Delaware Court of Chancery Examines the Garner Exception to the Attorney-Client Privilege

Posted on July 16, 2018 by - Uncategorized

Two recent decisions from the Delaware Court of Chancery offer new insight into the court’s application of an important exception to the attorney-client privilege in breach of fiduciary duty actions. The Garner exception to the attorney-client privilege, first articulated by the Fifth Circuit Court of Appeals in Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970), cert. denied, 401 U.S. 974 (1971), requires fiduciaries defending claims for breaches of fiduciary duty to produce otherwise privileged documents upon a showing of good cause by the party asserting the claims. The Supreme Court of Delaware has emphasized that the exception is “narrow, exacting, and intended to be very difficult to satisfy.” Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Trust Fund IBEW, 95 A.3d 1264, 1278 (Del. 2014). Consistent with this view, in Buttonwood Tree Value Partners, L.P. v. R.L. Polk & Co., Inc., 2018 WL 346036 (Del. Ch. Jan. 10, 2018) and Morris v. Spectra Energy Partners (DE) GP, LP, 2018 WL 2095241 (Del. Ch. May 7, 2018), the Court of Chancery found the Garner exception inapplicable while providing new guidance on its limits.

Buttonwood Tree Value Partners, L.P. v. R.L. Polk & Co., Inc.

In this case, former minority stockholders of R.L. Polk & Co., Inc. (Polk) asserted direct breach of fiduciary duty claims against the Polk family, which collectively held approximately 90 percent of Polk common stock, and against directors affiliated with the Polk family. Plaintiffs alleged that these defendants breached their duties of loyalty and care in connection with a self-tender transaction orchestrated by the Polk family. According to plaintiffs, the transaction enriched the Polk family, who afterwards received dividends amounting to one-third of the self-tender price and sold the company for three times the self-tender valuation.

Invoking the Garner exception, plaintiffs moved to compel the production of privileged documents withheld by defendants that related to the sale of the company, the self-tender, and various restructuring options under consideration at the time of the self-tender. The court explained that in evaluating whether a stockholder has established sufficient “good cause” to warrant application of the Garner exception, Delaware courts focus on three of the factors identified by the Fifth Circuit in Garner: “(1) the colorability of the claim; (2) the extent to which the communication is identified versus the extent to which the shareholders are blindly fishing; and (3) the apparent necessity or desirability of shareholders having the information and availability of it from other sources.” In its view, the first and second of these factors act as “gatekeepers” that “strain out frivolous attempts to vitiate the privilege.” The third factor, applicable only when the first two are satisfied, reflects “a balancing test to see whether the interest in discovery, or that of maintaining the privilege, is paramount.” The court noted that Garner “balances the [attorney-client] privilege’s purpose of encouraging open communication between counsel and client against the right of a stockholder to understand what advice was given to fiduciaries who are charged with breaching their duties.” (Quotations and citations omitted.)

The court found that the first factor weighed in favor of disclosure of the privileged documents at issue because the court previously held that the complaint stated claims against the Polk family and its affiliated directors for breaches of fiduciary duty, and therefore the claims were colorable. The court found that the second factor also weighed in favor of disclosure because the documents at issue, although “relatively large” in number (1,200), were tailored to plaintiffs’ allegations, and there was no indication that production of the documents would be overly burdensome.

Having found that plaintiffs “cleared the initial hurdle” imposed by the first two factors, the court turned to the third factor and found that it weighed against disclosure because the plaintiffs had not demonstrated that the information sought was unavailable from other nonprivileged sources. In so finding, the court noted that plaintiffs had yet to depose any witnesses, and there was no reason to believe that depositions would fail to reveal information about the sale of the company, the self-tender, and the restructuring options considered at the time of the self-tender. The court rejected plaintiffs’ argument that the documents at issue were necessary to prepare for the forthcoming depositions or to test the witnesses’ credibility. The court reasoned that such concerns are always present, and if the court were to adopt them as a basis to apply the Garner exception, the scope of the exception “would expand significantly, an outcome contrary to our Supreme Court’s admonition that the exception is ‘narrow, exacting, and intended to be very difficult to satisfy.’” (quoting Wal-Mart, 95 A.3d at 1278). The court emphasized that a stockholder invoking Garner must establish that they “have exhausted every available method of obtaining the information they seek.” Given that plaintiffs did not do so, the court concluded that the balancing test under the third factor “tip[ped] against disclosure of the privileged documents,” and held that the Garner exception did not apply.

Having held that plaintiffs failed to demonstrate that their motion to compel should be granted, the court found it unnecessary to decide whether Garner could apply to the direct, as opposed to derivative, claims in issue. Defendants argued that Garner applies only to derivative claims “where [the] defendant corporate actors assert the privilege on behalf of the very entity that the plaintiffs purport to represent derivatively, in which case the assertion of the privilege on behalf of the corporation and its principals may be inimical to the corporate interest.” Without deciding the issue, the court noted that the Garner exception logically applied in the context of direct claims for breach of fiduciary duty, “but that the nature of the action must be accounted for in the balance of interests that Garner requires.”

Morris v. Spectra Energy Partners (DE) GP, LP

The discovery dispute at issue in this decision arose in the context of a challenge to a transfer of certain assets of Spectra Energy Partners, LP (Spectra LP) to a principal of Spectra LP’s general partner, Spectra Energy Partners (DE) GP, LP (Spectra GP). Spectra LP’s limited partnership agreement (the LPA) eliminated common-law fiduciary duties, but required Spectra GP to act in good faith with respect to such transfers. The plaintiff, a common unitholder of Spectra LP, claimed that Spectra GP breached its duty to act in good faith by knowingly approving a transfer of assets for approximately $500 million less than the assets were purportedly worth.

The plaintiff moved to compel the production of two documents in unredacted form under the Garner exception. In a matter of first impression, the court considered whether the Garner exception applies in circumstances where a limited partnership has eliminated common-law fiduciary duties. Relying on precedent holding that the Garner exception is limited to circumstances where there is a fiduciary relationship between the party challenging the privilege and the party asserting it, the court concluded that the Garner exception does not apply when fiduciary duties are expressly disclaimed.

In so finding, the court emphasized the policy underlying the Garner exception, which rests on the “mutuality of interest” between a stockholder and a fiduciary when the fiduciary seeks legal advice in connection with actions taken or contemplated in his role as a fiduciary. In such circumstances, the court reasoned, the stockholder is “the ultimate beneficiary of legal advice sought by fiduciaries qua fiduciaries,” making it appropriate for the stockholder to view the communications reflecting the advice in certain circumstances. The court recognized that the Garner exception has been applied in situations far removed from stockholder derivative suits (i.e., actions by trust beneficiaries against the trust and trustee, and actions by creditors against a bankruptcy creditor’s committee), but a fiduciary relationship existed in these cases, establishing the requisite mutuality of interest between the parties.

Given that there was no fiduciary relationship between the plaintiff and Spectra GP under the express terms of the LPA, the court concluded that the mutuality of interest underpinning the Garner exception did not exist, and the Garner exception therefore did not apply.

Key Takeaways

Although application of the Garner exception is necessarily a fact-specific inquiry, these recent decisions offer certain key insights for litigants prosecuting or defending breach of fiduciary duty claims in the Delaware Court of Chancery:

  • Fiduciary relationship required, and contractual duties are not enough. The court’s decision in Morris makes clear that the Garner exception is unavailable where common-law fiduciary duties are disclaimed by contract and therefore no fiduciary relationship exists. The LPA in Morris replaced common-law fiduciary duties with contractual duties, and although not expressly addressed, the court’s decision appears to render Garner inapplicable to actions involving breaches of contractual duties. Therefore, even if a plaintiff asserting breaches of contractual duties could otherwise satisfy the high burden required for Garner’s application, it is unavailable in that setting.
  • Garner likely applies to direct fiduciary breach claims, but the burden of establishing good cause may be higher in that context. Although the court in Buttonwood did not decide the issue, it surmised in dicta that the Garner exception would apply to direct fiduciary duty claims as well as derivative claims. In Garner, where the claims were both direct and derivative, the Fifth Circuit noted that its decision was not dependent on whether the derivative claim was “in the case or out.” Garner, 430 F.2d at 1097 n.11. In Buttonwood, however, the court cautioned that the nature of the claim should be considered when balancing the interests inherent in the attorney-client privilege against the interests of a stockholder seeking to review privileged communications. This suggests that stockholders invoking the Garner exception in the context of direct fiduciary duty claims may face a higher burden of establishing the requisite “good cause” necessary to invoke the exception.
  • Garner does not apply if information sought is potentially available through depositions. When evaluating “the apparent necessity or desirability of shareholders having the information and availability of it from other sources,” the court will not likely find sufficient good cause to invoke Garner if the moving stockholder can obtain the information sought through depositions. Similarly, the potential usefulness of otherwise privileged documents to deposition preparation is not enough under Garner. Rather, a stockholder must exhaust other available options, consistent with the Delaware Supreme Court’s expectation that the Garner exception should “be very difficult to satisfy.”

FIFA Rules in Light of US, Canada, and Mexico Being Announced as Hosts of 2026 FIFA World Cup

Posted on June 30, 2018 by - Uncategorized

On 13 June 2018, with 134 of the 200 votes cast, the three countries of the so-called “United Bid”, Canada, Mexico and the U.S., were designated by the Congress of the Fédération Internationale de Football Association (“FIFA”) as hosts of the 2026 FIFA World Cup. This is a historical decision, not only for the three selected countries, but also because it is the first time that the host country of one of the most prestigious international soccer competitions has been designated by a vote of all the members of the governing body of soccer worldwide, i.e. by all 211 national member associations of FIFA.

The new process of selection and nomination of the host country was introduced by FIFA after the FIFA Executive Committee’s decision in December 2010 to appoint Russia and Qatar as hosts of the 2018 and 2022 World Cups, respectively, led to severe criticism, debate and investigations. The subsequent change from a secret vote by a small group of officials to a democratic and transparent voting process by the Congress has been widely welcomed. Indeed it shows an openness by FIFA to amend and improve its rules and decision-making processes.

Interestingly, FIFA has also issued new rules concerning how host countries should navigate human rights. Again, in reaction to concerns triggered by the Russia and the Qatar World Cups, FIFA issued a new Human Rights Policy in May 2017 which articulated FIFA’s statutory human rights commitment and outlined FIFA’s approach to its implementation in accordance with the UN Guiding Principles on Business and Human Rights. Such implementation in Canada, Mexico and the United States will undoubtedly be closely monitored by the Human Rights Watch organization, which has already advised FIFA in connection with World Cup bidding requirements.

Despite these recent positive developments, one should consider whether other rules governing international soccer are in need of critical analysis and substantive revision. In this regard, a top priority could be the FIFA Regulations on the Status and Transfer of Players (“RSTP”), which were issued in 2001 and, remarkably, are probably the only legal instrument existing in the world of sport that regulates, on a worldwide level, basically all issues relating to the international transfer of athletes within a particular sport. The RSTP apply as soon as a player is transferred from one country to another. Over the past 17 years, millions of players have been registered and/or transferred under the RSTP and thousands of disputes have arisen and have been dealt with, in large part by FIFA judicial organs and the Court of Arbitration for Sport, in respect of the RSTP.

However, recent developments show that the RSTP need to be reconsidered in order to address certain highly problematic issues that have emerged in international soccer. For instance, recent transfers have triggered huge fees paid to certain agents. Another recent area of concern is the tendency of some larger clubs to place a very high number of players under contract and then temporarily loan such players to other clubs. Finally, the increasing number of minor players attempting to move to other countries and register with a foreign club in the hopes of making a fortune, triggers concerns surrounding fundamental issues such as education and child abuse.

It will be interesting to observe how FIFA will work with all relevant stakeholders (soccer players, national member associations, clubs, leagues, etc.) to create a more modern and fair version of the RSTP. Such work is never easy, given often-conflicting stakeholder interests. Nevertheless, one maintains hope that a new, better version of the RSTP will soon emerge. For the good of the game.

What’s Next for Sports Betting in the U.S.?

Posted on June 27, 2018 by - Business Regulation and Regulated Industries

On May 14 of this year, the Supreme Court issued a decision that has changed the landscape of gambling in the United States. In Murphy v. NCAA, 138 S. Ct. 1461, the Court invalidated the federal law that had limited sports betting to Nevada. Since that decision, several states have passed, or are in the final stages of passing, laws authorizing wagering on sports. While the Court’s decision has unleashed pent-up enthusiasm in states for regulated sports betting, the road forward is likely to be contentious.

The Law and Its Detractors

Congress passed the Professional and Amateur Sports Protection Act (PASPA) in 1992 to address concerns that legalized sports betting would expand from Nevada to other states. Senator Bill Bradley was the driving force for proposals to ban sports betting in the U.S.  Bradley claimed that government-sanctioned sports betting undermined the more noble aspirations of sporting competitions in favor of the pursuit of gambling winnings. 

But Bradley and other proponents were unable to gather the votes needed to pass a law that would prohibit sports betting. To achieve what they thought would be the same result, they enacted a law that forbade states from passing laws that authorized or licensed sports betting. Nevada was allowed to continue to offer sports betting and New Jersey was given one year from the law’s effective date to adopt sports wagering. As it turned out, supporters of PASPA could not have been more wrong about the law being the equivalent of a federal law prohibiting sports betting.

While New Jersey failed to act within the one-year grace period, they later had a case of non-buyer’s remorse. In 2011, voters passed a constitutional amendment to allow sports betting and in 2012 the regulatory structure for sports betting was in place. But it took New Jersey six years of court battles before their attack on PASPA finally paid off.

The Supreme Court’s Ruling 

Justice Alito’s opinion for the Court left little doubt that PASPA violated the Constitution. The law’s fatal flaw was in its mandate to the states that they could not authorize or license sports betting. According to the Court, Congress lacks the constitutional authority to dictate how a state chooses to legislate. The Court ruled that Congress had unconstitutionally “commandeered” the legislative processes of states by barring them from adopting sports betting. PASPA thus violated fundamental tenets of federalism and constituted a “direct affront to state sovereignty.”

The Court also rejected the argument that the portion of PASPA directed at the states could be severed from a provision that barred private persons from operating sports books. Once the provision directed at the states was invalidated, the Court decided, the entire statutory framework of the law collapsed.

While the result itself might not have been a surprise, the emphatic repudiation of the core provision of PASPA by seven justices was remarkable. Constitutional law scholars have already begun to ponder the implications of the Court’s aggressive application of the “commandeering” principle.

States Jump In    

Flush with success, New Jersey wasted little time in parlaying its court victory. On June 14, New Jersey Governor Phil Murray placed the first legal sports bet in the state. But New Jersey was beaten to the punch by Delaware which began taking sports bets on June 5. Other states have joined the rush as well. For example, the Mississippi Gaming Commission quickly adopted regulations for sports betting based on a 2017 law permitting daily fantasy sports. Sports betting could be live there by the end of July. The West Virginia Lottery approved regulations that will likely lead to sports wagering by September 1. Rhode Island and Pennsylvania have also already legalized sports betting.

The Devil is in the Details

While other states are likely to jump on the sports betting bandwagon, the bandwagon may move forward with fits and starts. For example, New York state legislators considered sports betting proposals but adjourned June 20 without acting. New York’s experience suggests that as states undertake consideration of sports betting they will face several challenging and controversial issues.

Fees

First, the major sports leagues will continue to press the argument that they deserve to be compensated from the money that sports books collect. This argument was initially framed as an “integrity” fee. The leagues use this term because they assert they will be put to considerable expense in monitoring betting patterns to determine if there is unusual betting activity that would suggest corruption of a game. 

Alternatively, the leagues have asserted that sports books should be required to use, and pay for, official league data as the basis for determining the results of sports bets. Adam Silver, the NBA Commissioner, has put the case for compensation in even sharper relief, claiming that the leagues were entitled to royalty fees because they were “content creators.”

While the leagues have pressed the monetization issue aggressively, none of the states which have enacted sports betting provisions included fees for the leagues. A proposal in New York specified the leagues would receive one-fifth of a percent of wagers placed but, as noted, New York’s legislative bodies took no action on sports betting before adjourning. Had New York acted and included the fee, the leagues would have been emboldened to promote the fee to other states.

Taxing Sports Betting

Second, legislators will have to determine the proper tax rate for sports betting. High tax rates could severely undermine the objectives for legal, regulated sports betting. For example, Rhode Island’s staggering 51% tax of the revenues collected from sports betting, and Pennsylvania’s rate of 36%, may well backfire. Taxing at those levels will challenge even the best sports book operator to make a profit, and states with high tax rates may have difficulty attracting operators.

Sports book operators who do venture into high tax jurisdictions may have to charge more for their product by offering less favorable odds or significantly limiting bet maximums.  The high taxation discourages the migration of bettors from the unregulated (illegal) sports betting options to the regulated state platforms. The former pay no taxes, have no regulatory compliance costs, and no expensive infrastructure to maintain. This allows them to offer more attractive betting options. If one of the purposes of regulated sports betting is to drive the criminal element out of the industry, high tax rates will have exactly the opposite effect.

In setting tax rates, many legislators will be surprised when they learn that sports betting is unlikely to be a budget game-changer for states. Legislators understandably get excited when they hear claims that sports betting is a $200 billion industry in the U.S. But even if that figure is accurate, it means only that $200 billion is wagered. Sports books are low margin operations; historically, sports books in Nevada pay back approximately 95% of the money wagered to those placing winning bets. In last year’s Super Bowl, Nevada sports books won a paltry 0.7% of the money bet. While every little bit helps, the revenue generated from taxes on the $10 billion retained by the sports books is far from transformative.

Mobile Sports Betting

Third, states will need to address how sports wagers can be made.  Limiting sports betting to bricks and mortar casinos will stunt revenues from regulated sports betting. Much of the rise in Nevada’s sports wagering revenues is attributable to the availability of mobile apps that allow sports bets to be made from anywhere in the state. Whatever else can be said about the gambling preferences of millennials, requiring them to go to casinos to place sports bets, or even betting kiosks in convenience stores, will not be popular. Mississippi’s recently enacted law allows mobile betting, but requires the bettor to be present on the licensed premises. Such limitations on mobile wagering may be revisited when it becomes apparent revenues are being lost.

Indian Tribes

Fourth, legislators in states such as California, Connecticut, and Florida will have to manage issues relating to the compacts those states have with Indian tribes. These compacts often provide for the tribes to share revenues with the state in exchange for granting the tribes exclusivity in offering gambling. Renegotiation of the compacts to allow for sports betting to be offered by others will not be seamless. Tribes themselves may want in on sports wagering.

The Future

New Jersey’s ultimately successful effort to overturn PASPA was an epic struggle, and the story of how sports betting will actually be regulated in the U.S. promises to be no less riveting. The uncertainties and inefficiencies of a state-by-state model could prompt Congress to consider enacting a law with a uniform federal template that states would be required to use for sports betting. States would stoutly resist such legislation, and Congress would need to show an unusual level of resolve to overcome that opposition. In any event, the next year will present a dynamic and fluid environment for regulated sports wagering in the U.S. to exhibit its nascent presence in the gambling world.

CFPB Re-Examination of Disparate Impact and ECOA

Posted on June 15, 2018 by - Business Regulation and Regulated Industries

The Consumer Financial Protection Bureau’s (“CFPB”) Acting Director, Mick Mulvaney, recently announced that the CFPB will re-examine its position on disparate impact liability under the Equal Credit Opportunity Act (“ECOA”). Based on recent federal developments that reflect a trend of repudiating Obama-era financial reform and limiting the regulatory discretion of the CFPB, the end of disparate impact enforcement by the CFPB seems likely. 

The disparate impact doctrine establishes liability for a facially neutral policy or practice that results in a discriminatory effect, even absent a discriminatory intent. Since the inception of the agency, the CFPB has relied heavily on the disparate impact doctrine in its fair lending enforcement. In an April 2012 Bulletin entitled “Lending Discrimination,” the CFPB “reaffirm[ed that] the legal doctrine of disparate impact remains applicable as the Bureau exercises its supervision and enforcement authority to enforce compliance with ECOA and Regulation B.” A March 2013 Bulletin entitled “Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act” reiterated that the CFPB would apply a disparate impact analysis and provided guidance on how indirect motor vehicle lenders could avoid disparate impact violations of ECOA and Regulation B. 

These actions were not without controversy. In December 2017, the Government Accountability Office (“GAO”) concluded that, although the 2013 CFPB Bulletin was not a formal regulation, it still was a “rule” subject to the Congressional Review Act of 1996 (“CRA”). This determination greatly increased congressional oversight of the CFPB, as the CRA allows Congress to effectively veto rules issued by federal agencies. Agencies must submit rules subject to the CRA to Congress after they have been finalized but before they take effect. After submission, Congress has 60 legislative days to approve or veto the rule.  The GAO’s conclusion effectively prohibited the CFPB from unilaterally issuing guidance that serves as de facto regulation for anyone subject to CFPB supervision or enforcement.

On May 21, 2018, Congress officially repealed the CFPB’s March 2013 Bulletin through a CRA resolution signed by the President. In a contemporaneous press release, Acting Director Mick Mulvaney stated that the CFPB also will re-examine its use of disparate impact for ECOA enforcement. Mulvaney thanked the President and Congress for “reaffirming that the Bureau lacks the power to act outside of federal statutes” and noted that “[a]s an executive agency, we are bound to enforce the law as written, not as we may wish it to be.” Mulvaney indicated that the Supreme Court’s 2015 decision in Texas Department of Housing and Community Affairs v. The Inclusive Communities Project influenced the decision to re-examine the CFPB’s position on disparate impact. Mulvaney’s announcement followed the Department of Housing and Urban Development’s decision to seek public comment on whether its Disparate Impact Regulation, which it applies to the Fair Housing Act (“FHA”), is consistent with the Inclusive Communities decision.

In Inclusive Communities, the Court held in a 5-4 decision that the FHA recognizes a disparate-impact theory. However, the Court did not extend the application of the disparate impact doctrine to ECOA, and the Court’s analysis strongly suggests that disparate impact would not apply to ECOA. It is likely that the CFPB will look towards the analysis in Inclusive Communities to determine if it will apply disparate impact to ECOA.

The Court’s decision in Inclusive Communities relied heavily on specific language in the FHA that the court found imputed disparate impact liability. The Court noted that, in addition to the FHA, Title VII of the Civil Rights Act of 1964 and the Age Discrimination in Employment Act (ADEA) recognize the disparate-impact doctrine. The Court found that Title VII, the ADEA, and the FHA all have “operative text” that looks at results of a policy or practice, as opposed to the intent.  ECOA does not seem to have equivalent language. 

The Court also noted that from the time the FHA was enacted to when it was amended, “all nine Courts of Appeals to have addressed the question had concluded the Fair Housing Act encompassed disparate-impact claims.” The Court found the fact that Congress amended the FHA, but still retained the relevant statutory text, indicated that Congress intended for disparate impact to apply. The Court also found that exemptions to liability under FHA, which address the role of property appraisals, drug convictions, and occupancy restrictions, arguably presupposed the application of disparate impact under the FHA. There is likely no similar evidence of legislative intent to apply disparate impact to ECOA.

The Court also found that disparate impact liability was consistent with the “statutory purpose” of the FHA. There is a strong possibility that a court would find that disparate-impact liability was consistent with the statutory purpose of ECOA, an anti-discrimination law. However, it is unlikely that the general intent of the law would be dispositive over statutory language and, arguably, evidenced legislative intent.

Based on Inclusive Communities and policy goals of this presidential administration, it seems likely that the days of CFPB using the disparate impact doctrine to enforce ECOA may be over.

Dodd-Frank Rollback Law Includes Increased Flexibility for Growth Companies and Venture Funds

Posted on June 15, 2018 by - Securities

On May 24, 2018, President Trump signed into law a broad rollback of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In addition to a number of changes applicable specifically to financial institutions, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act) contains a number of reforms to federal securities laws and regulations that will affect privately held, high-growth companies; venture capital funds; and public reporting companies, including:

  • Rule 701: Directs the U.S. Securities and Exchange Commission (SEC) to raise the threshold amount that triggers mandatory increased issuer disclosure for issuances of securities under a compensatory benefit plan in reliance on Rule 701 from $5 million to $10 million in any 12-month period.
  • Investment Company Act of 1940 (1940 Act): Exempts from investment company status certain venture capital funds that have no more than 250 investors and no more than $10 million in aggregate capital contributions and uncalled committed capital.
  • Regulation A: Directs the SEC to permit public reporting companies: (a) to make exempt offerings under Regulation A; and (b) to satisfy the periodic and current reporting requirements for Regulation A Tier 2 offerings by meeting the reporting requirements of section 13 of the Securities Exchange Act of 1934 (Exchange Act).

Although mandated under the law, the reforms to Rule 701 and Regulation A are not immediate. The changes are required to be made by the SEC within 60 days of adoption of the Act, and the SEC already has a substantial rulemaking docket in process. Accordingly, the revisions may not be effective for several months.

Rule 701—Increased Minimum Value to Trigger Enhanced Disclosure

The Act directs the SEC to increase the amount of securities that a private company may offer and sell under employee benefit plans before enhanced disclosure by that company is triggered. The Act increases the threshold amount for enhanced disclosure from $5 million to $10 million over a 12-month period. Rule 701 is an exemption to the registration requirements of the Securities Act of 1933 (the Securities Act) that allows private companies to issue securities under employee benefit plans, including options, restricted stock, and restricted stock units. Rule 701 has an overall limitation on use based on the value of the awards at the time of issuance in any 12-month period not exceeding the greater of: (i) $1 million; (ii) 15 percent of the issuer’s total assets; and (iii) 15 percent of the issuer’s total class of equity offered, in each case measured as of its last balance sheet date. As a result, Rule 701 generally is flexible with the size of the issuer.

In addition, Rule 701 currently includes an enhanced disclosure requirement by an issuer if, in any 12-month period, the issuer awards more than $5 million in securities in the aggregate in reliance on Rule 701. If the enhanced disclosure threshold is exceeded, issuers must provide all recipients of securities issued under Rule 701 with various and potentially onerous required disclosures, including risk factors associated with investing in the issuer’s securities and GAAP-compliant financial statements that are no more than 180 days old. The issuer must give this information to each participant (including participants who received an award before the threshold was exceeded) within a reasonable period of time before the date of sale. The date of sale in some cases may be at the time of grant (for example, RSUs and restricted stock).

The Act directs the SEC to raise the 12-month threshold for enhanced disclosure to $10 million from $5 million. In addition, it provides that the SEC must also include a provision to adjust the threshold for inflation every five years.

Key takeaways: Private companies that issue stock options and other securities to employees, consultants, directors, and other stakeholders should continue to monitor their compliance with Rule 701. As companies remain private for longer periods of time and valuations increase, they have been much more likely to reach the current $5 million disclosure threshold in a 12-month period in recent years. At the same time, the SEC’s enforcement staff recently has demonstrated an increased interest in Rule 701 and has begun imposing civil penalties for failure to comply with Rule 701’s disclosure requirements. Until the SEC rulemaking for Rule 701 is complete, issuers who are nearing the $5 million disclosure threshold should consult their attorneys to discuss strategies for managing Rule 701 securities offerings and any required disclosures. However, some issuers may want to consider delaying certain grants to later dates when the $10 million disclosure threshold becomes available (hopefully in the coming months) to avoid triggering the enhanced disclosure requirements.

1940 Act—Expanded Exemption for Venture Capital Funds

The Act also amends section 3(c)(1) of the 1940 Act to permit certain funds to accept more than the prior limit of 100 investors without being required to register as an investment company, which provides significantly more potential capital fundraising flexibility to venture capital funds that rely on section 3(c)(1). Having an applicable exemption under the 1940 Act is critical for venture fund sponsors to avoid registration requirements that would make the operation of typical venture funds financially impractical. Previously, section 3(c)(1) exempted any fund from the definition of an investment company under the 1940 Act if it was beneficially owned by no more than 100 persons and did not make a public offering of its securities. The new amendments allow a venture capital fund relying on section 3(c)(1) to accept up to 250 investors instead, so long as the fund: (i) has at all times less than $10 million in aggregate capital contributions and uncalled committed capital; and (ii) meets the definition of a “venture capital fund,” which is defined through a cross reference to Rule 203(l)-1 under the Investment Advisers Act of 1940 (the Advisers Act).[1] The $10 million limit will be adjusted every five years to account for inflation.

Key takeaways: Section 3(c)(1)’s 100-investor limit previously was the most significant regulatory factor limiting the size of venture funds that are not able to rely on section 3(c)(7)—the other 1940 Act exemption most relied upon by venture funds. Section 3(c)(7) similarly exempts funds from the definition of an investment company that do not make public offerings, and unlike section 3(c)(1), includes no limitation on the number of investors. In exchange, however, it requires that all investors be “qualified purchasers” (generally, individuals with at least $5 million in investments and entities with $25 million). Many fund managers with funds running up against the 100-investor limitation under section 3(c)(1) simultaneously form a parallel, side-by-side fund that individually relies on section 3(c)(7) to increase the amount of investor capital they can accept. For funds raising $10 million or less in capital, the new amendments may reduce the need for such side-by-side structures and/or may increase the capital raised that otherwise would be left on the table for regulatory purposes in any structure involving a fund that relies on section 3(c)(1).

Venture fund sponsors should note that there is no safe harbor or exception in the event that a venture capital fund initially intending to rely on the amended 250-investor limitation subsequently accepts more than $10 million in capital commitments if at that time the fund has more than 100 investors. In addition, based on the plain language of the amendment, fund sponsors should be aware that the standard “general partner” capital commitment may be included within this $10 million limitation. Accordingly, fund sponsors should take care and be deliberate in monitoring their fundraising activities and closings if they intend to rely on the exemption as amended.

Regulation A—Exemption for Public Reporting Companies

Finally, the Act directs the SEC to permit reporting companies to take advantage of the Regulation A exemption for securities offerings and to satisfy the periodic and current reporting requirements for Regulation A Tier 2 offerings by meeting the reporting requirements of section 13 of the Exchange Act. Often referred to as “mini-public offerings,” Regulation A offerings are exempt from securities registration requirements and can be made to the general public, but the issuer must prepare abbreviated disclosure filings that are subject to SEC review and comment. There are two tiers of Regulation A offerings. Tier 1 offerings may not raise more than $20 million in a 12-month period but require less disclosure. Tier 2 offerings may raise up to $50 million in a 12-month period but require issuers to satisfy ongoing, periodic reporting obligations. In addition, Tier 2 offerings preempt state securities registration requirements, although states may still require notice filings, consents to service of process, and filing fees.

Currently, reporting companies cannot issue securities under Regulation A. Once Regulation A is revised, reporting companies will be able to make Regulation A offerings, and reporting companies making Tier 2 offerings will be deemed to have satisfied the periodic disclosure requirements if they have satisfied their Exchange Act periodic disclosure obligations.

Key takeaways: The mandated changes to Regulation A will primarily benefit small public companies. Many small public companies that do not qualify as well-known seasoned issuers may be ineligible to take advantage of the streamlined Form S-3ASR for seasoned offerings. Although registered offerings on Form S-1 can involve a lengthy and expensive drafting and SEC comment process, the disclosures required under Regulation A can be abbreviated and less costly. In addition, reporting companies that do not trade on national exchanges must comply with state securities registration requirements. By making Tier 2 offerings, these companies will be able to avoid the complexity and cost of complying with blue sky laws for every state in which purchasers reside. However, because Tier 1 Regulation A offerings may not exceed $20 million in a 12-month period, and Tier 2 Regulation A offerings may not exceed $50 million in a 12-month period, with further restrictions for selling stockholders, it remains unclear whether this additional flexibility will be of substantial practical benefit for many companies given the alternative of Form S-3.

[1]      This cross reference harmonizes the amendment with the exemption from registration under the Advisers Act that is commonly relied upon by many venture fund managers. Rule 203(l)-1 under the Advisers Act defines a “venture capital fund” to generally include private funds that meet specific conditions. These conditions include representing to investors that the private fund pursues a venture capital strategy, holding 80 percent or more of the fund’s aggregate capital contributions and uncalled committed capital in certain “qualifying investments,” conforming to specific limitations regarding the amount and types of leverage they can take on, and placing significant limitations on the ability of investors to redeem their interests. For these purposes, “qualifying investments” generally include equity securities issued by and acquired from operating companies that, among other things, are not reporting companies or foreign traded.

MHS Capital LLC v. Goggin: Reviewing Fiduciary Duty and Exculpation Provisions in Limited Liability Company Agreements

Posted on June 15, 2018 by - Uncategorized

In MHS Capital LLC v. Goggin, the Delaware Chancery Court, in addressing claims for breach of contract and breach of fiduciary duty, provided guidance to members and managers of limited liability companies (LLCs) and their counsel regarding issues to consider when negotiating and adopting fiduciary duty modifications and exculpatory provisions in limited liability company agreements.

Background

In Goggin, a member of East Coast Miner LLC (ECM) brought suit against ECM’s manager and his associates challenging several allegedly self-dealing transactions. The plaintiff alleged, among other things, that ECM’s manager had caused ECM’s part ownership of specified assets to be diverted to different entities that the manager and his associates owned and controlled. The assets in question were subject to a lien that ECM held against a bankrupt entity. Pursuant to the lien, ECM had the right to credit bid on the secured assets in a bankruptcy auction. The plaintiff alleged that ECM’s manager had arranged for the bankruptcy court’s order to transfer the assets to a consortium of entities, all the members of which, other than ECM, were allegedly owned and controlled by ECM’s manager and his associates. The plaintiff brought series of claims against ECM’s manager, including claims for breach of ECM’s LLC agreement and breach of fiduciary duty.

ECM’s manager moved to dismiss, arguing that the provisions of ECM’s LLC agreement operated to preclude any recovery of monetary damages, and that any award of equitable relief was precluded by the bankruptcy court’s order with respect to the asset transfer. In analyzing the claims, the Delaware Chancery Court noted that two provisions of ECM’s LLC agreement were particularly relevant. First, it contained provisions specifying the standard of conduct applicable to the manager, dispensing with traditional fiduciary duties and replacing them with a provision obligating the manager to “discharge his duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” Second, it contained a broad exculpatory clause providing that “[t]he Manager shall not be liable to [ECM] or any Member [of ECM] for monetary damages for breach of such person’s duty as a Manager, except as otherwise required under the [LLC] Act.”

The Breach of Contract Claims

On the record before it, at the motion to dismiss stage, the Delaware Chancery Court assumed that the conduct of ECM’s manager challenged in the complaint constituted a breach of the LLC agreement’s contractual standard of conduct. The key question, in view of the breadth of the LLC agreement’s exculpatory clause, was whether plaintiff had stated a breach of contract claim for which relief could be granted. Given that the exculpatory clause broadly eliminated claims for monetary damages, the court principally considered whether an award of equitable relief could be granted and, if so, whether any such award would conflict with the bankruptcy court order. That order specified that the purchasers in the bankruptcy sale would take title to the underlying assets free and clear of encumbrances, and that persons holding claims would be enjoined from asserting those claims against the purchasers with respect to the assets.

Ruling on the motion to dismiss, the Delaware Chancery Court found that its “‘broad discretionary power to fashion appropriate equitable relief,’” as well as its ability to “‘depart from strict application of the ordinary forms of relief where circumstances require,’” would potentially allow it to craft an equitable remedy. The Delaware Chancery Court noted that so long as the plaintiff stated a claim for which relief could be granted, its claim would survive defendant’s motion to dismiss, regardless of the nature of the exact relief that would ultimately be granted. By way of illustration, the court cited precedent where it had “declined to dismiss an otherwise well-pled claim for promissory or equitable estoppel that rested on a request for rescission which may have been ‘impossible’ to grant,” on the basis that, in light of its broad equitable powers, “it did not need to evaluate the effect of any remedial order at the pleading stage.” Without speculating as to any specific type of relief (or its viability), the court noted that “it may be possible” to grant equitable relief that would not run afoul of the bankruptcy court’s order. That analysis, however, involved “a fact-intensive question” not capable of resolution at the motion to dismiss stage.

The Breach of Fiduciary Duty Claims

The Delaware Chancery Court next addressed the defendant’s motion to dismiss the plaintiff’s claims for breach of fiduciary duty. It reviewed the nature of the fiduciary duty claims—including the allegations that the defendant failed to act in the best interests of ECM by usurping opportunities belonging to ECM—and held that they were duplicative of the plaintiff’s claim for breach of contract. Noting that “Delaware law is clear that fiduciary duty claims may not proceed in tandem with breach of contract claims absent an ‘independent basis for the fiduciary duty claims apart from the contractual claims,’” the Delaware Chancery Court dismissed plaintiff’s fiduciary duty claims, noting that in order for a breach of fiduciary duty claim to proceed simultaneously with a breach of contract claim, the former would have to “depend on additional facts,” be “broader in scope, and involve different considerations in terms of a potential remedy.’” In the present case, all of the conduct that could have been the subject of a breach of fiduciary duty claim was already the subject of plaintiff’s breach of contract claim—and was being reviewed under the contractual standard. Moreover, the plaintiff was seeking the same remedy for both claims.

Practical Observations

As the Delaware Chancery Court in Goggin indicated, section 18-1101(c) of the Delaware Limited Liability Company Act (the LLC Act) provides members and managers with broad authority to expand, restrict, or eliminate duties (including fiduciary duties) pursuant to an LLC agreement, subject to the implied covenant of good faith and fair dealing. In addition, section 18-1101(e) of the LLC Act provides that an LLC agreement may eliminate or limit the liability of members or managers for breach of contract and breach of duty, including any fiduciary duty, except for bad faith violations of the implied contractual covenant of good faith and fair dealing. The Delaware Chancery Court’s opinion in Goggin serves as an important reminder that fiduciary duty modifications and exculpatory provisions must be considered together, and must be carefully crafted to ensure that in the event of a dispute, they will operate as the parties intended.

Although not expressly addressed in the opinion, several important observations emerge from a review of Goggin. First, the Delaware courts will apply and respect contractual modifications that supplant traditional fiduciary duties of care and loyalty. Parties seeking to modify fiduciary duties, however, should make their desire to override fiduciary duties clear, and they should carefully consider the scope of the duties, if any, that will be used in lieu of the traditional duties of care and loyalty. To that end, parties seeking to pare back fiduciary duties should ensure that the language deployed to that end does not effectively build back traditional duties by contract.

Next, once the scope of duties has been identified, parties should consider the circumstances under which members or managers may be held liable for falling short of the standard of conduct. The LLC Act’s authorization of provisions that exculpate members and managers from liability in a broad range of circumstances contrasts sharply with the Delaware General Corporation Law’s (the DGCL) relatively limited authorization of exculpation. Section 102(b)(7) of the DGCL, which deals with exculpation, only permits a corporation, through its certificate of incorporation, to exculpate its directors (not officers) against liability to the corporation or its stockholders for monetary damages for breaches of the duty of care. (Section 102(b)(7) specifically disallows exculpation for any breach of the duty of loyalty as well as for unlawful dividends and stock redemptions and repurchases, acts not in good faith or involving intentional misconduct, or a knowing violation of law or transactions from which a director derives an improper personal benefit.)

Although certificates of incorporation of Delaware corporations routinely provide for exculpation of directors to the fullest extent permitted by the DGCL, LLC agreements are more likely to contain bespoke provisions regarding the exposure of managers and members to liability for breach of contractual or fiduciary duties. Many LLC agreements, for example, will preclude exculpation for damages stemming from specified types of conduct, such as bad faith or willful misconduct. Some agreements, however, will decline to exculpate members or managers for losses resulting from their own gross negligence. See, for example, LLCs, Partnerships, Unincorporated Entities Committee, Single-Member LLC Entity Member Form. Although claims for gross negligence may be difficult to plead, prior decisions of the Delaware courts indicate that successfully pleading such claims may not be as challenging as one might expect. See William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law (observing that the Delaware Supreme Court, in two cases following its adoption of a standard of review requiring plaintiffs to plead gross negligence in order to state a claim for a breach of the duty of care, “purport[ed] to apply the gross negligence standard of review [but] in reality applied an ordinary negligence standard”). Indeed, the exposure of directors to liability for action taken in good faith under this pleading standard prompted the adoption of section 102(b)(7) of the DGCL. See generally 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations § 4.13[B], at 4-99 (3d ed. 2018 Supp.). Accordingly, managers of LLCs who are not entitled to exculpation for conduct that is grossly negligent run a substantial risk of liability for breach of the duty of care (or any analogous contractual duty) in connection with action otherwise taken in good faith. Indeed, managers of an LLC in that scenario may be afforded less protection against claims based on the duty of care than the directors of nearly every Delaware corporation. Even more problematic from the standpoint of a manager is the circumstance in which the LLC agreement establishes an “ordinary negligence” standard of care but fails to provide that the manager is exculpated for monetary liability for breaches of duty.

Conclusion

Given the contractual freedom provided by the LLC Act, there are numerous potential formulations of the standards of conduct of members and managers and of the circumstances under which they will (or will not) be exculpated from liability against breach. Members and managers and their counsel must consider the interplay between the standards of conduct (whether stemming from default fiduciary duties or contractually specified analogues) and the nature and scope of any clauses exculpating members and managers for breach of duty to ensure that the parties achieve the desired balance of incenting (or not unduly discouraging) value-maximizing risk-taking on the one hand, and providing means of policing and enforcing specified classes and categories of misconduct on the other.

Why Destruction of Information Is So Difficult and So Essential: The Case for Defensible Disposal

Posted on June 15, 2018 by - Uncategorized

The information universe is expanding in truly mind-numbing ways. There is a new exabyte of data created every few hours across the globe. (One exabyte of data is the equivalent of 50,000 years of continuous movies.) That Mount-Everest-sized pile of information is replicated many times every day and continues to grow faster and faster. Big companies typically have millions or billions of files stored in multiple locations, including third-party-owned Clouds. For many companies, that means they can’t keep all their information forever because they are collapsing under its weight. So why are companies hard-pressed to clean house of unneeded information?

Companies historically had records-management programs so that they could manage records and properly dispose of them in accordance with the company retention policy at some future date. At the time, making retention rules work meant that employees had to apply the rules to their records. That was simple when each employee boxed their paper records annually and applied a retention rule to each box. However, having employees apply business rules to millions or billions of files from various systems is like drinking from a firehose through a straw. In other words, cleaning house according to the retention schedule applied to each record one by one for most businesses is no longer doable.

The current business environment is like information’s “perfect storm”—more data in more formats and systems with less visibility into what information assets exist, more laws directing how it must be managed, more consequences for mismanagement, and more challenges in managing it according to old company rules with much of it floating in a Cloud.

Why Does Information Just Pile Up?

Companies relied for years on paper and electronic information, sometimes duplicating each other over and over. Although electronic information legally is on par with its paper counterparts for almost all purposes, lawyers fallaciously believed paper was the “best evidence,” and thus the two piles grew even though paper printouts of electronic records could be legally destroyed.

Today, much of the growth in information volumes comes from communications, social media, and collaboration technologies the output of which may not rise to the level of a company record. Thus, the pile grows further with information that may be “nonrecord,” which need not be retained to satisfy legal or business needs.

While litigants began to focus on electronic information for discovery purposes, sometimes company lawyers over-preserved information so as not to worry about its destruction during the pendency of a matter. What that set in motion was everything, even information ready for destruction pursuant to the retention rules, continuing to be preserved. Wide-sweeping legal holds that took precedence over retention rules stopped the proper destruction of records in the ordinary course of business according to company policy. Thus, the pile grew larger still because employees couldn’t classify and/or manage the growing amount of information, given that the sheer volume of files, documents, and e-mail became overwhelming.

Compounding matters, there was a need to manage information according to other information-related policy regimes, like information security, privacy, attorney-client privilege, etc., which often impacted the same information. Further compounding the problem was that information classification couldn’t be easily accomplished given limited functionality in most technology unless information was being purposefully stored in document and records-management applications. In other words, if employees were so inclined (and they generally weren’t), most technology in use didn’t allow for such compliance rules to be easily applied or applied at all. Thus, the pile grew.

The fallacious belief that storage is cheap further impacted storage growth. Although storage costs per terabyte are decreasing a few percentage points, any cost savings are dwarfed by company information footprints doubling every year or two, and with storage costs between $5–$10 million per year, per petabyte, storage costs are now huge for companies with big information footprints. Thus, the pile grew larger.

Then Big Data happened. Big Data is not about large piles of information. It’s about using analytics or artificial intelligence (AI) software to crawl through large piles of information to answer a business question. Suddenly there was even less pressure to clean house. Business folks want more information for longer periods of time to run queries and see what they learn from a business perspective.

In 2018 the tide seems to be turning in that less information may be retained given significant compliance events. First, with endless information security and privacy failures, companies realize their risk profile declines with smaller information footprints, which can be accomplished by keeping less and for a shorter period. As Jeff Stone, et. al put it in a May 29, 2018 article in the Wall Street Journal:

Cybersecurity threats are relentless, they’re getting stronger and they are coming from more directions than ever . . . more, the consequences of a breach can be disastrous, with staggering losses of customer data and corporate secrets—followed by huge costs to strengthen security, as well as the threat of regulatory scrutiny and lawsuits.

Further, the EU’s General Data Protection Regulation (GDPR) became law and is forcing companies to rethink what information they keep and for how long because GDPR requires it.

What Is Defensible Disposition and How Will It Help?

A solution to the unmitigated data sprawl is to “defensibly dispose” the business content that no longer has business or legal value to the organization. Defensible disposition is a way to take on piles of information without employees classifying .

To apply a retention rule to large chunks of information to make a business decision to dispose of it requires different diligence depending upon the content; thus, there is no one-size-fits-all approach to defensible disposition. In some cases, a software analytics tool may need to crawl the contents looking for specific terms, and in others, knowing the age of the information pile, the business unit that created it, the lack of active litigation, and so on might be enough to purge the entire contents without looking at each file. Having worked with so many companies cleaning up stored information, determining the amount of diligence needed in analyzing information piles to make a company comfortable to purge is rather variable.

In any event, lawyers’ input will be essential to help define a reasonable diligence process to assess the legal requirements for continued information retention and/or preservation, based on the information at issue. Thereafter, lawyers can also help select a practical information assessment and/or classification approach, given information volumes, available resources, and risk profile.

Does Litigation Profile Matter?

A good time to clean up outdated information is when there are fewer legal or compliance issues that require continued preservation of information. Disposing of information when no litigation or government investigations or audits exist is less risky. Otherwise, before information can be purged, the company must conduct sufficient diligence to ensure that nothing is destroyed that will give rise to a spoliation claim. That, of course, begs the questions of how diligence will be performed when it’s impractical to review millions or billions of files or documents.

Can Technology Help?

There are all kinds of analytics and classification technologies that can help analyze information and may help with defensible disposition; however, having used these technologies for years to help companies deal with dead data, the expense and/or complexity should not be underestimated. Putting aside cost, these technologies are better and faster than employees at classifying information. As Maura R Grossman, JD, Ph.D., et. al described in the Richmond Journal of Law and Technology, “[t]his work presents evidence supporting the contrary position: that a technology-assisted process, in which only a small fraction of the document collection is ever examined by humans, can yield higher recall and/or precision than an exhaustive manual review process, in which the entire document collection is examined and coded by humans.”

Studies and courts make clear that when appropriate, companies should not fear using technologies to help manage information. For example, in Moore v. Publicis Groupe, Judge Andrew Peck made clear in the discovery context that “[c]omputer-assisted review appears to be better than the available alternatives, and thus should be used in appropriate cases . . ounsel no longer have to worry about being the “first” or “guinea pig” for judicial acceptance of computer assisted review.”

Can I Clean House with Methodology Alone?

If information has piled up and you don’t think it makes sense to crawl it for records or preservation obligations, then there are other ways to get rid of content.

For example, if your company has 100,000 back-up tapes from 20 years ago, minimal review might be required before the whole lot of tapes can be comfortably disposed. On the other hand, if you have an active shared drive with records and information that is needed for ongoing litigation, there must be deeper analysis with analytics and/or classification technologies. In other words, the facts surrounding the information will help inform whether the information can be properly disposed with minimal analysis or whether it requires deep diligence.

Conclusion

Defensible disposition is needed like never before, given that information is growing unfettered for most businesses and impacting their ability to function. In addition, a bloated information footprint further increases a business’s privacy and information security risk profile. Although there are many reasons why retention is no longer happening as it used to, what is clear is that keeping everything forever is not without great costs or risks that must be addressed. In the end, lawyers must find a way to get rid of information without creating greater business and legal issues for their clients. Without their guidance, no one will destroy data, and it will continue to overwhelm.

Gagosian Gallery Faces Two Lawsuits Over Non-Delivery of Koons Statues

Posted on June 15, 2018 by - Uncategorized

There is a very tiny world out there in which people pay millions of dollars in advance payments for “factory-manufactured” balloon animal stainless steel sculptures—some in the shape of Greek and Roman goddesses—only to be told by “sales and contract performance drones” that there would be years of delay due to “the high volume of data” from “numerous scans of balloons,” along with technical difficulties in “reverse engineering” and “Computer-Aided Design processes (known as ‘CAD’).” This world—rich, strange— is detailed in Steven Tananbaum’s filed on April 19 in New York County court against the Gagosian Gallery and artist Jeff Koons. Eight days later, on April 27, Hollywood producer Joel Silver filed a similar referencing Tananbaum’s complaint.

Tananbaum alleges breach of contract and violations of New York UCC §2-609 (Right to adequate assurances) and Article 15 of New York’s Arts and Cultural Affairs Law, specifically   which is meant to protect art buyers of sculptures. According to Tananbaum, the world of Gagosian features “unadorned avarice and conspiratorial actions in connection with factory-manufactured industrial products called Jeff Koons sculptures,” all run by a “well-oiled machine” that “exploit[s] art collectors’ desire to own Jeff Koons sculptures.” And underneath it all lies a “fraudulent financial routine that harkens the name Ponzi.”

Gagosian Gallery is the largest art gallery in the world, a complex economic and cultural entity whose workings are central to the complaints. There are 16 locations globally and several hundred employees. It has its own private planes. Art galleries can purchase art directly from the artist and represent them to the public (i.e. primary market) or they can purchase art from entities other than the artist (i.e. secondary market): Gagsosian Gallery does it all. It represents living artists, artists’ estates and resells secondary market art. It clears about $1 billion in art sales each year while publishing about 40 books annually. When representing an artist, it is in the best interest of Gagosian, like any art gallery, to create buzz around the artist’s work; one way to create buzz and to sell to the global market is by attending art fairs. In 2000, there were 55 major art fairs around the world. Last year there were 260. A booth at Frieze art fair in New York City might cost $125,000 to rent for a weekend. With added on-site handling costs to build out the booth and shipping and handling costs of the art itself, a large gallery may need to sell hundreds of thousands of dollars of art just to break even.

Jeff Koons is the most commercially successful artist of all time; he has managed to create intrigue and interest for his balloon animal sculptures. In 2012, Koons’ stainless steel Tulips sold at Christie’s for $33,700,000.00—this was a record high for Koons, and the second highest auction price ever recorded for a living artist. Only one year later, in November 2013, his Balloon Dog (Orange) sculpture, which is a stainless-steel sculpture in the shape of a balloon animal that stands 121 inches tall, sold at Christie’s for a realized price of $58.4 million and became the record price at auction for a work of art by a living artist. Bottom line: Jeff Koons’ auction price high went from $33.7 million to $58.4 million in a single year.

The demand for Koons’ balloon animal sculptures has only increased. Last year, rapper and businessman Jay Z commissioned a 40-foot balloon dog from Koons to be on stage with him at the V-Festival in Weston Park, England. Koons has entered commercial deals with Google to design phone cases inspired by his Gazing Ball series, which involve generic classical Greek sculptures of plaster with a shiny blue glass sphere attached. Last year, with much fanfare, Louis Vuitton released a line of handbags designed by Koons called the “Masters Collection.” Each handbag was covered in one of a series of paintings by artists such as Rubens, Da Vinci, or Van Gogh; they could easily be mistaken for a bag at any museum gift shop.  They were priced at around $4000 and bore the LV monogram in one corner and a Koons monogram in another. This October, Louis Vuitton will release a second line of “Masters” designed by Koons—they feature the same concept, only with paintings of different artists like Turner and Monet. As Tananbaum’s complaint alleges, this is the commercial world of Jeff Koons and the gatekeeper is Gagosian Gallery.

In September 2013, Steven Tananbaum agreed to purchase Balloon Venus Hohlen Fels (Magenta) for $8 million from Gagosian Gallery with an estimated completion date of December 2015 and paid a deposit of $1.6 million. A few months later in early 2014, Joel Silver agreed to purchase Balloon Venus (Yellow) from Gagosian Gallery for $8 million with an estimated completion date of June 2017 and made a deposit of $1,600,000.00. In 2014 and early 2015, Tananbaum made additional payments totaling $3.2 million and Silver made additional payments totaling $2.2 million.  

In 2015 and 2016, both Tananbaum and Silver were periodically informed that the completion dates for their works would be pushed back a few months; later, they were informed the art would be delayed two years. During this time, Tananbaum made his third payment of $1.6 million and Silver did not make his two scheduled payments.

Then, despite the delayed delivery of the previous piece, in December 2016, Tananbaum agreed to purchase two more stainless steel balloon sculptures by Koons: Eros for $6 million with an estimated completion date of January 2019 and Diana (edition 3 of 3, an edition being part of a limited-run series) for $8.5 million with an estimated completion date of August 2019.Tananbaum made an additional deposit of $1.2 million for Eros. Regarding the Diana series, in January 2017, Gagosian gave Tananbaum an option to cancel after review of the first edition of Diana (which had a completion date of October 2018), and Tananbaum paid a deposit of $2.125 million for the third edition of Diana.

In January 2017, after learning that the completion date had been pushed back another two years to July 2019, Silver attempted to cancel the purchase and requested a refund. Gagosian counsel informed Silver that any more missed payments would result in a forfeit of payments already made. A was subsequently signed by Gagosian, Silver, and Koons. It included a new payment schedule for the remaining $4.8 million owed and a new completion date of December 2020.

By January 2018, Tananbaum had paid $4.8 million on the Balloon Venus agreement, $2.4 million on the Eros agreement and $4.25 million on the Diana agreement. It was at this time Tananbaum was informed that the new completion date for Balloon Venus would be August 2019 and for Eros would be October 2019. In February 2018, he was informed that Diana edition 1 would “not be ready this year.” In April 2018, Tananbaum filed the complaint. Around the same time, Joel Silver filed a similar complaint after his offer to make additional payments to an escrow account was rejected by Gagosian.  

When a work of art is on display or for sale, the year the work was completed is always shown next to information such as size and medium. For Jeff Koons’ balloon animal stainless steel sculptures, the completed date is instead usually a range of 6 to 8 years.  His “iconic” Play-Doh sculpture—which was on view at the Whitney Museum for the Koons retrospective in 2014 and is currently on view at the Rockefeller Center in advance of its auction date at Christie’s—took nearly twenty years to complete (1994-2012). Play-Doh is made of aluminum, stands at 11 feet tall, and resembles the leftovers of a Play-Doh project.

According to their complaints, Tananbaum and Silver asked for information about the foundry, fabricator, studio, photos, production schedules and any evidence that production had even started when learning of production delays. Neither received any photos nor specific information about production. Tananbaum’s complaint detailed a number of works—including one that was the subject of another lawsuit involving Gagosian—that were prioritized before Tananbaum’s. These actions and inactions may support Tananbaum’s NYUCC claims and both Tananbaum and Silver’s NYACAL claims. Defendants’ responses are due June 20, 2018 in the Tananbaum case.

Employers Triumph: Arbitration Class and Collective Action Waivers Are Enforceable, but What Should Employers Do?

Posted on June 14, 2018 by - Uncategorized

In a landmark victory for employers, the U.S. Supreme Court held that agreements requiring employees to arbitrate claims on an individual basis are enforceable. The case, Epic Systems Corp. v. Lewis, 584 U.S. ____ (2018), consolidated three different cases on appeal from the Fifth Circuit, Seventh Circuit, and Ninth Circuit. Murphy Oil U.S.A., Inc. v. NLRB, 808 F.3d 1013 (5th Cir. 2015); Epic Systems Corp. v. Lewis, 823 F.3d 1147 (7th Cir. 2016); Morris v. Ernst & Young, LLP, 834 F.3d 975 (9th Cir. 2016). In each of those cases, employees challenged the validity of an arbitration agreement that provided employees were required to arbitrate disputes, but not on a class or collective basis. Justice Neil Gorsuch, writing for the majority, boiled down the dispute to two simple questions:

  • Should employees and employers be allowed to agree that any disputes between them will be resolved through one-on-one arbitration?
  • Or should employees always be permitted to bring their claims in class or collective actions, no matter what they agreed with their employers?

The Court, recognizing that these questions are debatable as a matter of policy, held that the answer was clear as a matter of law. “You might wonder if the balance Congress struck in 1925 between arbitration and litigation should be revisited in light of more contemporary developments. You might even ask if the [Federal Arbitration] Act was good policy when enacted. But all the same you might find it difficult to see how to avoid the statute’s application.” First, the Court reaffirmed the principle that the Federal Arbitration Act (FAA), 9 U.S.C. § 2, instructs courts to enforce arbitration agreements according to their terms, including those terms providing for individualized arbitration proceedings. Second, the Court held that the National Labor Relations Act (NLRA) does not create a right to class actions in the courtroom or arbitral forum. As such, the Court held that neither the FAA nor NLRA permits the Court to declare agreements to arbitrate one-on-one as illegal.

The Federal Arbitration Act

In holding that the FAA required the Court to enforce agreements to arbitrate individually, the Court acknowledged that the FAA directs courts to “enforce arbitration agreements according to their terms, including terms that specify with whom the parties choose to arbitrate their disputes and the rules under which that arbitration will be conducted.”

The Court then examined the saving clause of the FAA. The saving clause allows courts to refuse to enforce arbitration agreements “upon such grounds as exist at law or in equity for the revocation of any contract.” The employees argued that the NLRA renders class and collective action waivers illegal; therefore, their illegality was a “ground” that “exists at law” to revoke an arbitration agreement. The Court rejected this argument. Temporarily setting aside the NLRA issue, the Court held that the saving clause’s use of the language “any contract” means that it applies only to generally applicable contract defenses—like fraud, duress, or unconscionability—not defenses specific to arbitration contracts. The Court held that the FAA saving clause did not apply to a contract merely because it requires bilateral arbitration.

The National Labor Relations Act

After holding that the FAA normally requires courts to enforce class and collective action waivers, the Court then turned to the issue of whether the NLRA overrides the FAA. The employees argued that section 7 of the NLRA, which protects “concerted activities” of employees, encompasses class and collective actions. The Court rejected this argument.

First, examining the language of the NLRA and its regulatory scheme, the Court held that section 7 does not speak to class or collective actions, despite heavily addressing collective bargaining and labor organization practices.

Second, because the underlying lawsuits arose under the Fair Labor Standards Act (FLSA), the Court would be required to interpret the NLRA as dictating the FLSA’s procedures and then overriding the FAA. The Court refuses to do so: “It’s a sort of interpretive triple bank shot, and just stating the theory is enough to raise a judicial eyebrow.”

Third, citing examples, the Court decided that its own precedent rejects the notion that Congress intended to displace the FAA with another statute. The Court held that under its own case law, section 7 applies to efforts by employees to organize and collectively bargain in the workplace—not the treatment of class or collective actions in court or arbitration proceedings.

Finally, the Court refused to apply Chevron deference to the National Labor Relations Board (NLRB) because the NLRB sought to interpret not only the NLRA, but also the FAA, which is outside the purview of the NLRB. In addition, the Court held, “Chevron leaves the stage” because there is not an unresolved ambiguity in the statutes after employing traditional tools of statutory construction.

The Dissenting Opinion and Response

The dissent, authored by Justice Ruth Bader Ginsburg, accused the majority of harking back to the Lochner era and the days of the Court readily enforcing “yellow dog” contracts that prevented union organizing. (In Lochner v. New York, the Court held that “freedom of contract” made a state law limiting employee work time unconstitutional. 198 U.S. 45 (1905). The so-called Lochner era came to an end when the Court upheld a state minimum wage law in West Coast Hotel Co. v. Parrish, 300 U.S. 379 (1937)). The dissent would hold that the text, legislative history, purposes, and longstanding construction of the NLRA suggest that Congress “likely meant to protect employees’ joining together to engage in collective litigation.” The dissent also rejects the notion that anything in the FAA or the Court’s case law requires subordination of the NLRA to the FAA. Rather, even assuming that the FAA and NLRA were in conflict, the dissent would hold that the NLRA controls.

Taking the dissent head-on, the majority refused to engage in a discussion of policy, and instead sought to interpret the FAA and NLRA in a way “that gives effect to all of Congress’s work, not just the parts we might prefer.” Addressing the accusation that the Court was returning to the Lochner era, the Court stated, “This Court is not free to substitute its preferred economic policies for those chosen by the people’s representatives. That, we had always understood, was Lochner’s sin.”

Advice for Employers

The Supreme Court’s decision clears the way for class and collective action waivers. The decision should lead any employer that does not already utilize mandatory arbitration agreements with these waivers to consider whether implementing these agreements makes sense for its business. From a pure cost standpoint, for many employers and certainly most large employers, the ability to prevent higher-dollar class and collective actions has a lot of appeal. We have seen many cases in which, even if the underlying claims are not strong, the class or collective action procedure is used as a vehicle to increase costs and try to force settlement.

On the flip side, companies must consider what impact requiring arbitration agreements with class and collective action waivers could have on employee morale. The anger in Justice Ginsburg’s dissent is echoed by many employee-side commentators who decry the decision as undermining employee rights. Similarly, many on the employee-rights side argue that arbitration itself disfavors employees. These conclusions overlook the laudable attributes of arbitration proceedings and the frequent reality that it is plaintiffs’ attorneys, and not employees, who reap the most benefit from class and collective procedures. Still, the view that arbitration and class and collective action waivers disfavor employees is genuinely held by many.

No matter what, in light of the decision, all employers should consider whether mandatory arbitration agreements with class and collective action waivers make sense for their workforce.

20 Questions and Answers on the Fundamentals of Records Management

Posted on June 14, 2018 by - Uncategorized

Lawyers should not expect their clients to have the expertise of a professional records manager; however, there are some basic fundamentals about how records should be managed that every organizational employee should know to protect company interests. Many large organizations can afford to employ an army of professional records managers, but for the hundreds of thousands of organizations that either cannot afford that luxury or who depend on its lawyers for that expertise, it is the lawyers’ responsibility to make sure an organization’s employees have the fundamentals of records management permanently inscribed in their daily work.

The problem is that lawyers assigned the records-management responsibility for the overall organization cannot be physically available on a minute-by-minute basis to address questions each employee confronts with respect to managing each and every record he or she either creates or receives regularly. By thoroughly educating each and every organizational employee on these fundamentals, however, the professional records manager and the lawyers serving in this capacity can be available to deal with the more complex and specialized record-management issues that arise. In addition, training employees on the fundamentals of managing their records accomplishes at least three important organizational purposes: (1) employees are better able to protect the organizational interests with this knowledge; (2) lawyers will gain a higher degree of employee respect when they demonstrate how straightforward managing their records is when done on a regular basis; and (3) lawyers will earn a higher degree of trust from employees when those employees know that the lawyers are a source of records management expertise when needed.

Below are 20 questions pertaining to some of the fundamentals of records management employees should be asking, and the answers lawyers can provide.

  1. What qualifies as a record?

In its simplest and most straightforward form, a record is data, information, knowledge, and/or expertise recorded or received in any medium because there is a chance it will be needed in the future, the disposition of which is determined by the organization’s approved record schedule.

  1. When and how do I dispose of records I no longer need?

Find an item on the organization’s record schedule that specifies how long that record must be retained and after that period has expired, follow the disposition method specified in the schedule.

  1. What is an organization’s record schedule?

A functional listing specifying different types of organizational records that must be retained and for how long. It is not the form in which the record exists that determined how long it must be retained, but the substance of that record’s content.

  1. What if no item on the schedule describes the record in hand?

The person in the organization designated as the organization’s records manager should be notified so that an item covering those kinds of records can be drafted, approved, and added to the schedule.

  1. What else about the record schedule should I understand?

An effective record schedule specifies which records should be stored and maintained in the organization’s working areas for how long, and when those records should be transferred to off-site storage and for how long.

  1. Who in an organization is responsible for managing its records?

The individual who either creates or receives the record is responsible for determining if it is a record, where it should be retained, how long it should be retained, and how it should be disposed of in compliance with the organization’s record schedule.

  1. How should I “file” a record I create or receive so it can be found if I am not available?

The person in the organization designated as the organization’s records manager should be responsible for creating a file structure for each organizational unit with read access shared by all members of that unit.

  1. What organizational records am I permitted to share with those outside of my organization?

The person in the organization designated as the organization’s records manager should draft a records-sharing policy that is approved by the organization’s top management for sharing records with those outside the organization.

  1. Am I allowed to share my personal knowledge of the organization that is not recorded in its records with those outside the organization?

The sharing of an employee’s tacit knowledge with those outside the organization should be covered in the organization’s policy about sharing the organization’s data, information, knowledge, and expertise with those outside the company.

  1. Why should a professional records manager understand and appreciate many of the details of the organization’s operations?

It is only with an understanding and appreciation of many of the details of the organization’s operations that a professional records manager can help the organization’s employees make the quality of the data, information, knowledge, and expertise in those records as accurate and as complete as possible. Further, with this knowledge of its operations, the records manager will likely spot potential trouble about which he or she can seek legal advice.

  1. What and why should an employee know about records that are “vital”?

Vital records are those absolutely necessary for a unit, department, or the entire organization to operate. Given that most employees are creating and receiving records, some of which may qualify as vital, he or she should be able to recognize which records are vital and properly store and protect them.

  1. Should records created or received electronically be treated any differently than those created by other means?

No, all records, no matter how they were created or received should be handled, stored, and disposed of the same way based on the content of the record.

  1. Are voice-mail messages records?

They are, and they should be reduced to some physical form so they can be handled, stored, and disposed of in the same ways as all other organizational records.

  1. Are there special records requirements for the industry to which my organization belongs?

Yes. A great number of industries, such as banks, health care providers, pharmaceutical developers, manufactures, and many more, have their own record-keeping requirements.

  1. Are there operational subject areas that have special record-keeping requirements?

Yes. Any number of operational subject areas such as hiring, firing, fair employment, occupational health and safety, products liability, securities, antitrust, and any number of others have their own record-keeping requirements. If in doubt, seek the advice of the person in the organization designated as the organization’s records manager. If that is not satisfactory, seek the answer from a lawyer responsible for the legal matters of the organization.

  1. What can I do to help the organization’s records manager be more effective and efficient?

One can work to be a prime example of a great record keeper. Setting this example will encourage coworkers and peers to see that effective record keeping is possible, not that difficult, and significantly beneficial when one or others need the data, information, knowledge, and/or expertise in one’s records. Equally important, one should work to continually record new information, knowledge, and expertise that one learns, or observes in others, while working.

  1. Will I be rewarded or recognized if I invest enough time and keep my records properly?

Most records will never be needed again; the unanswerable question is which ones will be needed sometime in the future. When one of the organization’s top executives or managers has a vague recollection of having seen a record that he or she now desperately needs—particularly to defend or protect the organization—and you are the one to produce it, hopefully you will be considered a hero and eventually promoted and/or financially rewarded.

  1. What could be the consequences if I keep poor, inattentive, or sloppy records?

One could lose one job if one’s poor record keeping puts the company in significant jeopardy, or one could be subject to civil or criminal penalties if the information one has recorded is used to support and prove such legal actions.

  1. What should I do if I see others in the organization destroying records that must be preserved?

Report it to one’s own manager, the person in the organization designated as the organization’s records manager, and/or the lawyer responsible for the legal matters of the organization.

  1. What do I do if I have a technical question about a record I have created or received?

The person in the organization designated as the organization’s records manager should be able to answer such questions; if not, seek the answer from a lawyer responsible for the legal matters of the organization.

With these answers firmly in employees’ minds, any organization will be able to significantly improve its overall record keeping, lawyers for the organization and its professional records manager will have fewer questions to answer about the organization’s record keeping, and employees will be much more satisfied that they are keeping their records effectively.