This is a RUSH transcript from "The O'Reilly Factor," May 20, 2010. This copy may not be in its final form and may be updated.

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BILL O'REILLY, HOST: Continuing now with Fox News anchor Megyn Kelly. You can see her on "America Live" at 1:00 in the afternoon.

Big controversy over 21-year-old Sara Isaacson, member of the Army ROTC, was booted out of there after going public with being a lesbian. Question: Should she have to pay back $80,000 the Army had given her in scholarships? So what do you think?

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MEGYN KELLY, HOST, "AMERICA LIVE": Yes, I absolutely think she should. The Army paid 80 grand to put her through UNC Chapel Hill, very good school, on condition that when she was done, she would serve the Army. She — it's November, basically, she's about to graduate. And now suddenly she realizes she's a lesbian. Fine by me. Be a lesbian. But the Army has a don't ask, don't tell policy. What part of don't tell didn't she understand? OK? She objects to it. So she decides she must tell in order to be true to herself and hold up her own integrity. Fine by me, again. But don't keep the money. You have to return the 80 grand that the American taxpayer paid to put you through school, so that we can have the benefit of your military service when it was over.

O'REILLY: All right. This is fairly easy though. The Army, I think, could sue her for fraud in the inducement in the sense that she made a pact, a contract with the Army…

KELLY: Right.

O'REILLY: …knowing that Bill Clinton, President Clinton had signed don't ask, don't tell. She knew that.

KELLY: Right, Right.

O'REILLY: We assume.

KELLY: She claimed she thought she was straight when she went into college. And it wasn't until, you know, her senior year that it dawned on her.

O'REILLY: Well, you know, we all can be confused from time to time in college, but I don't know if you're confused at that level. However, let's say…

KELLY: I don't care if she was confused.

O'REILLY: That's right. Maybe she was confused.

KELLY: Right.

O'REILLY: Maybe she didn't know. But you saw the contract. And you're not compelled to tell anybody anything.

KELLY: Right. And her commander said to her you don't have to tell us this.

O'REILLY: Yes, don't tell us.

KELLY: Don't tell us.

O'REILLY: We don't want to know.

KELLY: You can stay in the Army as you claim you want to.

O'REILLY: So she's — I agree with you. 80 grand. But I think the Army…

KELLY: This…

O'REILLY: The Army's just asking for it back. I think they should sue her for it back.

KELLY: They say that they haven't actually — it's her brigade that has recommended that the Army demand the 80 grand back. The Army hasn't officially decided to do it yet.

O'REILLY: No, and the Army won't, because they don't want to do this stuff under the Defense Department of President Obama.

KELLY: But I just want to say two things.

O'REILLY: But you said the $80,000 taxpayer money.

KELLY: Yes.

O'REILLY: That's the key.

KELLY: Yes, that's the key.

O'REILLY: Yes.

KELLY: And what I was going to say is this reminds me of the case we talked about a couple of years ago, where the woman was put through med school, and then right upon graduating from med school — at residency actually, she was finishing…

O'REILLY: Right.

KELLY: …she said you know what? I'm suddenly a conscientious objector to the war. And now…

O'REILLY: There you go.

KELLY: And I just want to practice anesthesia in private practice.

O'REILLY: You can go.

KELLY: Return the money. Return the money.

O'REILLY: I want to make one correction. Our pal Robert Gibbs, White House spokesman, says that Barack Obama did read the Arizona law, and we take him at his word.

All right. Now, Supreme Court, I just want a quick one on this. Says you can keep sex offender's incarcerated. The states can do that.

KELLY: Yes.

O'REILLY: After their term is up…

KELLY: Right.

O'REILLY: …if they're deemed dangerous by psychiatrists. But the two dissenters were conservative guys.

KELLY: Yes.

O'REILLY: Clarence Thomas and Scalia.

KELLY: Yes.

O'REILLY: Right, because they don't want to give the states that kind of power, correct?

KELLY: Yes, they felt uncomfortable giving them unlimited power to basically say after you've served your term, they can keep you behind bars indefinitely. But there are all sorts of requirements both — or protections built into the law. I mean, not the least of which is you have to be deemed insane.

O'REILLY: By a bunch of people.

KELLY: Exactly.

O'REILLY: Not just one guy.

KELLY: And you have to continue to, you know, you can continue to appeal it under other grounds.

O'REILLY: Right. But see, I want people to know that this — law and order's usually considered conservatives are tough and liberals are — all the liberals on the court to be fair. Even our pal Ruth Bader Ginsburg voted saying yes, you got to keep them.

KELLY: That's right.

O'REILLY: And I would have, too, because you have to protect the public above all.

KELLY: It was 7 to 2.

O'REILLY: All right. Hooters, I've never been — yes, I think I was there once when I was like eight.

KELLY: You love the chicken wings.

O'REILLY: But I don't — haven't been around. A lot of fried food there. Anyway, they have good-looking waitresses. And one of them, Cassie Smith…

KELLY: Yes.

O'REILLY: …was told either you lose weight or you're out of here. Your Hooters are out of here. Here's the sound bite.

(BEGIN VIDEO CLIP)

CASSIE SMITH, HOOTERS EMPLOYEE: They gave me 30 days weight probation-like type thing. They offered me a free membership to a gym. And they said that if in 30 days, I improved what I needed to work on, which was my short and tank top size fitting, that they would leave me alone. And if I didn't, they would separate me from the company.

(END VIDEO CLIP)

O'REILLY: All right. So does she have to lose the weight to work at Hooters?

KELLY: Sadly, I think the legal answer is yes. I'm in the minority on this.

O'REILLY: Sadly?

KELLY: Well, I don't like that. I don't think women being told they have to lose…

O'REILLY: OK.

KELLY: She's very fit. She's very thin.

O'REILLY: I understand that but…

KELLY: What's the problem, Hooters?

O'REILLY: Shouldn't corporations have the right just to say, look, we sell this. You have to look a certain way. You don't have to work for us.

KELLY: Well, certainly dress codes have been upheld by the Supreme Court…

O'REILLY: Except at American Eagle Outfitters, where you can now be a transgender person. Go ahead.

KELLY: OK, we digress. Dress codes are fine. The problem for her if this is alleged weight discrimination. In most states in the union, that's not a protected class. You know, race is…

O'REILLY: Right.

KELLY: …sex is, age is, but not weight. In Michigan, where she lives, weight is protected. But you can get around that as an employer if you can show that being skinny is basically required for your business model.

O'REILLY: Isn't it required in Hooters?

KELLY: And that's the same as if a stripper wanted to come in and weighed 300 pounds, and the stripper employer would say sorry, but that's not going to work for us.

O'REILLY: All right, so she had…

KELLY: Not to say Hooters girls are strippers, but they have to be fit, they have to be thin.

O'REILLY: So she has to lose the weight?

KELLY: Sexual titillation is part of the business.

O'REILLY: She has to lose the weight?

KELLY: So I think actually she's going to lose if she decides to file a lawsuit.

O'REILLY: Particularly because she is in Michigan. But you know, Michigan does have that weight clause.

KELLY: Michigan protects weight.

O'REILLY: Right, protects.

KELLY: But in any state where weight is protected, the employer can defend by saying it's a business necessity. You know, in my law job, if they said, you know, you have to be skinny…

O'REILLY: Yes, sure.

KELLY: …to practice law, they'd lose. But at Hooters, Hooters may have a good defense, although they claim that's not what this is about.

O'REILLY: Now I had to restrain myself from any comments that would have been offensive about Hooters.

KELLY: Yes, because I'll slap a lawsuit on you so fast.

O'REILLY: No, I know. And I'm not going to even get involved ever with them. All right. Megyn Kelly, very good analysis on the Arizona law.

KELLY: Thank you.

O'REILLY: Very good.

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