The Legal Environment

The legal aspect of the general environment includes the legislation, regulation and court decisions that govern and regulate business behavior. In this lesson we shall consider types of laws, sources of law, the legal system, business organizations and the law, contract law and agency.

Types of laws

Laws relating to both individuals and organisations can be classified in a number of ways: international and national, public and private, criminal and civil. In practice there are no hard and fast rules to classification and some categories may overlap (e.g. where a person’s behaviour is deemed to infringe different areas of law).

Public and private law

Put simply, public law is the law which concerns the state, whether in international agreements or disputes or in the relationship between the state and the individual. Thus public law consists of international treaties and conventions, constitutional law, administrative law and criminal law. In contrast, private law is law governing the relationships between individuals and comprises laws in respect of contract, tort, property, trusts and the family

Criminal law

Criminal laws relate to a legal wrong (criminal offence) — a breach of a public duty, punishable by the state on behalf of society.


A tort is a civil wrong other than a breach of contract or a breach of trust and is a duty fixed by law on all persons (e.g. road users have a duty in law not to act negligently). The law of tort, therefore, is concerned with those situations where the conduct of one party threatens or causes harm to the interests of another party and the aim of the law is to compensate for this harm. The most common torts are negligence, nuisance, defamation and trespass.


A trust is generally defined as an ‘equitable obligation imposing on one or more persons a duty of dealing with property, over which they have control, for the benefit of other persons who may enforce the obligation’. This property may be in the form of money or stocks and shares or in other types of asset, particularly land, where trusts have become a very common way of permitting persons who are forbidden to own legal estates in land to enjoy the equitable benefits of ownership. Partnerships, for example, cannot hold property as legal owners, so often several partners will act as trustees for all the partners (as a partnership has no separate corporate identity it cannot own property. Similarly, minors may not hold legal estates, so their interests must be protected by a trust, administered by an individual or an institution.

Sources of law

Laws invariably derive from a number of sources including custom, judicial precedent, legislation and international and supranational bodies.


Early societies developed particular forms of behaviour (or customs) which came to be accepted as social norms to be followed by the members of the community to which they applied. Today customs would be regarded as usage recognised by law, whether by judicial precedent (case law) or through statutory intervention and hence they are largely of historical interest. Occasionally, however, they are recognised by the courts as being of local significance and may be enforced accordingly as exceptions to the general law (e.g. concerning land usage).

Cases cited must be considered carefully by judges to determine whether there are material differences in the case before the court and the earlier decision. To reach a decision, the court must find what is termed the ratio decidendi of the previous case. Put very simply, the ratio of a case are the essential steps in the legal reasoning which led the court to make that particular decision. Anything which cannot be regarded as a rationes is termed obiter dicta or ‘things said by the way’. The whole of a dissenting judgment in a case is regarded as obiter. Obiter dicta are not binding but may be regarded as persuasive arguments if the facts of the case permit.

Clearly there are times when, perhaps because of the position of a court in the hierarchy, decisions are not to be regarded as binding precedent. However, if the judgment has been delivered by a jurisdiction which has a common law system or, most importantly, by the Judicial Committee of the Privy Council, then those decisions will be regarded as being of persuasive precedent, and may be used to help the court reach its own decision.


A substantial proportion of current law – including laws governing the operations of business organizations are derived from legislation or statute. The initiative in this sphere lies effectively with the government of the day which can virtually guarantee a bill will become law, if it has a working majority in the House. The vast majority of legislation emanates from government and takes the form of Acts of Parliament or delegated legislation. Acts of Parliament are those bills which have formally been enacted by Parliament and have received presidential assent and, they represent the supreme law of the land. In addition to creating new laws (e.g. to protect the consumer), statutes may also be used to change or repeal existing laws. As its name suggests, delegated legislation is law made by a body or person to which Parliament has given limited powers of law-making.

The legal system:

A country’s legal system can be said to have two main functions: to provide an enabling mechanism within which individuals and organizations can exist and operate (e.g. companies are constituted by law) and to provide a means of resolving conflicts and of dealing with those who infringe the accepted standards of behaviour. These functions are carried out by a variety of institutions, including the government and the courts, and a detailed analysis of the legal system within a state would require consideration of the interrelationship between politics and law. The focus here is on the courts as a central element of a country’s legal system, with responsibility for interpreting the law and administering justice in democratic societies. It is worth remembering however, that political and governmental activity take place within a framework of law and that framework is itself a product of the political process at a variety of spatial levels.

Business organizations and the law

Business organisations have been described as transformers of inputs into output in the sense that they acquire and use resources to produce goods or services for consumption, all aspects of this transformation process are influenced by the law.

It is important to emphasis from the outset that the law not only constrains business activity (e.g. by establishing minimum standards of health and safety at work which are enforceable by law), but also assists it (e.g. by providing a means by which a business unit can have an independent existence from its members), and in doing so helps an enterprise to achieve its commercial and other objectives. In short, the legal environment within which businesses operate is an enabling as well as a regulatory environment and one which provides a considerable degree of certainty and stability to the conduct of business both within and between democratic states.

Given the extensive influence of the law on business organisations, it is clearly impossible to examine all aspects of the legal context within which firms function. Accordingly, in the analysis below attention is focused primarily on contract law, agency, and some of the more important statutes enacted to protect the interests of the consumer, since these are areas fundamental to business operation.

Below are examples of business activities and the legal influences.

Business activity: Establishing the organisation

Examples of legal influences: Company laws, partnerships, business names


Business activity: Acquiring resources

Examples of legal influences: Planning laws, property laws, contract, agency


Business activity: Business operations

Examples of legal influences: Employment laws, health and safety laws, contract agency Consumer laws contract.


Contract Law:

The Essentials All businesses enter into contracts, whether with suppliers or employees or financiers or customers, and these contracts will be important — and possibly crucial — to the firm’s operations. Such contracts are essentially agreements (oral or written) between two or more persons which are legally enforceable, provided they comprise a number of essential elements. These elements are: offer, acceptance, consideration, intention to create legal relations and capacity. Let us briefly consider these elements.


Before parties enter into a contractual relationship, they usually engage in an informal relationship which may or may not result in a contract depending on whether the parties were able to reach a mutual agreement or not. To have an agreement, two or more persons must arrive at a mutual understanding with one another; a party makes a proposition and another accepts the proposal.

An offer therefore is a declaration by the offeror and the offeree that they intend to be legally bound by the terms stated in the offer if it is accepted by the offeree (e.g. to supply component parts at a particular price within a specified time period). This declaration may be made orally or in writing or by conduct between the parties and must be clear and unambiguous. Furthermore it should not be confused with an ‘invitation to treat’, which is essentially an invitation to make an offer, as is generally the case with advertisements, auctions and goods on display. Tenders are offers; a request for tenders is merely an invitation for offers to be made.

Termination of an offer can happen in several ways. Clearly an offer is ended when it is accepted but, that apart, an offer may be revoked at any time up to acceptance. It is of no consequence, legally, that an offer may be kept open for a certain time. It is only when some consideration is paid for ‘buying the option’ that the time factor is important and this ‘buying the option’ would generally be a separate contract in any case. If an offer is for a certain length of time, then later acceptance is ineffective, and even where there is no specified time limit, the courts will imply a reasonable time. Thus, in Ramsgate Victoria Hotel v Monte fibre (1866), shares in the hotel were offered for sale. After several months the offer was `accepted’ but the court held that too much time had passed, bearing in mind that the purpose of the shares offer was to raise money.

Another way for an offer to come to an end is by the failure of a condition. Although a genuine offer is always held to be firm and certain, sometimes it may be conditional and not absolute. Thus, should A wish to buy a model car from B, B may agree but impose conditions on the deal, such as stating that A must collect at a specific time on a certain day at a particular place and must pay in cash. This is known as a ‘condition precedent’ and failure to complete the conditions will nullify the agreement. There is another type of condition, called a ‘condition subsequent’ where there is a perfectly good contract which runs until something happens. For instance, a garage may have a good contract with an oil company to buy petrol at Lx per 1000 litres until the price of oil at Rotterdam reaches Lx per barrel. It is only when oil reaches the stipulated price that the contract ends.


Just as an offer must be firm and certain, the acceptance of an offer by the person(s) to whom it was made must be unequivocal and must not contain any alterations or additions. Acceptance as (Clark 2013) put it must be unconditional as the basis of a contract is the mutual consent of the parties concerned. The offeror made a proposition and the offeree indicates either expressly or by implication, his willingness to be bound on the terms stated in the offer. Accordingly, any attempt to alter the terms of an offer is regarded as a counter-offer and thus a rejection of the original offer, leaving the original offeror free to accept or decline as he or she chooses.

While acceptance of an offer normally occurs either in writing or verbally, it may also be implied by conduct. In the case of Brogden v Metropolitan Railways Co. (1877) Mr Brogden had supplied the company for many years without formalities. It was then decided to regularise the position and a draft agreement was sent to him. He inserted a new term, marked the draft ‘approved’ and returned it to the company where it was placed in a drawer and forgotten about, although both parties traded with each other on the terms of the draft for more than two years. Following a dispute, Mr Brogden claimed there was no contract. The House of Lords decided differently, saying that a contract had been created by conduct.

Inferring the acceptance of an offer by conduct is quite different from assuming that silence on the part of the offeree constitutes acceptance; silence cannot be construed as an acceptance. Equally, while the offeror may prescribe the method of acceptance (although this is regarded as permissive rather than directory), the offeree may not prescribe a method by which he or she will make acceptance. For instance, an offer may be made by fax, thus implying that a fast response is required; therefore a reply accepting the offer which is sent by second-class mail may well be treated as nugatory.

There are some rules about acceptance which are important. Postal acceptance, for example, is a good method of communication and one which is universally used by businesses, but to be valid for contractual purposes a communication must be properly addressed and stamped and then placed into the hands of the duly authorised person (i.e. the post box or over the counter). An acceptance sent to a home address may be nullified if there has been no indication that this is acceptable. Similarly, acceptance of the offer must be effectively received by the offeror where modern, instantaneous methods of communication are used. Thus if a telephone call is muffled by extraneous sound, then the acceptance must be repeated so that the offeror hears it clearly.


This refers to the price which each side pays and the advantages or benefits each side enjoys for the promise or performance of a contract. That is to say, both the offeror and the offeree give or promise to give something of value to one another, this valuable consideration could be money, goods, services or given up of a legal right. Together, offer and acceptance constitute the basis of an `agreement’ or meeting of minds, provided the parties are clear as to what they are agreeing about (i.e. a consensus ad idem exists). However, a court will rarely enforce a ‘naked promise’. As a result, a promise must have `consideration’. Consideration has been defined as some right, interest, profit or benefit accruing to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other. In commercial contracts, the consideration normally takes the form of a cash payment in return for the goods or services provided (i.e. the `price’ in a contract of sale). It does not need to be the full market value, but it must be something tangible. In contracts involving barter, however, which are sometimes used in international trade, goods are often exchanged for other goods or for some other form of non-pecuniary consideration (e.g. information or advice).

Intention to create legal relations

Not every agreement is intended to create a legally binding relationship. For example, most domestic agreements — such as the division of household chores — would not constitute a contract recognised in law. In commercial agreements, however, it is generally accepted that both parties intend to make a legally binding contract and therefore it is unnecessary to include terms to this effect. Should such a presumption be challenged, the burden of proof rests with the person who disputes the presumption.


A contract may be valid, voidable or void and one of the factors which determines this is the contractual capacity of the respective parties to the agreement. Normally speaking, an adult may make a contract with another adult which, if entered into freely and without any defects, and which is not contrary to public policy, is binding upon them both (i.e. valid). However, the law provides protection for certain categories of persons deemed not to have full contractual capacity (e.g. minors, drunks and the mentally disordered); hence the practice by firms of excluding people under the age of 18 from offers of goods to be supplied on credit.

Concentrating on minors – those below voting age – the law prescribes that they can only be bound by contracts for ‘necessaries’ (e.g. food, clothing, lodging) and contracts of employment that are advantageous or beneficial, as in the case of a job which contains an element of training or education. In most other instances, contracts with minors are void- or voidable and as such will be either unenforceable or capable of being repudiated by the minor.

In the case of business, legal capacity depends on the firm’s legal status. Unincorporated bodies (e.g. sole traders, partnerships) do not have a distinct legal personality and hence the party to the agreement is liable for their part of the bargain. Limited companies, by contrast, have a separate legal identity from their members and hence contractual capacity rests with the company, within the limits laid down in the objects clause of its Memorandum of Association.

Other factors

To be enforceable at law a contract must be legal (i.e. not forbidden by law or contrary to public policy). Similarly, the agreement must have been reached voluntarily and result in a genuine meeting of minds. Consequently contracts involving mistakes of fact, misrepresentation of the facts, or undue influence or duress may be void or voidable, depending on the circumstances. In insurance contracts, for instance, the insured is required to disclose all material facts to the insurer (e.g. health record, driving record), otherwise a policy may be invalidated. In this context a ‘material fact’ is one which would affect the mind of a prudent insurer, even though the materiality may not be appreciated by the insured.


As business activity has become more specialised and complex, firms have increasingly turned to outside individuals to carry out specialist functions such as freight forwarding, overseas representation, insurance broking and commercial letting. These individuals (known as agents) are authorised by the individual or organisation hiring them (known as the principal) to act on their behalf, thus creating an agency relationship. As in other areas of commercial activity, special rules of law have evolved to regulate the behaviour of the parties involved in such a relationship.

In essence, the function of an agent is to act on behalf of a principal so as to effect a contract between the principal and a third party. The agent may be a ‘servant’ of the principal (i.e. under their control as in the case of a sales representative) or an ‘independent contractor’ (i.e. their own master as in the case of an estate agent) and will be operating with the consent of the principal whether by contract or implication. Having established a contractual relationship between the principal and the third party, the agent generally leaves the picture and usually has no rights and duties under the contract thus made.

With regard to an agent’s specific obligations under an agency agreement, these are normally expressly stated under the terms of the agreement, although some may also be implied. Traditionally the common law of agency prescribes, however, that agents:

  • Obey the lawful instruction of the principal, otherwise they may be in breach of contract.
  • Exercise due care and skill, in order to produce a deal which is to the principal’s best advantage.
  • Act personally, rather than delegate, unless expressly or implicitly authorised to do so.
  • Act in good faith, thus avoiding conflicts of interest or undisclosed profits and bribes.
  • Keep proper accounts, which separate the principal’s funds from those which belong personally to the agent

Moreover, in so far as an agent is acting under the principal’s authority, the principal is bound to the third party only by acts which are within the agent’s authority to make. Consequently ultra vires acts only affect the principal if he or she adopts them by ratification and the agent may be liable for the breach of the implied warranty of authority to the third party.

In addition to these common law duties owed by the principal, the Commercial agents in transactions involving the sale or purchase of goods, also perform the following duties to their principals:

  • a commercial agent must look after the interests of her/his principal and act dutifully and in good faith;
  • make proper efforts to negotiate and, where appropriate, conclude the transactions;
  • communicate to their principal all the necessary information available to them;
  • comply with reasonable instructions given by the principal.

The duties of the principal to the agent on the other hand include:

  • to act dutifully and in good faith;
  • to provide the commercial agent with the necessary documentation relating to the goods in question;
  • to obtain necessary information for the agent. This is a higher standard, perhaps requiring searching for data, than under the common law, where all the principal needs to do is to disclose information in their possession;
  • to notify the agent within a reasonable period of time if the usual volume of trade is likely to be significantly reduced;
  • to inform the agent within a reasonable period of time of the principal’s acceptance, refusal, or non acceptance of a commercial transaction arranged by the agent.

Law and the consumer

Neo-classical economic theory tends to suggest that laws to protect the consumer are unnecessary. However, modern economists (in particular behavioural economists) have shown that the traditional assumption of working markets is not necessarily reliable, so regulation is sometimes required. If individuals are behaving rationally when consuming goods and services, they would arrange their consumption to maximise their satisfaction (or ‘utility’), in the words of an economist. Products which because of poor quality or some other factor reduced a consumer’s utility would be rejected in favour of those which proved a better alternative and this would act as an incentive to producers (and retailers) to provide the best products. In effect, market forces would ensure that the interest of the consumer was safeguarded as suppliers in a competitive market arranged their production to meet the needs and wants of rational consumers.

The ‘ideal’ view of how markets work is not always borne out in practice. Apart from the fact that consumers do not always act rationally, they often do not have access to information which might influence their choice of products; in some cases they may not even have a choice of products (e.g. where a monopoly exists) although this situation can change over time (e.g. through privatisation of state monopolies). Also, given the respective resources of producers and consumers, the balance of power in the trading relationship tends to favour producers who can influence consumer choices using a range of persuasive techniques, including advertising.

Taken together, these and other factors call into question the assumption that the consumer is ‘sovereign’ and hence the extent to which individuals have inherent protection in the marketplace from powerful (and, in some cases, unscrupulous) suppliers. It is in this context that the law is seen to be an important counterbalance in a contractual relationship where the consumer is, or may be, at a disadvantage, and this can be said to provide the basis of legal intervention in this area.

Existing laws to protect consumers are both civil and criminal and the relevant rights, duties and liabilities have been created or imposed by common law (especially contract and tort) or by statute. Significantly, as the examples below illustrate, a large element of current consumer law has resulted from statutory intervention, much of it in the last 30 years. Indeed, a sizeable quality of consumer protection law comes from the continental orgaizations e.g ECOWAS, EU by way of directives. These laws — covering areas as diverse as trade descriptions, the sale of goods and services, and consumer credit and product liability — indicate a growing willingness on the part of governments to respond to the complaints of consumers and their representative organisations and to use legislation to regulate the relationship between business organisations and their customers. Europe is keen to encouraging consumers to take advantage of cross-border EU markets by harmonising consumer protection. To this end Europe has been adopting consumer protection directives, the most significant recent one being the Unfair Commercial Practices Directive, which has caused a lot of the pre-existing domestic law to be replaced.


Organizations are guided in its operation by the laws of the land in which it operates. The sources of these laws could be the custom of the land, judicial precedent, and legislation among others. Unfortunately, many managers are not aware of the potential legal risks associated with traditional managerial decisions like recruiting, hiring, and firing employees. Companies also face potential legal risks from customer initiated lawsuits. Business managers must therefore try as much as possible to understand the laws of the country in which it operates so that they can appropriately take the advantages of the opportunities and at the same time avoid the pit falls.