In complex Chapter 11 cases, general unsecured creditors frequently find themselves buried under layers of secured debt and alternative financing arrangements. Equitable subrogation allows the estate, upon satisfaction of a secured debt, to preserve the associated lien and step into the secured creditor’s position, rather than having the security discharged to confer a windfall on the party whose debt was paid or its junior creditors. Used strategically, equitable subrogation can allow an estate and its unsecured creditors to reach value that would otherwise remain locked beneath stacks of secured debt. This article examines equitable subrogation as it can be applied in Chapter 11 cases, focusing on debtor-guarantor relationships and plan design considerations, and uses a recent retail Chapter 11 case to illustrate those principles.
Equitable Subrogation: Core Principles
Equitable subrogation is a long-standing doctrine grounded in principles of fairness rather than contract. “Subrogation” is another word for “substitution.” Equitable subrogation permits a party who pays a debt for which another is primarily liable to step into the shoes of the satisfied creditor when equity requires.[1] It is an “equitable assignment.”[2]
If a guarantor meets the requirements for equitable subrogation, it obtains the rights of the creditor, including the creditor’s rights in collateral.[3] Where payment of a debt typically discharges a security interest, equitable subrogation permits the security interest to survive in favor of the subrogee.[4] The doctrine does not create new rights or reorder priorities;[5] instead, it operates as a form of equitable assignment, preserving existing rights that would otherwise be lost through payment.
Courts often emphasize that equitable subrogation turns on substance rather than form.[6] The inquiry focuses on whether the payor satisfied an obligation for which another was primarily liable and whether, in equity, the burden of that obligation should be without prejudice to the payor. In this sense, subrogation is less concerned with the mechanics of payment than with the consequences of allowing a lien to be extinguished by payment when doing so would distort the parties’ preexisting priorities. By treating subrogation as an equitable assignment, courts preserve the economic reality of the transaction and prevent inequitable results.
Courts have applied equitable subrogation in a wide variety of contexts, including insurance, suretyship, and real estate.[7] In bankruptcy, the doctrine may arise where a party pays a secured obligation to protect its own legal or economic interests. When applicable, subrogation prevents junior lienholders or unsecured claimants from benefiting from the extinguishment of senior secured debt without having satisfied that debt themselves.
Guarantors, Nonvoluntary Payment in Full Satisfaction, and Priority Preservation
For subrogation to apply, the debtor must not be the primary obligor, must not voluntarily pay the debt, and must satisfy the debt. Courts have held that subrogation is not available to a party who voluntarily pays another’s debt “for the purpose of gaining the security interest.”[8]
Courts generally reject a rigid application of the so-called volunteer rule where payment is made pursuant to a preexisting legal obligation or to protect the payor’s own interests.[9] Guarantors who satisfy the debt of a primary obligor typically do not act voluntarily; rather, their payment is compelled by the guaranty itself.
Equitable subrogation also requires that the guarantor satisfy the obligation in full. It is not available to a guarantor who settles with the creditor without obtaining a release of the creditor’s lien or the primary obligor.[10] In bankruptcy, untriggered debtor guaranties are contingent and subject to estimation under 11 U.S.C. § 502(c), which could result in significant payment of the obligation without the requisite satisfaction of it.[11]
Equally important is the distinction between a guarantor and a primary obligor. A party that is primarily responsible for a debt cannot invoke equitable subrogation, as there is no inequity in requiring that party to bear the burden of payment.[12] By contrast, a guarantor who satisfies a secured obligation may be equitably subrogated to the creditor’s lien rights, provided that subrogation does not unfairly prejudice third parties.[13]
These requirements underscore that equitable subrogation is not a device for manufacturing priority. Courts will deny subrogation where payment is truly voluntary, where the payor is the primary obligor rather than a guarantor, where the guarantor does not fully satisfy the obligation, or where the application of the doctrine would disrupt settled expectations that equity seeks to protect.
Although the Bankruptcy Code expressly addresses creditor subrogation under § 509,[14] it does not displace state-law equitable subrogation rights available to debtors.[15] Where state law permits subrogation, and where guaranty agreements do not expressly waive that right, equitable subrogation may arise independently of the Bankruptcy Code. Because equitable subrogation is, as the name suggests, an equitable remedy, courts will not infer its availability where the parties have expressly agreed to waive or limit subrogation rights, particularly in guaranty agreements drafted to alter common-law suretyship principles.
This distinction between Bankruptcy Code subrogation rights and state-law equitable subrogation rights is particularly important in debtor-guarantor scenarios. Section 509 addresses the rights of co-debtors and guarantors who pay claims against the debtor, but it does not speak to the inverse situation in which a debtor satisfies an obligation it guaranteed for a nondebtor affiliate. In those circumstances, courts look to applicable state law to determine whether equitable subrogation arises and whether the resulting rights become property of the estate.[16]
Recognizing this distinction avoids conflating statutory subrogation with equitable subrogation and underscores that equitable subrogation remains available, where appropriate, to preserve estate value even in the absence of explicit Bankruptcy Code authorization.
Structuring Plans to Preserve Subrogation Rights
The manner in which a secured obligation is satisfied can determine whether subrogation rights are preserved or lost. Because payment of a secured debt ordinarily extinguishes the associated lien, practitioners must take care to structure transactions so that equity preserves the lien for the benefit of the subrogee.
Chapter 11 plans offer a powerful vehicle for effectuating equitable subrogation. A plan may expressly acknowledge guaranty relationships, identify the purpose of the payment, and provide for the equitable assignment of loan documents and collateral rights to the estate or a post-confirmation trust. Plan confirmation provides finality and reduces the need for post-confirmation litigation over lien priority and ownership.
In practice, this requires careful attention to how the transaction is characterized and documented. Plans that rely on equitable subrogation should clearly identify the debtor’s guaranty obligation, the source and purpose of the payment, and the parties’ intent that the lien securing the satisfied debt be preserved for the benefit of the estate. Ambiguity on these points increases the risk that payment will be characterized as a voluntary discharge rather than a subrogable transaction.
Incorporating these concepts directly into the plan also promotes transparency. Creditors are afforded notice of the intended treatment of liens and collateral, and confirmation binds parties who might otherwise seek to challenge the preservation of the secured position after the fact. In this way, plan-based equitable subrogation can reduce litigation risk while providing a predictable framework for distributing value.
Where payment and assignment are integrated into a confirmed plan, the resulting subrogation rights become property of the estate under § 541(a)(7),[17] thereby preserving value for distribution in accordance with the plan’s priority scheme. An assignment agreement further evidencing the equitable assignment/subrogation is a best practice.
Addressing these issues directly in the plan reduces the risk that equitable subrogation will later be challenged as inequitable, waived, or prejudicial to third parties.
Illustrative Application: A Retail Chapter 11 Case
These principles were recently illustrated in a retail Chapter 11 case involving a debtor that had guaranteed secured loans made to affiliated real estate entities. The affiliates owned income-producing commercial properties that secured the senior lender’s claims through first-priority mortgages. The debtor, while not the primary obligor on those loans, was liable under broad guaranties and had also pledged its own assets as additional collateral.
As is common in retail restructurings, the debtor’s capital structure included multiple layers of asserted claims. In addition to the senior secured lender, various junior and disputed lien claimants asserted interests in the debtor’s cash proceeds, including claims styled as secured under nontraditional financing arrangements, such as merchant cash advance agreements. Absent payment of this debt by the debtor, equitable subrogation would not have been an option. And, absent a mechanism to preserve the senior lender’s lien position following payment, the satisfaction of the guaranteed debt would have extinguished the mortgages and related liens, allowing other parties to improve their relative position simply by virtue of that payment.
The Chapter 11 plan required the debtor to pay the secured guaranty debt and addressed this collateral extinguishment risk directly. Rather than treating payment of the guaranteed debt as a transaction that discharged the associated mortgages, assignments of rents, and security interests, the plan expressly acknowledged the debtor’s status as a guarantor, the purpose of the payment, and the parties’ intent that the estate succeed to (i.e., step into the shoes of) the lender’s rights following payment. The plan provided for the satisfaction of the secured obligation, the equitable assignment of the secured lender’s liens, and the assignment of the loan documents and mortgage interests to a post-confirmation trust to further evidence the equitable assignment under principles of equitable subrogation.
Through this structure, the estate stepped into the shoes of the satisfied secured creditor and retained the benefit of the existing lien position and collateral, rather than allowing those rights to be lost upon payment. As a result, the collateral continued to support a secured claim held for the benefit of the estate, altering the priority and distribution analysis under the confirmed plan. Absent payment of this debt by the debtor and the equitable assignment of the secured creditors’ loan documents, unsecured creditors would have been completely out of the money.
The application of equitable subrogation in this context did not create new rights or elevate unsecured creditors beyond the position previously occupied by the senior lender. Instead, it preserved existing priority rights that would otherwise have been extinguished and prevented a windfall to the affiliated real estate entities whose debt was paid and to other parties whose claims depended on the discharge of the senior security interests. The case illustrates how equitable subrogation, when addressed deliberately through plan design, can play a meaningful role in preserving estate value in cases involving guaranties and affiliated collateral.
Conclusion
Equitable subrogation remains an underutilized tool in Chapter 11 practice. Properly applied and incorporated into a plan, it can preserve secured rights that would otherwise be extinguished by payment—providing a potential lifeline for unsecured creditors.
See JPMorgan Chase Bank v. Cook, 318 F. Supp. 2d 159, 165 (S.D.N.Y. 2004). ↑
Barnes v. Cady, 232 F. 318, 324 (6th Cir. 1916). ↑
Boyd v. Superior Bank FSB (In re Lewis), 270 B.R. 215 (Bankr. W.D. Mich. 2001). ↑
Barnes v. Cady, 232 F. at 324 (“Under some circumstances the payment of a mortgage does not satisfy it or destroy its lien, because equity regards the person making the payment as the owner thereof for certain definite purposes and keeps it alive and preserves its lien for his benefit and security.”). ↑
“[I]t is well-established that the subrogee acquires no greater rights than those possessed by the subrogor. . . .” Boyd v. Superior Bank FSB, 270 B.R. at 217. ↑
In re Minn. Kicks, Inc., 48 B.R. 93, 104 (Bankr. D. Minn. 1985) (“[P]recluding the assertion of subrogation rights to issuers of standby letters of credit while allowing guarantors to assert them would be no more than an exercise in honoring form over substance.”). ↑
Fireman’s Fund Ins. Co. v. TD Banknorth Ins. Agency, Inc., 72 A.3d 36, 40 (Conn. 2013) (“The common-law doctrine of legal or equitable subrogation therefore enables an insurance company that has made a payment to its insured to substitute itself for the insured and to proceed against the responsible third party.”); United Prairie Bank v. Molnau Trucking LLC, 23 N.W.3d 535, 543 (Minn. 2025) (“In the suretyship context, a surety that performs its obligations under a bond it has issued [has] the right of equitable subrogation.”); Kim v. Lee, 31 P.3d 665, 670 (Wash. 2001) (“[I]n the real estate context, equitable subrogation has been traditionally invoked only to prevent unjust enrichment.”). ↑
Bednarowski & Michaels Dev., LLC v. Wallace, 293 F. Supp. 2d 728, 730–731 (E.D. Mich. 2003) (explaining that a “key requirement” is that the party seeking subrogation must be “compelled” to pay the debt of another). ↑
In re Chalk Line Mfg., Inc. 181 B.R. 605, 610 (Bankr. N.D. Ala. 1995) (permitting equitable subrogation where subrogee paid obligation to “protect its contract interest” but not “under compulsion.”). ↑
Pa. Nat’l Mut. Cas. Ins. Co. v. City of Pine Bluff, 354 F.3d 945, 951 (8th Cir. 2004) (“A prerequisite to equitable subrogation is the surety’s full satisfaction of any underlying debt or obligation.”). ↑
In re Fox, 64 B.R. 148, 153 (Bankr. N.D. Ohio 1986). ↑
Mich. Hosp. Serv. v. Sharpe, 339 Mich. 357, 373–74, 63 N.W.2d 638 (1954) (a party who is primarily obligated cannot use equitable subrogation to recover from other parties). ↑
Nationstar Mortg., LLC v. Williams (In re Williams), 643 B.R. 369, 377 n.10 (Bankr. M.D. Ga. 2022) (the prejudice analysis includes “whether the superior or equal rights of others would be prejudiced by the application of equitable subrogation to the lien”). ↑
11 U.S.C. § 509(a) (“Except as provided in subsection (b) or (c) of this section, an entity that is liable with the debtor on, or that has secured, a claim of a creditor against the debtor, and that pays such claim, is subrogated to the rights of such creditor to the extent of such payment.”). ↑
“State law subrogation, although deriving from similar considerations, is distinguishable from statutory subrogation under § 509(a) of the Bankruptcy Code, which grants the right of subrogation to a co-debtor or guarantor of the debtor who has paid the creditor’s claim.” Boyd v. Superior Bank FSB (In re Lewis), 270 B.R. 215, 217 n.1 (Bankr. W.D. Mich. 2001). ↑
Dwyer v. Ins. Co. (In re Pihl, Inc.), 560 B.R. 1, 8 n.37 (Bankr. D. Mass. 2016) (“Many courts have noted that the requirements of § 509 are distinguishable from those of equitable subrogation, but have held or implied that either theory may provide a basis for subrogation in a bankruptcy case.”). ↑
Property of the estate includes “[a]ny interest in property that the estate acquires after the commencement of the case”); see also 5 Collier on Bankruptcy ¶ 541.16 (16th ed. 2024) (“An example of the application of section 541(a)(7) would be if the trustee entered into a contract after commencement of the case. The estate’s interest in such a contract would, pursuant to section 541(a)(7), be property of the estate.”). ↑
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Materials Preview
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in late March / early April each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous forum, titled “Green Thumb Lighting,” describes the fictional bankruptcy of a heat lamp manufacturer after its production facility was destroyed by a fire, further complicated by the use of some of its products to grow medical marijuana.
The hypothetical raises questions around federal bankruptcy law and marijuana. Although marijuana use has been legalized by forty states and the District of Columbia for either recreational or medical use, it remains illegal under federal law. This hypothetical addresses various issues that arise when a business related to the marijuana industry faces insolvency. Among other things, the hypothetical addresses whether and under what circumstances a company with marijuana-related income or operations is permitted to seek protection under the Bankruptcy Code. In addition, the hypothetical address related issues surrounding the treatment of marijuana-related creditor claims and the ability of companies in the marijuana space to access traditional banking relationships. Finally, the hypothetical addresses the extent of a debtor’s property interests in existing government grants, the scope of a debtor’s directors’ and officers’ fiduciary obligations, and the ability of a debtor’s professionals to recoup fees under an indemnification provision in their engagement letter.
Green Thumb Lighting: Case Problem
In 2010, a group of successful Pennsylvania farmers decided to use their knowledge of mass cultivation to develop a new LED lighting technology for indoor farming. The technology, which the group ultimately integrated into large light bulbs, offered a unique combination of spectrum ratio (color) and heat intensity while consuming relatively little power. The group first shared the technology with industry friends and colleagues, but after realizing it was a hit, the group decided to incorporate. Each of the group members served as an officer of Green Thumb Lighting, Inc., with friends and other investors as shareholders.
Until 2015, Green Thumb experienced great success and became known as the premier indoor heat lamp manufacturer. During that time, Green Thumb successfully brought on several of the industries’ largest farmers as clients. Indeed, one particular client, Queen Ranch in California, accounted for approximately 25 percent of Green Thumb’s yearly revenue. As a result, Green Thumb grew quickly to employ over 500 employees, with its headquarters and a large manufacturing facility in Reading, Pennsylvania. The company also leased several small offices throughout the state to offer its salespeople convenient and flexible work locations and off-site inventory storage units for faster regional deliveries—both typically leased from the company’s customers.
Unfortunately, in early 2015, widespread wildfires destroyed a large portion of Queen Ranch. As a result, Queen Ranch reached out to many of its suppliers, including Green Thumb, to cancel outstanding, as well as future, purchase orders until Queen Ranch could redevelop its land. Unless it replaced the Queen Ranch revenue, Green Thumb would experience substantial losses. Desperate for new clients, Green Thumb began an expansive marketing program.
During this time, the Pennsylvania legislature began contemplating the adoption of a medical marijuana program for qualifying citizens. News of this possibility quickly spread as it was covered by every major and local news outlet in Pennsylvania. Shortly thereafter, the Pennsylvania legislature passed the Medical Marijuana Act, which, among other things, created a limited number of licenses for winning applicants to grow cannabis. The application process was public and involved an evaluation of many different factors, including the applicant’s likelihood of success. The committee responsible for this evaluation was statutorily obligated to announce the winners by June 2016.
While the applications were pending, Green Thumb was able to secure enough clients to make up for the Queen Ranch lost revenues. Most of these new clients, however, were only willing to enter into agreements that would become effective in July 2016. With no other choice, Green Thumb took the purchase orders to its state-chartered bank, Sulton Bank, which handled all of its deposit accounts, seeking a line of credit to cover expenses until the agreements kicked in. Sulton Bank agreed to provide a revolving loan secured by all of Green Thumb’s account receivables.
Though certain counterparties failed to satisfy their obligations, Green Thumb began to cash in on most of the agreements in July 2016 and established its integrated relationships with such customers, leasing off-site sales and inventory storage spaces. Things were good. Green Thumb was profitable and running like a well-oiled machine. With money to spend, the CEO of Green Thumb decided to purchase an expensive commercial liability insurance policy that covered almost every loss imaginable. The policy provided that disputes “will be governed by the law of the state in which the suit is brought.”
Unfortunately, later in 2017, the Green Thumb production facility experienced a fire of its own. Apparently, a glitch in the company’s custom bulb manufacturing software triggered a series of equipment malfunctions, which resulted in an electrical fire that destroyed virtually all of the Green Thumb facility. Production stopped, but the company continued to bear overhead costs.
Right after the fire, Green Thumb provided its insurance provider with notice of the damage and subsequently filed a claim under its fire coverage. The insurance provider confirmed receipt of the claim but because of the circumstances surrounding the fire, it notified Green Thumb that processing would require additional diligence. Between the damage to its assets and the lost revenue attributable to a lack of production, Green Thumb simply could not afford the delay. Worse yet, creditors began to circle as Green Thumb’s loan maturity approached.
Faced with limited options, Green Thumb sought the advice of a prominent law firm, Harper Marsh & Luzardo LLP (“HML”). HML first pressed the insurance company for answers, but the provider just gave them the runaround. Meanwhile, after several months, Sulton Bank began threatening to enforce its security interests against all of Green Thumb’s account receivables. Various other unsecured creditors, including customers who had funds on deposit with Green Thumb, also began to threaten action. Customers paid these deposits to lock in the price of the bulbs that they would purchase at a later date.
With the walls closing in, Green Thumb initiated negotiations with Sulton Bank to file for Chapter 11 bankruptcy relief and then pursue a claim against the insurance provider. Part of those discussions involved a $1 million cash collateral agreement provided by Sulton Bank, which would remain Green Thumb’s depository bank, and premised on the anticipated post-petition receipt of outstanding account receivables from Green Thumb’s newly acquired customers arising from pre-petition sales and post-petition sales of remaining off-site inventory. The proceeds of the cash collateral agreement would be used to pay key employee salaries and the lease payments for Green Thumb’s off-site locations and fund continued operations to service such customers, among other things.
On February 12, 2018 (“Petition Date”), Green Thumb, with help from HML, filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the Eastern District of Pennsylvania. At the same time, Green Thumb filed several first-day motions, including approval of the Sulton Bank cash collateral agreement. With no objections, the bankruptcy court approved the cash collateral agreement. The bankruptcy case was off to a good start.
HML began preparing a complaint against Green Thumb’s insurance provider alleging several claims, all of which ultimately sought coverage of the fire damage. Shortly after the Petition Date, HML filed and properly served the complaint on the provider.
One day before the deadline to answer the complaint, the insurance provider reached out to Green Thumb to explain how it intended to respond. According to the provider, its investigation revealed that some bulbs manufactured by Green Thumb were being used by medical marijuana cultivators. It was the insurance provider’s position that funding a new facility would thus violate the federal Controlled Substances Act despite the Pennsylvania medical marijuana program. The insurance provider filed its response the next day.
Unsurprisingly, Sulton Bank was not pleased with the insurance provider’s discovery and response. The case now appeared more complicated (and expensive) than originally anticipated. With pressure mounting, Sulton Bank moved to convert the case to a Chapter 7 and appoint a trustee who would liquidate the remaining assets and litigate the claim against the insurance provider. The bankruptcy court agreed and entered an order converting the case and appointing a trustee.
Questions
(1) After conversion, the Chapter 7 trustee filed a motion to dismiss the bankruptcy case because the debtor had been technically receiving “illegal” proceeds under federal law. What grounds / code provision(s) is the motion based on, and will the bankruptcy court grant the motion? Can the bankruptcy case be saved by bifurcating Green Thumb’s business going forward, i.e., abandoning cannabis-related assets? If the motion is granted, what are Green Thumb’s state law remedies, if any?
(2) Assuming the case is permitted to proceed, can the cannabis-producing customers that paid deposits for the bulbs file claims against the estate?
(3) May the Chapter 7 trustee continue to deposit the debtor’s cash in the state-chartered Sulton Bank?
(4) Is the insurance company obligated to provide coverage of the assets notwithstanding their use to grow state-sanctioned cannabis? Does the Chapter 7 trustee have a good objection to the secured claim of Sulton Bank on the basis that the loan agreement is unenforceable? Though the cash collateral agreement purports to bind the Chapter 7 trustee, does it?
(5) In 2015, Green Thumb applied for and was awarded grant funds from the Pennsylvania State Department of Agriculture (“Department”) to purchase certain equipment used to manufacture the bulbs. Among other things, the statute governing the grant program spells out very specific requirements regarding how grant funds are to be expended. The statute also mandates certain invoicing, payment, and reporting procedures.
To receive these funds, the Department required Green Thumb to execute a grant agreement. This agreement included a provision that restricted the sale of the assets funded by the grant proceeds for a period of five years:
For a period of 5 years from the date of this Agreement, Green Thumb will not lease, sell, transfer, or assign any and all property, whether real or personal, that is purchased in whole or in part with funds provided by the Department under this Agreement. Green Thumb agrees to obtain the prior written approval of the Department prior to leasing, selling, transferring, or assigning such property, in whole or in part.
Remarkably, these particular assets survived the fire; and after making a few calls, the Chapter 7 trustee found a suitable buyer for the equipment.
In due course, the Chapter 7 trustee filed a § 363 motion asking the bankruptcy court for authorization to consummate the sale. Enforcing the pre-petition grant agreement, however, the Department then filed an objection arguing that the equipment purchased with grant proceeds was not property of the debtor’s estate. How should the bankruptcy court rule?
(6) Having lost almost all of their investments, the shareholders, as well as other creditors of Green Thumb, retained an attorney to pursue any and all claims against the directors and officers (“D&Os”) of Green Thumb. The shareholders asked the attorney whether the D&Os have breached any of their fiduciary duties. How should the attorney respond? What are the D&Os’ best defenses?
(7) Struggling to sell the remaining assets, the Chapter 7 trustee found an investment bank, GreenView LLC, to market and sell the business, and filed an employment application under § 328 on its behalf. The engagement letter included a provision that stated:
Indemnification. The Company agrees to indemnify and hold harmless GreenView from and against all claims, direct damages, losses, and actual out-of-pocket reasonable expenses, including court costs and reasonable attorneys’ fees.
Skeptical of the need for an investment bank’s assistance, however, Sulton Bank objected, seeking § 330 review of any fees and reimbursement of costs sought by GreenView. After several rounds of negotiations with Sulton Bank, GreenView agreed to incorporate the following language in the retention order:
a. The Trustee is authorized to retain GreenView to act as her investment banker under 11 U.S.C. §§ 327(a) and 328(a).
b. Notwithstanding the preceding paragraph of this Order and any provision to the contrary in the Application or the Engagement Letter, the U.S. Trustee and Sulton Bank shall have the right to object to GreenView’s request(s) for interim and final compensation and reimbursement based on the reasonableness standard provided in § 330 of the Bankruptcy Code consistent with other investment banking fees earned during an expedited § 363 marketing process.
After the business was sold, GreenView filed a fee application seeking compensation in the amount of $1.5 million. Outraged at GreenView’s request, Sulton Bank objected to the fee application, arguing that GreenView did not contribute to the sale because it never solicited the purchaser. Following a hearing, the bankruptcy court reduced GreenView’s fees by $200,000. Now, under the indemnification provision in the engagement letter, GreenView seeks reimbursement of $20,000 in legal fees for defending its fee application. Is GreenView entitled to reimbursement for these fee-defense fees?
Summary of Legal Authorities for Questions #1 and #2
U.S.C. Authorities
11 U.S.C. § 707
The court may dismiss a case under this chapter only after notice and a hearing and only for cause, including—
(1) unreasonable delay by the debtor that is prejudicial to creditors;
(2) nonpayment of any fees or charges required under chapter 123 of title 28; and
(3) failure of the debtor in a voluntary case to file, within fifteen days or such additional time as the court may allow after the filing of the petition commencing such case, the information required by paragraph (1) of section 521(a), but only on a motion by the United States trustee. . . .
11 U.S.C. § 721
The court may authorize the trustee to operate the business of the debtor for a limited period, if such operation is in the best interest of the estate and consistent with the orderly liquidation of the estate.
11 U.S.C. § 363(c)(1)
(c)(1) If the business of the debtor is authorized to be operated under section 721, 1108, 1203, 1204, or 1304 of this title and unless the court orders otherwise, the trustee may enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice or a hearing.
21 U.S.C § 841
(a) Unlawful acts
Except as authorized by this subchapter, it shall be unlawful for any person knowingly or intentionally—
(1) to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance; or
(2) to create, distribute, or dispense, or possess with intent to distribute or dispense, a counterfeit substance.
21 U.S.C. § 846
Any person who attempts or conspires to commit any offense defined in this subchapter shall be subject to the same penalties as those prescribed for the offense, the commission of which was the object of the attempt or conspiracy.
21 U.S.C. § 856
(a) Unlawful acts
Except as authorized by this subchapter, it shall be unlawful to—
(1) knowingly open, lease, rent, use, or maintain any place, whether permanently or temporarily, for the purpose of manufacturing, distributing, or using any controlled substance;
(2) manage or control any place, whether permanently or temporarily, either as an owner, lessee, agent, employee, occupant, or mortgagee, and knowingly and intentionally rent, lease, profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance. . . .
Case Authorities
In re Olson, No. NV-17-1168-LTiF, 2018 WL 989263 (B.A.P. 9th Cir. Feb. 5, 2018)
Overview
“The Debtor [was] 92 years old, legally blind, and [lived] in an assisted living facility.” Among other reasons,
[s]he sought [C]hapter 13[] relief to stop foreclosure of her commercial real property. One of the tenants at that property operated a marijuana dispensary on the premises and continued to pay rent to Debtor postpetition. Debtor’s plan called for her to sell the commercial real property to pay off all creditors. At the hearing on the motion to sell and reject the lease with the tenant, the bankruptcy court dismissed the case sua sponte on the ground that Debtor’s postpetition acceptance of rents from the dispensary business was an ongoing criminal violation that disqualified her from bankruptcy relief.
On appeal, the U.S. Court of Appeals for the Ninth Circuit vacated the decision and remanded. The Ninth Circuit held that the bankruptcy court failed to make adequate findings to discern the standard under which it ordered dismissal.
Facts
Prepetition, Debtor Patricia G. Olson was the general partner of Olson Bijou Center, L.P., a California limited partnership (“OBC”). OBC owned a shopping center on Lake Tahoe Boulevard in South Lake Tahoe, California . . . (the “Shopping Center Property”).
Beginning in January 2013, Appellee Cody Bass began leasing space in the Shopping Center Property from OBC. . . . The lease expressly authorized Mr. Bass to operate a “dispensary.”[] Pursuant to that authority, Mr. Bass operated at the leased premises Tahoe Wellness Cooperative (“TWC”), a marijuana dispensary authorized under California law.
“The Shopping Center Property was encumbered by a deed of trust in favor of U.S. Bank, N.A.” After the Shopping Center Property missed payments, U.S. Bank recorded a notice of default and later recorded a notice of sale. The foreclosure sale was set. In response, the debtor filed a Chapter 13 petition, which stayed the foreclosure proceeding.
. . . That same day, she filed a quitclaim deed transferring OBC’s interest in the Shopping Center Property to herself individually. Mr. Bass continued to pay rent postpetition to Debtor or her counsel.
About a month after the bankruptcy filing, the bankruptcy court approved a stipulation between Debtor and U.S. Bank for the use of cash collateral for Debtor’s ordinary operating expenses and maintenance of the Shopping Center Property as well as assisted living expenses and health insurance. . . . In exchange, Debtor granted U.S. Bank a postpetition replacement lien on all rents generated from the Shopping Center Property and agreed to make adequate protection payments of $4,000 per month. According to the stipulation, at that time expected rental income was $16,220 per month, including TWC’s monthly rental payment of $10,200. In early May 2017, the court approved another cash collateral stipulation extending the agreement to use cash collateral . . . and modifying the budget to exclude the rent from TWC. There [was] no evidence in the record to indicate whether the postpetition rents paid by Mr. Bass were used to make payments pursuant to the initial cash collateral stipulation. . . .
. . . Debtor filed a motion to sell free and clear under § 363(f) the Shopping Center Property and the adjacent property, which she also owned, for $3 million [to pay all creditors]. . . . Debtor also filed a motion to reject the lease and the option agreement with Mr. Bass.[] In her declaration in support of the motion to reject, Debtor stated that she had entered into the lease with Mr. Bass in January 2013 and that Mr. Bass “currently operates a medical marijuana dispensary at 3443 Lake Tahoe Blvd[.]” . . .
Mr. Bass opposed both motions. In his declaration in support of his opposition to the motion to sell, Mr. Bass confirmed that he had been operating a marijuana dispensary on the premises pursuant to the terms of his lease with OBC and that he had paid rent to the Debtor postpetition.
The bankruptcy court sua sponte dismissed the debtor’s case after learning about the dispensary.
The bankruptcy court
concluded, “based on its interpretation of relevant case law,” that because Debtor had continued to receive rent postpetition, the case had to be dismissed:
I think it’s a crime for Ms. Olson to be accepting rents from an illegal operation, so I am dismissing this case. . . . My finding is this debtor is leasing property for an unlawful purpose under federal law, although lawful under state law . . . and has continued to accept rents during the course of her bankruptcy.
. . . In response to a request for clarification from Debtor’s counsel, the [bankruptcy] court explained:
[I]f the debtor has committed a crime during the course of the bankruptcy and continued for several months to commit a crime during the course of the bankruptcy, I think that is a basis for not providing relief to the debtor. Had the debtor, prior to filing bankruptcy or not during the bankruptcy had not committed the crime of taking money from a marijuana operation, I would feel differently. But that’s not what happened here. Because you don’t, in my opinion, get to go through five or six months of a bankruptcy knowingly receiving illegal proceeds and then say, oh, I’m not going to take those anymore, I want to sell the property now, so I get to play here. I don’t think that’s correct.
Court Analysis
The Ninth Circuit began its analysis with the basic proposition that a bankruptcy court grants or denies relief based on a specific provision of the Bankruptcy Code. In this case, the Ninth Circuit offered two possible provisions: (1) bad faith under § 1307(c) and (2) the bankruptcy court’s inherent authority under § 105. According to the Ninth Circuit, the former requires a bankruptcy court to engage in a totality of circumstances analysis. The latter, on the other hand, can only be invoked “within the confines of the Bankruptcy Code,” particularly when a statute “adequately addresses the conduct at issue,” such as § 1307(c).
Turning to § 1307, the Ninth Circuit noted that dismissal is a two-step analysis:
First, it must be determined that there is “cause” to act. Second, once a determination of “cause” has been made, a choice must be made between conversion and dismissal based on the “best interests of the creditors and the estate.” . . .
Although not listed, bad faith is cause for dismissal. . . . [To] determin[e] bad faith, the bankruptcy court [should] apply a totality of the circumstances analysis, considering (1) whether the debtor misrepresented facts in her petition or plan, unfairly manipulated the Bankruptcy Code, or otherwise filed her [C[hapter 13 petition or plan in an inequitable manner; (2) the debtor’s history of filings and dismissals; (3) whether the debtor only intended to defeat state court litigation; and (4) whether egregious behavior is present.
Conclusion
According to the Ninth Circuit, “[t]he bankruptcy court stated that it had ‘looked at the cases,’ but did not articulate any rules drawn from those cases that applied to the facts before it.” The Ninth Circuit noted that “[s]ome courts have held that, to the extent estate assets are used for or generated by the operation of a federally prohibited marijuana business, a trustee or debtor in possession may not administer those assets without violating federal law.” Further,
[s]ome courts have held that a bankruptcy filing or a plan of reorganization proposed by a debtor who is involved in an illegal enterprise is not in good faith, even where the debtor does not have a subjective bad motive, is in legitimate need of bankruptcy relief, and there is otherwise no indicia of an attempt to abuse the bankruptcy process.
Finally, “some courts have concluded that a debtor engaged in an illegal business who seeks bankruptcy relief comes into court with unclean hands and is not eligible for relief.”
The Ninth Circuit ultimately held that the bankruptcy court “made no finding of bad faith or unclean hands.” Further, the bankruptcy court improperly “concluded that it was a crime for Debtor to be accepting rents from Mr. Bass’ business without making any findings showing that all the elements of a CSA [Controlled Substances Act] violation had been established.” Accordingly, on remand, the Ninth Circuit directed the bankruptcy court to “articulate the findings that led it to determine that Debtor was violating the CSA and what legal standard it relied upon in dismissing the case.”
In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015)
Overview
The United States Trustee (“UST”) moved to dismiss the Chapter 7 case filed by a Colorado marijuana grower and his wife, while the debtors simultaneously moved to convert the case to one under Chapter 13. The U.S. Bankruptcy Court for the District of Colorado ruled that “cause” existed to dismiss the case based on the UST’s inability to lawfully administer the debtors’ assets, and the debtors could not convert the case to one under Chapter 13.
The U.S. Court of Appeals for the Tenth Circuit affirmed and held that
neither a Chapter 7 nor 13 trustee c[ould] administer the most valuable assets in [the debtors’] estate. Without those assets or the marijuana based income, the debtors [could not] fund a plan without breaking the law, and [were] therefore ineligible for relief under Chapter 13. . . .
[Further,] [a]dministering the debtors’ Chapter 7 estate would require the Trustee to either violate federal law by possessing and selling the marijuana assets or abandon them. If he did the former, the Trustee would be at risk of prosecution; if he did the latter, the creditors would receive nothing while the debtors would retain all of their assets and receive a discharge as well.
According to the Tenth Circuit, that “amount[ed] to prejudicial delay that [was] sufficient to demonstrate cause to dismiss their Chapter 7 case under § 707(a).”
Facts
The debtors jointly owned a commercial building in Denver that consist[ed] of two units (the “Property”). Mr. Arenas gr[ew] and wholesale[d] marijuana in one unit.[] He and [Mrs.] Arenas lease[d] the other unit to Denver Patients Group, LLC (“DPG”), a marijuana dispensary. . . .
The debtors filed their Chapter 7 bankruptcy petition after they brought an eviction action against DPG in state court that resulted in a $40,000 attorney’s fees award against them. . . . Lacking the resources to pay the $40,000 judgment . . . , the debtors filed a Chapter 7 petition. . . . According to [the debtors’] schedules, Mrs. Arenas [was] disabled and receive[d] monthly pension benefits and social security totaling $2,977.[] The family’s remaining monthly income of $4,265 stem[med] from rental income and Mr. Arenas’ marijuana business.[] Their monthly expenses [were] approximately $7,235, making their monthly net income $7. Their nonexempt assets [were] 25 marijuana plants (valued at $6,250)[] and the Property[] (collectively the “Assets”). . . .
The UST filed a motion to dismiss for cause under § 707(a). The UST alleged that it would be impossible for a Chapter 7 trustee to administer the Assets without violating federal law. In response, the [debtors] moved to convert their case to Chapter 13 [under § 706] and objected to the motion to dismiss. After an evidentiary hearing on both motions, the bankruptcy court issued a written order denying the debtors’ motion to convert and granting the UST’s motion to dismiss.
Court Analysis
With respect to converting the Chapter 7 case to a Chapter 13 case under § 706, the Tenth Circuit analyzed the debtors’ good faith by examining the totality of the circumstances.
First, the debtors’ “monthly income from sources other than marijuana was not enough to fund their plan.” The debtors conceded “that the only way they can fund a plan is with the rental income from the marijuana dispensary. Without the rental income, their monthly expenses of $7,000 exceed[ed] their non-marijuana income by $4,000 a month. Even with the rental income, the plan [was] barely feasible because their Schedule I reflect[ed] a surplus of less than $8 a month, yielding at best, a nominal dividend.[] [Mrs.] Arenas [was] disabled and unable to work. That, combined with [Mr.] Arenas’ age and employment history, amply support[ed] a finding that the debtors’ income [was] unlikely to increase during the plan term. The court considered the debtors’ “ability to earn and likelihood of future increases in income” and concluded that their plan [was] not likely confirmable because it [was] not feasible.
Conversion was therefore inappropriate.
Second, short of exposing him to physical harm, nothing could be more burdensome to the Trustee’s administration than requiring him to take possession, sell and distribute marijuana Assets in violation of federal criminal law. There is no way the Trustee could administer the plan without committing one or more federal crimes.[]
Finally, as for the debtors’ “motivation and sincerity,” the bankruptcy court found the debtors to be sincere and credible and took pains to emphasize that their motives in seeking bankruptcy relief were not improper.[] That said, the court also recognized that lack of good faith carries an objective rather than a subjective meaning. If the debtors [were] incapable of proposing a confirmable plan, it [was] objectively unreasonable for them to seek Chapter 13 relief whether their intentions [were] kindly or not. . . .
With respect to dismissal under § 707(a), the Tenth Circuit held that “[t]he impossibility of lawfully administering the estate constituted cause for dismissal. . . .” Moreover, “[i]f the Trustee abandoned the Assets, the debtors would retain their business after exposing the Trustee to grave risk, provide the creditors with little or no recovery, and receive a discharge, protected all the while from their creditors’ collection efforts by the automatic stay and then the discharge injunction.” This, according to the Tenth Circuit, was “the epitome of prejudicial delay” and therefore cause for dismissal.
a licensed “caregiver” and marijuana grower under the Michigan Medical Marijuana Act[,][] filed for relief under [C]hapter 13 after falling behind on his house payments, his utility payments, and at least one payment on his truck. . . .
The United States Trustee filed a motion to dismiss . . . , arguing that “the debtor appears to be engaged in the marijuana industry and the Court should not enforce the protections of the Bankruptcy Code to aid violations of the federal Controlled Substances Act.” . . .
The bankruptcy court recognized that debtors generally “cannot conduct an enterprise that admittedly violates federal criminal law while enjoying the federal benefits” of the Bankruptcy Code. However, the court also recognized that “the Debtor filed his case in good faith, and it is quite obvious from his credible testimony that he is in dire need of bankruptcy relief and the court’s assistance.” Thus, the court held that the debtor was entitled to bankruptcy relief—provided, however, that the debtor discontinue the medical marijuana business.
Court Analysis
The court began by recognizing the tension between state and federal law, and expressly stated that “the Debtor’s post-petition medical marijuana business violates federal law and renders the Debtor ineligible for relief under the Bankruptcy Code.” According to the bankruptcy court, however, “the conclusion that dismissal is required does not necessarily follow”:
The Debtor’s business is patently incompatible with a bankruptcy proceeding, but his financial circumstances are not. In other words, if the Debtor were not engaged in post-petition criminal activity, there would likely be no controversy about his eligibility for relief under [C]hapter 13.[] The problem, of course, is that he derives nearly half of his income from activity that Congress forbids as criminal. The Debtor, it seems, must choose between conducting his medical marijuana business and pursuing relief under the Bankruptcy Code. The court has ample authority to require him to make that choice, and given his obvious financial distress, the court concludes that this approach is preferable to dismissal.
Such authority was found in §§ 1304 and 363 of the Bankruptcy Code. Under those provisions, a bankruptcy court is given discretion to limit the use of estate property in certain circumstances. Because the debtor’s use of the marijuana property violates the CSA, the court found that those provisions gave the court authority to mitigate the risk of forfeiture by ordering the debtor to cease operations.
Conclusion
First, the court ordered that the marijuana plants—and any products or inventory derived from the marijuana plants—be abandoned. Second, the court ordered the debtor “to destroy the marijuana plants and any product or inventory derived” from the marijuana plants. “Eliminating the contraband from the estate by way of immediate abandonment, and ordering its destruction as a condition of the Debtor’s eligibility to proceed further, will remove the shadow that the contraband casts on this proceeding.”
In other words,
to balance the court’s (and the Debtor’s) obligations under federal law, including federal criminal law, the Debtor’s legitimate need for relief under [C]hapter 13, and Michigan’s policy choices reflected in the MMMA, the court will refrain from dismissing the Debtor’s case at this time, but will enjoin him from conducting his medical marijuana business (and violating the CSA), while his case is pending.
The debtor’s business involved leasing warehouse space to tenants who were engaged in the business of growing marijuana. In fact, “[a]pproximately 25% of the Debtor’s income [was] produced from leasing space in the Debtor’s Warehouse to tenants who use[d] that space for the cultivation of marijuana.” A secured creditor, VFC Partners 14 LLC (“VFC”), sought dismissal of the case under the “clean hands doctrine” and argued that the debtor’s activities “made it unworthy of the equitable protection of the bankruptcy court. In addition, VFC argue[d] that the Debtor’s case was filed in bad faith and should be dismissed on that basis.”
Court Analysis and Conclusion
The court applied § 1112 of the Bankruptcy Code, which provides a list of factors to be considered when determining whether “cause” exists to convert or dismiss a Chapter 11 case. Because that list is nonexclusive, the court also considered VFC’s clean-hands argument in the context of determining “cause.”
The court first found “gross mismanagement of the estate”:
The Debtor has freely acknowledged that it engages in conduct that exposes the Debtor to criminal liability and that exposes its primary asset to forfeiture. It acknowledges that its criminal behavior has continued post-petition. The fact that it engaged in this conduct and entered into the leases with its tenants pre-petition does not constitute mismanagement of the estate because the estate is a post-petition entity. However, the Debtor entered its bankruptcy case with the offending leases in place and has maintained those leases during the pendency of its [C]hapter 11 bankruptcy case. It is that post-petition presence of activity on the Debtor’s property—pursuant to leases that it knowingly entered into—that violates the CSA; exposes the Debtor to criminal liability; and exposes both the Debtor and its mortgage creditor to forfeiture of the Warehouse that constitutes gross mismanagement of the estate and requires the Court to either convert this case to a case under [C]hapter 7 or to dismiss it.
Second, the court found that the debtor lacked clean hands:
Title 11 U.S.C. § 1129(a)(3) provides that a plan may only be confirmed if it is “proposed in good faith and not by any means forbidden by law.” Because a significant portion of the Debtor’s income[] is derived from an illegal activity, § 1129(a)(3) forecloses any possibility of this Debtor obtaining confirmation of a plan that relies in any part on income derived from a criminal activity. This Debtor has no reasonable prospect of getting its plan confirmed. Even if § 1129 contained no such good faith requirement, under no circumstance can the Court place itself in the position of condoning the Debtor’s criminal activity by allowing it to utilize the shelter of the Bankruptcy Code while continuing its unlawful practice of leasing space to those who are engaged in the business of cultivating a Schedule I controlled substance.
Finally, the court ordered a subsequent hearing to determine whether conversion or dismissal was proper.
In response to state laws permitting certain marijuana-related activity, FinCEN issued guidance to clarify Bank Secrecy Act expectations for financial institutions seeking to provide services to marijuana-related businesses (“FinCEN Guidance”).
The FinCEN Guidance began with an overview of the memorandum issued by then–Deputy Attorney General James M. Cole, which provided guidance to federal prosecutors concerning marijuana enforcement under the CSA (“Cole Memo”). Among other things, the Cole Memo established a set of priorities that prosecutors should consider when deciding whether to enforce the CSA:
Preventing the distribution of marijuana to minors;
Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
Preventing marijuana possession or use on federal property.
The FinCEN Guidance then established that “the decision to open, close, or refuse any particular account or relationship should be . . . based on a number of factors specific to th[e] institution.” According to the FinCEN Guidance, “[t]hese factors may include [the institution’s] business objectives, an evaluation of the risks associated with offering a particular product or service, and its capacity to manage those risks effectively.”
“In assessing the risk or providing services to a marijuana-related business,” the FinCEN Guidance also established the standard of due diligence that the institution should perform. Importantly, when dealing with information regarding state licensure obtained in connection with customer due diligence, “a financial institution may reasonably rely on the accuracy of information provided by state licensing authorities.”
Finally, the FinCEN Guidance expressly stated that “[t]he obligation to file a SAR [suspicious activity report] is unaffected by any state law that legalizes marijuana-related activity.” In doing so, the FinCEN Guidance established three levels of SAR reporting, and provided a list of “red flags” to help assist institutions identify activity that implicates one of the Cole Memo priorities. Notably, FinCEN has made clear that its guidance remains in place despite former attorney general Session’s rescission of the Cole Memo.
Plaintiff’s Complaint allege[d] that Defendant breached the parties’ insurance coverage contract by failing to pay Plaintiff’s insurance claims for stolen property. Plaintiff, who own[ed] and [lived] at a property in the Puna District of the State and County of Hawai`i, purchased a homeowners insurance policy from the Defendant (the “Policy”).
Among other things, the Policy provided “coverage for loss to ‘trees, shrubs, and other plants.’”
[T]welve plants were stolen from Plaintiff’s property. Nine of the twelve plants were fully matured . . . marijuana plants. The remaining three plants were less mature plants. . . . Plaintiff [alleged] that she “lawfully possessed, grew, nurtured and cultivated the plants consistent with the laws of the State of Hawaii . . . permitt[ing] individuals to possess and grow marijuana for medical purposes[.]”
Court Analysis and Conclusion
The district court began with the fundamental proposition that an illegal contract, or one that is in violation of public policy, is unenforceable. Despite marijuana’s legal status under state law, the court held that the contract must also be lawful under federal law to be enforced. In Tracy, the court refused to enforce the contract because “Plaintiff’s possession and cultivation of marijuana, even for State-authorized medical use, clearly violates federal law. To require Defendant to pay insurance proceeds for the replacement of medical marijuana plants would be contrary to federal law and public policy, as reflected in the CSA.”
Mann v. Gullickson, No. 15-cv-03630, 2016 WL 6473215 (N.D. Cal. Nov. 2, 2016)
Overview and Facts
In Mann v. Gullickson, the plaintiff sold two businesses to the defendant: (1) Dispensary Permits.com (“DP”), “a consulting business for state-regulated marijuana dispensary or cultivation licenses”; and (2) weGrow Enterprises, Inc. (“weGrow”), “a franchise hydroponic retail operation.” In exchange, the defendant forgave a $10,000 loan to the plaintiff and executed a promissory note agreeing to pay the plaintiff another $400,000.
After the defendant defaulted on the promissory note, the plaintiff sued the defendant for breach of contract. The defendant then moved for summary judgment contending that the parties’ agreement was void for illegality because it related to medical marijuana—a prohibited substance under the CSA. To support this argument, the defendant proposed a bright-line rule: “California law includes federal law and thus, a violation of federal law is a violation of law for purposes of determining whether or not a contract is unenforceable . . . .” The plaintiff advocated for a more nuanced approach that focused on the legality of the remedy, not the legality of the subject matter.
Court Analysis and Conclusion
Indeed, the court sided with the plaintiff and denied the defendant’s motion. Although the district court recognized the “continued erosion of any clear and consistent federal public policy in this area,” the court ultimately couched its opinion on the nature of the businesses and held that requiring the defendant to satisfy the note’s obligation did not force the defendant to “possess, cultivate, or distribute marijuana, or to in any other way require her to violate the CSA.” The court emphasized that “[t]here is no indication in the record the Companies directly grew or sold marijuana.” Thus, the note was not void for illegality.
In Green Earth Wellness Center, a cannabis company sued its insurance carrier for failing to pay on claims, unreasonable delay, and bad faith.
Green Earth operated a medical marijuana dispensary and commercial grow facility near Colorado Springs. Green Earth made two claims to its carrier, Atain. For its first claim, Green Earth claimed that “smoke and ash from [a nearby wildfire] overwhelmed [Green Earth’s] ventilation system, eventually intruding into the growing operation and causing damage to Green Earth’s marijuana plants.” For its second claim, Green Earth claimed that burglars broke into Green Earth’s facility causing damage to the roof and stealing marijuana plants. Atain denied both claims.
Atain argued that the policy excluded coverage for “[c]ontraband, or property in the course of illegal transportation or trade.” Atain further argued that “public policy requires that coverage be denied, even if the [insurance] Policy would otherwise provide it.”
Court Analysis and Conclusion
The court determined that Colorado law applied as the insurance contract mandated that disputes “will be governed by the law of the state in which the suit is brought.”
Applying Colorado state law meant that the district court could disregard Atain’s “illegality under federal law” argument. The court further held that (1) Atain’s policy failed to define contraband; (2) Atain failed to prove Green Earth violated Colorado’s marijuana laws; and (3) there were mixed messages regarding enforcement at the federal level. Consequently, the court found that Atain’s “contraband” exclusion was ambiguous.
The appeal to the U.S. Court of Appeals for the Third Circuit arose out of an adversary action brought by the Chapter 11 trustee of
debtor Life Service Systems, Inc. (LSS) against defendant Westmoreland Human Opportunities, Inc. (WHO), charging the latter with a breach of its fiduciary duty to LSS’s Unsecured Creditors Committee (Committee). Both LSS and WHO [were] non-profit organizations which provide[d] community services to residents of Westmoreland County in western Pennsylvania.
In 1995, LSS was selected by the Department of Housing and Urban Development (HUD) to receive grant moneys under the federal Supportive Housing Program; LSS and HUD executed a Supportive Housing Grant Agreement (Grant Agreement) as part of this grantor/grantee arrangement. Shortly thereafter, LSS experienced significant financial difficulties, ultimately filing a Chapter 11 bankruptcy petition.
Facts
“Because WHO was one of LSS’s largest creditors, it accepted an invitation to join the Unsecured Creditors Committee.”
“During its tenure on the Committee, WHO, without notifying either its fellow Committee members or the Bankruptcy Court, assumed LSS’s position as recipient of Supportive Housing Program funds, executing a[n] . . . Amendment” to the Grant Agreement. LSS’s Chapter 11 trustee “alleged that WHO, by assuming LSS’s interest in the grant relationship in this manner, breached its fiduciary duty to Committee constituents. WHO defended arguing “that LSS’s interest in the Supportive Housing Program grant relationship was not property of LSS’s bankruptcy estate and thus did not trigger a fiduciary duty owed” by WHO.
“The Bankruptcy Court rejected WHO’s defense, holding that LSS’s interest in the grant relationship constituted part of LSS’s bankruptcy estate and that WHO had therefore violated its fiduciary obligations. It entered judgment against WHO in the sum of $135,653.” The district court affirmed.
Court Analysis
On appeal, the Third Circuit disagreed with the bankruptcy and district courts and held that
LSS’s interest in the grant relationship with HUD is excluded from the definition of “property of the estate” set forth in § 541 of the Bankruptcy Code. Despite § 541’s considerable breadth, HUD’s singular supervisory interest in ensuring the effective administration of the Supportive Housing Program, evidenced by the pervasive, strict, and minute oversight over the grant relationship imposed by the Program’s relevant statutory and regulatory provisions, suffices to exclude LSS’s interest in the Supportive Housing Program grant relationship from § 541’s property definition.
Conclusion
The Third Circuit concluded that had the bankruptcy court “given proper weight to HUD’s strong interest, LSS’s interest in the grant relationship would have been excluded from LSS’s estate for bankruptcy purposes.” In addition, the Third Circuit “note[d] that considerations of bankruptcy policy militate[d] in favor of excluding LSS’s interest from § 541’s property definition,” distinguishing the “LSS’s Trustee’s attempts to rely on case law holding that government-issued licenses, in general, qualify as property of the estate under the Bankruptcy Code.”
In re Joliet–Will County Community Action Agency, 847 F.2d 430 (7th Cir. 1988)
Overview and Facts
The Joliet–Will County Community Action Agency (“Joliet–Will”) was “a private nonprofit community service organization financed exclusively by federal and state grants. The organization’s charter authorize[d] it to raise funds from foundations and other private donors,” although it had never done so.
ACTION, the federal agency that has succeeded the Office of Economic Opportunity, awarded Joliet–Will two grants for a “foster grandparents” program. Other federal agencies granted money for child care, family planning, insulation for homes of low-income people, legal assistance to the poor, and other community service activities to various Illinois state agencies that in turn passed on the money to Joliet–Will (sometimes with matching state grants as well) in accordance with the terms of the federal grants. Joliet–Will was mismanaged, and ultimately went broke and filed a petition for bankruptcy under Chapter 7 of the Bankruptcy Code. A trustee was appointed. Her inventory of the assets in the possession of Joliet–Will turned up cash plus furniture, office equipment, vehicles, aluminum siding, insulation materials, and other personal property. . . .
The federal and state agencies . . . claim[ed] that all of Joliet–Will’s assets belong[ed] to them because all th[e] assets [were] either federal or state grant money or personal property bought with such grant money, and [were] therefore . . . not available for distribution to the creditors. The bankruptcy . . . and the district court . . . disagreed, ruling that Joliet–Will’s assets should be distributed to the trade creditors pro rata, minus the usual costs of administration.
Court Analysis and Conclusion
On appeal, the U.S. Court of Appeals for the Seventh Circuit carefully reviewed the terms under which the grants were made, and reversed. The Seventh Circuit decision in favor of the federal and state agencies was based on the following factors:
“The grants imposed minute controls on the use of the funds, such that the recipient has very little discretion.”
“The statutes creating the grant programs . . . d[id] not authorize the federal government or any state government to allow appropriated funds to be used to pay creditors of a private institution unless the creditor incurred an expense specifically authorized by the grants and applicable regulations.”
A number of cases reviewed by the court held “that federal funds in the hands of a grantee remain the property of the federal government unless and until expended in accordance with the terms of the grant.”
“[T]he treatment of such grants in other areas of law, notably criminal law, [is that] thefts of federal grant money (or personal property bought with such money) are treated as thefts from the federal government.”
In re Premier Airways, Inc., 303 B.R. 295 (Bankr. W.D.N.Y. 2003)
Overview and Facts
Prior to its Chapter 7 filing,
Premier Airways, Inc. (“Premier”) operated a small airport in the Town of Angola, New York. This facility occupied 177.73 acres of land consisting of seven parcels. Four of these parcels constituted an original airfield that the debtor acquired in 1990. Then in 1993, the debtor obtained an AIP [Airport Improvement Program] grant [from the Federal Aviation Administration (“FAA”)] to purchase three contiguous parcels for airport expansion. As a condition for the grant, Premier agreed to follow comprehensive regulations regarding the structure and operation of the expanded facility. Physically, these regulations required that the airport provide space to the FAA for air traffic control and air navigation activities. Premier also agreed to reduce obstructions in its air space; to open its facility to general public use; to serve as a “reliever airport” in the event that no other commercial airport was available; to avoid closings for non-aeronautical reasons without the permission of the FAA; and to maintain accounts that [were consistent] with FAA guidelines. The regulations mandated compliance with environmental, labor and anti-discrimination laws. Most importantly, Premier promised never to sell, mortgage or encumber the facility. In the event that the newly acquired parcels were no longer used as an airport, Premier was obliged to return a proportionate part of the proceeds of sale to the FAA. . . .
. . . Eventually, however, Premier encountered financial problems and filed a [Chapter 7] petition. . . . With due diligence, the [C]hapter 7 trustee proceeded to liquidate the estate’s assets. Meanwhile, the FAA filed a proof of claim for an equitable lien. . . .
The FAA essentially contend[ed] that the expansion parcels were not property of the bankruptcy estate, and that therefor, the United States retain[ed] a superior interest in that portion of the sale proceeds . . . attributable to those parcels.
Court Analysis and Conclusion
Although it acknowledge[d] that section 541 of the Bankruptcy Code gives broad definition to property of the estate, the FAA assert[ed] that from this definition, courts have excluded property acquired through the use of federal grants, where the federal interest suffices to deem that property an asset of the federal government[,] [specifically relying on Judge Posner’s holding in Joliet –Will County].
Unlike with personal property, however, the bankruptcy court held that
[p]ursuant to 11 U.S.C. § 544(a)(3), the trustee enjoyed the rights of a bona fide purchaser of the expansion properties. Thus, proceeds from their sale [were] property of the bankruptcy estate, free of any secured claim or equitable lien of the FAA. Accordingly, the FAA [held] only the status of a general unsecured creditor.
Summary of Legal Authorities for Question #6
Case Authorities
Miller v. American Telephone & Telegraph Co., 507 F.2d 759 (3d Cir. 1974)
Overview and Facts
Plaintiffs, stockholders in American Telephone and Telegraph Company (“AT&T”), brought a stockholders’ derivative action . . . against AT&T and all but one of its directors. The suit centered upon the failure of AT&T to collect an outstanding debt of some $1.5 million owed to the company by the Democratic National Committee (“DNC”) for communications services provided by AT&T during the 1968 Democratic national convention. . . .
Plaintiffs’ complaint alleged that “neither the officers or directors of AT&T have taken any action to recover the amount owed” from on or about August 20, 1968, when the debt was incurred, until May 31, 1972, the date plaintiffs’ amended complaint was filed. The failure to collect was alleged to have involved a breach of the defendant directors’ duty to exercise diligence in handling the affairs of the corporation[] [because of] a preference to the DNC in collection procedures in violation of § 202(a) of the Communications Act of 1934 . . . , [which] amounted to AT&T’s making a “contribution” to the DNC in violation of a federal prohibition on corporate campaign spending.
On a motion to dismiss filed by the defendants, the district court dismissed the complaint on the theory that collection efforts are within the business judgment purview of the directors unless it could be proved that the directors’ action was “plainly illegal, unreasonable, or in breach of a fiduciary duty.”
Court Analysis and Conclusion
In reviewing New York law, the applicable law due to the AT&T’s place of incorporation, the court held that
[t]he plaintiffs’ complaint in the instant case alleges a similar “waste” of $1.5 million through an illegal campaign contribution. . . . The alleged violation of the federal prohibition against corporate political contributions not only involves the corporation in criminal activity but similarly contravenes a policy of Congress clearly enunciated in 18 U.S.C. § 610.[] That statute and its predecessor reflect congressional efforts: (1) to destroy the influence of corporations over elections through financial contributions and (2) to check the practice of using corporate funds to benefit political parties without the consent of the stockholders.
Accordingly, the Third Circuit held that the complaint alleged actual damages to the corporation, and stated a cause of action for which relief could be granted.
In re Beyries, No. 10-13482, 2011 WL 5975445 (Bankr. N.D. Cal. Nov. 29, 2011)
“Plaintiff Northbay Wellness Group (“NWG”) [was] a corporation set up to sell medical marijuana. It operated during 2005 and 2006 and generated several million dollars in sales. Plaintiff Dona Frank was its chief executive officer as well as a director,” and
defendant [and Chapter 7 debtor] Michael Beyries was the attorney for NWG [who] counseled them on how to conduct their business. . . . NWG and Frank [sought] to establish that they ha[d] nondischargeable claims against Beyries. . . .
During the time Beyries was representing [NWG], Frank gave him many thousands of dollars from the sale of marijuana in cash stuffed into envelopes. The funds were not counted, no records were kept, and Beyries gave no receipt. Frank testified that she gave “at least” $25,000.00 to Beyries in this fashion. The evidence established that these funds were not for current legal expenses but were rather intended as a defense fund in case anyone associated with NWG was prosecuted by state or federal officials. Since the money was not for legal services being performed at the time and there was no fee agreement designating the money as prepaid fees, the conclusion [was] that the funds belonged in Beyries’ trust account. His failure to properly account for this money was therefore nondischargeable pursuant to § 523(a)(4) of the Bankruptcy Code.
However, the court held that it could not “enter a judgment for plaintiffs because they were engaged in unlawful activity.” That is, “[w]hile the sale of marijuana may be legal under state law, it is a . . . federal crime which cannot be legalized by a state.” The bankruptcy court therefore dismissed the adversary proceeding because the plaintiffs had “unclean hands.”
On appeal, however, the holding was reversed, and the Ninth Circuit directed the bankruptcy court to apply a balancing test, rather than a per se test, that weights the substance of the right asserted by the plaintiff against the misconduct giving rise to the plaintiff’s “unclean hands.” See Northbay Wellness Group, Inc. v. Beyries, 789 F.3d 956 (9th Cir. 2015).
In re Pingrey, No. 12-10158, 2012 WL 1833928 (Bankr. N.D. Cal. May 18, 2012)
“Claimant Charles Arnold was grievously and permanently injured while an employee on the ranch of Chapter 13 debtor Dale Pingrey. Prior to the bankruptcy, Arnold was prosecuting a personal injury action against Pingrey in state court. Arnold . . . filed a proof of claim in the bankruptcy proceedings” and asked the bankruptcy court “to abstain from adjudicating his claim in favor of the state court.”
Pingrey was transparent about his intentions for filing Chapter 13—“[h]is business was growing marijuana, which may be legal under California law but not federal law,” and “Pingrey believe[d] that if he litigate[d] in federal court, he c[ould] show that Arnold’s claim [was] barred by the doctrine of unclean hands.” The bankruptcy court noted that it “cannot imagine any court applying this equitable doctrine to bar Arnold from recompense for his severe injuries. Pingrey’s reliance on an earlier decision of this court is misplaced; the equities are different.” Accordingly, due to the fact that the litigation was already pending in state court and the fact that litigation in Chapter 13 cases is rarely carried out in bankruptcy court, the bankruptcy court abstained from proceeding with the litigation.
This Article explores the conflict between state and federal marijuana laws from a business entity law perspective. For example, managers owe a fiduciary duty of good faith to their businesses and equity holders. One of the ways in which managers can violate this duty is by causing their business to intentionally violate the law. This is a problem for the marijuana industry because its managers constantly and intentionally violate federal law and therefore violate their fiduciary duties by growing and selling marijuana. This Article concludes that the industry’s ability to attract professional stakeholders is harmed by marijuana business stakeholders’ inability to take advantage of key business law protections, such as limited liability. This Article [thus] proposes a state law exception that allows marijuana businesses to operate normally under state business entity law, with normal business entity law protections, despite their continuing violation of federal law. . . .
. . . In form, the exception would hold that a violation of another jurisdiction’s laws, which directly contradicts laws passed within Colorado, w[ould] not act as a violation of the law for purposes of establishing good faith and clean hands in a Colorado court with regard to a business operating entirely within Colorado’s borders. The court c[ould] apply this exception when it finds that state public policy outweighs the value of enforcing the foreign jurisdiction’s law. . . .
The exception could originate either from a court ruling or legislative action. A court could find that for purposes of a state’s business entity laws, the violation of the CSA by a domestic marijuana business is not a violation of the law, or a state legislature could pass a law giving courts this guidance. Whichever body created the exception, the function would be the same—state courts would allow marijuana businesses to take advantage of normal business entity law protections and regulations.
The article goes on to conclude that if new laws were passed,
equity holders would not lose limited liability protection simply because they funded a marijuana business. If the marijuana business becomes insolvent and is unable to pay its debts, the equity holders would not be liable to the business’s creditors automatically and simply because they funded an illegal business. This, of course, would not mean that they could not lose their limited liability in other ways, such as under a normal application of the alter ego test. The effect of this would be to promote high net worth investors coming into the industry. These investors would bring with them demands for professional management of their businesses. Likewise, marijuana business managers would not be in continuous violation of their duty of good faith simply because they are operating in violation of the CSA. Again, this would not mean that managers could not violate their duty of good faith by breaking other laws, such as state marijuana regulations. But because managers would not be in continuous violation of the law, now they would have an incentive to operate the business within all non-CSA laws so as to avoid personal liability. This should have the effect of giving comfort to investors in marijuana businesses that the business they invested in will be operated professionally.
Summary of Legal Authorities for Question #7
U.S.C. Authorities
11 U.S.C. § 328
(a) The trustee, or a committee appointed under section 1102 of this title, with the court’s approval, may employ or authorize the employment of a professional person under section 327 or 1103 of this title, as the case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or percentage fee basis, or on a contingent fee basis. Notwithstanding such terms and conditions, the court may allow compensation different from the compensation provided under such terms and conditions after the conclusion of such employment, if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions. . . .
11 U.S.C. § 330
(a)(1) After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103—
(A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and
(B) reimbursement for actual, necessary expenses. . . .
(3) In determining the amount of reasonable compensation to be awarded to an examiner, trustee under chapter 11, or professional person, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including—
(A) the time spent on such services;
(B) the rates charged for such services;
(C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;
(D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;
(E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and
(F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.
The U.S. Supreme Court held that the Bankruptcy Code does not permit bankruptcy courts to award attorney fees to counsel employed by the bankruptcy estate for work performed in defending a fee application.
Respondent ASARCO LLC hired petitioner law firms pursuant to § 327(a) of the Bankruptcy Code to assist it in carrying out its duties as a Chapter 11 debtor in possession. . . . When ASARCO emerged from bankruptcy, the law firms filed fee applications requesting fees under § 330(a)(1), which permits bankruptcy courts to “award . . . reasonable compensation for actual, necessary services rendered by” § 327(a) professionals. ASARCO challenged the applications, but the Bankruptcy Court rejected ASARCO’s objections and awarded the law firms fees for time spent defending the applications. ASARCO appealed to the district court, which held that the law firms could be awarded fees for defending their fee applications. The Fifth Circuit reversed, holding that § 330(a)(1) did not authorize fee awards for defending fee applications.
Court Analysis and Conclusion
First, the Supreme Court analyzed the American Rule regarding fees, whereby “each litigant pays his own attorney fees, win or lose,” absent explicit statutory or contractual authority. It then reviewed the statutory authority of §§ 327(a) and 330(a) and held that the Bankruptcy Code does not permit bankruptcy courts to award attorney fees to counsel or other professionals employed by the bankruptcy estate for work performed in defending a fee application in court. That is, the statutory text authorizing “reasonable compensation for actual, necessary services rendered by” such professionals neither explicitly nor implicitly “authorizes courts to shift the costs of adversarial litigation from one side to the other,” and so cannot displace the American Rule with respect to fee-defense litigation.
Second, and crucial to the Supreme Court’s decision, was the statutory language of § 330(a)(1): compensation is available “only for ‘actual, necessary services rendered.’” The Supreme Court went on to explain: “Time spent litigating a fee application against the administrator of a bankruptcy estate cannot be fairly described as labor performed for—let alone disinterested service to—that administrator.” And § 330(a)(1) allows only compensation for work performed in service of the bankruptcy estate.
“[T]he Debtor and its affiliates filed [C]hapter 11 petitions,” and “[t]he UST appointed [a] Committee, which thereafter retained counsel.” Committee counsel each sought § 328(a) approval
of a provision in their retention applications entitling them to compensation from the Debtors’ estates (subject to approval by the Court pursuant to sections 330 and 331) for any fees, costs or expenses, arising from the successful defense of their fees.
The UST objected to the inclusion of the fee defense provisions in the retention applications,[] [arguing] that the provision is precluded by the recent Supreme Court holding in ASARCO. . . . The UST also argue[d] that the fee defense provisions should not be approved because such fees are outside the scope of employment and are unreasonable. . . .
The UST argued that all terms of employment must actually relate to the services to be rendered by the professionals, i.e., the representation of the committee and its interests. It argued that defending one’s own fees is not a service performed by committee counsel for the committee but instead are services performed only for themselves. Last, the committee argued that “[c]ourts generally hold that exculpation and indemnification clauses are permissible in retention agreements if the clauses are reasonable in accordance with 11 U.S.C. § 328(a).”
Court Analysis and Conclusion
The bankruptcy court addressed two questions in arriving at its conclusion that the fee-defense provisions in the retention applications could not be approved.
First, it addressed whether the retention agreements were contracts and held that they are. According to the court, “[h]owever, it is not a bi-lateral one; rather, it is subject to objection by other parties and is ultimately subject to approval (and modification) by the Court.”
Second, the court addressed whether the retention agreement contract was a contractual exception to the American Rule. The court held it was not, noting that
there is not a contract between two parties providing that each will be responsible for the other’s legal fees if it loses a dispute between them. Rather, here there is a contract between two parties (the Committee and Committee Counsel) that in the event Committee Counsel win a challenge to their fees, a third party (the estate) will pay their defense costs even if the estate is not the party who objected. As the UST notes, this is not the typical contract modifying the American Rule.
The court further noted that the retention agreement could not bind the estate as the estate was not a party to it. The court also noted that even if the retention agreement was a contractual exception, the contract was still one that must be reviewed and approved as permissible by the bankruptcy court.
Finally, the bankruptcy court reviewed examples of cases where such indemnification clauses were held permissible in a non-bankruptcy context and found none of them persuasive because the examples either predated ASARCO or were allowed as bald orders without any reasoning. Accordingly, the bankruptcy court “conclude[d] that ASARCO prevent[ed] the Court from concluding that section 328 permits defense fees even if they were routinely allowed by the market in bankruptcy or non-bankruptcy contexts prior to that ruling.”
After the commercial failure of the former Intercontinental Hotel at O’Hare Airport, River Road Hotel Partners, LLC, and its affiliates (“Debtors”) filed for Chapter 11 bankruptcy. The Debtors retained FBR Capital Markets & Co. (“FBR”) as their financial adviser to oversee a planned restructuring. In addition to a restructuring fee, a provision in the retention agreement provided that FBR would be reimbursed for legal fees and expenses “in connection with” its services or for expenses incurred “related to or result[ing] from [] performance . . . of the services contemplated by . . . this agreement.” The bankruptcy court approved the retention agreement with the qualification that “the reimbursement of all FBR’s out-of-pocket expenses shall be subject to further review and approval by the Court pursuant to section 330 of the Bankruptcy Code.” FBR sought $1.8 million, mostly attributable to the attorney fees it paid in defense of its request for its restructuring fee.
Court Analysis and Conclusion
First, the district court held that ASARCO was “directly on point” despite FBR’s attempt to distinguish ASARCO given that the case involved a nonlegal professional, as opposed to the lawyers in ASARCO. The district court found this distinction to be irrelevant: “Sections 327(a) and 330(a) apply to all professionals, and ASARCO’s discussion is cast in broad language to include all professionals, not just attorneys.” The district court also rejected FBR’s argument that ASARCO was not applicable because FBR was seeking “reimbursement” rather than a direct payment for services: “FBR still seeks compensation for funds expended in fee-related litigation, which brings the matter directly under ASARCO’s ruling. FBR’s attempt to differentiate meaningfully Section 330(a)(1)(A) from 330(a)(1)(B) fails also, because ASARCO explicitly cited both of those subparts and held, ‘This text cannot displace the American Rule with respect to fee-defense litigation.’”
Second, the district court found that the retention agreement did not act as a stand-alone contract, thus entitling FBR to reimbursement, because the retention agreement had to be read together with the retention order. “By making out-of-pocket expenses subject to Section 330 review, the Retention Order bound the Bankruptcy Court to abide by the statute.” In other words, the two documents did not qualify as a contract exception to the American Rule given the language of the retention order.
In the Nortel Networks case, an indenture trustee asserted a claim against the bankruptcy estate, including an $8.1 million claim for attorney fees. The indenture trustee also asserted the right to be paid for the fees incurred defending the $8.1 million fee request. The indenture, which was a contract between the debtor and, inter alia, the indenture trustee, contained a provision allowing the trustee to be reimbursed for such fees. The Nortel Networks court, after reviewing ASARCO and Boomerang Tube, concluded that the indenture came within the contract exception of the American Rule.
The debtor’s counsel filed a retention application seeking approval under § 328(a) of language specifically providing for payment of any fees incurred in defending its requests for payment of fees. The paragraph for which it sought approval provided:
The Client agrees to pay all reasonable legal fees incurred in obtaining Court approval of all employment and fee applications including dealing with any objections to any of the applications is [sic] also compensable to [the Gorman firm]. The Client agrees to pay all reasonable legal fees including dealing with any objections to court approval . . . The Client agrees that all reasonable fees and expenses incurred by [the Gorman firm] in collecting and/or obtaining approval of its fees and costs by bankruptcy or any other court shall be added to the total fees and costs due from the Client. All such fees and costs if disputed shall be resolved by the Court.
The creditors’ committee objected to the provision requiring payment of the debtor’s counsel’s fees for defending its fee application. The committee argued that the fee-defense provision was not allowed under the ASARCO holding.
The court reviewed the rationale for the holdings in the ASARCO and Boomerang Tube cases and the respective courts’ disallowance of those fee-defense provisions. The court then reviewed the Nortel Networks case and the reasoning for the court’s allowance of the fees incurred by the indenture trustee in defending its fee request. The court noted that “Nortel’s relevance [was] limited by the fact that the court did not have to decide whether the fee defense provision was a reasonable term under § 328(a), because counsel for the indenture trustee was not employed by the bankruptcy estate.”
The Hungry Horse court found that ASARCO’s holding was limited to § 330(a) of the Bankruptcy Code and held:
ASARCO does not hold that a fee-defense provision can never be a “reasonable term” under § 328(a). Nothing in the Code says that an employment term must benefit the estate to be reasonable. A typical employment agreement between a lawyer and client has many terms; some benefit the client, while others benefit the lawyer. Considered together, they may be reasonable.
It then went on to provide an example of a fee-defense provision that might be “reasonable”:
Fee Defense. The Client agrees to pay all reasonable legal fees and expenses incurred by the Firm, and also by any counsel retained by the unsecured creditors’ committee (if one is formed in the Client’s bankruptcy case) for successfully defending their respective fee applications. The bankruptcy court must approve all of such fees as reasonable. The Client will have no obligation to pay for any fees or expenses the Firm incurs defending fees that are not allowed.
People looking for legal help today have more ways to find an attorney than ever before: search engines, AI chatbots, social media, online directories, and word-of-mouth referrals that inevitably lead to an online search. At the center of it all sits a law firm’s website, serving as the hub where all of these paths converge.
Based on over twenty-five years of experience working with solo attorneys and small law firms on thousands of law firm website projects, I am here to share what makes a law firm website as effective as possible.
Why Do I Need a Law Firm Website?
Law firm websites traditionally had three primary functions: establishing credibility for the firm and its attorneys, generating new business from various marketing channels, and providing a tech-forward client experience. Recently, a fourth function has emerged: building artificial intelligence (“AI”) visibility.
Let’s explore each of these a bit more.
Establishing Credibility for Attorneys and Law Firms
A law firm’s website often has the job of making the first impression. The website needs to quickly and effectively convey what the firm does and why it stands out from the competition. Prospective clients, potential employees, opposing counsel, and professional peers should easily find it when they search for the firm or its attorneys by name.
The main objective is to seamlessly blend the firm’s offline reputation with its online presence so that the website feels like a natural extension of the services and expertise the firm provides.
Generating New Business from Marketing Efforts
For many firms, their website is the primary tool to help them generate new business. Think of the website as the hub for all online and offline marketing efforts. Whether they learn of a firm through a referral or the firm’s marketing efforts, most people will visit a law firm’s website before contacting it for legal services.
To convert those visitors into contacts, the website must be easy to navigate, have audience-focused content, represent the brand well, and make it simple to reach the firm in a variety of ways.
Extending Great Client Service with Online Functionalities
A website can serve as an extension of a law firm’s client experience. Integrating online payment, client portals, and electronic intake forms can simplify day-to-day tasks and make communication with clients feel easy.
Using your website as a resource hub can take that experience to the next level. Not only do educational materials help build authority online, they can help law firm clients understand their case and navigate challenges better when they arise. These resources can be blog articles, white papers, video libraries, newsletters, and so on.
Building Authority and AI Visibility
Generative AI is changing user behavior at a rapid pace. As products like ChatGPT, Gemini, and Claude increase in sophistication, they are becoming popular tools for people looking for law firm recommendations.
These tools increasingly recommend attorneys directly to users, who may contact a law firm without ever visiting the firm’s website. A common example of this is the use of AI Overviews and AI Mode in Google. These create a zero-click experience because the user gets the answer they’re seeking without clicking anywhere else.
Establishing AI visibility means helping systems like ChatGPT and Gemini understand what your law firm does and when to recommend it to users. This is where the firm’s website becomes less a destination for the human user and more a source that AI draws on to learn about the firm and inform its summaries and recommendations.
What Content to Include in Your Law Firm Website
With a website playing a role in so many aspects of a firm’s business, things can quickly feel overwhelming. But websites can be built in stages. Starting with just the basics, here are the core elements all law firm websites should have.
Homepage
This is the page that really makes the first impression. It should clearly communicate the firm’s brand and services, and it should draw users in with a variety of visuals and ways to quickly discover available content. Within seconds and without scrolling, a visitor should have a relatively clear picture of what the firm is about.
A homepage should include a thorough amount of content because search engines value it more heavily than any other page. The homepage will commonly introduce the firm and then highlight and preview content from other sections of the website, such as client reviews, case results, practice areas, firm news, blog posts, and attorney introductions.
Attorney Profiles
Aside from the homepage, attorney profile pages are the most frequently visited part of law firm websites. They should include recent professional headshots, a medium-length profile that speaks to the attorney’s experience, contact information, and bulleted lists of other professional accomplishments.
Attorney profiles should be engaging, spark interest, and confirm important details about the attorney’s background and how it relates to services the firm provides. It should not be a full-length CV, though that can be linked to separately if appropriate for the practice and clientele.
Practice Areas and Services
A page listing the practice areas or services a law firm provides starts to get into the meat of what the firm does and what uniquely separates it from other firms that do the same thing. For a validation-oriented website in a referral-driven practice, a list of services may be enough. But firms that want traction with online marketing or AI visibility should publish a thorough page for each service or practice area.
About Us
This page or section serves as a catchall to cover aspects of the firm’s founding, purpose, history, core values, and community involvement that weren’t covered by the homepage. For smaller practices, this content especially helps to establish the firm as its own entity. It can also be a great area to honor and reference older or founding attorneys who have retired from the firm but still have name recognition in the community or industry.
Published Reviews
Outside of the homepage and attorney profiles, reviews are the next most popular type of content on law firm websites. Reviews, especially those showcasing published reviews from third-party party sites like Google Business and Avvo, show potential clients that other people in similar situations have had success with the firm. Individual reviews come across as authentic endorsements and, when paired with a client photo and star graphics, can make a very strong impression.
Contact Information
At the end of the day, the website is there to facilitate connection with the law firm. Contact information should be visible on all pages. A contact form should be made available for people contacting the firm after hours or who aren’t available for a phone call at that moment. The firm may also add additional contact methods, such as live chat or SMS texting. People have all sorts of ways they prefer to communicate with a business; just look at how many ways you can order pizza! It is important that your law firm meets clients where they’re at to encourage them to connect with you in the most convenient way for them.
Disclaimers and Privacy Policy
Law firms need to be especially careful to have disclaimers and privacy policies that maintain compliance with various state, national, and international requirements. Firms need to be explicit about what does and does not create an attorney-client relationship. They also need to disclose how personally identifiable information (“PII”) is used and shared with third parties, such as advertising platforms. New in recent years is 10DLC compliance for firms that want to communicate and market to their clients via SMS text messaging.
How Do Law Firm Websites Need to Adapt with AI?
Since many people are turning to generative AI to research and synthesize information and using its answers to form their opinions, AI visibility is important to position your firm more broadly in the marketplace. This means understanding how to facilitate your law firm’s presence in generative AI outputs.
Before getting into the weeds with technical recommendations to improve law firm website performance with generative AI, it’s important to recognize the ultimate goal of these tools: AI chatbots are competing to be the fastest, most reliable source of information that saves the user time and helps them make better decisions.
Deliver a Strong Opening
Generative AI processes content in a much more resource-intensive way than traditional search engines. To manage their resources, generative AI systems use retrieval processes to decide which content is worth pulling into their responses. By adding tables of contents, TL;DR summaries, and statements like “this article contains” to the opening of a page, you can increase the odds the AI tool will commit resources to processing your content.
Get to the Point
Generative AI tools prioritize content that gets to the point and doesn’t bury an answer deep within a story. Clear, direct statements are more likely to be quoted and cited by generative AI (and humans) than ones heavily hedged with words like “probably,” “often,” and “frequently.” If something is true, it’s best to state it clearly and then follow up with nuance or exceptions.
Use Proper Content Structure
Clearly organizing page content with descriptive headings and a logical progression to a conclusion helps generative AI systems process information more efficiently. For instance, a page can define a problem, then explain solutions, discuss practical application, and finally note exceptions to be aware of.
Break a Problem Down
Generative AI systems often give answers that explain why something works. When your law firm is cited in answers like these, it builds trust and shows experience. In your articles and substantive content, use first-principles thinking to break problems and issues down into the essential elements, challenge assumptions, and demonstrate why your solutions and explanations are superior.
Maximize Website Speed
When a generative AI goes outside of its internal knowledge and searches the web for an answer, the clock is ticking. While users understand that the AI tool is processing, they still expect an answer within seconds. This means that an AI needs to browse and process dozens of pages in that time. Websites need to respond quickly to these requests, or the tool may move on to websites that respond faster.
Generally a generative AI system will be looking to have a page respond within half a second and completely load within 2.5 to 5 seconds. Google publishes a page speed evaluation tool, and website developers have many tools at their disposal to increase website speed, including caching utilities and content delivery networks.
Build a Broadly Positive Online Reputation
Generative AI systems understand that when a person is looking for legal help, they’re
looking for a recommendation to a law firm or a lawyer, not just a website. To that end, AIs will use information available online, beyond a law firm’s website, to influence its recommendations. This includes professional peer review websites like Martindale-Hubbell and Best Lawyers, client review websites like Google, Yelp, and Avvo, social media sites like LinkedIn, and state bar records for disciplinary checks. They can also bring in information news and legal publications and other online sources such as Reddit. An exercise every law firm and lawyer should try is to ask their AI tool of choice what it thinks about them and their firm.
A Word of Caution
Just as search engines gave rise to an entire industry of people promoting shady tricks and quick ways to top results, so too is generative AI. Your BS detector needs to be better than ever. And while some trickery may result in short-term gains, over the long run, meaningfully building your firm’s online reputation in a way that resonates with humans (client reviews, quality publishing, speaking, engagement in the community, being helpful) will also resonate with generative AI.
Other Tips to Keep in Mind for Your Law Firm Website
So far, we have covered the basics of what a law firm website needs and how it functions in the age of generative AI. What follows here are four additional things to consider during the creation and continued evolution of your firm’s site.
Prioritize and Commit
Exciting as websites are, trying to tackle everything a law firm may want (i.e., new design, podcast, blog, social presence, and digital advertising campaign) all at once may quickly overwhelm a firm’s staff and resources. Spend time up front to discover what matters most to the firm, and tackle that first. Then expand the scope of content and resources after the website launches. This builds in flexibility for marketing and operations to take shape as the practice evolves.
Use SEO
Having a website show up on search, and in generative AI chatbots, requires search engine optimization (“SEO”). Effective SEO includes attention to technical functionality, on-page keyword implementation, authoritative content writing, and linking strategies. All of this jargon is to say: your law firm website needs to be fast, informative, and regularly updated.
Although SEO efforts can be started during the initial website creation process, law firms that want to generate new business from their online presence need to make SEO part of their long-term marketing strategy. Additionally, if your firm is planning to update your current website design, it’s important to have SEO-focused professionals help with the transition to ensure design and content decisions do not negatively affect any online visibility the firm has earned.
Prioritize Digital Accessibility
All websites, especially those representing businesses, need to comply with Americans with Disabilities Act (“ADA”) requirements and be accessible to individuals with disabilities. This means that the website is fully functional for people with visual, auditory, and physical disabilities, among others.
Users with visual disabilities such as blindness or vision loss will typically use assistive technology, such as a screen reader, or configure the display settings on their device (e.g., contrast, font size,) to make things readable to them. The website needs to let these users navigate, read content, and complete actions without interference. It should not override or block, in any way, the configurations or technologies the visitor is using.
To accommodate users with auditory disabilities, one important step is to ensure that video and audio content has captions or transcripts available. Most video services and podcast services now automatically add captions using AI. Often, the firm simply needs to enable these options and double-check the accuracy.
ADA compliance should be baked into a website’s code and design decisions from the beginning. This will not only ensure the best experience for the visitor, it improves how the website performs for AI agents and search engines.
Focus on Quality Written Content
Producing new website marketing content or migrating existing content to a new website platform is one of the most time-consuming parts of website development. Attorneys will often take on the task of content writing but quickly lose steam due to client obligations and the reality that it takes several hours, even with generative AI assistance, to write a decent page of website content. It also doesn’t help that writing marketing copy, especially about yourself, is surprisingly difficult compared to the legal writing they’ve trained to do. Engaging with a professional writer, or a website agency that has writers on staff, can save significant time and frustration all around.
When it comes to migrating existing content, firms are often surprised by how much work it takes to properly move content to a new website configuration. It’s not uncommon for an established law firm to have a body of content that has grown to hundreds or even thousands of pages and media files. This all needs to be migrated with great care to avoid any business or marketing disruptions.
Start Designing Your Law Firm’s Website Today
Having a professional website that aligns with a firm’s business and marketing goals is one of the best investments a law firm can make. Well-crafted websites pay for themselves over and over in time saved and business earned. Further, firms that work to nail down the foundations of their web presence now will be better able to adapt to the rapidly evolving generative AI landscape.
Today, law firms have more options than ever for developing a website. However, between do-it-yourself website builders, online gig boards, specialized law firm marketing agencies, and in-house teams, it can be a real challenge to decide what’s best for your firm. You can, of course, search online and find many capable solutions and providers. Websites frequently contain design credits at the bottom, so you can also search for law firms that are similar to yours, either in your market or outside of it, to discover who is performing well and see how they got it done. And don’t forget good old-fashioned conversations with your peers, especially those who have similar business ambitions and websites you admire.
Once you’ve compiled a short list of options, be sure to research thoroughly so that you can weigh the pros and cons of each, compare proposals and costs, and make a confident decision.
This is an updated version of an article that originally appeared in Business Law Today on January 27, 2023. The previous version was authored by Grace Lau.
The dominant narrative surrounding in-house legal departments emphasizes risk control. Legal is expected to prevent disputes, ensure regulatory compliance, and protect the enterprise from downside exposure. In boardrooms and budget discussions, legal value is often articulated in negative terms: losses avoided, fines reduced, or claims successfully defended.
This narrative, while accurate, is incomplete.
Some of the most valuable work performed by in-house legal teams does not merely internalize risk for the company; it enables customers by quietly reducing friction, clarifying legal boundaries, and building trust. This value is real and consequential, yet unrecognized because it arises as a by-product of Legal’s everyday work rather than as a discrete, customer-facing initiative.
Intellectual Property Practice as Customer Enablement
Intellectual property (“IP”) practice provides a clear illustration of how internal legal work benefits customers. The routine work of in-house IP counsel often includes identifying, challenging, and invalidating patents that pose undue risk to the company’s freedom to operate. While the intended beneficiary of this work is the employer, its effects extend well beyond the firm.
By removing weak or overbroad patents from the landscape, in-house IP counsel reduces uncertainty not only for the company but also for customers who rely on its products and technologies. Customers benefit from clearer operating boundaries, reduced exposure to downstream infringement claims, and greater confidence in adopting and integrating the company’s products.
This knock-on effect of customer enablement is rarely acknowledged as a form of legal value, despite being a predictable outcome of Legal’s ordinary responsibilities.
Legal Risk Clearance as Customer Enablement
The IP example is not unique. It reflects the secondary value of a broader category of in-house legal activity—namely, legal risk clearance.
Across legal disciplines, in-house teams routinely identify, assess, and resolve legal uncertainty to protect the enterprise. When this risk clearance occurs early and effectively, it also stabilizes the environment in which customers interact with the company’s products and services. Legal risk clearance, therefore, functions as a form of customer enablement.
Customers may not see risk clearance, but they notice the results: fewer disputes, clearer rules, safer products, and greater confidence.
Parallel Examples Across Legal Functions
Contracting offers another example. As part of contractual risk clearance, in-house legal teams develop standardized agreements, define fallback positions, and resolve recurring points of contention to manage risk and improve efficiency.
The customer-facing effects are substantial. Standardized contractual frameworks reduce negotiation time, lower transaction costs, and decrease post-execution disputes. Customers benefit from faster onboarding, clearer expectations, more predictable commercial relationships, and, when customers use outside counsel, reduced bills.
In regulated industries, in-house legal teams spend significant time interpreting regulatory requirements and engaging with regulators to align internal practices with evolving standards. This work is undertaken to reduce the company’s enforcement risk.
Early regulatory risk clearance benefits customers by enabling faster approvals, fewer disruptions, and reliable access to compliant products. Customers directly experience these outcomes even if the work is behind the scenes.
Why This Value Is Often Overlooked
This form of value creation is frequently underappreciated because it is indirect, preventive, and embedded in routine legal work. When friction is successfully removed, problems never materialize, and the value remains invisible.
As a result, legal departments are often evaluated based on activity volume or cost control rather than on the conditions they improve for customers and markets.
Why Customer Value Must Be Part of the Legal Value Story
The prevailing approaches to assessing in-house legal performance are incomplete because they focus almost entirely on the enterprise. Legal value is typically described in terms of cost containment and risk avoidance, without considering the external effects of Legal’s work.
Yet much of the everyday work performed by in-house legal teams produces tangible benefits for customers. Through legal risk clearance across areas such as IP, contracting, regulatory compliance, and product safety, Legal reduces uncertainty, removes friction, and builds trust, all of which directly affect customers.
For this reason, any serious account of in-house legal value must consider customer impact. Excluding the customer perspective systematically understates Legal’s contribution and obscures one of its most strategically important roles: enabling others to operate with confidence.
Recognizing customer enablement does not dilute Legal’s traditional mission. It strengthens it. By accounting for the external effects of Legal’s internal work, organizations can more accurately capture the full value of their in-house legal teams, and more deliberately deploy them where that value matters most.
For decades, immigration compliance in corporate transactions was often relegated to a post-closing human resources task, secondary to intellectual property, environmental, and other operational diligence. That approach is no longer defensible. Intensified federal enforcement, expanded use of the successor liability doctrine, proliferating state law compliance obligations, and the growing dependence of U.S. businesses on foreign national labor all mean that immigration compliance must be central to any informed due diligence strategy and reflected in negotiated deal terms to effectively mitigate potential post-closing risk and protect investment value.
Recent enforcement actions signal a renewed and unprecedented focus on worksite compliance, Form I-9 audits, and joint-employer liability, including aggressive scrutiny of subcontractor workforces. At the same time, long-standing but often misunderstood immigration liabilities embedded in mergers and acquisitions (“M&A”) transactions—particularly those involving workforce continuity—have become increasingly visible to regulators, deal teams, lenders, investors, insurers, and other parties central to the dealmaking process.
Immigration due diligence is essential to evaluating deal value, ensuring continuity of operations, and assessing post-closing enforcement exposure, as well as allocating risk through negotiated deal terms. Parties that fail to engage at the right depth and stage of the transaction do so at their own operational and legal peril. This article briefly describes the diligence that every transactional attorney should be prepared to conduct—or outsource—on behalf of their client.
Red-Hot Immigration Enforcement Risk
The intensity of immigration enforcement has historically ebbed and flowed with presidential administrations, but the intensity exhibited by the current administration is unprecedented. Civil Form I-9 audits can result in millions of dollars in fines even when no unauthorized employment is found. If unauthorized employment is found, exposure escalates, and the penalties can be catastrophic: significant monetary fines, debarment from government contracting, business license impact, reputational harm, operational disruption, increased labor costs, and EBITDA compression are the best-case scenario. Indictments and criminal convictions—for both the organization and individual employees—are all on the table.
Immigration and Customs Enforcement (“ICE”) is no longer focusing on low-hanging fruit; instead, they are embracing complex investigations and prosecutions premised on joint-employer liability, successor liability, and subcontractor compliance. Exposure arising from a subcontractor’s violations is no longer hypothetical. Companies can no longer hide behind shell corporations or staffing agencies to circumvent Form I-9 requirements, and, absent a robust and well-negotiated subcontractor agreement with appropriate compliance and indemnification provisions, companies may find themselves on the hook for a third party’s compliance failures.
Deal Structure and Immigration Consequences
The form of an M&A transaction—asset purchase versus stock purchase—has profound immigration implications. A stock deal preserves the employing entity and often supports continuity of immigration sponsorship under successor-in-interest principles, but it also carries forward all historical immigration liabilities to the buyer. By contrast, an asset purchase may limit inherited liability but frequently disrupts visa sponsorship, requiring employers to refile or amend petitions, reverify employment authorization, enroll or re-enroll in E-Verify as required, and, in some cases, terminate employees who cannot promptly transfer or maintain status. These disruptions can undermine deal value by causing loss of critical talent and increasing transition costs.
Another important factor is how employees are treated at closing—for example, as new hires versus continuous employees. Organizations need to be able to defend this choice when the audit arrives, supported by clear, contemporaneous, nonprivileged documentation explaining the rationale and operational steps taken. As part of diligence, buyers should, at minimum, obtain and conduct a privileged review of a risk-based sample of Forms I-9 (and, where applicable, review E-Verify compliance), with escalation to broader review where red flags appear. Sellers should be prepared to facilitate that review, remediate curable defects before closing, and align on transition plans to preserve lawful status and work authorization for key employees. Identified Form I-9 issues may justify purchase price reductions, indemnities, or escrow holdbacks, as well as additional negotiated deal terms (including representations, warranties, covenants, and conditions), and they may potentially implicate required disclosures on corresponding schedules. Additionally, such issues may result in potential exclusions from any representation and warranty insurance (“RWI”) policy.
Hidden Form I-9 Liability in Corporate Transactions
Form I-9 compliance represents one of the most frequently overlooked risks in M&A transactions. When a buyer acquires a workforce through a merger or acquisition, it must either adopt existing Forms I-9 or treat employees as new hires.
Adopting legacy Forms I-9 means inheriting all defects—substantive and technical—associated with those forms. Errors in Forms I-9 are common and can result in fines assessed on a per-form basis. In large transactions, this liability can quickly become material. The risk, however, is not cabined to monetary penalties. The larger risk is that the buyer entity may inherit a partially or wholly unauthorized workforce, thus creating compliance and legal exposure as well as workforce continuity risk. This risk can also drive increased labor costs, particularly in sectors or geographies where labor availability is limited or otherwise commands a premium.
Treating employees as new hires can reduce historical exposure but must be handled carefully. If this avenue is chosen, all new Forms I-9 must be completed no later than three business days from the closing effective date. While some transactions include a pre-closing announcement that provides additional runway to complete the new Forms I-9, many sellers resist pre-closing disclosure to the workforce because of confidentiality obligations, the risk of employee flight, union requirements, customer or vendor instability, or competitive harm if the deal does not close. As a result, buyers often have little to no advance access to the workforce, making it necessary to stand up a rapid, post-closing onboarding process. Attempting to reverify an entire workforce within the first three days after close is a difficult, but not impossible task.
Whatever the buyer’s approach to Forms I-9, E-Verify participation must also be addressed early in transaction planning. If the buyer adopts legacy Forms I-9, it generally cannot create E-Verify cases for existing employees. If employees are treated as new hires, the buyer entity must create E-Verify cases within three business days of the closing effective date and be prepared to manage tentative nonconfirmations (which indicate Form I-9 data entered does not match the records that E-Verify checks against, but do not necessarily mean the employees are not authorized to work in the United States) without taking premature adverse action.
These Form I-9 considerations add risk to the already complex landscape of E-Verify for dealmakers. The decision to implement or terminate E-Verify participation can affect workforce onboarding, employee relations, and potential labor availability, and E-Verify noncompliance creates standalone risk. If acquired employees are assigned to qualifying federal contracts, they may become subject to E-Verify, even if not treated as a new hire for Form I-9 purposes. Moreover, in addition to federal law, a growing number of states and municipalities mandate E-Verify participation for certain employers. The failure to comply can result in business license impact, debarment, or monetary fines. Conversely, other states limit how employers may use E-Verify and have expanded antidiscrimination protections related to citizenship and immigration status, creating additional exposure if onboarding practices are applied inconsistently across locations. In certain sectors or geographies, client contracts may require E-Verify enrollment even if not required by applicable law. The failure to comply with contractual E-Verify requirements may jeopardize existing or prospective contracts or, at best, may result in reputational damage and loss of trust with clients. Thorough review of not only federal and state-level obligations, but also all material customer contracts, during diligence is critical to preventing these consequences.
At the end of the day, Form I-9 compliance is not merely an HR task to be parked on a post-closing checklist. It is a critical window into workforce integrity and the overall compliance culture, as well as a mechanism for identifying, quantifying, and mitigating risks to deal value, including exposure to fines, operational disruption, and EBITDA pressure. Buyers should conduct diligence that assesses not only financial risk, but also reputational, operational, and continuity risks embedded in the target’s workforce and verification practices. While many Form I-9 defects are a problem money can solve, risks such as reputational damage or loss of key labor can have far-reaching consequences that materially erode deal economics and undermine integration plans.
Subcontractors and Joint Employer Risk
Immigration enforcement increasingly targets subcontractor arrangements, particularly where buyers attempt to insulate themselves from liability. While employers cannot directly verify subcontractor employees’ work authorization, robust pre-closing diligence and strong contractual controls are necessary to mitigate joint employer findings. Diligence should extend beyond the target’s direct payroll to high-risk relationships—subcontractors, staffing agencies, and other sources of temporary workers—and include a review of subcontractor agreements for applicable immigration compliance, indemnification provisions, audit rights, and notice covenants for government inquiries or audits.
A Transaction’s Impact on Foreign National Employees
Foreign national employees are often central to a target company’s operations. Visa categories such as H-1B, L-1, E-1, E-2, O-1, and TN are highly sensitive to changes in corporate structure. Transactions that fail to account for these dependencies risk immediate work authorization gaps, costly refilings, or forced departures.
In addition, pending green card sponsorship creates long-term exposure. Labor certifications under the PERM regulations, immigrant petitions, and adjustment applications can be invalidated by changes in legal entity, geographic location, or job duties—resetting years of progress and harming employee retention.
Immigration Due Diligence as a Deal Standard
Immigration law is complex and nuanced. At a minimum, practitioners should review the following when conducting immigration due diligence for a transaction:
Forms I-9:
Ensure that a Form I-9 exists for each employee.
Determine error rate on existing Forms I-9.
Review electronic system (if used).
Review I-9 retention practices, including purging.
Determine any prior audits (state or federal) and their outcomes.
E-Verify:
Determine if target is an E-Verify participant and enrolled hiring sites.
Determine if participation is mandatory or required by client contract.
Determine level of compliance.
Determine any prior audits (state or federal) and their outcomes.
Subcontractors:
Assess which workers are employed by subcontractors or staffing agencies.
Assess if any temporary workers in operationally critical roles.
Review subcontractor agreements.
Assess if subcontractors used to circumvent E-Verify obligations or actual or constructive knowledge.
Work with employment specialists to assess potential misclassification risk.
Conclusion
Immigration compliance is no longer a peripheral issue: It is a core transactional risk with direct financial, operational, and reputational consequences. As enforcement intensifies and global mobility becomes increasingly regulated, immigration due diligence has emerged as a required discipline in corporate transactions. Addressing these issues early in the transaction positions buyers to identify potential risks and adjust valuation, negotiate targeted indemnities or holdbacks, structure deal terms around identified risks, and sequence post-closing remediation to protect deal economics and continuity of operations.
For dealmakers and counsel, the question is no longer whether to conduct immigration due diligence, but how early and how deeply it is integrated into the transaction process—from preliminary risk screens and data requests at the letter of intent (“LOI”) stage, to targeted sampling and remediation planning during confirmatory diligence, through to integration playbooks and post-closing monitoring to protect the continuity of operations and minimize EBITDA pressure. The choice is simple: integrate immigration diligence into the deal, or potentially pay for it later.
In large part due to the significant increase in special purpose acquisition company (“SPAC”) formation in the financial markets over the past few years, there has been a similar increase in SPAC-related litigation—most notably in the Delaware Court of Chancery. While some of the suits filed are standard securities class action matters, the more interesting disputes (to the writers of this article, of course) allege breaches of fiduciary duties (i.e., direct action breach of fiduciary class action lawsuits). As of the writing of this article, none of these fiduciary duty suits has been tried to verdict.
The primary focus of the fiduciary litigation is the alleged inaccuracy and insufficiency of public disclosures during the SPAC merger process. SPACs (often referred to as “blank check” companies) raise capital as a vehicle to take private companies public (“de-SPAC” transaction). Generally, the disagreements regarding the public disclosures involve the periods leading up to the de-SPAC transaction. Additionally, premerger SPAC shareholders have alleged that fiduciaries recommended unfair de-SPAC transactions and that SPAC insiders engaged in self-dealing.
SPACs Explained
On January 24, 2024, the Securities and Exchange Commission (“SEC”) published Final Rule S7-13-22, with the stated purpose of “enhanc[ing] investor protections in initial public offerings by special purpose acquisition companies . . . and in subsequent business combination transactions between SPACs and private operating companies.”[1] In that rule, the SEC defined SPACs as follows: “[S]pecial purpose acquisition companies . . . are shell companies organized and managed by a sponsor for the purpose of merging with or acquiring one or more unidentified private operating companies, commonly known as a de-SPAC transaction, within a certain time frame.”[2]
SEC Final Rule S7-13-22 continues to state:
The de-SPAC transaction is a hybrid transaction that contains elements of both an initial public offering . . . and a merger and acquisition . . . transaction. While structured as an M&A transaction, the de-SPAC transaction also is the functional equivalent of the private target company’s IPO, because it results in the target company becoming part of a combined company that is a reporting company and provides the private target company with access to cash proceeds that the SPAC had previously raised from the public. As part of this process, the shareholders of the SPAC go from owning shares in the shell company to owning shares in a combined company that conducts the business of the private target. As a result, the de-SPAC transaction implicates disclosure and liability concerns associated with both IPOs and M&A transactions.[3]
The SEC also sets forth the following regarding the structure and life cycle of a SPAC:
SPAC initial public offering (“IPO”): Once formed, a SPAC will conduct its IPO in the form of a firm commitment underwritten IPO of $5 million or more in units consisting of redeemable shares and of warrants.[4]
IPO proceeds placed in escrow: Following its IPO, a SPAC places all or substantially all of the IPO proceeds into a trust or escrow account.[5]
Trading period: Typically, the SPAC registers its shares and warrants under section 12(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and lists the units for trading on a national securities exchange.[6]
Target identification: Next, the SPAC seeks to identify a target company for a de-SPAC transaction within the time frame specified in its governing documents. The governing documents often provide a time frame of twenty-four months, but it can be as long as thirty-six months. If the SPAC does not complete the de-SPAC transaction within that time frame, it may seek an extension or dissolve and liquidate.[7]
Merger announcement: If the SPAC enters into a business combination agreement with a target company, the SPAC files a Form 8-K announcing the transaction and detailing certain information on the material terms of the business combination agreement.[8]
Shareholder vote: Prior to the closing of the de-SPAC transaction, the shareholders of the SPAC typically have the opportunity to either (a) require the SPAC to redeem their shares and receive a pro rata share of the amount in the IPO proceeds and related assets held in trust or escrow or (b) remain a shareholder of the surviving company after the business combination.[9]
Private investment in public equity (“PIPE”) financing: In order to offset aforementioned shareholder redemptions, or to fund larger de-SPAC transactions, SPACs often conduct additional private capital-raising transactions, typically in the form of PIPE transactions.[10]
Proxy statement filing: Generally, shareholder approval is required for certain relevant items during the de-SPAC transaction (e.g., amendments to the governing documents of the SPAC or authorization of additional securities for issuance). In such instances, a SPAC provides its shareholders with a proxy statement on Schedule 14A of an information statement on Schedule 14C.[11]
Tender offer: After issuances of required registration and proxy statements, the SPAC may disseminate a tender offer statement for the redemption offer to its security holders with information about the target company.[12]
Merger completion / de-SPAC transaction: After the completion of the de-SPAC transaction, the combined company must file a Form 8-K within four business days that includes information about the target company equivalent to the information that a new reporting company would be required to provide when filing a Form 10 under the Exchange Act.[13]
For the purposes of the fiduciary duty litigation, relevant actions occur between step #5 (merger announcement) and step #9 (tender offer) noted above. It is during this time period when SPAC shareholders evaluate the accuracy and sufficiency of public disclosures made by the SPAC sponsors. Specifically, at this time, the SPAC shareholders rely on the aforementioned disclosures to inform their decision about whether to opt into the merger or redeem their shares at par value plus interest.
Important SPAC Decisions
Denial of Motion to Dismiss: In re MultiPlan Corp. Stockholders Litigation
In the first decision to test Delaware fiduciary principles in a de-SPAC context, Vice Chancellor Lori Will denied a motion to dismiss and applied entire-fairness review to the MultiPlan merger, concluding that the sponsor’s “founder shares” and the board’s parallel incentives created a disabling conflict, and that materially incomplete disclosures deprived public stockholders of a fully informed choice about whether to redeem at the $10-per-share trust value or remain invested.[14] The court framed the harm as a direct injury to each investor’s personal redemption right (and not, as in most mergers and acquisitions (“M&A”) litigation, a derivative injury) and confirmed that SPAC fiduciaries owe the traditional duty of candor even though investors already possess the contractual right to exit. Although the merits never reached trial, the parties settled for $33.75 million, now an informal reference point for valuing “MultiPlan claims.”
Dismissal: In re Hennessy Capital Acquisition Corp. IV Stockholder Litigation
In this decision, the Delaware Court of Chancery delivered the first post-MultiPlan dismissal of a SPAC fiduciary-duty suit, underscoring that entire-fairness scrutiny does not relax Delaware’s pleading standards.[15] Vice Chancellor Will noted in that case that, after the MultiPlan decision, “SPAC lawsuits are ubiquitous in Delaware.”[16] The court held that sponsor conflicts and a steep post-merger price decline, standing alone, cannot sustain a claim; plaintiffs must allege specific, knowable omissions that actually distorted the redemption decision. Because Canoo’s strategic overhaul took place only after the merger and there were no well-pled facts showing that the SPAC fiduciaries knew of undisclosed problems pre-closing, the complaint failed.
More Recent Case: Solak v. Mountain Crest Capital
On October 18, 2024, the Delaware Court of Chancery denied the defendants’ motion to dismiss in a failure-to-disclose matter even though the court stated that the allegations were “not strong” as compared with other SPAC cases that survived motions to dismiss.[17] In this matter, John Solak v. Mountain Crest Capital, LLC, the defendant raised $57.5 million through an IPO on January 8, 2021. On April 7, 2021, the defendant announced a merger agreement with Better Therapeutics.
The defendant filed with the SEC and issued proxy statements to shareholders to approve the merger on October 12, 2021. The shareholder vote meeting was scheduled for October 27, 2021, and the deadline to redeem shares was October 25, 2021. The proxy statement valued the shares at $10, but the dilution of the redemptions and founder shares, along with the costs of the merger, reduced the actual cash balance to less than $7.50 per share.
Investors Split into Two Groups: In re InterPrivate
The shareholder complaint in the In re InterPrivate litigation[18] shows how potential divergent shareholder class interests play out when investors split into two economically divergent groups. In the 2024 complaint, plaintiffs say the sponsor and directors steered the merger with Aeva, masked problems, and thereby impaired a fair redemption decision. The complaint adds an allegation that the price was misleading and that the value of what was purchased was not $10 per share but instead $8.50 after taking into account cash dilution as a result of the merger.
But roughly 50 percent of the issued and outstanding shares in fact redeemed at $10.20 (“Redemption Class”). Others kept (or later sold) shares that soon traded below $3 after trading at $16.16 the first day of trading (“Market-Loss Class”). The case appears headed toward settlement as of the time of this writing but presents interesting issues for consideration for damages estimation in this new twist on the MultiPlan line of cases.
Why InterPrivate Complicates Damages and Class Structure
Two economic cohorts:
The Redemption Class claims it was tricked out of the secure $10 trust value and therefore seeks rescissory damages measured against that floor.
The Market-Loss Class alleges classic stock-drop harm, typically quantified with an event-study anchored in the price at the time of post-merger corrective disclosures.
Typicality and predominance questions:
Because the Redemption Class and the Market-Loss Class rely on different valuation baselines, the defendants argued that Rule 23 requires separate subclasses with distinct experts and damage models; otherwise, the predominance of common issues breaks down, and the named plaintiff may not be typical of both groups.
SPAC Damages and Open Questions
SPAC damages present a unique twist on estimation of damages in Delaware fiduciary cases. The presence of the redemption option and the subsequent outcome in share price present the potential for two different estimates to exist in tension. Forensic accountants can help litigators navigate those tensions with the following general principles:
Redemption-floor model. This model focuses on the potential damages to the Redemption Class. Lost-redemption damages equal (Trust-per-share + interest – actual disposition price) × shares. The analyst must confirm each holder’s election record and any interest earned in trust. Prejudgment interest is then subsequently applied.
Market-loss model. This model focuses on potential damages to the Market-Loss Class. Apply an event-study to isolate price inflation attributable to the undisclosed facts at closing; then measure decline when the truth emerges (often the first post-merger corrective disclosure). Prejudgment interest is then subsequently applied.
If subclasses are required, experts must run both models and provide the court with parallel damages schedules. If a single class survives, experts should still show how aggregate damages decompose by cohort to aid plan-of-allocation negotiations and fairness-hearing scrutiny.
The following open questions remain:
Will Delaware approve an all-in settlement when cohorts’ economic interests diverge?
How will judgment offsets be calculated when some investors already recovered $10 through redemption?
Will future SPAC litigants plead around InterPrivate by appointing separate subclass representatives at the outset, or will they instead focus pleading on only the Redemption Class?
Together, MultiPlan sets the fiduciary-duty and entire-fairness framework, while InterPrivate spotlights the practical valuation and certification hurdles that arise once redeeming and nonredeeming investors pursue the same direct claim.
Conclusion
The rise of SPACs was a unique phenomenon in corporate and securities law, and just as a wave of Delaware SPAC litigation from the 2020–2021 SPAC wave makes its way through Delaware courts, another wave of major SPAC deals is emerging. This article can serve as a guide to help litigators and forensic accountants navigate the unique fiduciary and damages issues in SPAC matters.
Appendix: Case Status Cheat Sheet
While many Delaware SPAC cases are pending, the chart below provides a representative sample of some of the more significant open SPAC matters in Delaware and summarizes the questions at issue and case status for each.
Case
Stage
Key Remedy/Issue
Latest Move
In re MultiPlan Corp. S’holders Litig.
Settled (Oct. 2024).
$33.75 million cash; direct claim for impairment of redemption right.
Settlement approved; sets headline valuation for future risk. Source: The D&O Diary.
In re Hennessy Cap. Acquisition Corp. IV Stockholder Litig.
Dismissed at pleadings (May 2024); first full defense win post-MultiPlan.
Court found no well-pled disclosure violation, and thus no redemption-right impairment.
Plaintiffs filed notice of appeal (pending). Source: Hogan Lovells.
In re Skillsoft S’holders Litig.
Dismissed pre-discovery (Feb. 2025) under entire-fairness.
VC Laster found no nonratable benefit to sponsor.
Motion for reargument denied April 1, 2025. Source: Enhanced Scrutiny.
Smith v. Fattouh (InterPrivate/Aeva)
Putative class action; term-sheet for $14 million global settlement signed July 2, 2024 (court approval pending).
Claims mirror MultiPlan but raise two-track damages problem: (i) redeemers capped at trust ~$10; (ii) market purchasers allege drop-based damages.
First Brands Group, LLC (“First Brands”) is a leading global manufacturer and supplier of automotive aftermarket parts, having acquired its portfolio of twenty-five aftermarket leading brands largely through the incurrence of third-party debt.
On September 28, 2025, First Brands and certain affiliates filed voluntary petitions for bankruptcy relief. In connection with the filings, First Brands disclosed $6.1 billion in aggregate principal amount of on–balance sheet outstanding funded debt obligations (including an asset-based loan facility), $2.3 billion in aggregate “off–balance sheet” financings incurred through special purpose vehicles, and about $800 million in unsecured supply chain financing liabilities.[1] First Brands, additionally, had about $2.3 billion in factoring liabilities.
The extent of First Brands’ liabilities had not previously been known because a significant amount of its liabilities was comprised of off–balance sheet liabilities such as factoring arrangements. Under U.S. generally accepted accounting principles, factoring arrangements may not be required to appear on a company’s balance sheet because ownership of the asset has been transferred and the seller has no right or obligation to repurchase the asset. In addition, when a company arranges factoring programs for its own customers, those arrangements may be classified as off–balance sheet if the supplier’s obligation to the company remains a trade payable.
While financing sources were caught off guard by the extent of First Brands’ liabilities, query whether those financing sources should have been given the extensive amount of debt that First Brands incurred in connection with its acquisition strategy. First Brands’ high leverage, its ability to obtain debt from private capital sources speedily with limited diligence, and the general ability to maintain debt off–balance sheet made masking financial difficulties a realistic outcome.
The real surprise for financing sources in the First Brands case came when allegations were made that First Brands had not transferred proceeds of receivables to factors and that some invoices were financed more than once. These actions by First Brands should be the catalyst for financing sources to try to put themselves in the best position possible to detect and prevent double counting or evaporation of collateral.
How financing sources accomplish those twin goals and understanding the relevant types of working capital financings implicated are the focus of this article.
Understanding Relevant Types of Financing
Asset-Based and Other Lending Arrangements
Asset-Based Loans
An asset-based loan is a financing secured by a company’s valuable assets, notably accounts receivable, inventory, equipment, or real estate, in contrast to reliance on cash flows. This type of financing is typically considered more secure than cash flow lending because availability is tied to the existence of the underlying assets. Accounts that are sold in, or sometimes simply subject to, a factoring arrangement as described below are typically excluded from the borrowing base of an asset-based loan. Such an exclusion is to avoid double counting of assets that are being sold in a factoring arrangement.
Cash Flow Loans
While cash flow loans often are secured, the loans are generally not as dependent on a recovery from collateral as are asset-based loans. Any disappearing collateral, however, will inevitably affect recovery of all types of loans.
Factoring Arrangements
Factoring Arrangements Description
Factoring arrangements are relatively common in the automotive aftermarket space, in part due to lengthy payment terms negotiated by customers. Factoring generally is a mechanism used by companies to bring in cash from the sale of accounts receivable earlier than the standard payment terms for those receivables.
Third-Party Factoring
In a third-party factoring arrangement, the company sells ordinary course accounts receivable to a financial institution (not affiliated with a customer) at a discount. In this arrangement, the company transfers the proceeds of the receivables to the financial institution and owes the associated liability, if any, to the factor. In the First Brands case, the parties intended the transfers of receivables to constitute true sales, the obligations were largely nonrecourse, and there was no resulting liability on First Brands’ balance sheet.
Supplier Financing / Customer Factoring
In a “supplier financing” or “customer factoring” arrangement, the company sells the receivables to a financial institution aligned with a customer for shorter terms of payment. In this type of factoring, the customer pays the receivable to the financial institution directly and not through the company. Some customers require suppliers to enter into these arrangements to increase the supplier’s capacity to sell to the customer and permit the buyer to negotiate lengthy repayment terms (up to 365 days).
Unsecured Supply Chain Financing
First Brands also had unsecured supply chain financing arrangements where First Brands arranged for its suppliers to enter into factoring arrangements similar to the “supplier financing” described above except that First Brands was the buyer.
Recourse or Nonrecourse Factoring and Balance Sheet Effects
Factoring can be on a recourse or nonrecourse basis. Nonrecourse factoring arrangements are not debt on a company’s balance sheet if they meet certain criteria and may be considered true sales. The company adds cash to its balance sheet from the proceeds of the receivables without credit risk with respect to the receivables. In a recourse scenario, the company is obligated to buy back receivables that are not paid.
Practical Tips to Protect Against Double Counting and Evaporation of Collateral
Many observers believed that the nature of First Brands’ liabilities as off–balance sheet financings was the reason for the demise of the business; however, ultimately, the over-leveraging of First Brands was the real culprit. Whether a financing is an on– or off–balance sheet liability, lenders and factors need to take steps to understand the company’s entire “debt” position and to keep track of collateral.
Due Diligence Is Crucial
Lenders need to make sure not to shortchange fully verifying collateral. Speed of execution is a benefit to getting deals done but should not stand in the way of completing robust financial and other diligence.
Lenders and factors should go beyond standard audits of collateral and demand comprehensive financial disclosures. First Brands allegedly prevented lenders from inspecting collateral, which is an obvious red flag.[2]
Implement an Early Warning System
While financial covenants act as a “canary in the coal mine” in most deals, those covenants can be manipulated. When relying on collateral, ongoing monitoring of collateral and independent verification of accounts receivable can avoid disappearing collateral and improper recordkeeping. When factors did not receive some meaningful amount of expected proceeds from the receivables sold to them, early warning mechanisms should have resulted in alarm bells ringing.
Independent Oversight
As businesses grow (sometimes aggressively, as was the case with First Brands, corporate governance needs to include at least an independent director and auditing committee. Independent oversight of collateral, including agreed-upon procedures, adds an extra layer of transparency.
With regard to First Brands, the founder and his brother, the chief financial officer, allegedly had a history of limiting information to financing sources,[3] and there were prior lawsuits against the founder claiming that he hid information. Having independent oversight may have helped prevent (or at least raise concerns over) the lack of transparency.
Lenders’/Factors’ Toolkits
To understand the full scope of a company’s liabilities, a lender should request disclosure of factoring arrangements, limit the amount of factoring, and require granular collateral schedules, annual updates of same, and notice of duplicate invoices. A factor should understand the scope of competing liabilities and require collateral verification. While some of these safeguards rely on the company being forthcoming, these concepts are a good start to an effective “tool kit” of action items. Lenders and/or factors also should require updated Uniform Commercial Code lien searches and random inspection of collateral.
For greater control, a lender and/or factor should require a dedicated account for the collection of receivables that are pledged to it, such as a lockbox or an account subject to exclusive control. In some asset-based loans and in factoring arrangements (particularly those that are nonrecourse), proceeds then should be swept daily for application to the outstanding debt or forwarding of payment to the factor.
As set out in the Receivables Purchase Agreement filed with the court, First Brands acted as the “servicer” or “collection agent” of/for the accounts receivable, which were required to be deposited into an account over which the factor had control or, if the factor agreed, in another company account. Upon receipt of the proceeds into the applicable account, First Brands was required to forward those payments to the factoring counterparty within a prescribed period of time. First Brands did not comply with its obligation to forward proceeds of the sale of the receivables. To avoid this possibility, a company should not be permitted to be the sole servicer for the collection of receivables in a factoring arrangement as it was in the First Brands matter. An account that is merely subject to control or relies on the company to forward proceeds may not be sufficient to ensure that the company delivers the proceeds.
Conclusion
While it is hard to protect against fraud, implementing protective measures to avoid double counting or disappearance of collateral can reduce lenders and factors’ exposure.
High Net Worth (“HNW”) and Ultra-High Net Worth (“UHNW”) families often form family offices to address three priorities: privacy, control, and continuity. Lawyers and advisors to such families know that these goals cannot be achieved with sophisticated structures alone. Indeed, the legal structure is just one part of the equation. The real work, and the real risk, lies in aligning the decisions of the people operating and impacted by the structures with those priorities.
In my practice, I have seen thriving family enterprises deteriorate not from poor legal and tax planning, but from poor decision-making and the failure to account for economic and familial realities. I’ve also seen families preserve and expand wealth because they did the internal work and embraced governance that accounted for human behavior just as much as financial strategy. As a result, I am convinced that modern family office advisory work sits at the intersection of law, governance, and behavioral finance. Lawyers who want to serve this client base must be fluent in all three.
The New Era of Family Offices
Family offices have existed for generations, but their role has expanded dramatically in the last decade. Liquidity events, business exits, intergenerational transfers, and rising private wealth have pushed families to professionalize their internal systems. As a result, lawyers are more involved than ever before, not just as estate planners or corporate counsel, but as architects of long-term strategy.
The modern family office is no longer defined by investment management alone. It is a hub that coordinates legal compliance, governance, tax strategy, philanthropy, real estate, operating companies, and family education. It is, in many ways, the “enterprise platform” for generational wealth.
But overreliance on complex legal and tax strategies exposes families to bias, and they ignore the basic realities of human behavior. This is where behavioral finance becomes indispensable.
The Legal Architecture Still Matters—But It’s Not Enough
Business lawyers advising family offices must, at a minimum, understand the central set of legal considerations:
Entity selection and jurisdictional advantages
Multilayered trust structures
Tax planning across generations
Regulatory exemptions under the Investment Advisers Act
Fiduciary duties and conflict management
Internal controls, oversight, and compliance protocols
These are fundamental. But they are also insufficient unless paired with an appreciation of the behaviors that shape how families actually operate.
For example, families often choose entity structures that mirror long-held beliefs about control rather than prioritize what best protects the enterprise. A founder’s overconfidence may lead to centralized decision-making that exposes the family to unnecessary risk. Anchoring bias may cause a family to cling to a valuation from the liquidity event, influencing everything from investment strategy to internal compensation. Present bias, our natural tendency to prioritize today over tomorrow, is one reason estate planning is delayed until it becomes an emergency.
Legal tools can mitigate these risks, but only if they are designed with the underlying human tendencies in mind.
Where Behavioral Finance Adds Value
Behavioral finance helps advisors understand the predictable ways people make irrational decisions, especially under pressure or uncertainty. In the family office context, several patterns appear repeatedly.
1. Cognitive Biases in Wealthy Families
Overconfidence can lead founders or next-generation leaders to overestimate their judgment in unfamiliar asset classes.
Loss aversion often causes overly conservative investment shifts after a downturn.
Confirmation bias affects hiring, investment committee decisions, and selection of outside advisors.
Anchoring on past successes or business valuations can distort long-term planning.
2. Emotional Dynamics
Wealth magnifies emotional realities rather than diminishing or erasing them. The enterprise is impacted when, for example:
Mortality avoidance delays estate and succession planning.
Sibling dynamics play out through governance disputes.
A founder’s identity becomes intertwined with control.
Guilt and fear influence inheritance structures.
If lawyers ignore these dynamics, even the strongest estate plan will fail in practice.
3. Money Scripts and Intergenerational Beliefs
Every family carries inherited narratives about wealth: scarcity, abundance, secrecy, responsibility, entitlement. These scripts shape how individuals behave within a family office, often more than any governing document.
A key role for advisors is helping clients identify the narratives that support longevity (and the ones that quietly undermine it).
Governance as a Behavioral System
Effective governance is not about thick binders or elaborate flowcharts. It is about creating processes that help people make better decisions.
When families understand that governance is a behavioral tool, not merely a corporate requirement, they engage with it differently. A well-designed governance system:
Clarifies roles and authority
Creates consistent decision pathways
Reduces power conflicts
Establishes norms for transparency
Adds friction where needed (e.g., cooling-off periods)
Provides accountability without eroding trust
Family constitutions, investment policy statements, trustee guidelines, and dispute-resolution protocols all serve a behavioral purpose: They reduce the cognitive load of decision-making and create structure in moments of uncertainty.
I often tell clients that governance is a form of love. It protects relationships while protecting the enterprise.
Designing the “Behavioral Family Office”
Lawyers who advise family offices have a unique opportunity to help families build systems that acknowledge how people actually behave, not how we wish they would. A modern advisor approach includes five essential steps:
1. Start with Purpose
Purpose is not a tagline; it is a strategic anchor. Families who articulate their shared purpose experience fewer conflicts and make more consistent decisions.
2. Map the Decision Network
Understanding who influences whom is as important as understanding who legally holds authority. Influence, not titles, drives most family office outcomes.
3. Identify Behavioral Risks Early
Common risks include:
Founder dependency
Concentrated decision power
Lack of development of the next generation
Emotional spending masked as “strategic”
Avoidance of difficult conversations
A behavioral risk assessment is as important as tax analysis.
4. Build Structures That Nudge Good Decisions
Examples include:
Incentive trusts that reward milestones
Governance boards with diverse voices
Voting structures that prevent concentration of authority
Independent committee members
Required education or training before accessing capital
When legal design aligns with behavioral insight, families are more likely to stay aligned.
5. Develop a Succession Process, Not a Moment
Succession fails when it is treated as a task or event. It succeeds when it is treated as a gradual transfer of authority, relationships, and wisdom.
The Lawyer as Architect of Wealth, Governance, and Decision Systems
Modern family office clients are not looking for technicians alone. They seek advisors who can think holistically. Professionals who understand legal frameworks, business strategy, and human behavior are most effective.
Lawyers who embrace this broader role become:
Navigators in moments of conflict
Interpreters of family dynamics
Architects of governance and continuity
Guardians of legacy
Advisors who protect both the enterprise and the people behind it
In many cases, we are the first professionals families call when something feels “off,” long before an accountant or investment advisor is aware of the issue. That trust creates both an obligation and an opportunity.
Conclusion
The work of advising family offices demands more than legal acumen. It requires empathy, strategic thinking, and a clear-eyed understanding of how people behave when money, identity, and family intersect. When lawyers integrate behavioral finance with traditional legal frameworks, we help families build legacies that endure.
Family offices will continue to evolve, and the most effective advisors will evolve with them. For business lawyers willing to expand their toolkit, this is one of the most meaningful and impactful areas of practice today.
If you’re a lawyer reading this article, you know far too well that this job requires juggling many responsibilities at once, from managing demanding expectations and keeping your team on track to navigating constant deadlines.
If you read that line again, you will see that these responsibilities mirror what mothers do every day. We practice these skills not just forty to sixty hours during the workweek, but 24-7. I write this article as a full-time plaintiff personal injury litigator / trial lawyer in my eleventh year of practice and a mom to a two-year-old and a four-year-old.
You might be thinking, “How does navigating a toddler’s meltdown translate into being a better lawyer?” Let me answer that question by sharing my insight into the parallels between motherhood and the practice of law. I hope by the time you finish reading this article, you’ll see just how much the unique skillsets of “lawyer moms” strengthen the way we show up as attorneys—often in ways that benefit clients and teams every single day.
Working with Demanding People
As a lawyer, your clients, opposing counsel, supervisors, and judges place significant pressure on you constantly. The job requires creative problem-solving, steady negotiation, and reframing expectations. Whether you’re asking for an extension or pushing back on an unrealistic demand, you’re continually managing what others want and guiding them toward what’s actually reasonable.
As a mom, you deal with the demands of kids whose wants aren’t always rational. When they don’t get what they want, the reaction can be loud and dramatic. You quickly learn how to redirect, offer practical compromises (like ten minutes of television to avoid a bedtime tantrum), and stay calm through the chaos. That patience, quick thinking, and careful expectation-setting show up every day in legal practice.
Leading Your Team to Do Their Best Work
No matter how long you’ve been practicing, as a lawyer, you lead a team. That team includes court reporters, interpreters, paralegals, associates, and law partners. The practice of law is collaborative, and the stronger you are at guiding and supporting the people around you, the better results you get for your clients.
The stakes as a leader are also high as a mom. You’re leading your children toward becoming independent, happy, and fulfilled people. Lawyer moms also find themselves leading the adults who shape their child’s life, from teachers to grandparents to coaches.
Managing Competing Deadlines and a Busy Schedule
All lawyers are busy, and trial lawyers can be even busier. We learn to juggle deadlines and obligations that constantly shift with case developments, while also thinking ahead to what needs to be scheduled—depositions, client meetings, and everything else required to keep a case moving forward.
A mom is the ultimate juggler at home. She orders diapers before they run out. She applies for preschool early so her child gets a spot. She schedules haircuts in time for picture day. She often keeps track of the entire family’s medical appointments, too. She’s an expert at managing a full calendar to make sure everything her child needs is planned for and taken care of.
Regulating Emotions
Has opposing counsel ever yelled at you? Ever stood before a judge having a bad day? Has a client insisted on something the law doesn’t support? Being a lawyer often means staying calm and guiding a situation toward a reasonable outcome.
A mom has mastered the art of staying cool as a cucumber in stressful situations and isn’t thrown off by heightened emotions. How you react to your child affects their well-being, so you learn not to sweat the small stuff. That perspective helps you see the big picture and keep going.
Practicing the Art of Resilience When You “Lose”
With a career in law comes pressure and stress. As a lawyer, you have days where you “lose,” whether a motion doesn’t go your way or a deposition feels like a failure. A good lawyer is resilient—able to bounce back immediately, refocus, and keep pushing forward for the client.
Resilience is a mom’s superpower. You know your children depend on you. So you see both good and bad moments in your child’s life and push on with the same resilience that you carry with you every day.
* * *
Motherhood has made me a stronger lawyer, and I know I’m not alone. Lawyer moms bring resilience, perspective, and an ability to stay on their A-game even when things get messy.
I hope that the legal community recognizes that having a lawyer mom as part of your legal team is incredibly valuable to your firm and your clients.
The insured covenant provisions of an insurance policy set forth a series of ongoing covenants and obligations binding on the insured with respect to the coverage under the policy.[1] In some insurance policies, coverage under the policy is explicitly conditioned on the insured’s compliance with such covenants and obligations, provided that the insurer has suffered actual prejudice as a result of noncompliance. In some U.S. states, case law or statute imposes an insurer prejudice requirement for forfeiture of coverage to result from the insured’s covenant noncompliance, even if the policy in question does not set forth such a requirement.
In a modern representation and warranty insurance (“RWI”) policy,[2] however, all or almost all of an insured’s ongoing covenants and obligations are made subject to an explicit insurer prejudice requirement before there will be a forfeiture or limitation of coverage due to noncompliance. The purpose of such a provision is typically to prohibit the insurer from denying or limiting coverage to an insured based on the insured’s covenant noncompliance unless and only to the extent that the insurer has been actually prejudiced by the noncompliance, with the burden of proof on the insurer. Such an insurer prejudice provision is favorable to the insured.
This article addresses the question of what measure of evidence might demonstrate insurer prejudice sufficient to permit an RWI carrier to deny or limit coverage based on an insured’s noncompliance with policy covenants and obligations, for the purpose of an insured’s refuting an assertion of insurer prejudice.
Anatomy and Meaning of the Insurer Prejudice Provision
“Any failure of an Insured to comply with Clauses 7.2 (except as provided in Clause 7.4), 7.3, 7.7, 8.1, 8.2 or 10.10 shall not relieve the Insurer of its obligations under this Policy;”
For examples of the wording of these sections, please refer to the Appendix.
The foregoing portion of the insurer prejudice provision effectively prescribes that the insured’s covenants and obligations in the RWI policy are independent of the insurer’s obligation to insure loss under the policy. Thus, an insured’s noncompliance with one or more of such covenants and obligations will not result in a forfeiture or limitation of any insured’s coverage under the policy, except and only to the extent provided in the remaining portion of the insurer prejudice provision, as discussed below.[3]
“however, the Insurer shall be entitled to reduce the amount of Loss payable under this Policy to reflect the extent (but only the extent) to which the Insurer’s position has been actually prejudiced by such failure,”
The foregoing portion of the insurer prejudice provision sets forth a limited exception to the independent covenant portion of the provision. To the extent that the insured’s failure to comply results in actual prejudice to the insurer, the insurer can reduce the amount of loss it is obligated to cover under the policy.
“with the Insurer having the burden of proving such actual prejudice and such amount.”
As will be discussed below in the section titled “Applicable Delaware Law in the Absence of an Insurer Prejudice Provision,” the issue of whether the insurer or the insured has the burden of proving insurer prejudice can be of exceptional significance. Moreover, the burden on the insurer of proving the amount of loss affected by such prejudice may be of even greater significance in constraining the limiting effect of the insurer prejudice provision.
In some cases, applicable law may shift the burden of proof from the insurer to the insured based on the gravity of the insured’s noncompliance. The RWI policy’s insurer prejudice provision overrides such applicable law by prescribing that the insurer always has the burden of proving the fact and extent of insurer prejudice.
Applicable Delaware Law in the Absence of an Insurer Prejudice Provision
Given that many RWI policies are governed by Delaware law, this article will focus on Delaware law.[4] Since this article assumes that the RWI policy in question contains an explicit insurer prejudice provision like the above example, this section will provide only a brief overview of applicable Delaware law in the absence of such a provision.
An important aspect of evaluating applicable Delaware law is recognizing that it is purely an evaluation by analogy analysis, generally to automotive and liability insurance policies, as there simply are no Delaware cases or statutes specific to RWI policies.[5]
The seminal case in Delaware regarding insurer prejudice is State Farmv. Johnson, a Delaware Supreme Court case decided in 1974. The case involved an issue of untimely notice given by an insured under an automobile liability insurance policy, in which the Court established a two-part test applicable to untimely notice:
Has the insured complied with the policy’s notice provision, with the burden of proof on the insured?
If the insured has failed to comply, has the insurer suffered prejudice as a result of the insured’s noncompliance, with the burden of proof on the insurer?
A critical underpinning of the holding in Johnson was the Delaware Supreme Court’s finding that the insurance policy in question was a contract of adhesion, which meant that the policy’s terms and conditions were “‘not talked out or bargained for as in the case of contracts generally,’” and therefore that the policy “‘should be read to accord with the reasonable expectations of the [insured] so far as its language will permit.’”[6] “[W]e hold that when an insured fails in his burden of proving compliance with the notice condition, before any forfeiture [of coverage] can result, the insurer has the burden of showing that it has thereby been prejudiced.”[7]
There has been a series of Delaware law cases extending or distinguishing Johnson in various contexts:
Brandywine One Hundred Corp.v.Hartford Fire Insurance, U.S. District Court for the District of Delaware, 1975—insurer prejudice not required in the case of insured noncompliance with a one-year notice of suit covenant.[8]
Falcon Steelv.Maryland Casualty, DE Superior Court, 1976—explanation of measure of insurer prejudice required, discussed below in section titled “Proof of Insurer Prejudice.”[9]
Hall v.Allstate, DE Superior Court, 1985—insurer prejudice required in the case of insured noncompliance with a prior-consent-to-settlement covenant.[10]
National Union Fire Insurance Co. of Pittsburghv.Rhone-Poulenc Basic Chemicals, DE Superior Court, 1992—insurer prejudice not required if insurance policy not an adhesion contract.[11]
E.I. du Pont de Nemoursv.Admiral Insurance Co., DE Superior Court, 1995—insured noncompliance with notice, cooperation/assistance, and prior-consent-to-settlement covenants alleged by insurer; Court stated that Delaware courts have not required insurer prejudice for cooperation/assistance noncompliance, although at least one commentator, as referenced in the case, has noted that prejudice may be relevant to the materiality of the noncompliance.[12]
Sutchv.State Farm, DE Supreme Court, 1995—explanation of measure of insurer prejudice required, discussed below in “Proof of Insurer Prejudice.”[13]
Jonesv.State Farm, DE Supreme Court, 1997—demonstration of actual prejudice required, reversing lower court’s finding of prejudice as a matter of law, discussed below in “Proof of Insurer Prejudice.”[14]
Homsey Architectsv.Harry David Zutz Insurance, DE Superior Court, 2000—insurer prejudice not required for an untimely notice under a claims-made policy, distinguishing Johnson as involving an occurrence policy.[15]
Allstatev. Fie, DE Superior Court, 2006—shifting of burden of proof regarding insurer prejudice to insured in case of insured noncompliance with prior-consent-to-settlement covenant.[16]
Sun-Times Media Group v. Royal & Sunalliance Insurance Co. of Canada, DE Superior Court, 2007—insurer prejudice required in case of insured noncompliance with a prior-consent-to-settlement covenant.[17]
Wilhelm v.Nationwide, DE Superior Court, 2011—explanation of measure of insurer prejudice required, discussed below in “Proof of Insurer Prejudice.”[18]
Medical Depot v.RSUI Indemnity, DE Superior Court, 2016—insurer prejudice required for a claims-made policy with continuing coverage, distinguishing Homsey.[19]
Northrop Grumman Innovation Systems v.Zurich American Insurance, DE Superior Court, 2021—explanation of measure of insurer prejudice required, questioning Wilhelm, discussed below in “Proof of Insurer Prejudice.”[20]
In addition to the foregoing cases, a number of cases in Delaware, decided at the motion to dismiss or motion for summary judgment stage, have addressed the question of whether or not insurer prejudice is an issue of fact or an issue of law and, in that regard, whether insurer prejudice can ever be presumed to exist at the motion to dismiss or motion for summary judgment stage (such as in the case of an extended unexcused delay by an insured in giving a claim notice).[21]
Except as discussed in the next section below, whether any of the Delaware cases dealing with insurer prejudice would be considered binding or even analogous precedent with respect to an RWI policy that does not contain an insurer prejudice provision is questionable for a number of reasons, including:
None of the cases involved an RWI policy.
Whether an RWI policy would be considered a claims-made policy.[22]
Whether an RWI policy would be considered a contract of adhesion.[23]
Whether an RWI policy would be considered different on some other basis from the policies involved in the cases.
Whether the presence of a duty to defend in the policies involved in some of the cases is a distinguishing factor from an RWI policy, which disclaims any insurer duty to defend.
Proof of Insurer Prejudice
Regardless of whether or not an RWI policy contains an insurer prejudice provision, the Delaware cases dealing with the measure of proof of insurer prejudice required should be considered persuasive analogous precedent for analyzing RWI policies.
The most important element of establishing insurer prejudice is that actual prejudice, not merely prejudice in theory, is required for RWI coverage to be forfeited or limited.[24] The seminal case in Delaware regarding proof of insurer prejudice is Falcon Steelv.Maryland Casualty, DE Superior Court, 1976.[25]
The Falcon Steel Court’s holding that insurer prejudice had not been proved was with respect to a comprehensive general liability (“CGL”) insurance policy. In support of that holding, the Court’s various findings resonate in terms of what an RWI carrier should be required to demonstrate to satisfy its burden of proof regarding insurer prejudice and the amount of loss affected thereby, including:
“[Insurer’s expert witnesses’] testimony as to the effect of delayed notice was for the most part mere speculation . . . , since they lacked sufficient specific factual information upon which to base a sound opinion.”[26]
“The test is not what the insurer might have done, but rather what results it is probable would have been produced if the insurer had been given the opportunity to function upon receipt of timely notice. Prejudice must be determined based upon loss of substance and not merely loss of opportunity for the insurer to follow its established procedures.”[27]
“The question of whether or not the delay in notification has caused prejudice to [the insurer] must be based on evidence and reasonable inferences and cannot be left to mere speculation.”[28]
“It is clear that the Delaware Supreme Court in Johnson rejected the concept that mere passage of time creates the kind of prejudice which bars recovery against an insurer. It is obvious that every diligent insurer upon prompt receipt of notice would take steps to preserve and perpetuate evidence and that it could be surmised that this might not be done as effectively at a later time. If this is all that Johnson stands for, it would not have been necessary for the Court to give the full consideration to the subject of prejudice which it did.”[29]
“In order to carry [its] burden [of proof], an insurer must show that evidence which it is reasonably probable could have been developed by prompt investigation has not or cannot be developed by later investigation or that in some other respect it is reasonably probable that a resolution of the claim could have been reached if prompt notice had been given which cannot be reached after the late notice.”[30]
A number of Delaware cases after Falcon Steel have considered the issue of proof of insurer prejudice. In Sutchv.State Farm, DE Supreme Court, 1995, the Court reversed a determination by the Delaware Superior Court that the insurer had been prejudiced by the insured’s failure to give timely notice of the claim. In reaching that decision, the Court found that the insurer “had notice and the opportunity to intervene [in the underlying case] to protect its interests” and had failed to do so, and therefore had “failed to demonstrate any prejudice.”[31]
In Wilhelmv.Nationwide, DE Superior Court, 2011, the Court found that the insurer had “suffered prejudice as a result of [the insureds’] delay in two way [sic] primary ways: (1) it was unable to investigate Mr. Wilhelm’s pre-accident condition because certain older medical records are no longer available, and (2) it was unable to have an expert examine Mr. Wilhelm at a time close to the 1998 accident so that it could asses [sic] what injuries were attributable to that accident as opposed to other accidents and the lapse of time in general.”[32] The Court in Wilhelm went on to hold that “those facts, along with the ‘inordinate lapse of time’ between the accident and notification, demonstrate that [the insurer] is in a less favorable position in defending this suit as a result of [the insureds’] delayed notice. [The insurer] has suffered prejudice as a matter of law, and thus, is not obligated to provide coverage pursuant to its policy.”[33]
The Wilhelm case seems to be an outlier from the Falcon Steel line of cases in relying on aspects of theoretical prejudice rather than of actual prejudice, in giving weight to the inordinate lapse of time in the insureds’ giving notice in determining prejudice, and in finding prejudice as a matter of law on summary judgment. In a 2021 case, Northrop Grumman Innovation Systemsv.Zurich American Insurance, a different Delaware Superior Court judge seemed to call into question the viability of the holding in Wilhelm, noting that the Wilhelm Court’s determination of prejudice as a matter of law in those circumstances was “not too far from skipping a prejudice analysis altogether.”[34]
The combination of an issuer prejudice provision of the type described above and the Falcon Steel line of cases regarding proof of insurer prejudice creates a very high hurdle for an RWI carrier seeking to deny or limit coverage based on an insured’s policy covenant or obligation noncompliance.[35] An insurer’s burden of proving actual prejudice and the amount of loss affected thereby would be particularly challenging in the case of a settlement entered into without the prior consent of the insurer or in the case of a first-party loss, such as a purchase price overpayment loss based on a financial statement representation and warranty breach. In those types of cases, the burden on the insurer of having to prove what would have happened differently had the insured complied with the policy covenant and the amount of loss that would have thereby been avoided may simply prevent the insurer from denying or limiting coverage based solely on the policy covenant or obligation noncompliance, particularly if the insurer’s attempt to do so ends up being decided by an AAA arbitration panel, as provided for in most RWI policies.
That said, there are practical considerations an insured should take into account with respect to RWI covenant compliance, including:
Even an AAA arbitration panel may be inclined to give an RWI insurer the benefit of the doubt in the case of an inordinate delay in covenant or obligation compliance or in the case of willful or intentional noncompliance.[36]
Noncompliance by an insured with an RWI policy’s covenants or obligations may present a roadblock, or at least a speed bump, in terms of getting the insurer to act promptly and reasonably with respect to a pay-out pursuant to the policy.
Noncompliance may also exacerbate other concerns an RWI insurer may have about a claim under the policy regarding the breach, the loss, or the proximate relationship between the loss and the breach being asserted by the insured.
Conclusion
A well-crafted insured-favorable insurer prejudice provision in an RWI policy may constrain the RWI carrier’s ability to deny or limit coverage well beyond what applicable law allows in the absence of such a provision. Taken together with the obstacles upon the RWI carrier in proving actual prejudice imposed by the Falcon Steel line of cases, the hurdle for the carrier may simply be too high to overcome. However, practical considerations may weigh in favor of covenant compliance notwithstanding such a provision and the Falcon Steel line of cases.
Practice Tips for Attorneys for Insureds
Consider the following:
In the RWI policy arrangement and negotiation phase, make sure that the policy contains an insured-favorable insurer prejudice provision applicable to all of the insured’s ongoing covenants and obligations under the policy (other than the covenant to give a claim notice prior to the expiration of the policy period for such notices), and try to avoid any carve-outs and limitations on the insurer’s obligation to prove actual prejudice and the amount of loss affected thereby. Relying on applicable state law in the absence of such a provision is dicey, at best.
If the RWI policy does not contain an insurer prejudice provision, review applicable governing law for the policy to determine whether or not insurer prejudice is required and which party has the burden of proof, keeping in mind ways in which applicable law may not be analogous.
Try to avoid willful or intentional noncompliance by the insured with its RWI policy covenants and obligations.
Be cognizant of any practical considerations favoring compliance by the insured.
If the RWI carrier asserts insured noncompliance, request that the carrier identify specifically how it has been actually prejudiced by such noncompliance and the amount of loss that would have otherwise been avoided.
Be prepared to put the RWI carrier to the test of proving such actual prejudice and such amount.
Appendix
Examples of an Insured’s Ongoing Covenants and Obligations and of an Insurer Prejudice Provision
Example of an Insured’s Ongoing Covenants and Obligations
7.2 Notification
With respect to a Breach, the Insured shall deliver a Claim Notice to the Insurer, signed by an executive officer of the Insured, as soon as practicable after a Specified Person has Actual Knowledge of such Breach, taking into account Insured’s obligation in Clause 7.3.
7.3 Claim Notice contents
(i) The Claim Notice shall describe the facts and circumstances relating to the claim (including, where appropriate, specific references to the relevant Insured Obligations) in sufficient detail to allow the Insurer to assess the claim to the extent the Insured has knowledge of such facts and circumstances.
(ii) A Claim Notice shall not be invalid for failing to provide all necessary facts and circumstances and other information relating to the claim so as to enable the Insurer to assess the claim.
7.4 Late notification
With respect to any Breach, the Insurer shall not be liable for the underlying Loss nor shall the Retention be eroded unless the Claim Notice with respect to such Breach has been delivered to the Insurer:
(i) prior to the relevant Expiration Date for the applicable Breach; or
(ii) no later than 20 Business Days after the relevant Expiration Date to which the Claim Notice relates if a Specified Person first has Actual Knowledge of the Breach set out in the Claim Notice in the 20 Business Day period prior to such relevant Expiration Date.
7.7 Cooperation Clause
The Insurer, at its sole expense, shall be entitled to participate fully in the defense, negotiation and settlement of any Loss (with respect to a Third Party Demand, to the extent permitted by the terms of the Acquisition Agreement) such that the Insured Group shall (without limitation):
(i) to the extent reasonably permitted by the circumstances, not incur any Defense Costs without prior consultation with and the prior written consent of the Insurer, which consent shall not be unreasonably withheld, delayed or conditioned (provided, however, that the Insured Group may incur Defense Costs without the Insurer’s prior written consent up to USD$______);
(ii) not settle, compromise or discharge any Third Party Demand without prior consultation with and the prior written consent of the Insurer, which consent shall not be unreasonably withheld, delayed or conditioned, but, for clarity, such consent shall only be required if the amount of such settlement together with any Loss paid plus Losses alleged in any pending claims, would exceed the Retention in effect at such time;
(iii) to the extent reasonably practicable, use its reasonable and good faith efforts (subject to existing confidentiality agreements) to provide the Insurer with copies of all correspondence and documentation available in connection with the claim under this Policy and to the extent possible afford the Insurer sufficient time in which to review and comment on such documentation;
(iv) subject to existing confidentiality agreements, use its reasonable and good faith efforts to grant the Insurer access to documentation and information of the Insured Group relevant to the Loss as reasonably requested by the Insurer and grant the Insurer upon reasonable prior notice access to the Insured Group’s representatives for interviews and witness statements during normal business hours and in reasonable locations;
(v) use its reasonable and good faith efforts to keep the Insurer reasonably informed of proposed meetings with the Seller or any other relevant third party in connection with any Loss and allow the Insurer to attend such meetings where able to do so, and, subject to existing confidentiality agreements, where the Insurer so requests in writing, provide a detailed written description to the Insurer of the outcome of meetings and discussions at which the Insurer was not present;
(vi) use its reasonable and good faith efforts to conduct all negotiations and proceedings in respect of any Third Party Demand with advisers consented to by the Insurer in writing (such consent not to be unreasonably withheld, delayed or conditioned) and take such action as the Insurer may reasonably request to contest, avoid, resist, compromise or otherwise defend a Third Party Demand; and
(vii) subject to existing confidentiality agreements, use its reasonable and good faith efforts to provide the Insurer with such other information and assistance in connection with any (a) Loss, (b) Third Party Demand or (c) subrogation action per Clause 9 as the Insurer may reasonably request.
8.1 Mitigation and preservation of rights
To the extent required by applicable law, the Insured shall, and shall cause the other members of the Insured Group to, take all commercially reasonable steps to mitigate any Loss after any Specified Person has Actual Knowledge of any matter that would reasonably be expected to give rise to any Loss; provided that the Insured Group shall not be obligated to seek any recovery from the Seller. The Insured shall, and shall cause the other members of the Insured Group to, take all commercially reasonable steps to preserve all rights against any other person in respect of any Loss and to preserve the Insurer’s subrogation rights with respect thereto to the extent such subrogation rights exist hereunder. If the Insurer believes that the Insured should take any additional actions in order to comply with its obligations pursuant to this paragraph, the Insurer shall request such actions promptly in writing.
8.2 Maintenance of records
Until the later of 60 Business Days after (i) the expiration of the Policy Period or (ii) the final resolution of all claims or disputes relating to this Policy, the Insured Group shall, to the extent within their control and in accordance with their respective record retention policies, maintain all of their respective documentation and information relating to the due diligence and consummation of the transaction provided for in the Acquisition Agreement; provided that the Insured Group may destroy documents in the ordinary course of their businesses consistent with past practices and their respective record retention policies so long as such destruction is not done with the intent to harm the Insurer.
10 Other Insurance
The Insured shall or, to the extent practicable, shall cause its affiliates to maintain and/or purchase insurance coverage for the acquired business in a commercially reasonable manner. The coverage provided under this Policy shall be excess of any other valid and collectible insurance coverage with respect to any Loss resulting from the underlying facts and circumstances of any (i) Breach or matter that would reasonably be expected to give rise to a Breach, (ii) Third Party Demand and/or (iii) Loss. The Named Insured shall discuss with the Insurer, at the Insurer’s reasonable request, whether any bond, indemnity or other insurance policy is applicable or available with respect to the matters described in any Claim Notice. Notwithstanding any other provision in this Policy, any dispute as to the applicability of, or delay in obtaining coverage under, any such bond, indemnity or other insurance policy shall not be a basis for delay or refusal of payment hereunder, and the Insured Group shall not be obligated to first pursue claims against any other bond, indemnity or other insurance policy prior to being eligible for any payment under this Policy. If there is a dispute as to whether the coverage under this Policy shall be excess of other coverage or if other coverage shall be excess of the coverage under this Policy, the Insured Group may recover under this Policy, and the Insurer, to the extent allowed under applicable law, shall be subrogated to the Insured Group’s rights under the applicable other coverages.
Example of an Insurer Prejudice Provision
8.3 Failure to comply
Any failure of an Insured to comply with Clauses 7.2 (except as provided in Clause 7.4), 7.3, 7.7, 8.1, 8.2 or 10.10 shall not relieve the Insurer of its obligations under this Policy; however, the Insurer shall be entitled to reduce the amount of Loss payable under this Policy to reflect the extent (but only the extent) to which the Insurer’s position has been actually prejudiced by such failure, with the Insurer having the burden of proving such actual prejudice and such amount.
This article is the sixth in the RWI Practice Insights series by John T. Capetta.
Insurance policies, including RWI policies, typically also contain covenants and obligations of the insured in order for coverage to be put into place, often structured as conditions to the coverage’s commencing or remaining in place (such as payment of the premium). The ongoing covenants and obligations referred to in this article instead are the covenants and obligations of the insured that apply with respect to the making and pursuit of claims by the insured under the policy. ↑
This article focuses on U.S. buyer-side RWI policies and U.S. law, principally Delaware law. ↑
The parenthetical in the foregoing portion of the insurer prejudice provision—“(except as provided in Clause 7.4)”—effectively carves out claim notices not given on a timely basis in accordance with Clause 7.4 from the effects of the insurer prejudice provision (contained in Clause 8.3 in this example). An insurer may also try to carve out from the purview of Clause 8.3: (i) settlements, compromises or discharges of Third Party Demands to which it has not provided its prior consultation or consent as required by Clause 7.2; and/or (ii) willful and/or intentional noncompliance with any of an insured’s ongoing covenants and obligations under the RWI policy. ↑
For a discussion of U.S. law regarding the giving of claim notices generally, see 3 New Appleman on Insurance Law Library Edition § 16.03[1] (2024), including § 16.03[1][d][iii] regarding what constitutes insurer prejudice. ↑
Because almost all U.S. RWI policies provide for American Arbitration Association (“AAA”) arbitration of disputes, customarily at the choice of the insured, there is a dearth of U.S. case law generally regarding RWI policies. However, in Ratajczak v. Beazley Solutions Ltd., 870 F.3d 650 (7th Cir. 2017), the United States Seventh Circuit Court of Appeals, applying New York law, found that actual prejudice was not required with respect to an insured’s failure to comply with a warranty and indemnity policy’s covenant not to settle without the insurer’s consent. Id. at 656–657. A warranty and indemnity policy is the U.K. version of an RWI policy. ↑
State Farm Mut. Auto. Ins. Co. v. Johnson, 320 A.2d 345, 347 (Del. 1974) (quoting Cooper v. Gov’t Emps. Ins. Co., 237 A.2d 870 (N.J. 1968), a New Jersey Supreme Court case). ↑
Most of these motion to dismiss and motion for summary judgement cases involve the denial of the relevant motion on grounds that make the cases of little or no relevance to this article. However, in Rodriguez v. Great American Insurance Co., No. N21C-11-051, 2022 WL 591762 (Del. Super. Ct. Feb. 23, 2022), Delaware Vice Chancellor Slights (sitting as Superior Court Judge pro tempore by designation of the Chief Justice of the Delaware Supreme Court) granted the defendant director & officer (“D&O”) insurance company’s motion to dismiss, finding, among other things, that the insured target company directors had failed to satisfy their duty to defend under the applicable D&O insurance policy, and that this failure to defend in the underlying action constituted “a material breach of the [D&O] Policy that has resulted in obvious [material] prejudice to” the defendant D&O insurance company, preventing the plaintiffs (former target company stockholders) from maintaining an action for coverage against the defendant D&O insurance company. Id. at *10. Because Vice Chancellor Slights found that the breach of the policy’s duty to defend prevented coverage under the policy, he did not have to make a ruling on whether the plaintiff target company stockholders’ “notion of subrogation” permitted them to bring an action directly against the D&O insurance company. Id. at *9.
In Rodriguez, a specific provision of the applicable D&O insurance policy (the “No Action Clause”) required the insureds’ full compliance with all of the terms of the policy as a condition precedent to coverage, as to which Vice Chancellor Slights determined that, even if a showing of actual prejudice was implicitly required for coverage to be forfeited, actual prejudice had occurred based solely on the allegations set forth in the plaintiffs’ complaint. Id. at *10. Vice Chancellor Slights also found that insured target company directors had failed to comply with their obligation to obtain the D&O insurance company’s consent to any admission of liability in the underlying case, which admission resulted from the insureds’ defaulting in the underlying action. However, he did not make reference to that failure to comply with the consent obligation in finding that the No Action Clause had been triggered. Id. ↑
RWI policies are generally considered to be claims-made policies, rather than occurrence policies. However, RWI policies differ in significant ways from typical claims-made liability insurance policies, including by providing coverage for a multiyear claims period rather than a one-year claims period followed by a series of additional one-year claims periods with the same carrier or different carriers. ↑
The question of whether or not an RWI policy would be considered a contract of adhesion centers around whether or not the terms and conditions of the RWI policy were negotiated by the insured, either in the course of arranging the policy or in the case of a policy based on a previously negotiated form between the insurer and the insured (or, in some cases, by counsel to the insured for its clients), including whether the insurer or the insured prepared the first draft of the policy. For an example of a Delaware case in which a court found that the insured had been involved in the negotiation of the terms and conditions of a liability insurance policy, and therefore that the policy was not a contract of adhesion requiring insurer prejudice for potential forfeiture of coverage, see Nat’l Union Fire Ins. Co. of Pittsburgh v. Rhone-Poulenc Basic Chems. Co., No. 87C-SE-11, 1992 WL 22690 (Del. Super. Ct. Jan. 16, 1992). ↑
See Jones v. State Farm Fire & Cas. Ins. Co., 703 A.2d 644 (Del. 1997) (unpublished table decision). ↑
Id. at 518 (citations omitted). Some courts outside Delaware have also focused on the amount of insurer actual prejudice required, such as “substantial prejudice” or “appreciable prejudice.” ↑
Sutch v. State Farm Mut. Auto. Ins. Co., 672 A.2d 17, 22 (Del. 1995). ↑
Wilhelm v. Nationwide Gen. Ins. Co., No. 09C-07-155 MJB, 2011 WL 4448061, at *5 (Del. Super. Ct. May 11, 2011) (footnote omitted). ↑
Northrop Grumman Innovation Sys., Inc. v. Zurich Am. Ins. Co., No. N18C-09-210, 2021 WL 347015, at *15 (Del. Super. Ct. Feb. 2, 2021). ↑
Among other things, how an insurer can uncover sufficient information regarding actual prejudice to it and the amount of loss affected thereby from a recalcitrant insured results in a particularly daunting burden of proof for the insurer. ↑
Whether there is any substantive difference between “willful” and “intentional” for this purpose is uncertain. Definitions of “willful” often include “intentional” as a synonym or an element of the definition. However, some resources describe a difference for the term “willful” in requiring an element of “maliciousness” or the like. See, e.g., Willful, Black’s Law Dictionary (12th ed. 2024). ↑
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