“How General Counsels Battle the Weaknesses in the United States Rule of Law” is part of a series on intersections between business law and the rule of law, and their importance for business lawyers, created by the American Bar Association Business Law Section’s Rule of Law Working Group. Read more articles in the series.
Most discussions about the Rule of Law (“ROL”) in the United States focus on either the criminal legal system or how the U.S. ROL is a goal to be attained by developing nations. Less attention is given to evaluating how the fundamental structures of the United States legal system impact its ROL strength. While the ROL in the United States is a standard, I have found in my practice as a General Counsel (“GC”) that the U.S. ROL is not the gold standard.[1] Further, the current state of the U.S. ROL is not an inherent side effect of a developed legal system; rather, it is a product of choices we have made about how to structure the U.S. ROL.[2]
A country with a healthy ROL “requires the law be: validly made and publicly promulgated, of general application, stable, clear in meaning and consistent, and ordinarily prospective.”[3] As a GC, I have found that certain features of the U.S. ROL make it harder for businesses to uphold the ROL. For example, instead of an independent government body in charge of legislative language and drafting, we have chosen the collaborative, and often adversarial, process of having statutes born out of political parties’ compromises and deal-making.[4] This process does not ensure clear, concise, and coherent statutes that the public can easily understand but instead tends to produce convoluted and incoherent statutes that are the product of so much give and take that by the time they reach the president’s desk, the entire point of drafting the law in the first place may be lost. Another example is that instead of having a judicial system that encourages trials and frequent judicial opinions, our system encourages settlements and plea deals, thus reducing how often the law is applied to new facts.[5] While settlements and plea deals are efficient, they limit the public’s ability to learn how the law will apply to different facts and scenarios to help guide the public on what can and cannot be done. While the ROL in the U.S. has many healthy features, its struggles with indeterminacy and a new shift toward inconsistency weaken the ROL and play a large role in the challenges I face as a GC.
How the ROL Impacts My Practice
The above-stated design choices make it difficult for GCs to advise business clients trying to scale their operations. Our clients’ customers expect their businesses to follow them all over the country as seamlessly as information travels across the internet. Our clients also expect their GCs to advise them on exactly how to meet client and customer expectations while operating within the confines of applicable laws. However, the deficiencies in the U.S. ROL make this job an extraordinary challenge by: (1) increasing how much time GCs must spend with our clients explaining why they must try to be compliant, because it discourages them that total compliance is impossible in many areas; (2) increasing the difficulty of translating the law to our business stakeholders clearly and concisely, since our ROL is neither clear nor concise; and (3) increasing the difficulty in advising businesses on legal strategy because legal outcomes are unpredictable.
Time Spent Convincing the Business Impossible Compliance is Worth its Time and Money
ROL principles concerning the generality, clarity, publicity, stability, and prospective nature of the norms that govern a society[6] offer significant value and benefits to business. Rarely do business stakeholders intend to operate their business outside of the confines of the law. However, their motivation to put effort into ensuring compliance is decreased by uncertainty that full compliance is even possible within the U.S. legal system. These compliance challenges become magnified when businesses operate across state lines, as: (1) following the law in one jurisdiction does not ensure compliance with another jurisdiction; (2) it may be unclear which laws apply to the business; and (3) the lack of uniform enforcement makes it appear as though some businesses are allowed to operate outside of the law while others are not.[7] This creates a challenge for GCs, who constantly have to start compliance programs by convincing our clients that compliance, even while elusive, is worth the effort and resources. We must spend time and energy convincing them that it is better to try to comply rather than to ignore and deal with the consequences later. When the law is unclear or impossible to fully follow, unhelpful questions leak into the compliance discussion. Our clients start to wonder, what is the probability of enforcement? Are any of my competitors also following this law? The lack of clarity in the U.S. ROL fills my day with keeping business stakeholders motivated to try to become compliant, even when full compliance is not attainable.
Translate the Law to Business Stakeholders Clearly and Concisely
As in-house attorneys, we often get questions about the law in a format where the business stakeholder wants to know just enough law to legally run their business, but not so much as to become experts in the legal field. However, due to the complexity of the ROL, it is a constant challenge to successfully translate the law in a way that will be understood—and understood in a way that fosters compliant behavior. We try to come up with phrases that are easy to remember and simple to perform. One method of communicating the law to increase compliance is to pick the strictest state law and apply that policy requirement across all business operations across the country. The drawback of that approach, however, is that it gives local businesses a potential advantage because a local business does not have to comply with the laws of stricter states. We are often battling how much to rely on these cheat codes for communicating legal concepts to our clients because they come with legal and business risks.
At the core of why translating the law to our clients is so difficult, is that if you tell your clients everything they need to know and do to become compliant, they will not be able to internalize it and are therefore unlikely to follow the law (which is the ultimate goal). I see my job as a GC as one that entails not simply the act of informing the business about the law, but rather informing the business in a way that moves stakeholders’ behavior toward compliance. A good example of this dilemma is the length of employee handbooks. It is generally accepted that as the length of employee handbooks increases, the likelihood that employees will read them decreases. This catch-22 would not exist if there was more consistency in employment laws across the country. Playing the balancing act—providing just enough information to make sure the business is advised, but not so much information the individuals who implement the advice feel overwhelmed and ignore all guidance—feels like walking a tightrope on the best of days. As the internet inevitably pushes business across borders, a simplified legal system that is consistent across state lines would mitigate how much legal information is required for a business to simply sell its widgets and services across the country and thus limit the legal communication gymnastics required of a GC.
Advising the Business When Legal Outcomes Are Unpredictable
As stated above, the structure of the ROL in the United States makes it especially difficult to predict how a judge or regulator will interpret specific facts due to how infrequently guidance and decisions are issued. However, it is our job to give our client the likelihood of legal outcomes to help the business allocate resources and decide on business strategy. Recently, fast-changing political and legal regimes have made it even harder to predict where a court or regulator will land on a legal issue. Because more laws and policies, no matter how generic, are now interpreted in ways that have more to do with the personal and local politics of the government adjudicator than their text, there is even less predictability for legal outcomes.
As a GC, I experience the negative impacts of local unwritten rules when we go to court in jurisdictions all over the country. Some local courts prefer local attorneys. It is not a written rule, but it is the local ROL. How do you advise your client on the winnability of a case if an unwritten local rule is going to play a larger role in the success of your case than the written law and the facts? As a GC, I have to spend time investigating whether unwritten home rules could impact our case in certain jurisdictions. This is a breakdown in one of the main ROL principles, which is that laws must be public. Local unwritten ROL is often discussed in the context of business risk in developing nations, but it is very much a feature of the U.S. ROL that needs far greater attention.[8]
How GCs Can Support the ROL
GCs must advocate for clear, coherent, and consistent laws that apply across the country. We should push our clients to see the long-term benefits of moving lobbying away from advocating for confusing loopholes that benefit our clients in the short term and toward lobbying for laws that increase the determinacy of our ROL. To be clear, this is not a call for “de-regulation.” I don’t believe in that approach because I have found no difference in the complexity of a statute advertised as “de-regulated” versus “regulated.” I have to read them both, and a “de-regulated” statue still requires me to train staff on what they must do to get the benefit of the “de-regulation.” A better framework is to focus on what our clients actually need, clarity. Our clients need clarity in both their legal obligations and the advice they receive from their GC so that they can make the best business decisions possible. Most of all, our clients need to focus as much of their time as possible on providing the best products or services to their customers, not on state-specific compliance training.
As in-house attorneys, we should always remember that we play an active role in creating or damaging the ROL in the United States. Every time we advise our clients, advocate to regulators, and go before a judge, we ask for a certain type of ROL to exist in the country. The question is, will our request improve or damage the ROL we seek in the U.S.?
Relatedly, the World Justice Project ranks the US as 41st out of 139 nations with respect to the strength of ROL in the US civil justice system. Under this category, the US is ranked 126th out of 139 nations for the access and affordability of the civil justice system. Finally, the US is ranked 41st out of 139 nations when it comes to the absence of improper government influence on the civil justice system, https://worldjusticeproject.org/rule-of-law-index/country/2021/United%20States/Civil%20Justice/. ↑
On June 21, 2022, President Biden signed a bill into law that retroactively raises the cap on debt for eligibility for subchapter V status. In the author’s opinion, the legislation falls under the category of “better late than never.”
In August 2019, when Congress amended the Bankruptcy Code to create a new subchapter V for small business debtors, the cap for eligibility to file under that subchapter was $2,725,625 in total noncontingent, liquidated, secured and unsecured debt. Like many provisions of the Bankruptcy Code, that number was subject to adjustment every three years to reflect consumer price index changes.[1]
Then, in 2020, COVID-19 arrived. Among the many legislative responses to the crisis, Congress passed and the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act raised the cap on eligibility for bankruptcy under subchapter V to $7.5 million, with an expiration date of one year from its enactment: March 27, 2021. As COVID-19 continued to burden the economy, in early 2021 the increased cap was extended to March 27, 2022, by the COVID-19 Bankruptcy Relief Extension Act. Despite the late March expiration of the increased cap, Congress as a whole failed to act until June 2022, even though the bill had bipartisan support. The President signed the bill (S. 3823, Bankruptcy Threshold Adjustment and Technical Corrections Act) into law on June 21, 2022.[2] The law addresses four subjects: subchapter V, eligibility for Chapter 13, the definition of “small business debtor” applicable to small business cases, and the United States Trustee System Fund. Here are the amendments:
Subchapter V. The Bankruptcy Threshold Adjustment and Technical Corrections Act reinstates the $7.5 million cap for two years and applies the revised cap to any cases filed on or after March 27, 2020, and pending on or after June 21, 2022. This enlarged cap is scheduled to sunset two years after the June 21, 2022, effective date of the amendment.
Chapter 13. The Bankruptcy Threshold Adjustment and Technical Corrections Act also makes a major temporary change to the eligibility requirements of Chapter 13. Before the amendment, eligibility was capped at $1,395,875 in secured debt and $465,275 in unsecured debt, for a total of no more than $1,861,150. The June amendment gets rid of the distinction between secured and unsecured debt and sets the cap for noncontingent, liquidated debts at less than $2,270,000. Unlike the changes related to subchapter V, the change only took effect on June 21, 2022. It will also, however, expire two years after its effective date (June 21, 2024) unless Congress acts to extend it.
Other Less Dramatic Changes. The definition of subchapter V “debtor” in Code section 1182 has also been narrowed somewhat to only exclude any debtor or affiliate of any debtor that is subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)).[3] This amendment as written also sunsets two years after the amendment’s effective date, but because at the time of the sunset the ongoing definition of “small business debtor” will apply to subchapter V cases, and because that definition was also amended to incorporate the same restriction, the restriction will continue to apply to subchapter V debtors.
Moreover, the law modifies the feasibility requirement for confirmation of a subchapter V plan. Before the amendment, the Bankruptcy Code stated that in order to confirm a subchapter V plan without the consent of all impaired classes, any the plan had to be “fair and equitable” to all impaired, non-consenting classes. “Fair and equitable” was defined in section 1191(c)(3) to require, among other things, that the debtor show:
(A) (i) The debtor will be able to make all payments under the plan; or (ii) there is a reasonable likelihood that the debtor will be able to make all payments under the plan; and
(B) the plan provides appropriate remedies, which may include the liquidation of nonexempt assets, to protect the holders of claims or interests in the event that the payments are not made.
Thus, as written, it appeared that even if the debtor established by a preponderance of the evidence that it would be able to make all payments under the plan, the plan had to incorporate provisions to protect holders of claims and interests “in the event that the payments are not made.” That apparently was a glitch, and the provision, as renumbered, makes it clear that the plan must include the “remedies” only if the debtor has not proven it would be able to make all payments under the plan. This change also applies to any case filed on or after March 27, 2020, and pending on or after June 21, 2022. It does not sunset.
In addition, Bankruptcy Code section 1183 is amended to provide that a subchapter V trustee may be authorized to operate the business of a subchapter V debtor that is removed from being a debtor-in-possession. Before the amendment, the Code provided for the removal of a debtor-in-possession but did not specify that the subchapter V trustee needed authorization to operate the business of the debtor. This change also applies to any cases filed on or after March 27, 2020, and pending on or after June 21, 2022. It, too, does not sunset.
Small Business Cases. Notwithstanding the introduction of subchapter V for small business debtors, there remain special provisions for small business debtors that elect not to reorganize under subchapter V. These debtors, which are subject to the rules for “small business cases” rather than subchapter V cases, are subject to tight deadlines for plan submission and confirmation and do not have subchapter V trustees appointed in their cases. The definition for debtors in these cases had excluded “any debtor that is a corporation that is an affiliate of an issuer (as defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c).” Now the exemption is narrower: entities that may not be “small business debtors” only include any debtor or affiliate of any debtor that is subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)). This amendment also applies to any cases filed on or after March 27, 2020, and pending on or after June 21, 2022. It, too, does not expire.
U.S. Trustee System Fund. The Bankruptcy Threshold Adjustment and Technical Corrections Act also makes technical corrections to the law regarding the United States Trustee System Fund. These amendments are effective “as if enacted on October 1, 2021” and do not sunset.
Clearly, Congress has had a great deal of issues to address, including war in Europe, climate change, and inflation. That being understood, it is unfortunate that Congress failed to act more quickly: subchapter V has proven to be extremely popular and leaving the matter in limbo may well have led to confusion, additional restructuring costs, and additional stress on potential debtors. Between COVID-19, inflation, and supply chain problems, small businesses had already undergone too much stress in the last few years.
These changes were implemented too late for inclusion in the recently published 2022 edition of The Portable Bankruptcy Code & Rules, which contains changes to the Bankruptcy Code through March 2022. All these changes will be set forth in the 2023 edition of The Portable Bankruptcy Code and Rules, which will also feature the many amendments to the Bankruptcy Rules that are expected to become effective in December.
For an in-depth discussion of this change, see In re Phenomenon Mktg. & Entm’t, LLC, No. 2:22-bk-10132-ER, 2022 Bankr. LEXIS 2105, 2022 WL 304241 (Bankr. C.D. Cal. Aug. 1, 2022). ↑
The Pride Parades were back this summer—after a two-year hiatus because of COVID—and the large crowds and enthusiasm demonstrated acceptance and support of the LGBTQ community in our society. Many business law firms are committed to serving and supporting LGBTQ staff, clients, and initiatives as part of their diversity programs.
Below is a sampling of how five business law firms have institutionalized their approach to LGBTQ inclusion through policies, working groups, and programs.
Cassels Brock & Blackwell LLP
The 2SLGBTQ+ Affinity Group at Cassels Brock & Blackwell LLP exists to ensure that 2SLGBTQ+ firm members are enabled and motivated to succeed to their maximum potential, while being comfortable bringing their full and complete selves to work. The Group works to support the recruitment, retention, and promotion of 2SLGBTQ+ talent to and within the firm. All firm members who identify as 2SLGBTQ+ and allies are welcome to attend the Group’s monthly meetings and events to support one another’s career development and discuss issues particular to the 2SLGBTQ+ community.
For 2022, the Group is kicking off Pride season with its second annual virtual drag show featuring a dynamic and diverse cast of local drag queens and a drag king who will dance, lip sync, and discuss everything surrounding drag, gender expression, allyship, and queerness. The Group will also be attending Pride runs and walks in Toronto and Vancouver to raise funds for local 2SLGBTQ+ community spaces and resources. In addition, the Group has recently announced that it is in the process of establishing an independent peer support group to better provide more well-rounded support to firm members who identify as 2SLGBTQ+. In recent days, the Group has begun exploring the possibility of hosting, together with the Parents of Young Families Affinity Group, a recurring drag story-time.
Finally, the Group has been working closely with the firm’s larger Inclusion and Diversity Committee to bring in speakers to address topics such as pronouns and gender/sexual identities, the progressive pride flag, and court challenges to anti-2SLGBTQ+ legislation.
Cleary Gottlieb Steen & Hamilton LLP
Cleary Gottlieb believes that fostering interactions among lawyers with similar affinities, as well as those with diverse experiences and perspectives, makes the firm a more welcoming and supportive place—and one that is better positioned to serve the firm’s clients and support the Cleary community. Cleary’s affinity groups collaborate with firm leadership, conduct continuing legal education programs, raise awareness about topics relevant to the members of their respective groups, identify culturally relevant pro bono matters and potential partnerships, and organize networking activities. Affinity groups are empowered to be active participants in the firm’s efforts to achieve greater inclusion.
Cleary is pleased to support the LGBTQ+ Affinity Group and the Pride Professionals’ Affinity Network. These groups were created to connect LGBTQ+ associates and professional staff across the firm, and they have grown from the firm’s efforts to highlight the unique experiences of LGBTQ+ individuals. These groups cultivate an inclusive culture, where the values, voices, and perspectives of Cleary’s LGBTQ+ professionals are celebrated and reflected. Cleary is proud to host impactful and robust programming, including cultural events and talks with LGBTQ+ activists and trailblazers, to raise awareness about the issues these individuals face and the contributions they make to our communities. We regularly invite provocative and dynamic speakers to engage with our community, and we endeavor to showcase and highlight intersectionality, especially across racial/ethnic identities.
Additionally, Cleary Gottlieb engages and partners with leading LGBTQ+ stakeholders inside and outside of the legal industry. Cleary advances these efforts with national organizations and minority bar associations to demonstrate its solidarity with the LGBTQ+ community and showcase and reinforce its dedication to supporting this community.
Covington & Burling LLP
Covington’s LGBT+ Affinity Group has a global presence and invites the participation of the firm’s lawyers and staff. The affinity group leads work closely with Covington’s Diversity & Inclusion (D&I) Team to implement strategic initiatives in response to the needs of the LGBT+ community within the firm. Most recently, the group developed its first-ever strategic action plan focused on belonging, retention, and development of affinity group members. Their plan objectives will be accomplished through multiple activities, including hosting regular affinity group meetings; implementing inclusionary practices to support all LGBT+ colleagues in the workplace; and creating more visibility opportunities with key clients for LGBT+ lawyers. Covington’s LGBT+ Affinity Group also provides mentoring, learning, and development opportunities for its members and promotes intersectional efforts by collaborating on programs and events with the firm’s six other affinity groups.
In an effort to be more inclusive of individuals across the spectrum of gender and gender identity, the LGBT+ Affinity Group championed the firm-wide use of pronouns in email signatures. Words matter, and the use of pronouns in email signatures sends a clear message of solidarity and support to future and current Covington colleagues, as well as clients. In alignment with this initiative, the affinity group collaborated with the D&I team to develop a reference guide to instruct colleagues on how to modify their email signature blocks.
This year, Covington celebrated Pride in a big way, supporting the LGBT+ community in Brussels and Frankfurt (May), the U.S. (June), and London (July). These events encouraged Covington colleagues to learn about and reflect on the achievements and diverse identities of members of the LGBT+ community. These events included:
Participation in the London 2022 Pride March wearing an exclusive Pride Month T-shirt that was distributed to members in the U.S. and London offices.
A conversation with Amy Schneider, the most successful woman ever to compete on Jeopardy! This engaging discussion touched on her being the first openly transgender contestant to qualify for the Tournament of Champions, her role in amplifying trans voices, and how everyone can act as an ally for trans rights.
A discussion in partnership with UCLA’s Williams Institute on federal policy under President Biden, state legislation targeting LGBT+ youth, and what the Supreme Court’s recent decision on abortion rights could mean for the LGBT+ community.
An educational workshop on LGBTQI+ awareness that included colleagues in Brussels and Frankfurt.
White & Case LLP
White & Case’s LGBT+ affinity group—Spectrum—has three affinity networks, one of which is available for all U.S.-based colleagues, both lawyers and business services staff. These groups provide ongoing peer support and regular networking opportunities, making the firm a more attractive prospect for potential LGBT+ recruits by demonstrating that diversity is valued, and facilitating professional networking opportunities with clients’ and other law firms’ LGBT+ networks.
White & Case has joined the community of organizations that support and adhere to the UN Standards of Conduct for Business Tackling Discrimination against Lesbian, Gay, Bi, Trans, andIntersex People. The UN Standards contain five principles aimed at helping businesses improve LGBT+ equality and inclusion. White & Case is working closely with its Spectrum LGBT+ Networks to translate this support into actionable goals. For example, the firm rolled out a new gender pronoun signature template globally in 2021 to show those who wish to share their pronouns that doing so is supported by White & Case. This was accompanied by ongoing onboarding and global educational materials, such as videos and FAQs, to encourage all colleagues to increase their understanding of the use of pronouns.
White & Case is a long-term sponsor of the Lavender Law Conference & Career Fair, the largest LGBT+ legal conference in the country, as well as other LGBT+ initiatives, such as the Lambda Liberty Awards National Dinner. Its lawyers also staff the LGBT Bar Association of Greater New York’s monthly legal clinic, which provides assistance for low-income members of the LGBT+ community in need of brief legal advice on a range of topics. As part of the firm’s Global Citizenship initiative, its Pro Bono legal services are the centerpiece, with White & Case being one of the largest providers of pro bono legal services in the world. Many cases relate to LGBT+ issues, including immigration and asylum challenges for LGBT+ people. Whitman-Walker Health is a common pro bono partner for the firm, and we also sponsor and participate in the organization’s annual Walk to End HIV. Most recently in 2022, White & Case partnered with one of its key clients to refresh the IGLYO’s Inclusive Education Report across forty-five countries. IGLYO is a nonprofit organization that builds the skills and experience of LGBT+ youth to become leaders within the LGBT+ and human rights sectors. The firm’s LGBT+ lawyers continue to achieve peer and community recognition, such as the 2020 40 Under 40 Awards from the LGBT Bar, which recognized two firm LGBT+ lawyers as having distinguished themselves in their field and demonstrated a profound commitment to LGBT+ equality. Other awards have included 2020 Asian Law Alliance Diversity Award.
In addition, White & Case hosts annual Pride celebrations and events across multiple offices in the U.S. The firm organizes educational events to discuss diversity and inclusion issues specific to the LGBT+ community. In the most recent event, “An Audience with Olympic Champion Tom Daley,” the Olympic champion in diving discussed how he triumphed over negativity and bias throughout his career, covering a range of issues including homophobia and challenges with mental health.
White & Case also conducts personalized outreach to law school LGBT+ affinity groups, and previous panel and speaker sessions have included law school professors discussing Supreme Court cases and decisions around LGBT+ diversity issues.
Holland & Knight LLP
Holland & Knight proudly supports the LGBTQ community and has long welcomed and encouraged the celebration of Pride Month. Throughout Pride Month 2022, as in years past, the firm offered an array of information, resources, and additional ways to show support, including a feature on the front page of the firm’s website, as well as a social media graphic and special Pride Month email signatures for use by employees. Other Holland & Knight efforts and outreach included:
Social Media Pride Profiles: Holland & Knight’s social media channels provided “Pride Profiles” featuring members of the firm’s Pride Planning Committee, including Associates Amy O’Brien and Cameron Rivers. Partner Jessica MacAllister and Associates Brian Goodrich and Fernando Tevez also were highlighted. In addition to posting on LinkedIn, the firm shared the profiles on its Twitter, Facebook, YouTube, and Instagram accounts. As Ms. MacAllister stated in her profile, Holland & Knight’s LGBTQ Affinity Group “has served as a safe space for me to share in our communities’ successes and disappointments” and “is a place where empathy meets action. I am proud to be a member of a group that works tirelessly towards equality and inclusion in both our workplace and in our communities.”
Going Beyond the Pride Flag: On June 22, the firm hosted a webinar for employees and clients titled “Beyond the Pride Flag: Breaking Barriers as an Openly Gay Executive,” featuring Habitat for Humanity Vice President for Individual Giving Jeremy Kraut-Ordover. Mr. Kraut-Ordover discussed the challenges he faced growing up, the importance of being an advocate, and how he ended up thriving in his role as a high-ranking executive of a Christian organization as an openly gay and Jewish man.
Charitable Fundraiser: Holland & Knight’s LGBTQ Affinity Group sponsored a Pride Month fundraiser, with donations shared between the Equality Florida Institute and Equality Texas Foundation. These organizations work to secure full equality for LGBTQ+ individuals in Florida and Texas—two strongholds of the firm. Donations, which topped more than $11,000, were accepted through the Holland & Knight Charitable Foundation’s donation portal and payroll deduction.
Holland & Knight’s support of the LGBTQ community doesn’t end with Pride Month. Throughout the year, through its representation on the firm’s Diversity Council, the LGBTQ Affinity Group works to ensure that Holland & Knight remains a leader among law firms with regard to its LGBTQ-friendly policies and initiatives. Externally, members of the LGBTQ Affinity Group participate in various pro bono and community service efforts to improve the lives and rights of the LGBTQ community. These include furnishing essential services to LGBTQ youth, providing outreach and support to families impacted by HIV/AIDS, and participating in name and gender marker change clinics for transgender individuals.
A ruling in In re Multiplan Corp. Stockholder Litigation accepting the relevance of misstatements in a Special Purpose Acquisition Company (“SPAC”) transaction continues to highlight the role of information disclosure in corporate financing. SPACs are blank-check public companies whose purpose is to acquire a privately held company within a given time period. This business combination (known as the “de-SPAC”) effectively allows the private company to become publicly traded.[1] In denying motions to dismiss, the Delaware Chancery Court considered the allegation that the SPAC’s fiduciaries (including its sponsor and board of directors) misstated certain information about the business combination. The SPAC investors, the Court argued, would have been “substantially likely to find this information important when deciding whether to redeem [their shares ahead of a proposed acquisition].”[2] As I will explain further below, the redemption right alluded to by the Court is a typical feature of SPACs.
The Chancery Court’s decision is related to commentary and research on the role of information disclosure in SPACs. Some have argued that an advantage of SPACs over IPOs stems from the view that the Private Securities Litigation Reform Act (“PSLRA”) safe harbor for forward-looking statements applies to SPACs as opposed to IPOs.[3] The logic is that under this safe harbor protection, SPACs are able to provide forward-looking statements to investors that make the business combination more attractive, compared to IPOs.[4]
However, even if this perceived advantage did contribute to the rise in SPACs in 2020–21, others are skeptical about such advantage. Among them is the SEC’s former Acting Director of the Division of Corporation Finance John Coates, who, in a statement delivered while in office, argued that “liability risks for those involved [in SPACs] are higher, not lower, than in conventional IPOs.”[5] Mr. Coates went on to contend that this is particularly true due to “the potential conflicts of interest in the SPAC structure.”[6] A March 2022 SEC proposal along the same lines would require companies to increase disclosure related to conflicts of interest, compensation, and dilution costs related to SPAC transactions.[7]
This article provides economic and financial insight to help frame the role of information in SPAC transactions.
Information Asymmetries in Corporate Finance
Information disclosure serves a clear economic purpose, which is to help alleviate the asymmetry of information between investors and company insiders. Nobel prize recipient George Akerlof used the term “market for lemons” in the used car sales market to illustrate the harm that information asymmetries cause to the market.[8] Akerlof argued that sellers of used cars have more knowledge about the quality of a used car than potential buyers. Because buyers cannot tell cars’ quality apart, the price at which these cars sell must be the same irrespective of true quality. But then the seller of a good quality car cannot receive the true value of the car. He concludes that “bad cars drive out the good because they sell at the same price as good cars.”[9] If left unattended, the market breakdown caused by asymmetric information results in less commerce.
The same issue arises in corporate finance. Investors typically know less about the quality of a given asset compared to those who manage it. To solve information asymmetries and alleviate their cost, a host of contractual solutions, economic institutions, and regulations exist. For example, the IPO underwriting process provides a certification role that entices investors to participate in the IPO even when they have less information than the company insiders.[10] Similarly, in the context of mergers and acquisitions, the acquiring company conducts exhaustive due diligence before completing the acquisition of its target. Finally, regulation and government agencies establish disclosure requirements and monitoring aimed at alleviating the cost of information asymmetries.[11]
Information asymmetries are relevant because the two sides of the trade have different objectives. Going back to Akerlof’s example of a used car, its seller wants to obtain the highest price whereas a prospective buyer wants to pay the lowest price possible. Investors and company insiders might have misaligned incentives as well. For example, CEOs might undertake extravagant investments or engage in self-dealing behavior.[12] This is why a CEO’s compensation package often includes stock options. A CEO only benefits from public stock options when the company’s stock reaches a certain level. To the extent that shareholders prefer a higher stock price, stock options can contribute to aligning CEO and shareholder incentives.[13] I next explain how misalignments between investors and company insiders might apply in the context of SPACs, specifically between SPAC sponsors and investors.
The Role of Information Disclosure in SPACs
SPACs are not immune to the asymmetry of information and diverging interests that exist in financial markets. First, SPAC investors likely have less information about acquisition prospects in general, and the ultimate target company specifically, compared to SPAC sponsors.[14] This is so because the SPAC target is a privately held company often in a nascent industry. And this is more likely to be true if investors are relatively “unsophisticated” (i.e. retail investors compared to institutional investors). Partly because of this, investors can redeem their shares (at the price paid, plus interest) before the completion of the acquisition. This redemption right provides a hedge against pre-acquisition risk as it allows the SPAC investor to cash the shares and recover the full investment irrespective of the market price of the SPAC share at the time. Furthermore, a recent feature of the last wave of SPACs decouples the acquisition vote from the redemption decision. That is, the SPAC investor can redeem her shares and vote “yes” to the acquisition, if she wishes to do so. Klausner et al. report an average redemption rate of 58% for their 2019–20 merger cohort, indicating that a majority of SPAC shares are redeemed before the acquisition is completed.[15]
Second, existing literature posits that conflicts of interest between SPAC sponsors and SPAC investors are also likely to exist.[16] Initially, SPAC sponsors typically hold 20% to 30% of the SPAC’s equity (the “promote”) in the form of common shares. However, they pay less than SPAC investors for these common shares.[17] While having skin in the game typically helps alleviate differing interests between investors and SPAC insiders (as I have argued above with the use of stock options in publicly traded companies), the fact that SPAC sponsors acquire their equity stake at a significantly lower price than SPAC investors can create conflicts. Two observations are worth mentioning here. First, if the SPAC finds no acquisition target, the SPAC is liquidated and the funds raised in the SPAC’s IPO, which sit in a trust, are returned to investors (with interest). Because the promote has no redemption rights, SPAC sponsors can only make a profit if the business combination is completed. Second, because SPAC sponsors pay less (per share) than SPAC investors, there is a range of acquisition prices for which SPAC investors earn negative returns whereas SPAC sponsors’ returns are positive. The evidence provided below indicates that this scenario might not be uncommon.
Thus, in the presence of information asymmetries and diverging interests, the role of (credible) information disclosure can play an important role. The safe harbor debate introduced at the beginning of this article can be analyzed in this context. Any credible information about the acquisition proposed by SPAC sponsors is likely to help investors decide to vote in favor of or against the business combination, and whether to redeem the SPAC shares. Forward-looking projections provided in the acquisition prospectus are part of this information set. The evidence summarized below indicates that indeed this information is relied upon by those investors more likely to suffer a bigger information gap vis-à-vis SPAC sponsors.
What Do Current Studies Tell Us About SPACs and the Role of Information Disclosure?
Several studies have calculated annualized returns, a common measure of performance, for SPACs. For purposes of this article, I focused on studies that include the latest wave of SPAC transactions.[18] Table 1 below provides average returns reported in three studies. These returns correspond to common shares and do not include returns stemming from any warrants or rights.[19] Moreover they are adjusted by the returns on a comparable basket of securities, that is, they are calculated as the SPAC’s excess return over a comparable index.
As shown in Table 1, all studies show that pre-de-SPAC returns are on average positive. In contrast, these studies show average negative de-SPAC returns. In other words, a SPAC investor who redeemed their shares before the acquisition would have more than recovered their investment (consistent with SPAC’s redemption rights), whereas an investor holding onto their common shares past the completion of the acquisition would have, on average, lost money during the first year.
Table 1. Summary of SPAC Performance, by SPAC Period and Study[20]
Study
Sample Size
(Number)
Sample Period
Pre-de-SPAC Share Returns
(Ann. %)
De-SPAC Share Returns
(1-year %)
Gahng, Ritter, and Zhang (2021)
210
01/2010 – 12/2019
15.9%
-24.7%
Klausner, Ohlrogge, and Ruan (2021)
47
01/2019 – 06/2020
11.6%
-34.9%
Dambra, Even-Tov, and George (2022)
121
01/2010 – 12/2020
N/A
-31.5%
The averages above paint only part of the picture as variation across transactions exists. For example, Gahng et al. found that:
More reputable lead underwriters are associated with higher SPAC and de-SPAC returns;
deals with more potential dilution (based on warrants and rights present in each unit) perform relatively worse in terms of de-SPAC returns; and
high redemption rates and longer timelines to close the business combination are both associated with lower subsequent de-SPAC returns.
Turning now towards the issue of information disclosure, studies on SPAC’s disclosure of forward-looking statements report that a majority of de-SPACs provide at least one financial projection. Dambra et al. found that 85% of their sample of SPACs provided revenue forecasts in their investor presentations.[21] Blankespoor et al. found that 80% of the transactions in their sample provided at least one financial projection, with revenue and EBITDA being the most common forms.[22]
Furthermore, Dambra et al. draw several conclusions from their study. First, they found evidence that revenue forecasts are biased overall. Second, they found that “SPAC investors respond favorably to merger announcements as a function of the revenue CAGR disclosed in the investor presentations.”[23] Indeed, returns around the time of the investor presentations are larger the higher the revenue growth disclosed in that presentation.[24] Third, they found that retail investors engage in more trading when revenue growth forecasts are higher, but they did not find the same pattern when institutional investor trading was analyzed.[25] They interpret this result to suggest that such disclosures get the attention of relatively less sophisticated investors.
In summary, economic research performed so far indicates that the average poor performance of de-SPAC transactions highlights the importance of information disclosure to investors, particularly retail investors. Thus, changes in regulation in that regard will most likely dictate the course and popularity of SPACs going forward. The debate generated around the recent SEC proposal is testimony of that.[26] Stay tuned.
Econ One Research, 550 South Hope Street, Suite 800, Los Angeles, CA, 90071, USA. E-mail correspondence: [email protected].
For a summary of SPAC features, see Gahng, M., Ritter, J., and Zhang, D., “SPACs,” SSRN Working Paper, January 29, 2021; and Klausner, M., Ohlrogge, M., and Ruan, E., “A Sober Look at SPACs,” Yale Journal of Regulation, January 2022. ↑
In re Multiplan Stockholders Litigation, consolidated case number 2021-0300 (Delaware Court of Chancery, January 3, 2022) at p. 56. Seealso, Jacques, F., “The Evolving Landscape of SPACs,” Business Law Today, February 7, 2022. ↑
Blankespoor, E., Hendricks, B., Miller, G., and Stockbridge, D., “A Hard Look at SPAC Projections,” Management Science, March 24, 2022. ↑
Securities and Exchange Commission, File No. S7-13-22. ↑
Akerlof, G., “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” Quarterly Journal of Economics, vol. 84, no. 3, Oxford University Press, 1970, pp. 488–500. ↑
Tirole at pp. 16-17. Some also argue that CEOs might be overconfident. See Kaplan S., Sørensen, M., and Zakolyukina, A., “What is CEO overconfidence? Evidence from executive assessments,” Journal of Financial Economics, 2021. Whatever a CEO’s objective might be, the implication is that they may undertake actions that are not in the best interest of shareholders unless there are proper incentives in place. ↑
Id. at pp. 20-25, where problems with the design of stock options are also discussed. ↑
In turn, as in most acquisitions, SPAC sponsors might also have less information about the target company than the target management in place at the time of the acquisition. ↑
See Klausner et al. at p. 19. Gahng et al. report a 37% average redemption ratio (p. 57). ↑
See Klausner et al. at p. 23. Additionally, the SEC argues that there can be conflicts between non-redeeming shareholders and redeeming shareholders holding onto warrants. See SEC File No. S7-13-22, p. 172. ↑
As explained in Gahng et al., “[t]ypically, the units purchased by investors include Class A shares that can vote on a merger and are redeemable. The sponsors purchase Class B shares that do not have voting privileges and are not redeemable but will convert into Class A shares, which will be subject to lockup restrictions, when a merger is completed. The sponsors typically pay a total of $25,000 for 5,000,000 or more Class B shares, a price of about 0.5 cents per share.” (p. 1). On the other hand, SPAC investors typically pay $10 a unit. ↑
For earlier studies, see Kolb, J., and Tykvová, T., “Going public via special purpose acquisition companies: Frogs do not turn into princes,” Journal of Corporate Finance, volume 40, 2016, pp. 80-96. See also, Dimitrova, L., “Perverse incentives of special purpose acquisition companies, the ‘poor man’s private equity funds,’” Journal of Accounting and Economics, volume 63, issue 1, 2017, pp. 99-120. These studies found de-SPAC underperformance, as explained further below. ↑
Antitrust in labor markets remains a hot topic for government, business, and labor. Consistent with the Biden administration’s “Executive Order on Promoting Competition in the American Economy,” the antitrust enforcement agencies continue to push the use of the antitrust laws to enhance the mobility and bargaining power of employees. On July 26, 2022, the U.S. Department of Justice’s Antitrust Division and the National Labor Relations Board (NLRB) entered into a memorandum of understanding (MOU) to strengthen the agencies’ partnership through greater coordination in information sharing, investigations and enforcement activity, training, education, and outreach.[1] Similarly, on July 19, the U.S. Federal Trade Commission entered into a separate MOU with the NLRB “outlin[ing] ways in which the Commission and the [NLRB] will work together moving forward on key issues such as labor market concentration, one-sided contract terms, and labor developments in the ‘gig economy.’”[2]
Developments in litigation related to antitrust considerations in labor markets have also been significant, as state and federal courts continue to work through the recent spate of filed cases that challenge no-hire provisions. In June 2022, McDonald’s obtained a judgment on the pleadings, ending the antitrust litigation challenging the legality of the no-hire restraint in its franchise agreements. McDonald’s convinced the court that its previous inclusion of no-hire clauses within its franchise agreements did not violate Section 1 of the Sherman Act. Ultimately, the court’s decision turned on the application of the rule of reason, as opposed to per se treatment or quick-look, which the plaintiffs argued were the proper standards to apply to the no-hire clauses. The court also rejected the plaintiffs’ argument that the relevant geographic market for analyzing McDonald’s market power was limited to only McDonald’s-branded restaurants nationally. The decision reaffirms the application of traditional antitrust principles in buy-side labor markets, despite the considerable pressure from politicians, government enforcement agencies, and the U.S. Plaintiffs’ Class Action Bar to apply heightened antitrust scrutiny to these restraints.
Deslandes v. McDonald’s USA LLC
On June 28, 2017, plaintiff Leinani Deslandes, a McDonald’s employee, filed a class-action complaint against McDonald’s in Illinois federal court, alleging that the company violated Section 1 by including a no-hire provision in its franchise agreements. In 2019, a nearly identical class-action complaint was filed by plaintiff Stephanie Turner in the same court, and the cases were combined for litigation.[3] Both plaintiffs sought to represent former and current employees of McDonald’s who allegedly suffered from wage suppression and limited competition as a result of the no-hire clauses.
Until 2017, McDonald’s franchise agreements contained no-hire clauses that prohibited franchisees from employing or seeking to employ individuals who worked for other McDonald’s restaurants. These restraints applied to all other McDonald’s restaurants, including restaurants owned and operated by McDonald’s corporation or its subsidiaries. The plaintiffs alleged the restrictions limited the employment opportunities available to McDonald’s employees, which resulted in suppressed wages.
Court Grants McDonald’s Motion for Judgment on the Pleadings
On June 28, 2022, the court granted McDonald’s motion for judgment on the pleadings.[4] Having previously partially granted McDonald’s motion to dismiss and having denied the plaintiffs’ motion for class certification, the only claims remaining before the court were plaintiff Deslandes and plaintiff Turner’s individual claims against McDonald’s for violation of Section 1.[5]
McDonald’s argument for judgment on the pleadings relied heavily on the court’s previous denial of the plaintiffs’ motion for class certification in which the court held the rule of reason, as opposed to quick-look analysis, applied to the no-hire provisions.[6] McDonald’s argued that the plaintiffs had failed to plead the relevant markets in which they sold their labor, let alone that McDonald’s had market power in the relevant markets, and therefore, the plaintiffs could not prove their claims as a matter of law.
In response, the plaintiffs alleged that while the court had rejected the application of quick-look analysis, the no-hire provision could still be found to be per se illegal. The plaintiffs also argued that they were not required to plead legal theories and therefore, were not required in their complaints to define the relevant markets. Lastly, the plaintiffs argued that employment by McDonald’s constituted its own market, and therefore, the relevant market was the national market of McDonald’s restaurants.
The court rejected each of the plaintiffs’ arguments in turn. The court found that the plaintiffs’ claims “‘presumptively’ call for rule of reason analysis” based on the Supreme Court’s recent decision in NCAA v. Alston,[7] and because the plaintiffs specifically alleged the restraint was part of a franchise agreement. Therefore, it was ancillary to an agreement that was output enhancing.[8]
Next, the court rejected the argument that the plaintiffs were not required to plead the relevant market.[9] The court acknowledged that the plaintiffs did not need to plead legal theories but ruled they did need to plead sufficient facts to support a judgment in their favor, and by failing to plead the relevant market, the plaintiffs could not show that the noncompete clauses were unlawful.[10]
Lastly, the court rejected as implausible the plaintiffs’ contentions that the relevant market was the national market of McDonald’s restaurants.[11] The court instead accepted McDonald’s argument that the relevant market was the market for quick-service food employees in the immediate area (within ten miles) in which the plaintiffs lived.[12] The court noted that unlike certain high-level positions, such as chief executive officers, companies do not undertake national searches for candidates to fill the positions at local fast-food establishments, and therefore, the relevant labor market could not be a national market.[13]
Although the court had rejected all of the plaintiffs’ arguments, it did not stop there, ruling that even if it were inclined to grant the plaintiffs’ request for leave to amend their pleadings, the amendment would be futile.[14] The court stated that because the relevant market was the local labor market in close proximity to where the plaintiffs reside, the plaintiffs could not possibly allege that McDonald’s had market power in the relevant markets.[15] The court cited to the undisputed fact that 517 quick-service restaurants were within ten miles of plaintiff Deslandes’s home, and 253 quick-service restaurants were within ten miles of plaintiff Turner’s home.[16] This undisputed evidence established conclusively that the plaintiffs could not prove that McDonald’s had significant market power within the relevant market for either plaintiff.[17]
The plaintiffs filed a notice of appeal of the order dismissing their claims on July 27, 2022.
Conclusion
The court’s ruling in McDonald’s is good news for franchisors and, more generally, firms that use ancillary restraints, such as no-hire or no-poach provisions. First and foremost, the McDonald’s ruling reinforced the viability of the ancillary restraint doctrine and that courts remain open to considering, on a case-by-case basis, whether no-hire provisions are ancillary to the broader agreement. Parties that want their no-hire provision to be deemed ancillary should take the time to document their legitimate business interest for the provision and the relationship between that interest and the lawful, beneficial goals of the parties’ overarching agreement.
Second, the McDonald’s ruling reinforced the traditional rule that ancillary restraints are presumptively evaluated under the rule of reason. This was particularly notable in McDonald’s, which addressed no-hire provisions in the franchise context and where the defendant has company-owned stores that compete against its franchisees. Despite the plaintiffs’ arguments that the court should apply the quick-look or subject the noncompete clauses to per se treatment, the court maintained and ultimately dismissed the litigation on the application of the rule of reason. The court’s consistent application of the rule of reason is notable because like the plaintiffs, federal antitrust enforcement agencies and legislators have been advocating for heightened scrutiny of restraints in labor markets that, they argue, tend to suppress wages and employee mobility. The court’s application of the rule of reason helps allow franchisors to protect themselves and their interests with no-hire clauses, provided the clauses are ancillary to franchise agreements.
Lastly, this decision shows how difficult it will be for employees to claim that buy-side restraints caused them harm. Determinations as to the relevant market and the market power within the relevant market are fact-specific determinations unique to each plaintiff. By ruling that the relevant market in McDonald’s was quick-serve restaurants, as opposed to just other McDonald’s restaurants, the plaintiffs could not claim that the restraints prevented them from working. And, because the relevant market was not the national market, but instead a more local market near the plaintiffs’ residence, the nationwide class claims failed.
The decision of a single court will not deter the federal and state agencies in their effort to improve the bargaining position and mobility of the U.S. workforce. In fact, civil litigants who have sought to rely on the McDonald’s decision in unrelated cases have been met with DOJ intervention and pushback.[18] Similarly, we would expect the DOJ and perhaps other agencies to seek to participate in the appeal of the McDonald’s decision.
Deslandes v. McDonald’s USA, LLC, No. 1:17-cv-4857 (N.D. Ill. June 28, 2017); Turner v. McDonald’s USA, LLC, 19-cv-5524 (N.D. Ill. August 15, 2019). ↑
The parties cross moved for summary judgment, and McDonald’s also moved for judgment on the pleadings. Deslandes v. McDonald’s USA, LLC, No. 1:17-cv-4857, at 1-2 (N.D. Ill. June 28, 2022). ↑
Deslandes v. McDonald’s USA, LLC, No. 1:17-cv-4857, at 18 (N.D. Ill. June 25, 2019); Deslandes v. McDonald’s USA, LLC, No. 1:17-cv-4857, at 27 (N.D. Ill. July 18, 2021). ↑
Deslandes v. McDonald’s USA, LLC, No. 1:17-cv-4857, at 7-12 (N.D. Ill. July 18, 2021). ↑
The Eastern District of Pennsylvania Bankruptcy Conference (EDPABC) is a non-profit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.
MATERIALS PREVIEW
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, 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 “Dr. Hibbert and Dr. Nick,” describes the highly contentious chapter 11 case of a joint venture formed by the two doctors. Dr. Hibbert filed for the joint venture after escalating disagreements resulted in Dr. Nick (through a family trust) seizing its medical equipment to open a competing practice next door. The hypothetical poses questions relating to the automatic stay, extensions of time under section 108 of the Bankruptcy Code and redemption rights, cause to appoint a chapter 11 trustee, and competing chapter 11 plans.
DR. HIBBERT AND DR. NICK
After completing their respective radiology residency programs, Dr. Hibbert and Dr. Nick open an outpatient imaging center together. The joint business venture is funded by a revolving loan from a traditional bank (the Bank) secured against medical receivables and a purchase money loan from Dr. Nick’s family trust (the Nick Trust) secured by the imaging equipment. The two doctors obtain a single National Provider Identifier (NPI) from the Centers for Medicare and Medicaid Services (CMS).
Several years later, the two doctors have a falling out. Dr. Hibbert accuses Dr. Nick of being a quack physician engaged in dubious patient acquisition and billing practices. Dr. Nick accuses Dr. Hibbert of stealing money from the company, defaming him in front of patients, and sleeping with his spouse.
Dr. Hibbert, who has sole check writing authority over the business’ deposit accounts, opts to fail to make the next payment due to the Nick Trust on the equipment loan. The Nick Trust opts to notice the default, accelerate the loan, and demand payment in full. Dr. Hibbert opts not to fund Dr. Nick’s next payroll check.
The Nick Trust then opts to utilize some self-help of its own. In full compliance with applicable law, the Nick Trust repossesses the imaging equipment and moves it into adjoining medical office space—newly leased by the Nick Trust. Without the imaging equipment, Dr. Hibbert is unable to provide patient services.
Four days later, Dr. Nick announces the grand opening of “Dr. Nick’s Medical Imaging Center.” Dr. Nick begins providing services to patients utilizing the imaging equipment. Dr. Nick also issues reimbursement requests for such services to CMS using the NPI.
Unable to continue to operate, Dr. Hibbert files a voluntary petition for chapter 11 bankruptcy protection on behalf of the joint business venture. Four days later, Debtor’s counsel sends a letter to the Nick Trust demanding the return of the imaging equipment and threatening sanctions for its willful violation of the automatic stay. The Nick family accountant, who solely controls the Nick Trust, ignores the letter.
Debtor’s counsel ultimately files a motion, pursuant to 11 U.S.C. § 542 and 11 U.S.C. § 362(k), seeking turnover of the medical equipment as estate property and sanctions against the Nick Trust. The Nick Trust responds that it lawfully repossessed the imaging equipment prepetition and has only passively retained it since its repossession.
Discovery confirms that the Nick family accountant, (a) repossessed the imaging equipment at the request of Dr. Nick with actual knowledge of Dr. Nick’s retaliatory goal vis-à-vis Dr. Hibbert, but (b) was unaware that Dr. Nick had been using the imaging equipment because Dr. Nick effectively concealed the same from the Nick family accountant.
Question #1
Has the Nick Trust willfully violated the automatic stay?
Citing the Third Circuit’s decision in In re: Denby-Peterson, the bankruptcy court holds that the Nick Trust did not violate the automatic stay willfully because the Nick Trust’s possession of the imaging equipment post petition had been passive. The issue is appealed to the Supreme Court, which grants the writ of certiorari to resolve the circuit split among the Second Circuit, the Third Circuit, and the Tenth Circuit. If you were a Supreme Court Justice, how would you decide the issue?
Assume that the bankruptcy court’s order is not appealed. Instead, new evidence comes to light that the Nick family accountant was aware that Dr. Nick had been using the imaging equipment and, in fact, had worked with Dr. Nick to accomplish his scheme of opening “Dr. Nick’s Medical Imaging Center.” With this new evidence in hand, Dr. Hibbert seeks reconsideration of the bankruptcy court’s order.
In response, the Nick Trust presents a written agreement among Dr. Hibbert, Dr. Nick, and the Nick Trust entitled the “Discounted Repayment Option Contract” (the Agreement). The Agreement provides that Dr. Hibbert will deliver the imaging equipment to the Nick Trust at the adjoining medical office space leased by the Nick Trust.
It further provides Dr. Hibbert and Dr. Nick with the option, but not the obligation, to make a discounted repayment of the equipment loan owed to the Nick Trust in exchange for a return of the imaging equipment. Under the terms of the Agreement, such discounted repayment must occur within seven days of the date of the Agreement.
If such discounted repayment is not timely made, the Agreement provides the Nick Trust with the option, but not the obligation, to retain the imaging equipment in full satisfaction of the equipment loan.
If neither option is exercised, the Nick Trust may pursue its common law rights and remedies. The Agreement is silent as to what the Nick Trust may do with the equipment while in possession of it.
The Nick Trust argues that it did not violate the automatic stay willfully because the debtor did not make the discounted repayment within the seven-day time period. Further, the debtor’s counsel’s demand letter was not sent until after the seven-day time period had expired.
The debtor’s counsel replies that the Agreement provides for a cure period with respect to the payment default under the equipment loan. The debtor’s counsel further argues that the Agreement is analogous to a common law equitable right of redemption. Therefore, 11 U.S.C. § 108(b) extends the time period under which the debtor may make the discounted repayment to the sixtieth day following the petition date. The argument being that the Agreement “fixes a period within which the debtor … may … cure a default, or perform any similar act.”
The Nick Trust sur-replies with the following arguments. Any and all cure rights under the agreement documenting the equipment loan have indisputably expired. Further, a discounted repayment is not a cure, or similar to a right of redemption, because payment in full is not being made.
Moreover, the Agreement is a standalone option contract. Because the Agreement creates options, and not obligations, the debtor is not in default of the Agreement. Because the debtor is not in default of the Agreement, 11 U.S.C. § 108(b) does not apply because there is no default to be cured. Further, the exercise of an option under an option contract is not similar to curing a default under the contract.
Question #2
Does 11 U.S.C. § 108(b) extend the deadline under the Agreement by which the debtor must exercise the option to make the discounted repayment?
Assume that the Agreement did not contain mutual options between the debtor and the Nick Trust. Instead, assume that the Agreement provided the debtor with the unilateral option to make the discounted repayment within the seven-day time period and that, if such discounted repayment was not timely made, the Agreement automatically and immediately terminated. Under these facts, the Nick Trust argues that 11 U.S.C. § 108(b) does not apply because the prerequisite of the existence of “an agreement” is no longer satisfied, i.e., 11 U.S.C. § 108(b) can only be used to extend cure or similar rights under non-terminated agreements. Can 11 U.S.C. § 108(b) be used to extend the post-petition termination of the Agreement?
Do any of these new facts impact your view as to whether the Nick Trust willfully violated the automatic stay?
The bankruptcy court ultimately orders the Nick Trust to return the imaging equipment to the debtor. With the equipment returned, Dr. Hibbert recommences the debtor’s operations.
Unhappy with the result, Dr. Nick and the Nick Trust pursue a scorched-earth litigation strategy in the bankruptcy case, using their combined equity and secured creditor rights to oppose every motion filed by the debtor, to bring their own motions, and to commence adversary proceedings against the debtor and Dr. Hibbert. Dr. Nick and the Nick Trust make it a point to ensure that every hearing in the case becomes a multiple-day affair. They instruct their counsel to summarily reject any requests made by the debtor, when legally permitted to do so, to be completely unhelpful to the debtor’s counsel, and to approach every issue with a tone of righteous indignation and rancor.
Their strategy results in a few initial victories in the bankruptcy court. As a result, Dr. Hibbert and the debtor’s counsel feel compelled to no longer take the high road and instead fight fire with fire. Thus, Dr. Hibbert and the debtor return the favor by pursuing their own scorched-earth litigation strategy.
Exclusivity under 11 U.S.C. § 1121 expires without the debtor filing a plan. At the first opportunity, the Bank files a proposed plan of liquidation. Dr. Hibbert responds with a competing plan of reorganization. Dr. Nick and the Nick Trust respond with their own competing plan of reorganization.
During the second day of oral argument on the parties’ respective first amended disclosure statements, the bankruptcy court makes the off-hand, somewhat joking comment, “There is so much acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust that I’m considering the sua sponte appointment of a chapter 11 trustee pursuant to the Third Circuit’s decision in In re Marvel Entertainment Group.”
Dr. Nick and the Nick Trust seize on the comment and the next day file a motion for the appointment of a chapter 11 trustee for “cause” pursuant to 11 U.S.C. § 1104. The sole basis for the motion is the alleged clear and convincing evidence of the “acrimony” among Dr. Hibbert, Dr. Nick, and the Nick Trust, which has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases.
Dr. Hibbert and the debtor oppose the motion, arguing that the level of acrimony in the case is legally insufficient and, in any event, Dr. Nick and the Nick Trust created the acrimony and, therefore, should not obtain relief based on it.
Because the Bank may or may not have properly perfected its security interest in the medical receivables—which issue has so far gone unnoticed because of the focus on the issues among Dr. Hibbert, Dr. Nick, and the Nick Trust—the Bank also summarily opposes the motion.
Question #3
If you are representing Dr. Nick and the Nick Trust, how would you present clear and convincing evidence of legally sufficient acrimony to carry your motion?
If you are representing Dr. Hibbert or the debtor, how do you present evidence of a lack of legally sufficient acrimony to carry your objection to the motion?
What facts are required to be proven by clear and convincing evidence to establish that the acrimony has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases?
At the hearing, the Bank concedes that the acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases. Nevertheless, the Bank argues that the acrimony in the case is legally insufficient for the appointment of a trustee because the appointment of a trustee is not the only effective way to move the case forward. Instead, the Bank argues that because competing plans have been filed, all that is left to do in the case is hold a vote on the plans. Is the Bank’s argument persuasive?
The bankruptcy court agrees with the Bank and does not appoint a chapter 11 trustee. As a result, the Bank’s proposed plan of liquidation is confirmed. Given that an independent, undistracted fiduciary may have uncovered the potential issues with the Bank’s security interest, has the case nevertheless reached an acceptable result?
List of Authorities for Question #1
11 U.S.C. § 542
(a) Except as provided in subsection (c) or (d) of this section, an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.
…
(b) Except as provided in section 362(a)(7) of this title, an entity that has neither actual notice nor actual knowledge of the commencement of the case concerning the debtor may transfer property of the estate, or pay a debt owing to the debtor, in good faith and other than in the manner specified in subsection (d) of this section, to an entity other than the trustee, with the same effect as to the entity making such transfer or payment as if the case under this title concerning the debtor had not been commenced.
…
(e) Subject to any applicable privilege, after notice and a hearing, the court may order an attorney, accountant, or other person that holds recorded information, including books, documents, records, and papers, relating to the debtor’s property or financial affairs, to turn over or disclose such recorded information to the trustee
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
…
(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
(4) any act to create, perfect, or enforce any lien against property of the estate;
…
(k)
(1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.
(2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages.
In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019)
Factual Background
Ms. Denby-Peterson purchased a Chevrolet Corvette, which was repossessed pre-petition by secured creditors following a payment default. Ms. Denby-Peterson subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). Denby-Peterson notified the secured creditors of her bankruptcy filing and demanded they return the Corvette. The creditors refused, prompting Denby-Peterson to file motions for turnover of estate property pursuant to 11 U.S.C. § 542 and for sanctions for willful violation of the automatic stay under 11 U.S.C. § 362(k).
The Bankruptcy Court held a hearing on these matters, granting the motion for turnover but denying the motion for sanctions. The sanctions motion was denied on the basis that there could be no willful violation of the stay absent violation of the turnover order, which obviously had yet to occur. Denby-Peterson appealed the denial of the sanctions motion, but the U.S. District Court for the District of New Jersey (the District Court) upheld the Bankruptcy Court’s rulings. Denby-Peterson then appealed once again, this time to the U.S. Court of Appeals for the Third Circuit (the Court).
Court’s Analysis
The Court was confronted with the question of whether passive retention of collateral seized pre-petition constituted a “willful violation” of the automatic stay. The Court answered this question in the negative and therefore upheld the District Court’s ruling affirming the Bankruptcy Court. The Court looked to the obligations governing turnover of collateral in 11 U.S.C. §§ 362 and 542 and found that these obligations were not “self effectuating.” While the turnover provision of § 542 is mandatory, the Court noted that it is not automatic—certain statutory conditions must be met to trigger the turnover obligations, e.g. 11 U.S.C. § 542(a). To allow a debtor to demand turnover absent fulfillment of these statutory conditions would be to allow the stripping of a creditor’s property without due process. Rather than approve Denby-Peterson’s self-effectuating interpretation of § 542 turnover, the Court instead held that the turnover provisions do not take effect until they are empowered by judicial order.
Turning to 11 U.S.C. § 362(k), the Court found that retention of property seized pre-petition did not constitute the necessary “exercise of control” to give rise to sanctions. Looking to the statutory language, the Court concluded that “exercise of control” requires an affirmative act on the part of the party accused of violating the stay. The Court held that mere passive retention of property already in a party’s possession did not rise to the level of an affirmative act. Without such an affirmative act, there was no “exercise of control,” and without that, there could be liability under § 362(k). To button the issue up, the Court referenced the Supreme Court’s decision in Maryland v. Strumpf, 516 U.S. 16 (1995), which allowed a bank to freeze and retain a debtor’s assets without violating the stay. The Court found that this ruling would not be reconcilable with a requirement that turnover of assets be automatic and self-effectuating.
Weber v. SEFCU (In re Weber), 719 F.3d 72 (2d Cir. 2013)
Factual Background
This case concerned a secured creditor (Creditor) seizing a debtor’s vehicle pre-petition owing to payment default. Debtor subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the Northern District of New York (the Bankruptcy Court), of which Creditor was aware. Creditor nonetheless failed to return possession of Debtor’s vehicle after becoming aware of its bankruptcy petition. Debtor subsequently filed an adversary proceeding requesting turnover of the vehicle under 11 U.S.C. § 542 and sanctions pursuant to 11 U.S.C. § 362(k). Creditor returned the vehicle following the adversary action, but maintained that it could not be liable for sanctions under § 362(k) as it had not been holding the vehicle in violation of any turnover order. This understanding had previously been articulated by the U.S. District Court for the Northern District of New York (the District Court) in the case of Manufacturers & Traders Trust Co. v. Alberto (In re Alberto), 271 B.R. 223 (N.D.N.Y. 2001). The Bankruptcy Court determined that Creditor was in compliance with Alberto, and therefore could not be subject to sanctions under § 362(k).
Debtor appealed that decision to the District Court, which overturned its earlier Alberto decision. Relying primarily on the Supreme Court case of United States v. Whiting Pools, Inc., 462 U.S. 198 (1983), the District Court found that Creditor had been required to return the vehicle as soon as it was aware of the bankruptcy filing. To retain control over the vehicle was “exercising control” over it in violation of § 362, meaning that Creditor was liable for sanctions under § 362(k). Creditor subsequently appealed the District Court’s decision to the U.S. Court of Appeals for the Second Circuit (the Court).
Court’s Analysis
The Court first determined that the text of 11 U.S.C. §§ 541 and 542 required that all of the assets of a debtor’s estate be returned to the debtor at the filing of a bankruptcy case; doing so was necessary to build and administer the estate. Citing heavily to Whiting Pools, the Court found that retaining property of the estate that was repossessed pre-petition effectively deprives the estate of that property. To avoid this, a creditor must return any estate property to the debtor at the filing of the estate. Doing so does not surrender the creditor’s interest in the property; it is merely a surrender of physical possession.
The Court next turned to the question of whether the turnover provision was “self-effectuating,” or, as the Alberto court had held, was only implicated upon entry of an order for turnover. The Court found that, by the language of § 541 detailing what constituted “property of the estate,” any property in which the debtor had an interest held by anyone anywhere at the time of the filing becomes property of the estate. The Court reasoned that this would be incompatible with the Alberto court’s ruling that turnover is not self-effectuating. By retaining control of the vehicle, Creditor had been “exercising control” over it; no affirmative act was necessary, as the property was unquestionably estate property which was in Creditor’s control. To retain control of estate property after the filing of the petition was a violation of the automatic stay.
The Court last addressed whether Creditor could still be liable for sanctions under 11 U.S.C. § 362(k) despite its reliance on the precedent of Alberto. Considering the question of whether the stay violation was “willful,” the Court determined that nothing prevented Creditor from surrendering Debtor’s vehicle at the time Debtor requested. Creditor simply chose to retain possession of the vehicle because it felt case law entitled it to do so. The “willful” in 11 U.S.C. § 362(k), according to the Court, meant only that the stay violation was a voluntary act. The Court did not read any specific intent requirement into § 362(k). Given that Creditor chose to retain the vehicle—and unwittingly violate the stay—of its own free will, the violation was “willful” under § 362(k) and the Creditor was liable for damages.
WD Equip., LLC v. Cowen (In re Cowen), 849 F.3d 943 (10th Cir. 2017)
Factual Background
Jared Cowen (Debtor) owned two commercial trucks, both of which were repossessed under questionable and possibly fraudulent circumstances. Debtor filed a chapter 13 petition in the Bankruptcy Court for the District of Colorado (the Bankruptcy Court) and demanded the creditors return his two trucks. Both creditors refused; one claimed that he had transferred legal title of the truck over to his own name pre-petition, and the other claimed that the truck had been sold to an unknown Mexican national for cash in an undocumented sale, though a bill of sale was later produced. Debtor filed a motion for sanctions for willful violation of the automatic stay owing to both creditors’ failure to turn over the trucks, which he alleged were property of his bankruptcy estate. The Bankruptcy Court agreed with Debtor, finding that the documentation showing that his legal interest in both trucks had been forged, the failure to return the trucks violated 11 U.S.C. § 362(a)(3), and awarding damages pursuant to 11 U.S.C. § 362(k). That order was substantively affirmed on appeal to the U.S. District Court for the District of Colorado (the District Court). The creditors thereafter appealed to the U.S. Court of Appeals for the Tenth Circuit (the Court), arguing that their retention of the trucks, or proceeds of the trucks, did not constitute an “act” to “exercise control of” estate property, as the trucks were seized pre-petition.
Court’s Analysis
The question before the Court was whether the passive retention of estate property seized pre-petition constitutes a violation of the automatic stay after notice of a bankruptcy filing. The Court noted that the Bankruptcy Court and the District Court seemingly subscribed to the “majority view” of this question, which holds that such activity is a violation of the automatic stay. In reversing the District Court, the Court held that the majority view took a policy-driven approach not supported by the text of the Bankruptcy Code. The Court put particular emphasis on the word “act” in 11 U.S.C. 362(a)(3): “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” The Court reasoned that the requirement that there be an “act” meant that an affirmative post-petition action on the part of the creditor was necessary to incur liability for a stay violation. Mere passive retention of property seized pre-petition did not rise to that level. The Court further elaborated that the majority view’s reliance on reading § 362(a)(3) in conjunction with 11 U.S.C. § 542 also was unsupported by the text, as the two provisions had no intertextual connection. The Court expressed its belief that if Congress had intended to add an affirmative obligation of turnover to the automatic stay provisions of 11 U.S.C. § 362(a)(3), it would have done so explicitly; Congress does not “hide elephants in mouseholes.” The Court finished by noting that its holding did not absolve the creditors of liability under § 362(k), as their fraudulent acts taken to effect and conceal their repossession of the estate property constituted “acts” within the scope of 11 U.S.C. § 362(a)(3).
List of Authorities for Question #2
11 U.S.C. § 108
(a) If applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor may commence an action, and such period has not expired before the date of the filing of the petition, the trustee may commence such action only before the later of—
(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or
(2) two years after the order for relief.
(b) Except as provided in subsection (a) of this section, if applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor or an individual protected under section 1201 or 1301 of this title may file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the date of the filing of the petition, the trustee may only file, cure, or perform, as the case may be, before the later of—
(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or
(2) 60 days after the order for relief.
Counties Contracting & Constr. Co. v. Constitutional Life Ins. Co., 855 F.2d 1054 (3d Cir. 1988)
Factual Background
The issue in this case was whether a life insurance policy’s grace period for premium payments was extended, and if so, for how long. Debtor held a life insurance policy on one of its employees through Constitutional Life Insurance Co. (Insurer). The life insurance policy included a statutorily mandated 31-day grace period for late premium payments. Debtor failed to pay the premium, but then filed for chapter 11 bankruptcy within the grace period. After having filed for bankruptcy, Debtor received multiple notices of its failure to pay the premiums. Debtor never paid the overdue premiums. The insured employee died shortly thereafter, and Debtor demanded payment under the policy.
Debtor’s argument was that 11 U.S.C. § 362(a)(3)’s prohibition against obtaining property of the estate operated to stay the grace period indefinitely. Insurer argued that, at most, 11 U.S.C. § 108(b)(2) had afforded Debtor a 60-day extension of the grace period, which had already expired. The parties voluntarily withdrew the reference to the U.S. District Court for the Eastern District of Pennsylvania (the District Court), which ruled in favor of Insurer. Debtor then appealed to the U.S. Court of Appeals for the Third Circuit (the Court).
Court’s Analysis
The Court ruled in favor of Insurer and affirmed the District Court’s ruling. The Court determined that 11 U.S.C. § 108(b)(2) operated to afford debtors an additional 60 days to take any action that they otherwise would have been able to take prior to filing for bankruptcy, so long as the time for doing so had not expired as of the bankruptcy filing. This was the case with the grace period for payment of the overdue premiums, so Debtor had an additional 60 days from the date of filing to pay those premiums and thereby keep the insurance policy in place. The Court explained that the purpose of 11 U.S.C. § 108(b) was to give debtors an opportunity to preserve those rights that they otherwise would have had during the administratively complicated time of a bankruptcy filing. As the grace period was a cure period, 11 U.S.C. § 108(b) plainly applied to the insurance policy, as it allowed debtors additional time to “cure a default, or any other similar act.” Allowing 11 U.S.C. § 362 to act as an indefinite stay of cure periods would be counter to public policy, as bankruptcy debtors would be able to enjoy whatever rights they otherwise may have had for the entire duration of the bankruptcy—a clearly unintended result, especially given the inclusion of § 108(b). The decision of the District Court was therefore affirmed.
In re Hric, 208 B.R. 21 (Bankr D.N.J. 1997)
Factual Background
Debtor filed for a petition for chapter 13 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Court). Prior to the filing of the petition, Debtor had defaulted on his mortgage payment and his home was subsequently foreclosed upon. The house was sold at a foreclosure sale, but the deed was never delivered to the purchaser. After the sale, but within the ten-day period provided by New Jersey law for the exercise of the right of redemption, Debtor filed his bankruptcy case. Debtor contended that, because no deed had been delivered, the sale had not been finalized and he was entitled to cure his default and pay the mortgage through the chapter 13 plan. The purchaser argued that the sale was finalized after its bid was recognized as the highest and the bidding was closed, and that at most Debtor only had sixty days from the date of the petition to exercise the right of redemption under 11 U.S.C. § 108(b).
Court’s Analysis
The Court first determined that 11 U.S.C. § 1322 permits a debtor to cure a mortgage default up until such time as the sale is finalized at auction, as the delivery of the deed is a ministerial act that may be subject to delays totally unrelated to the sale process. The Court found this to be in harmony with applicable New Jersey law. The Court then looked to 11 U.S.C. § 108(b)(2), which permits a debtor 60 days to “cure a default,” or “perform any similar act” which would be available to it under applicable nonbankruptcy law. Looking to New Jersey law, the Court found that New Jersey did not permit the curing and reinstating of a mortgage following foreclosure. However, New Jersey did afford a homeowner a ten day period within which to exercise its statutory right of redemption by paying off the mortgage in full. The Court determined that this was a “similar act” to curing a default, and that therefore Debtor had had 60 days from the date of the petition to pay the mortgage in full. Because more than 60 days had already elapsed as of the time of the decision, the Court held that the sale had been finalized.
In re Global Outreach, S.A., 2009 Bankr. LEXIS 993 (Bankr. D.N.J. 2009)
Factual Background
At issue in this case was whether 11 U.S.C. § 108(b)(2) extended the time period by which a debtor could perform under a contract. Global Outreach, S.A. (Debtor) entered into a contract with YA Global Investments, L.P. (YA). The agreement provided that YA would make a loan to Debtor, in exchange for Debtor placing title to certain properties into a holding company. By the terms of the agreement, if Debtor defaulted and failed to cure within fifteen days, then Debtor would have an additional thirty days to pay all outstanding monies under the loan and have the properties returned. YA gave Debtor notice of a default and reminded it of the fifteen-day cure period. After those fifteen days passed, YA sent Debtor another notice reminding it of the thirty-day redemption period. Within those thirty days, Debtor filed for bankruptcy in the Bankruptcy Court for the District of New Jersey (the Court).
The Court sua sponte raised the question of whether the provisions of 11 U.S.C. § 108(b)(2), which provide an additional sixty days for debtors to “cure a default, or take any similar act” under applicable nonbankruptcy law, applied to the case. YA argued that it did not, as the additional thirty-day provision was not a cure provision, but rather a repayment provision. Debtor argued that the repayment was a “similar act” to curing a default, and thus it had an additional sixty days to pay the loan in full.
Court’s Analysis
The Court agreed with Debtor and ruled that 11 U.S.C. § 108(b)(2) extended the time period by which Debtor could repay the loan in full by sixty days. In doing so, the Court relied upon Counties Contracting and Construction Co. v. Constitution Life Insurance Co., 855 F.2d 1054 (3d Cir. 1988) and In re Hric, 208 B.R. 21 (Bankr. D.N.J. 1997). The Court found that while it was true that the provision in question was not a cure provision, it was analogous to the right of redemption at issue in Hric. Therefore, because the Debtor was not seeking to cure a default under the contract (which right had expired prepetition), but was instead seeking to pay the entirety of the loan balance, 11 U.S.C. § 108(b)(2) granted it an additional sixty days from the petition filing within which to do so.
In re 1075 Yukon LLC, 590 B.R. 527 (Bankr. D. Colo. 2018)
Factual Background
At issue in this case was whether 11 U.S.C. § 108(b) extended the time for which a debtor could perform under an option contract. Debtor sold certain real property to Buyer pre-petition.
The parties simultaneously entered into a second agreement (the Option Contract) that provided for Debtor’s ability to repurchase the property if certain conditions were met. The Option Contract was subsequently amended to extend the deadline by which Debtor must exercise its repurchase option, and provided that the option automatically terminated at the deadline. Debtor filed its petition for chapter 11 bankruptcy in the Bankruptcy Court for the District of Colorado (the Court) approximately one hour before the option deadline.
Forty-three days later, Debtor filed a motion to exercise the option and repurchase the property. Debtor relied upon 11 U.S.C. § 108(b)(2), which allows a debtor 60 days to “file any pleading, demand, notice, proof of claim or loss, cure a default, or perform any other similar act” that the debtor may have been entitled to perform if the timeframe for doing so had not expired prior to the bankruptcy filing. Debtor contended that, because it was entitled to exercise the option to purchase the property, and the deadline to do so had not terminated prior to the bankruptcy filing, § 108(b)(2) gave it an additional 60 days to do so. Buyer objected, stating that allowing Debtor an additional 60 days from a predetermined, agreed-upon deadline was an impermissible modification of private contract rights.
Court’s Analysis
The Court agreed with Buyer and held that § 108(b)(2) did not apply to option contracts. In reaching this conclusion, the Court looked to the specific language relating to “curing a default.” In examining all other relevant case law, the Court found that any extension granted by § 108(b)(2) was in the nature of curing a default, e.g. exercising a statutory right of redemption. Therefore, the Court concluded that “similar act” in § 108(b)(2) meant an act similar to curing a default. The Court found that allowing an expansive reading of § 108(b)(2), as some other courts had done, would give it a broader effect than was intended. Indeed, doing so in the context of option contracts would give the debtor more rights than they had prior to filing a bankruptcy—a clear impossibility. Because there could be no default under an option contract, only the expiration of the option, there could also be no curing of a default under one. Without the ability to cure a default, the Court reasoned that there was nothing for § 108(b) to extend, and that the option had therefore expired on the originally agreed date.
List of Authorities for Question #3
11 U.S.C. § 1104
(a) At any time after the commencement of the case but before confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee—
(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor; or
(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor.
…
11 U.S.C. § 1112
(b)
(1) Except as provided in paragraph (2) and subsection (c), on request of a party in interest, and after notice and a hearing, the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause unless the court determines that the appointment under section 1104(a) of a trustee or an examiner is in the best interests of creditors and the estate.
…
11 U.S.C. § 105
(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.
In Re Marvel Entertainment Group, 140 F.3d 464 (3d Cir. 1998)
Factual Background
Marvel Entertainment Group, Inc. (Marvel) filed for chapter 11 bankruptcy in the Bankruptcy Court for the District of Delaware (the Bankruptcy Court). Marvel initially acted as a debtor-in-possession. From the outset, the bankruptcy was essentially dominated by two competing groups: a group of bond-holding entities controlled by Carl Icahn (the Icahn Interests), which effectively held all of Marvel’s stock, and a group of large creditors (the Lenders) and their agent, Chase Manhattan Bank (Chase). The Icahn Interests and the Lenders both used the bankruptcy to vie for control of Marvel through extensive litigation and contested financing proposals.
Eventually, the Icahn Interests gained control of Marvel by receiving authority to vote the stock that it held; this put the Icahn Interests in the position of being both a creditor and shareholder of the debtor and the debtor-in-possession. The Icahn-controlled debtor then began filing various adversary proceedings against the Lenders, which the Lenders described as retaliation for their refusal to enter settlement agreements. The acrimony between the two groups eventually led the District Court for the District of Delaware (the District Court) to withdraw the reference to the Bankruptcy Court and order the appointment of a chapter 11 trustee.
The District Court approved the appointment of a trustee (the Trustee), who subsequently moved for appointment of his law firm as counsel to the trustee (the Firm). The Firm disclosed that it was concurrently engaged in representing Chase in an unrelated matter involving the construction of an arts center; the fees for this engagement constituted 0.1 percent of the firm’s overall annual revenue, the representation was substantially concluded, and Chase had previously provided the Firm with a waiver of any and all conflicts of interests arising from the representation. The District Court denied the appointment of the Firm on the basis that it “taint[ed] the appearance of objectivity.” The Trustee appealed, which was consolidated with the Icahn Interests’ appeal of the order appointing the Trustee.
Court’s Analysis
The United States Court of Appeals for the Third Circuit (the Court) began by finding that it had jurisdiction to hear an appeal of an order appointing a trustee pursuant to 28 U.S.C. § 1291. The Court reasoned that, if it could not take jurisdiction at the time of the appeal, then the only alternative would be that the order appointing the Trustee would not be appealable until the completion of the bankruptcy case. The Court found that this would be an absurdity, as it would raise the possibility of having to redo the entire bankruptcy if the order appointing the Trustee were to be overturned.
Turning to the question of whether appointment of the Trustee was appropriate, the Court noted that the standard for appointing a trustee was simply “for cause” under 11 U.S.C. § 1104(a)(1). The question the case presented was whether “acrimony” between a debtor-in-possession and creditors constituted “cause” under § 1104(a)(1). Answering the question in the affirmative, the Court held that “acrimony” could constitute “cause” to appoint a trustee on a case-by-case basis, where disagreement between a debtor-in-possession and its creditors extends “beyond the healthy conflicts that always exist between debtor and creditor.” The Court noted that there existed a “strong presumption” in favor of leaving a debtor-in-possession in control of its own case owing to its familiarity with its own business and organization. However, the Court found that such presumption was inapplicable in this case, where the Icahn Interests had only recently taken control as the debtor-in-possession. The Court refused to adopt a per se rule for when acrimony rose to the level of cause, instead directing that it was a factual determination to be made by the court. The Court further found that, even if the acrimony in this case did not rise to the level of “cause” under § 1104(a)(1), it would nonetheless have been warranted by the more flexible “best interests” standard of § 1104(a)(2) owing to the intransigence of the two groups. The Court noted that “the debtor-in-possession’s interests conflicted with those of its creditors to such an extent that the appointment of a trustee may be the only effective way to pursue reorganization.”
The Court finally addressed the disqualification of the Firm as counsel to the Trustee. Reversing the District Court, the Court held that counsel may not be disqualified under 11 U.S.C. § 327(a) for the mere appearance of conflict alone. Instead, looking at the text of the statute, the Court held that disqualification was only permissible due to the existence of an actual or potential conflict.
U.S. Mineral Prods. Co. v. Official Comm. of Asbestos Bodily Injury & Prop. Damage Claimants (In re U.S. Mineral Prods. Co.), 105 Fed. App’x 428 (3d Cir. 2004)
Factual Background
This case concerned contentious bankruptcy proceedings between the debtor (Debtor) and an official committee of unsecured creditors (the Committee). The Committee was appointed to represent the interests of several asbestos injury-related claimants. During the proceedings, the Bankruptcy Court for the District of Delaware (the Bankruptcy Court) admonished the parties that failure to reach a confirmable plan would result in the appointment of a chapter 11 trustee. Debtor never contested that the Bankruptcy Court had the authority to appoint a trustee of its own accord; Debtor only maintained that a trustee was not necessary. The United States Trustee filed a statement opining that appointment of a trustee was necessitated by the acrimonious relationship between Debtor and the Committee, as well as by concerns over Debtor’s management engaging in self-dealing transactions. The Bankruptcy Court eventually appointed a chapter 11 trustee sua sponte at a hearing on the progress of any plan. Debtor objected to the appointment, arguing that a court cannot appoint a trustee under 11 U.S.C. § 1104(a) absent a motion to do so by a party-in-interest. Debtor further contended that it was not given adequate notice and hearing for the issue of appointment of a trustee.
Court’s Analysis
The U.S. Court of Appeals for the Third Circuit (the Court) rejected Debtor’s contention and affirmed the Bankruptcy Court’s order sua sponte appointing a trustee. The Court found that any requirement of a motion being filed by a party-in-interest had been “severely diluted” by the 1984 amendments to 11 U.S.C § 105, which permitted sua sponte action on the part of bankruptcy courts. This broad discretion, coupled with the “best interests” standards of 11 U.S.C. § 1104(a)(2) made clear that a bankruptcy court may sua sponte appoint a trustee when doing so is in the best interests of the estate. The Court also noted that § 1104(a) does not mention a “motion by a party in interest,” but merely a “request by a party in interest.” Even if such a request from a party-in-interest was a necessary prerequisite, the Court found that the United State Trustee’s statement would have satisfied such a requirement anyway.
From a factual perspective, the Court found that this standard had easily been met based upon the acrimonious relationship between the parties and the standards articulated in In re Marvel Entertainment Grp., Inc., 140 F.3d 463 (3d Cir. 1998). The Court also found that any applicable notice and hearing requirements had been satisfied, as Debtor was aware of the Bankruptcy Court’s intention to appoint a trustee, was aware of the United States Trustee’s statements in support of appointing a trustee, and itself argued that a trustee was not necessary. At no time during these proceedings did Debtor ever raise the issue of whether the Bankruptcy Court could appoint a trustee absent a motion. The Court therefore found that all of the necessary conditions for the Bankruptcy Court’s appointment of a trustee had been met.
Official Comm. of Asbestos Claimants v. G-I Holdings, Inc. (In re G-I Holdings, Inc.), 385 F.3d 313 (3d Cir. 2004)
Factual Background
The Debtor, G-I Holdings, Inc. (Debtor) filed for chapter 11 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). Debtor was the defendant in asbestos-related mass-tort actions prior to and during the bankruptcy. Pursuant to 11 U.S.C. § 1102(a), the United States Trustee appointed a committee of unsecured creditors to represent the interests of the asbestos-related claimants (the Committee). The Committee moved for appointment of a chapter 11 trustee, arguing that such appointment was warranted under 11 U.S.C. §§ 1104(a)(1) and 1104(a)(2). The Committee relied upon In re Marvel Entertainment Grp., Inc., 140 F.3d 463 (3d Cir. 1998), arguing that significant conflict existed between Debtor and the asbestos claimants which required the appointment of a trustee. The Bankruptcy Court denied the Committee’s request for appointment of a trustee. On appeal, the District Court of the District of New Jersey (the District Court) upheld the order of the Bankruptcy Court. The Committee appealed once again, this time to the U.S. Court of Appeals for the Third Circuit (the Court).
The Committee’s argument on appeal concerned the applicable burden of proof. The Bankruptcy Court based its decision in part on the presumption in favor of deferring to a debtor-in-possession rather than a trustee, as articulated in In re Marvel. The Bankruptcy Court found that the Committee had failed to meet this burden, as it had not shown by clear and convincing evidence that the circumstances required the appointment of a trustee. On appeal to the District Court, the Committee argued that the presumption in favor of leaving Debtor as debtor-in-possession should not apply because Debtor was a holding company, and therefore familiarity with its business operations was irrelevant. Furthermore, the Committee contended that there would be little to no cost associated with appointing a trustee, because it would only need to manage the asbestos claims. Finally, the Committee argued that Debtor had a “structural inability” to discharge its fiduciary duties to its creditors. The District Court noted that there was no support from In re Marvel or elsewhere for the Committee’s argument concerning the applicable burden of proof, and upheld the decision of the Bankruptcy Court. The Committee again appealed, arguing that (1) because of the factual circumstances, the presumption in favor of leaving Debtor as debtor-in-possession should not apply, and (2) because no such presumption existed, the Committee should only need to show that appointment of a trustee was warranted by a preponderance of the evidence, rather than by clear and convincing evidence.
Court’s Analysis
The Court looked to its earlier decisions in In re Marvel and In re Sharon Steel Corp., 871 F.2d 1217 (3d Cir. 1989) and found that both plainly provided that a party moving for the appointment of a trustee bears the burden of persuasion by clear and convincing evidence. The Court noted that its earlier language in In re Marvel concerning the “presumption” in favor of keeping a debtor’s current management in place merely was another way of describing this burden. The usage of the word “presumption,” taken in context within In re Marvel, simply reflected the fact that a movant must meet the heighted evidentiary burden of clear and convincing evidence for the relief it seeks. The “presumption” was not an independent factual issue that the moving party could rebut and dispel, separate and apart from the evidentiary burden. It was, rather, the evidentiary burden itself. It therefore could not be altered, as the Committee maintained, by facts which would undermine any putative presumption.
The Court further held that even if there did exist such a factual presumption, its existence or absence would have no bearing on the burden of proof. The Court’s precedents in In re Marvel and Sharon Steel both squarely held that a party moving for appointment of a trustee bears the burden of proof by clear and convincing evidence, with no caveats. Therefore, even if the Court were to accept the Committee’s first argument concerning the factual lack of support for such a presumption, there would be no logical coupling between that finding and a lowering of the burden of proof. The Court accordingly affirmed the order of the District Court, and the Committee’s motion for appointment of a trustee remained denied.
Kevan A. McKenna, P.C. v. Official Comm. of Unsecured Creditors (In re Kevan A. McKenna, P.C.), 2011 U.S. Dist. LEXIS 57985, Case No. 10-472 ML (D.R.I. May 31, 2011)
Factual Background
The debtor in this case was a law firm acting as a chapter 11 debtor-in-possession (the Debtor). Debtor’s case was fraught with conflict between it and the official committee of unsecured creditors (the Committee). The Committee moved for conversion of Debtor’s case under 11 U.S.C. § 1112(b). The Bankruptcy Court for the District of Rhode Island (the Bankruptcy Court) held a hearing on the motion and took the matter under advisement. The Bankruptcy Court then sua sponte appointed a chapter 11 trustee based upon the “totality of the circumstances” in the case. The Bankruptcy Court specifically singled out obstructive conduct on the part of Debtor’s principal among the reasons why it was appointing a trustee. Debtor appealed to the U.S. District Court for the District of Rhode Island (the Court), raising three issues. Firstly, Debtor argued that the Bankruptcy Court could not sua sponte appoint a trustee; a motion by a party-in-interest was necessary. Secondly, Debtor argued that it was deprived of notice and hearing on the issue of appointment of a trustee. Finally, Debtor argued that there was not a factual record established on which appointment of a trustee could be based.
Court’s Analysis
The Court began by explaining how 11 U.S.C. § 1112(b) and 11 U.S.C. § 1104 worked in conjunction to provide that, when considering whether to dismiss or convert a case, a bankruptcy court may also consider appointment of a trustee if doing so is in the best interests of the estate. The bankruptcy court must make the determination based upon which alternative is in the best interests of the estate, as drawn from the factual record. The Court found that a request of a party-in-interest was not necessary for appointment of a trustee, as 11 U.S.C. § 105(a) directs that no requirement of a motion or request prevents a bankruptcy court from otherwise sua sponte taking action necessary to implement or enforce court orders. The Court cited relevant case law for the proposition that § 105(a)’s directive includes the sua sponte authority to appoint a trustee. The Court next found that Debtor was afforded adequate notice and hearing through the motion to convert, which was fully briefed and argued. Any action under § 1112(b) to convert or dismiss must also necessarily entail the possibility of appointment of a trustee by the inclusion of § 1104, and so Debtor was effectively notified as to the possibility. Moreover, the motion to convert would have required the appointment of a chapter 7 trustee to administer the estate, which the Court found to be effectively analogous to the possibility of appointment of a chapter 11 trustee for notice purposes. As for Debtor’s final contention regarding the evidentiary record, the Court found upon review that the facts adduced in the conversion hearing did rise to the level of clear and convincing evidence. Debtor had repeatedly failed to comply with court orders, had repeatedly overdrawn its bank accounts and otherwise mismanaged its finances, and failed to file a disclosure statement within the timeframe required by the Bankruptcy Court. Taken together, these facts made clear that appointment of a chapter 11 trustee was in the best interests of Debtor’s estate.
Nixon Peabody LLP 1300 Clinton Square Rochester, New York 14604 585-263-1000 [email protected] www.nixonpeabody.com
Christopher M. Mason
Nixon Peabody LLP Tower 46 55 West 46th Street New York, New York 10036 212-940-3000 [email protected] www.nixonpeabody.com
§ 1.1. Introduction
In past years, we have tried to be comprehensive in our survey of developments in alternative dispute resolution, covering all cases pending or decided in the United States Supreme Court, all the materially substantive opinions issued by the federal Circuit Courts of Appeals, and all the materially substantive opinions issued by the highest courts in all 50 states (and the District of Columbia and the Commonwealth of Puerto Rico), together with comments on legislative and administrative developments. Every year, the volume of these opinions and developments increased as alternative dispute resolution became more and more widely accepted and used.
But, perhaps in part because of the courts beginning to catch up with backlogs from the continuing COVID-19 pandemic, and perhaps because alternative dispute resolution was in some situations over the past two years the only practical alternative for many disputes to reach a conclusion, trying to cover virtually all the individual opinions and activity we had covered in the past seems to have reached a level where including all of the increased volume of case law may detract from the value of a summary. So this year, while we have reviewed all the same source material (all the Supreme Court, federal Circuit Court, and highest state court opinions, together with legislative and administrative activity) we are not trying to report on virtually every decision. Instead, we have tried to include matters we consider particularly important, interesting, or unique.
To begin with, despite our projection last year that the United States Supreme Court might issue a useful decision in Henry Schein Inc. v. Archer & White Sales, Inc., No. 19‐963 (U.S. argued Dec. 8, 2020) in 2021, the Court ultimately dismissed the writ of certiorari in that case as having been improvidently granted. As a result, the Court did not issue any substantive arbitration decisions in 2021.
But the Court did grant certiorari in five cases that remain pending before the Court as of December 2021. Three of those involve splits among the federal Courts of Appeals regarding the propriety of “looking through” pleadings to establish federal jurisdiction and the limits of federal court’s authority to compel discovery in international arbitration under 28 U.S.C. § 1782(a).
In addition to the cases involving Circuit splits now under review by the Supreme, the federal Courts of Appeals continue throughout 2021 to grapple with what it means to be “engaged in commerce” for section 1 exemption under the FAA.
Furthermore, in our 2020 ADR Annual Review, we explained that the Antitrust Division of the Department of Justice (the “Division”) issued “Updated Guidance Regarding the Use of Arbitration and Case Selection Criteria,” which signaled an interest in increasing the use of arbitration. Although the arbitration guidance was ultimately published in the Federal Register, its impact remains unclear at this time.
We also discussed the Forced Arbitration Injustice Repeal Act (“FAIR Act”), which has been introduced in one form or another for many years and generally would invalidate pre-dispute arbitration agreements in the employment, civil rights, consumer, and antitrust contexts, and would require employers to litigate workplace disputes in court. The bill was reintroduced as H.R. 963 in February 2021, and the House Judiciary Committee signed off on the bill in early November 2021. Of course, it must still pass both the House and the Senate before being signed by the President, but this is something that litigators should continue to monitor.
§ 1.2. Legislative and Regulatory Developments
§ 1.2.1. Revised Uniform Arbitration Act
The Uniform Law Commissioners drafted and proposed the original Uniform Arbitration Act (the “UAA”) in 1955. It provided, among other things, basic procedures for the conduct of an arbitration by agreement. Forty-nine jurisdictions adopted the original UAA, including the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. Four states, Alabama, Georgia, Mississippi, and West Virginia, did not enact any version of the original UAA.
In 2000, the Commission revisited and substantially revised the UAA to produce the 2000 Uniform Arbitration Act (the “Revised UAA”). The Revised UAA allows for consolidation of separate arbitration proceedings, expressly provides for immunity for arbitrators from civil liability, authorizes the award of punitive damages and attorneys’ fees when such an award would be authorized in a civil action, and provides arbitrators with discretion to order discovery, issue protective orders, and decide motions for summary judgment, similar to a judicial proceeding.
Twenty-two states have adopted the Revised UAA, including Alaska, Arizona, Arkansas, Colorado, Connecticut, the District of Columbia, Florida, Hawaii, Kansas, Michigan, Minnesota, Nevada, New Jersey, New Mexico, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, Utah, Washington, and West Virginia. No new states adopted the Revised UAA in 2021, although legislation introduced in Vermont in 2019 was reintroduced in 2021. The progress of states enacting the Revised UAA can be tracked at www.uniformlaws.org.
§ 1.2.2. Uniform Mediation Act
The Uniform Mediation Act (the “UMA”), as promulgated by the Uniform Law Commission in 2001 after a joint drafting effort with the American Bar Association’s Dispute Resolution Section, and as amended in 2003 to incorporate the Model Law on International Commercial Conciliation, was adopted by Georgia in 2021. It also continued in effect in the District of Columbia, Hawaii, Idaho, Illinois, Iowa, Nebraska, New Jersey, Ohio, South Dakota, Utah, Vermont, and Washington. The progress of states enacting the UMA may be tracked at www.uniformlaws.org.
§ 1.2.3. The United Nations Convention on International Settlement Agreements Resulting from Mediation
On August 7, 2019, 46 countries signed on to the United Nations Convention on International Settlement Agreements Resulting from Mediation (the “Singapore Convention”). The initial signatories included (in addition to Singapore, of course) major States such as the United States, China, and India, but did not include, for example, Australia, the European Union, or the United Kingdom. Since then, Ghana and Rwanda have signed on as well.
As discussed in our 2019 compilation, the Singapore Convention provides, for the first time, an international process for the direct enforcement of cross-border settlement agreements arising out of mediation. To fall within the scope of the Singapore Convention, a settlement agreement must be in writing, must result from a mediation, must be between two or more parties who have their place of business in different States, and must involve, as the place of business of each party, a State that has acceded to or ratified the Singapore Convention. There are some substantial exceptions to its coverage, however: the Singapore Convention will not apply to settlement agreements that relate to consumer transactions, or to family law, inheritance issues, or employment law; to settlement agreements that have been approved by a court or concluded in the course of proceedings before a court and that are enforceable as a judgment in the State of that court; or to settlement agreements that have been recorded and are enforceable as an arbitral award.
Mediation is defined under the new Singapore Convention as “a process, irrespective of the expression used or the basis upon which the process was carried out, whereby the parties attempt to reach an amicable settlement of their dispute with the assistance of a third person or persons (the ‘mediator’) lacking the authority to impose a solution upon the parties to the dispute.” Presuming that the Singapore Convention does go into effect, a settlement agreement that qualifies will allow a party to use a simplified procedure for enforcement. That party will provide to the relevant authority in the State where the party seeks to enforce the settlement agreement two basic pieces of evidence: first, a copy of the signed settlement agreement; and, second, proof that the settlement agreement resulted from a mediation. This latter requirement can be satisfied by a mediator’s signature on the settlement agreement or by a document signed by the mediator confirming that there was a mediation.
Once it receives this evidence, the relevant authority (most likely a court) is required to “act expeditiously.” Under limited circumstances it may refuse enforcement. These include proof of the incapacity of a party to the settlement agreement; proof that the settlement agreement is null and void, inoperative, or incapable of being performed; proof that the settlement agreement is not binding, or is not final, according to its terms; proof that the settlement agreement has been subsequently modified; proof that necessary obligations for enforcement of the settlement agreement have not been performed or are not clear and comprehensible; proof that granting relief would be contrary to the terms of the settlement agreement; proof that the mediator committed a serious breach of standards applicable to him, her, or the mediation, without which breach the party seeking to avoid enforcement would not have settled; proof that the mediator failed to disclose circumstances raising justifiable doubts as to his or her impartiality or independence, which failure had a material impact or undue influence on a party, and without which failure the party would not have settled; proof that granting relief would be contrary to the public policy of the State in which enforcement is sought; or proof that the subject matter of the dispute was not capable of settlement by mediation under the law of that State.
While this is not a short list, it is likely that, as with arbitration awards under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”), enforcement of mediation settlements under the Singapore Convention is likely to be granted in most instances. Importantly, however, the Convention does not itself define the remedies for breach of a settlement agreement. Because permissible remedies are different in different countries, parties to international commercial mediation settlements will likely want to specify at least some remedies in their settlement agreements, and in doing so consider whether those remedies will be enforceable in the most likely jurisdictions of enforcement. Similarly, such parties will want to think carefully about choice of law decisions in their settlement agreements.
§ 1.2.4. State Codes
§ 1.2.4.1. California
While no significant statutes were passed this year by the California state government regarding arbitration, we reported last year on Assembly Bill No. 51 (“AB 51”). In February, the United States District Court for the Eastern District of California issued a preliminary injunction blocking implementation of AB 51. AB 51 was passed in 2019 to prohibit employers from requiring employees to waive any right, forum, or procedure established by the California Fair Employment and Housing Act or the California Labor Code. This includes a bar of any agreement that requires employees to opt out of a waiver or take any affirmative action to preserve their rights to a judicial forum, as would occur in an agreement mandating arbitration of an employment dispute.
AB 51 was set to take effect on January 1, 2020, but was challenged in court by the Chamber of Commerce of the United States of America, among other interested parties, alleging that the FAA preempted AB 51 and all legislation enacted under its mantle of authority. The District Court agreed with the plaintiffs and enjoined implementation of the laws enacted under AB 51 to preserve the mandate of the FAA. The court found that the challengers of the bill were likely to succeed on the merits because the FAA preempted AB 51 in two ways. First, AB 51 imposed restrictions on the formation of arbitration agreements that do not apply to contracts generally, violating the express direction under Section 2 of the FAA requiring courts and state legislatures to “place arbitration agreements ‘on equal footing with all other contracts.’” Second, AB 51 punished the exercise of a federally protected right to include arbitration agreements in employment contracts, directly impeding the FAA.
The District Court found that the challengers of AB 51 were likely to succeed on their strong arguments for preemption of the FAA, and granted a preliminary injunction blocking the bill from taking effect. The litigation is continuing.
§ 1.2.5. Rules of the International Chamber of Commerce
On January 1, 2021, the International Chamber of Commerce’s (“ICC”) 2021 Rules of Arbitration (the “2021 Rules”) became effective. These rules replace the ICC’s 2017 Rules of Arbitration (the “2017 Rules”). While the 2021 Rules do not significantly amend the predecessor 2017 Rules, there are several material changes to rules relating to the framework of ICC arbitration. We repeat them from our 2020 update for convenience below.
First, the 2021 Rules address virtual proceedings and communications by amending Article 26, which provides the rules for hearings. Article 26(1) has been updated to explicitly provide the arbitral tribunal with authority to conduct virtual hearings at its discretion either in person or virtually through “videoconference, telephone or other appropriate means of communication.” Although tribunals were not previously prohibited from conducting virtual hearings, clarifying the rules to explicitly provide this power addresses any doubts that may exist in a time where COVID-19 has led to a shift to the use of virtual proceedings. By including the “other appropriate means of communication” language, the ICC appears to have drafted this rule to anticipate evolving technology.
The framework of how arbitration is conducted under the ICC Rules has been further changed by amending the rules involving multi-party arbitration. One of the more significant changes in the 2021 Rules can be found in Article 7, which deals with the joinder of additional parties. Article 7(5) is a newly added provision that allows parties to make requests for joinder after the confirmation or appointment of any arbitrator in the proceeding. The 2017 Rules required that all parties, including the party sought to be joined, agree to such joinder, but the 2021 Rules contain no such requirement and instead leave it to the arbitral tribunal to decide the request. Article 10’s provisions on consolidation of arbitration have also been changed under the 2021 Rules. Under the 2017 Rules, Article 10 provided that the ICC’s International Court of Arbitration (the “ICC Court”) could consolidate two or more arbitrations where “all of the claims in the arbitrations are made under the same arbitration agreement.” This language created ambiguity as to whether consolidation was possible only for claims made under the same contract, or if it also applied when claims arise from multiple agreements with mirror arbitration clauses. The 2021 Rules address this ambiguity by amending Article 10(b) to apply to claims made under the same “agreement or agreements,” so arbitrations may be consolidated where they involve multiple agreements with mirror arbitration clauses.
The 2021 Rules also include multiple changes designed to address potential conflicts of interest in arbitration proceedings. First, Article 11, which contains general provisions, has been revised with the inclusion of Article 11(7) requiring parties to promptly inform the ICC Secretariat of any agreements where a non-party has an economic interest in the outcome of the arbitration through an agreement to fund a party’s claims or defenses. This change places the affirmative obligation on parties at the outset to inform of the involvement of litigation funders to address potential conflicts at the outset. Second, the 2021 Rules provide a new paragraph under Article 12(9) addressing the constitution of the arbitral tribunal. The ICC Court now has the power to appoint each member of the arbitral tribunal, even if this method differs from what the parties had envisioned in their arbitration agreement. However, this power is limited to “exceptional circumstances” that would avoid “a significant risk of unequal treatment and unfairness that may affect the validity of the award.” Third, Article 17 has been renamed to “Party Representation” and now requires parties to immediately notify the Secretariat, arbitral tribunal, and other parties of any change in their representation. Notably, the tribunal has been given the authority under this rule to exclude new representatives from participating in arbitration if necessary to avoid a conflict of interest with an arbitrator.
Other noteworthy updates in the 2021 Rules include a new provision in Article 36(3) allowing a party to apply to the Secretariat for an additional award for claims made in the arbitral proceeding that the tribunal has omitted to decide. Additionally, the pecuniary threshold to avoid application of the expedited rules has been increased from $2 million under the 2017 Rules to $3 million under the 2021 Rules for arbitration agreements concluded on or after January 1, 2021.
Lastly, the 2021 Rules reflect an effort to increase transparency, as a party may now, among other things, request that the ICC Court communicate its reasons for reaching its decisions, although the ICC Court is not required to communicate such reasons when exceptional circumstances dictate that it should not.
§ 1.3. The United States Supreme Court Docket
In early November 2021, the Court heard oral argument in Badgerow v. Walters, 975 F.3d 469 (5th Cir. (La.) 2020), cert granted, 141 S. Ct. 2620 (U.S. May 17, 2021) (No. 20-1143). In that case, the Court is considering a split among the federal Circuits regarding whether district courts possess subject matter jurisdiction over petitions to confirm or vacate arbitration awards to the extent “the underlying controversy between the parties arises under federal law.”
Denise Badgerow, a financial advisor formerly employed with REJ Properties, Inc. (“REJ”), began a FINRA arbitration action against three principals of REJ following her termination from the company. The three principals were also affiliates of Ameriprise Financial, so Badgerow later added a Title VII sex discrimination claim against Ameriprise in the FINRA arbitration. In her claims, Badgerow sought damages against the principals for tortious interference of contract and for violating a Louisiana “whistleblower” law. She also sought to hold Ameriprise jointly liable for the principals’ and REJ’s conduct. The FINRA panel dismissed all of Badgerow’s claims with prejudice.
Badgerow then sued in Louisiana state court to vacate the FINRA panel’s award, contending that the principals of REJ had committed fraud on the FINRA panel. She named only the REJ principals in the state court action. She did not name REJ itself or Ameriprise. When the principals removed to federal district court, Badgerow sought remand, arguing the district court lack subject matter jurisdiction because the claims asserted against the principals were based solely on state law.
The district court denied Badgerow’s motion to remand, holding that it had subject matter jurisdiction over Badgerow’s petition to vacate because she had asserted a Title VII declaratory judgment claim against Ameriprise in the arbitration. The court ultimately found that no fraud had been committed in the arbitration and confirmed the FINRA panel’s dismissal of all of Badgerow’s claims.
Badgerow then appealed to the Fifth Circuit. She argued there that the district court had lacked subject matter jurisdiction over the petition to vacate and, therefore, had improperly denied her motion to remand. The Fifth Circuit affirmed, in reasoning important to the review now granted by the Supreme Court.
The Fifth Circuit began by reviewing the Supreme Court’s decision in Vaden v. Discover Bank, 556 U.S. 49 (2009). In that case the Court adopted a “look-through” analysis for “determining federal jurisdiction in actions to compel arbitration under section 4 of the FAA.” Although the plaintiff’s petition to vacate in Badgerow was brought pursuant to section 10 of the FAA, the Fifth Circuit explained that motions brought under sections 9, 10, and 11 of the FAA are all subject to the same look-through approach. In particular, “a federal court should determine its jurisdiction by looking through an FAA petition to the parties’ underlying substantive controversy.” If the claims involved in the underlying dispute evidence that the dispute could have been brought in federal court, “then federal jurisdiction lies over the FAA petition.”
Badgerow had contended that because she only sought to vacate the dismissal of her claims against the principals and not her claims asserted Ameriprise, the federal declaratory judgment action against Ameriprise asserted in the FINRA arbitration could not be properly considered in the look-through analysis. But, according to the Fifth Circuit, Vaden says otherwise. Under Vaden, the court believed that its task was to determine whether “a federal court would have had jurisdiction over an action raising the same claims against the [p]rincipals that Badgerow brought in the FINRA arbitration proceeding—namely tortious interference and Louisiana ‘whistleblower.’” In making this determination, the court noted that Badgerow’s claims against the principals and Ameriprise “arose from the same common nucleus of operative fact,” and that the Title VII declaratory judgment claim against Ameriprise would have created sufficient federal jurisdiction to allow for supplemental jurisdiction over Badgerow’s state law claims against the principals. Accordingly, the Fifth Circuit upheld the district court’s jurisdiction and affirmed its denial of remand. Badgerow then petitioned for certiorari, which the Supreme Court granted.
As Badgerow explains in her opening brief on the merits, the question presented to the Supreme Court is “[w]hether federal courts have subject-matter jurisdiction to confirm or vacate an arbitration award under Section 9 and 10 of the FAA where the only basis for jurisdiction is that the underlying dispute involved a federal question.” Badgerow contends that federal courts do not possess such jurisdiction because the text of the FAA simply does not countenance a “look-through” approach to motions filed pursuant to sections 9 and 10 of the FAA. Section 4 of the FAA, allowing a party to compel arbitration, “has unique language that instructs courts, explicitly, to look through the petition to the underlying dispute.” This unique language, according to Badgerow, is the phrase “save for such agreement”. Because sections 9 and 10 of the FAA do not include similar language, Badgerow contends that courts cannot perform the same look-through for confirmation of arbitral awards under section 9 and vacatur of arbitral awards under section 10.
The respondents in Badgerow argue in opposition that motions to confirm or vacate arbitration awards are mere “adjuncts” to an underlying controversy between arbitrating parties. According to them, the FAA “authorizes various procedural devices that allow parties to enlist courts in facilitating arbitration.” These procedural devices include applications for stays under section 3, petitions to compel under section 4, applications for the appointment of arbitrations under section 5, and petitions to subpoena witnesses under section 7. Sections 9, 10, and 11, which allow for confirmation, vacation, or modification of arbitration awards, respectively, are no different, in their view. All of these applications and motions are simply vehicles for the courts to ensure that an underlying controversy is “successfully resolved through arbitration.” Similarly, the FAA’s repeated reference to such motions being filed in the “United States district court[s]” further shows that the FAA presupposes federal courts have jurisdiction over those motions. Therefore, if a federal court determines that it would have had jurisdiction over an underlying controversy, it necessarily has jurisdiction to hear FAA motions related to a disputed arbitration.
The Supreme Court held oral argument on these issues on November 2, 2021. Justice Thomas began the questioning by inquiring into Badgerow’s view that section 4 of the FAA creates federal jurisdiction, noting “[c]ounsel, we have said or suggested from time to time that the FAA doesn’t provide federal question jurisdiction. So how do you square that with the notion that Section 4 . . . provides such jurisdiction? Badgerow’s counsel responded by contending that section 4 is an exception to the traditional rule that a court is to only look to the well-pleaded complaint for determining jurisdiction. Justice Kagan followed up by suggesting “well, if we look to the well-pleaded complaint, the well-pleaded complaint says something about Section 9 and that arises under federal law.” Counsel responded by explaining that, with exception of section 4, the FAA does not create jurisdiction and that jurisdiction under sections 9 and 10 would predominantly arise only in diversity cases.
Justice Kagan, however, cast doubt on this argument by noting “isn’t that a little bit backwards, that it ends up that you put the diversity cases in the federal court system and you take all the cases that involve federal questions and say, oh, the federal courts don’t have anything to do with those cases?” And Justice Kavanaugh summarized what seemed to be the sense of many members of the Court by asking:
[D]oesn’t it make sense to have a – a uniform rule if you’re not going to have, oh, the Act itself confers jurisdiction, a uniform way to think about jurisdiction? And the uniform way that I understood it’s always been thought about was you look through to the underlying controversy, it’s pretty simple, and you do that kind of all the way through.
Despite the somewhat uphill fight Badgerow seems to face, Chief Justice Roberts did challenge the respondents on the issue of whether federal courts would have to handle many more FAA proceedings if the Court agreed with the “look through” argument, noting that “the consequence of your position is to federalize a lot more of FAA actions, procedures, than it seems would make sense if you buy the idea that this is a statute that doesn’t give generally federal jurisdiction. The Court will likely issue its decision this year.
The Court also granted certiorari in December 2021 in two cases that have since been consolidated: ZF Automotive US, Inc. v. Luxshare, Ltd., (U.S. Dec. 10, 2021) (No. 21-401), and AlixPartners, LLP v. The Fund for Protection of Investors’ Rights in Foreign States, 2021 WL 5858633 (U.S. Dec. 10, 2021) (Consolidated No. 21-401). In these cases, the Court is considering a split among the Circuits regarding whether a federal court’s authority “to render assistance in gathering evidence for use in ‘a foreign or international tribunal,’ encompasses private commercial arbitral tribunals[.]” As argued by ZF Automotive in its Petitioner’s Brief, the Fourth and Sixth Circuits have held that the federal courts possess such authority whereas the Second, Fifth, and Seventh Circuits have found that they do not.
In Luxshare, Luxshare applied under 28 U.S.C. § 1782 in a federal court in the Eastern District of Michigan to be allowed discovery against ZF Automotive and two ZF executives for use in a prospective arbitration proceeding between Luxshare and ZF that was to occur in Munich, Germany and pursuant to German Arbitration Institute (DIS) rules. Section 1782 allows a district court to require a person who resides in a respective district to “give his testimony or to produce a document or other thing for use in a proceeding in a foreign or international tribunal[.]” The district court granted Luxshare’s motion and allowed Luxshare to “obtain limited email production and to take one deposition.” As explained by the district court, courts generally consider four factors in deciding whether to grant a Section 1782 application:
whether the person from whom discovery is sought is a participant in the foreign proceeding;
the nature of the foreign tribunal, the character of the proceedings, and the receptivity of the agency abroad to federal-court judicial assistance;
whether the application conceals an attempt to circumvent foreign proof-gathering restrictions or other policies; and
whether the discovery sought is unduly intrusive or burdensome.
ZF largely contended that since it was going to be a participant in the German arbitration proceeding, the DIS arbitration tribunal more properly could compel discovery instead of the district court. However, the district disagreed, and relying largely on affidavits from Luxshare’s German counsel testifying that the DIS rules had no mechanism to compel the requested discovery, the district court found that the four factors weighed in favor of granting the application and, therefore, granted the same.
After ZF failed to provide the ordered discovery, Luxshare moved to compel, and, in response, ZF appealed and filed a motion to stay with the Sixth Circuit. While the matter was pending before the Sixth Circuit, the district court granted Luxshare’s motion to compel and ordered production within 14 days from a Sixth Circuit ruling “denying the motion to stay or dismissing the appeal.” ZF petitioned for a writ of certiorari before the Sixth Circuit issued a final decision on the appeal, which the Supreme Court granted in December 2021.
In Alix Partners, the Second Circuit considered issues similar to those presented in Luxshare but also considered whether a foreign investor may properly invoke Section 1782 to obtain an order compelling discovery from a U.S. company for use in an arbitration proceeding between the foreign investor and a foreign government. In affirming the Southern District of New York’s order compelling the disputed discovery, the Second Circuit found that Section 1782 provides such authority. Luxshare and Alix Partners undoubtedly present confounding jurisdictional issues with profound implications, and parties (and related nonparticipants) involved in international disputes should pay close attention.
In addition to Circuit splits presented in the above cases, the Court granted a petition for writ of certiorari regarding the Eight Circuit’s decision in Morgan v. Sundance, Inc., 992 F.3d 711 (8th Cir. (Iowa) 2021), wherein the Eight Circuit reversed a district court’s order that denied a motion to compel arbitration filed by Sundance, finding that the plaintiff had failed to show prejudice from Sundance’s delay in seeking arbitration.
Robyn Morgan, who worked at one of Sundance’s Taco Bell franchises, brought a collective action on behalf of herself others similarly against Sundance alleging Sundance violated the Fair Labor Standards Act by failing to properly pay overtime to its workers. Sundance moved to dismiss the complaint alleging that another similar suit had already been filed in Michigan. The district court denied the motion approximately four months later, and Sundance thereafter answered the complaint without asserting any right to arbitration. Sundance ultimately settled the Michigan action, and despite Morgan’s participate in the global mediation that led to the Michigan action settlement, Morgan’s action did not settle and, instead, continued to proceed. The parties, however, did not conduct any discovery. Following the failed mediation, and after the case had been pending for about eight months, Sundance moved to compel Morgan’s claims to arbitration. The district court denied Sundance’s motion finding that Sundance had “substantially invoked the litigation machinery primarily by waiting eight months to assert its right to arbitrate this dispute[,]” and, therefore, that Morgan would be prejudiced by being compelled to arbitrate.” The Eighth Circuit disagreed.
As explained by the Eighth Circuit, four months of the disputed eight-month period was due to the district court’s consideration of Sundance’s first-to-file motion to dismiss. The court also noted that Sundance’s first-to-file motion did not address the merits of the dispute and, instead, only focused on quasi-jurisdictional issues. Additionally, the court explained that Sundance’s participation in mediation should be considered an effort to avoid “invoking the litigation machinery,” not a substantial invocation of the machinery Further, according to the court, the parties spent little time actively litigating and spent no time regarding the merits of Morgan’s case. Accordingly, the court found that Morgan had not been prejudiced by Sundance’s eight-month delay and reversed the district court’s denial of Sundance’s motion to compel arbitration.
Morgan petitioned the Supreme Court to grant a writ of certiorari, which the Court granted in November 2021. Morgan principally challenged the Eighth Circuit’s ruling that Morgan failed to show prejudice by Sundance’s eight-month delay in seeking arbitration. The question presented, according to Morgan (citing AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011)) is whether “the arbitration-specific requirement that the proponent of a contractual waiver defense prove prejudice violate this Court’s instruction that lower courts must ‘place arbitration agreements on an equal footing with other contracts?’”
Noting a great variety of views among the federal Courts of Appeals and states’ highest courts regarding whether prejudice is required, and to what extent, Morgan asserts that “the Eighth Circuit placed itself firmly into the strong-prejudice camp.” As explained by Morgan, although the Eighth Circuit acknowledged that Sundance acted inconsistently with its right to compel arbitration, the court “refused to find this conduct constituted waiver . . . because ‘Morgan was not prejudiced by Sundance’s litigation strategy.’”
Although the case is in its early stages before the Court, the Court’s grant of Morgan’s petition perhaps does not bode well for parties who wait an extended time to seek arbitration. There, of course, is some strategy with first moving to dismiss claims early in the litigation and then seeking to compel arbitration later, if necessary. However, that strategy might need to be reconsidered in light of the Court’s acceptance of this case. Litigators should pay close attention to the Court’s disposition of this case.
Finally, the Court granted a petition for writ of certiorari regarding the 7th Circuit’s decision in Saxon v. Southwest Airlines Co., 993 F.3d 492 (7th Cir. (Ill.) 2021). In that case, the Seventh Circuit held that airport ramp supervisors are “transportation workers” exempt from the FAA.
A ramp supervisor in Saxon brought a putative class action against Southwest Airlines arguing that the company had failed to pay proper overtime to its ramp supervisors in violation of the Fair Labor Standards Act. Southwest moved to compel based on an arbitration provision that was contained in an employment agreement between it and the supervisor. In response, the supervisor argued that she exempt from the FAA because she was part of a “class of workers engaged in foreign or interstate commerce.” The district court disagreed and ruled that the supervisor was too far removed from interstate commerce to fall within the FAA exemption. The Seventh Circuit disagreed and reversed.
The Seventh Circuit first discussed the phrase “class of workers” contained in the section 1 FAA exemption and explained that the question was not whether the supervisor, on an individual basis, was engaged in commerce but, rather, whether Southwest ramp supervisors as a whole were engaged in commerce and whether the supervisor was a member of that class. The court then explained under United States Supreme Court precedent, “[t]o be engaged in commerce for purposes of § 1 . . . is to perform work analogous to that of seamen and railroad employees, whose occupations are centered on the transport of goods in interstate and foreign commerce.” Thus, according to the Seventh Circuit, the essential question was “whether the interstate movement of goods” was a central part of a ramp supervisor’s job.
Focusing on undisputed evidence that supervisors often acted as ramp agents when Southwest was short of workers and, therefore, required to “spend a significant amount of their time engaged in physically loading baggage and cargo onto planes” that traversed other states or countries, the court found that the supervisors were engaged in interstate or foreign commerce. The court similarly found that the supervisor was a member of the cargo loader class. In an putative attempt to placate Southwest’s concerns with its ruling, the court ruled that ramp supervisors could still be subject to arbitration “under state law or through an agreement outside of [their] contract[s] of employment.” Regardless, in the end, the court ruled that the supervisor was a transportation worker exempt from the FAA and, as such, reversed the district court’s ruling compelling arbitration.
Southwest, thereafter, filed its petition for writ of certiorari with the Supreme Court. As explained by Southwest, the essential question is:
Whether workers who load or unload goods from vehicles that travel in interstate commerce, but do not physically transport such goods themselves, are interstate ‘transportation workers’ exempt from the Federal Arbitration Act.
The Court granted certiorari in December 2021, and it will be interesting to see how the Court further defines what it means to be engaged in commerce for purposes of FAA exemption.
§ 1.4. Who Decides—The Court or the Arbitrator?
Swiger v. Rosette, 989 F.3d 501 (6th Cir. (Mich.) 2021). Where a party opposing arbitration challenges an arbitration agreement as a whole but fails to specifically challenge a delegation clause contained in the agreement, it is for the arbitrator to decide whether the claims are subject to arbitration.
A consumer brought suit against finance company executives arguing the executives and the finance company issued a loan to the consumer that violated Michigan state law and federal law. One of the executives moved to stay the case and compel arbitration based on an arbitration provision and delegation clause that was contained in the loan contract. Based on the delegation clause, the executive argued that the district court should compel arbitration of both the case itself and the case’s threshold arbitrability questions. Citing an opinion from the Second Circuit, the district court ruled that enforceability of the arbitration agreement had already been decided against the executive in a similar case and, therefore, denied the executive’s motion to compel arbitration. Finding that the district court should have enforced the delegation clause, the Sixth Circuit reversed.
Preliminarily, the Sixth Circuit explained that FAA allows parties to agree that an arbitrator will decide arbitrability questions, including whether parties have agreed to arbitrate at all or whether an agreement encompasses a particular controversy. As explained by the court, these delegation clauses “preclude[] courts from resolving any threshold arbitrability disputes, even those that appear wholly groundless.” Only when a party specifically challenges a delegation clause may a court consider the enforceability of such clause. Accordingly, a party must specifically attack a delegation clause and challenging the entire agreement itself will not be sufficient. The court then explained that when the consumer challenged arbitration, she challenged the enforceability of the entire arbitration agreement and failed to challenge the delegation clause specifically. Even on appeal, according to the court, the consumer failed to challenge the delegation clause. Accordingly, and due to the consumer’s failure to challenge the delegation clause, the Sixth Circuit ruled that the district court should have enforced it and referred the case to arbitration. The court, therefore, reversed the district court and remanded the case.
Bossé v. New York Life Ins. Co., 992 F.3d 20 (1st Cir. (N.H.) 2021). Where an arbitration provision includes an unmistakable arbitrability delegation clause, the arbitrator is to decide arbitrability, not the court.
An insurance agent brought suit against New York Life arguing that his business relationship with New York Life was improperly terminated due to his race. In response, New York Life moved to compel arguing that certain arbitration clauses contained in various agreements executed with the agent during his tenure with the company required the agent to arbitrate his claims. At least one of the clauses specifically stated that any disputes between the parties were to be decided by an arbitrator. Nonetheless, the district court ruled that the arbitrability determination was for it to decide, not an arbitrator. Specifically, the district court ruled that Section 2 of the FAA required an arbitration clause to bear some relationship to the respective agreement or contract. According to the district court, the subject arbitration clauses improperly required arbitration of “any” dispute between the parties and was not sufficiently limited to disputes bearing a relationship to the contract itself. Accordingly, the district court declined to enforce the arbitration clauses. The First Circuit reversed.
Relying on the U.S. Supreme Court’s decision in Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S. Ct. 524 (2019), the First Circuit explained that where parties have clearly and unmistakably delegated issues of arbitrability to the arbitrator, courts must enforce the parties’ expectations as reflected in the agreement and, therefore, defer to the arbitrator to decide the issue. Reviewing the language contained in one of the arbitration clauses, the court explained that the parties had not only agreed to arbitrate any disputes arising between them but also “‘any dispute as to whether such Claim is arbitrable.’” Additionally, another arbitration clause provided that the arbitration was to be administered by the AAA in accordance with its rules. As explained by the court, rule 6(a) of the AAA Employment Arbitration Rules and Mediation Procedures requires the arbitrator to decide whether claims are arbitrable.
Additionally, the court rejected the agent’s argument that a court must assess whether a dispute is encompassed by an arbitration agreement to properly determine whether arbitrability was delegated to an arbitrator. According to the court, that type of “short-circuiting” was explicitly rejected by Henry Schein. Furthermore, the court summarily found there was no support for the agent’s argument that an arbitration clause must bear some relationship to the underlying contract to be enforceable.
Accordingly, finding that the arbitration clauses unmistakably delegated the arbitrability determination to the arbitrator, the court reversed the district court and ordered the district court to compel arbitration.
Glacier Park Iron Ore Properties, LLC v. U.S. Steel Corp., 961 N.W.2d 766 (Minn. 2021). Absent clear and unmistakable evidence that parties have agreed to arbitrate arbitrability, the arbitrability determination is a function for the court.
Glacier Park initiated an action against U.S. Steel arguing that a lease agreement entered into between U.S. Steel and trust from which Glacier Park acquired assets and rights, was wrongly procured through a breach of the trust’s fiduciary duty. After filing the action, Glacier Park moved to compel arbitration. Although the lease did not clearly express that the parties agreed that the question of arbitrability was subject to arbitration, Glacier Park argued that under an older Minnesota “reasonably debatable” standard, the arbitrator should decide arbitrability. The trial court disagreed, finding that the FAA dictated the court, not the arbitrator, to decide arbitrability. The Court of Appeals affirmed.
On appeal to the Supreme Court, the Supreme Court agreed that the FAA applied because the case involved interstate commerce. Accordingly, the Supreme Court inquired into whether the lease evidenced that Glacier Park and U.S. Steel clearly and unmistakably intended to arbitrate arbitrability. In examining the arbitration provision, the Court noted that although the parties specified certain disputes were subject to arbitration, the provision did not provide that the arbitrability of the claim itself was subject to arbitration. As explained by the Court, parties to an arbitration must expressly state that arbitrability is subject to arbitration, and Glacier Park and U.S. Steel failed to do that. Accordingly, the Supreme Court affirmed the Court of Appeals and held that the question of whether the breach of fiduciary claim was arbitrable was a question for the court.
Melaas v. Diamond Resorts U.S. Collection Dev., LLC, 953 N.W.2d 623 (N.D. 2021). The court, not an arbitrator, decides whether a party provided the necessary consent to enter into an arbitration agreement.
A customer to a timeshare agreement sued Diamond Resorts seeking to void the agreement due to improper actions of Diamond Resorts during the execution of the agreement. Diamond Resorts moved to compel arbitration based upon an arbitration provision contained in the timeshare agreement. The customer contested arbitration arguing that she was a vulnerable adult and, therefore, could not have properly consented to entering into the agreement. The trial court compelled arbitration without considering whether the customer possessed the requisite capacity to consent to the agreement in the first instance. The Supreme Court found this was in error.
The Court first noted that because arbitration is a matter of consent, a court can only order arbitration if it satisfied that the parties actually agreed to arbitrate their disputes. Similarly, because there is a possibility that a party to an arbitration agreement lacked the mental capacity to consent to entering into the agreement, the court – not an arbitrator – must decide whether the agreement was properly formed. If the court determines that a valid arbitration agreement exists, it must order arbitration of the dispute. Accordingly, because the trial court failed to determine whether the timeshare agreement was properly formed, the Supreme Court remanded the case to the trial court to hold an evidentiary hearing to determine whether a contract containing an arbitration agreement properly existed.
§ 1.5. What Constitutes an Agreement to Arbitrate?
Foster v. Walmart, Inc., 15 F.4th 860 (8th Cir. (Ark.) 2021). Where there exist material disputes of fact as to whether parties have agreed to arbitrate, a court should proceed summarily to trial to determine the issue.
Gift card purchasers brought suit against Walmart after the gift cards turned out to be worthless due to third parties tampering with, and stealing, the funds that originally were included on the gift cards. Walmart moved to compel based on a notation that was contained on the back of the gift cards directing purchasers to “see Walmart.com for complete terms.” According to Walmart, if the purchasers had visited that website, they would have come across an arbitration provision which explained that the purchasers accepted arbitration by using or accessing the Walmart sites. The district court denied Walmart’s motion to compel finding that the purchasers never had notice of the arbitration clause and could not have consented to arbitration unless they saw the clause first. On appeal, the Eighth Circuit found that the issue more-properly should have been determined in a trial instead of being decided by the district court itself.
The Eighth Circuit first explained that its task was to determine whether the record revealed any material issue of fact as to whether the parties had an agreement to arbitrate and to the extent that it did, the FAA required the court remand the case for trial. The court then discussed the possible theories behind whether the parties agreed to arbitrate. The first possibility was the instant the plaintiffs purchased their gift cards. According to Walmart, the plaintiff purchasers had notice of the arbitration agreement because it directed them to Walmart’s website for the cards’ complete terms. Nonetheless, the court found that the arbitration clause that was contained on the website explained that the plaintiffs accepted arbitration only by using or accessing Walmart’s websites. Accordingly, as explained by the court, if Walmart wanted the arbitration agreement to be formed at the point-of-purchase, it should have expressly said so in the arbitration clause.
The next possibility for agreeing to the arbitration clause was at the moment the plaintiffs actually accessed Walmart’s sites pursuant to the language contained in the clause. Crucial to this determination, according to the court, was whether the plaintiffs had adequate notice of the “browsewrap agreement.” As explained by the court, to be bound, the plaintiffs were required to either obtain actual notice of the arbitration clause or inquiry notice. The court then noted that the record before it and the district court was “meager,” and, therefore, it was difficult to determine whether the plaintiffs possessed sufficient notice. Characterizing these issues as material disputes of fact, the court explained that the FAA required the district court to proceed summarily to a trial on the issue of notice. Accordingly, the Eighth Circuit reversed the district court and remanded the case for trial for determining whether the parties agreed to arbitrate.
Kauders v. Uber Technologies, Inc., 159 N.E.3d 1033 (Mass. 2021). No arbitration agreement is formed where a signatory does not have reasonable notice of the arbitration terms and does not provide a reasonable manifestation of assent to the terms.
Users of Uber’s phone application brought suit against Uber after drivers for Uber refused to transport the riders because they were blind and accompanied by guide dogs. Uber moved to compel arbitration based on an arbitration provision contained in the terms and conditions contained in the application, which was granted by the trial court. Following arbitration, the riders moved for reconsideration of the trial court’s order requiring arbitration due to an interim opinion issued by the First Circuit Court of Appeals holding that Uber’s registration process did not create a contract with the application’s users because it failed to provide reasonable notice of its terms and conditions. The trial court agreed with the riders that the application failed to provide reasonable notice of its terms and conditions, including the arbitration provision, and, therefore, there was no contract between the riders and Uber. Uber appealed contending the terms and conditions constituted an enforceable contract. The Massachusetts Supreme Judicial Court disagreed.
The Supreme Judicial Court first acknowledged that it had not yet had an occasion to address “what standard a court should use when considering issues of contract formation for online contracts.” Nonetheless, the Court noted that the standard for creating online contracts should not differ from ordinary contract formation. Accordingly, the Court delineated a two prong test for determining whether a party has agreed to the terms of an online contract: there must be both (1) reasonable notice of the terms of the contract; and (2) reasonable manifestation of assent to the terms.
As it relates to the first element, the Court explained that a rider’s mere agreement to use the application did not necessarily mean that the rider also agreed to the “Terms & Conditions” because the application did not require the user to actually click on the link or otherwise review the terms and conditions when creating an account.” Moreover, according to the Court, the page upon which the terms and conditions were hyperlinked focused on payment information and the link was minimally prominent on the page. Accordingly, the Court found that Uber failed to show that it provided the riders with reasonable notice of the terms and conditions, including the disputed arbitration provision. For the same reasons, the Court held that the drivers did not reasonably manifest assent to the terms and conditions. Because there was no reasonable notice of the terms and conditions and because the drivers did not reasonably manifest assent to the terms and conditions, the Supreme Judicial Court ruled that there was no enforceable arbitration agreement between Uber and the riders and, accordingly, remanded the case.
Hillhouse v. Chris Cook Construction, LLC, 325 So.3d 646 (Miss. 2021). An arbitration provision is unenforceable where it requires arbitration to take place in a non-existing forum.
Purchasers of a home brought negligence and contractual claims against a contractor following a flooding of their home. The construction company moved to compel based on an arbitration provision that was contained in the purchase contract. The trial court granted the construction company’s motion to compel despite the fact that the provision required mediation to occur before the Southern Arbitration and Mediation Association (“SAMA”) which had ceased to exist seventeen years prior to the parties entering into the contract. The purchasers appealed arguing that because SAMA did not exist at the time of the contract execution, the arbitration provision was unenforceable. The Supreme Court agreed.
The Supreme Court explained that the contract provided that all claims “shall” be subject to SAMA. Accordingly, arbitration before SAMA was an express contractual requirement. Because SAMA as a forum was an express contractual requirement, the Court explained that it could not rewrite the contract merely because the forum was unavailable. To do so, according to the Court, would be to choose a forum not anticipated by either party. The Court, therefore, reversed the trial court finding that the arbitration provision was unenforceable due to SAMA’s nonexistence and unavailability.
Fitness, Fun, & Freedom, Inc. v. Perdue, No. 20-0344, 2021 WL 653240 (W. Va. Feb. 19, 2021) (unpub.). Minor who enters into a contract containing an arbitration provision may disaffirm the contract, including its arbitration provision, upon reaching majority, even after suit is filed.
Parents of a minor who was injured at a trampoline park brought suit against the trampoline park after the minor broke his legs while using a trampoline at the park. Prior to going to the trampoline park, the minor completed a release of liability on the trampoline park’s website, forging his mother’s signature to the release. The release contained a broad arbitration provision requiring arbitration of any and all claims related to trampoline park and its equipment. Based on the arbitration provision, the trampoline park moved to compel. Thereafter, the parents amended their complaint to add the trampoline manufacturer as a defendant. In the amended complaint, the minor also disaffirmed the release because he had, by that point, reached the age of majority. Because of the minor’s disaffirmance of the release, including its arbitration provision, the trial court denied the trampoline park’s motion to compel. The Supreme Court of Appeals affirmed.
The Supreme Court first explained that a trial court’s review of a motion to compel is limited to two questions: (1) does a valid arbitration agreement exist, and (2) do the subject claims fall within its scope. The Court then noted that contracts entered into by minors are voidable and may be disaffirmed after reaching majority. The Court, therefore, found that because the minor disaffirmed the release, including the arbitration provision, upon reaching majority, the release was no longer valid. Accordingly, the Supreme Court of Appeals affirmed the trial court’s denial of the trampoline parks’ motion to compel.
§ 1.5.1. Issues of FAA Preemption
Harper v. Amazon.com Srvcs., Inc., 12 F.4th 287 (3d Cir. (N.J.) 2021). Where it is unclear whether claims are exempt from being arbitrated under the FAA, a court should first inquire into whether the respective claims are arbitrable under state law before ordering discovery regarding exemption under the FAA.
In Harper, a “flexible” “last mile” delivery driver for Amazon brought suit against Amazon alleging entitlement to additional wages and tips and related violations of New Jersey labor laws. Despite the existence of an arbitration provision in his agreement with Amazon, the plaintiff initiated suit against Amazon in the Superior Court of New Jersey. Amazon removed to federal court based on diversity jurisdiction and the plaintiff, thereafter, asserted a putative class action against Amazon. In response, Amazon moved to compel arbitration under the FAA but also argued that the plaintiff’s claim was also arbitrable under state law. The plaintiff argued that he was exempt under Section 1 of the FAA because he made deliveries across state lines. The district court denied Amazon’s motion to compel and ordered discovery to determine whether the plaintiff was included within the section 1 exemption. The district court expressly did not decide whether the plaintiff’s claims were arbitrable under state law. The Third Circuit found this was in error.
The Third Circuit first acknowledged that section 1 has been interpreted to cover employees in any transportation industry who are engaged in the interstate or foreign movement of commerce or are so closely-related to it so as to practically be a part of it. It is crucial to make a determination as to an employee’s status because a court must know whether a contract itself falls within our without the scope of sections 1 and 2 of the FAA. However, in some instances, as explained by the court, “the scope of the class of workers cannot be determined by examining the nature of the work performed by the class” and limited discovery may be ordered to obtain facts about the class of works. Nonetheless, if there are state law grounds for enforcing arbitration even if the FAA does not apply, courts must first consider and answer that question before ordering discovery. The court explained that this inquiry must take place because “[n]ot all state laws” are displaced by the FAA. Instead, only state laws which conflict with the FAA are preempted. Where a state law enforces arbitration, there is no conflict.
Accordingly, and in light of the above, the Third Circuit vacated the district court’s denial of Amazon’s motion to compel, and remanded the case to the district court to determine whether the case was arbitrable under applicable state law and ordered that such determination be made before “turning to questions of fact and discovery” regarding the applicability of the section 1 exemption under the FAA.
A Better Way Wholesale Autos, Inc. v. Saint Paul, 258 A.3d 1244 (Conn. 2021).
State statute requiring a party to move to vacate an arbitration award within thirty days was not preempted by the FAA.
A car purchaser initiated an arbitration proceeding contending that the car company failed to disclose certain charges in violation of the federal Truth in Lending Act and Connecticut’s Unfair Trade Practices Act, and the arbitrator ruled in favor of the car purchaser. The car company moved to vacate the arbitrator’s award thirty-six days later, arguing that the arbitration had exceed his powers. In response, the car purchaser argued that because Connecticut law required the car company to move to vacate within thirty days of the award, the car company’s application was untimely and the trial court, therefore, lacked jurisdiction to vacate the award. In support of its motion to vacate, the car company argued that the Connecticut statute was preempted by the FAA’s three month limitation period since the respective financing agreement provided that the FAA would apply. The trial court rejected the car company’s argument that the statute was unconstitutional and dismissed the car company’s application to vacate. Connecticut’s intermediate appellate court affirmed the trial court finding that the FAA did not preempt the thirty-day Connecticut statutory provision. The Supreme Court similarly affirmed the trial court finding the Connecticut statute was not preempted by the FAA.
As an initial matter, the Supreme Court acknowledged that the FAA does not expressly preempt state law on temporal requirements, not does it reflect any congressional intent to occupy the entire arbitration field. Accordingly, the Supreme Court considered whether there was a conflict between the FAA’s ninety-day provision to move to vacate and Connecticut’s thirty-day provision. In the end, the Supreme Court found that there was no such conflict because the thirty-day provision does not interfere with a party’s right to challenge an arbitration award and, in fact, furthers arbitration’s goal of resolving disputes timely. Accordingly, the Supreme Court affirmed the trial court’s dismissal of the car customer’s vacation application as being untimely.
§ 1.6. Jurisdiction Under the Federal Arbitration Act
Tantaros v. Fox News Network, LLC, 12 F.4th 135 (2d Cir. (N.Y.) 2021). State statute prohibiting mandatory arbitration clauses for employment discrimination claims “except where inconsistent with federal law” raised federal issue of whether claims brought pursuant to the statute were preempted by the FAA.
Fox News initiated an arbitration action against one of its political commentators arguing that the commentator failed to obtain prior approval before publishing a book, thereby breaching her employment agreement. A few months after Fox News initiated arbitration, the plaintiff brought suit against Fox News and some of its senior executives in New York state court alleging “sexual harassment, hostile work environment, tortious interference with business expectancy, and retaliation for her complaints of sexual harassment.” Thereafter, the New York state court granted a motion to compel arbitration filed by the defendants, compelling the plaintiff’s claims to arbitration.
While the claims of all the parties were being arbitrated, the New York State Legislature passed a law declaring void mandatory arbitration clauses covering sexual harassment claims “‘[e]xcept where inconsistent with federal law.’” The law was later amended to cover all employment discrimination claims, not just sexual harassment claims. Based on the new law, the plaintiff sought a temporary restraining order and injunctions against being required to continue to arbitrate her employment claims and a declaratory judgment action that the new law prohibited enforcement of the arbitration agreement. The defendants removed to federal court arguing that the plaintiff’s new suit “necessarily raise[d] an issue of federal law: whether [the plaintiff’s] claim is consistent with the FAA.” The district court agreed, and relying on Supreme Court precedent, denied remand, finding that the plaintiff’s case arose under federal law. On appeal, the plaintiff argued the district court erred in failing to remand because: “(1) the action [did] not necessarily raise an issue of federal law because preemption [was] an anticipated defense; (2) any federal issue [was] not substantial; and (3) the exercise of federal jurisdiction [in the case] would upset the federal-state balance.” The Second Circuit disagreed.
The court first explained that although federal question jurisdiction is commonly based on a plaintiff specifically pleading a federal cause of action, a “special and small category” of cases brought pursuant to state law can implicate a federal issue. As explained by the court, federal jurisdiction will exist over this smaller set of claims if a federal issue is: “(1) necessarily raised, (2) actually disputed, (3) substantial, and (4) capable of resolution in federal court without disrupting the federal-state balance approved by Congress.”
As it relates to the first element, the court found that federal law was necessarily raised because the New York state statute specifically required the plaintiff plead her claims consistent with federal law. The court also found that the plaintiff’s claims presented a substantial question of federal law because “the issue [would] inform all future claims brought” under the New York state statute and because the case implicated the FAA and national policy favoring arbitration. Lastly, the court found that the exercise of federal jurisdiction in the case did not threaten the balance of federal and state responsibilities because although New York had a competing interest in interpreting its own laws, the New York legislature expressly drafted the disputed state law while being cognizant that federal law might be at issue. Accordingly, finding that “resolution of a significant federal issue” was necessary to the plaintiff’s claims, the Second Circuit affirmed the district court’s denial of remand.
Doe v. Trump Corp., 6 F.4th 400 (2d Cir. (N.Y.) 2021). Courts do not possess jurisdiction to grant a motion to compel arbitration filed by a nonparty to a lawsuit in response to a subpoena that was served on the nonparty.
In Trump Corp., business owners who had lost investments after entering into business relationships with a multilevel marketing company brought suit against the Trump Corporation and members of the Trump family alleging the defendants falsely represented that the marketing company was successful and that the defendants were independent of the marketing company. The plaintiffs did not name the marketing company as a defendant, presumably because the agreements between the business owners and the marketing company contained arbitration clauses. After suit was filed, the plaintiffs served a subpoena on the marketing company seeking documentation related to its relationship to, and communications with, the defendants. After the marketing company failed to produce responsive materials, the plaintiffs moved to compel production. In response, the marketing company moved to compel arbitration of the discovery dispute and the disputes between the plaintiffs and the defendants. The district court granted he plaintiffs’ motion to compel production, in part, and denied the marketing company’s motion to compel arbitration.
Regarding the marketing company’s motion to compel arbitration, the district court explained that the discovery dispute did not fall within the scope of the arbitration agreement because the lawsuit was about the defendants’ purported bad acts and did not relate to the plaintiffs’ obligations under the agreement between the plaintiffs and the marketing company. Additionally, the district court held that the marketing company lacked standing to compel the lawsuit between the plaintiffs and the defendants to arbitration because it was not a party to the lawsuit and, therefore, lacked standing to move to compel arbitration. Similarly, the district court held that it lacked jurisdiction to compel the discovery dispute to arbitration. The Second Circuit affirmed, finding that the district court’s lack of jurisdiction was dispositive as to whether the district court improperly failed to compel arbitration.
The Second Circuit opened its review with an acknowledgment that the FAA does not create federal jurisdiction and, instead, requires an independent jurisdictional basis over the parties’ dispute. Accordingly, a federal court can only compel arbitration if the dispute between the parties could be litigated in federal court if it were not for an arbitration agreement. In this respect, the court found that there was no “actual case or controversy” between the plaintiffs and the marketing company because the plaintiffs did not assert any claims against the marketing company and the marketing company had not intervened or otherwise been impleaded into the lawsuit. Accordingly, because there was no live case or controversy between the plaintiffs and the marketing company, the Second Circuit ruled that the district court properly found that it was without jurisdiction to compel arbitration. The Second Circuit, therefore, affirmed the district court’s denial of the marketing company’s motion to compel arbitration.
§ 1.6.1. Federal Appellate Jurisdiction Under Section 16 of the Federal Arbitration Act
Hamrick v. Partsfleet, LLC, 1 F.4th 1337 (11th Cir. (Fla.) 2021). Federal appellate courts lack jurisdiction to hear appeals based on a district court’s state-law-based denial of a motion to compel arbitration.
A final-mile delivery driver brought a collective action, on behalf of himself and those similarly situated, against U.S. Pack Holdings, LLC, a final-mile delivery company, arguing that U.S. Pack failed to pay wages owed under the Fair Labor Standards Act. U.S. Pack moved, pursuant to both the FAA and state arbitration law, to compel arbitration based on arbitration provisions that were contained in the plaintiffs’ independent contractor agreements with U.S. Pack. The district court denied U.S. Pack’s motion to compel finding that the drivers were exempt from the FAA due to section 1’s transportation worker exemption. Additionally, the district court ruled that U.S. Pack could not compel arbitration under state law because the parties expressly chose the FAA to govern the independent contractor agreements. U.S. Pack, thereafter, sought to appeal the district court’s denial based on both the FAA and state law. Although the Eleventh Circuit ultimately determined that the district court failed to properly consider whether the plaintiffs were in a class of workers that engaged in interstate commerce and, therefore, remanded the case so that the district court could conduct a proper analysis, the Eleventh Circuit ruled that it was without jurisdiction to review the district court’s decision regarding arbitration based on state law.
The Eleventh Circuit first acknowledged that the district court’s denial of U.S. Pack’s motion to compel was an interlocutory order. The court then noted that appellate courts generally are “precluded from hearing interlocutory appeals under the final judgment rule.” Nonetheless, as explained by the court, the FAA expressly allows appellate review of interlocutory orders denying motions to compel pursuant to the FAA. That allowance, however, does not apply to denials of motions to compel arbitration based on state law. Additionally, general pendent appellate jurisdiction which allows review of non-appealable decisions that are “inextricably intertwined” with appealable decisions, did not provide an avenue for the Eleventh Circuit’s review. As explained by the court, a determination of whether the plaintiffs were transportation workers under the FAA could be made without referencing or relying on state arbitration law. Thus, the court found that the district court’s FAA arbitration determination and its state law determination were not inextricably intertwined or interwoven. As such, the court dismissed for lack of appellate jurisdiction the part of U.S. Pack’s appeal that was based on the district court’s denial of arbitration under state law.
§ 1.7. Nonsignatories to an Arbitration Agreement
§ 1.7.1. Can Nonsignatories Compel Signatories to Arbitrate?
Reeves v. Enterprise Products Partners, LP, 17 F.4th 1008 (10th Cir. (Okla.) Nov. 9, 2021). Where a party to an arbitration agreement alleges substantially independent and concerted misconduct between a signatory and nonsignatory to an arbitration agreement, the nonsignatory may properly compel arbitration based on equitable estoppel.
Two welders brought a putative class action against an energy company after performing work for the energy company through third-party staffing agencies, for which the welders allegedly were not properly compensated. The employment contracts between the plaintiffs and the staffing agencies contained arbitration clauses. Accordingly, the energy company moved to compel arguing that the plaintiffs’ claims raised allegations of “substantially interdependent and concerted misconduct” by the energy company and the staffing agencies. Therefore, according to the energy company, the plaintiffs should have been equitably estopped from contesting arbitration. The district court rejected the energy company’s arguments and denied the company’s motion to compel. The Tenth Circuit reversed.
The Tenth Circuit first explained that an arbitration agreement’s scope, including who it binds, is a question of state law. Therefore, according to the court, its task was to determine whether the Oklahoma Supreme Court would allow the nonsignatory energy company to enforce the arbitration clause. However, as explained by the court, the Oklahoma Supreme Court had not yet addressed the applicability of concerted misconduct estoppel. Nonetheless, the court noted that two Oklahoma Court of Appeals cases affirmatively adopted “the two-prong misconduct equitable estoppel test,” finding that “equitable estoppel applied for nonsignatories in two circumstances[.] The circumstance applicable in Reeves, according to the Tenth Circuit, was where “the signatory raises allegations of substantially interdependent and concerted misconduct by both the nonsignatory and one or more of the signatories to the contract.”
The court explained that equitable estoppel is centered on “fairness,” and that the plaintiffs sought to hold the energy company liable based on duties imposed by the employment contracts but simultaneously sought to avoid the arbitration provisions contained in the contracts. Additionally, as explained by the court, the staffing agencies actually were the parties who paid the plaintiffs and not the energy company and, therefore, the plaintiffs’ allegations against the energy company and the staffing agencies were substantially interdependent essentially requiring the staffing agencies to become parties to the case. The court then noted that equitable estoppel seeks to prevent parties from “playing fast and loose with the courts” and that the plaintiffs carefully left the staffing agencies out of their pleadings. However, as explained by the court, the plaintiffs were nonetheless required to honor the arbitration agreements with the staffing agencies and arbitrate their claims against the energy company because the claims were based on the energy company’s and staffing agencies’ substantially interdependent and concerted misconduct. The Ninth Circuit, therefore, reversed the district court’s denial of the energy company’s motion to compel arbitration.
Setty v. Shrinivas Sugandhalaya LLP, 3 F.4th 1166 (9th Cir. (Wash.) 2021). Although a nonsignatory to an arbitration agreement can, in some instances, equitably estop a signatory from contesting arbitration, even under the New York Convention, the claims asserted by the nonsignatory must actually be related to the agreement that includes the arbitration provision.
On remand from the United States Supreme Court, the Ninth Circuit reconsidered its earlier decision that an Indian manufacturing company, which was not a signatory to a disputed partnership deed containing an arbitration agreement, could not equitably estop a competitor company and its principal, signatories to the deed, from avoiding arbitration of a trademark infringement claim. As the matter originally existed before the Ninth Circuit, the manufacturing company had appealed a district court order denying its motion to compel arbitration. Relying on the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”), the manufacturing company had sought to compel arbitration based on a partnership deed between the competitor and its principal that contained an arbitration provision. However, because the manufacturing company was not even in existence at the time the competitor and its principal entered into the arbitration agreement and, therefore, not a party to the agreement, the court summarily affirmed the district court’s denial of the motion to compel.
On appeal to the United States Supreme Court, the Court asked the Ninth Circuit to reconsider its ruling in light of the Court’s ruling in GE Energy Power Conversion France SAS v. Outokumpu Stainless USA, LLC, 140 S. Ct. 1637 (2020). In Outokumpu, the Court held that the New York Convention does not prohibit the enforcement of arbitration agreements by nonsignatories who can meet the elements of equitable estoppel. On remand, the Ninth Circuit “accept[ed] that a nonsignatory could compel arbitration in a New York Convention case” but that the manufacturing company’s allegations did “not implicate the agreement that contained the arbitration clause—a prerequisite for compelling arbitration under the equitable estoppel framework.” Quite simply, according to the court, the manufacturing company’s claims had no relationship to the partnership deed between the competitor and its principal. More specifically, the trademarks at issue, according to the court, were based on mere “prior use” of the contested marks over a period of time and were not based on the disputed partnership deed. Accordingly, finding that because the manufacturing company’s claims were not based on the disputed partnership deed, the court found that the company could not rely on equitable doctrine principles to enforce the deed’s arbitration clause as a nonsignatory. The court, therefore, again affirmed the district court’s denial of the manufacturing company’s motion to compel arbitration.
Doe v. Carmel Operator, LLC, 160 N.E.3d 518 (Ind. 2021). Although the doctrine of equitable estoppel may, in some instances, allow a nonparty to an arbitration agreement to enforce the agreement against a party to the agreement, the nonparty must show that it knew of, and relied upon, the agreement.
A guardian for an elderly resident of a senior living facility brought suit against the facility and a background check company after one of the facility’s employees sexually abused the resident. Both the facility and company moved to compel arbitration based upon a residency agreement between the resident and the facility. Although the company was not a signatory to the agreement, it contended that it was an agent of the facility and, therefore, explicitly contemplated by the terms of the agreement. Alternatively, the company argued that it was covered by the arbitration agreement under the doctrine of equitable estoppel. The trial court agreed with the company and compelled arbitration of the guardian’s claims. The Court of Appeals affirmed. The Supreme Court, however, reversed finding that the company was neither an agent of the facility nor entitled to the protections afforded by equitable estoppel.
As it relates to the company’s contention that it was agent and, therefore, protected under the agreement’s provision extending protection to the facility’s employees and agents, the Supreme Court found that there was no evidence that the facility controlled the company’s process for conducting the disputed background check. Thus, according to the Supreme Court, the company was not acting as an agent for the facility when it was conducting its background check of the subject employee. Furthermore, as it relates to equitable estoppel, the Supreme Court ruled that the company could not prove that it knew about the agreement or that it detrimentally relied upon the agreement. The Supreme Court expressly rejected the company’s suggestion that the Court adopt an alternative theory of estoppel based on “substantial interdependence” of the guardian’s claims against the facility and the company. Accordingly, finding that the company neither was an agent of the facility nor entitled to protection under the doctrine of equitable estoppel, the Supreme Court reversed the trial court’s order compelling arbitration of the guardian’s claims against the company.
§ 1.7.2. Can Signatories Compel Nonsignatories to Arbitrate?
O’Hanlon v. Uber Technologies, Inc., 990 F.3d 757 (3d Cr. (Pa.) 2021). Nonusers of rideshare services are not bound by arbitration provisions generally governing the use of service where the nonusers allege that the service is engaging in discriminatory practices.
Motorized-wheelchair users sued Uber alleging that Uber violated the ADA and discriminated against persons with mobility disabilities by failing to offer wheelchair-accessible vehicles in the Pittsburgh, Pennsylvania area. Uber moved to compel arguing that the plaintiffs were bound by the arbitration clause in Uber’s terms of use because the plaintiffs would not be able to bring any claims against Uber without effectively steeping into the shoes of an actual Uber user. Therefore, according to Uber, the plaintiffs should be equitably estopped from denying the enforceability of the arbitration provision. Similarly, Uber argued that the plaintiffs lacked standing to bring the suit in the first instance since they did not actually use the Uber application.
In denying Uber’s motion to compel, the district court found that the plaintiffs sufficiently had pleaded an injury in fact without actually having used the Uber application. Relatedly, the district court found that the plaintiffs’ claims were based on the ADA and not Uber’s terms of use. For the same reasons, the district court found that the plaintiffs could not be equitably estopped from contesting the enforceability of the arbitration provision contained in Uber’s terms of use. On appeal, the Third Circuit found that it need not address the standing issue because there is no obligation to address standing on an appeal from a motion to compel arbitration. Additionally, the Third Circuit ruled that, under Pennsylvania law, the plaintiffs could not be estopped from denying the of the arbitration provision.
The Third Circuit first noted that under Pennsylvania law, “only parties to an arbitration agreement are subject to arbitration[.]” However, according to the court, equitable estoppel may, in some instances, bind a nonsignatory to an arbitration clause when “the non-signatory knowingly exploits the agreement containing the arbitration clause despite having never signed the agreement.” A nonsignatory exploits a disputed agreement by embracing the agreement and directly benefiting from it. In those situations, a nonsignatory cannot later reject those portions of the respective agreement with which it disagrees. However, these principles do not govern instances where there is no evidence that the nonsignatory availed itself of the agreement or received any benefits under the agreement. Accordingly, a nonsignatory who does not avail itself of benefits under an agreement containing an arbitration clause can properly litigate its claims against another in court.
Considering the above, the court found that the plaintiffs had alleged that they had “not downloaded Uber’s app, used its service, or otherwise availed themselves of any aspect of Uber’s service agreement.” Indeed, according to the court, the plaintiffs have alleged that Uber’s discriminatory conduct prevented them from using the application in the first instance. Accordingly, the court found that the plaintiffs could not be equitably estopped from rejecting the Uber’s service agreement’s arbitration clause and affirmed the district court’s denial of Uber’s motion to compel.
Wagner v. Apache Corp., 627 S.W.3d 277 (Tex. 2021). A party that contractually assumes the obligations and responsibilities of another is bound by an arbitration provision that is contained in the assumed contract, despite not being an original signatory to the contract.
After purchasing and being assigned certain oil assets from Apache, Wagner Oil then assigned the assets to several other assignees. The subsequent assignment provided that the assignees would assume and agree to be bound for all obligations contained in the earlier assignment between Wagner Oil and Apache. The purchase agreement between Wagner Oil and Apache contained an arbitration provision that bound successors and assigns of Wagner Oil and Apache. Several years after Apache and Wagner Oil entered into the purchase and assignment agreement and after Wagner Oil assigned its rights to other assignees, individual landowners brought suit against Apache related to environmental contamination caused by Apache prior to selling its assets to Wagner Oil. Apache, thereafter, filed a demand for arbitration against Wagner Oil and its assignees seeking indemnity and defense. In response, Wagner Oil and its assignees filed a declaratory judgment action in a state trial court seeking a declaration that the Wagner Oil assignees were not parties to the original purchase agreement and, therefore, not subject to arbitration. The trial court agreed with the Wagner Oil assignees and denied Apache’s motion to compel arbitration. The Court of Appeals reversed, finding that the Wagner Oil assignees assumed the obligations under the original purchase agreement and, therefore, were bound by the arbitration provision. The Supreme Court affirmed.
The Supreme Court first expressed that under federal arbitration law, not only are signatories to arbitration agreements bound to arbitrate, but non-signatories can similarly be bound under various theories, including assumption. The Court then explained that the original purchase agreement between Wagner Oil and Apache expressly stated that the arbitration clause was binding upon the parties and their successors and assigns. Similarly, the original assignment between Apache and Wagner Oil provided that the parties’ successors and assignees would forever be subject to the assignment and the terms and conditions of the original purchase agreement. Furthermore, the assignment from Wagner Oil to the other assignees provided that the assignees assumed and agreed to be bound by all obligations imposed on Wagner Oil in its earlier assignment with Apache. Accordingly, the Court found that the Wagner Oil assignees expressly assumed Wagner Oil’s obligations imposed in the original purchase agreement and assignment and, therefore, were subject to the arbitration provision contained in the purchase agreement. The Supreme Court, therefore, affirmed the Court of Appeals and remanded the matter to the trial court so that it could order the parties to arbitrate.
NC Financial Solutions of Utah, LLC v. Commonwealth ex rel. Herring, 854 S.E.2d 642 (Va. 2021). State attorneys general are not bound by arbitration provisions contained in contracts between loan companies and consumers when seeking remedies on behalf of the consumers under state consumer protection laws.
The Attorney General of the Commonwealth of Virginia brought an action against an online lender for violations of Virginia’s consumer protection laws seeking, in part, the return of monies that were paid by state consumers. The online lender moved to dismiss the action contending that because the subject contracts with the consumers contained arbitration provisions, Virginia was required to arbitrate its claims against the online lender. Virginia responded by arguing that it was not a party to the consumer contracts and, therefore, was not bound by the arbitration provisions contained in the contracts. Relying on precedent from the United States Supreme Court, the trial court found that Virginia was not bound by the arbitration provisions. The Virginia Supreme Court affirmed.
The Supreme Court first acknowledged that the FAA reflects the liberal federal policy of favoring arbitration agreements. However, even this liberal federal recognition, as explained by the Court, cannot alter general state contract law regarding the scope of agreements containing arbitration provisions. Accordingly, the Court explained that a party cannot be compelled to arbitration unless it has agreed to arbitrate. The Court then discussed the U.S. Supreme Court’s opinion in EEOC v. Waffle House, Inc., 534 U.S. 279 (2002), wherein the U.S. Supreme Court found that because the EEOC was not a party to an arbitration agreement between an employer and an employee, the EEOC was not required to arbitrate claims it asserted on behalf of the employee against the employer. Finding that the principles elucidated in Waffle House applied in the instant NC Financial Solutions case, the Vermont Supreme Court held that Virginia was not bound by the arbitration provisions between the lender and the consumers. Accordingly, the Supreme Court affirmed the trial court’s order compelling arbitration.
§ 1.8. Scope of Arbitration Agreement
§ 1.8.1. Scope of Arbitration Clauses in Labor and Employment Actions
Cooper v. Ruane Cunniff & Goldfarb Inc., 990 F.3d 173 (2d Cir. (N.Y.) 2021). In employment matters, a claim relates to employment only if the merits of the claim specifically involve facts particular to a plaintiff’s own employment.
An employee brought a putative ERISA class action for breach of fiduciary duty against Ruane, a retirement management company, alleging Ruane mismanaged retirement monies contributed by the employee and his employer. Based on an arbitration provision between the employee and his employer that required the employee to arbitration all claims related to his employment, Ruane moved to compel. The district court granted the motion to compel, finding that the management company was entitled to enforce the arbitration provision under the doctrine of equitable estoppel. Additionally, the district court found that the employee’s claims related to his employment because the claims concerned Ruane’s alleged poor management of the retirement funds, which could be considered the employee’s compensation. On appeal, the Second Circuit reversed holding that the employee’s claims were not related to his employee. Because the court found that the employee’s claims were not encompassed by the arbitration provision in the first instance, the court did not address whether the employee was equitably estopped from contesting Ruane’s ability to enforce the arbitration provision.
In determining that the employee’s claims were not related to his employment, the court made several observations. As an initial matter, the court acknowledged that the FAA reflects a national policy of favoring arbitrations. However, as explained by the court, arbitration can be ordered only where a court is satisfied that parties to an arbitration agreement have agreed to arbitrate the particular dispute. Accordingly, the dispositive issue was whether the employee’s claim for breach of fiduciary duty related to employment. Analyzing the Ninth Circuit’s decision in United States ex rel. Welch v. My Left Foot Children’s Therapy, LLC, 871 F.3d 791 (9th Cir. 2017), the court explained the Welch court found that an employee’s False Claims Act claim was not covered by the phrase “any claims.” More specifically, the Welch court found that the employee’s claims, which were based on her employer’s alleged fraudulent submission of Medicaid claims to the government, were not “related to” her employment for purposes of that dispute. In reaching its conclusion, the Welch court explained that the subject matter of the employee’s FCA claim did not implicate facts particular to that employee’s employment. In addition to the Ninth Circuit’s Welch decision, the Cooper court cited opinions from the Fifth and Eleventh Circuits holding that sexual assaults suffered by employees at employer-provided residential dwellings were not related to the employees’ employment and, therefore, claims regarding the assaults were outside the scope of the respective arbitration agreements.
Similar to the plaintiffs in the aforementioned cases, the Cooper court found that none of the facts relevant to consideration of the merits of the plaintiff’s claims related to his employment. More specifically, the court explained that the employee’s claims principally rested on Ruane’s retirement investment decisions and did not concern the employee’s work performance, evaluations, supervisorial treatment, compensation, workplace conditions, or anything immediately related to the employee’s work experience. Furthermore, as explained by the court, nonemployees, such as other beneficiaries of the retirement plan, plan fiduciaries, and the Secretary of Labor, could have pursued similar claims. Accordingly, finding that the employee’s claims did not relate to his employment because the merits of the claims did not involve facts particular to the employee himself, the court ruled that the claims did not relate to his employment and, therefore, were not subject to arbitration. Accordingly, the court reversed the district court and remanded the case.
Cunningham v. Lyft, Inc., 17 F.4th 244, (1st Cir. (Mass.) 2021). Lyft drivers are not engaged in interstate commerce so as to fall within exemption provided under section 1 of the FAA.
Drivers who used the Lyft application to locate riders brought putative class action against Lyft alleging that Lyft improperly misclassified them as independent contractors instead of employees. Lyft moved to compel arguing that an arbitration agreement contained in the drivers’ terms of service required the plaintiffs to individually arbitrate their claims against Lyft. In response, the drivers contended they were engaged in interstate commerce, thus falling within FAA’s section 1 exemption and, therefore, not bound by the arbitration agreement. More specifically, the drivers contended that they were engaged in interstate commerce because they (1) transported passengers to and from the Logan Airport in Massachusetts for trips to and from other states and countries and (2) some drivers transported customers across state lines. The district court agreed that the drivers were exempt from the FAA and, therefore, denied Lyft’s motion to compel arbitration. The First Circuit reversed.
The First Circuit first discussed the U.S. Supreme Court’s decision in United States v. Yellow Cab Co. and explained that in Yellow Cab, the Supreme Court found that that when local cab drivers merely transferred passengers between their homes and the local railroad station, the drivers were not involved in interstate transportation under the Sherman Act. Instead, a passenger’s interstate journey began when the passenger boarded the train at the station. The First Circuit likened the Lyft drivers’ activities to those of the cab drivers in Yellow Cab and found that if the cab drivers were not affecting interstate commerce under the Sherman Act, then the Lyft drivers were not engaged in interstate commerce when transporting passengers to and from the Logan Airport.
The court then considered the drivers’ contention that they fell within the section 1 exemption because they occasionally transported passengers across state lines. Reviewing uncontested data in the record related to the distances and respective locations traveled by Lyft drivers, the court noted that the question was essentially whether a class of workers qualify for section 1 exemption when many, but not all, of those workers transport passengers across state lines and only for a small percentage of their trips. The court then acknowledged that there was a split between the two circuits that had already considered the issue.
The court explained in Int’l Brotherhood of Teamsters Local Union No. 50 v. Kienstra Precast, Inc., the Seventh Circuit found that cement drivers who traversed interstate for approximately two percent of their trips fell within the section 1 exemption. However, in Capriole v. Uber Technologies, Inc., the Ninth Circuit found that Uber drivers were not engaged in interstate commerce when they transported passengers across state lines only about 2.5% of the time. Agreeing with the 9th Circuit’s rationale, the Cunningham court provided three reasons why the Lyft drivers were not engaged in interstate commerce: (1) not all Lyft drivers transport passengers interstate, (2) the section 1 exclusion must be applied narrowly and Lyft drivers are not primarily devoted to moving goods and people beyond state lines, and (3) Lyft’s primary business is to facilitate local, intrastate trips.
The court, therefore, found that the Lyft drivers were not engaged in interstate commerce and, therefore, the FAA and the respective arbitration agreement governed the drivers’ claims. Accordingly, the First Circuit reversed the district court’s order denying Lyft’s motion to compel.
Capriole v. Uber Technologies, Inc., 7 F.4th 854 (9th Cir. (Ca.) 2021). Uber drivers are not sufficiently involved in interstate commerce to fall within the FAA section 1 exemption.
Drivers with Uber brought a putative class action against Uber alleging Uber failed to properly pay the drivers all compensation that was owed and improperly required the driver to pay certain business expenses. In response, Uber moved to compel based on arbitration provisions that were contained in its agreements with the drivers. The plaintiffs contested arbitration contending that they were engaged in foreign or interstate commerce. The district court disagreed and granted Uber’s motion to compel. The Ninth Circuit affirmed.
The Ninth Circuit first explained that the residual clause contained in section 1 of the FAA which covers workers engaged in foreign or interstate commerce must be interpreted narrowly. Echoing the United States Supreme Court’s decision in Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186 (1974), the Ninth Circuit explained that being “engaged in commerce” for purposes of section 1 exemption, was narrower than “affecting commerce” or “involving commerce.” Accordingly, and in determining whether the exemption applied, the court explained that what mattered most is the “nature of the business for which a class of workers perform their activities,” not the item being transported in interstate commerce or whether the transporters, themselves, cross state lines. Further, according to the court, the residual category of “any other class of workers” contained in Section of the FAA is constrained by the references to “seamen” and “railroad employees,” which immediately precede the text of the residual category. As such, according to the court, the determination of whether Uber drivers are engaged in interstate commerce must be assessed on a national level, instead of a narrower geographic region.
With the aforementioned parameters in mind, the court considered whether Uber drivers were engaged in foreign or interstate commerce. The court rejected the drivers’ contention that because they “sometimes cross[ed] state lines or pick[ed] up and drop[ped] off passengers at airports who [were] heading to (or returning from) interstate travel,” they were engaged in interstate commerce. Comparing the services provided by Uber drivers to those provided by local taxicab drivers, the court explained that Uber drivers are not engaged in interstate commerce because “their work predominantly entails intrastate trips[.]” More specifically, the court explained that only 2.5% of Uber trips between 2015 and 2019 started and ended in different states. Additionally, as explained by the court, only 10.1 of Uber trips taken in 2019 began or ended at an airport. Therefore, according to the court, interstate movement could not be said to be a central part of Uber drivers’ job description and most Uber drivers and riders would concede that Uber trips often are short and local, not involving crossing state lines or trips to transportation hubs.
The court then distinguished Uber drivers from Amazon Flex workers at issue in the court’s 2020 Rittmann v. Amazon.com, Inc. decision. In Rittmann, the court explained that AmFlex workers were engaged in interstate commerce because they “‘complete[d] the delivery of goods that Amazon ship[ped] across state lines and for which Amazon hire[d] AmFlex workers to complete the delivery’ as the last leg of a single, unbroken stream of interstate commerce.” As explained by the Capriole court, Uber drivers generally are “unaffiliated, independent participates in the [a] passenger’s overall trip,” instead of being “an integral part of a single, unbroken stream of commerce[.]”
Accordingly, and in light of the above, the court ultimately concluded that the Uber drivers did not fall within FAA’s interstate commerce exemption and affirmed the district court’s grant of Uber’s motion to compel.
§ 1.8.2. Scope of Arbitration Clauses in other Contracts
Selden v. Airbnb, Inc., 4 F.4th 148 (D.C. Cir. 2021). Race discrimination claims brought pursuant to Title II of the Civil Rights Act of 1964 are arbitrable.
A prospective African American renter who attempted to use Airbnb to rent a room in an occupied home brought suit against Airbnb after the prospective host denied his rent request but allegedly accepted rent requests from purported white individuals who requested the same room on the same dates. More specifically, the plaintiff alleged that Airbnb violated, among other laws, Title II of the Civil Rights Act of 1964, which prohibits race-based discrimination in public accommodations. Because the terms of service of Airbnb contained an arbitration clause, the district court compelled the plaintiff’s claims to arbitration. The claims were eventually arbitrated with the arbitrator ruling in favor of Airbnb.
Thereafter, the plaintiff moved to vacate the arbitrator’s award which was denied by the district court. On appeal, the plaintiff argued, among other things, that the district court erred by ordering arbitration of his discrimination claims, which, according to the plaintiff, were prohibited from being arbitrated pursuant to Title II. The D.C. Circuit disagreed.
The D.C. Circuit first acknowledged that the question of whether Title II claims were arbitrable was a matter of first impression for the court. However, according to the court, there is nothing in Title II which forecloses arbitration. Although Title II states that district courts possess jurisdiction over proceedings brought pursuant to Title II, the court explained that “[a] statutory grant of jurisdiction neither guarantees a right to a federal court trial nor forbids arbitration as an alternate forum.” According to the court, if Congress wanted to prohibit arbitration of Title II claims, it expressly could have done so. Finding that there was no language in Title II overcoming “the FAA requirement to enforcement agreements to arbitrate,” the court ruled that the district court properly compelled arbitration of the plaintiff’s Title II claim.
§ 1.9. Waiver of Arbitration
Forby v. One Technologies, L.P., 13 F.4th 460 (5th Cir. (Tex.) 2021). A waiver of the right to arbitrate claims that are initially presented in a lawsuit does not extend to waiver of additional claims that are asserted in the future.
A consumer brought a class action against One Tech arguing that One Tech deceived consumers by advertising that it provided “free” credit reports while simultaneously charging the consumers for the reports. One Tech moved to arbitrate the consumer’s claims as initially filed but the Fifth Circuit ruled that One Tech waived its right to arbitrate those claims because it had sought to move to dismiss some of the consumer’s claims and did not move to arbitrate until obtaining a ruling on the motion to dismiss. However, after the case was remanded to the district court, the consumer added an additional federal statutory claim against One Tech. Arguing that the additional claim substantially reshaped the consumer’s case, One Tech again moved to compel the consumer’s claims contending that it could not have waived, at least, the additional claim. The district court denied One Tech’s motion explaining that the amended complaint did not alter the consumer’s case in any unforeseeable way. The Fifth Circuit disagreed and reversed.
The Fifth Circuit first explained that there is a strong presumption against waiver. Accordingly, as explained by the court, a party can only invoke the judicial process in a manner sufficient to evidence waiver for “a specific claim it subsequently seeks to arbitrate.” In other words, “waiver of arbitral rights is claim-specific[.]” Instead of litigating the consumer’s additional claim, according to the court, One Tech moved to compel the claim’s arbitration. Finding that One Tech could not have waived the consumer’s additional claim when it moved to dismiss the original claims because the claim had not yet been pleaded, the court ruled that One Tech did not waive its right to arbitrate that claim. Accordingly, the Fifth Circuit reversed the district court and remanded the case.
Health Care Authority for Baptist Health v. Dickson, __ So.3d __, 2021 WL 138859 (Ala. Jan. 15, 2021). A party waives its right to arbitration when it has notice that claims are potentially subject to arbitration but fails to seek discovery of the relevant documentation necessary to determine arbitrability and, instead, actively participates in litigation for two years in court.
Hospital patient in a putative class action brought breach of contract and related claims against a hospital and other defendants contesting the amount of insurance that was reimbursed by an insurer for services received at the hospital. In response, the hospital moved to dismiss the case for the patient’s failure to join the insurer as a party and because of improper venue. Although the hospital’s motion to dismiss was denied, the case was ultimately transferred to another trial court under the forumnon conveniens doctrine. The hospital, thereafter, answered the patient’s complaint but failed to assert arbitration as a defense.
Instead, the parties continued to litigate the case in the trial court, including, among other things, requesting the court enter a joint class discovery and certification scheduling order. After the case had been pending for a little over two years, the hospital moved to compel arbitration arguing that the provider agreement between the hospital and the insurer required the patient to submit his claims to arbitration since his insurance policy with the insurer required arbitration. More specifically, the provider agreement between the hospital and the insurer provided for arbitration contingent upon whether there was an arbitration provision in the patient’s insurance policy with the insurer. The hospital argued that it did not learn of the right to arbitrate until it received a copy of the patient’s health insurance policy during discovery, which was only a couple of months prior to moving for arbitration. In response, the patient contended that the hospital waived its right to arbitrate because the hospital substantially invoked the litigation process. The trial court apparently agreed with the patient because it denied the hospital’s arbitration motion, although it did not provide a rationale for doing so. Nonetheless, the Alabama Supreme Court affirmed the denial.
As explained by the Supreme Court, the hospital knew that the provider agreement between it and the insurer contained an arbitration provision even though it was contingent upon the language used in the insurance policy covering the patient. Accordingly, the hospital should have more-diligently and timely sought a copy of the insurance policy so that it could determine where the patient’s claims were subject to arbitration. Instead, according to the Supreme Court, the hospital improperly waited over two years, and after the action had been transferred to another trial court and after class-related discovery had already began, to pursue arbitration. Due to its motions to dismiss or transfer and because of its participated in class-related discovery, the Supreme Court found that the hospital had substantially-invoked the litigation process before moving to compel. Additionally, the Supreme Court found that the patient had been prejudiced due to incurring litigation expenses that would otherwise have been avoided through arbitration. Accordingly, the Supreme Court found that the hospital had waived its right to arbitration and affirmed the denial of the hospital’s motion to compel arbitration.
§ 1.10. Confirmation and Vacatur of Arbitration Awards
Seneca Nation of Indians v. New York, 988 F.3d 618 (2d Cir. (N.Y.) 2021). Arbitration panel did not manifestly disregard the Indian Gaming Regulatory Act (“IGRA”) by requiring the Seneca Nation of Indians to continue making payments to the state of New York under a gambling compact between the Nation and New York after an express initial time period expired.
The Nation and New York entered into a gambling compact wherein the Nation was provided exclusive rights to maintain specified gambling machines in parts of Western New York in exchange for making graduated revenue-sharing payments to New York from the machines. The agreement provided for an initial 14-year term but that term automatically renewed for 7 years, unless one of the parties objected. The agreement also provided that the highest graduated amount, which expressly covered years 8 through 14 of the initial term, that the Nation would be required to pay to New York would be 25% of the monies made on the machines. The agreement did not expressly address the terms of the Nation’s payments to New York after the initial 14-year period ended, despite the agreement’s provision that the term would automatically extend seven years absent objection. Nonetheless, because neither party objected to renewal after the initial 14-year term ended, the agreement renewed for an additional 7 years.
A few months following the renewal, the Nation informed the State of New York that it did not intend to make any additional payments during the 7-year renewal period. In response, New York contended that it was entitled to continued payments at 25%, and the parties ultimately submitted the dispute to arbitration. Two members of a three-member panel ultimately found that the renewal provision was ambiguous and based on consideration of extrinsic evidence, ultimately determined that it would be “commercially unreasonable and against common sense to find that the word ‘renew’ would extend the Nation’s exclusivity without obligating the Nation to provide any continuing consideration to New York.”
Nonetheless, the Nation argued that the panel could not award additional payments because the Secretary of the Interior did not approve additional revenue sharing as purportedly required under the IGRA. The panel majority responded by explaining that it was simply finding that the renewal terms in the agreement, which had already been approved by the Secretary of Interior when the agreement was executed, included revenue sharing obligations – it was not approving “additional” payments. Accordingly, the Panel ordered the Nation to continue making the 25 percent payments during the seven-year renewal term.
The Nation moved to vacate the award in district court, arguing that “the panel majority manifestly disregarded IGRA’s requirement that the Secretary review and approve compact obligations or amendments—in this case, any payments beyond the 14-year term.” The district court affirmed the arbitration award, finding that the panel did not create a new payment obligation. Instead, according to the court, the Secretary had “approved the renewal provision, and the panel simply interpreted that approved provision to require further payments.” Thus, according to the district court, the panel did not manifestly disregard the IGRA. The Second Circuit agreed.
The Second Circuit first noted that although an arbitrator’s manifest disregard of either the law or the terms of an arbitration agreement remains a valid ground for vacatur, as long as the arbitrator provides “even a barely colorable justification for his or her interpretation of the contract,” the arbitration award will be affirmed. The Second Circuit explained that to prove a manifest disregard of law, it must be shown that an arbitrator knew of a relevant legal principle and “willfully flouted the governing law by refusing to apply it.” Considering these principles, the Second Circuit found that the panel did not manifestly disregard the IGRA.
The court explained that the IGRA merely requires the Secretary of Interior’s approval of gaming compacts but not “interpretations of existing contractual terms.” The contested renewal term, as explained by the court, had already been approved by the Secretary when the agreement was made. Accordingly, the parties were not required to again seek approval just because they disputed how the renewal term should be interpreted. Additionally, as explained by the court, the panel’s reliance on extrinsic evidence in interpreting the renewal term did not constitute a transformation of the compact requiring separate IGRA approval. Furthermore, according to the court, even if IGRA’s secretarial approval was required where an arbitrator issued an award based on extrinsic evidence, the requirement was not “well defined, explicit, and clearly applicable” and, therefore, it could not be said that the panel willfully flouted that purported requirement. Therefore, the court ruled that the panel did not manifestly disregard governing law and, as such, affirmed the district court’s denial of the Nation’s request to vacate the arbitration award.
§ 1.10.1. Timing for Moving to Confirm or Vacate
BST Ohio Corp. v. Wolgang, 176 N.E.3d 31 (Ohio 2021). Statutory timeframe for moving to vacate arbitration award does not prevent opposing party from seeking confirmation of the award prior to the end of the timeframe nor does it limit the court’s respective confirmation of the award.
BST initiated an arbitration proceeding against Wolgang arising out of the alleged mismanagement of a property that was jointly owned by BST and Wolgang. The same day the arbitrator issued its ruling, BST moved to confirm the award. In response, Wolgang petitioned to vacate the award in California but did not move to oppose the confirmation application in Ohio. The Ohio trial court eventually scheduled a hearing on the confirmation motion and Wolgang sought a stay of the confirmation hearing contending that under Ohio’s statutory scheme, it had three months to move to vacate, modify, or correct the award. During the hearing, Wolgang reiterated that it had three months to move to vacate the award and that the confirmation proceeding, therefore, was premature. During the hearing, the trial judge informed Wolgang that regardless of the three-month period, it should have filed a response to the application for confirmation. Wolgang failed to do so and approximately two weeks after the hearing (and before the three month period for moving to vacate had ended), the trial court denied Wolgang’s motion to stay and confirmed the arbitration award. Wolgang appealed and the Court of Appeals agreed that the because Wolgang had three months to move to vacate the award, the trial court prematurely confirmed the award. The Supreme Court disagreed.
Reviewing the language of the respective statute, the Court found that the three-month time period to move to vacate was an “upper limit” that could be limited by another party filing a pleading or motion requiring a response. Accordingly, the party opposing confirmation must take action to formally oppose confirmation regardless of the three-month deadline to move to vacate. Otherwise, a court considering a motion to confirm may properly confirm an award. The Supreme Court explained that Wolgang could have simply filed a placeholder motion explaining that it opposed confirmation and would be submitted more substantive briefing in the future. Wolgang, however, failed to do so and at its peril. Accordingly, the Supreme Court reversed the Court of Appeals.
§ 1.11. Waiver Of Appellate Review Of District Court Order Confirming Or Vacating Arbitration Award
Beckley Oncology Assocs., Inc. v. Abumasmah, 993 F.3d 261 (4th Cir. (W. Va.) 2021). Parties to an arbitration agreement may properly agree to waive appellate review of a district court’s order confirming or vacating an arbitration award.
A doctor initiated an arbitration action against a medical health facility arguing the health facility owed him certain incentive payments following his termination from employment. The arbitrator ultimately issued an award in favor of the doctor, and the health facility moved to vacate the arbitration award in federal district court. The district court dismissed the health facility’s complaint and confirmed the award. On appeal to the Fourth Circuit, the doctor argued that the health facility had waived its right to appeal the arbitration award because the respective employment agreement expressly contained a judicial appeal waiver. Recognizing that the validity of an arbitration provision waiving appellate judicial review was a matter of first impression for the Fourth Circuit, the court ultimately ruled that such a waiver was valid under the FAA.
Pointing to the Tenth Circuit’s decision in MACTEC, Inc. v. Gorelick, 427 F.3d 821 (10th Cir. (Col.) 2005), the court stated that the waiver of appellate review of an arbitration decision constituted a compromise wherein parties to an agreement trade the risks associated with contested appellate review for a “one-shot opportunity before the district court.” Furthermore, as explained by the Tenth Circuit, a party’s right to obtain review of a district court’s confirmation or vacation of an arbitration award only exists due to statute and, therefore, a party may waive that right. Lastly, according to the court, “reflexive appeal[s] of arbitration awards seem[] to be an increasingly common course, leading to arbitration no longer being treated as an alternative to litigation, but as its precursor.” Accordingly, the court dismissed the appeal finding that the parties had properly waived appellate review of the district court’s decision.
The rights and protections available to directors of corporations and managers of limited liability companies (LLCs) against liability, including rights to advancement of expenses, indemnification, exculpation, and D&O insurance, operate within a broader framework. That framework requires reference to the precise terms of the organizational documents of the company they serve and any additional contractual rights or benefits those directors and managers obtain by or through the company. In the context of private equity and venture capital backed companies, the rights and protections afforded to directors or managers must also be considered in light of any rights and protection given by the private equity or venture capital fund (or an entity affiliated with the fund) to directors or managers designated by the private equity or venture capital fund.
This outline addresses the rights and protections available to directors of Delaware corporations and managers of Delaware LLCs. While we recognize that differences in the laws of the jurisdiction of incorporation or formation of a particular fund or any particular portfolio company may affect the drafting of provisions establishing the rights and protections of directors or managers, or the availability of such rights and protections, the principles of Delaware law discussed herein are useful for illustrating the issues directors and managers of private equity and venture capital backed entities (and the sponsors) should consider. This outline does not expressly address the rights of officers, employees, or other agents of corporations or LLCs, although we note that many of the basic concepts set forth herein with respect to the contractual protections that may be afforded to directors and managers are also applicable to such other parties.
Under Delaware law, there are multiple layers of structural protection for directors of corporations and managers of LLCs against liability, including rights to advancement of expenses, exculpation, and indemnification. In addition, corporations and LLCs are entitled to purchase and maintain D&O insurance to protect directors and managers. All such protections operate within a system and must be considered together. Moreover, the specific language used to establish rights and protections must be consulted to determine the specific availability of rights and protections. Private equity and venture capital funds frequently want to ensure that the directors or managers that they appoint to a portfolio company receive a robust set of rights and protections from that portfolio company—and that the portfolio company is the so-called “indemnitor of first resort,” with no rights to seek contribution from the fund.
Exculpation
Section 102(b)(7) of the Delaware General Corporation Law (“DGCL”) permits a corporation to include in its certificate of incorporation a provision eliminating personal monetary liability for a director’s breach of fiduciary duties except (1) breaches of the duty of loyalty, (2) acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law, (3) transactions where a director derives an improper personal benefit, and (4) illegal dividends or stock repurchases. In general, the existence of an exculpatory provision contemplated by Section 102(b)(7) that is applicable to the maximum extent permitted by law will result in the dismissal of a claim for monetary damages based solely on a breach of the duty of care. No exculpatory provision, however, will operate to prevent an injunction for breach of the duty of care, nor will it result in a dismissal of claims where the plaintiff has adequately pled a breach of the duty of loyalty or bad faith (or any other non-exculpable conduct).
Section 18-1101(e) of the Delaware Limited Liability Company Act (“LLC Act”) provides that a limited liability company agreement may provide for the limitation or elimination of any and all liabilities for breach of contract and breach of duties (including fiduciary duties) of a manager to the company or to another member or manager or to another person that is a party to or is otherwise bound by the agreement. However, a limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing. Unlike the DGCL, which only allows for exculpation of directors against monetary damages to the corporation or its stockholders for a breach of the duty of care, the LLC Act allows the limited liability company agreement to provide broad rights to exculpation, subject only to the bad faith violations of the implied contractual covenant of good faith and fair dealing. Although the LLC Act provides for broad exculpation of managers, many limited liability company agreements will contain exceptions and qualifications on rights to exculpation, including standard of conduct or other requirements or conditions. Parties should take care in reviewing these exceptions and qualifications, specifically those relating to “gross negligence” (which is the standard for assessing a breach of the duty of care).
Indemnification
The DGCL contains three principal subsections dealing with indemnification of directors. Section 145(a) of the DGCL empowers a corporation to indemnify its directors against expenses, judgments, fines, and amounts paid in settlement incurred in connection with actions other than those brought by or in the right of the corporation, subject to a determination that the indemnitee has met the requisite standard of conduct. Section 145(b) empowers a corporation to indemnify its directors against expenses incurred in connection with the defense or settlement of an action brought by or in the right of the corporation, subject to the standard of conduct determination, and except that no indemnification may be made as to any claim to which the person has been adjudged liable unless the court determines such person is fairly entitled to indemnification. Section 145(c)(1) provides that to the extent a director has been successful on the merits or otherwise in defense of any action, suit, or proceeding referenced in Section 145(a) or Section 145(b), the director shall be indemnified against expenses actually and reasonably incurred by the director in connection therewith.
Under Section 145(f) of the DGCL, the rights to indemnification under Section 145(a) and Section 145(b) may be made mandatory through the certificate of incorporation, bylaws, resolution, or other agreement. The use of the words “shall indemnify” or “must indemnify” generally provides mandatory rights, while the use of the words “may indemnify” or “shall have the power to indemnify” generally connotes permissive rights. The specific language used will be critically important in determining the protection available to a director.
Nevertheless, even if rights are made mandatory, except where Section 145(c) obligates the corporation to indemnify the director against expenses, there must be a determination that the director met the standard of conduct necessary to obtain rights to indemnification. That determination must be made, with respect to a current director, by one of: a majority of the directors not party to the proceeding, a committee of such directors, independent counsel, or the stockholders. Private equity and venture capital funds may consider negotiating for the right for their director designees to have such determination made by independent counsel.
In considering rights to indemnification, it is important to highlight that the protection afforded under Section 145(b), which relates to indemnification for claims brought by or in the right of the corporation, including derivative claims, only provides protections against expenses—but not judgments or amounts paid in settlement. Due to the corporation’s lack of power to indemnify against such potential liabilities, corporations frequently seek insurance to provide coverage against such claims. Section 145(g) of the DGCL permits corporations to purchase and maintain insurance to protect directors against all manner of liabilities, whether or not the corporation would be permitted to indemnify the director.
Section 18-108 of the LLC Act provides that a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever. Unlike the DGCL, the LLC Act does not contain any specific limitations on the availability of indemnification, such as the standard of conduct requirements in Sections 145(a) and 145(b) or any of the limitations on the type of liabilities for which indemnification is available under Section 145(b). Conversely, the LLC Act does not include any supervening rights to indemnification; thus, managers will not have any rights to indemnification unless (and only to the extent) they are provided by contract.
Advancement
Section 145(e) of the DGCL provides that expenses incurred by a current director of the corporation in defending a proceeding may be paid by the corporation in advance of the final disposition of the proceeding upon receipt of an undertaking by such person to repay the advanced amounts if it is determined that the person is not entitled to be indemnified. As with rights to indemnification, rights to advancement may be made mandatory pursuant to Section 145(f). Again, the specific language used to create the mandatory rights will be critical in determining the availability of rights. The use of the words “shall advance” will generally be construed to create mandatory rights, while the use of “may advance” or “shall have the power to advance” will generally be construed as permissive rather than compulsory.
Section 145(e) provides that such expenses incurred by a former director may be paid in advance upon such terms as the corporation deems appropriate. Section 145(e), by its terms, relates to the expenses a director incurs in defending a proceeding. Thus, where rights to advancement merely make mandatory the permissive advancement rights set forth in Section 145(e), a director generally will not be entitled to require the corporation to advance their expenses incurred in connection with affirmative actions brought by the director, subject to limited exceptions, such as affirmative defenses and compulsory counterclaims.
The basic philosophy behind advancement is that the corporation should pay the expenses incurred by its directors as those expenses are incurred to enable the directors to mount a defense against claims and to vindicate their actions. For that reason, it is often advisable to ensure that rights to advancement are not made subject to any conditions or other requirements other than the requirement, imposed under Section 145(e), that current directors must provide an undertaking to repay any amounts advanced if it is ultimately determined that they are not entitled to indemnification.
The Delaware courts have held that rights to indemnification and advancement are distinct rights that must be separately provided. Thus, a provision providing that the corporation shall “indemnify and hold harmless” directors, of itself, will not be sufficient to give directors separate rights to advancement of expenses. Each of the rights must be separately identified and made mandatory in order to ensure that directors have the protection of both layers.
Although Section 18-108 of the LLC Act does not expressly reference “advancement,” the Delaware courts have made clear that they defer completely to the contracting parties to create and delimit rights and obligations with respect to indemnification and advancement. The LLC Act does not include express restrictions or requirements on advancement rights (such as undertakings to repay amounts advanced). Again, LLCs are contractual in nature. Rights to advancement will not be assumed or implied unless they (and only to the extent) they are expressly provided by contract (i.e., the limited liability company agreement).
Indemnitor of First Resort
Private equity and venture capital funds often seek to ensure that the portfolio companies to which they designate directors include rights to indemnification and advancement of expenses via so-called “indemnitor of first resort” provisions in the companies’ governing documents or other agreements. These provisions are designed to ensure, among other things, that a private equity or venture capital fund that has its own obligation to indemnify or advance expenses of the persons whom it designates to the governing body is not subject to contribution in the event the corporation makes the payments.
These provisions generally require the portfolio company to expressly acknowledge that the director has rights of indemnification, advancement, and insurance from the sponsor; to agree that it is the indemnitor of first resort and that it is obligated to advance all expenses and indemnify for all judgments, penalties, fines, and amounts paid in settlement; and to waive any claims against the sponsor for contribution or subrogation. Where indemnitor of first resort provisions are included in portfolio company governing documents or other agreements, the private equity or venture capital fund should be made an express third-party beneficiary of the provision.
D&O Insurance
There are multiple issues that arise in connection with the purchase and maintenance of D&O insurance, and there are different types of insurance available.
In general, “Side-A” coverage insures individual executives of the company and provides for the advancement of defense costs where executives are not indemnified by the insured company. Side A coverages provides personal asset protection; it responds when the company is unable to indemnify the director (legally or financially). There are no retention amounts.
“Side-B” coverage pays for losses incurred by the insured company in indemnifying individual executives for claims against those executives. It provides balance sheet protection to the company and responds when the company has satisfied its policy retention for indemnifiable loss against individuals.
“Side-C” coverage provides “Entity Coverage.” It pays for “Losses” incurred by the company arising from claims against the company itself. For public companies, it usually for covers “securities claims” only. Side C coverage provides balance sheet protection for claims against the company and generally responds when the company is named in a securities claim.
In assessing D&O coverage, parties should consider various issues, if for no other reason than to set expectations. Major issues include resolving conflicts between the company and individuals if the company has the sole right to notice a claim or circumstance; whether individuals can recover “fees-on-fees” if they must sue the insurance company under the policy; whether individual insureds can obtain a copy of the policy when they need one; and the impact of “related” and “interrelated claims” provisions.
This article is based on a CLE program that took place during the ABA Business Law Section’s 2022 Hybrid Spring Meeting. To learn more about this topic, view the program as on-demand CLE, free for members.
At the ABA Business Law Section’s 2022 spring meeting in Atlanta, the M&A Committee presented a CLE panel discussing case law regarding drafting MAE, indemnification, fraud carve-outs, and other miscellaneous provisions. That CLE panel, which included insightful commentary by Chief Justice Collins J. Seitz, Jr. of the Delaware Supreme Court, is available to view as on-demand CLE, free for Section members. Below is a summary of the decisions and topics discussed.
(i) MAE, Ordinary Course, and other Lessons learned from COVID Litigation
COVID-19 has exposed certain structural vulnerabilities in M&A agreements that can be exploited when there is an unexpected event, namely: the Material Adverse Effect definition, the “ordinary course” covenant, and the covenant bring-down condition. Deal points data from 2019–2021 showed Buyers’ and Sellers’ response to such vulnerabilities:
MAE Definition. Two pro-Buyer developments: Rather than adhering to the standard single-prong definition (i.e., an MAE on the business, subject to carve-outs), there is an increased prominence of the dual prong definition (i.e., that an MAE also includes the ability to consummate/perform the transaction). Second, the “disproportionate effect” override continues (in most instances) to be tied to the industry within which the company operates rather than similar companies within that industry. One pro-Seller development: the exclusions to the MAE definition are more often expressed in relational terms that permit an expansive reading of the exclusions’ scope (i.e., language such as “arising under, resulting from or relating thereto” that does not require a direct causal link).
“Ordinary Course” Covenant. One pro-Seller development: Early deal data from 2021 suggest that Sellers have become increasingly successful in negotiating an “efforts” based standard. Nevertheless, a majority of deals continue to impose an absolute obligation on the target to operate in the ordinary course of business, and those that do contain such a flat covenant are also likely to retain a “consistent with past practice” requirement.
Closing Condition. The covenant bring-down condition continues to be tied to a Buyer-friendly “in all material respects” standard of materiality rather than the MAE standard.
There was a string of COVID “broken deal” cases brought in 2020 in the Delaware courts, with the first decided in the Delaware Court of Chancery on April 30, 2021.[1] In December of 2021, the Delaware Supreme Court decided its first COVID “broken deal” case on appeal: AB Stable VIII LLC v. Maps Hotels and Resorts One LLC.[2]AB Stable offered the following interpretative points regarding these three areas of structural vulnerability:
MAE Definition. The exceptions to the definition of MAE do not need to refer to the root cause of the adverse development to be effective. In other words, there is no requirement that the definition reference “COVID” or a “pandemic” if the effect of the pandemic was itself described by the exception.
“Ordinary Course” Covenant. “Ordinary course” means to operate in accordance with how a business has routinely conducted its business in normal circumstances, not how it or others in its industry operated in the pandemic. “Consistent with past practice” looks only at how such seller operated the business in the past. And a “reasonableness” standard is not implicit in the “ordinary course” obligation.
Closing Condition. The MAE closing condition does not bleed into the covenant bring-down condition’s “in all material respects” standard. The court made it clear that the two provisions serve different purposes: (i) the MAE closing condition allocates the risk of changes in a target’s valuation, and (ii) the “ordinary course” covenant reassures a buyer that the target has not materially changed its business or practices during the pendency of the transaction. The “in all material respects” covenant bring-down condition does not require a showing equivalent to an MAE or even a showing equivalent to the common law doctrine of material breach, but rather only that a deviation occurred that significantly altered the total mix of information available to Buyer when viewed in the context of the parties’ contract, resulting in a meaningful change from Buyer’s reasonable expectations about how the business would be operated between signing and closing.
One can expect that the structural vulnerabilities discussed above will become the subject of further attention in M&A agreements as the parties seek to address their impact on closing certainty.
(ii) Indemnification, Fraud, and Reliance Lessons
The dense, highly negotiated agreements used in mergers or acquisitions often require courts to decide which party better interprets technical provisions concerning their indemnification obligations or rights, and the ability of parties to assert fraud claims. The variations of nonreliance, integration, exclusive remedies, and indemnification clauses, and the way the clauses interact with each other and the public policies underlying fraud claims, lead to a seemingly endless variety of interpretation questions. Together the decisions guide sellers and buyers as to how to limit (or preserve) their indemnification obligations (or rights) and exposure to (or ability to assert) fraud claims.
Concerning fraud claims, the Delaware Court of Chancery decision in Online Healthnow, Inc. and Bertelsmann, Inc., v. CIP OCL Investments, LLC et al.,[3] analyzed how sellers can contractually seek to modify their exposure to post-closing fraud claims. Vice Chancellor Slights noted that they can do so in four ways: “(1) ‘what’ information the buyer is relying on, (2) ‘when’ the buyer may bring a claim, (3) ‘who’ among the sellers may be held liable, and (4) ‘how much’ the buyer may recover if it proves its claim.”[4] The Vice Chancellor relied on what he described as the seminal decision in this area, Abry Partners V., L.P. v. F&W Acquisition LLC,[5] to answer the “what” and “how much” questions, reiterating that parties may contractually disclaim reliance on extra-contractual statements, but may not contractually limit their liability for knowingly making false statements within the contract itself given Delaware’s “distaste for immunizing fraud.”[6]
Vice Chancellor Slights then focused on the “when” and “who” questions in the case, analyzing an agreement that contained “remarkably robust survival, anti-reliance and non-recourse provisions that appear to atomize Plaintiffs’ claims across all of the recognized planes of contractual limitations.”[7]Abry and its progeny make clear that “contractual limitations on liability are effective when used in measured doses,” but it would be “too much dynamite” to “invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.”[8] That meant the survival provision could not cut off a claim for contractual fraud, and the non-recourse provision could not insulate a third party from liability if that party knew of and facilitated the fraudulent misrepresentations made in the acquisition agreement.[9] On the specifics alleged, the plaintiff in Online Healthnow had adequately pled the parties knew of and facilitated the fraudulent misrepresentations through their participation in the sale process and drafting of the agreement.[10]
Regarding indemnification and reliance cases, the number of cases discussing these points is such that a full discussion is beyond the scope of the CLE presentation or this summary. A number of those cases were thus discussed briefly,[11] before using the recent Chancery decision in Spay Inc. v. Stack Media Inc.,[12] as a case study. There, the court largely denied a motion to dismiss because the purchase agreement did not bar the asserted claims. First, the court determined that the limitation on survival applicable to non-fundamental representations and warranties did not by its terms apply to covenants.[13] Because the purchase agreement failed to specify a survival period applicable to covenants, the covenants survived until expiration of the applicable statute of limitations.[14] Further, the survival period applicable to non-fundamental representations and warranties was not applicable where the claim for breach was based on fraud (which was not defined in the agreement).[15] The exclusive remedy provision specifically stated that such fraud was not exclusively governed by the indemnification regime in the purchase agreement, meaning claims for breaches based on such fraud could still be brought after expiration of the contractual survival period.[16] The court did not address, but referenced in dicta that the survival period for representations may not apply to the closing certificate unless expressly stated.[17]
(iii) Beware the Boilerplate
Sample, model, or previously used agreements commonly serve as the starting point for drafting transactional documents. Using those provisions and treating them as boilerplate that does not require customization, however, may result in outcomes not considered by the parties. Recent decisions construing boilerplate provisions, and particularly those relating to governing law, exclusive forum, and jury trial waivers, should make practitioners consider whether to modify those provisions to better reflect the interests of their clients.
As Professor John Coyle of the University of North Carolina School of Law has observed, there is a secret language of choice-of-law and forum selection clauses.[18] As a result, to ensure that the law chosen by the parties applies to not only resolution of any interpretive questions arising under the contract (i.e., ambiguities) but also determination of their substantive rights and obligations, parties should expressly state that the contract shall be “governed” (as opposed to interpreted or construed) by the laws of the specified jurisdiction.[19] Similarly, if the parties’ intent is to have the specified “governing” law apply not just to contract claims but also to tort or statutory claims relating to the contract, then many jurisdictions (among them New York[20]) require that they expressly say so; inclusion of the phrase “and claims relating to this agreement” should eliminate any doubt as to the parties’ intent (most courts view “arising out of” as too narrow in scope). And a majority of U.S. courts (New York and Delaware—but not California—among them) distinguish between substantive law and procedural law when interpreting choice of law provisions. Since statutes of limitation are generally considered procedural in nature, a clause that provides the contract is to be governed by the law of a specified state, without more, runs the risk of selecting only such state’s substantive, not its procedural, law, resulting in the statutes of limitation of the forum jurisdiction, not those of the specified governing jurisdiction, being applied.[21] To avoid that result, parties’ governing law provision should contain the phrase “including those laws applicable to statute of limitations.”
Finally, a word or two about exclusive forum selection clauses. What if the parties desire all claims relating to an agreement to be litigated exclusively in a specified jurisdiction? Would the following accomplish that goal: “The sole and exclusive jurisdiction for any litigation for enforcement of this Agreement shall be in the courts of [X]”? The answer is no—“enforcement” merely applies to the obligations set forth in the contract.[22] As is true with respect to governing law, if parties want to ensure that all claims are adjudicated in a specific jurisdiction, they should replace “litigation for enforcement” with “litigation related to this Agreement.” And parties need to recognize that courts will refuse to enforce forum selection clauses if they believe the chosen forum would not apply a constitutional or statutory right, or the benefit of a fundamental public policy to which a party is entitled.[23]
Snow Phipps Group, LLC v. KCake Acquisition, Inc., 2021 WL 1714202 (Del. Ch. Apr. 30, 2021) (Agreement signed March 6, 2020). ↑
891 A.2d at 1061. The Delaware Supreme Court last year blessed this balancing of interests. Express Scripts v. Bracket Holdings Corp., 248 A.3d 824, 830-32 (Del. Feb 23, 2021). ↑
See, e.g., Fortis v. Johnson & Johnson, 2021 WL 4314115 (Del. Ch. Dec. 13, 2021) (unambiguous non-reliance provision is required to preclude extracontractual claims against a buyer based on factual misrepresentations); Sofregren v. Allergan, 2021 WL 1400071 (Del. Super. Apr. 1, 2021) (concluding omissions were not disclaimed in non-reliance clause); Infomedia Group, Inc. v. Orange Health Solutions, Inc., 2020 WL 4384087 (Del. Super. July 31, 2020) (concluding there is no distinction between omissions and concealment for purposes of non-reliance clause); Flowshare, LLC v. GeoResults, Inc., 2018 WL 3599810 (Del. Super. July 25, 2018) (standard integration clause by itself did not disclaim reliance). ↑
The following discussion draws heavily from Professor Coyle’s scholarship, and in particular “The Canons of Construction of Choice-of-Law Clauses,” 92 Wash. L. Rev. 631 (2017). ↑
While most courts view the terms as functionally equivalent, not so the Second Circuit. Arnone v. Aetna, 860 F.3d 97 (2d. Cir. 2017). (“The choice of law provision, in stating that the [contract] will be ‘construed’ in accordance with Connecticut law, sets forth only which jurisdiction’s law of contract interpretation and contract construction will be applied. In the context presented here, that provision is insufficient to bind this court to apply the full breadth of Connecticut law, to the exclusion of another jurisdiction’s law, in fields other than interpretation of the language in this contract.”) ↑
See, e.g., Knierieman v. Bache Halsey Stuart Shields, 427 N.Y.S.2d 423 (1980). ↑
See, e.g., Pivotal Payments Direct Corp. v. Planet Payment, Inc., 2015 WL 11120934 (Del. Super. Ct. January 4, 2016) (claims brought in Delaware court for breach of contract with a New York choice of law ended up having Delaware’s three-year rather than New York’s six-year statute of limitation apply). ↑
See, e.g., S-Fer Int’l, Inc. v. Paladian Partners, Ltd., 906 F. Supp. 211, 2134 (S.D.N.Y. 1995). ↑
Some states, like California, have a strong public policy prohibiting pre-trial waiver of jury trials; seeWest v. Access Control Related Enterprises, LLC, C.A. No. N17C-11-137 (Del. Super. Ct. Jan. 26, 2021) (California’s is rooted both in Constitution and statute). When the exclusive forum results in the litigation being permissible only in Delaware’s Court of Chancery, which does not provide for jury trials, or in New York state court where the practical effect would likely be validation of the pre-trial waiver, California courts have declined to enforce the forum selection clause and have permitted the matter to be litigated in California instead. Handoush v. Lease Finance Group, 254 Cal. Rptr 3d 461 (Ct. App. 2019) (New York forum selection); West v. Access Control Related Enterprises LLC, Superior Court of California, L.A. County BC642062 (July 29, 2020) (Delaware forum selection). ↑
Much has been written about authenticity in the fields of business and leadership, but by comparison, not so much in the legal field. Yet, for all the reasons authenticity is discussed in those fields, it is equally central to the practice of law. It fosters relationships, encourages collaboration, builds trust, and differentiates you from others.
Research shows that when we cater to others and hide who we are, it is cognitively and emotionally draining, which can undermine performance. And when we don’t know the preferences and expectations of our audience, we are more anxious, which also can hurt performance.[1] When I started to think about how to bring authenticity to my practice, I thought of preparation for trial and, in particular, Federal Rule of Evidence 901—Authenticating or Identifying Evidence. The essence of the rule is in the first part: to authenticate an item of evidence, the proponent must produce evidence sufficient to support a finding that the item is what the proponent claims it is. What does that mean when it is applied to a person? At a basic level, I think of it as demonstrating that you are who you are. That’s not to say that “authenticity” should be an excuse to do only what is comfortable or to be completely unfiltered in any professional setting. Just as I would think through carefully what documents or testimony I would use or elicit to meet the standard under Rule 901, I also have to think through what personal qualities I have that would make me a better lawyer. Here, I identify four ways to bring authenticity to the practice of law.
Start with Being Self-Aware
Having a better understanding of yourself helps to create more relevant and motivating goals. If this were a trial, I would begin with a list of issues that need to be proven in order to prevail. Start making that list. What are the top five priorities for you professionally and personally? What are your personality traits? Keep in mind that we all have multiple versions of ourselves that show up depending on the context. Just as knowing your case inside and out is an important step toward success for a client, knowing yourself is equally important. If you are concerned that you have blinders on, then solicit feedback from colleagues and family members as you would from mock jurors. Others’ perception of you is an equally important part of the picture.
Effective Vulnerability Can Build Trust
By being vulnerable at the right time in the right situation, you can build trust and strengthen connections. Once, during jury selection for a case pending in the federal court in Connecticut, I watched a trial attorney from Texas ask—in a thick “Texan” drawl—whether potential jurors would give his client a fair chance and not be biased against the trial team’s “Texas-ness.” His delivery of his difference and vulnerability was very effective in turning around a potential distraction.
Humans are hard-wired to read each other’s expressions. Research shows that observing someone who is injured will trigger the brain’s “pain matrix.”[2] Similarly, observing someone who is suppressing their feelings triggers physiological reaction in the observer.[3] Research also shows that we are particularly sensitive to signs of trustworthiness.[4] Finding the right context and the right method of delivery is not easy, but accepting the idea that vulnerability leads to trust and being curious about what context and method of delivery may be effective is a good first step.
Identify Values for Your Team
Throughout a trial, key pieces of evidence need to be made clear to the jury. Those key pieces of evidence are based on a thorough understanding of the facts and the law. The same applies to identifying and communicating core values to a team. Having a diverse team means thoughtfully addressing the challenges of working with people of different backgrounds. In fact, a study using fMRI to observe adults randomly assigned to two groups, one “leopards” and the other “tigers,” showed that even randomly assigned groups displayed in-group biases.[5] If we are hardwired to pick up on differences, then shared values can act as a unifying thread that anchors a team toward a common goal.
Practice Active Listening
During trial, it is important to listen carefully to testimony. On cross-examination, the testimony may not be the same as the testimony obtained in a deposition, so unexpected answers may be potential areas for impeachment or further exploration. And on direct examination, the testimony may not be the same as you had prepared the witness to deliver, so unexpected answers may need to be remedied. Outside of trial, active listening is equally important but often difficult to do. Most people fall into four listening styles: (1) the analytical listener who aims to analyze a problem from a neutral starting point; (2) the relational listener who aims to build connection and understand the emotions underlying a message; (3) the critical listener who aims to judge the content of the conversation and reliability of the speaker; and (4) the task-focused listener who shapes a conversation towards efficient transfer of important information.[6] Each style is effective, and developing the ability to shift between different styles can help improve listening and achieve conversational goals.
Properly authenticating documents during trial is a learned process that pays off in better results the more you practice. The same can be said for practicing authenticity in work and in life.
Gino, Francesca, Research: It Pays to Be Yourself, Harvard Business Review, Feb. 13, 2020. ↑
Lamm C, Nusbaum HC, Meltzoff AN, Decety J (2007) What Are You Feeling? Using Functional Magnetic Resonance Imaging to Assess the Modulation of Sensory and Affective Responses during Empathy for Pain. PLOS ONE 2(12): e1292. https://doi.org/10.1371/journal.pone.0001292. ↑
Dirks, KT, and Ferrin, DL (2002) Trust in leadership: Meta-analytic findings and implications for research and practice. Journal of Applied Psychology 87(4): 611–628. https://doi.org/10.1037/0021-9010.87.4.611. ↑
