Supreme Court Clarifies Rights Under Section 1981
 
May 3, 2006
 

Perhaps indicating an unwillingness to expand coverage of the civil rights laws, the Supreme Court held on February 22, 2006, that “a plaintiff cannot state a claim under [42 U.S.C.] §1981 unless he has (or would have) rights under the existing (or proposed) contract that he wishes to ‘make or enforce.’” It ruled that the African-American sole shareholder of a closely-held corporation could not sue Domino’s Pizza, Inc., under Section 1981 for breaching its contracts with the corporation – even though he alleged that Domino’s breached the contracts because of racial prejudice toward him. Domino’s Pizza, Inc. v. McDonald (Feb. 22, 2006). Although this decision narrows Section 1981 as it applies to employers’ relationships with independent contractors, it does not affect its scope with respect to employees.

The Law

Section 1981 (42 U.S.C. §1981) was passed immediately after the Civil War to assist newly-freed slaves. It is the country’s oldest civil rights law. But it is rather narrowly tailored. It grants all citizens in the U.S. the “same right to make and enforce contracts” as white citizens. In other words, it makes unlawful a refusal to enter into a contractual relationship or to perform that contract if the refusal is racially motivated. The Supreme Court has read Section 1981 to apply to private conduct. In the early 1990s, Congress amended Section 1981 to clarify that it applies to all parts of the contracting process. For employers, this amendment makes clear that Section 1981 prohibits racially-motivated refusals to hire, terminations, and any other racially-motivated employment actions – including racial harassment.

Section 1981 is in some ways broader than other federal anti-discrimination laws, such as Title VII. It allows an employee to sue without filing with the EEOC, as well as to recover unlimited compensatory and punitive damages, and it carries a four-year statute of limitations. It also applies to relationships with independent contractors, whereas the other anti-discrimination statutes apply only to employees.

Another fundamental legal principle is that a corporation is separate from its shareholders – even if there is only one shareholder. This means that a contract entered on behalf of the corporation is not the contract of the shareholder. This principle has benefits and burdens. It means that the shareholder is generally not liable if her corporation fails to perform the contract. But it also means that the shareholder is not entitled to enforce the contract separate from the corporation.

The Facts

John McDonald was the sole shareholder and president of a closely-held corporation, JWM Investments, Inc. JWM and Domino’s (but not McDonald himself) were parties to several contracts under which JWM was to build four restaurants. When the first one was completed, Domino’s refused to take steps required by the contracts that JWM needed to get financing for the other restaurants. At one point Domino’s agent told McDonald, “’I don’t like dealing with you people anyway,’” and Domino’s refused to perform the remaining contracts to build the other stores. The agent would not explain what he meant by “you people.” JWM ultimately filed for bankruptcy in part because of the failed contracts. During the bankruptcy proceedings, JWM settled its claims.

McDonald sued Domino’s under Section 1981 in his individual capacity, even though the contracts were with the corporation, not himself. He alleged that Domino’s had breached its contracts with JWM because of racial animus toward McDonald himself and that he had personally suffered as a result. McDonald claimed that as a result of Domino’s racially-motivated refusal to perform its contracts with JWM, his personal net worth declined by more than $8 million and he suffered emotional distress.

The trial court ruled for Domino’s, holding that because McDonald was not a party to the contract, he could not recover under Section 1981. The court of appeals reversed, holding that a nonparty to the contract such as McDonald could recover under Section 1981 when he claimed the contract was breached because of racial animus toward him and he suffered injuries distinct from those to the corporation. Thus, the fundamental issue in the case is whether an individual who is not a party to the contract the other party refuses to honor may sue under Section 1981.

Supreme Court Limits Section 1981

The Supreme Court disagreed and ruled that McDonald cannot sue under Section 1981. It ruled that to sue under Section 1981, the party must be trying to make or enforce the contract for himself, not another entity such as a corporation. He has to be suing about his own contract. The Court rejected McDonald’s argument that he should be able to sue because he stood to benefit from the contract and he was personally injured by racism. It noted that “the shareholder and contracting officer of a corporation has no rights and is exposed to no liability under the corporation’s contracts.” It further reasoned that when Section 1981 was enacted just after the Civil War, the law generally prohibited an agent of a corporation from suing on his own behalf to enforce a contract of the corporation. Thus, it concluded that Congress would not have intended someone other than the contracting party to sue for discrimination under Section 1981.

Addressing McDonald’s argument that its ruling would somehow diminish an individual’s civil rights, the Court noted that §1981 “is only one of a multitude of civil rights statutes,” and that some of the forms of discrimination McDonald gives as examples would be addressed under Title VII. “Trying to make [§1981] a cure-all not only goes beyond any expression of congressional intent but would produce satellite §1981 litigation of immense scope.”

What It Means for You

The McDonald decision shows that the Supreme Court views Section 1981 as a fairly narrow statute directed at racial discrimination in contracting rather than a broad brush effort to eradicate discrimination generally. On a practical level, for employers, it impacts your relationships with independent contractors. It means that only those independent contractors who attempt to make a contract with you can sue you under Section 1981. The owner of a corporation that attempts to contract with you will not be able to sue.

There are two caveats. First, the Supreme Court noted that some of the courts of appeals have allowed a corporation to sue under Section 1981 where a contract was breached because of racial animus toward a corporate employee. Although a corporation could not recover emotional distress, it could recover compensatory and punitive damages caused by the refusal to enter into or perform the contract at issue. Second, the Supreme Court’s decision does not affect employees’ ability to sue you under Section 1981. Employees suing under Section 1981 would be attempting to enforce their own contracts. Thus, Section 1981 remains an additional remedy for employees who sue for race discrimination.

For more information, e-mail Todd Steenson at todd.steenson@hklaw.com or call toll free, 1-888-688-8500.

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