The American legal system

Every business decision has a legal dimension. Hiring a cashier creates an employment relationship with statutory minimums and rights that cannot be signed away. Accepting a purchase order forms a contract. Posting a review of a competitor's product can expose the company to a defamation claim. Leasing a delivery van, collecting customer email addresses, borrowing from a bank and firing an underperforming manager all trigger rules that managers are expected to know well enough to spot problems early and ask for advice before they become expensive. This course gives that working knowledge. It does not turn you into a lawyer, and nothing in it is legal advice; its goal is to help you recognize legal risk, speak the language of the professionals you hire and make better business decisions.

This first lesson explains how the American legal system is built: where law comes from, how power is divided between the federal government and the fifty states, how the Constitution and the Bill of Rights affect business, how courts create binding precedent and how administrative agencies regulate whole industries. Later lessons build on this map. BUS-101 introduced the forms of business ownership and the business environment; this course goes deeper into the legal rules behind them.

What law is and why it matters to managers

Law is the body of rules that a society enforces through its institutions: legislatures make rules, courts interpret and apply them, and police, regulators and sheriffs enforce the results. Law differs from ethics and social norms because it is backed by state power. A business that breaks a social norm may lose customers; a business that breaks the law may pay damages, fines or penalties, lose its license to operate or see its managers imprisoned. Many rules overlap: lying to a customer is unethical, and if the lie induces a contract it may also be an actionable misrepresentation or an offense under consumer protection law.

For a manager, legal knowledge serves four purposes. It prevents problems, because a well-drafted contract or a compliant hiring process costs far less than a lawsuit. It identifies opportunities, because intellectual property, limited liability and secured lending are legal tools that create value. It supports negotiation, because knowing what a court would likely do sets the bargaining range in a dispute. And it improves communication with lawyers, who can do their best work only when clients give them the right facts at the right time.

Classifying law

Lawyers classify rules in several ways, and the classification often decides who can sue, which court hears the case, what must be proved and what remedy is available. Public law governs the relationship between the state and individuals or organizations; it includes constitutional, administrative, criminal and tax law. Private law governs relationships between private parties; it includes contract, tort, property and corporate law. Substantive law defines rights and duties, such as the rule that a contract needs consideration; procedural law sets out how rights are enforced, such as the deadline to file a defense.

The most important distinction for business is between civil and criminal matters. In a civil case a private party, the plaintiff, sues another, the defendant, usually for money. The plaintiff must prove the case by a preponderance of the evidence, meaning that its version is more likely than not. In a criminal case the government prosecutes a defendant for conduct that harms society, and guilt must be proved beyond a reasonable doubt. Between these sits a large body of regulatory offenses, such as breaches of workplace safety, environmental or securities rules, which are prosecuted by the state but usually carry fines rather than imprisonment and are often easier to prove than crimes.

Sources of law

American law comes from four main sources. The United States Constitution is the supreme law of the land: it creates the three branches of the federal government, lists the powers of Congress and protects individual rights through the Bill of Rights and later amendments. Each state also has its own constitution. Statutes are passed by Congress or a state legislature; examples include the Fair Labor Standards Act and the Delaware General Corporation Law. Federal statutes are collected in the United States Code. Regulations are detailed rules made by agencies under authority delegated by a statute, such as the Department of Labor's overtime rules, and are published in the Code of Federal Regulations. Finally, the common law, or case law, is the body of principles developed by judges deciding individual cases, which governs large areas such as contract and negligence where no statute applies.

Most of the United States follows the English common law tradition. Louisiana is the exception: its private law is based on the civil law tradition, with a civil code influenced by French and Spanish law. To reduce differences between states, private organizations draft model or uniform laws that states may adopt. The most important for business is the Uniform Commercial Code (UCC), prepared by the Uniform Law Commission and the American Law Institute and adopted at least in large part by every state, which governs sales of goods, negotiable instruments, bank deposits and secured transactions. The American Law Institute also publishes Restatements of the Law, such as the Restatement (Second) of Contracts, which summarize the common law and are often cited by courts even though they are not binding.

Federalism and the Commerce Clause

The Constitution creates a federal system. Congress may legislate only on the subjects listed in Article I, Section 8, such as taxation, bankruptcy, patents and copyrights, currency and the regulation of commerce with foreign nations, among the states and with Indian tribes. The Tenth Amendment reserves all other powers to the states or the people, so states regulate most contracts, property, corporations, professional licensing and much of employment and consumer law. The Supremacy Clause in Article VI makes valid federal law prevail over conflicting state law, and Congress can preempt state law in a field either expressly or by occupying the field.

The Commerce Clause has been interpreted broadly. In Wickard v. Filburn (1942) the Supreme Court held that Congress could regulate wheat a farmer grew for his own use because, taken together with similar activity, it substantially affected interstate commerce. This broad reading supports federal laws on workplace safety, minimum wages, civil rights in employment and public accommodations, and environmental protection. There are limits: in United States v. Lopez (1995) the Court struck down a federal law banning guns near schools because it did not regulate economic activity. The dormant Commerce Clause also limits states, preventing them from discriminating against or unduly burdening interstate commerce, for example by taxing out-of-state goods more heavily than local ones. Cities and counties exercise powers granted by state law, such as zoning, business licensing and local taxes.

The Bill of Rights and business

The Bill of Rights, the first ten amendments to the Constitution, and the Fourteenth Amendment protect rights such as freedom of speech and religion (First Amendment), protection against unreasonable searches (Fourth Amendment), due process and protection against takings of property without just compensation (Fifth and Fourteenth Amendments) and equal protection (Fourteenth Amendment). Under the state action doctrine these rights restrict government, not private parties. A private employer that fires someone for a political post does not violate the First Amendment, although state laws or federal labor law may still protect the employee in some situations. Discrimination by private businesses is addressed by statutes such as Title VII of the Civil Rights Act of 1964 and the Americans with Disabilities Act.

Businesses can rely on constitutional rights when government regulates them. Corporations have free speech rights, including in political spending (Citizens United v. FEC, 2010). Commercial speech, such as advertising, receives intermediate protection: under the test in Central Hudson Gas & Electric v. Public Service Commission (1980), the government may regulate truthful advertising about lawful products only if it has a substantial interest, the regulation directly advances it and the regulation is not more extensive than necessary. False or misleading advertising receives no protection. The Due Process Clauses require fair procedures before government takes property, and the Takings Clause requires just compensation when government takes private property for public use. Courts review most economic regulation under the deferential rational basis test, so laws on business are usually upheld if they are rationally related to a legitimate government interest.

Precedent and how courts make law

In the common law system, judges follow precedent under the doctrine of stare decisis, Latin for to stand by things decided. A lower court must follow the decisions of higher courts in the same hierarchy on the same legal question; this is binding precedent. Decisions from other jurisdictions, or from courts of the same level, are persuasive: a judge may adopt their reasoning but need not. The binding part of a decision is the ratio decidendi, the legal principle necessary to decide the case on its material facts. Comments that are not necessary to the decision are obiter dicta and are only persuasive, although obiter from a top court carries great weight.

Precedent gives predictability, which business needs to plan. It also allows the law to evolve. Courts can distinguish a precedent by showing that the material facts of a new case are different, and the highest court can overrule its own earlier decisions when they are clearly wrong or out of step with social change. Because legislation overrides the common law, a legislature can also reverse a judge-made rule by statute, provided the statute is constitutional.

Administrative agencies and regulation

Much of the law that affects business day to day is made and enforced by administrative agencies rather than courts. Federal examples include the Federal Trade Commission (FTC), the Securities and Exchange Commission (SEC), the Equal Employment Opportunity Commission (EEOC), the Occupational Safety and Health Administration (OSHA), the Environmental Protection Agency and the Internal Revenue Service; states have their own agencies for licensing, insurance, utilities and workers' compensation. Agencies make rules through notice-and-comment rulemaking under the Administrative Procedure Act, investigate, hold hearings before administrative law judges and impose penalties. A business that disagrees can seek internal review and then judicial review in court. In Loper Bright Enterprises v. Raimondo (2024) the Supreme Court overruled the Chevron doctrine, so courts no longer defer to an agency's reasonable interpretation of an ambiguous statute and must decide the best reading themselves, which has made agency rules easier to challenge.

Law, ethics and the legal professions

Legal compliance is a floor, not a ceiling. Conduct can be legal but unethical, such as aggressively enforcing a contract term against a small supplier in crisis, and the reputational cost can exceed any legal gain. Conversely, ethical intentions do not excuse legal mistakes: a manager who sincerely believes a worker is a contractor still exposes the company to unpaid payroll taxes and penalties if the law says otherwise. Good legal risk management combines compliance programs, training, sound contracts, insurance and early advice. Lesson 12 pulls these tools together in a legal risk audit.

Lawyers in the United States, called attorneys, are licensed by each state after passing that state's bar examination or, increasingly, the Uniform Bar Examination, and generally may practice only in the states where they are admitted. Paralegals usually work under attorney supervision and are not separately licensed in most states, though a few states have created limited licenses for non-lawyers. Communications between a client and attorney for the purpose of legal advice are protected by the attorney-client privilege, and materials prepared in anticipation of litigation are protected by the work-product doctrine; these protections are one reason to involve counsel early when a dispute or investigation looms. In a corporation, the privilege belongs to the company, not to individual employees, which is why in-house counsel give employees an Upjohn warning before interviews.