contracting parties have rights or duties under the contract? Can the right to receive a benefit from the contract be assigned, and can the duties be delegated so that a new person is responsible? Can persons not a party to the contract sue to enforce its terms? These questions are addressed in Chapter 14 “Third-Party Rights”.

How do contractual duties terminate, and what remedies are available if a party has breached the contract? These issues are taken up in Chapter 15 “Discharge of Obligations” and Chapter 16 “Remedies”.

Together, the answers to these four basic inquiries determine the rights and obligations of contracting parties.

KEY TAKEAWAY

Contract law developed when the strictures of feudalism dissipated, when a person’s position in society came to be determined by personal choice (by mutual agreement) and not by status (by how a person was born). Capitalism and contract law have developed together, because having choices in society means that people decide and agree to do things with and to each other, and those agreements bind the parties; the agreements must be enforceable.

Case Study Ethic EXERCISES

Why is contract law necessary in a society where a person’s status is not predetermined by birth?

Contract law serves some economic functions. What are they?

8.2 Sources of Contract Law

LEARNING OBJECTIVES

Understand that contract law comes from two sources: judges (cases) and legislation.

Know what the Restatement of Contracts is.

Recognize the Convention on Contracts for the International Sale of Goods.

The most important sources of contract law are state case law and state statutes (though there are also many federal statutes governing how contracts are made by and with the federal government).

Case Law

Law made by judges is called case law. Because contract law was made up in the common-law courtroom by individual judges as they applied rules to resolve disputes before them, it grew over time to formidable proportions. By the early twentieth century, tens of thousands of contract disputes had been submitted to the courts for resolution, and the published opinions, if collected in one place, would have filled dozens of bookshelves. Clearly this mass of material was too unwieldy for efficient use. A similar problem also had developed in the other leading branches of the common law.

Disturbed by the profusion of cases and the resulting uncertainty of the law, a group of prominent American judges, lawyers, and law teachers founded the American Law Institute (ALI) in 1923 to attempt to clarify, simplify, and improve the law. One of the ALI’s first projects, and ultimately one of its most successful, was the drafting of the Restatement of the Law of Contracts, completed in 1932. A revision—the Restatement (Second) of Contracts—was undertaken in 1964 and completed in 1979. Hereafter, references to “the Restatement” pertain to the Restatement (Second) of Contracts.

The Restatements—others exist in the fields of torts, agency, conflicts of laws, judgments, property, restitution, security, and trusts—are detailed analyses of the decided cases in each field. These analyses are made with an eye to discerning the various principles that have emerged from the courts, and to the maximum extent possible, the Restatements declare the law as the courts have determined it to be. The Restatements, guided by a reporter (the director of the project) and a staff of legal scholars, go through several so-called tentative drafts—sometimes as many as fifteen or twenty—and are screened by various committees within the ALI before they are eventually published as final documents.

The Restatement (Second) of Contracts won prompt respect in the courts and has been cited in innumerable cases. The Restatements are not authoritative, in the sense that they are not actual judicial precedents; but they are nevertheless weighty interpretive texts, and judges frequently look to them for guidance. They are as close to “black letter” rules of law as exist anywhere in the American common-law legal system.

Common law, case law (the terms are synonymous), governs contracts for the sale of real estate and services. “Services” refer to acts or deeds (like plumbing, drafting documents, driving a car) as opposed to the sale of property.

Statutory Law: The Uniform Commercial Code

Common-law contract principles govern contracts for real estate and services. Because of the historical development of the English legal system, contracts for the sale of goods came to be governed by a different body of legal rules. In its modern American manifestation, that body of rules is an important statute: the Uniform Commercial Code (UCC), especially Article 2, which deals with the sale of goods.

History of the UCC

A bit of history is in order. Before the UCC was written, commercial law varied, sometimes greatly, from state to state. This first proved a nuisance and then a serious impediment to business as the American economy became nationwide during the twentieth century. Although there had been some uniform laws concerned with commercial deals—including the Uniform Sales Act, first published in 1906—few were widely adopted and none nationally. As a result, the law governing sales of goods, negotiable instruments, warehouse receipts, securities, and other matters crucial to doing business in an industrial market economy was a crazy quilt of untidy provisions that did not mesh well from state to state.

The UCC is a model law developed by the ALI and the National Conference of Commissioners on Uniform State Laws; it has been adopted in one form or another by the legislatures in all fifty states, the District of Columbia, and the American territories. It is a “national” law not enacted by Congress—it is not federal law but uniform state law.

Initial drafting of the UCC began in 1942 and was ten years in the making, involving the efforts of hundreds of practicing lawyers, law teachers, and judges. A final draft, promulgated by the ALI, was endorsed by the American Bar Association and published in 1951. Various revisions followed in different states, threatening the uniformity of the UCC. The ALI responded by creating a permanent editorial board to oversee future revisions. In one or another of its various revisions, the UCC has been adopted in whole or in part in all American jurisdictions. The UCC is now a basic law of relevance to every business and business lawyer in the United States, even though it is not entirely uniform because different states have adopted it at various stages of its evolution—an evolution that continues still.

Organization of the UCC

The UCC consists of nine major substantive articles; each deals with separate though related subjects. The articles are as follows:

Article 1: General Provisions

Article 2: Sales

Article 2A: Leases

Article 3: Commercial Paper

Article 4: Bank Deposits and Collections

Article 4A: Funds Transfers

Article 5: Letters of Credit

Article 6: Bulk Transfers

Article 7: Warehouse Receipts, Bills of Lading, and Other Documents of Title

Article 8: Investment Securities

Article 9: Secured Transactions

Article 2 deals only with the sale of goods, which the UCC defines as “all things…which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid.”Uniform Commercial Code, Section 2-105. The only contracts and agreements covered by Article 2 are those relating to the present or future sale of goods.

Article 2 is divided in turn into six major parts: (1) Form, Formation, and Readjustment of Contract; (2) General Obligation and Construction of Contract; (3) Title, Creditors, and Good Faith Purchasers; (4) Performance; (5) Breach, Repudiation, and Excuse; and (6) Remedies. These topics will be discussed in Chapter 17 “Introduction to Sales and Leases”, Chapter 18 “Title and Risk of Loss”, Chapter 19 “Performance and Remedies”, Chapter 20 “Products Liability”, and Chapter 21 “Bailments and the Storage, Shipment, and Leasing of Goods”.

Figure 8.1 Sources of Law

International Sales Law

The Convention on Contracts for the International Sale of Goods

A Convention on Contracts for the International Sale of Goods (CISG) was approved in 1980 at a diplomatic conference in Vienna. (A convention is a preliminary agreement that serves as the basis for a formal treaty.) The CISG has been adopted by more than forty countries, including the United States.

The CISG is significant for three reasons. First, it is a uniform law governing the sale of goods—in effect, an international Uniform Commercial Code. The major goal of the drafters was to produce a uniform law acceptable to countries with different legal, social, and economic systems. Second, although provisions in the CISG are generally consistent with the UCC, there are significant differences. For instance, under the CISG, consideration (discussed in Chapter 11 “Consideration”) is not required to form a contract, and there is no Statute of Frauds (a requirement that certain contracts be evidenced by a writing). Third, the CISG represents the first attempt by the US Senate to reform the private law of business through its treaty powers, for the CISG preempts the UCC. The CISG is not mandatory: parties to an international contract for the sale of goods may choose to have their agreement governed by different law, perhaps the UCC, or perhaps, say, Japanese contract law. The CISG does not apply to contracts for the sale of (1) ships or aircraft, (2) electricity, or (3) goods bought for personal, family, or household use, nor does it apply (4) where the party furnishing the goods does so only incidentally to the labor or services part of the contract.

KEY TAKEAWAY

Judges have made contract law over several centuries by deciding cases that create, extend, or change the developing rules affecting contract formation, performance, and enforcement. The rules from the cases have been abstracted and organized in the Restatements of Contracts. To facilitate interstate commerce, contract law for many commercial transactions—especially the sale of goods—not traditionally within the purview of judges has been developed by legal scholars and presented for the states to adopt as the Uniform Commercial Code. There is an analogous Convention on Contracts for the International Sale of Goods, to which the United States is a party.

Case Study Ethic EXERCISES

How do judges make contract law?

What is the Restatement of the Law of Contracts, and why was it necessary?

Why was the Uniform Commercial Code developed, and by whom?

Who adopts the UCC as governing law?

What is the Convention on Contracts for the International Sale of Goods?

8.3 Basic Taxonomy of Contracts

LEARNING OBJECTIVES

Understand that contracts are classified according to the criteria of explicitness, mutuality, enforceability, and degree of completion and that some noncontract promises are nevertheless enforceable under the doctrine of promissory estoppel.

Keep your eyes (and ears) alert to the use of suffixes (word endings) in legal terminology that express relationships between parties.

Some contracts are written, some oral; some are explicit, some not. Because contracts can be formed, expressed, and enforced in a variety of ways, a taxonomy of contracts has developed that is useful in grouping together like legal consequences. In general, contracts are classified along four different dimensions: explicitness, mutuality, enforceability, and degree of completion. Explicitness is the degree to which the agreement is manifest to those not party to it. Mutuality takes into account whether promises are given by two parties or only one. Enforceability is the degree to which a given contract is binding. Completion considers whether the contract is yet to be performed or whether the obligations have been fully discharged by one or both parties. We will examine each of these concepts in turn.

Explicitness

Express Contract

An express contract is one in which the terms are spelled out directly. The parties to an express contract, whether it is written or oral, are conscious that they are making an enforceable agreement. For example, an agreement to purchase your neighbor’s car for $5,500 and to take title next Monday is an express contract.

Implied Contract (Implied in Fact)

An implied contract is one that is inferred from the actions of the parties. When parties have not discussed terms, an implied contract exists if it is clear from the conduct of both parties that they intended there be one. A delicatessen patron who asks for a turkey sandwich to go has made a contract and is obligated to pay when the sandwich is made. By ordering the food, the patron is implicitly agreeing to the price, whether posted or not.

The distinction between express and implied contracts has received a degree of notoriety in the so-called palimony cases, in which one member of an unmarried couple seeks a division of property after a long-standing live-together relationship has broken up. When a married couple divorces, their legal marriage contract is dissolved, and financial rights and obligations are spelled out in a huge body of domestic relations statutes and judicial decisions. No such laws exist for unmarried couples. However, about one-third of the states recognize common-law marriage, under which two people are deemed to be married if they live together with the intent to be married, regardless of their failure to have obtained a license or gone through a ceremony. Although there is no actual contract of marriage (no license), their behavior implies that the parties intended to be treated as if they were married.

Quasi-Contract

A quasi-contract (implied in law) is—unlike both express and implied contracts, which embody an actual agreement of the parties—an obligation said to be “imposed by law” in order to avoid unjust enrichment of one person at the expense of another. A quasi-contract is not a contract at all; it is a fiction that the courts created to prevent injustice. Suppose, for example, that the local lumberyard mistakenly delivers a load of lumber to your house, where you are repairing your deck. It was a neighbor on the next block who ordered the lumber, but you are happy to accept the load for free; since you never talked to the lumberyard, you figure you need not pay the bill. Although it is true there is no contract, the law implies a contract for the value of the material: of course you will have to pay for what you got and took. The existence of this implied contract does not depend on the intention of the parties.

Mutuality

Bilateral Contract

The typical contract is one in which the parties make mutual promises. Each is both promisor and promisee; that is, each pledges to do something, and each is the recipient of such a pledge. This type of contract is called a bilateral contract.

Unilateral Contract

Mutual promises are not necessary to constitute a contract. Unilateral contracts, in which one party performs an act in exchange for the other party’s promise, are equally valid. An offer of a reward—for catching a criminal or for returning a lost cat—is an example of a unilateral contract: there is an offer on one side, and the other side accepts by taking the action requested.

Figure 8.2 Bilateral and Unilateral Contracts

Enforceability

Void

Not every agreement between two people is a binding contract. An agreement that is lacking one of the legal elements of a contract is said to be a void contract—that is, not a contract at all. An agreement that is illegal—for example, a promise to commit a crime in return for a money payment—is void. Neither party to a void “contract” may enforce it.

Voidable

By contrast, a voidable contract is one that may become unenforceable by one party but can be enforced by the other. For example, a minor (any person under eighteen, in most states) may “avoid” a contract with an adult; the adult may not enforce the contract against the minor if the minor refuses to carry out the bargain. But the adult has no choice if the minor wishes the contract to be performed. (A contract may be voidable by both parties if both are minors.)

Ordinarily, the parties to a voidable contract are entitled to be restored to their original condition. Suppose you agree to buy your seventeen-year-old neighbor’s car. He delivers it to you in exchange for your agreement to pay him next week. He has the legal right to terminate the deal and recover the car, in which case you will of course have no obligation to pay him. If you have already paid him, he still may legally demand a return to the status quo ante (previous state of affairs). You must return the car to him; he must return the cash to you.

A voidable contract remains a valid contract until it is voided. Thus a contract with a minor remains in force unless the minor decides he or she does not wish to be bound by it. When the minor reaches majority, he or she may “ratify” the contract—that is, agree to be bound by it—in which case the contract will no longer be voidable and will thereafter be fully enforceable.

Unenforceable

An unenforceable contract is one that some rule of law bars a court from enforcing. For example, Tom owes Pete money, but Pete has waited too long to collect it and the statute of limitations has run out. The contract for repayment is unenforceable and Pete is out of luck, unless Tom makes a new promise to pay or actually pays part of the debt. (However, if Pete is holding collateral as security for the debt, he is entitled to keep it; not all rights are extinguished because a contract is unenforceable.) A debt becomes unenforceable, too, when the debtor declares bankruptcy.

A bit more on enforceability is in order. A promise or what seems to be a promise is usually enforceable only if it is otherwise embedded in the elements necessary to make that promise a contract. Those elements are mutual assent, real assent, consideration, capacity, and legality. Sometimes, though, people say things that seem like promises, and on which another person relies. In the early twentieth century, courts began, in some circumstances, to recognize that insisting on the existence of the traditional elements of contract to determine whether a promise is enforceable could work an injustice where there has been reliance. Thus developed the equitable doctrine of promissory estoppel, which has become an important adjunct to contract law. The Restatement (Section 90) puts it this way: “A promise which the promisor should reasonably expect to induce action or forbearance on the party of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. The remedy granted for breach may be limited as justice requires.”

To be “estopped” means to be prohibited from denying now the validity of a promise you made before.

The doctrine has an interesting background. In 1937, High Trees House Ltd. (a British corporation) leased a block of London apartments from Central London Properties. As World War II approached, vacancy rates soared because people left the city. In 1940 the parties agreed to reduce the rent rates by half, but no term was set for how long the reduction would last. By mid-1945, as the war was ending, occupancy was again full, and Central London sued for the full rental rates from June on. The English court, under Judge Alfred Thompson Denning (1899–1999), had no difficulty finding that High Trees owed the full amount once full occupancy was again achieved, but Judge Denning went on. In an aside (called a dicta—a statement “by the way”—that is, not necessary as part of the decision), he mused about what would have happened if in 1945 Central London had sued for the full-occupancy rate back to 1940. Technically, the 1940 amendment to the 1937 contract was not binding on Central London—it lacked consideration—and Central London could have reached back to demand full-rate payment. But Judge Denning said that High Trees would certainly have relied on Central London’s promise that a reduced-rate rent would be acceptable, and that would have been enough to bind it, to prevent it from acting inconsistently with the promise. He wrote, “The courts have not gone so far as to give a cause of action in damages for the breach of such a promise, but they have refused to allow the party making it to act inconsistently with it.”Central London Property Trust Ltd. v. High Trees House Ltd. (1947) KB 130.

In the years since, though, courts have gone so far as to give a cause of action in damages for various noncontract promises. Contract protects agreements; promissory estoppel protects reliance, and that’s a significant difference. The law of contracts continues to evolve.

Degree of Completion

An agreement consisting of a set of promises is called an executory contract before any promises are carried out. Most executory contracts are enforceable. If John makes an agreement to deliver wheat to Humphrey and does so, the contract is called a partially executed contract: one side has performed, the other has not. When John pays for the wheat, the contract is fully performed. A contract that has been carried out fully by both parties is called an executed contract.

Terminology: Suffixes Expressing Relationships

Although not really part of the taxonomy of contracts (i.e., the orderly classification of the subject), an aspect of contractual—indeed, legal—terminology should be highlighted here. Suffixes (the end syllables of words) in the English language are used to express relationships between parties in legal terminology. Here are examples:

Offeror. One who makes an offer.

Offeree. One to whom an offer is made.

Promisor. One who makes a promise.

Promisee. One to whom a promise is made.

Obligor. One who makes and has an obligation.

Obligee. One to whom an obligation is made.

Transferor. One who makes a transfer.

Transferee. One to whom a transfer is made.

KEY TAKEAWAY

Contracts are described and thus defined on the basis of four criteria: explicitness (express, implied, or quasi-contracts), mutuality (bilateral or unilateral), enforceability (void, voidable, unenforceable), and degree of completion (executory, partially executed, executed). Legal terminology in English often describes relationships between parties by the use of suffixes, to which the eye and ear must pay attention.

EXERCISES: Case Study Ethic

Able writes to Baker: “I will mow your lawn for $20.” If Baker accepts, is this an express or implied contract?

Able telephones Baker: “I will mow your lawn for $20.” Is this an express or implied contract?

What is the difference between a void contract and a voidable one?

Carr staples this poster to a utility pole: “$50 reward for the return of my dog, Argon.” Describe this in contractual terms regarding explicitness, mutuality, enforceability, and degree of completion.

Is a voidable contract always unenforceable?

Contractor bids on a highway construction job, incorporating Guardrail Company’s bid into its overall bid to the state. Contractor cannot accept Guardrail’s offer until it gets the nod from the state. Contractor gets the nod from the state, but before it can accept Guardrail’s offer, the latter revokes it. Usually a person can revoke an offer any time before it is accepted. Can Guardrail revoke its offer in this case?

8.4 Cases

Explicitness: Implied Contract

Roger’s Backhoe Service, Inc. v. Nichols

681 N.W.2d 647 (Iowa 2004)

Carter, J.

Defendant, Jeffrey S. Nichols, is a funeral director in Muscatine.…In early 1998 Nichols decided to build a crematorium on the tract of land on which his funeral home was located. In working with the Small Business Administration, he was required to provide drawings and specifications and obtain estimates for the project. Nichols hired an architect who prepared plans and submitted them to the City of Muscatine for approval. These plans provided that the surface water from the parking lot would drain onto the adjacent street and alley and ultimately enter city storm sewers. These plans were approved by the city.

Nichols contracted with Roger’s [Backhoe Service, Inc.] for the demolition of the foundation of a building that had been razed to provide room for the crematorium and removal of the concrete driveway and sidewalk adjacent to that foundation. Roger’s completed that work and was paid in full.

After construction began, city officials came to the jobsite and informed Roger’s that the proposed drainage of surface water onto the street and alley was unsatisfactory. The city required that an effort be made to drain the surface water into a subterranean creek, which served as part of the city’s storm sewer system. City officials indicated that this subterranean sewer system was about fourteen feet below the surface of the ground.…Roger’s conveyed the city’s mandate to Nichols when he visited the jobsite that same day.

It was Nichols’ testimony at trial that, upon receiving this information, he advised…Roger’s that he was refusing permission to engage in the exploratory excavation that the city required. Nevertheless, it appears without dispute that for the next three days Roger’s did engage in digging down to the subterranean sewer system, which was located approximately twenty feet below the surface. When the underground creek was located, city officials examined the brick walls in which it was encased and determined that it was not feasible to penetrate those walls in order to connect the surface water drainage with the underground creek. As a result of that conclusion, the city reversed its position and once again gave permission to drain the surface water onto the adjacent street and alley.

[T]he invoices at issue in this litigation relate to charges that Roger’s submitted to Nichols for the three days of excavation necessary to locate the underground sewer system and the cost for labor and materials necessary to refill the excavation with compactable materials and attain compaction by means of a tamping process.…The district court found that the charges submitted on the…invoices were fair and reasonable and that they had been performed for Nichols’ benefit and with his tacit approval.…

The court of appeals…concluded that a necessary element in establishing an implied-in-fact contract is that the services performed be beneficial to the alleged obligor. It concluded that Roger’s had failed to show that its services benefited Nichols.…

In describing the elements of an action on an implied contract, the court of appeals stated in [Citation], that the party seeking recovery must show:

(1) the services were carried out under such circumstances as to give the recipient reason to understand:

(a) they were performed for him and not some other person, and

(b) they were not rendered gratuitously, but with the expectation of compensation from the recipient; and

(2) the services were beneficial to the recipient.

In applying the italicized language in [Citation] to the present controversy, it was the conclusion of the court of appeals that Roger’s’ services conferred no benefit on Nichols. We disagree. There was substantial evidence in the record to support a finding that, unless and until an effort was made to locate the subterranean sewer system, the city refused to allow the project to proceed. Consequently, it was necessary to the successful completion of the project that the effort be made. The fact that examination of the brick wall surrounding the underground creek indicated that it was unfeasible to use that source of drainage does not alter the fact that the project was stalemated until drainage into the underground creek was fully explored and rejected. The district court properly concluded that Roger’s’ services conferred a benefit on Nichols.…

Decision of court of appeals vacated; district court judgment affirmed.

CASE QUESTIONS: Case Study Ethic

What facts must be established by a plaintiff to show the existence of an implied contract?

What argument did Nichols make as to why there was no implied contract here?

How would the facts have to be changed to make an express contract?

Mutuality of Contract: Unilateral Contract

SouthTrust Bank v. Williams

775 So.2d 184 (Ala. 2000)

Cook, J.

SouthTrust Bank (“SouthTrust”) appeals from an order denying its motion to compel arbitration of an action against it by checking-account customers Mark Williams and Bessie Daniels. We reverse and remand.

Daniels and Williams began their relationship with SouthTrust in 1981 and 1995, respectively, by executing checking-account “signature cards.” The signature card each customer signed contained a “change-in-terms” clause. Specifically, when Daniels signed her signature card, she “agree[d] to be subject to the Rules and Regulations as may now or hereafter be adopted by the Bank.” (Emphasis added.)…[Later,] SouthTrust added paragraph 33 to the regulations:…

ARBITRATION OF DISPUTES. You and we agree that the transactions in your account involve ‘commerce’ under the Federal Arbitration Act (‘FAA’). ANY CONTROVERSY OR CLAIM BETWEEN YOU AND US…WILL BE SETTLED BY BINDING ARBITRATION UNDER THE FAA.…

This action…challenges SouthTrust’s procedures for paying overdrafts, and alleges that SouthTrust engages in a “uniform practice of paying the largest check(s) before paying multiple smaller checks…[in order] to generate increased service charges for [SouthTrust] at the expense of [its customers].”

SouthTrust filed a “motion to stay [the] lawsuit and to compel arbitration.” It based its motion on paragraph 33 of the regulations. [T]he trial court…entered an order denying SouthTrust’s motion to compel arbitration. SouthTrust appeals.…

Williams and Daniels contend that SouthTrust’s amendment to the regulations, adding paragraph 33, was ineffective because, they say, they did not expressly assent to the amendment. In other words, they object to submitting their claims to arbitration because, they say, when they opened their accounts, neither the regulations nor any other relevant document contained an arbitration provision. They argue that “mere failure to object to the addition of a material term cannot be construed as an acceptance of it.”…They contend that SouthTrust could not unilaterally insert an arbitration clause in the regulations and make it binding on depositors like them.

SouthTrust, however, referring to its change-of-terms clause insists that it “notified” Daniels and Williams of the amendment in January 1997 by enclosing in each customer’s “account statement” a complete copy of the regulations, as amended. Although it is undisputed that Daniels and Williams never affirmatively assented to these amended regulations, SouthTrust contends that their assent was evidenced by their failure to close their accounts after they received notice of the amendments.…Thus, the disposition of this case turns on the legal effect of Williams and Daniels’s continued use of the accounts after the regulations were amended.

Williams and Daniels argue that “[i]n the context of contracts between merchants [under the UCC], a written confirmation of an acceptance may modify the contract unless it adds a material term, and arbitration clauses are material terms.”…

Williams and Daniels concede—as they must—…that Article 2 governs “transactions in goods,” and, consequently, that it is not applicable to the transactions in this case. Nevertheless, they argue:

It would be astonishing if a Court were to consider the addition of an arbitration clause a material alteration to a contract between merchants, who by definition are sophisticated in the trade to which the contract applies, but not hold that the addition of an arbitration clause is a material alteration pursuant to a change-of-terms clause in a contract between one sophisticated party, a bank, and an entire class of less sophisticated parties, its depositors.…

In response, SouthTrust states that “because of the ‘at-will’ nature of the relationship, banks by necessity must contractually reserve the right to amend their deposit agreements from time to time.” In so stating, SouthTrust has precisely identified the fundamental difference between the transactions here and those transactions governed by [Article 2].

Contracts for the purchase and sale of goods are essentially bilateral and executory in nature. See [Citation] “An agreement whereby one party promises to sell and the other promises to buy a thing at a later time…is a bilateral promise of sale or contract to sell”.…“[A] unilateral contract results from an exchange of a promise for an act; a bilateral contract results from an exchange of promises.”…Thus, “in a unilateral contract, there is no bargaining process or exchange of promises by parties as in a bilateral contract.” [Citation] “[O]nly one party makes an offer (or promise) which invites performance by another, and performance constitutes both acceptance of that offer and consideration.” Because “a ‘unilateral contract’ is one in which no promisor receives promise as consideration for his promise,” only one party is bound.…The difference is not one of semantics but of substance; it determines the rights and responsibilities of the parties, including the time and the conditions under which a cause of action accrues for a breach of the contract.

This case involves at-will, commercial relationships, based upon a series of unilateral transactions. Thus, it is more analogous to cases involving insurance policies, such as [Citations]. The common thread running through those cases was the amendment by one of the parties to a business relationship of a document underlying that relationship—without the express assent of the other party—to require the arbitration of disputes arising after the amendment.…

The parties in [the cited cases], like Williams and Daniels in this case, took no action that could be considered inconsistent with an assent to the arbitration provision. In each case, they continued the business relationship after the interposition of the arbitration provision. In doing so, they implicitly assented to the addition of the arbitration provision.…

Reversed and remanded.

Case Study Ethic CASE QUESTIONS

Why did the plaintiffs think they should not be bound by the arbitration clause?

The court said this case involved a unilateral contract. What makes it that, as opposed to a bilateral contract?

What should the plaintiffs have done if they didn’t like the arbitration requirement?

Unilateral Contract and At-Will Employment

Woolley v. Hoffmann-La Roche, Inc.

491 A.2d 1257 (N.J. 1985)

Wilntz, C. J.

Reversed and remanded for trial.

CASE QUESTIONS: Case Study Ethic

What did Woolley do to show his acceptance of the terms of employment offered to him?

In part of the case not included here, the court notes that Mr. Woolley died “before oral arguments on this case.” How can there be any damages if the plaintiff has died? Who now has any case to pursue?

The court here is changing the law of employment in New Jersey. It is making case law, and the rule here articulated governs similar future cases in New Jersey. Why did the court make this change? Why is it relevant that the court says it would be easy for an employer to avoid this problem?

8.5 Summary and Exercises

Summary

Contract law developed as the status-centered organization of feudal society faded and people began to make choices about how they might order their lives. In the capitalistic system, people make choices about how to interact with others, and—necessarily—those choices expressed as promises must be binding and enforceable.

The two fundamental sources of contract law are (1) the common law as developed in the state courts and as summarized in the Restatement (Second) of Contracts and (2) the Uniform Commercial Code for the sale of goods. In general, the UCC is more liberal than the common law in upholding the existence of a contract.

Types of contracts can be distinguished by four criteria: (1) express and implied, including quasi-contracts implied by law; (2) bilateral and unilateral; (3) enforceable and unenforceable; and (4) completed (executed) and uncompleted (executory). To understand contract law, it is necessary to master these distinctions and their nuances.

Reference 2

Chapter 9

The Agreement

LEARNING OBJECTIVES

After reading this chapter, you should understand the following:

What a contract offer is, and what proposals are not offers

How an offer is communicated

How definite the offer needs to be

How long an offer is good for

How an offer is accepted, who can accept it, and when acceptance is effective

In this chapter, we begin the first of the four broad inquiries of contract law mentioned in Chapter 8 “Introduction to Contract Law”: Did the parties create a valid contract? The answer is not always obvious; the range of factors that must be taken into account can be large, and their relationships subtle. Since businesspeople frequently conduct contract negotiations without the assistance of a lawyer, it is important to attend to the nuances in order to avoid legal trouble at the outset. Whether a contract has been formed depends in turn on whether

the parties reached an agreement (the focus of this chapter);

consideration was present;

the agreement was legal; and

the parties entered into the contract of their own free will, with knowledge of the facts, and with the capacity to make a contract.

Factors 2, 3, and 4 are the subjects of subsequent chapters.

9.1 The Agreement in General

LEARNING OBJECTIVES

Recognize that not all agreements or promises are contracts.

Understand that whether a contract exists is based on an objective analysis of the parties’ interaction, not on a subjective one.

The Significance of Agreement

The core of a legal contract is the agreement between the parties. This is not a necessary ingredient; in Communist nations, contracts were (or are, in the few remaining Communist countries) routinely negotiated between parties who had the terms imposed on them. But in the West, and especially in the United States, agreement is of the essence. That is not merely a matter of convenience; it is at the heart of our philosophical and psychological beliefs. As the great student of contract law Samuel Williston put it, “It was a consequence of the emphasis laid on the ego and the individual will that the formation of a contract should seem impossible unless the wills of the parties concurred. Accordingly we find at the end of the eighteenth century, and the beginning of the nineteenth century, the prevalent idea that there must be a “meeting of the minds” (a new phrase) in order to form a contract.”Samuel Williston, “Freedom of Contract,” Cornell Law Quarterly 6 (1921), 365.

Although agreements may take any form, including unspoken conduct between the parties, they are usually structured in terms of an offer and an acceptance.Uniform Commercial Code, Section 2-204(1). These two components will be the focus of our discussion. Note, however, that not every agreement, in the broadest sense of the word, need consist of an offer and an acceptance, and that it is entirely possible, therefore, for two persons to reach agreement without forming a contract. For example, people may agree that the weather is pleasant or that it would be preferable to go out for Chinese food rather than to see a foreign film; in neither case has a contract been formed. One of the major functions of the law of contracts is to sort out those agreements that are legally binding—those that are contracts—from those that are not.

The Objective Test

In interpreting agreements, courts generally apply an objective standard (outwardly, as an observer would interpret; not subjectively). The Restatement (Second) of Contracts defines agreement as a “manifestation of mutual assent by two or more persons to one another.”Uniform Commercial Code, Section 3. The Uniform Commercial Code defines agreement as “the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance.”Uniform Commercial Code, Section 1-201(3). The critical question is what the parties said or did, not what they thought they said or did, or not what impression they thought they were making.

The distinction between objective and subjective standards crops up occasionally when one person claims he spoke in jest. The vice president of a company that manufactured punchboards, used in gambling, testified to the Washington State Game Commission that he would pay $100,000 to anyone who found a “crooked board.” Barnes, a bartender, who had purchased two boards that were crooked some time before, brought one to the company office and demanded payment. The company refused, claiming that the statement was made in jest (the audience at the commission hearing had laughed when the offer was made). The court disagreed, holding that it was reasonable to interpret the pledge of $100,000 as a means of promoting punchboards:

[I]f the jest is not apparent and a reasonable hearer would believe that an offer was being made, then the speaker risks the formation of a contract which was not intended. It is the objective manifestations of the offeror that count and not secret, unexpressed intentions. If a party’s words or acts, judged by a reasonable standard, manifest an intention to agree in regard to the matter in question, that agreement is established, and it is immaterial what may be the real but unexpressed state of the party’s mind on the subject.Barnes v. Treece, 549 P.2d 1152 (Wash. App. 1976).

Lucy v. Zehmer (Section 9.4.1 “Objective Intention” at the end of the chapter) illustrates that a party’s real state of mind must be expressed to the other party, rather than in an aside to one’s spouse.

KEY TAKEAWAY

Fundamentally, a contract is a legally binding “meeting of the minds” between the parties. It is not the unexpressed intention in the minds of the parties that determines whether there was “a meeting.” The test is objective: how would a reasonable person interpret the interaction?

Case Study Ethic EXERCISES

For the purposes of determining whether a party had a contractual intention, why do courts employ an objective rather than a subjective test?

What is the relationship between “the emphasis laid on the ego and the individual will” in modern times (Williston) and the concept of the contractual agreement?

9.2 The Offer

LEARNING OBJECTIVES

Know the definition of offer.

Recognize that some proposals are not offers.

Understand the three essentials of an offer: intent, communication, and definiteness.

Know when an offer expires and can no longer be accepted.

Offer and acceptance may seem to be straightforward concepts, as they are when two people meet face-to-face. But in a commercial society, the ways of making offers and accepting them are nearly infinite. A retail store advertises its merchandise in the newspaper. A seller makes his offer by mail or over the Internet. A telephone caller states that his offer will stand for ten days. An offer leaves open a crucial term. An auctioneer seeks bids. An offeror gives the offeree a choice. All these situations can raise tricky questions, as can corresponding situations involving acceptances.

The Definition of Offer

The Restatement defines offer as “the manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his assent to that bargain is invited and will conclude it.”Restatement (Second) of Contracts, Section 24. Two key elements are implicit in that definition: the offer must be communicated, and it must be definite. Before considering these requirements, we examine the threshold question of whether an offer was intended. Let us look at proposals that may look like, but are not, offers.

Proposals That Are Not Offers

Invitations to Bid

Invitations to bid are also not generally construed as offers. An auctioneer does not make offers but solicits offers from the crowd: “May I have an offer?—$500? $450? $450! I have an offer for $450. Do I hear $475? May I have an offer?”

Communication

A contract is an agreement in which each party assents to the terms of the other party. Without mutual assent there cannot be a contract, and this implies that the assent each person gives must be with reference to that of the other. If Toni places several alternative offers on the table, only one of which can be accepted, and invites Sandy to choose, no contract is formed if Sandy says merely, “I accept your terms.” Sandy must specify which offer she is assenting to.

From this general proposition, it follows that no contract can be legally binding unless an offer is in fact communicated to the offeree. If you write an e-mail to a friend with an offer to sell your car for a certain sum and then get distracted and forget to send it, no offer has been made. If your friend coincidentally e-mails you the following day and says that she wants to buy your car and names the same sum, no contract has been made. Her e-mail to you is not an acceptance, since she did not know of your offer; it is, instead, an offer or an invitation to make an offer. Nor would there have been a contract if you had sent your communication and the two e-mails crossed in cyberspace. Both e-mails would be offers, and for a valid contract to be formed, it would still be necessary for one of you to accept the other’s offer. An offer is not effective until it is received by the offeree (and that’s also true of a revocation of the offer, and a rejection of the offer by the offeree).

The requirement that an offer be communicated does not mean that every term must be communicated. You call up your friend and offer to sell him your car. You tell him the price and start to tell him that you will throw in the snow tires but will not pay for a new inspection, and that you expect to keep the car another three weeks. Impatiently, he cuts you off and says, “Never mind about all that; I’ll accept your offer on whatever terms you want.” You and he have a contract.

These principles apply to unknown offers of reward. An offer of a reward constitutes a unilateral contract that can be made binding only by performing the task for which the reward is offered. Suppose that Bonnie posts on a tree a sign offering a reward for returning her missing dog. If you saw the sign, found the dog, and returned it, you would have fulfilled the essentials of the offer. But if you chanced upon the dog, read the tag around its neck, and returned it without ever having been aware that a reward was offered, then you have not responded to the offer, even if you acted in the hope that the owner would reward you. There is no contractual obligation.

In many states, a different result follows from an offer of a reward by a governmental entity. Commonly, local ordinances provide that a standing reward of, say, $1,000 will be paid to anyone providing information that leads to the arrest and conviction of arsonists. To collect the reward, it is not necessary for a person who does furnish local authorities with such information to know that a reward ordinance exists. In contract terms, the standing reward is viewed as a means of setting a climate in which people will be encouraged to act in certain ways in the expectation that they will earn unknown rewards. It is also possible to view the claim to a reward as noncontractual; the right to receive it is guaranteed, instead, by the local ordinance.

Although a completed act called for by an unknown private offer does not give rise to a contract, partial performance usually does. Suppose Apex Bakery posts a notice offering a one-week bonus to all bakers who work at least six months in the kitchen. Charlene works two months before discovering the notice on the bulletin board. Her original ignorance of the offer will not defeat her claim to the bonus if she continues working, for the offer serves as an inducement to complete the performance called for.

Definiteness

The common law reasonably requires that an offer spell out the essential proposed terms with sufficient definiteness—certainty of terms that enables a court to order enforcement or measure damages in the event of a breach. As it has often been put, “The law does not make contracts for the parties; it merely enforces the duties which they have undertaken” (Simpson, 1965, p. 19). Thus a supposed promise to sell “such coal as the promisor may wish to sell” is not an enforceable term because the seller, the coal company, undertakes no duty to sell anything unless it wishes to do so. Essential terms certainly include price and the work to be done. But not every omission is fatal; for example, as long as a missing term can be fixed by referring to some external standard—such as “no later than the first frost”—the offer is sufficiently definite.

In major business transactions involving extensive negotiations, the parties often sign a preliminary “agreement in principle” before a detailed contract is drafted. These preliminary agreements may be definite enough to create contract liability even though they lack many of the terms found in a typical contract. For example, in a famous 1985 case, a Texas jury concluded that an agreement made “in principle” between the Pennzoil Company and the Getty Oil Company and not entirely finished was binding and that Texaco had unlawfully interfered with their contract. As a result, Texaco was held liable for over $10 billion, which was settled for $3 billion after Texaco went into bankruptcy.

Offers that state alternatives are definitive if each alternative is definite. David offers Sheila the opportunity to buy one of two automobiles at a fixed price, with delivery in two months and the choice of vehicle left to David. Sheila accepts. The contract is valid. If one of the cars is destroyed in the interval before delivery, David is obligated to deliver the other car. Sometimes, however, what appears to be an offer in the alternative may be something else. Charles makes a deal to sell his business to Bernie. As part of the bargain, Charles agrees not to compete with Bernie for the next two years, and if he does, to pay $25,000. Whether this is an alternative contract depends on the circumstances and intentions of the parties. If it is, then Charles is free to compete as long as he pays Bernie $25,000. On the other hand, the intention might have been to prevent Charles from competing in any event; hence a court could order payment of the $25,000 as damages for a breach and still order Charles to refrain from competition until the expiration of the two-year period.

The UCC Approach

The Uniform Commercial Code (UCC) is generally more liberal in its approach to definiteness than is the common law—at least as the common law was interpreted in the heyday of classical contract doctrine. Section 2-204(3) states the rule: “Even though one or more terms are left open, a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy.”

The drafters of the UCC sought to give validity to as many contracts as possible and grounded that validity on the intention of the parties rather than on formalistic requirements. As the official comment to Section 2-204(3) notes, “If the parties intend to enter into a binding agreement, this subsection recognizes that agreement as valid in law, despite missing terms, if there is any reasonably certain basis for granting a remedy.…Commercial standards on the point of ‘indefiniteness’ are intended to be applied.” Other sections of the UCC spell out rules for filling in such open provisions as price, performance, and remedies.Chiefly, Uniform Commercial Code, Sections 2-305 through 2-310.

One of these sections, Section 2-306(1), provides that a contract term under which a buyer agrees to purchase the seller’s entire output of goods (an “outputs contract”) or a seller agrees to meet all the buyer’s requirements (a “requirements” or “needs” contract) means output or requirements that occur in good faith. A party to such a contract cannot offer or demand a quantity that is “unreasonably disproportionate” to a stated estimate or past quantities.

Duration of Offer

An offer need not be accepted on the spot. Because there are numerous ways of conveying an offer and numerous contingencies that may be part of the offer’s subject matter, the offeror might find it necessary to give the offeree considerable time to accept or reject the offer. By the same token, an offer cannot remain open forever, so that once given, it never lapses and cannot be terminated. The law recognizes seven ways by which the offer can expire (besides acceptance, of course): revocation, rejection by the offeree, counteroffer, acceptance with counteroffer, lapse of time, death or insanity of a person or destruction of an essential term, and illegality. We will examine each of these in turn.

Revocation

People are free to make contracts and, in general, to revoke them.

Revocability

The general rule, both in common law and under the UCC, is that the offeror may revoke his or her offer at any time before acceptance, even if the offer states that it will remain open for a specified period of time. Neil offers Arlene his car for $5,000 and promises to keep the offer open for ten days. Two days later, Neil calls Arlene to revoke the offer. The offer is terminated, and Arlene’s acceptance thereafter, though within the ten days, is ineffective. But if Neil had sent his revocation (the taking back of an offer before it is accepted) by mail, and if Arlene, before she received it, had telephoned her acceptance, there would be a contract, since revocation is effective only when the offeree actually receives it. There is an exception to this rule for offers made to the public through newspaper or like advertisements. The offeror may revoke a public offering by notifying the public by the same means used to communicate the offer. If no better means of notification is reasonably available, the offer is terminated even if a particular offeree had no actual notice.

Revocation may be communicated indirectly. If Arlene had learned from a friend that Neil had sold his car to someone else during the ten-day period, she would have had sufficient notice. Any attempt to accept Neil’s offer would have been futile.

Irrevocable Offers

Not every type of offer is revocable. One type of offer that cannot be revoked is the option contract (the promisor explicitly agrees for consideration to limit his right to revoke). Arlene tells Neil that she cannot make up her mind in ten days but that she will pay him $25 to hold the offer open for thirty days. Neil agrees. Arlene has an option to buy the car for $5,000; if Neil should sell it to someone else during the thirty days, he will have breached the contract with Arlene. Note that the transactions involving Neil and Arlene consist of two different contracts. One is the promise of a thirty-day option for the promise of $25. It is this contract that makes the option binding and is independent of the original offer to sell the car for $5,000. The offer can be accepted and made part of an independent contract during the option period.

Partial performance of a unilateral contract creates an option. Although the option is not stated explicitly, it is recognized by law in the interests of justice. Otherwise, an offeror could induce the offeree to go to expense and trouble without ever being liable to fulfill his or her part of the bargain. Before the offeree begins to carry out the contract, the offeror is free to revoke the offer. But once performance begins, the law implies an option, allowing the offeree to complete performance according to the terms of the offer. If, after a reasonable time, the offeree does not fulfill the terms of the offer, then it may be revoked.

Revocability under the UCC

The UCC changes the common-law rule for offers by merchants. Under Section 2-205, a firm offer (a written and signed promise by a merchant to hold an offer to buy or sell goods for some period of time) is irrevocable. That is, an option is created, but no consideration is required. The offer must remain open for the time period stated or, if no time period is given, for a reasonable period of time, which may not exceed three months.

Irrevocability by Law

By law, certain types of offers may not be revoked (statutory irrevocability), despite the absence of language to that effect in the offer itself. One major category of such offers is that of the contractor submitting a bid to a public agency. The general rule is that once the period of bidding opens, a bidder on a public contract may not withdraw his or her bid unless the contracting authority consents. The contractor who purports to withdraw is awarded the contract based on the original bid and may be sued for damages for nonperformance.

Rejection by the Offeree

Rejection (a manifestation of refusal to agree to the terms of an offer) of the offer is effective when the offeror receives it. A subsequent change of mind by the offeree cannot revive the offer. Donna calls Chuck to reject Chuck’s offer to sell his lawn mower. Chuck is then free to sell it to someone else. If Donna changes her mind and calls Chuck back to accept after all, there still is no contract, even if Chuck has made no further effort to sell the lawn mower. Having rejected the original offer, Donna, by her second call, is not accepting but making an offer to buy. Suppose Donna had written Chuck to reject, but on changing her mind, decided to call to accept before the rejection letter arrived. In that case, the offer would have been accepted.

Counteroffer

A counteroffer, a response that varies the terms of an offer, is a rejection. Jones offers Smith a small parcel of land for $10,000 and says the offer will remain open for one month. Smith responds ten days later, saying he will pay $5,000. Jones’s original offer has thereby been rejected. If Jones now declines Smith’s counteroffer, may Smith bind Jones to his original offer by agreeing to pay the full $10,000? He may not, because once an original offer is rejected, all the terms lapse. However, an inquiry by Smith as to whether Jones would consider taking less is not a counteroffer and would not terminate the offer.

Acceptance with Counteroffer

This is not really an acceptance at all but is a counteroffer: an acceptance that changes the terms of the offer is a counteroffer and terminates the offer. The common law imposes a mirror image rule: the acceptance must match the offer in all its particulars or the offer is rejected. However, if an acceptance that requests a change or an addition to the offer does not require the offeror’s assent, then the acceptance is valid. The broker at Friendly Real Estate offers you a house for $320,000. You accept but include in your acceptance “the vacant lot next door.” Your acceptance is a counteroffer, which serves to terminate the original offer. If, instead, you had said, “It’s a deal, but I’d prefer it with the vacant lot next door,” then there is a contract because you are not demanding that the broker abide by your request. If you had said, “It’s a deal, and I’d also like the vacant lot next door,” you have a contract, because the request for the lot is a separate offer, not a counteroffer rejecting the original proposal.

The UCC and Counteroffers

The UCC is more liberal than the common law in allowing contracts to be formed despite counteroffers and in incorporating the counteroffers into the contracts. This UCC provision is necessary because the use of routine forms for contracts is very common, and if the rule were otherwise, much valuable time would be wasted by drafting clauses tailored to the precise wording of the routine printed forms. A buyer and a seller send out documents accompanying or incorporating their offers and acceptances, and the provisions in each document rarely correspond precisely. Indeed, it is often the case that one side’s form contains terms favorable to it but inconsistent with terms on the other side’s form. Section 2-207 of the UCC attempts to resolve this “battle of the forms” by providing that additional terms or conditions in an acceptance operate as such unless the acceptance is conditioned on the offeror’s consent to the new or different terms. The new terms are construed as offers but are automatically incorporated in any contract between merchants for the sale of goods unless “(a) the offer expressly limits acceptance to the terms of the offer; (b) [the terms] materially alter it; or (c) notification of objection to them has already been given or is given within a reasonable time after notice of them is received.”

An example of terms that become part of the contract without being expressly agreed to are clauses providing for interest payments on overdue bills. Examples of terms that would materially alter the contract and hence need express approval are clauses that negate the standard warranties that sellers give buyers on their merchandise.

Frequently, parties use contract provisions to prevent the automatic introduction of new terms. A typical seller’s provision is as follows:

Amendments

Any modification of this document by the Buyer, and all additional or different terms included in Buyer’s purchase order or any other document responding to this offer, are hereby objected to. BY ORDERING THE GOODS HERE FOR SHIPMENT, BUYER AGREES TO ALL THE TERMS AND CONDITIONS CONTAINED ON BOTH SIDES OF THIS DOCUMENT.

Section 2-207 of the UCC, liberalizing the mirror image rule, is pervasive, covering all sorts of contracts, from those between industrial manufacturers to those between friends.

Lapse of Time

Offers are not open-ended; they lapse after some period of time. An offer may contain its own specific time limitation—for example, “until close of business today.”

In the absence of an expressly stated time limit, the common-law rule is that the offer expires at the end of a “reasonable” time. Such a period is a factual question in each case and depends on the particular circumstances, including the nature of the service or property being contracted for, the manner in which the offer is made, and the means by which the acceptance is expected to be made. Whenever the contract involves a speculative transaction—the sale of securities or land, for instance—the time period will depend on the nature of the security and the risk involved. In general, the greater the risk to the seller, the shorter the period of time. Karen offers to sell Gary a block of oil stocks that are fluctuating rapidly hour by hour. Gary receives the offer an hour before the market closes; he accepts by fax two hours after the market has opened the next morning and after learning that the stock has jumped up significantly. The time period has lapsed if Gary was accepting a fixed price that Karen set, but it may still be open if the price is market price at time of delivery. (Under Section 41 of the Restatement, an offer made by mail is “seasonably accepted if an acceptance is mailed at any time before midnight on the day on which the offer is received.”)

For unilateral contracts, both the common law and the UCC require the offeree to notify the offeror that he has begun to perform the terms of the contract. Without notification, the offeror may, after a reasonable time, treat the offer as having lapsed.

Death or Insanity of the Offeror

The death or insanity of the offeror prior to acceptance terminates the offer; the offer is said to die with the offeror. (Notice, however, that the death of a party to a contract does not necessarily terminate the contract: the estate of a deceased person may be liable on a contract made by the person before death.)

Destruction of Subject Matter Essential to the Offer

Destruction of something essential to the contract also terminates the offer. You offer to sell your car, but the car is destroyed in an accident before your offer is accepted; the offer is terminated.

Postoffer Illegality

A statute making unlawful the object of the contract will terminate the offer if the statute takes effect after the offer was made. Thus an offer to sell a quantity of herbal weight-loss supplements will terminate if the Food and Drug Administration outlaws the sale of such supplements.

KEY TAKEAWAY

An offer is a manifestation of willingness to enter into a contract, effective when received. It must be communicated to the offeree, be made intentionally (according to an objective standard), and be definite enough to determine a remedy in case of breach. An offer terminates in one of seven ways: revocation before acceptance (except for option contracts, firm offers under the UCC, statutory irrevocability, and unilateral offers where an offeree has commenced performance); rejection; counteroffer; acceptance with counteroffer; lapse of time (as stipulated or after a reasonable time); death or insanity of the offeror before acceptance or destruction of subject matter essential to the offer; and postoffer illegality.

Case Study Ethic EXERCISES

Why is it said an offer is a “manifestation” of willingness to enter into a contract? How could willingness be “manifested”?

Which kind of standard is used to determine whether a person has made an offer—subjective or objective?

If Sandra posts a written notice offering “to the kitchen staff at Coldwater Bay (Alaska) transportation to Seattle at the end of the fishing season,” and if David, one of the maintenance workers, says to her, “I accept your offer of transportation to Seattle,” is there a contract?

What are the seven ways an offer can terminate?

9.3 The Acceptance

LEARNING OBJECTIVES

Define acceptance.

Understand who may accept an offer.

Know when the acceptance is effective.

Recognize when silence is acceptance.

General Definition of Acceptance

To result in a legally binding contract, an offer must be accepted by the offeree. Just as the law helps define and shape an offer and its duration, so the law governs the nature and manner of acceptance. The Restatement defines acceptance of an offer as “a manifestation of assent to the terms thereof made by the offeree in a manner invited or required by the offer.”Restatement (Second) of Contracts, Section 24.The assent may be either by the making of a mutual promise or by performance or partial performance. If there is doubt about whether the offer requests a return promise or a return act, the Restatement, Section 32, provides that the offeree may accept with either a promise or performance. The Uniform Commercial Code (UCC) also adopts this view; under Section 2-206(1)(a), “an offer to make a contract shall be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances” unless the offer unambiguously requires a certain mode of acceptance.

Who May Accept?

The identity of the offeree is usually clear, even if the name is unknown. The person to whom a promise is made is ordinarily the person whom the offeror contemplates will make a return promise or perform the act requested. But this is not invariably so. A promise can be made to one person who is not expected to do anything in return. The consideration necessary to weld the offer and acceptance into a legal contract can be given by a third party. Under the common law, whoever is invited to furnish consideration to the offeror is the offeree, and only an offeree may accept an offer. A common example is sale to a minor. George promises to sell his automobile to Bartley, age seventeen, if Bartley’s father will promise to pay $3,500 to George. Bartley is the promisee (the person to whom the promise is made) but not the offeree; Bartley cannot legally accept George’s offer. Only Bartley’s father, who is called on to pay for the car, can accept, by making the promise requested. And notice what might seem obvious: a promise to perform as requested in the offer is itself a binding acceptance.

When Is Acceptance Effective?

As noted previously, an offer, a revocation of the offer, and a rejection of the offer are not effective until received. The same rule does not always apply to the acceptance.

Instantaneous Communication

Of course, in many instances the moment of acceptance is not in question: in face-to-face deals or transactions negotiated by telephone, the parties extend an offer and accept it instantaneously during the course of the conversation. But problems can arise in contracts negotiated through correspondence.

Stipulations as to Acceptance

One common situation arises when the offeror stipulates the mode of acceptance (e.g., return mail, fax, or carrier pigeon). If the offeree uses the stipulated mode, then the acceptance is deemed effective when sent. Even though the offeror has no knowledge of the acceptance at that moment, the contract has been formed. Moreover, according to the Restatement, Section 60, if the offeror says that the offer can be accepted only by the specified mode, that mode must be used. (It is said that “the offeror is the master of the offer.”)

If the offeror specifies no particular mode, then acceptance is effective when transmitted, as long as the offeree uses a reasonable method of acceptance. It is implied that the offeree can use the same means used by the offeror or a means of communication customary to the industry.

The “Mailbox Rule”

The use of the postal service is customary, so acceptances are considered effective when mailed, regardless of the method used to transmit the offer. Indeed, the so-called mailbox rule has a lineage tracing back more than one hundred years to the English courts.Adams v. Lindsell, 1 Barnewall & Alderson 681 (K.B. 1818).

The mailbox rule may seem to create particular difficulties for people in business, since the acceptance is effective even though the offeror is unaware of the acceptance, and even if the letter is lost and never arrives. But the solution is the same as the rationale for the rule. In contracts negotiated through correspondence, there will always be a burden on one of the parties. If the rule were that the acceptance is not effective until received by the offeror, then the offeree would be on tenterhooks, rather than the other way around, as is the case with the present rule. As between the two, it seems fairer to place the burden on the offeror, since he or she alone has the power to fix the moment of effectiveness. All the offeror need do is specify in the offer that acceptance is not effective until received.

In all other cases—that is, when the offeror fails to specify the mode of acceptance and the offeree uses a mode that is not reasonable—acceptance is deemed effective only when received.

Acceptance “Outruns” Rejection

When the offeree sends a rejection first and then later transmits a superseding acceptance, the “effective when received” rule also applies. Suppose a seller offers a buyer two cords of firewood and says the offer will remain open for a week. On the third day, the buyer writes the seller, rejecting the offer. The following evening, the buyer rethinks his firewood needs, and on the morning of the fifth day, he sends an e-mail accepting the seller’s terms. The previously mailed letter arrives the following day. Since the letter had not yet been received, the offer had not been rejected. For there to be a valid contract, the e-mailed acceptance must arrive before the mailed rejection. If the e-mail were hung up in cyberspace, although through no fault of the buyer, so that the letter arrived first, the seller would be correct in assuming the offer was terminated—even if the e-mail arrived a minute later. In short, where “the acceptance outruns the rejection” the acceptance is effective. See Figure 9.1.

Figure 9.1

When Is Communication Effective?

Electronic Communications

Electronic communications have, of course, become increasingly common. Many contracts are negotiated by e-mail, accepted and “signed” electronically. Generally speaking, this does not change the rules. The Uniform Electronic Transactions Act (UETA) was promulgated (i.e., disseminated for states to adopt) in 1999. It is one of a number of uniform acts, like the Uniform Commercial Code. As of June 2010, forty-seven states and the US Virgin Islands had adopted the statute. The introduction to the act provides that “the purpose of the UETA is to remove barriers to electronic commerce by validating and effectuating electronic records and signatures.”The National Conference of Commissioners on Uniform State Laws, Uniform Electronic Transactions Act (1999) (Denver: National Conference of Commissioners on Uniform State Laws, 1999), accessed March 29, 2011, . In general, the UETA provides the following:

A record or signature may not be denied legal effect or enforceability solely because it is in electronic form.

A contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation.

If a law requires a record to be in writing, an electronic record satisfies the law.

If a law requires a signature, an electronic signature satisfies the law.

The UETA, though, doesn’t address all the problems with electronic contracting. Clicking on a computer screen may constitute a valid acceptance of a contractual offer, but only if the offer is clearly communicated. In Specht v. Netscape Communications Corp., customers who had downloaded a free online computer program complained that it effectively invaded their privacy by inserting into their machines “cookies”; they wanted to sue, but the defendant said they were bound to arbitration.Specht v. Netscape Communications Corp., 306 F.3d 17 (2d Cir. 2002). They had clicked on the Download button, but hidden below it were the licensing terms, including the arbitration clause. The federal court of appeals held that there was no valid acceptance. The court said, “We agree with the district court that a reasonably prudent Internet user in circumstances such as these would not have known or learned of the existence of the license terms before responding to defendants’ invitation to download the free software, and that defendants therefore did not provide reasonable notice of the license terms. In consequence, the plaintiffs’ bare act of downloading the software did not unambiguously manifest assent to the arbitration provision contained in the license terms.”

If a faxed document is sent but for some reason not received or not noticed, the emerging law is that the mailbox rule does not apply. A court would examine the circumstances with care to determine the reason for the nonreceipt or for the offeror’s failure to notice its receipt. A person has to have fair notice that his or her offer has been accepted, and modern communication makes the old-fashioned mailbox rule—that acceptance is effective upon dispatch—problematic.See, for example, Clow Water Systems Co. v. National Labor Relations Board, 92 F.3d 441 (6th Cir. 1996).

Silence as Acceptance

General Rule: Silence Is Not Acceptance

Ordinarily, for there to be a contract, the offeree must make some positive manifestation of assent to the offeror’s terms. The offeror cannot usually word his offer in such a way that the offeree’s failure to respond can be construed as an acceptance.

Exceptions

The Restatement, Section 69, gives three situations, however, in which silence can operate as an acceptance. The first occurs when the offeree avails himself of services proffered by the offeror, even though he could have rejected them and had reason to know that the offeror offered them expecting compensation. The second situation occurs when the offer states that the offeree may accept without responding and the offeree, remaining silent, intends to accept. The third situation is that of previous dealings, in which only if the offeree intends not to accept is it reasonable to expect him to say so.

As an example of the first type of acceptance by silence, assume that a carpenter happens by your house and sees a collapsing porch. He spots you in the front yard and points out the deterioration. “I’m a professional carpenter,” he says, “and between jobs. I can fix that porch for you. Somebody ought to.” You say nothing. He goes to work. There is an implied contract, with the work to be done for the carpenter’s usual fee.

To illustrate the second situation, suppose that a friend has left her car in your garage. The friend sends you a letter in which she offers you the car for $4,000 and adds, “If I don’t hear from you, I will assume that you have accepted my offer.” If you make no reply, with the intention of accepting the offer, a contract has been formed.

The third situation is illustrated by Section 9.4.3 “Silence as Acceptance”, a well-known decision made by Justice Oliver Wendell Holmes Jr. when he was sitting on the Supreme Court of Massachusetts.

KEY TAKEAWAY

Without an acceptance of an offer, no contract exists, and once an acceptance is made, a contract is formed. If the offeror stipulates how the offer should be accepted, so be it. If there is no stipulation, any reasonable means of communication is good. Offers and revocations are usually effective upon receipt, while an acceptance is effective on dispatch. The advent of electronic contracting has caused some modification of the rules: courts are likely to investigate the facts surrounding the exchange of offer and acceptance more carefully than previously. But the nuances arising because of the mailbox rule and acceptance by silence still require close attention to the facts.

Reference 3

Employment Contracts

Lester A. Myers

In: Encyclopedia of Business Ethics and Society

Edited by: Robert W. Kolb

DOI:

Subject: Business Ethics (general)

An employment contract is a legal agreement that governs the terms according to which one or more parties provide personal services for one or more other parties, typically in the context of an employeremployee relationship. A contract may be express, that is, reciting terms for performance between the parties, or it may be implied in the law according to the behavior of the parties. The regulatory frameworks, policy justifications, and business practices that govern employment relationships vary widely across jurisdictions, with the two principal approaches being employment-at-will and for-cause regimes.

Types of Personal Services Agreements: Employment Agreements and Independent Contractor Agreements

There are two primary categories of personal services agreements: employment agreements and independent contractor agreements. The criteria for distinguishing between these types of work relationships in the common law include the degree of the worker’s integration into the operations of the employer’s organization, the scale and scope of the worker’s service, whether the worker uses his or her own tools and materials, the number of employers the worker serves, whether the worker risks a financial loss in the relationship, the employer’s degree of oversight and approval for the work product, and, especially, whether the employer retains the right to control the manner and pace of the work.

If applying these common-law factors supports the conclusion that the provider of personal services is an independent contractor, then the parties are acting at arm’s length and are truly separate legal entities. The legal rules governing their relationship would be the general rules of contract. However, if applying the common-law factors supports the conclusion that the provider of personal services is an employee, then the relationship constitutes employment in the strict sense, with concomitant common-law duties of agency owing to the employer, including fiduciary duties of care, loyalty, and good faith. To sustain a practicable scope for this analysis, the remainder of this discussion will deal with the employment relationship.

Types of Employment Contracts: Express and Implied Contracts

An employment contract is a personal services agreement between an employer and an employee that is legally enforceable. The two typical forms of contract in the common-law tradition are express contract and implied contract. An express contract is one in which the parties enumerate the terms of their agreement in ways that allow it not only to be clear for practical purposes but also to be legally sufficient and enforceable. For example, an express contract should specify the identities of the parties, their respective performance commitments, their respective consideration, the timing and means for payment, the standards for assessing the sufficiency of the work product, the term of service, the governing law(s), the procedure(s) for giving notice of termination, and the means for adjudicating disputes.

In addition, the formation process for an express contract must satisfy legal standards for the document to be enforceable, including the legality of the subject matter, the mental competency of the parties, the real or apparent authority of the parties, and the legal majority of the parties (typically the age of 18 for natural persons). A contract may be in writing or oral, but it is prudent—and in many cases legally necessary under the statute of frauds in the applicable jurisdiction—to execute it in writing, particularly when the term of service exceeds 1 year from the date of the agreement.

An implied contract is an agreement that a court construes and interprets as legally enforceable retrospectively, on the basis of the actions of the parties. If a court finds that the parties behaved as though they believed that a contract existed between them, then it is likely that it will rule that there impliedly was a contract, as a matter of law.

Regulatory Frameworks for the Employment Relationship: Employment-at-will and For-Cause Regimes

The two main regimes for construing the nature and durability of employment relationships before the law and in the context of business practices are (1) employment at will and (2) a for-cause framework. Under the employment-at-will doctrine, the employee (“servant,” in legal parlance) serves at the pleasure of the employer (“master”). The employer may terminate the employee’s service for a good reason, for a bad reason, or for no reason at all. This has been the default rule for most jurisdictions within the United States since at least the middle of the 19th century, and it is in the United States that this policy continues to enjoy its widest favor.

Against the backdrop of this default rule, there are four principal categories of exceptions that circumscribe the scope for employment at will in the United States—that is, four examples of situations in which a justification for an employment action may be necessary. First, for employees of the federal government, there are due process protections that arise from the Fifth Amendment to the U.S. Constitution. Such protections stem from legal constructions of incipient property rights in this employment and the special dual roles of the government, not just as an employer but also as a civil power with the capacity to deprive people of such property as well as life and liberty. Under the Fourteenth Amendment to the Constitution, this protection likewise extends to employees of state and local governments, under the doctrine of equal protection. (The principal exception to this protection for government employees relates to attorneys who serve the government in the role of counsel; it is a long-standing public policy and standard for professional practice that a client must remain free to choose its counsel.)

Second, statutory prohibitions protect employees from arbitrary or discriminatory employment actions based on (1) activities that are beneficial or even necessary as a matter of public policy and (2) status factors—for example, gender, age, family relationships, ethnic origin, religious beliefs, and national origin.

An example of the first type of statutory protection is the National Labor Relations Act of 1935, which prohibits retaliation against employees for union activity, litigation against their employer, or testifying against their employer in court. Other statutes, including the Occupational Safety and Health Act of 1970, prohibit retaliation for reporting or helping investigate dangerous, unethical, and/or illegal situations. This act also authorizes the Occupational Safety and Health Administration to administer the whistleblower provisions of 13 other statutes, such as trucking, airline, nuclear power, pipeline, environmental, and securities laws.

Other statutes extend the second major type of protection by prohibiting arbitrary or discriminatory employment actions based on the aforementioned status factors, which the federal and state governments have determined to be worthy of protection as a matter of public policy, particularly because these factors tend to be irrelevant to the substance of the employment relationship. Examples of such legislation at the federal level include the Civil Rights Act of 1964, the Age Discrimination in Employment Act of 1968, the Pregnancy Discrimination Employment Act of 1978, the Americans with Disabilities Act of 1990, and the Family and Medical Leave Act of 1993. (While some local jurisdictions include sexual orientation among these protected status factors, the federal government does not.)

Third, common-law protections on the basis of precedent and public policy help prevent arbitrary employment determinations that curtail employees’ basic rights and duties when it comes to political participation. For example, it generally is illegal for an employer to terminate or penalize an employee for exercising his or her right to vote or for serving jury duty.

In the same way, common law and public policy generally prohibit employment policies and practices that constrain employees from acting in the public interest. For example, employers generally may not threaten or retaliate against employees for reporting serious dangers to life or property or information about crimes, at least without risking lawsuits for retaliatory discharge. Substantive codes of conduct of professional associations have complemented the aforementioned statutory protections by providing frameworks for assessing the legal and ethical reasonableness of their members’ actions in whistle-blowing about such matters, particularly in light of the aforementioned long-standing fiduciary duties of care, loyalty, and good faith, and these codes have provided a measure of additional protection in some state jurisdictions.

Fourth, parties to an employment relationship may contract away their right to at-will terms either through individual contracts or through group contracts—for example, collective bargaining agreements. Courts tend not to consider the question of the sufficiency of legal consideration in contracts between parties that bargain in good faith and at arm’s length. As a result, the primary constraints on employment contracts are those that apply to contracts generally, including the aforementioned factors of majority age, mental competency, and real or apparent authority of the contractors, as well as legality of the subject matter of the contract.

Because of the aforementioned doctrine of implied contract, parties must exercise care not only in the legally cognizable terms to which they expressly assent but also in their behavior toward one another, which a court may construe as evincing a willingness to form a bond of obligation. In the past, factors such as a long period of service, an employer’s oral or written assurances about long-term employment, the wording of job application forms, the offering of service-dependent benefits, and the content of employee procedure manuals have supported findings of implied contract. In light of such rulings, employers, particularly corporate employers, have implemented prophylactic procedures to minimize such risks, for example, in the form of express disclaimers of contract and notices that all employment is at will, sometimes with requirements for written employee acknowledgments.

While these are the principal exceptions to the policy of employment at will in the United States, two points are worth noting. First, these legal restrictions derive their legitimacy from substantive moral principles. Hence, it is meaningful to interpret these justifications and assess their normative sufficiency apart from the positive laws by which constitutional framers, legislators, judges, and contractors attempt to express them. The discussion below demonstrates this in terms of the principle of autonomy, the freedom to contract, and the duty to promote efficient markets for labor and capital.

Second, despite differences in legal systems—for example, common-law and civil law frameworks—and business and litigation practices around the world, the systematic questions regarding the nature and scope of employment contracts persist across societies, including how to balance interests in efficient employment markets with just treatment of employers and employees. The language surrounding issues of employment at will often is jurisprudential, but the issues are deeper than the idiomatic exigencies and concerns of countries’ legal systems.

The other major framework for governing the employment relationship is a for-cause regime, which limits significant employment actions, including terminations, to justifications on the basis of “good” reasons, upon some articulable due process arrangement that takes into account factors relevant to the substance of the employment relationship, including employee performance, market conditions, and resource constraints on the employer’s ability to continue to employ the employees. Montana has been the principal jurisdiction to follow a for-cause regime (for postprobationary employees), with the passage of the Wrongful Discharge From Employment Act in 1987.

In August 1991, the National Conference of Commissioners on Uniform State Laws proposed the Model Employee Termination Act (META). This act represented a compromise that provided an example set of laws for states to consider for adoption, to promote just treatment for employers and employees across the United States, by preserving incentives for effective job performance, reducing uncertainty, and lowering costs for litigation and damages. The provisions also extended the scope for legal protections to classes of employees beyond the typically wealthier groups that were willing and able to risk the costs of litigation. Although many states have considered provisions along the lines of the META, none has adopted its terms legislatively, and employment at will remains the default rule throughout most of the United States.

Justifications for and Critiques of Employment-at-will and For-Cause Regimes

While the employment-at-will regime seems harsh from the perspective of employees, a principled justification for it lies in the right of the parties to contract freely—that is, without coercion or deception (at a minimum). Even though the language of this principle invokes “contracting,” it does not refer principally to a legal notion of contract. Rather, the usage in this normative context is similar to the meaning of a social contract, in that it refers to the ground rules for the relationship between the parties. (It is not exactly the same because a traditional social contract approach typically looks at a broader scope of relationships.) A key feature that this notion of employment contracting holds in common with the social contract model is the focus on ex ante agreements between employers and employees, as demonstrative of the freedom of the parties. The moral legitimacy for contracting arises from the autonomous judgment of the parties in (1) discerning their respective interests and (2) forming agreements that they intend to be resilient enough to govern ongoing, evolving relationships, even through adverse conditions beyond their control.

A corollary to this rights-based contractual claim is the right of each party to protect and to determine the use of its property—namely, the capital of the employing organization in the case of the employer and the productive capacity, or personal capital, of the worker in the case of the employee. The ownership rights of the respective parties reflect their capacity for autonomous contracting. One of the ways in which they manifest this autonomy is in forming employment relationships, with few or no barriers to entry and exit.

This reciprocity in contracting capacity lends a formal legitimacy to employment at will, in that either party may enter or terminate a contract provided it does not coerce or defraud the other. To enjoin an employee from terminating an employment relationship on the basis of his or her autonomous judgment would be to constrain unjustly his or her freedom to contract and, what is just as important, his or her freedom to terminate contracts.

The correlative argument for employment at will is that it likewise would not be justifiable to restrict the freedom of the employer to terminate the relationship. Public policy would not support imposing an employment relationship on either party, and so, despite incidental ex post claims, deprivations, and hardships that individual employers and employees might experience, their rational ex ante preferences would be to preserve the freedom to contract. In other words, the logic of employment at will as a moral argument and a public policy assumes that employers and employees as respective classes of contractors agree to support this regime as the most effective way to protect their respective interests.

When they are not discrete classes, that is, when employees own all or part of their employer, then the justification for employment at will involves recognizing a principled proportionality between the employees’ interests as workers and as owners. Such owner-employees seek to safeguard their autonomy by preserving in a balanced way the capital in their personal productive capacities and the organization’s capital. As they do this, they consider the respective markets for these resources in the short term and over the long term. As employees, they have options for finding other jobs, and as capitalists, they have options for holding or trading in their investments. Balancing these risks and opportunities in a practicable proportion is an ethical duty that employee-owners owe to themselves, to one another, and to those who depend on them for the prudent management of these stores of wealth. As a consequence, owneremployees should consider that the advantages they might gain as workers through constraints on the practice of employment at will might pale in comparison with the long-term costs they bear as capitalists.

The ethical justification for a for-cause regime lies principally in appeals to the autonomy of the parties and to justice as due process, both substantively, in terms of the bases for entering, modifying, or terminating an employment relationship, and procedurally, in terms of the recourse that the parties have for appeal and possible revision or reversal of the decision. Under a for-cause regime, only “good reasons” suffice for making significant employment decisions, because the emphasis is on the cogency of the determinations as they implicate the parties’ autonomy rather than on the mere license to make them.

Out of respect for this autonomy, such a policy does not permit “bad reasons” as bases for such decisions, nor does it permit facially arbitrary or unreasonable decisions. The constitutional, statutory, common-law, and contractual exceptions to the employment-at-will rule above effect a similar result, by disqualifying large classes of bad reasons. However, these exceptions do not exclude merely “unreasonable” bases for employment actions. Defenders of the practice of employment at will would argue that the law should permit parties the discretion to act arbitrarily—even foolishly—provided that they do not act coercively or fraudulently, and that it is preferable to leave the regulation of arbitrary and foolish behavior to the forces of markets for labor, capital, and reputation.

In addition to invoking the moral autonomy of employees to justify a for-cause regime, one can point to the moral benefit of promoting efficiency in markets by distributing information essential for markets to function. When employers inform employees of the reasons for their termination, this can strengthen the efficiency and effectiveness of the market for labor. Current and prospective employees can learn the expectations of employers and the standards for performance that will merit recruitment, retention, and promotion. On a macroeconomic scale, this will benefit the participants in the labor market, both employers and employees.

However, such practices also can increase the legal liability and risk for employers significantly, since these revelations involve others in the bases for management’s deliberative process regarding employment decisions. Putative reasons for dismissal may not fare well under scrutiny by those inside and outside the employing organization, who may view the reasons as pretexts for discriminatory and/or retaliatory policies or actions. Even when the employing organization observes a demonstrable discipline in such practices and carefully documents its contemporaneous judgments, it can become vulnerable to a broader scope of litigation than under an employment-at-will regime—that is, for retaliatory discharge, discrimination, and even defamation.

While an analogy with the aforementioned protections that public sector employees enjoy would be facially appealing as an additional justification for a for-cause scheme, critics would argue that such a construction would risk conflating substantive enduring differences between the public and private sectors, not the least of which are the qualitatively distinct constitutional and ethical interests of government employees in protection from government expropriation of their property, liberty, and lives. Regardless of the comparative scale, scope, and power of corporations and other private organizations, they do not pose the same qualitative threat to these fundamental rights that a government agency does when it functions as both an employer and a promulgator and enforcer of laws. It is possible to draw analogies with constitutional conceptions of due process in order to justify a for-cause regime, without insisting on a de facto extension to the private sector of practices for government employees.

A for-cause framework does not reject the freedom to contract that underwrites the doctrine of employment at will. Rather, it focuses on the material circumstances of the asymmetries in knowledge and power that obtain between employers and employees in the bounded rationality, the opportunism, and, especially, the asset specificity of the parties—for example, in the investments they make in training, in career development, and in serving clients, customers, stockholders, and other stakeholders. The assumption underlying a forcause regime is that there are normatively significant barriers to entry and exit from the employment market and employment relationships and that these conditions pose particular risks for the moral autonomy of employees.

As a result, support for a for-cause regime does not require abandoning the ex ante contracting model—for example, on grounds that subsequent breakdowns in employment relationships, or other circumstances, justify abrogating a “social contract” in favor of protecting employees to the detriment of employers. This would open the door to special pleading and arbitrary conditions that would endanger the interests of all parties to employment relationships, if only because it would raise the cost of contracting.

Rather, one can preserve a contracting model and structure procedures that reflect these asymmetries and give preference to the interests of employees for substantive and procedural due process. A contracting model need not impose a policy of employment at will. Contracting is consistent with a for-cause regime as well, as long as there are ethically justifiable procedures to protect the interests of the parties to the employment relationship, with special deference to the moral autonomy of employees. (Such policies likewise should protect the interests of employers when asymmetries of information and power favor employees—for example, when an employee exerts significant influence on the employer’s prospects for success, through his or her level of authority or specialized talents.)

Reference 4

Chapter 16

Risks Related to the Job: Workers’ Compensation and Unemployment Compensation

Workers’ compensation is a state-mandated coverage that is exclusively related to the workplace. Unemployment compensation is also a mandated program required of employers. Both are considered social insurance programs, as is Social Security. Social Security is featured in Chapter 18 “Social Security” as a foundation program for employee benefits (covered in Chapter 19 “Mortality Risk Management: Individual Life Insurance and Group Life Insurance” through Chapter 22 “Employment and Individual Health Risk Management”). Social insurance programs are required coverages as a matter of law. The programs are based only on the connection to the labor force, not on need. Both workers’ compensation and unemployment compensation are part of the risk management of businesses in the United States. The use of workers’ compensation as part of an integrated risk program is featured in Case 3 of Chapter 23 “Cases in Holistic Risk Management”.

Workers’ compensation was one of the coverages that helped the families who lost their breadwinners in the attacks of September 11, 2001. New York City and the state of New York suffered their largest-ever loss of human lives. Because most of the loss of life occurred while the employees were at work, those injured received medical care, rehabilitation, and disability income under the New York workers’ compensation system, and families of the deceased received survivors’ benefits. The huge payouts raised the question of what would happen to workers’ compensation rates. The National Council on Compensation Insurance (NCCI) predicted a grim outlook then, but by 2005, conditions improved as frequency of losses declined and the industry’s reserves increased.Dennis C. Mealy, FCAS, MAAA, Chief Actuary, NCCI, Inc., “State of the Line,” May 8, 2008; Orlando, Florida, 2008; NCCI Holdings, Inc. The workers’ compensation line has maintained this strong reserve position and has been helped by a continual downward trend in loss frequency. Consequently, the industry reported a combined ratio of 93 percent in 2006 and projects a 99 percent combined ratio for 2007. This indicates positive underwriting results. However, medical claims severity (in contrast to frequency) has continued to grow, as shown in Figure 16.1 “Changes in the Distribution of Medical versus Indemnity Claims in Workers’ Compensation*”.

Workers’ compensation is considered a social insurance program. Another social insurance program is the unemployment compensation offered in all the states. This chapter includes a brief explanation of this program as well. To better understand how workers’ compensation and unemployment compensation work, this chapter includes the following:

Links

Workers’ compensation laws and benefits

How benefits are provided

Workers’ compensation issues

Unemployment compensation

Figure 16.1 Changes in the Distribution of Medical versus Indemnity Claims in Workers’ Compensation*

* 2007p: Preliminary based on data valued as of December 31, 2007;

1987, 1997: Based on data through December 31, 2006, developed to ultimate;

based on the states where NCCI provides rate-making services, excludes the effects of deductible policies

Source: Dennis C. Mealy, FCAS, MAAA, National Council on Compensation Insurance (NCCI), Inc. Chief Actuary, “State of the Line” Annul Issues Symposium (AIS), May 8, 2008, Accessed March 28, 2009, . © 2008 NCCI Holdings, Inc. Reproduced with permission.

Links

At this point in our study, we look at the coverage employers provide for you and your family in case you are hurt on the job (workers’ compensation) or lose your job involuntarily (unemployment compensation). As noted above, these coverages are mandatory in most states. Workers’ compensation is not mandatory in New Jersey and Texas (although most employers in these states provide it anyway). In later chapters, you will see the employer-provided group life, health, disability, and pensions as part of noncash compensation programs. These coverages complete important parts of your holistic risk management. You know that, at least for work-related injury, you have protection, and that if you are laid off, limited unemployment compensation is available to you for six months. These coverages are paid completely by the employer; the rates for workers’ compensation are based on your occupational classification.

In some cases, the employer does not purchase workers’ compensation coverage from a private insurer but buys it from a state’s monopolistic fund or self-insures the coverage. For unemployment compensation, the coverage, in most cases, is provided by the states.Exceptions are taxing governmental entities, such as the school districts in Texas, that may be allowed to self-insure unemployment compensation. They have a pool administered by the Texas Association of School Boards. Regardless of the method of obtaining the coverage, you are assured by statutes to receive the benefits.

As with the coverages discussed in Chapter 13 “Multirisk Management Contracts: Homeowners” to Chapter 15 “Multirisk Management Contracts: Business”, external market conditions are a very important indication of the cost of coverage to your employer. When rates increase dramatically, many employers will opt to self-insure and use a third-party administrator (TPA) to manage the claims. In workers’ compensation, loss control and safety engineering are important parts of the risk management process. One of the causes of loss is ergonomics, particularly as related to computers. See the box “Should Ergonomic Standards Be Mandatory?” for a discussion. You would like to minimize your injury at work, and your employer is obligated under federal and state laws to secure a safe workplace for you.

Thus, in your pursuit of a holistic risk management program, workers’ compensation coverage is an important piece of the puzzle that completes your risk mitigation. The coverages you receive are only for work-related injuries. What happens if you are injured away from work? This will be discussed in later chapters. One trend is integrated benefits, in which the employer integrates the disability and medical coverages of workers’ compensation with voluntary health and disability insurance. Integrated benefits are part of the effort to provide twenty-four-hour coverage regardless of whether an injury occurred at work or away from work. Currently, nonwork-related injuries are covered for medical procedures by the employer-provided health insurance and for loss of income by group disability insurance. Integrating the benefits is assumed to prevent double dipping (receiving benefits under workers’ compensation and also under health insurance or disability insurance) and to ensure security of coverage regardless of being at work or not. (See the box “Integrated Benefits: The Twenty-Four-Hour Coverage Concept.”) Health and disability coverages are provided voluntarily by your employer, and it is your responsibility to seek individual coverages when the pieces that are offered are insufficient to complete your holistic risk management. Figure 16.2 “Links between Holistic Risk Pieces and Workers’ Compensation and Unemployment Compensation” shows how your holistic risk pieces relate to the risk management parts available under workers’ compensation and unemployment compensation.

Figure 16.2 Links between Holistic Risk Pieces and Workers’ Compensation and Unemployment Compensation

16.1 Workers’ Compensation Laws and Benefits

LEARNING OBJECTIVES

In this section we elaborate on the following:

History of workers’ compensation

Legal enactment of workers’ compensation

Benefits provided under workers’ compensation

Each state and certain other jurisdictions, such as the District of Columbia and other U.S. territories, has a workers’ compensation system to enforce a series of state laws that requires employers to pay workers for their work-related injuries and illnesses with no relationship to who caused the injury or illness.

History and Purpose

In the nineteenth century, before implementation of workers’ compensation laws in the United States, employees were seldom paid for work-related injuries. A major barrier to payment was that a worker had to prove an injury was the fault of his or her employer to recover damages. The typical employee was reluctant to sue his or her employer out of fear of losing the job. For the same reason, fellow workers typically refused to testify on behalf of an injured colleague about the circumstances surrounding an accident. If the injured employee could not prove fault, the employer had no responsibility. The injured employee’s ability to recover damages was hindered further by the fact that even a negligent employer could use three common law defenses to disavow liability for workers’ injuries: the fellow-servant rule, the doctrine of assumption of risk, and the doctrine of contributory negligence.

Under the fellow-servant rule, an employee who was injured as a result of the conduct of a fellow worker could not recover damages from the employer. The assumption of risk doctrine provided that an employee who knew, or should have known, of unsafe conditions of employment assumed the risk by remaining on the job. Further, it was argued that the employee’s compensation recognized the risk of the job. Therefore, he or she could not recover damages from the employer when injured because of such conditions. If an employee was injured through negligence of the employer but was partly at fault, the employee was guilty of contributory negligence. Any contributory negligence, regardless of how slight, relieved the employer of responsibility for the injury.

These defenses made recovery of damages by injured employees nearly impossible and placed the cost of work-related injuries on the employee. As a result, during the latter part of the nineteenth century, various employer liability laws were adopted to modify existing laws and improve the legal position of injured workers. The system of negligence liability was retained, however, and injured employees still had to prove that their employer was at fault to recover damages.

Even with modifications, the negligence system proved costly to administer and inefficient in protecting employees from the financial burdens of workplace injuries.A counterargument is postulated in D. Edward and Monroe Berkowitz, “Challenges to Workers’ Compensation: A Historical Analysis,” in Workers’ Compensation Adequacy, Equity & Efficiency, ed. John D. Worral and David Appel (Ithaca, NY: ILR Press, 1985). The authors contend that workers were becoming successful in suing employers. Thus, workers’ compensation developed as an aid to employers in limiting their responsibilities to employees. The need for more extensive reform was recognized, with many European countries instituting social insurance programs during the latter half of the 1800s. Beginning with Wisconsin in 1911,For a detailed history of workers’ compensation laws, see the Encyclopedia of Economic and Business History, . U.S. jurisdictions developed the concept of workers’ compensation that compensated workers without the requirement that employers’ negligence must be proved (that is, with strict employer liability). Costs were borne directly by employers (generally in the form of workers’ compensation insurance premiums) and indirectly by employees who accepted lower wages in exchange for benefits. To the extent, if any, that total labor costs were increased, consumers (who benefit from industrialization) shared in the burden of industrial accidents through higher prices for goods and services. Employees demanded higher total compensation (wages plus benefits) to engage in high-risk occupations, resulting in incentives for employers to adopt safety programs. By 1948, each jurisdiction had similar laws.

In compromising between the interests of employees and those of employers, the originators of workers’ compensation systems limited the benefits available to employees to some amount less than the full loss. They also made those benefits the sole recourse of the employee against the employer for work-related injuries. This give-and-take of rights and duties between employers and employees is termed quid pro quo (Latin for “this for that”). The intent was for the give and take to have an equal value, on average. You will see in our discussion of current workers’ compensation issues that some doubt exists as to whether equity has been maintained. An exception to the sole recourse concept exists in some states for the few employees who elect, prior to injury, not to be covered by workers’ compensation. Such employees, upon injury, can sue their employer; however, the employer in these instances retains the three defenses described earlier.

In addition to every state and territory having a workers’ compensation law, there are federal laws applicable to longshore workers and harbor workers, to nongovernment workers in the District of Columbia, and to civilian employees of the federal government. Workers’ compensation laws differ from jurisdiction to jurisdiction, but they all have the purpose of ensuring that injured workers and their dependents will receive benefits without question of fault.

Integrated Benefits: The Twenty-Four-Hour Coverage Concept

Are your wrists painful? Or numb? (If you think about it long enough, you’ll convince yourself they’re one or the other.) Perhaps you have a repetitive stress injury or carpal tunnel syndrome. Maybe it’s now painful enough that you need to take a few days off. But wait—you use a computer at work, so this could be a work-related injury. Better go talk to the risk manager about filing a workers’ compensation claim. But wait—you spend hours at home every night playing computer games. If this is an off-hours injury, you should call your health maintenance organization (HMO) for an appointment with your primary care physician so you can arrange for short-term disability. But wait—when your boss is not looking, you surf the Internet at work. What do you do?

If you worked for Steelcase, Inc., an office-furniture manufacturer based in Grand Rapids, Michigan, your wrists might still hurt, but you would not have to worry about who to call. Steelcase used to handle its medical benefits like most companies do: the risk management department handled workers’ compensation; the human resources department handled health insurance, short-term disability, and long-term disability; and four separate insurers provided the separate coverages. Several events caused top management to rethink this disintegrated strategy: rising medical costs, a slowdown in the economy that forced a look at cost-saving measures, and the results of a survey showing that employees simply did not understand their benefits. “The employees hammered us in terms of not understanding who to call or what they get,” Steelcase manager Libby Child told Employee Benefit News in June 2001.

In 1997, Steelcase became one of the first U.S. companies to implement an integrated benefits program. It combined long- and short-term disability, workers’ compensation, medical case management, and Family and Medical Leave Act administration, and outsourced the record-keeping duties. Now a disabled employee—whether the injury is work-related or not—can make one phone call and talk to a representative who collects information, files any necessary claims, and assigns the worker to a medical case manager. The case manager ensures that the employee is receiving proper medical treatment and appropriate benefits and helps him or her return to work as soon as possible.

The integrated plan has been a hit with employees, who like the one-call system, and with managers because lost-time days decreased by one-third after the program was implemented. Steelcase’s financial executives are happy, too: the combined cost of short-term disability, long-term disability, and workers’ compensation dropped 13 percent in the program’s first three years.

In California, however, results with integrated benefits have been mixed. The California state legislature authorized three-year pilot programs in four counties to study the effectiveness of twenty-four-hour health care in the early 1990s, a time when workers’ compensation premiums were inordinately expensive for employers. By the time the programs were under way, these costs had become more competitive. Thus, most employers viewed a change to integrated benefits as simply too risky in relation to the traditional workers’ compensation system. Nonetheless, then California Insurance Commissioner (and current California Lieutenant Governor) John Garamendi championed the concept of integrated benefits. Garamendi maintains that placing workers’ compensation and health coverage under managed care has the potential to save California $1 billion through reductions in administrative and legal expenses, fraud, and medical costs.

With Steelcase and other pioneers proving the success of integrated benefits, it is a wonder that all companies have not jumped on the bandwagon. Many are, but there are still some obstacles to overcome:

The shift from paper record keeping to computer databases raises concerns over privacy.

Risk managers and human resources personnel may have turf wars over the combination of their duties.

To fully integrate and to be able to generate, meaningful data, all computer systems must be compatible and their operators trained; however, human resource departments and the treasurer (where risk management resides) may not have the same systems.

Workers’ compensation is provided by property/casualty insurers, while health and disability are provided by life/health insurers, so integration may be complicated.

Regulations vary widely for workers’ compensation and employee benefits.

In the past few years, many companies, large and small, have taken the leap toward integrating benefits. Recent converts include Pacific Bell; San Bernardino County in California; Pitney Bowes; and even an insurance company, Nationwide. Several organizations specializing in the twenty-four-hour coverage concept have also emerged. Notably, the Integrated Benefits Institute (IBI) merges health, absenteeism, and disability management under one banner and provides consulting services. Integrated Benefits LLC is another brokerage firm in this area operating in the Carolinas, and United 24 has produced success bringing together managed care, workers’ compensation, and disability insurance for Wisconsin employers. For any business that wants to reduce sick time off and disability benefits—which cost the average company 14.3 percent of payroll—the issue of integrating benefits is not “whether” but “when.”

Sources: Diana Reitz, “It’s Time to Resume the 24-Hour Coverage Debate,” National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 8, 1999; Annmarie Geddes Lipold, “Benefit Integration Boosts Productivity and Profits,” Workforce.com, accessed March 31, 2009, ; Karen Lee, “Pioneers Return Data on Integrated Benefits,” Employee Benefit News, June 2001; Lee Ann Gjertsen, “Brokers Positive on Integrated Benefits,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, July 7, 1997; Leo D. Tinkham, Jr., “Making the Case for Integrated Disability Management,” National Underwriter, Life & Health/Financial Services Edition, May 13, 2002; Phyllis S. Myers and Etti G. Baranoff, “Workers’ Compensation: On the Cutting Edge,” Academy of Insurance Education, Washington, D.C., instructional video with supplemental study guide, video produced by the Center for Video Education, 1997.

Coverage

Coverage under workers’ compensation is either inclusive or exclusive. Further, it is compulsory or elective, depending on state law. A major feature is that only injuries and illnesses that “arise out of and in the course of employment” are covered.

Inclusive or Exclusive

Inclusive laws list all the types of employment that are covered under workers’ compensation; exclusive laws cover all the types of employment under workers’ compensation except those that are excluded. Typically, domestic service and casual labor (for some small jobs) are excluded. Agricultural workers are excluded in nineteen jurisdictions, whereas their coverage is compulsory in twenty-seven jurisdictions and entirely voluntary in four jurisdictions. Some states limit coverage to occupations classified as hazardous. The laws of thirty-nine states apply to all employers in the types of employment covered; others apply only to employers with more than a specified number of employees. Any employer can comply voluntarily.

Compulsory or Elective

In all but two states, the laws regarding workers’ compensation are compulsory. In these two states (New Jersey and Texas) with elective laws, either the employer or the employee can elect not to be covered under workers’ compensation law. An employer who opts out loses the common law defenses discussed earlier. If the employer does not opt out but an employee does, the employer retains those defenses as far as that employee is concerned. If both opt out, the employer loses the defenses. It is unusual for employees to opt out because those who do must prove negligence in order to collect and must overcome the employer’s defenses.

An employer who does not opt out must pay benefits to injured employees in accordance with the requirements of the law, but that is the employer’s sole responsibility. Thus, an employee who is covered by workers’ compensation cannot sue his or her employer for damages because workers’ compensation is the employee’s sole remedy (also called exclusive remedy). (In fact, workers’ compensation is losing its status as the employee’s sole remedy against the employer. Later in this chapter, we will discuss some of the current methods used by employees to negate the exclusive remedy rule.) By coming under the law, the employer avoids the cost of litigation and the risk of having to pay a large judgment in the event an injured employee’s suit for damages is successful.

In Texas, 65 percent of employers opted to stay in the system despite the fact that workers’ compensation is not mandatory.Daniel Hays, “Despite Option, More Texas Firms Offer Comp,” National Underwriter Online News Service, February 1, 2002. The results were obtained through a survey of 2,808 employers between August and October 2001 following the passage of a measure that outlawed the use of preinjury liability waivers by employees. It is likely that as insurance rates rise, more companies will opt to stay out of the system. Nearly all employers that opt out reduce their likelihood of being sued by providing an alternative employee benefit plan that includes medical and disability income benefits as well as accidental death and dismemberment benefits for work-related injuries and illnesses.Employee benefits are discussed in Chapter 19 “Mortality Risk Management: Individual Life Insurance and Group Life Insurance” to Chapter 20 “Employment-Based Risk Management (General)”. Alternative coverage never exactly duplicates a state’s workers’ compensation benefits. In addition, the employer purchases employer’s liability insurance to cover the possibility of being sued by injured employees who are not satisfied with the alternative benefits.

Proponents of an opt-out provision argue that competition from alternative coverage provides market discipline to lower workers’ compensation insurance prices. Furthermore, greater exposure to common law liability suits may encourage workplace safety. Opponents see several drawbacks of opt-out provisions:

Some employers may fail to provide medical benefits or may provide only modest benefits, resulting in cost shifting to other segments of society.

The right of the employee to sue may be illusory because some employers may have few assets and no liability insurance.

Employees may be reluctant to sue the employer, especially when the opportunity to return to work exists or if family members may be affected.

Safety incentives may not be enhanced for employers with few assets at risk.

Covered Injuries

To limit benefits to situations in which a definite relationship exists between an employee’s work and the injury, most laws provide coverage only for injuries “arising out of and in the course of employment.” This phrase describes two limitations. First, the injury must arise out of employment, meaning that the job environment was the cause. For example, the family of someone who has a relatively stress-free job but dies of cardiac arrest at work would have trouble proving the work connection and therefore would not be eligible for workers’ compensation benefits. On the other hand, a police officer or firefighter who suffers a heart attack (even while not on duty) is presumed in many states to have suffered from work-related stress.

The second limitation on coverage is that the injury must occur while in the course of employment. That is, the loss-causing event must take place while the employee is on the job in order to be covered by workers’ compensation. An employee injured while engaged in horseplay, therefore, might not be eligible for workers’ compensation because the injury did not occur while the employee was “in the course of employment.” Likewise, coverage does not apply while traveling the normal commute between home and work. Along these same lines of reasoning, certain injuries generally are explicitly excluded, such as those caused by willful misconduct or deliberate failure to follow safety rules, those resulting from intoxication, and those that are self-inflicted.

Subject to these limitations, all work-related injuries are covered, even if they are due to employee negligence. In addition, every state provides benefits for occupational disease, which is defined in terms such as “an injury arising out of employment and due to causes and conditions characteristic of, and peculiar to, the particular trade, occupation, process or employment, and excluding all ordinary diseases to which the general public is exposed.”Various concepts and statistics in this chapter are based on research described in S. Travis Pritchett, Scott E. Harrington, Helen I. Doerpinghaus, and Greg Niehaus, An Economic Analysis of Workers’ Compensation in South Carolina (Columbia, SC: Division of Research, College of Business Administration, University of South Carolina, 1994). Some states list particular diseases covered, whereas others simply follow general guidelines.

Benefits

Workers’ compensation laws provide for four types of benefits: medical, income replacement, survivors’ benefits, and rehabilitation.

Medical

All laws provide unlimited medical care benefits for accidental injuries. Many cases do not involve large expenses, but it is not unusual for medical bills to run into many thousands of dollars. Medical expenses resulting from occupational illnesses may be covered in full for a specified period of time and then terminated. Unlike nonoccupational health insurance, workers’ compensation does not impose deductibles and coinsurance to create incentives for individuals to control their demand for medical services.

When you study health care in Chapter 21 “Employment-Based and Individual Longevity Risk Management” and Chapter 22 “Employment and Individual Health Risk Management”, you will become very familiar with managed care. To save on the escalating costs of medical care in workers’ compensation, the medical coverage also uses managed care. Briefly, managed care limits the choice of doctors. The doctors’ decisions are reviewed by the insurer, and many procedures require preapproval. Along with many other states, Texas passed legislation in 2005 that incorporates managed care in the workers’ compensation system.Steve Tuckey, “Texas Legislature OKs Comp Reform,” National Underwriter Online News Service, May 31, 2005. Under these systems, doctors who take care of injured employees under workers’ compensation coverage are asked to try to get the employees back to work as soon as possible. The return-to-work objective is to ensure employees’ presence at work under any capacity, thus incurring less workers’ compensation losses. The industry is attempting to monitor itself for managing the care in a more cost-saving manner.Dale Chadwick and Peter Rousmaniere, “Managing Workers’ Comp: The Workers’ Compensation Managed-Care Industry Is Doing a Better Job of Monitoring Itself, but It Needs to Figure out What to Do with the Information,” Best’s Review, November 2001, (accessed March 31, 2009). One area that causes major increases in the workers’ compensation rate is the cost of drugs. In 2006, medical costs per lost time claim increased 8.6 percent over the prior year, compared to a 4 percent increase in the medical consumer price index (CPI).Dennis C. Mealy, FCAS, MAAA, National Council on Compensation Insurance, Inc. (NCCI) Chief Actuary, “State of the Line” Annul Issues Symposium (AIS), May 8, 2008, (accessed March 28, 2009). Figure 16.3 “Workers’ Compensation Medical Severity*” shows the costs of medical claims under workers’ compensation from 1995 to 2007. As you can see, the severity of medical claims (losses per claim) has outpaced the medical CPI every year since.

Figure 16.3 Workers’ Compensation Medical Severity*

* 2007p: Preliminary based on data valued as of December 31, 2007;

Medical severity 1995–2006: Based on data through December 31, 2006, developed to ultimate;

based on the states where NCCI provides ratemaking services, excludes the effects of deductible policies

Income Replacement

All workers’ compensation laws provide an injured employee with a weekly income while disabled as the result of a covered injury or disease. Income replacement benefits under workers’ compensation are commonly referred to by industry personnel as indemnity benefits. The amount and duration of indemnity payments depend on the following factors:

Whether the disability is total or partial, and temporary or permanent

The employee’s compensation

Each state’s maximum duration of benefits

The waiting period

Cost-of-living adjustments

Degree and Length of Disability

Total disability refers to the condition of an employee who misses work because he or she is unable to perform any of the important duties of the occupation. Partial disability, on the other hand, means the injured employee can perform some but not all, of the duties of his or her occupation. In either case, disability may be permanent or temporary. Permanent total disability means the injured person is not expected to be able to work again. Temporary total disability means the injured employee is expected to be able to return to work at some future time.The amount of weekly income benefits is the same for both permanent and temporary total disability.

Partial disability may be either temporary or permanent. Temporary partial payments are most likely to be made following a period of temporary total disability. A person who can perform some but not all work duties qualifies for temporary partial benefits. Such benefits are based on the difference between wages earned before and after an injury. They account for a minor portion of total claim payments.

Most laws specify that the loss of certain body parts constitutes permanent partial disability. Benefits expressed in terms of the number of weeks of total disability payments are usually provided in such cases and are known as scheduled injuries. For example, the loss of an arm might entitle the injured worker to two hundred weeks of total disability benefits; the loss of a finger might entitle him or her to thirty-five weeks of benefits. No actual loss of time from work or income is required because the assumption is that loss of a body part causes a loss of future income.

Of the fifteen largest classes of occupation, clerical jobs see the highest number of lost time claims. However, this by far the largest occupational class by payroll. The actual frequency of claims as a percentage of payroll dollars is among the lowest for clerical workers. Historically, trucking has seen the highest frequency of claims by payroll. Overall, the frequency of lost-time-only claims has declined, which is the good news in the workers’ compensation field. The largest drop is in the convalescent/nursing home claims. The least decline is in the drivers/chauffeurs and college professional classifications.

Amount of Benefits

Weekly benefits for death, disability, and (often) disfigurement are primarily based on the employee’s average weekly wage (average earned income per week during some specified period prior to disability) multiplied by a replacement ratio, expressed as a percentage of the average weekly wage. Jurisdictions also set minimum and maximum weekly benefits.

The replacement percentage for disability benefits ranges from sixty in one jurisdiction to seventy in two others, but in most jurisdictions it is 66⅔. The percentage reflects the intent to replace income after taxes and other work-related expenses because workers’ compensation benefits are not subject to income taxation. In Virginia, for example, the compensation rate is adjusted each year on July 1. Effective July 1, 2008, the maximum rate was $841, and the minimum rate was $210.25. The cost of living increase will be 4.2 percent, effective October 1, 2008.See Virginia Workers’ Compensation Commission Web site at (accessed March 28, 2009). In Texas, the maximum temporary income benefit for 2009 is $750 and the minimum is $112.See Texas Workers’ Compensation Commission Web site at (accessed March 28, 2009) for the details regarding the Texas benefits. Each state workers’ compensation commission has a Web site that shows its benefit amounts. Twenty jurisdictions lower their permanent partial maximum payment per week below their maximum for total disability. For these jurisdictions, the average permanent partial maximum is 66⅔ percent of their total disability maximum. With respect to death benefits, thirty-one jurisdictions use 66⅔ percent in determining survivors’ benefits for a spouse only; five of these use a higher percentage for a spouse plus children. The range of survivors’ benefits for a spouse plus children ranges from 60 percent in Idaho to 75 percent in Texas. Examples of Texas benefits calculations are demonstrated in hypothetical incomes in Table 16.1 “Hypothetical Examples of Texas Workers’ Compensation Income Calculations” A to D. In Texas, temporary income benefits equal 70 percent of the difference between a worker’s average weekly wage and the weekly wage after the injury. If a worker’s average weekly wage was $500, and an injury caused the worker to lose all of his or her income, temporary income benefits would be $350 a week.

Table 16.1 Hypothetical Examples of Texas Workers’ Compensation Income Calculations

Calculation of Temporary Income Benefits

Average weekly wage (hypothetical) $400

Less: wage after injury 0

Equals $400

Temporary income benefit (70 percent the “equals” amount) $280

Calculation of Supplemental Income Benefits

Average weekly wage $400

80 percent of weekly wage $320

Less: the current wage 0

Equals $320

Supplemental benefit (80 percent of the “equals” amount) $256

Calculation of Lifetime Income Benefits for Disability with a Loss of Limb

Average weekly wage $400

Lifetime income benefit (75 percent of weekly wage) $300

Calculation of Death Benefits

Average weekly wage $400

Death benefit (75 percent of weekly wage) $300

The next example is demonstrated in Table 16.1 “Hypothetical Examples of Texas Workers’ Compensation Income Calculations” B for temporary income after returning to work part-time. In Texas, an injured worker may get lifetime income benefits if the worker has an injury or illness that results in the loss of the hands, feet, or eyesight, or if the worker meets the conditions of the Texas Workers’ Compensation Act. Table 16.1 “Hypothetical Examples of Texas Workers’ Compensation Income Calculations” C provides an example of benefits for lifetime in such a case.

Duration of Benefits

In thirty-nine jurisdictions, no limit is put on the duration of temporary total disability. Nine jurisdictions, however, allow benefits for less than 500 weeks; two specify a 500-week maximum. The limits are seldom reached in practice because the typical injured worker’s condition reaches “maximum medical improvement,” which terminates temporary total benefits earlier. Maximum medical improvement is reached when additional medical treatment is not expected to result in improvement of the person’s condition.

In forty-three jurisdictions, permanent total benefits are paid for the duration of the disability and/or lifetime. These jurisdictions generally do not impose a maximum dollar limit on the aggregate amount that can be paid.

Waiting Periods

Every jurisdiction has a waiting period before indemnity payments (but not medical benefits) for temporary disability can begin; the range is from three to seven days. The waiting period has the advantages of giving a financial incentive to work, reducing administrative costs, and reducing the cost of benefits. If disability continues for a specified period (typically, two to four weeks), benefits are retroactive to the date disability began. Moral hazard is created among employees who reach maximum medical improvement just before the time of the retroactive trigger. Some employees will malinger long enough to waive the waiting period. Hawaii does not allow retroactive benefits.

Cost-of-Living Adjustment

Fifteen jurisdictions have an automatic cost-of-living adjustment (COLA) for weekly benefits. In some cases, the COLA takes effect only after disability has continued for one or two years. Because benefit rates are usually set by law, those rates in jurisdictions that lack automatic increases for permanent benefits become out of date rapidly during periods of inflation.

Survivors’ Benefits

In the event of a work-related death, all jurisdictions provide survivor income benefits for the surviving spouse and dependent children, as well as a burial allowance. The survivor income benefit for a spouse plus children is typically (in thirty jurisdictions) 66⅔ percent of the worker’s average weekly wage. Several jurisdictions provide additional income for one child only. Table 16.1 “Hypothetical Examples of Texas Workers’ Compensation Income Calculations” D provides an example of the death benefits in Texas. Burial benefits pay up to $2,500 of the worker’s funeral expenses. Burial benefits are paid to the person who paid the worker’s funeral expenses. The death benefits in New York were discussed earlier in this chapter. In the example case for Texas, the replacement of lost income is 75 percent, as shown in Table 16.1 “Hypothetical Examples of Texas Workers’ Compensation Income Calculations” D.

Rehabilitation

Most people who are disabled by injury or disease make a complete recovery with ordinary medical care and return to work able to resume their former duties. Many workers, however, suffer disability of such a nature that something more than income payments and ordinary medical services is required to restore them, to the greatest extent possible, to their former economic and social situation. Rehabilitation is the process of accomplishing this objective and involves the following:

Physical-medical attention in an effort to restore workers as nearly as possible to their state of health prior to the injury

Vocational training to enable them to perform a new occupational function

Psychological aid to help them adjust to their new situation and be able to perform a useful function for society

About one-fourth of the workers’ compensation laws place this responsibility on the employer (or the insurer, if applicable). Most of the laws require special maintenance benefits to encourage disabled workers to cooperate in a rehabilitation program. Nearly all states reduce or stop income payments entirely to workers who refuse to participate.

KEY TAKEAWAYS

In this section you studied the history of workers’ compensation, related laws, and benefits provided:

Traditionally, employers used three common law defenses against liability for injury to workers: the fellow-servant rule, assumption of risk doctrine, and contributory negligence doctrine.

Workers’ compensation was developed as a compromise that would force employers to cover employees’ injuries regardless of cause, in exchange for this being the employees’ sole remedy.

Workers’ compensation laws are inclusive or exclusive, compulsory or elective.

Covered injuries must arise out of and in the course of employment or be occupational diseases.

Benefits provided under workers’ compensation are medical, income replacement, survivors’ benefits, and rehabilitation.

Medical—unlimited as of the date of occurrence

Income replacement—usually at 66⅔ percent of the average weekly wage, subject to state maximum, lifetime maximum, and degree and length of disability

Survivor’s benefits—income benefits and burial allowances

Rehabilitation—physical, vocational, and psychological care necessary to restore (to the greatest extent possible) injured workers to their former economic and social situation

Case Study Ethic DISCUSSION QUESTIONS

Explain the former common law defenses employers utilized to avoid liability for employees’ on-the-job injuries.

What are the arguments for and against allowing employers to opt out of the workers’ compensation systems in Texas and New Jersey?

Given the rapid increases in workers’ compensation costs, would you argue that other states should return to offering an opt-out provision? (Note: In the early days of workers’ compensation laws in the United States, opt-out provisions were common because of concern about whether making workers’ compensation mandatory was constitutional—now, not an issue.)

A worker is entitled to workers’ compensation benefits when disability “arises out of and in the course of employment.” A pregnant employee applies for medical and income benefits, alleging that her condition arose out of and in the course of the company’s annual Christmas party. Is she entitled to benefits? Why or why not?

16.2 How Benefits Are Provided

LEARNING OBJECTIVES

In this section we elaborate on the following ways that workers’ compensation benefits are distributed:

Private insurance

Residual markets

State funds

Self-insurance

Second-injury funds

Workers’ compensation laws hold the employer responsible for providing benefits to injured employees. Employees do not contribute directly to this cost. In most states, employers may insure with a private insurance company or qualify as self-insurers. In some states, state funds act as insurers. Following is a discussion of coverage through insurance programs and through the residual markets (part of insurance programs for difficult-to-insure employers), self-insurance, and state funds.

Workers’ Compensation Insurance

Employers’ risks can be transferred to an insurer by purchasing a workers’ compensation and employers’ liability policy.

Coverage

The workers’ compensation and employers’ liability policy has three parts. Under part I, Workers’ Compensation, the insurer agrees

to pay promptly when due all compensation and other benefits required of the insured by the workers’ compensation law.

The policy defines “workers’ compensation law” as the law of any state designated in the declarations and specifically includes any occupational disease law of that state. The workers’ compensation portion of the policy is directly for the benefit of employees covered by the law. The insurer assumes the obligations of the insured (that is, the employer) under the law and is bound by the terms of the law as well as the actions of the workers’ compensation commission or other governmental body having jurisdiction. Any changes in the workers’ compensation law are automatically covered by the policy.

Four limitations, or “exclusions,” apply to part 1. These limitations include any payments in excess of the benefits regularly required by workers’ compensation statutes due to (1) serious and willful misconduct by the insured; (2) the knowing employment of a person in violation of the law; (3) failure to comply with health or safety laws or regulations; or (4) the discharge, coercion, or other discrimination against employees in violation of the workers’ compensation law. In addition, the policy refers only to state laws and that of the District of Columbia; thus, coverage under any of the federal programs requires special provisions.

Part 2 of the workers’ compensation policy, Employers’ Liability, protects against potential liabilities not within the scope of the workers’ compensation law, yet arising out of employee injuries. The insurer agrees to pay damages for which the employer becomes legally obligated because of

bodily injury by accident or disease, including death at any time resulting there from … by any employee of the insured arising out of and in the course of his employment by the insured either in operations in a state designated in … the declarations or in operations necessary or incidental thereto.

Examples of liabilities covered under part 2 are those to employees excluded from the law, such as domestic and farm laborers. Part 2 might also be applicable if the injury is not considered work-related, even if it occurs on the job.

Part 3 of the workers’ compensation policy provides Other States Insurance. Previously, this protection was available by endorsement. Part 1 applies only if the state imposing responsibility is listed in the declarations. To account for the case of an employee injured while working out of state who may be covered by that state’s compensation law, the Other States Insurance part of the workers’ compensation policy allows the insured to list states (perhaps all) where the employees may have potential exposure. Coverage is extended to these named locales.

Cost

Based on Payroll

The premium for workers’ compensation insurance typically is based on the payroll paid by the employer. A charge is made for each $100 of payroll for each classification of employee. This rate varies with the degree of hazard of the occupation.Rates are made for each state and depend on the experience under the law in that state. Thus, the rate for the same occupational classification may differ from state to state. Large employers can elect to have experience rating, which takes a company’s prior losses into account in determining its current rates.

Factors Affecting Rate

The rate for workers’ compensation insurance is influenced not only by the degree of hazard of the occupational classification but also by the nature of the law and its administration and, of course, by prior losses. If the benefits of the law are high, rates will tend to be high. If they are low, rates will tend to be low. Moreover, given any law, no matter its benefits level, its administration will affect premium rates. If those who administer the law are conservative in their evaluation of borderline cases, premium rates will be lower than in instances where administrators are less circumspect in parceling out employers’ and insurers’ money. Most laws provide that either the claimant or the insurer may appeal a decision of the administrative board in court on questions of law, but if both the board and the courts are inclined toward generosity, the effect is to increase workers’ compensation costs.

Workers’ compensation may be a significant expense for the employer. Given any particular law and its administration, costs for the firm are influenced by the frequency and severity of injuries suffered by workers covered. The more injuries, the more workers will be receiving benefits. The more severe such injuries are, the longer such benefits must be paid. It is not unusual to find firms in hazardous industries having workers’ compensation costs running from 10 to 30 percent of payroll. This can be a significant component of labor costs. Whatever their size, however, these costs are only part of the total cost of occupational injury and disease. The premium paid is the firm’s direct cost, but indirect costs of industrial accidents, such as lost time, spoiled materials, and impairment of worker morale, can be just as significant. These costs can be reduced by loss prevention and reduction, and by self-insuring the risk.

Loss Prevention and Reduction

Most industrial accidents are caused by a combination of physical hazard and faulty behavior. Once an accident begins to occur, the ultimate severity is largely a matter of chance. Total loss costs are a function of accident frequency and severity as explained in prior chapters. Frequency is a better indicator of safety performance than severity because chance plays a greater part in determining the seriousness of an injury than it does in determining frequency.

Accident Prevention

The first consideration is to reduce frequency by preventing accidents. Safety must be part of your thinking, along with planning and supervising. Any safety program should be designed to accomplish two goals: (1) reduce hazards to a minimum, and (2) develop safe behavior in every employee. A safety engineer from the workers’ compensation insurer (or a consultant for the self-insured employer) can give expert advice and help the program. He or she can identify hazards so they can be corrected. This involves plant inspection, job safety analysis, and accident investigation.

The safety engineer can inspect the plant to observe housekeeping, machinery guarding, maintenance, and safety equipment. He or she can help the employer organize and implement a safety training program to develop employee awareness and safe practices. He or she can analyze job safety to determine safe work methods and can set job standards that promote safety. The insurer usually provides employers with accident report forms and instructions on accident investigation. This is essential because every accident demonstrates a hazardous condition or an unsafe practice, or both. The causes of accidents must be discovered so that the information can assist in future prevention efforts. Inspections, job safety analysis, and accident investigations that lead consistently to corrective action are the foundations of accident prevention. The box “Should Ergonomic Standards Be Mandatory?” discusses the issues of job safety in the area of posture and position in the workplace.

Loss Reduction

Accident frequency cannot be reduced to zero because not all losses can be prevented. After an employee has suffered an injury, however, action may reduce the loss. First, immediate medical attention may save a life. Moreover, recovery will be expedited. This is why many large plants have their own medical staff. It is also why an employer should provide first-aid instruction for its employees. Second, the insurer along with the employer should manage the care of the injured worker, including referrals to low-cost, high-quality medical providers. Third, injured workers should take advantage of rehabilitation. Rehabilitation is not always successful, but experience has shown that remarkable progress is possible, especially if it is started soon enough after an injury. The effort is worthwhile from both the economic and humanitarian points of view. All of society benefits from such effort.

Residual Market

Various residual market mechanisms, such as assigned risk pools and reinsurance facilities, allow employers that are considered uninsurable access to workers’ compensation insurance. This is similar to the structure discussed earlier for automobile insurance. Usually employers with large losses, as depicted by high experience ratings, are considered high risk. These employers encounter difficulty in finding workers’ compensation coverage. The way to obtain coverage is through the residual or involuntary market (a market where insurers are required to provide coverage on an involuntary basis). Insurers are required to participate, and insureds are assigned to an insurer in various ways.

As reported in the NCCI “State of the Line” report, Figure 16.4 “Residual Market Premiums as of December 31, 2007” provides the workers’ compensation residual market premiums from 1985 to 2006; Figure 16.5 “Residual Market Combined Ratio as of December 31, 2007” provides the residual market combined ratio for the same period.

Eighteen jurisdictions have state-operated workers’ compensation funds in which the state government is responsible for collecting workers’ compensation founds and distributing benefits. In six of these, the state fund is exclusive; that is, employers are not permitted to buy compensation insurance from a private insurance company but must insure with the state fund or self-insure.Three of the six permit self-insurance exclusive funds are called monopolistic state funds. Where the state fund is competitive (that is, optional), employers may choose to self-insure or to insure through either the state fund or a private insurer.

Employer’s Risk

Industrial accidents create two possible losses for employers. First, employers are responsible to employees covered by the workers’ compensation law for the benefits required by law. Second, they may become liable for injuries to employees not covered by the law.For example, many workers’ compensation laws exclude workers hired for temporary jobs, known as casual workers. Injured employees who are classified as casual workers are not entitled to benefits under the law but may recover damages from the employer if they can prove that their injuries were caused by the employer’s negligence. The employer’s liability risk with regard to excluded employees is the same as it would be if there was no workers’ compensation law. The risks associated with these exposures cannot be avoided without suspending operations—hardly a practical alternative.

Where permitted, self-insurance of this exposure is common. Self-insurance is desirable, in part because of the predictability afforded by legislated benefits. In addition, employers can buy coverage (called excess loss insurance) for very large losses similar to the commercial umbrella liability policy discussed in Chapter 15 “Multirisk Management Contracts: Business” .

Figure 16.4 Residual Market Premiums as of December 31, 2007

* NCCI Plan states plus DE, IN, MA, MI, NJ, NC

Figure 16.5 Residual Market Combined Ratio as of December 31, 2007

Self-Insurance

Most state workers’ compensation laws permit an employer to retain the workers’ compensation risk if it can be proven that the employer is financially able to pay claims. Some states permit the risk to be retained only by employers who furnish a bond guaranteeing payment of benefits.

The major question for the self-insurance of the workers’ compensation risk is whether the firm has a large enough number of exposure units (employees) that its losses are reasonably stable and can be predicted with some accuracy. Clearly, an employer with ten employees cannot make an accurate prediction of workers’ compensation benefit costs for next year. Such costs may be zero one year and several thousand dollars another year. On the other hand, as the number of employees of the firm increases, workers’ compensation losses become more stable and predictable. Just how stable losses must be in order for self-insurance to be feasible depends on the employer’s ability and willingness to pay for losses that exceed expectations. The employer’s ability to pay for loss is a second important factor considered by regulators in determining whether or not to permit self-insurance. Captives are also used by many employers for this coverage. Of course, all types of self-insurance require the use of stop-loss coverage through reinsurance. The reinsurance is best for use with captives, as explained in Chapter 6 “The Insurance Solution and Institutions”. Smaller employers can join together with others, usually from the same industry, and create a group self-insurance program. Under these programs, each employer is responsible for paying the losses of the group when necessary—such as in the case of a member’s insolvency. The employer’s risk is not transferred; only the payment of losses is shared through the pooling mechanism discussed in Chapter 6 “The Insurance Solution and Institutions”. Group self-insurance members buy stop-loss coverage and are required to obtain regulatory approval for their existence.

Insurance or Self-Insurance?

Is your firm large enough to self-insure, and if it is, can you save money by doing so? Unless you have at least several hundred employees and your workers’ compensation losses have a low correlation with other types of retained exposures, self-insurance is not feasible. The low correlation implies diversification of the retained risk exposures. Unless self-insurance will save money, it is not worthwhile. Most employers who decide to self-insure use third-party administrators to administer the claims or contract with an insurer to provide administrative services only.

What are the possible sources for saving money? Ask yourself the following questions about your present arrangement:

Does your insurer pay benefits too liberally?

Does it bear the risk of excessive losses?

Does it bear the risk of employers’ liability?

Does it administer the program?

How large is the premium tax paid by the insurer?

How large is the insurer’s profit on your business?

What is your share of losses in the assigned risk plan that the insurer pays into?

Can the third-party administrator be a good buffer in disputes with angry employees?

As a self-insured firm, you will still provide the benefits specified by the workers’ compensation law(s) in the state(s) where you operate. Therefore, self-insuring reduces benefits only if you or your outside self-insurance administrator will settle claims more efficiently than your insurer.

Unless your firm is very large, you probably would decide to buy stop-loss insurance for excessive losses, and you would buy insurance for your employer’s liability (part B of a workers’ compensation insurance policy). Would you administer the self-insured program? Most likely, you would hire an outside administrator. In either case, the administrative expenses might be similar to those of your insurer. As a self-insurer, you would save the typical premium tax of between 2 and 3 percent that your insurer is required to pay to the state(s) where you do business. Profits are difficult to calculate because the insurer’s investment income must be factored in along with premiums, benefit payments, expenses, and your own opportunity cost of funds. If you do not pay premiums ahead, you can use the cash flow for other activities until they are used to pay for losses. While the workers’ compensation line of business produces losses in some years and profits in others, over a period of several years, you would expect the insurer to make a profit on your business. You could retain this profit by self-insuring.

Firms that do not qualify for insurance based on normal underwriting guidelines and premiums can buy insurance through an assigned risk plan, that is, the residual market. Because of inadequate rates and other problems, large operating losses are often realized in the residual market. These losses become an additional cost to be borne by insurers and passed on to insureds in the form of higher premiums. Assigned risk pool losses are allocated to insurers on the basis of their share of the voluntary (nonassigned risk) market by state and year. These losses can be 15 to 30 percent or more of premiums for employers insured in the voluntary market. This burden can be avoided by self-insuring. Many firms have self-insured for this reason, resulting in a smaller base over which to spread the residual market burden.

If your firm is large enough to self-insure, your workers’ compensation premium is experience rated. What you pay this year is influenced by your loss experience during the past three years. The extent to which your rate goes up or down to reflect bad or good experience depends on the credibility assigned by the insurer. This statistical credibility is primarily determined by the size of your firm. The larger your firm, the more your experience influences the rate you pay during succeeding years.

If an employer wants the current year’s experience rating to influence what it pays for workers’ compensation coverage this year, you can insure on a retrospective plan. It involves payment of a premium between a minimum and a maximum, depending on your loss experience. Regardless of how favorable your experience is, you must pay at least the minimum premium. On the other hand, regardless of how bad your experience is, you pay no more than the maximum. Between the minimum and the maximum, your actual cost for the year depends on your experience that year.

Several plans with various minimum and maximum premium stipulations are available. If you are conservative with respect to risk, you will prefer a low minimum and a low maximum, but that is the most expensive. Low minimum and high maximum is cheaper, but this puts most of the burden of your experience on you. If you have an effective loss prevention and reduction program, you may choose the high maximum and save money on your workers’ compensation insurance.

In choosing between insurance and self-insurance, you should consider the experience rating plans provided by insurers, as well as the advantages and disadvantages of self-insurance. The process of making this comparison will undoubtedly be worthwhile.

State Funds

A third method of ensuring benefit payments to injured workers is the state fund. State funds are similar to private insurers except that they are operated by an agency of the state government, and most are concerned only with benefit payments under the workers’ compensation law and do not assume the employers’ liability risk. This usually must be insured privately. The employer pays a premium (or tax) to the state fund and the fund, in turn, provides the benefits to which injured employees are entitled. Some state funds decrease rates for certain employers or classes of employers if their experience warrants it.

Cost comparisons between commercial insurers and state funds are difficult because the state fund may be subsidized. In some states, the fund may exist primarily to provide insurance to employers in high-risk industries—for example, coal mining—that are not acceptable to commercial insurers. In any case, employers who have access to a state fund should consider it part of the market and compare its rates with those of private insurers.

Second-Injury Funds

Nature and Purpose

If two employees with the same income each lost one eye in an industrial accident, the cost in workers’ compensation benefits for each would be equal. If one of these employees had previously lost an eye, however, the cost of benefits for him or her would be much greater than for the other worker (probably more than double the cost). Obviously, the loss of both eyes is a much greater handicap than the loss of one. To encourage employment in these situations, second-injury funds are part of most workers’ compensation laws. When an employee suffers a second injury, the employee is compensated for the disability resulting from the combined injuries; the insurer (or employer) who pays the benefit is then reimbursed by a second-injury fund for the amount by which the combined disability benefits exceed the benefit that would have been paid only for the last injury.

Financing

Second-injury funds are financed in a variety of ways. Some receive appropriations from the state. Others receive money from a charge made against an employer or an insurer when a worker who has been killed on the job does not leave any dependents. Some states finance the fund by annual assessments on insurers and self-insurers. These assessments can be burdensome.

KEY TAKEAWAYS

In this section you studied the ways workers’ compensation benefits are provided through insurance programs, residual markets, self-insurance, and state funds:

Employers’ risks can be transferred to a workers’ compensation and employers’ liability policy, which pays for the benefits injured workers are entitled to under workers’ compensation law and for expenses incurred as a result of liability on the part of the employer.

Workers’ compensation insurance premiums are based on payroll and experience (which is in turn influenced by loss prevention and reduction efforts).

Employers considered uninsurable can obtain workers’ compensation insurance through the residual market, made of assigned risk pools and reinsurance facilities.

Some jurisdictions have state-operated workers’ compensation funds as either the only source of workers’ compensation coverage or as an alternative to the private market.

Large employers with sufficient financial resources may be able to self-insure and thus pay for workers’ compensation.

Second-injury funds are set up to reimburse employers for payment to injured workers who suffer subsequent injuries that more than double the cost of providing them with compensation.

Case Study Ethic DISCUSSION QUESTIONS

How are workers’ compensation rates influenced?

Under what circumstances should an employer retain workers’ compensation risk?

How does a retrospective premium plan work?

What is the purpose of second-injury funds?

16.3 Workers’ Compensation Issues

LEARNING OBJECTIVES

In this section we elaborate on several issues that workers’ compensation insurers must contend with, including the following:

Cost drivers and reform

Erosion of exclusive remedy

Scope of coverage

As noted by the National Council of Compensation Insurance (NCCI), despite the improved results of the workers’ compensation line, the following are challenging issues faced by the industry:

Catastrophes such as terrorism

Cost drivers and reform

Capacity

Adequate reserves

Privacy

Erosion of exclusive remedy and scope of coverage

Mental health claims

Black lung

The Americans with Disabilities Act (ADA)

Ergonomics

Coverage for terrorism is a major issue for workers’ compensation. The problem has been somewhat alleviated by the relaunch of the Terrorism Risk Insurance Act (TRIA) of 2002 as the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), which provides protection until December 31, 2014. It is not a permanent solution, so the stakeholders are working on permanent solutions, including overall catastrophe pools.

As noted earlier, medical inflation, in addition to increased benefits through reforms in the states and attorney fees, have cost the system a substantial amount of extra expenses and caused escalation in the combined ratio for the workers’ compensation line. All medical care costs have, for decades, grown much faster than the overall consumer price index (CPI). Workers’ compensation medical care costs are of special concern. The high reimbursement rate (100 percent of allowable charges) by workers’ compensation relative to lower rates (generally 80 to 90 percent) in nonoccupational medical plans creates a preference for workers’ compensation among employees and medical care providers who influence some decisions about whether or not a claim is deemed work-related. The managed care option mentioned above is used, but because medical inflation is so high, the system cannot resolve the issue on its own.

Attorney involvement varies substantially among the states. It is encouraged by factors such as the following:

The complexity of the law

Weak early communication to injured workers

Advertisements by attorneys

Failure to begin claim payments soon after the start of disability

Employee distrust of some employers and insurers

Employee concern that some employers will not rehire injured workers

The subjective nature of benefit determination (e.g., encouraging both parties to produce conflicting medical evidence concerning the degree of impairment)

The solution may be a system that settles claims equitably and efficiently through promoting agreement and the employee’s timely return to work. Reforms in states such as California, Florida, Tennessee, and Wisconsin are examples of positive effects and cost controls. Wisconsin’s system is an example characterized by prompt delivery of benefits, low transaction costs, and clear communication between employers and employees.

The workers’ compensation combined ratio per calendar year since 1990 is shown in Figure 16.6 “Workers’ Compensation Combined Ratios”. The combined ratio has declined since its peak of 122 in 2001.

Figure 16.6 Workers’ Compensation Combined Ratios

Source: Dennis C. Mealy, FCAS, MAAA, National Council on Compensation Insurance (NCCI), Inc. Chief Actuary, “State of the Line” Annul Issues Symposium (AIS), May 8, 2008, accessed March 28, 2009, . © 2008 NCCI Holdings, Inc. Reproduced with permission.

As for the whole property/casualty industry, investment income results kept declining. The low interest rates took a toll on this long-tail line, requiring underwriting profits in order to provide returns to investors. The poor investment results are shown in Figure 16.7 “Workers’ Compensation Ratios of Investment Gain and Other Income to Premium”.

Figure 16.7 Workers’ Compensation Ratios of Investment Gain and Other Income to Premium

* Adjusted to include realized capital gains to be consistent with 1992 and after.

Investment gain on insurance transactions includes other income.

The next issue, privacy, has been discussed in prior chapters. This is an issue engulfing the whole industry and is relevant to the workers’ compensation line because of the medical and health components of this coverage. How to protect individuals’ health information from being identified and transmitted is the industry’s concern.

Employers, of course, benefit from having their liabilities limited to what is stipulated in workers’ compensation laws. When the benefits received by workers are a close approximation of what would be received under common law, employees receive a clear advantage as well from the law. Today, however, there is a perception that workers’ compensation provides inadequate compensation for many injuries. With high awards for punitive and general damages (neither available in workers’ compensation) in tort claims, workers often perceive the exclusivity of compensation laws as inequitable.

As a result, workers attempt to circumvent the exclusivity rule. One method is to claim that the employer acts in a dual capacity, permitting the employee an action against the employer in the second relationship as well as a workers’ compensation claim. For example, an employee injured while using a product manufactured by another division of the company might seek a products liability claim against the employer. Dual capacity has received limited acceptance. Consider the case of an employee of Firestone tires who uses the employer’s commercial auto with Firestone tires to make deliveries. If a tire exploded, the employee has a workers’ compensation claim as well as a case against the manufacturer of the tire—his own employer.

A second means of circumventing the exclusivity of workers’ compensation is to claim that the employer intentionally caused the injury. Frequently, this claim is made with respect to exposure to toxic substances. Employees claim that employers knew of the danger but encouraged employees to work in the hazardous environment anyway. This argument, too, has received limited acceptance, and litigation of these cases is costly. Further, their mere existence likely indicates at least a perception of faults in the workers’ compensation system.

A third circumvention of the exclusivity of workers’ compensation is the third-party over action. It begins with an employee’s claim against a third party (not the employer). For example, the employee may sue a machine manufacturer for products liability if the employee is injured while using the manufacturer’s machine. In turn, the third party (the manufacturer in our example) brings an action against the employer for contribution or indemnification. The action against the employer might be based on the theory that the employer contributed to the loss by failing to supervise its employees properly. The end result is an erosion of the exclusive remedy rule—as if the employee had sued the employer directly.

Another current issue in workers’ compensation is the broadening of the scope of covered claims. The original intent of workers’ compensation laws was to cover only work-related physical injuries. Later, coverage was extended to occupational illnesses that often are not clearly work-related. Claims for stress and cases involving mental health claims, especially after September 11, are on the increase.

The Supreme Court in 2002 clarified that only the inability to perform daily living activities is a disability under the Americans with Disabilities Act (ADA) and not the inability to perform a job. The ADA forbids employers with more than fifteen employees from discriminating against disabled persons in employment. Disabled persons are those with physical or mental impairments limiting major life activities such as walking, seeing, or hearing. The ADA requires that employee benefits, as a privilege of employment, be provided in a nondiscriminatory manner as well. Employees with disabilities must be given equal access to medical expense insurance coverage and disability coverage. If the medical plan does not cover certain treatment needed by persons with disabilities, such as vision care, the employer does not have to add vision care treatment. However, if vision care is provided by the plan, then vision care must also be offered to employees with disabilities. In addition, specific disabilities, such as vision impairment, or disability in general, cannot be excluded from coverage.

The other issue regarding repetitive activities that cause stress and carpal tunnel syndrome is still under consideration at the time of writing this text, as noted in “Should Ergonomic Standards be Mandatory?

Should Ergonomic Standards Be Mandatory?

In the waning days of the Clinton administration, the Occupational Safety and Health Administration (OSHA) issued sweeping new guidelines for ergonomics in the workplace. Ergonomics refers to the design and arrangement of workplace equipment in order to maximize worker safety, health, comfort, and efficiency. The new standards, which applied to all industries and nearly all types of businesses, both large and small, placed the ergonomic burden on employers (and, through them, on the states’ workers’ compensation insurance industry, which would be responsible for implementing the new rules). Every company was required to set up a program to manage ergonomics, including worker training, analysis and elimination of risk factors, and identification of musculoskeletal disorder (MSD) injuries. Of most concern to the insurance industry was a provision that mandated a set level of compensation for MSD injuries. By requiring compensation for ergonomic injuries to be between 90 and 100 percent of a worker’s salary, OSHA was infringing on state workers’ compensation systems, which awarded injured workers only 67 percent, on average, of their salaries up to a certain maximum.

Controversial from the start, the ergonomic standards were overturned by Congress in April 2001 just after George W. Bush took office. Working with the insurance industry, OSHA has since launched a voluntary program to reduce ergonomic injuries.

A review of OSHA activities (available at its Web site, reveals that OSHA developed a “four-pronged comprehensive approach to ergonomics designed to quickly and effectively address musculoskeletal disorders (MSDs) in the workplace.” The following are four segments of OSHA’s strategy for reducing injuries and illnesses from MSDs in the workplace:

Guidelines

Outreach and assistance

Enforcement

National advisory committee

The new guidelines include more cooperation with business, including technical support and an education campaign. However, not everyone is pleased with the new voluntary standards; labor advocates reject them as not providing enough protection for workers. OSHA has issued updates to its guidelines tailored to different industries in response to these criticisms. If you visit OSHA’s Web site, you can view the educational component of the voluntary program for yourself. Along with a description of potential hazards and solutions, the site contains pictures (some animated) of both the correct and incorrect ways to undertake various work activities. Figure 16.8 “FIGURE 16.8 OSHA’s Basics of Neutral Working Postures”, taken from OSHA’s Web site, is designed to illustrate the correct posture of a baker in a grocery store.

Figure 16.8

FIGURE 16.8 OSHA’s Basics of Neutral Working Postures

Case Study Ethic Questions for Discussion

Can too much workplace regulation put employees out of work? In the face of hard-to-meet standards, might some employers decide not to stay in business or to move their businesses to a country without such strict rules?

Is it ethically correct to require the same workplace standards from small start-up companies and large, well-established ones?

Should the states be the only entities allowed to set workers’ compensation rules? Why not the federal government?

Do voluntary programs work, or do they allow businesses to get away with ignoring workers’ injuries?

Sources: Steven Brostoff, “Senate Sidesteps Ergonomics Mandate,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, July 29, 2002; Bruce C. Wood, “Federal Regs Threaten State WC System,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, August 19, 2002; Mark A. Hofmann, “Senate Committee Approves Ergo Rule Bill,” Business Insurance, June 19, 2002, accessed March 31, 2009, ; Steven Brostoff, “Ergonomic Rule Bill Moves,” National Underwriter Online News Service, June 19, 2002; Steven Brostoff, “Insurance Groups Support Ergo Plan,” National Underwriter, Online News Service, August 27, 2002; Arlene Ryndak and Julie L. Gackenbach, “Congress Should Not Tie OSHA’s Hands on Ergonomic Regulations,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, May 20, 2002; “Risk Managers, Insurers Get a Break on Ergonomics,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, April 22, 2002; Steven Brostoff, “New Ergonomics Bill Draws Insurer Ire,” National Underwriter, Property & Casualty/Risk & Benefits Management Edition, April 29, 2002; Caroline McDonald, “Insurers: New OSHA Ergo Plan Okay,” National Underwriter Online News Service, April 5, 2002; OSHA’s Web site at (accessed March 28, 2009).

KEY TAKEAWAYS

In this section you studied the major issues faced by workers’ compensation insurers:

High reimbursement rates of medical costs contribute to the poor combined ratio of workers’ compensation.

Attorney involvement in the cases of injured workers inflates costs.

Perceptions of workers’ compensation as inadequate in indemnifying injured employees encourages workers to circumvent the exclusivity rule.

Broadening the scope of workers’ compensation coverage increases the number of claims.

Case Study Ethic DISCUSSION QUESTIONS

Why might workers’ compensation be viewed as preferential to nonoccupational health coverage? Does this create any incentives for anyone within the system?

In what ways can the exclusivity rule be circumvented by employees?

Do you disagree with any of the ways that the scope of workers’ compensation coverage has been broadened over the years? Explain.

16.4 Unemployment Compensation

LEARNING OBJECTIVES

In this section we elaborate on the following features of unemployment compensation:

State unemployment laws

Coverage provided

Financing of unemployment compensation

Administration of unemployment compensation

While workers’ compensation is quasi-social private insurance of significant concern to its many stakeholders, unemployment compensation is a purely social insurance program. Because of the high risk associated with projecting future rates of unemployment and associated claims, private insurers are not willing to provide this type of insurance. Unemployment compensation programs pay weekly cash benefits to workers who are involuntarily unemployed. The following sections cover state laws, coverage, how benefits are financed, and administration of unemployment compensation.

State Laws

State unemployment compensation programs were established as a result of federal legislation. However, each state creates, finances, and administers its own law. Like workers’ compensation, the law transfers to the employer at least part of the financial element of a risk faced by the employee. Unlike most workers’ compensation programs, however, the firm’s risk manager has no choice with regard to how the risk is handled. Neither private insurance nor self-insurance is permitted. Management can reduce the cost, however, by stabilizing the firm’s employment and preventing payment of unjustified benefits.

Employers Subject to Tax

The federal tax applies to firms that have one or more employees in each of twenty weeks during a calendar year, or firms that pay $1,500 or more in wages during any calendar quarter. As of January 1987, coverage was extended to agricultural employers that have ten or more employees in each of twenty weeks during the year or that pay $20,000 or more in wages during any calendar quarter. New provisions to include domestic and municipal employees, as well as employees of nonprofit organizations, have also been added.

Coverage

The federal law established minimum standards for coverage and benefits. Unless a state law meets the standards, no tax offset is permitted. Every state meets the standards, and in many cases they are exceeded. Today, all states cover state and local government employees, several cover farm workers, and a few cover domestic workers. About 97 percent of the civilian labor force is covered. In some cases, unemployment compensation is self-insured in a pool, as is the case with the unemployment compensation of employees of many Texas school districts that opted to use the pool administered by the Texas Association of School Boards.This is firsthand information by the author, who was employed by the Texas Association of School Boards in 1994–1995.

Unemployment compensation is designed to relieve workers in certain industries and occupations of part of the economic burden of temporary unemployment. Three aspects of benefit payments are important: (1) amount and duration, (2) qualifications for benefits, and (3) disqualifications.

Amount and Duration

The amount of the weekly benefit payment a worker may receive through unemployment compensation varies according to the benefit formula in the law of each state. Usually, the amount is about one-half of the worker’s full-time weekly pay within specified limits. The maximum is low and is easily accessible on the Web site of your state unemployment compensation agency (usually a division of the employment commission). Some states provide an additional allowance for certain dependents of the unemployed worker. With the passage of the 1986 Tax Reform Act, all unemployment benefits became fully taxable to the recipient for federal income tax purposes.

Most state laws have a waiting period—typically one week—between the time an unemployed worker files a claim for benefits and the time benefit payments begin. This is designed to place the burden of short-term temporary unemployment on the worker as well as to decrease the cost of the plan, thereby making possible greater coverage of more significant unemployment losses.

In most states, the maximum number of weeks that benefits can be paid is twenty-six. A federal-state program of extended benefits may continue payments for another thirteen weeks during periods of high unemployment, such as occurred in the early 1990s. In an economic emergency, federal funding may continue payments for another twenty-six weeks.

Qualifications for Benefits

To qualify for benefits, unemployed workers must fulfill certain conditions. They must first be involuntarily unemployed. Once they are involuntarily unemployed, they are required to register for work at a public employment office and file a claim for benefits. They must have been employed in a job covered by the state unemployment compensation law.An unemployed federal civilian or ex-serviceperson may be entitled to benefits under the conditions of a state law for determining benefit eligibility. The amount he or she may receive will be the same as if federal pay had been covered under the state law. Costs of the benefits are paid by the federal government. They must have earned a specified amount of pay or worked for a specified length of time, or both. They must be able to work (this is important in order to differentiate unemployment benefits from disability benefits), available for work, and willing to take a suitable job if it is offered to them. In most states, an unemployed worker who is sick and therefore unable to work is not entitled to unemployment compensation benefits. Some states permit payments to disabled workers under a separate disability program.Several states have compulsory temporary disability insurance laws to provide income benefits for disabled workers who are not receiving unemployment benefits. Some of these plans pay partial benefits to workers receiving workers’ compensation benefits. Others exclude these workers.

Disqualifications

Unemployed workers may be disqualified from benefits even if they meet the qualifications described above. As noted above, most state laws disqualify those who quit voluntarily without good cause or who were discharged for just cause. Those who refuse to apply for or accept suitable work, or are unemployed because of a work stoppage caused by a labor dispute, may be disqualified. Other causes for disqualification are receiving pay from a former employer, receiving workers’ compensation benefits, receiving Social Security benefits, or being deemed an independent contractor and therefore not an employee.

The effect of disqualification varies from state to state. In some cases, it means that the unemployed worker receives no benefits until he or she has again qualified by being employed for a specified length of time in covered work. In other cases, disqualification results in an increase in the waiting period. Some state laws not only increase the waiting period but also decrease the benefits.

How Benefits Are Financed

Noncontributory

Most unemployment compensation insurance is noncontributory: employers pay all the cost in most states.Employees contribute in Alabama, Alaska, and New Jersey. The Federal Unemployment Tax Act (FUTA) places a tax on employers at the rate of 6.2 percent of workers’ pay in covered jobs, excluding anything over $7,000 paid to a worker in a year for the purpose of financing unemployment compensation. Up to 5.4 percent can be offset by employers who pay a state tax or have been excused through experience rating. So, in effect, the federal tax may be only (6.2 − 5.4 =) 0.8 percent. Revenue from this tax is deposited in the Federal Unemployment Trust Fund and credited to the state for the payment of benefits under its plan. Each state has its own trust fund. The remaining part of the federal tax goes into general federal revenues. Congress appropriates money for grants to the states for their administration of the program. If appropriations for this purpose are less than the federal share of the payroll tax, then the remainder of such revenue is put into a reserve fund for aid to the states in payment of benefits when state reserves are low.

Experience Rating

All states have experience rating; that is, they reduce the contribution of employers whose workers have little unemployment. The theory of this rating system is that it encourages employers to reduce unemployment and stabilize employment to the extent that they can. One other effect, however, is to make employers interested in disqualifying workers who apply for benefits because the benefits paid out of their account reflect their experience under the plan.This does not necessarily mean that employers try to cheat employees out of benefits. There are many borderline cases in which there is room for argument about whether or not the unemployed worker is really involuntarily unemployed. Experience rating emphasizes the fact that employers pay the cost of benefits and motivates them to be interested in disqualifications. As in other human relations situations, one can find examples of bad behavior by both employers and employees. This has led to considerable discussion of disqualification standards and administration and to many hearings and disputes.

Administration

The federal portion of the unemployment compensation insurance program is administered by the Employment and Training Administration in the Department of Labor. Every state has its own employment security agency. Some are independent; others are in the State Department of Labor or some other state agency. Typically, the agency is also responsible for the administration of state employment search offices. There are more than 2,500 such offices in the United States where claims for benefits may be filed. Claimants apply for benefits and register for employment at the same time. The function of the office is to find employment for claimants or provide benefits.

KEY TAKEAWAYS

In this section you studied the following features of unemployment compensation, a pure social insurance program:

State unemployment programs pay weekly cash benefits to workers who are involuntarily unemployed.

Unemployment compensation is established by federal legislation, but it is administered by each state.

Applies to employers with one or more employees in each of twenty weeks of a year or paying at least $1,500 in wages per year.

Usually pays qualified, involuntarily unemployed workers half their weekly pay, subject to a waiting period and a maximum duration.

Financed through taxes on employers between 0.8 to 6.2 percent and subject to experience rating.

The federal portion of the program is administered by the Employment and Training Administration of the Department of Labor.

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