Sellers in merger and acquisition (M&A) deals almost always run the risk of breaching a representation or warranty in the agreement. Such a breach (often unintentional) is almost an inevitable hazard that every seller must contemplate.[1] This consideration often leads sellers to invoke (and buyers to accept) certain well-established conventions to partially reduce the negative consequences to sellers of such breaches. Buyers and sellers generally accomplish this by incorporating limitations to the sellers’ indemnity liability into the indemnification provisions, such as:
small deductibles (“baskets” and “thresholds”),
de minimis minimum claims,
maximum liability amounts (“caps”), and
time limitations (“survival periods”) which shrink the period of time after the closing during which the buyer can make claims to be indemnified.
Deductibles, baskets, and thresholds tend to minimize or at least defer disputes over small amounts of alleged damages (the proverbial “nickels and dimes”) arising from breaches of representations, and can be regarded as fostering peace between buyer and seller. Survival periods (usually years shorter than applicable statutes of limitations) bring closure and finality in the near term. Caps reflect the confidence and optimism of buyers and sellers in the extensive and rigorous pre-closing due diligence and disclosure processes and in the historic operating results of the target enterprise. Caps also provide assurance that – even if this confidence is misplaced – the seller, under the usual benign circumstances, will not need to disgorge huge portions of the total purchase price. Caps on recovery for breaches of representations therefore contribute to certainty, finality and peace of mind at least to the seller.
The risk to the buyer is reduced by the typical provisions in that if the buyer can establish that it has been deliberately misled or defrauded by the seller, all the various limitations discussed become inapplicable. Baskets, survival periods and caps are so routine as to be almost universal; the only questions are how big the baskets, how low the caps, and how long the survival periods. Such well-established limitations on sellers’ indemnification liability have the salutary effects of peace, certainty, finality and closure – worthy goals in business transactions.
Although not nearly as broadly accepted to be considered a tradition-bound convention such as a basket, cap or survival period,[2] sellers often argue (on the basis of “fairness”) that the amount of indemnification sellers should be required to pay the buyers in a breach of representation context should be further limited and that the payment should be reduced to the extent the buyer or target can (for tax purposes) deduct the outlay needed to rectify the loss or damage occasioned by or underlying the breach as an expense, whether by settling or paying the undisclosed liability or rectifying the misrepresented negative condition (such outlays referred to herein as a “Rectifying Expenditure(s)”). To do otherwise, the sellers’ argument goes, would enable the buyer to reap a “windfall” consisting of not only the full recovery of actual damages but also the value of the buyer’s tax benefit for the item for which indemnification is sought.[3] This argument might be referred to as the tax benefit offset (“TBO”) argument.
2. Defeating a Proposed TBO
Preeminent M&A lawyer James C. Freund stated in his famous book Anatomy of a Merger, published in 1975, that he never developed a cogent rebuttal to the seller’s argument in favor of the TBO. Mr. Freund’s proposed response in a hypothetical negotiation with seller’s counsel was to acknowledge that the seller’s point was not unreasonable or uncommon, but then to convince the sellers’ attorney that it would be too difficult and time-consuming to figure out the net effect of the tax saving, particularly when different fiscal years could be involved. Mr. Freund, undoubtedly a persuasive negotiator, states that most sellers yield the point.[4]
The experience of many other M&A negotiators in recent times do not bear out Mr. Freund’s confidence and good fortune in making the troublesome pro-seller TBO provision go away. More than 40 years after Mr. Freund’s statements, TBO provisions are found in many acquisition documents governing deals between large publicly-held buyers in multimillion dollar transactions in which the sellers and buyers are usually represented by prestigious and extremely well-qualified law firms. Studies of deal documents ABA Studies published by the American Bar Association Business Law Section M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee (the “ABA M&A Committee”), reported the percentage of deal documents studied that contained TBO provisions. The percentages varied from a high of 53% in 2011 to a low 27% in 2019, the most recent year in which the study was conducted. In that most recent study, which was published by the ABA M&A Committee in December, 2019 (the “Latest ABA Study”), of the 151 deals in 2018 and early 2019 covered, 41 deal documents included TBO provisions.[5]
Despite the prevalence of TBO provisions in modern M&A deal documentation, there are questions as to whether they are correctly conceived and effectively implemented. The purpose of this article is to examine the foundations (more correctly the lack of foundation) of the TBO provisions, examine the objections to such provisions, and hopefully discredit the TBO concept to the point of eradication in many or most taxable M&A deals.
A. Common Sense Objection
The authors suggest that, rather than being solicitous towards the seller advocate for the TBO gambit as Freund recommended, an incredulous response to and a summary dismissal of such an audacious theory would be more appropriate. If a TBO argument had been made by a defendant in a tort-based property damage claim, plaintiff’s reaction could be expected to be disbelief and firm rejection. If a defendant negligently or deliberately caused damage to a business owner’s truck, would a defendant successfully claim that the repair or replacement might be tax deductible to some extent and therefore the damages to be paid by the defendant should be reduced by the value of the benefit of any deduction or tax saving available to the plaintiff? In a breach of contract action brought by a business owner plaintiff for whom a defendant performed a contract in a faulty manner requiring rework or repair, could the defendant make a successful TBO argument? Legal intuition based on common sense would say absolutely not. The TBO gambit smacks of the apocryphal case of the man who murdered his parents seeking clemency because he is an orphan.
B. Lack of Legal Precedent Objection
Not only does the TBO gambit fail the “red face test” on first impression, it also fails to find any real historical legal support. Perhaps because of the sheer novelty and audacity of the TBO argument, little direct discussion of reduction of damages based on alleged tax benefit to a plaintiff has been found. However, several cases have indirectly addressed arguments by plaintiffs who have sought to increase damage award based on tax disadvantages suffered by plaintiffs who urged that the award of only pre-tax damages would not make the plaintiff whole. For example, in Sears v. Atchison Santa Fe Ry Co.,[6] employee plaintiffs were awarded over 15 years of back pay in a lump sum which would have been taxed in the year of receipt at a much higher rate than if taxed annually in increments over the period of employment. The court increased the ultimate award to “make the plaintiffs whole” in respect of the after-tax differential. However, even in these cases dealing with awards to plaintiffs, courts have been reluctant to venture into the tax area where complexity and variability of tax reporting positions and expert opinions abound.[7]
Randall v. Loftsgaarden is one of the few cases where a defendant sought to have damages reduced by the tax benefits received by the plaintiffs. The case involved the sale of tax-shelter investments by defendants to plaintiffs in violation of the federal Securities Act of 1933 and Securities Exchange Act of 1934.[8] In Randall v. Loftsgaarden, the Supreme Court held that the tax benefits resulting from the problematic tax shelter investments sold to the plaintiffs should not reduce the award to the plaintiffs. Another case, Hanover Shoe Inc. v United States Machinery Corp. (393 U.S. 481 (1968)[9] is particularly illuminating as it relates to the defendant’s use of the TBO argument. This was an anti-trust case where the defendant sought to reduce the amount recoverable by the plaintiff by calculating the plaintiff’s lost profits (the measure of damages in such anti-trust cases) on an after-tax basis. Plaintiff Hanover Shoe Inc. complained that the defendant only allowed the plaintiff to rent machinery instead of selling machines to plaintiff in violation of the anti-trust laws, causing the plaintiff to earn less profits because the rental arrangements were more costly to the plaintiff than an outright purchase of the machines. Defendant contended that the annual amount of lost profits should be reduced by the increased taxes that would have been payable by plaintiff on those lost profits, i.e., the profits should be calculated on an after-tax basis. Plaintiff responded that the defendant’s approach would result in double deduction for taxation on plaintiff: it had already been taxed on the profits actually earned and would be taxed again when the treble damages award was received. The Supreme Court rejected the defendant’s argument, and decided in favor of the plaintiff. The Supreme Court also noted the immense difficulty of attempting the recalculation of profits and taxes over a long period of time.[10]
Despite the absence of any jurisprudence supporting the TBO theory, and the likely judicial distaste for the concept, fairness requires the acknowledgement that the well-established notions of baskets, caps, survival periods also find no support in jurisprudence.
C. Complexity, Uncertainty and Unworkability Objection
Any indemnification regime which enables a seller to take account of the supposed actual tax benefits to the buyer leaves open the question as to how far the seller may venture in reviewing and evaluating the buyer’s federal and state income tax returns and the reporting positions buyer has taken. Such an inquiry and review would naturally open up the buyer’s tax positions, (perhaps very aggressive) tax reporting positions and tax strategy to discovery, and ultimately to disclosure. Opening the door of the inner sanctum to a hostile party and perhaps public record seems unwise at best.
There can be great uncertainty in calculating the value of a purported tax benefit to a buyer. Do tax rules limiting use of net operating loss carry-overs and built-in losses apply?[11] Taxation is a very complex area in which a variety of competing or conflicting reasonable tax reporting positions can be taken and where the opinions of learned tax experts can differ on many issues. Different reporting positions could lead to different outcomes and different tax-effected indemnification amounts. Who decides? Reporting can be challenged by the Internal Revenue Service long after the indemnification process has run its course. What happens then? Also, if the buyer was required to adopt a reporting position espoused by the seller, will the seller be willing or able to defend or to compensate the buyer if that position is successfully challenged by the IRS? Such uncertainty underscores the unworkability of the TBO mechanism.
The tax department of a buyer seeking to deal with a TBO provision would be required to continuously keep track of the effect and value of the impact of its reporting positions regarding Rectifying Expenditures as compared to the effect and value of a possible different reporting position (or range of reporting positions) as if the Rectifying Expenditure had not been made. In effect, the tax department would have to run a separate set of tax books on a hypothetical basis. Such double tax books requirement would be required for as long as the TBO’s specified period for recognizing receipt of tax benefits.
D. Tax Accounting and Reporting Objection
i. General Discussion
There are two basic types of taxable acquisitions: asset deals and stock deals.
The first type of taxable transaction, collectively referred to as “Asset Deals,” involves:
an acquisition by the buyer of the assets of a target company,
an acquisition by the buyer of the stock of a target company accounted for as an acquisition of assets pursuant to an election under section 338(h)(10) of the Internal Revenue Code , or
a forward triangular merger of a subsidiary of the buyer and the target in which the target company is merged out of existence and which is accounted for as a purchase of assets of the target.
The use of limited liability companies (“LLCs”) as business entities has increased in recent years, and a correspondingly increasing number of targets doing business as LLCs have appeared in M&A transactions. LLCs generally use a pass-through entity status for tax purposes, unless they are covered by an election to be treated as an association taxable as a corporation. In the case of an LLC as selling or target entity, the result of the purchase of all of the ownership interests in the entity is generally treated the same as a purchase of the assets of the entity for tax purposes. Revenue Ruling 99-6, Situation 2, provides that the purchase of all of the equity or membership interests in a target LLC by a buyer is treated the same as the sale by the former owners of all of the assets of the entity to the buyer — equivalent to a 338(h)(10) election for LLCs.[12]
The second type of taxable transaction involves a purchase by the buyer of the stock of the target company (without a section 338(h)(10) election) or a reverse triangular merger of a subsidiary of the buyer and the target in which the target company is the survivor (collectively, “Stock Deals”).
ii. General Tax Accounting Rules
A pre-closing event or negative condition that would constitute a breach of a representation by the seller may in real terms constitute an unfavorable occurrence for the buyer. But that does not mean that a buyer’s outlay to address the event or negative condition, in and of itself, will generate an expense that can currently be deducted by the buyer for federal income tax purposes. Certain post-closing expenditures, i.e. Rectifying Expenditures, by the buyer or a buyer subsidiary that are incurred to correct negative events or conditions that occurred prior to the closing, such as the misrepresented quantity or usable condition of inventory or machinery and equipment, would probably have to be capitalized by the buyer and would therefore not be immediately deductible. Accordingly, those Rectifying Expenditures would not give rise to an immediate “tax benefit” that could be viewed as a potential tax “windfall” which is the very basis of the “fairness” argument.
Further, even if the rectification of the misrepresented pre-closing event or condition does give rise to an otherwise legitimate deductible expense, it does not necessarily follow that the expense would be deductible by the buyer (or the target in the case of a Stock Deal). For an expense to be deductible as a trade or business expense by a taxpayer it must be an ordinary and necessary expense of that taxpayer’s trade or business. If the expense was incurred in some other taxpayer’s (i.e., the seller) trade or business it will generally not be deductible by a different taxpayer (e.g., the buyer) but may continue to be deductible by the first taxpayer (i.e., the seller).[13] Also, for an expense in respect of a liability to be deductible by an accrual basis taxpayer generally all the events needed to establish liability must have occurred, the liability must be fixed and determinable, and economic performance (which generally means payment by the taxpayer) must have occurred with respect to the expenditure by the end of year in which the deduction would be claimed (or in certain cases shortly after the end of that year). If the buyer merely pays a liability properly attributable to the seller that does not provide any assurance that the buyer will be entitled to a deduction for that expense.[14]
The task then is to apply these general tax accounting rules to the types of taxable transactions described above: Asset Deals and Stock Deals.
iii. Asset Deals
Where the buyer or the buyer’s subsidiary takes title to the assets of the purchased business and there is a breach of a seller’s representation to the buyer and as a result the buyer becomes subject to a liability or negative condition, the question is whether the Rectifying Expenditure in undoing the damage occasioned by such liability or negative condition is properly deductible by either the buyer or the seller. For an expenditure to be deductible by a taxpayer under the accrual method of accounting, it must meet three conditions:
1) it must be an ordinary and necessary expense of the taxpayer’s trade or business;
2) the liability must be fixed and determinable; and
3) economic performance (which generally means payment) by the taxpayer must have occurred with respect to the expenditure.
All three conditions must generally be met before the end of the taxable period of the taxpayer claiming the deduction. If the misrepresentation by the seller concerns a liability or negative condition that was not fixed and determinable on or prior to the closing, even if it could not have been deducted by the seller prior to the closing, the Rectifying Expenditure by the buyer in respect of the liability or condition does not necessarily convert to one that could be deducted as an expense by the buyer. In such a case the Rectifying Expenditure is really more akin to a liability that the buyer assumed as part of the purchase and should more properly be treated as part of the purchase price. Under existing authority it is generally accepted that any liability – even a contingent liability – that is assumed by the buyer in the purchase of the assets of a business must be capitalized into the cost of the acquisition and that liability may not be deducted by the buyer.[15] If a liability was a contingent liability at the closing and did not become fixed and determinable until after the closing, that liability could still not be deducted by the buyer.[16] The fact that the buyer will be precluded from claiming a deduction for an assumed liability will be the result whether the assumed liability is fixed and determinable or is contingent, whether it is identified or not identified, or whether the liability is known or unknown at the time it is assumed.[17]
Thus, in an Asset Deal, there is no merit from a tax point of view to a seller’s argument that a buyer will have a potential tax windfall from a Rectifying Expenditure that should be reflected as a reduction of seller’s indemnity payment. Asset Deals do not give rise to a viable tax benefit offset (referred to hereinafter as “Viable TBO”)
iv. Stock Deals
1. Free-Standing and Not Pass-Through
In a taxable Stock Deal, the target company remains in existence as a separate entity following the closing and if it is an accrual basis taxpayer, it should generally retain the ability to deduct a Rectifying Expenditure that was necessitated by and arose from the circumstances underlying a breach of representation. This is the case whether the liability was a fixed and determinable liability that was properly accrued prior to the closing or was a contingent liability that was properly accrued after the closing. A Stock Deal does not involve the disqualifying element of a “new” or different taxpayer trying to claim a deduction that is attributable to another taxpayer’s trade or business, which was the critical problem in an Asset Deal. Thus, in taxable Stock Deals there might be a potentially Viable TBO.
However, if the target company was a member of the seller’s affiliated group and was included on the consolidated return filed by that group prior to the Stock Deal, the target company may still be precluded from deducting after the closing a Rectifying Expenditure. Preclusion would be the result if the deduction was or should have been properly accrued for tax purposes prior to the closing. If that deduction was or should have been properly accrued for tax purposes prior to the closing it should be claimed on a consolidated return for that prior period and it should not be available to the target company following the closing. As in the case of an Asset Deal, there is no prospect for a Viable TBO if target was not a free-standing taxpayer.[18]
The result would be similar if the target prior to the closing was a corporation covered by an S election (or if it was a pass-through entity not covered by an election to be treated as an association taxable as a corporation). Under the S corporation rules, the income items and deductions of an S corporation that appear on its return for a particular year pass through to the stockholders of the corporation at that time and would not thereafter appear on any subsequent return filed by the corporation.[19] In other words, deductions that were or should have been properly accrued prior to the closing may not be available to the target company after the closing if the target company was covered by a consolidated return through the closing or if it was covered by an S election through the closing. The result is similar if the target was a limited liability company or other entity which is subject to “pass through” taxation. These Stock Deals involving pass-through targets do not present the possibility for a Viable TBO.
It may be observed that such Stock Deals where the target has been in a consolidated group or the target is a pass-through have a disqualifying feature that is shared with Asset Deals: the presence of an additional or different taxpayer entity (the consolidated group or the owners of the pass-through) which is entitled to claim the deduction.
2. Code Sections 382 and 383
Even if the target was a C corporation through the closing and was not included on a consolidated return covering the seller’s affiliated group (i.e., it was free-standing), the target’s ability to claim a tax-saving deduction could be also reduced or eliminated by operation of the net operating loss carryover and the built-in loss rules of section 382 and section 383 of the Internal Revenue Code (“Built-in Loss Rules”). These rules restrict the ability of a target corporation, in any year after there has been a prohibited change in the ownership of the target, to utilize net operating losses and built-in losses that were in place at the time of the change in ownership. A prohibited change in ownership will generally occur if over any three-year period there is a shift in the ownership of more than 50% of the outstanding stock of the target corporation, and the Section 382 rules apply once that threshold has been exceeded.
The Built-in Loss Rules in general restrict – on an annual basis after the prohibited change in ownership (i.e., the closing) – the target’s ability to utilize those net operating loss carryovers and built-in losses that were in place at the closing to the value of the target at the time of the change in ownership times the long term tax-exempt interest rate.[20] In December of 2020 the long term tax exempt rate was 0.99%.[21] Using that rate, if a target was acquired in December of 2020 for $5,000,000, the annual limitation on utilizing those losses constituting Rectifying Expenditures would only be $49,500.
The authors believe (admittedly without the support of empirical data) that the vast majority of merger and acquisitions that take place each year in the United States, and certainly almost all of the deals covered by the Latest ABA Study, involve the single year transfer of more than 50% ownership of target enterprises. Accordingly, the Built-in Loss Rules would minimize the potential tax benefits alleged by sellers to be available to most buyers of C corporation targets depending on the value of the target at the time of the closing.
3. Summary of Stock Deal Issues
In short, the argument that a foundational “windfall” would give rise to a Viable TBO (even if it was available) would only be available to a buyer or a buyer subsidiary in a taxable Stock Deal if the target meets two conditions:
(1) the target had been prior to the closing a “free standing” individually taxed entity (i.e., not part of seller’s consolidated group); and
(2) the target is a C corporation (or an LLC covered by an election to be treated as an association taxable as a corporation and not covered by an S election).
If the target does not meet that two-part test, then the Rectifying Expenditure as to the buyer will be treated as part of the purchase price or it will be treated as an expense properly allocated to another taxpayer.And even if the target is a free-standing C corporation, any deduction opportunity would also be severely limited by the Built-in Loss Rules discussed above. If the target was an S corporation or other pass-through entity such as a limited liability company (which is taxed as a partnership) or a partnership, any deduction constituting a Rectifying Expenditure which is actually attributable to a period prior to the closing would be allocated to the equity owners of that entity and would not be available to buyer. Thus, in the case of taxable Stock Deals the potential of a tax benefit windfall to the buyer would not materialize. Overall, a Viable TBO mechanism which is intended to achieve the “fairness” arguably sought by sellers would fail.
3. How Are Actual Deals Being Done?
A. Overview
In the several ABA Studies published by the ABA M&A Committee over the past decade, TBO provisions in deal documents appeared in many instances although there has been a clear declining trend since 2011 when TBO provisions appeared in a slight majority of deals studied. As mentioned earlier, 41 of the 151 deals covered by the Latest ABA Study in 2019 contained pro-seller TBO provisions – just over 27%. Of those 41 deals, 3 were tax free reorganizations in which TBO provisions could be viable from a tax point of view, but which would nevertheless be subject to the other objections outlined earlier in this article including the Built-in Loss Rules which severely restrict tax savings that an indemnifying seller would seek to exploit. Of the remaining 38 deals, 10 were Asset Deals for tax purposes which as argued above do not present Viable TBO situations. All the remaining 28 deals were Stock Deals which included potentially Viable TBO provisions, but only if the target were free-standing and taxed as a C corporation.
B. Language
Given the inherent complexity of taxation in general, it could reasonably be expected that contractual provisions regarding TBO would likewise tend to be extensive and complex. In fact, the TBO provisions in the documents in question in the Latest ABA Study were brief and relatively simple. There follow several representative examples of TBO provisions which run the gamut from simple to detailed to very detailed.
Simple “The amount of any and all Losses shall be determined net of …any Tax benefits realizable by or accruing to the Purchaser Indemnitees with respect to such Losses.”
Simple “Without limiting the effect of any other limitation contained in this Section … for purposes of computing the amount of any Damages incurred by the Indemnified Party under this Section … there shall be deducted an amount equal to the amount of any Tax benefit actually realized within two (2) years of such Damages in connection with such Damages, as determined on a ‘with and without’ basis.”
Conceptual “The amount of indemnification claims hereunder will be net of any tax benefits realized within three (3) taxable years by the Indemnified Party in connection with such claims.”
More detailed “The amount of any Buyer Indemnified Losses shall be reduced by the amount of any Tax Benefit directly or indirectly available to the Buyer Indemnitee relating thereto. For purposes of this Section …a ‘Tax benefit’ shall mean a reduction in the Buyer Indemnitee’s Tax (calculated net of any Tax detriment resulting from the receipt of any indemnification payment, including the present value of any Tax detriment resulting from the loss of any depreciation and amortization deductions over time, calculated using a discount rate of 3.5%) arising out of any Damages that create a Tax deduction, credit or other tax benefit.”
Very detailed Indemnity payment regarding Losses “shall be reduced to reflect any Tax Benefit actually realized in the year in which the indemnity payment is required to be made or in any prior year by Buyer …. Tax Benefit means any deduction, amortization, amortization, exclusion from income or other allowance that actually reduces in cash the of Tax that Buyer … would have been required to pay (or actually increased the amount of the Tax refund to which Buyer… would have been entitled in the absence of the item giving rise to the claim….For purposes of this section … Buyer …. shall be deemed to use all other deductions, amortizations exclusions from income or other allowances …prior to the use of ‘Tax Benefits’….”
C. Calculation of Tax Benefit Amount
All of the TBO provisions require a calculation of the amount of the tax benefit offset. Those provisions effectively call for subtracting the amount of actual tax paid by the buyer from the amount of tax which would have been paid without including the tax-reducing item (sometimes referred to as the “with and without” method). A variation on the with and without method seen in a few of the deals studied calls for subtracting the amount of actual tax paid by the buyer from the amount that would have been paid if the tax-reducing item is the last item included (sometimes referred to as the “last in” method). It is unclear whether there is any real difference in result under the two methods.
D. When Must Tax Saving Be Actually Realized by Buyer?
Most of the 28 Stock Deals studied specify a period of time during which the tax benefit or savings must be actually received or realized by the buyer in order to reduce an indemnity payment. Where a time period is specified, it is usually expressed in tax years measured from the date of incurrence of the damages underlying the breach of representation. Additional periods of one, two or even three years are specified. It should be noted that the limiting effects of the Built-in Loss Rules (currently about 1% per year) combined with the specified short periods which tax savings must be realized by the buyer in Viable TBO provisions greatly reduces to minimal percentages any possible reduction of sellers’ indemnity obligation.
E. Mandate on Buyer to Seek Tax Benefits; Mitigation
Most of the TBO provisions refer to tax savings or tax benefits “actually” received or realized (some say “in cash”) by the buyer. None of the TBO provisions expressly compel the buyer to seek tax savings or benefits.
Even the stand-alone express general mitigation obligation contractually imposed on buyers (found in 18 of the 28 Stock Deals with TBO provisions) do not obligate the buyer to seek tax benefits. Those stand-alone general mitigation provisions do not mention tax issues at all. Furthermore, almost all such mitigation provisions address the “gross” losses or damages, but not the “net” indemnification payment. Such contractual mitigation provisions do not by their terms extend to the attainment of tax advantages favoring the seller.
It is worth noting that another pro-seller provision analogous to TBO often seen in M&A documentation reduces the indemnity payment a seller must pay by any insurance recovery received or receivable by the buyer on account of the circumstances underlying the breach of representation. Such insurance provisions are found in all 28 Stock Deals in the Latest ABA Study. Unlike the silence of the language of TBO provisions, the insurance offset provisions frequently do expressly require the seller to seek recovery under available insurance. The implication would be that such an affirmative duty would not apply in the case of TBO when the two offset provisions appear in the same document.
F. What Role Does Seller Have in Buyer’s Tax Strategy?
None of the 28 Stock Deals with potentially Viable TBO provisions give seller any a priori role in the preparation of the buyer’s tax returns or the selection of the buyer’s tax reporting strategy. It appears, appropriately so, that in the first instance the buyer has total control of its tax reporting and filing. However, there should clearly be litigable potential for the seller to inquire as to the existence of tax savings even in the absence of contractual provisions to that effect. In a dispute over indemnification and TBO there could be significant risk to buyer that a court would grant a seller some right of discovery taking into account mitigation obligations, either common law or contractual.
G. Lack of Buyer Protection
None of the 28 Stock Deals in question contained any provisions that would protect an indemnified buyer if TBO issues were in play. There were no provisions protecting the confidentiality of buyer’s tax reporting. Further, there was no express provision leaving all tax reporting decisions to the exclusive discretion of the buyer. It is left unsaid what happens if the buyer is forced to litigate an indemnity claim. If the buyer’s indemnity claim resulted in litigation it would expose the buyer’s tax returns and its reporting positions to scrutiny and disclosure. The buyer could also be forced to show that it has not been unreasonable in declining to adopt tax positions advocated by the seller. Would the buyer’s tax returns and the testimony of its tax advisors be part of the public record in the case or could they be sealed? Would the buyer be forced to adopt tax positions advocated by the seller and adopted by the court even though buyer’s tax advisors recommended against adopting those positions? What assurance would the buyer have that the seller would be willing or able to defend a buyer which adopted those seller-friendly positions if a taxing authority later questioned those positions? Such critical questions are not addressed whatsoever in any of the TBO provisions in any of the deals in question. The risks and uncertainties could very well chill the inclination of buyers to seek redress through indemnification for obvious breaches of representations.
H. Procedural Shortcomings
What is missing from all the TBO provisions in all 41 deals covered in the Latest ABA Study is any treatment of the mechanics of implementing an adjustment of the payment under a TBO scheme other than in many of the deals which require buyer to refund a portion of a tax saving subsequent to receiving an unadjusted indemnity payment. Since there is no express requirement that the buyer seek tax benefit or tax savings, and since any tax benefit or tax saving would ordinarily occur well after the buyer successfully sought an unadjusted indemnification payment from the seller it would seem that it is up to the seller to proactively monitor the activity of the buyer and query the buyer about tax benefits subsequent to the indemnity payment. Perhaps there is an implied duty (good faith and fair dealing) on the part of the buyer to keep the seller informed, but no explicit provision to that effect is found in any of the documents. In any event, the absence of treatment of the mechanics suggests that the sellers who extract a TBO provision from the buyer are not trying very hard to provide for a truly functioning and effective provision that will provide a possible advantage. It may be that sellers are satisfied with extracting from buyers a provision that might inhibit a buyer from seeking redress through indemnification than in actually seeking workable reduced indemnification liability.
I. Do the 28 Stock Deals Pass the Free-Standing C Corp Test?
The ultimate test of the viability of TBO provisions in a Stock Deal is whether the target company is a free-standing taxpayer and is treated for tax purposes as a C corporation. The authors are not aware of any publicly available databases that would answer either of those questions. However, in some cases the documents themselves contain indications of status in whereas clauses, representations and warranties, and certain other provisions. On that basis the authors conclude that all 10 Asset Deals and at least 5 of the Stock Deals would actually fail the free-standing C corporation test.[22] Accordingly, in 18% of all Stock Deals in the Latest ABA Study the TBO provisions are just not viable from a tax point of view.
4. Conclusion
Earlier in this article it is suggested that the traditional limitations on indemnification payments such as baskets, caps and short survival periods foster peace, clarity, finality and closure between buyer and seller. That is not true of TBO provisions. TBO provisions actually greatly prolong the period of hostility between buyer and seller, and give rise to numerous additional issues and grounds for dispute. It appears obvious that many M&A practitioners do not understand the tax law and the practical consequences (especially to the buyer) in negotiating TBO provisions in deal documents. Seller-side practitioners can be excused for blindly advocating for TBO provisions along with all other obstacles to indemnification by buyer. The same can’t be said for buyers. The acceptance by buyers of such TBO provisions, without at the least insisting on measures to protect the buyer, suggests a lack of vigilance or failure to perceive the dangers.
When approximately 36% of all of the deals in the Latest ABA Study cannot possibly have the desired result under applicable tax law, and when the remaining 64% can only have an absurdly small percentage desired result under applicable tax law (i.e., the Built-in Loss Rules), it is time that the TBO concept is abandoned in all M&A transactions. It is the view of the authors, for all the reasons set forth in this article, that TBO provisions do not belong in M&A transactions.
[1] John F. Corrigan is a sole practitioner at John F. Corrigan Law. P.C. in Providence, Rhode Island. E. Hans Lundsten is of counsel at Adler Pollock & Sheehan P.C. in Providence, Rhode Island. The views expressed are solely those of the authors and do not necessarily represent the views of their respective firms or clients.
[2] Teams of experienced M&A lawyers, as members of the American Bar Association Business Law Section’s Mergers & Acquisition Committee (the “ABA M&A Committee”), have been studying the deal terms and conditions that have repeatedly been the subject of intense negotiations in merger and acquisition documentation for over a decade. This group—the Mergers & Acquisitions Market Trends Subcommittee—has conducted studies of critical deal terms found in acquisitions of private companies by public companies that are disclosed by the public companies as part of their reporting obligations under the Securities Exchange Act of 1934 (referred to in this article as “ABA Studies”). The ABA Studies are only available to members of the ABA M&A Committee.
The most recent Study, released in December 2019, covered transactions for which definitive deal documents were executed or completed in 2018 and the first quarter of 2019 that involved private targets being acquired by public reporting companies (this most recent study is referred to in this article as the “Latest ABA Study”). In the Latest ABA Study only 41 out of 151 deal documents contained TBO provisions.
[3] This Article will not cover acquisitions that are structured as tax-free reorganizations under one of the categories of transactions described in Section 368(a) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) because the general accounting rules (discussed, infra, under the caption “General Tax and Accounting Rules”) that apply to assumed liabilities and that could preclude a buyer or the target company from deducting an assumed liability by statute do not apply to transactions that qualify as a tax-free reorganization under Section 381(c) of the Internal Revenue Code and the buyer or the target company acquired in the transaction should be entitled to claim the deduction. VCA Corp. v. U.S., 566 F2d. 1192 (Fed. C. 1977); Rev. Rul. 83-73, 1983-1 C.B. 84. Therefore, a tax windfall to a buyer is quite possible in a tax-free reorganization, although since the buyer does not get a basis step-up for the acquired assets in a tax-free reorganization any arguable inequity the seller faces if it does not share the supposed tax “windfall” accruing to the buyer is probably offset because the buyer has forgone the tax benefit of the basis step-up in the acquisition.
[4] James Freund, Anatomy of a Merger (1975), pp 376-8.
[12] Section 1.708-1(b)(1), Income Tax Regulations and Rev. Rul. 99-6, Situation 2, 1999-6 I.R.B.6 (2/8/99).
[13]Welch v. Helvering, 290 U.S. 111, 113 (1933); Deputy v. DuPont, 308 U.S. 488, 494 (1940).
[14] 188 BNA Daily Report for Executives J-1, 2003, Treatment of Contingent Liabilities in an Acquisition Evolving (2003).
[15] Federal Tax Coordinator, Second Edition PL-5404, Successor’s Contingent Liabilities – Reorganization Expenses as Capital Expenditures (2012).
[16] The Federal Tax Coordinator article described supra note 17 above, provides that while some of the decisions, including the Seventh Circuit in its opinion in Illinois Tool Works, infra note 19, have observed that it might be possible in some situations for the assumption of a contingent liability by the buyer as part of an acquisition to give raise to a deduction (and not have to be capitalized) none of the decided cases have allowed a deduction for an assumed liability and none of them have described those situations where an assumed liability would be give raise to a deduction.
[17]Holdcroft Transp. Co. v. Comm., 153 F2d 323 (C.A. 8, 1946); Pacific Transport Company v. Comm., 483 F2d 209 (C.A. 9, 1973), cert. denied, 415 U.S. 948 (1974); Illinois Tool Works v. Comm., 117 T.C. 39 (2001,) aff’d 355 F.2d 997 (C.A. 7, 2004).
[18] Section 1.1502-21(b)(2)(ii), Income Tax Regulations.
[19] Section 1366(a) of the Internal Revenue Code.
[22] Many of the deal documents contained provisions which were ambiguous or which referred to schedules which were not available for review. In the absence of incontrovertible evidence that the target was not a free-standing C corporation, the authors gave the deal the benefit of the doubt and assumed the provision was a Viable TBO provision.
Financial institutions face significant risks from enforcement actions by prudential regulators as well as agencies charged with protecting consumers, investors, or the public at large, such as the Consumer Financial Protection Bureau (CFPB), Securities and Exchange Commission (SEC), and Department of Justice (DOJ). I recently published an article about what steps in-house counsel can take to mitigate those risks for their financial institution clients. This article has a different perspective. Rather than focusing on threats to the institution, it focuses on threats to in-house counsel in their personal capacity. At the outset, it is important to recognize that enforcement actions against in-house counsel are extremely rare. They are not, however, non-existent.
This article draws in part on an unpublished analysis prepared by one of my partners at Williams & Connolly that examines non-insider trading SEC action and DOJ criminal prosecutions against corporate in-house counsel over the past two decades. The analysis focuses on threats that in-house counsel may face personally from government agencies, and what lessons can be drawn from prior enforcement actions and criminal prosecutions against individuals. While not all of the lessons are drawn from actions involving in-house counsel specifically at financial institutions, the lessons are equally applicable to them.
Common Factors in Actions Involving In-House Counsel
Factor #1 – The top lawyer is nearly always the target, either in their own right or to undermine an ‘advice of counsel’ defense for other top executives
When the SEC or DOJ takes action against in-house lawyers, they almost always focus on the General Counsel or Chief Legal Officer. There are two overarching reasons for this. First, the top lawyer indisputably had the power and the mandate to address issues, and—rightly or wrongly—the failure to do so is often laid at the feet of the General Counsel or Chief Legal Officer. Another reason why General Counsel or Chief Legal Officers may find themselves in the crosshairs, particularly in criminal actions, may be to undermine the advice of counsel defense for other executives. When the government threatens civil or criminal claims against in-house lawyers, self-preservation instincts may surface. It is not uncommon for lawyers to disavow or distance themselves from certain positions being advanced by other targets of the investigation as a way to protect themselves.
Factor #2 – Big losses to the institution bring unwanted scrutiny to in-house counsel
Another common factor in SEC enforcement actions and criminal prosecutions against in-house counsel is when the institution itself suffers substantial losses. The bigger the failure of the institution, the greater the risk of exposure for the in-house counsel. When the institution is handed a large judgment or damning indictment, there is incredible pressure from consumers, politicians, and the media to hold someone accountable and actions may be second-guessed with the benefit of hindsight. The in-house counsel often becomes the scapegoat.
Factor #3 – In-house lawyers can insulate themselves by consulting outside counsel
Inside lawyers who relied upon outside lawyers are rarely, if ever, the targets of SEC enforcement actions or criminal prosecutions. The advice of counsel defense is a real deterrent to prosecution or enforcement. But to mount a viable defense, the consultation with outside counsel must be meaningful and – ideally – documented. Outside counsel needs to be apprised of the material facts and their advice should be memorialized contemporaneously; by extension, in-house counsel should act in a manner that is consistent with outside counsel’s advice to clearly demonstrate reliance on the advice.
Factor #4 – Complex or debatable problems are rarely a basis for individual enforcement action or prosecution, whereas perjury or obstruction are much easier cases
Enforcement lawyers and prosecutors prefer to pursue cases where there is a clear legal violation. SEC enforcement counsel and prosecutors will vigorously pursue claims of perjury or obstruction against in-house counsel because these actions tend to be straightforward and easy to prove. SEC enforcement proceedings against in-house counsel most commonly arise from disclosures, particularly omissions in disclosures. Self-dealing or other actions to line one’s pockets is not necessary for the SEC to bring an enforcement action. By contrast, when the violation itself is unclear or complicated, there is less risk to in-house counsel even if the SEC or DOJ decides to pursue an action against the institution. It is much easier to fault somebody when the violation is unambiguous. A corollary to this is that mere knowledge of conduct later deemed to be criminal is usually not enough to warrant prosecution against an in-house lawyer, unless the conduct was so egregious as to be unambiguously improper.
Factor #5 – Generalist lawyers cannot insulate themselves from liability by claiming ignorance
Do not get in over your head. In-house lawyers are expected to have the knowledge and experience necessary to discharge the responsibilities of their role. It is not uncommon for in-house lawyers in smaller institutions to wear several hats, such as also serving in a compliance function (or at least overseeing the compliance function). No matter how many hats they wear, in-house counsel will be held responsible for shortcomings, particularly when those shortcomings impact consumers or the institution in a material way. Neither the SEC nor DOJ are moved by arguments that the individual charged with these roles lacked the sophistication to discharge those responsibilities.
Practical Tips for In-House Counsel at Financial Institutions
These observations lead to some practical tips for in-house counsel for minimizing the enforcement profile of their institution and, by extension, themselves.
Ensure that your institution’s risk management function is well-resourced and appropriately staffed with competent personnel. An enforcement action is almost always far more costly (both as a matter of reputation and penalty) than maintaining a well-functioning compliance team. These staffing and resource investments can pay big dividends in terms of smooth regulatory relationships and the early identification and remediation of problems.
Establish and maintain a close working relationship with the Chief Risk Officer. Most institutions have three lines of defense (line of business, compliance, and audit) and the Chief Risk Officer should have clear visibility into each one. The Chief Risk Officer ideally should be not only a peer, but also a partner for in-house counsel.
Make sure that your institution is taking proactive steps to identify and address issues as they arise. Problems that fester or recur are more likely to provoke regulatory attention on in-house counsel’s action (or perceived inaction). Being proactive will help establish that in-house counsel (and the institution as a whole) exercised appropriate business judgment.
Be on high alert if your institution’s CAMELS ratings start to slip, as this may signal deeper issues with institutional controls or management. This also signals greater regulatory scrutiny, particularly when a bank or credit union is operating under a consent order or memorandum of understanding, and an increased likelihood of second-guessing.
When faced with particularly thorny questions: (1) consult with outside counsel; (2) make sure that their advice is memorialized in an appropriate fashion; and then (3) act on that advice. While there will invariably be a marginal cost associated with engaging outside counsel, the long-term benefits are almost always worth it.
There is a veritable alphabet-soup of scenarios which financial institution in-house counsel hope not to encounter: CID, OOI, PWL, NORA, 15-Day Letter.[1] When a bank or credit union receives a Civil Investigative Demand (CID), an Order of Investigation (OOI), a Preliminary Warning Letter (PWL), a Notice of Opportunity to Respond and Advise (NORA), or a 15-Day Letter, the institution knows one thing for sure: it is in the crosshairs of a potential enforcement action by a prudential regulator or the Consumer Financial Protection Bureau.
This article identifies lessons that in-house counsel at banks and credit unions may find helpful as they advise their own institutions. The lessons are drawn from my own experiences representing financial institutions – their directors and officers – under investigation or in enforcement litigation, and augmented by a review of other publicly filed actions and consent orders.
Enforcement Actions by Prudential Regulators
Prudential regulators such as the Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), National Credit Union Administration (NCUA), and Federal Reserve pursue formal enforcement actions when they believe that there have been violations of laws, rules, or regulations, unsafe or unsound banking practices, breaches of fiduciary duty, or violations of final orders or conditions imposed in writing or written agreements. The enforcement actions may seek anything from cease-and-desist orders to civil money penalties.
Banks or credit unions that find themselves the target of enforcement investigations rarely litigate against their prudential regulators, absent overreach in the agency’s jurisdiction or demand. The supervisory relationship is usually too important to risk long-term damage, and the restrictions on an institution’s ability to pursue business opportunities without supervisory approval are usually too stifling to be tolerated for long.
Individual executives are sometimes in a better position to fight. Not only do they not have the same institutional concerns, they usually can draw on a directors and officers liability (D&O) insurance policy or have their fees indemnified and possibly advanced by the institution. Moreover, they are often motivated to clear their reputation and avoid draconian sanctions, such as civil money penalties and/or removal and prohibition from the banking industry.
Here are three key takeaways based on my work handling enforcement actions by prudential regulators. These lessons might have forestalled or avoided the enforcement action altogether had they been part of the institution’s policies or performed at the outset.
Lesson #1 – An ineffective risk management function is a recipe for trouble
A common denominator in many enforcement actions is the lack of an effective risk management function with sufficient authority and voice within the bank to elevate concerns and drive changes. Sometimes risk management failures manifest themselves in the failure to comply with existing consent orders, resulting in repeat violations that are invariably dealt with far more harshly than the original violation. There are numerous examples where financial institutions failed to comply with existing consent orders that mandated changes to Bank Secrecy Act/Anti-Money Laundering (BSA/AML) practices, only to see recurring violations and correspondingly more draconian penalties.
Other enforcement actions are premised on inattention to governance and compliance mechanisms. This inattention can manifest in many ways, such as taking reactive approaches that depend on third parties – customers, credit reporting agencies, examiners – to identify problems; failing to investigate and address what in retrospect may be viewed as red flags; and providing superficial responses that fail to fix root causes. These shortcomings may be attributed to competing management priorities, or an inexperienced or ineffective risk management team. Institutions that have the most significant compliance violations tend to have risk management departments that are under-staffed, under-resourced, and under-appreciated. Whatever the underlying cause, regulators (with the benefit of hindsight) are predisposed to pursue enforcement actions if an institution is perceived as having a substandard risk management function.
The lesson here is that every financial institution should place a premium on having an effective and formidable risk management function. Risk management should have the resources and ability to evaluate internal and external complaints or reports of misconduct, investigate and report suspicious banking activity, conduct risk-based assessments of operations, assess compensation systems, detect and investigate outliers, consider feedback given by departing employees, and adhere to a transparent and well-documented disciplinary system.
Lesson #2 – Avoid high-risk products or services unless your institution has the requisite competence and expertise
Another common feature of investigations and enforcement actions is that they involve high-risk products, services, or customers. There have been a number of enforcement actions around flawed or deficient BSA/AML compliance and monitoring processes emanating from high-risk customers. For instance, third-party payment processors may pose heightened risk to financial institutions if they service merchants or businesses that regulators deem to be (potentially) fraudulent, predatory, or unsavory, such as telemarketers or internet gaming providers. Financial institutions that cater to digital asset customers such as cryptocurrency exchanges and other crypto-related businesses run the risk that prudential regulators may find their Customer Due Diligence (CDD) processes inadequate for the risk posed by these customers. Likewise, partnering with Fintech companies poses its own set of risks, as the financial institutional may be held accountable for the actions or omissions of the third-party company, which may be more focused on growth and product development than customer service and compliance without adequate oversight and controls.
Financial institutions whose CAMELS ratings are less than satisfactory should be particularly wary of banking high-risk customers, products, or services. Examiners rarely look fondly on this, and commonly criticize these practices and fault institutional management for the high-risk customer’s shortcomings when there is any problem. For those financial institutions that are considering banking with higher risk customers or partnering with Fintech companies, it is advisable to keep an open line of communication with prudential regulators – this proactive step helps avoid surprises and demonstrates an ability to handle the relationship. It is imperative to develop and periodically update an overarching banking strategy that has been approved by the Board and shared with regulators and to have a sophisticated and experienced BSA/AML officer charged with making sure that the strategy is followed. Institutions should also have the technology and resources to develop and apply enhanced due diligence procedures to high-risk customers, both at the outset and throughout the course of the relationship, and have a demonstrated track record of compliance.
Lesson #3 – Individuals may be held accountable for systemic shortcomings in institutional safety and soundness
Individual enforcement actions typically are predicated on breaches of the duty of loyalty and outright violations of law, and mostly focus on deception, obstruction, or self-dealing. Such misconduct presents a straightforward case for proving that institution-affiliate parties (IAPs) breached their fiduciary duties. By contrast, prudential regulators rarely pursue enforcement actions against individuals based solely on safety and soundness, as it can be difficult to blame any single individual for such a collective lapse.
However, regulators have come under increased criticism and scrutiny over the past decade for not holding individuals accountable for bank failures and other systemic risk management shortcomings. For example, in 2014 the Office of Inspector General analyzed bank enforcement actions and recommended that enforcement counsel pursue more cases against IAPs on safety and soundness violations. More recently, politicians and the media have exerted pressure on regulators to hold individuals accountable for institutional misconduct, particularly when that misconduct occurred on a systemic basis or affected large numbers of customers. As a result, there has been an uptick in enforcement actions against individuals premised on significant safety and soundness failures. It is no longer enough to simply avoid engaging in personal dishonesty or self-dealing to stay out of enforcement’s crosshairs. It is more likely now than ever that IAPs will be held personally accountable for institutional shortcomings if the problems are considered to be widespread or egregious.
A corollary of this observation is that in-house counsel are no longer exempt from being held responsible for institutional problems. It used to be that in-house lawyers were fairly insulated from enforcement actions unless they engaged in deception, obstruction, or some form of self-dealing. Now, however, there are signs of an emerging willingness to hold in-house lawyers accountable when the institution engages in unsafe and unsound practices for an extended period of time. This is not a strict liability regime; rather, enforcement counsel appear inclined to hold in-house counsel responsible when they believe (with the benefit of hindsight) that in-house counsel’s contemporaneous actions or inaction to address systemic problems were unreasonable, reckless, or grossly negligent.
What does this mean as a practical matter? To put it simply, if you see something, say (or do) something. The best way to inoculate yourself and to protect your institution is to act. In-house counsel should not ignore so-called red flags or other signs that there may be unsafe or unsound conduct. This is especially true for systemic issues rather than isolated problems. Warning signs can emanate from many different sources – for example, internal ethics complaints by employees, customer complaints, exit interviews with departing employees, or outlier analyses of the performance of employees or agents. The critical question is whether in-house counsel monitors how the warnings are being handled and takes affirmative and effective action if problematic trends persist. Ignoring systemic problems is a recipe for trouble; likewise, ineffective actions by counsel may not be enough to stave off an enforcement action, particularly if counsel does not take steps to elevate their concerns to others who can take effective action.
This is not to say that a General Counsel must operate as a de facto Chief Risk Officer. Most institutions of sufficient size separate those roles and establish independent reporting structures, and in-house counsel are permitted to rely on others (until it is no longer reasonable to do so). But it does put a premium on in-house counsel keeping abreast of systemic problems identified by the Risk Management function and assessing whether appropriate action is being taken. When problems persist and in-house counsel fails to follow up or take meaningful steps to ensure that those problems are being addressed in an effective manner, the risk of enforcement action for both the institution and the individual rises significantly.
It also means that in-house counsel should carefully review the scope and coverage provided by their D&O insurance policy, including whether there is Side A coverage that is exclusively available to D&Os. These policies can be critical to the defense of directors and officers, particularly in the unfortunate circumstance where the institution itself has been placed into receivership. While D&Os with larger insurance policies may be a more attractive target, I have yet to meet a client who wishes their D&O coverage was less. Indeed, more often than not the converse is true, and the individual clients wish their coverage was greater. Although it may feel remote and unnecessary at the time, having a substantial D&O policy is an important factor in being able to mount an effective legal defense.
Enforcement Actions by the CFPB
The Consumer Financial Protection Bureau (CFPB) presents a different regulatory challenge for financial institutions whose assets exceed the $10 billion jurisdictional threshold. Unlike prudential regulators whose primary mission is to ensure institutional safety and soundness, the CFPB’s mandate is to an institution’s consumers and not the institution itself.
The CFPB is charged with enforcing 18 different consumer protection statutes and armed with expansive unfair, deceptive, or abusive acts or practices (UDAAP) power under Title X of the Dodd Frank Wall Street Reform and Consumer Protection Act. Historically, the CFPB has wielded its power aggressively. The Bureau is known for taking enforcement positions that push the envelope. And while that posture was modulated to a degree during the Trump administration, the pendulum appears to be swinging back to a more aggressive enforcement posture, with particular emphasis on pursuing fair lending violations and abusive acts or practices.
While the key takeaways for dealing with prudential regulators continue to apply, there are other lessons that are unique to the CFPB’s enforcement investigations and actions. Prioritizing a strong Compliance Management System under the direction of qualified and capable Risk Management personnel will always be the most important thing a financial institution can do to stay on the good side of regulators. Institutions with a strong risk management function are more likely to spot issues and address them promptly, and therefore will have greater credibility with prudential and CFPB examiners alike. But what else should an institution do to better position itself with regard to the CFPB?
Lesson #1 – Approach supervisory responses, even Supplemental Information Requests and PARR letters, from an advocate’s perspective
Often the decision whether to refer a matter inside the CFPB from Supervision to Enforcement is a judgment call. In my experience, once a matter gets referred to Enforcement, it tends to take on a life of its own. That is not to say that every investigation inevitably ends with an enforcement action, but most of them do. That reality means that financial institutions should put a premium on their supervisory responses. The deadlines for providing responses are often short, particularly for Supplemental Information Requests. But institutions with the foresight to involve in-house counsel and – when appropriate – outside counsel, can improve the quality of their responses and frame them in ways that provide important context and ultimately make them more persuasive. This does not guarantee that an institution can avoid a referral to Enforcement, but it can make the difference in a close case. And even if there is a referral to Enforcement, having involved litigation counsel at the Supervisory stage ensures that the counsel is up-to-speed and ready to handle the matter from the outset.
Lesson #2 – It is never too late to fix things, even after an investigation starts
Sometimes financial institutions fall short despite their best efforts. Mistakes happen, or sophisticated databases do not function as expected, and consumers may be negatively impacted. Institutions that identify these problems, promptly take corrective action, and voluntarily disclose the issue almost always find themselves in a better overall position when dealing with the CFPB than those that do not. For starters, sometimes the Bureau will decline to take enforcement action if it believes that the institution was forthcoming, has a strong compliance management function, and took appropriate action to notify and remediate affected consumers. But even when the Bureau does elect to bring an enforcement action, it will often acknowledge the voluntary corrective actions that were taken and negotiate a reduced penalty below what it otherwise might have demanded.
Even when an institution does not identify the problem until after an investigation has begun, it still is not too late. Investigations rarely move quickly; they are most often measured in years rather than months. Financial institutions that take effective action early in an investigation to address deficiencies may come out ahead. If the institution implements new and effective controls to address the issue, they can then point to those changes to demonstrate their responsiveness to supervision, the important role played by management in driving these changes, and the effectiveness of the controls.
It is often quite compelling to have the institution’s own personnel showcase their work. For example, it may make sense to arrange for an in-person demonstration of newly developed controls, and to have employees show how it functions and how its use now prevents the problem at the heart of the investigation from recurring. When done correctly – i.e., with personnel who have the qualifications, credibility, and presentation skills needed to communicate their message – this sort of show-and-tell can reassure CFPB enforcement personnel that they do not need to make an example of the institution.
Lesson #3 – Sometimes it pays to litigate
Given the Bureau’s tendency to take aggressive positions, it is sometimes difficult to reach a reasonable settlement with the CFPB in a pre-litigation posture. There are institutional reasons why the Bureau tends to be more aggressive in enforcement actions. First, it is still a relatively new agency and is trying to cement its reputation as a tough and effective consumer advocate. The more wins it can get under its belt, and the more significant they are, the more fearsome it becomes. Second, the Bureau cannot possibly file enforcement actions against everyone who violates any of the 18 federal consumer protection laws under its purview. So it magnifies its leverage by pursuing high-profile entities – including financial institutions – to set examples for the rest of the industry, and then using those investigations and actions as templates to target others. Third, to borrow a baseball analogy, in its early years the Bureau preferred swinging for the fences to adopting a more conservative strategy premised on hitting singles or doubles. Early on, the CFPB pursued litigation on the periphery of its authority, such as around indirect auto lending, or controversial interpretations, such as around the proper interpretation of RESPA or Regulation E, rather than consistently tackling acts or practices more at the heart of its authority. This approach sparked substantial criticism of the CFPB’s “regulation by enforcement” approach. And fourth, the Bureau is trying to establish the parameters of its authority and therefore is incentivized to take more expansive and aggressive positions in order to do so.
Despite these dynamics, it is common to resolve enforcement actions without litigation. To their credit, CFPB enforcement counsel usually engages in substantive discussions about the merits of their claims. This process usually begins in earnest with a NORA response, but often continues after enforcement counsel obtains authority to sue. When they are fact- and principles-based, these discussions can lead both parties to modify their positions and reach an acceptable resolution. When this happens, the CFPB typically will include additional factual recitals requested by the institution to add context or emphasize voluntary remedial measures.
There are times, however, when management and the board of directors view the Bureau’s demands as too extreme or unreasonable. Perhaps the CFPB predicates its demand on agreeing to certain conditions, such as the amount of restitution or civil money penalty, or frames the facts in the proposed consent order in a way that the institution feels is misleading or inaccurate, or is pursuing claims that exceed its authority. In those circumstances, institutions are left with a stark choice: they can take the offer on the table, or they can choose to litigate. In those situations, financial institutions sometimes achieve substantially better outcomes when they choose to litigate the enforcement action.
I co-authored an article on this topic: Sometimes It Pays to Litigate Against the CFPB, Law360, Oct. 13, 2017. Although published over three years ago, the central premise of this article – that defendants threatened with CFPB enforcement actions should carefully weigh the merits of their legal and factual defenses and not assume that settlement will result in the best outcome – remains true today. This is not to say that institutions should litigate simply for the sake of litigation. To the contrary, if the institution lacks a compelling defense, then it may be best to accept the offer on the table. But when there are unsettled legal questions and a factual narrative that diverges from the CFPB’s telling, then litigation can pay off.
* * *
The benefits of avoiding damaging and expensive enforcement actions and reputational hits are incalculable. Financial institutions that internalize these lessons and devote the necessary resources to establishing a culture and system that prioritizes compliance will come out ahead in the long run. But even sophisticated financial institutions make mistakes, and when that happens it is important to remember that there are still things that can be done to improve your position with regulators and the overall outcome of any enforcement actions.
[1] Ryan Scarborough is a partner at Williams & Connolly LLP. He litigates enforcement actions brought by prudential regulators targeted at financial institutions, their directors and officers, and other institution affiliated parties, as well as consumer protection actions brought by the CFPB, securities actions brought by the SEC, and investigations by the DOJ.
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
To illustrate the state of arbitration law in 2020, we describe in this chapter selected cases from the United States Supreme Court docket, the federal Circuit Courts of Appeals (and several noteworthy cases from the federal District Courts), and the highest courts of each state that raise unique issues, provide instructive guidance on recurring issues in arbitration law, or are likely to be of interest to the general legal profession. We also discuss several legislative and regulatory developments and several discussions involving mediation issues.
Starting from the top, as we predicted in this chapter in the 2019 ANNUAL REVIEW OF RECENT DEVELOPMENTS IN BUSINESS AND CORPORATE LITIGATION (ABA 2020), the U.S. Supreme Court did not have a significant volume of arbitration cases in 2020. The Court issued just one substantive arbitration decision and heard argument on just one potentially significant case in which a decision is expected in 2021.[1] This, of course, meant that the Court denied review in a number of cases. Among those, one denial of certiorari in particular may also have been somewhat notable.
This year, at least two issues revealed splits among the Circuits on arbitration issues. First, numerous decisions considered whether and to what extent delivery workers in the “gig economy,” including those who carry goods the “last mile,” were within the scope of the residual clause of section 1 of the FAA[2] exempting from the Act contracts of “any other class of workers engaged in foreign or interstate commerce” as interpreted by the United States Supreme Court in Circuit City Stores, Inc. v. Adams.[3] These cases are discussed in section 1.8.1.
In addition, 28 U.S.C.A. § 1782 permits any party or other interested person involved in proceedings taking place before a foreign or international tribunal, or the tribunal itself, to make a request to a U.S. federal district court for an order compelling discovery from a person or entity that resides or is found in the district in which the court sits. Several decisions this year grappled with the question of whether discovery may be ordered in aid of private foreign and international arbitral proceedings, including the Seventh and Fourth Circuits, which came to conflicting conclusions relating to the same international proceeding. These cases are discussed below in section 1.17.
2020 also was the year that federal regulators in the Antitrust Division of the Department of Justice (the “Division”) embraced arbitration after a well-publicized success in arbitrating the definition of the relevant product market in a challenged merger. Capitalizing on that success, the Division issued its Updated Guidance Regarding the Use of Arbitration and Case Selection Criteria in November 2020, signaling an interest in increasing the use of arbitration.[4]
With a deeply divided Congress, and scant chance of abolishing the filibuster, broad-based legislative attacks on the growing use of arbitration agreements appear unlikely. Still, watch for a renewed battle over the proposed Forced Arbitration Injustice Repeal Act (“FAIR”), a bill that has been introduced in one form or another for many years, and which has already passed the House. FAIR 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.
§ 1.2 Legislative and Regulatory Development
§ 1.2.1 The Department of Labor
Countrywide Fin. Corp., 369 N.L.R.B. No. 12 (Jan. 24, 2020). Arbitration agreement that does not expressly prohibit filing charges with the National Labor Relations Board (“NLRB”) interfered with employees’ rights to file such charges because a reasonable employee would interpret the exclusive remedy language of the agreement as imposing such a prohibition.
This case arose during the two-year period when Countrywide Home Loans, Inc. (“Countrywide”) required applicants seeking employment to sign an arbitration agreement.[5] The agreement stated that covered claims included those “arising out of, relating to or associated with the Employee’s employment,” as well as “claims for benefits and claims for violation of any federal, state or other governmental constitution, statute, ordinance, regulation, or public policy” and provided that “[a]rbitration is the parties’ exclusive remedy for covered claims,” although it also stated that “[n]othing in this Agreement shall be construed to require arbitration of any claim if an agreement to arbitrate such claim is prohibited by law.”[6] At issue was whether this arbitration agreement violated section 8(a)(1) of the National Labor Relations Act (“NLRA”) by interfering with employees’ rights to file charges of violations of the NLRA with the NLRB. The NLRB applied the three-part balancing test of its Boeing Co.[7] decision to conclude that, as reasonably interpreted, Countrywide’s arbitration agreement did interfere with employees’ rights to file charges with the NLRB because employees would reasonably interpret the “exclusive remedy” language to limit their ability to file charges with the NLRB.[8] This was true even though the arbitration agreement did not explicitly prohibit filing charges with the NLRB.[9] Applying its own precedent, the NLRB found that there was no legitimate justification to outweigh administration of the NLRA.[10] The NLRB further applied its precedent to find that the savings clause language, which purported to except claims for which arbitration is “specifically proscribed” by federal law, was too vague to save the arbitration agreement.[11] The court reasoned that although a reasonable employee would understand that the arbitration agreement does not apply where “prohibited by law,” the reasonable employee cannot be expected to have the legal background to know where the language of the provision would apply.[12]
§ 1.2.2 The Department of Justice
In March 2020, the Antitrust Division of the Department of Justice (the “Division”) announced it had prevailed in its efforts in an arbitration to secure the divestiture by Novelis, Inc. (“Novelis”) of the North American aluminum production facilities of Aleris Corporation (“Aleris”) as a condition of Novelis’ acquisition of Aleris. In September 2019, the Division had commenced an antitrust enforcement proceeding under the Clayton Act by filing a complaint against Novelis. Prior to filing the Complaint, the Division and Novelis had agreed to refer the matter to binding arbitration in the event that the parties were unable to resolve certain issues within a certain period of time. After preliminary discovery, they agreed to refer the key issue of relevant product market definition to binding arbitration before an arbitrator they had chosen pursuant to their agreement. After a 10-day hearing, the arbitrator ruled in favor of the government.
The Division first released guidance on the potential use of arbitration in 1996 (the “1996 Guidelines”),[13] after passage of the Administrative Dispute Resolution Act of 1996 (“ADR Act”).[14] In the wake of the successful Novelis arbitration, the Division released Updated Guidance Regarding the Use of Arbitration and Case Selection Criteria in November 2020 (“Updated Guidance”).[15] The Updated Guidance addresses “the arbitration agreement, the decision whether to file a complaint in federal district court before the matter is referred to arbitration, selection, compensation and cost shifting, and the training of Antitrust Division staff on the use of arbitration,” as well as the Division’s learnings from the Novelis case.
The Updated Guidance highlights the potential advantages of alternative dispute resolution strategies such as arbitration, including the ability “to eliminate unnecessary civil litigation, shorten the time that it takes to resolve civil disputes, and achieve better case resolutions with the expenditure of fewer taxpayer resources.”[16] The stated policy will be to “encourage” the use of ADR where it may “shorten the time necessary to resolve a dispute, reduce the taxpayer resources used to resolve a dispute, or otherwise improve the outcome for the United States.”[17] However, where the prior guidance cautioned that “ADR techniques will likely be difficult to apply during the course of merger investigations,” due to time constraints, this language has been omitted from the Updated Guidance.[18]
The Updated Guidance includes selection criteria the Division will apply when considering arbitration. While acknowledging that arbitration requires the consent of both parties, arbitration is favored for matters in which an arbitrator would be more efficient or where the expense of bringing suit is overly burdensome in comparison to the consumer benefit, cases in which the issues are clear and can be agreed upon by the parties, where issues are factually or technically complex and would be benefited by an expert factfinder, where litigating in federal court could result in unacceptable delay, or where parties have a particular need to control the scope of relief.[19] The Updated Guidance also notes that “[a]rbitration also allows the parties to select an arbitrator with relevant expertise, such as in antitrust law or economics, which may allow the parties to streamline their advocacy or eliminate unnecessary expert testimony.”[20] Conversely, the “lost opportunity to create valuable legal precedent” and where “[t]he public’s interest in the matter is of such significance that resolution by a federal judge in an open forum is necessary” both weigh against arbitration.[21]
A comparison of factors to consider between the 1996 Guidelines and the Updated Guidance reveals similarities and changes. Several factors that favor arbitration have been repeated, including conservation of resources and technical or factual complexity.[22] Dropped from the Updated Guidance are considerations that were included in the 1996 Guidelines such as numerosity of parties, divergence of interest among the aggrieved parties, absent stakeholders, an ongoing relationship between the Division and the parties, and a hostile decision maker in the form of an unsympathetic judge.[23]
The Updated Guidance also described the requirements of the arbitration agreement of the parties, derived from the ADR Act, including specifying a maximum award and other conditions limiting the range of possible outcomes.[24] While the Updated Guidance cautions that the agreement should also address confidentiality of evidence and the proceedings, “[a]t a minimum, it is the policy and the strong preference of the Division that the arbitrator’s decision be made public.”[25]
While the ADR Act provides that the arbitrator can be “any … individual who is acceptable to the parties,” the Updated Guidance suggests the Division will have a strong preference toward “an antitrust specialist or former judge, either with economics training or with extensive experience handling complex antitrust cases,” stressing that a hand-selected arbitrator could bring enhanced expertise on economic issues and expert testimony, which could potentially be dispensed with where the arbitrator already possesses the appropriate knowledge and focused expertise.[26]
More than two decades after passage of the ADR Act, the Novelis case was the first use of arbitration in a merger enforcement action. It likely will not be the last.
§ 1.2.3 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.[27] Four states, Alabama, Georgia, Mississippi, and West Virginia, did not enact any version of the original UAA.[28]
In 2000, the Commission revisited and substantially revised the UAA to produce the 2000 Uniform Arbitration Act (the “Revised UAA”).[29] 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.[30]
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.[31] No new states have adopted the Revised UAA in 2020, although legislation in Massachusetts was reintroduced in 2019 and given a study order in 2020,[32] while a bill to adopt the Revised UAA was proposed in Vermont in 2019 and is still awaiting a vote as well.[33] The progress of states enacting the Revised UAA can be tracked at www.uniformlaws.org.
§ 1.2.4 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,[34] and as amended in 2003 to incorporate the Model Law on International Commercial Conciliation,[35] was not adopted by any new states in 2020. It continues in effect in the District of Columbia, Hawaii, Idaho, Illinois, Iowa, Nebraska, New Jersey, Ohio, South Dakota, Utah, Vermont, and Washington.[36] The Act was introduced again in 2019 in Massachusetts, and was given a study order in 2020.[37] The progress of states enacting the UMA may be tracked at www.uniformlaws.org.
§ 1.2.5 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”).[38]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.[39] Since then, Ghana and Rwanda have signed on as well.[40]
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.[41] 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.[42] 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.[43]
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.”[44] 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.[45] 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.[46]
Once it receives this evidence, the relevant authority (most likely a court) is required to “act expeditiously.”[47] 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.[48]
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”),[49] 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.
§ 1.2.6 State Codes
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”).[50] In February, the United States District Court for the Eastern District of California issued a preliminary injunction blocking implementation of AB 51.[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.[52] 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.[53]
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.[54] The District Court agreed with the plaintiffs and enjoined implementation of the laws enacted under AB 51 to preserve the mandate of the FAA.[55] 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.’”[56] Second, AB 51 punished the exercise of a federally protected right to include arbitration agreements in employment contracts, directly impeding the FAA.[57]
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.
§ 1.2.7 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”) will become effective.[58] These rules replace the ICC’s 2017 Rules of Arbitration (the “2017 Rules”).[59] 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.
First, the 2021 Rules addressed 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.”[60] 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.[61]
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.[62] 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.[63] 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.”[64] 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.[65]
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.[66] 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.”[67] 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.[68] 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.[69]
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.[70] 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.[71]
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.[72]
§ 1.2.8 International Swaps and Derivatives Association (“ISDA”)
ISDA 2020 IBOR Fallbacks Protocol. Largely unnoticed, a protocol by the International Swaps and Derivatives Association, Inc. (“ISDA”) may have the potential to subject very large numbers of transactions to arbitration if disputes arise.
On October 23, 2020, ISDA published its 2020 IBOR Fallbacks Protocol. “IBOR” means “Inter-Bank Offered Rate,” that is, rates such as “LIBOR” (the “London Inter-Bank Offered Rate”) that have fallen into disrepute and are in the process of being replaced worldwide by different systems of base rates. Trillions of dollars (and other currencies) of transactions are subject to IBOR rates. The largest volume (by notional currency amount) of such transactions are derivatives such as interest rate swaps. ISDA publishes standard documentation for such transactions and has been in the forefront of moving away from IBORs.
One of the features of ISDA’s approach to this transition has been to create a protocol that would amend existing deals (and apply to future deals) to provide fallbacks for existing IBOR rates and trigger events for such fallbacks generally by party, rather than transaction-by-transaction.[73] Thus, under the ISDA 2020 IBOR Fallbacks Protocol (the “Protocol”), if any two parties agree to adhere to the Protocol to fix IBOR issues in one of their transactions, they agree to apply it to all of their transactions until one of them withdraws from the Protocol (in which case, only new transactions by that party will not automatically be subject to the Protocol).[74] Furthermore, each of them, by agreeing to adhere to the Protocol, agrees to have adopted the Protocol for each transaction each of them has with any other entity that has adopted the Protocol. As the Protocol puts it:
By adhering to this Protocol in the manner set forth in this paragraph 1, each Adhering Party agrees, in consideration of the mutual promises and covenants contained herein, that the terms of each Protocol Covered Document between such Adhering Party and any other Adhering Party will be amended in accordance with the terms and subject to the conditions set forth in the Attachment hereto.[75]
The only way ISDA provides for a party to adopt the Protocol is to send an “Adherence Letter” in a form prescribed by ISDA.[76] That letter, addressed to ISDA, now contains what might be a surprise to some parties—an arbitration clause.[77] Traditionally ISDA has required parties to agree that, in using ISDA’s documentation and procedures, they would waive any claims against ISDA. Paragraph 2 of the Adherence Letter contains such a waiver: “we waive any rights and hereby release ISDA from any claims, actions or causes of action whatsoever (whether in contract, tort or otherwise) arising out of or in any way relating to this Adherence Letter or our adherence to the Protocol or any actions contemplated as being required by ISDA.”[78]
But paragraph 3 of the Adherence Letter further states that:
By adhering to the Protocol, we agree that all claims or disputes arising out of or in connection with adherence to the Protocol shall be finally settled under the Rules of Arbitration of the International Chamber of Commerce (the Rules) by three arbitrators, and hereby waive any right to assert any such claims or disputes against ISDA as a representative or member in any class or representative action. The claimant(s) (as defined in the Rules) shall nominate one arbitrator in the ‘Request for Arbitration’. The respondent(s) (as defined in the Rules) shall nominate one arbitrator in the ‘Answer to the Request’. The two party-nominated arbitrators shall then have 30 days to agree, in consultation with the parties to the arbitration, upon the nomination of a third arbitrator to act as president of the tribunal, barring which the International Chamber of Commerce Court shall select the third arbitrator (or any arbitrator that claimant(s) or respondent(s) shall fail to nominate in accordance with the foregoing).[79]
This agreement to arbitrate shall not be affected by the Revocation Notice as described in the Protocol.[80]
To the extent this clause was meant to apply only to claims between ISDA and a party adhering to the Protocol, it would probably seem consistent with ISDA’s purposes and practices. For example, ISDA is an international association, and applying ICC rules to disputes with it is not illogical.
Nor is this the only foray by ISDA into arbitration issues. Since 2007, it has indicated that arbitration can be appropriate for dispute resolution in ISDA transactions. In 2013 it published recommended language for arbitration clauses. And in 2018, it published updated recommendations for parties who wish to include arbitration provisions in their transactions.[81] A few ISDA documents for specific transactions—the Schedule to the ISDA 2002 Master Agreement (French law version) and the ISDA/IIFM Tahawwut Master Agreement (English or New York law versions)—also provide for ICC arbitration in Paris, London, or New York, depending on the particular law involved, but can be amended by parties. As to other documents, the 2018 ISDA guide provides non-binding guidance for arbitration clauses using ICC rules, London Court of International Arbitration (“LCIA”) rules, Dubai International Financial Centre-LCIA rules, American Arbitration Association-International Dispute Resolution Centre rules, Hong Kong International Arbitration Centre rules, Singapore International Arbitration Centre rules, Austrian law arbitration rules, Dutch law arbitration rules, Swiss law arbitration rules, Panel of Recognized International Market Experts in Finance (P.R.I.M.E.) rules, Arbitration Institute of the Stockholm Chamber of Commerce rules, German Arbitration Institute (DIS) rules, and Vienna International Arbitral Centre rules.[82]
In contrast to such flexibility, the Adherence Letter’s provision is mandatory, because to use the Protocol, a party must send ISDA an Adherence Letter.[83] More importantly, the language in the Adherence Letter is not as clear as it could be as to its purpose. It provides that “all claims or disputes arising out of or in connection with adherence to the Protocol” shall be arbitrated, not that “all claims or disputes with ISDA arising out of or in connection with adherence to the Protocol” shall be arbitrated.[84] The independent clause providing that signatories to the Adherence Letter “hereby waive any right to assert any such claims or disputes against ISDA as a representative or member in any class or representative action” is just that—an independent clause—that does not on its face restrict the earlier clause to claims only against ISDA.[85] Furthermore, paragraph 1 of the Adherence Letter demonstrates that the drafters knew how to write a clause that would not include ISDA, and instead be between only signatories to Adherence Letters (“[a]s between each Adhering Party and us . . . .”), thus implying that the drafters knew how to draft a clause that would be between only ISDA and signatories to Adherence Letters, not between and among them.[86]
While it seems more likely that ISDA did not intend to bind all signatories to Adherence Letters to arbitrate all disputes between them (as opposed to between ISDA and them), the language permits a different conclusion. And there had been some commentary that ISDA’s earlier positions on arbitration were not entirely effective because they required individual amendments of multiple documents.[87] Additional guidance or interpretation in 2021 may well be necessary to know for sure—otherwise, counterparties to conventional swap transactions may find themselves arguing over whether they must arbitrate (under ICC rules) issues such as disagreements over payments due when a swap is terminated.
§ 1.3 The United States Supreme Court Docket
We noted last year[88] that we did not expect the Supreme Court’s 2020 arbitration activity to be as heavy as in some past years. This proved to be true, not only because there was only one case that had been selected for review when we made that prediction, but also because the Court then kept to a smaller than average docket during the year, perhaps because of expectations concerning disputes about the Presidential election. In the end, the Court issued just one substantive arbitration decision and heard argument on just one potentially significant case in which a decision is expected in 2021. This, of course, meant that the Court denied review in a number of cases. Among those, one denial of certiorari in particular may also have been somewhat notable.
GE Energy Power Conversion France SAS v. Outokumpu Stainless USA LLC, 140 S. Ct. 1637 (2020). Non-signatories to an international arbitration agreement have standing to enforce that agreement in a United States court if they can show a sufficiently strong connection to a signatory.
The Court’s one announced decision in 2020 ended a nagging circuit split and narrowed the differences between domestic and international arbitration.[89] It did so by making it easier for non-signatories to enforce international arbitration agreements under the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”).[90]
GE Energy Power Conversion France SAS (“GE Energy”) manufactured electric motors that a general contractor for Outokumpu Stainless USA (“Outokumpu”) installed in a steel plant now owned by Outokumpu in Alabama. When the motors failed, Outokumpu sued GE Energy in Alabama state court. GE Energy removed the case to federal court under 9 U.S.C.A. § 205, which permits removal of cases involving international arbitration,[91] and sought to compel arbitration.
GE Energy had a problem, however: it had no direct contractual relationship with Outokumpu. The arbitration clause was in the relevant contracts between Outokumpu and its general contractor, not the subcontract between Outokumpu and GE Energy, although the contracts with the general contractor did define the “parties” to include subcontractors. Given these facts, GE Energy argued that Outokumpu’s claim “arose out of” the agreements with its general contractor; that subcontractors were either parties or intended to be treated as parties in such agreements; that GE Energy was such a subcontractor; and that GE Energy was therefore either a party, or that Outokumpu was equitably estopped from treating it any differently than a party, when it came to arbitration.
The District Court agreed with GE Energy by holding that it qualified as a “party” to the underlying contracts because those agreements defined the terms “Seller” and “Parties” to include subcontractors.[92] Because the court concluded that both Outokumpu and GE Energy were “parties,” it did not reach or decide the equitable estoppel argument.[93]
On appeal, however, the United States Court of Appeals for the Eleventh Circuit reversed.[94] It noted that the New York Convention (like the FAA) requires an agreement in writing, but that Article II of the New York Convention also provides that “[t]he term ‘agreement in writing’ shall include an arbitral clause in a contract or an arbitration agreement, signed by the parties or contained in an exchange of letters or telegrams.”[95] The Court of Appeals observed that GE Energy might well have had standing to enforce the underlying arbitration clause in a domestic arbitration under the FAA.[96] But, in its view, the New York Convention’s express reference to “signed by the parties” left less room than under the FAA for theories that would allow non-signatories to arbitrate, whether the specific contract language theory used by the District Court, or theories such as equitable estoppel.[97] Instead, the Court of Appeals held that “to compel arbitration, the Convention requires that the arbitration agreement be signed by the parties before the Court or their privies.”[98] Because GE Energy was not an actual signatory to the contracts between Outokumpu and its general contractor, no written agreement existed for GE Energy sufficient to satisfy Article II of the New York Convention.[99]
The Eleventh Circuit’s decision widened an existing circuit split. Like the Eleventh Circuit, the Ninth Circuit had held that non-signatories could not enforce arbitration agreements under the New York Convention.[100] Both the First Circuit and the Fourth Circuit had held the opposite.[101]
The Supreme Court resolved this split by first referring to the FAA and its allowance for the invocation of state law doctrines (such as equitable estoppel) applicable to contracts generally.[102] It next turned to the content of the New York Convention, noting (among other things) that it focuses primarily on arbitral awards, that its Article VII(1) states that the “Convention shall not . . . deprive any interested party of any right he may have to avail himself of an arbitral award in the manner and to the extent allowed by the law or the treaties of the country where such award is sought to be relied upon,” and that only one Article—Article II, in just three sentences—“addresses arbitration agreements.”[103]
Justice Thomas, writing for the Court, then explained that, because the implementing legislation for the New York Convention appears in “Chapter 2 of the FAA,”[104] and because “Chapter 2” provides that “Chapter 1”—the domestic provisions of the FAA—“applies to actions and proceedings brought under” Chapter 2 “to the extent that [Chapter 1] is not in conflict with” Chapter 2 or the New York Convention,[105] this means that the question before the Supreme Court was “whether the equitable estoppel doctrines permitted under Chapter 1 of the FAA . . . ‘conflict with . . . the Convention.’”[106] He concluded they “do not conflict.”[107]
The most fundamental reason that no conflict exists is that “[t]he text of the New York Convention does not address whether non-signatories may enforce arbitration agreements under domestic doctrines such as equitable estoppel” and “nothing in the text of the Convention could be read to otherwise prohibit the application of domestic equitable estoppel doctrines.”[108] While Article II(3) of the New York Convention provided that “courts of a contracting state ‘shall . . . refer the parties to arbitration’ when the parties to an action entered into a written agreement to arbitrate and one of the parties requests referral to arbitration,” there is nothing in this provision which restricts “contracting states from applying domestic law to refer parties to arbitration in other circumstances.”[109] That silence was therefore “dispositive.”[110]
In addition, nothing in the New York Convention rejects the use of domestic law. For example, because the provisions in Article II of the New York Convention are not comprehensive, they necessarily leave certain matters to domestic law. “Article II(1) refers to disputes ‘capable of settlement by arbitration,’ but it does not identify what disputes are arbitrable, leaving that matter to domestic law” and “Article II(3) states that it does not apply to agreements that are ‘null and void, inoperative or incapable of being performed,’ but it fails to define those terms,” leaving that to domestic law as well.[111] “Thus, nothing in the text of the Convention ‘conflict[s] with’ the application of domestic equitable estoppel doctrines permitted under Chapter 1 of the FAA.”[112]
While not dispositive, Justice Thomas also reviewed the negotiation and drafting history of the New York Convention, concluding that it “confirm[s] our interpretation of the Convention’s text.”[113] He looked as well to the “postratification understanding” by other countries concerning the use of domestic law in enforcing the New York Convention and found that “courts of numerous contracting states permit enforcement of arbitration agreements by entities who did not sign an agreement.”[114]
Because the decision by the Court of Appeals below rested on the theory that only a signatory could enforce the arbitration clauses at issue, that court never reached the issue of whether GE Energy “could enforce the arbitration clauses under principles of equitable estoppel or which body of law governs that determination.” The Supreme Court therefore remanded the case for further proceedings.
The Supreme Court’s decision was unanimous. But Justice Sotomayor issued a separate concurrence, noting a limitation to Justice Thomas’s analysis for the Court: “Any applicable domestic doctrines must be rooted in the principle of consent to arbitrate.”[115] In her view, this principle “constrains any domestic doctrines under Chapter 1 of the FAA that might ‘appl[y]’ to Convention proceedings (to the extent they do not ‘conflict with’ the Convention).”[116] For example, some theories of equitable estoppel do not account for this principle, while others do. As a result, “[l]ower courts must therefore determine, on a case-by-case basis, whether applying a domestic non-signatory doctrine would violate the FAA’s inherent consent restriction.”[117] Because the Court’s opinion in GE Energy itself is consistent with this “foundational FAA principle,” she joined it in full.
Henry Schein Inc. v. Archer & White Sales, Inc., No. 19‐963 (U.S. argued Dec. 8, 2020). Who decides whether a dispute falls within a carve-out to an arbitration clause, a court or an arbitrator?
The Henry Schein antitrust dispute (which has been going on for eight years now with no progress on the merits) is a familiar one to the Supreme Court. As we have previously reported,[118] in 2019 the Supreme Court decided that the FAA does not contain any “wholly groundless” exception that would permit a court to avoid deciding who should decide the issue of arbitrability.[119] Having remanded the case to the Fifth Circuit for it to determine whether, under the parties’ contract, a court should determine who decides the case, or whether an arbitrator should make that decision, and the Fifth Circuit having decided that a carve-out for injunctive relief disputes from the arbitration clause at issue meant that a case for injunctive relief would not have to go to an arbitrator for a decision on whether the carve-out applied,[120] the case is now back at the Supreme Court.
The arbitration clause at issue in Henry Schein states that “[a]ny dispute arising under or related to this Agreement (except for actions seeking injunctive relief and disputes related to trademarks, trade secrets, or other intellectual property of [Pelton & Crane]), shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association.”[121] While the general rule is that courts decide whether an arbitration clause covers a dispute,[122] if there is “clear and unmistakable evidence” that the parties agreed an arbitrator should decide the issue, then the arbitrator will do so.[123] But arbitration clauses typically refer a case to arbitration before an arbitration provider such as the AAA or JAMS. The rules of such organizations typically say that an arbitration they administer will proceed under the organization’s own rules. And both the AAA and JAMS provide in those rules that arbitrators have power to decide their own jurisdiction.[124]
Against this background, the specific question on which the Court granted certiorari and heard argument at the end of 2020 was “whether a provision in an arbitration agreement that exempts certain claims from arbitration negates an otherwise clear and unmistakable delegation of questions of arbitrability to an arbitrator.”[125] When the Court decides this issue, it will likely be determining how arbitration clauses (and arbitration rules) are drafted in the future. Notably, the Court also rejected two other questions. First, it avoided the question of whether incorporation of AAA rules by reference into a contract constitutes “clear and unmistakable intent to arbitrate arbitrability.” Most federal Courts of Appeals believe that such rules incorporated by reference into arbitration clauses are “clear and unmistakable evidence” that the parties have elected to have an arbitrator decide whether a dispute is covered by the clause or not.[126] But some courts disagree.[127] Second, the Court avoided the question of whether it is an arbitrator or a court which must decide if a non-signatory to an arbitration agreement can enforce it using a theory of equitable estoppel.[128]
Monster Energy Co. v. City Beverages LLC, No. 19‐1333 (U.S. June 9, 2020). The Supreme Court refuses to clarify when an arbitration award must be vacated for “evident partiality” under Section 10 of the FAA.[129]
As we reported last year[130] the Ninth Circuit recently overturned an arbitration award in favor of the beverage company Monster Energy because a JAMS arbitrator—retired California state judge John W. Kennedy—failed to disclose both his specific ownership interest in JAMS and that JAMS had administered 97 prior arbitrations with Monster Energy. (Interestingly, he had provided, in addition to a general disclosure, a specific disclosure “that he [had] arbitrated a separate dispute between Monster and a distributor which resulted in an award of some $400,000 against Monster.”)[131]
The Ninth Circuit decision was somewhat surprising to some because, while Monster Energy is a multi-billion-dollar company, its opponent—City Beverages LLC—is itself a large and sophisticated distributor. In addition, while the solution for arbitrators in California might seem simple (disclose everything you can), the decision was not as clear as it could have been about where the line should be drawn. And, of course, it left arbitrators elsewhere uncertain of whether they must follow Ninth Circuit precedent.
In a different year, perhaps the Supreme Court would have granted certiorari. The only time the Court has ever reviewed the “evident partiality” standard in the FAA was 52 years ago in the Commonwealth Coatings case.[132] There Justice Hugo Black interpreted “evident partiality” as coextensive with the judicial standard for disqualification, holding as a result that an arbitrator must not only be unbiased, “but must also avoid even the appearance of bias.”[133] The problem, however, was that a concurrence by Justice Byron White also concluded that vacatur of an arbitration award for evident partiality was only appropriate when the arbitrator failed to disclose “a substantial interest in a firm which has done more than trivial business with a party”—a somewhat less stringent test.[134]
Since Commonwealth Holdings, “[t]he First, Second, Third, Fourth, Fifth, and Sixth Circuits [require] those seeking vacatur of an arbitration award for evident partiality to show ‘a reasonable person would have to conclude that an arbitrator was partial to one party to an arbitration.’”[135] The Ninth and Eleventh Circuits, however, appear to use a less-demanding standard which permits vacatur for only a “reasonable impression of partiality.”[136] Despite this split, the Supreme Court passed—this time—on an opportunity to clarify the proper standard.
§ 1.4 Who Decides—The Court or the Arbitrator?
§ 1.4.1 Class Arbitration
Catamaran Corp. v. Towncrest Pharmacy, 946 F.3d 1020 (8th Cir. (Iowa) 2020). Silence on the issue is not sufficient to imply an agreement to arbitrate on a class action basis.
Four pharmacies filed a demand for class arbitration with the AAA in a dispute with Catamaran Corporation (“Catamaran”), a pharmacy benefit manager over reimbursement agreements with Catamaran’s predecessor.[137] The agreements contained similar provisions agreeing that disputes must be settled by arbitration. None of the agreements used the word “class” or referred to class arbitration. Catamaran initiated an action in federal court seeking to prevent the pharmacies from pursuing arbitration on a class-wide basis. The District Court denied Catamaran’s motion for summary judgment, finding that the agreements required the question of class action arbitration to be determined by an arbitrator.
On appeal, the Eighth Circuit reversed and remanded to the District Court, holding that class arbitration is a substantive question of arbitrability for the court to decide. On remand, the District Court granted Catamaran’s motion for summary judgment, finding that there was no contractual basis in the reimbursement agreements to support an agreement to class arbitration. The pharmacies appealed, arguing that the agreements did establish a contractual basis for class arbitration.[138]
On the second appeal, the Eighth Circuit affirmed the District Court’s order, holding that the agreements did not provide for class arbitration.[139] First, the court found that Supreme Court precedent prohibited compelling a party to submit to class arbitration under the FAA in the absence of a basis to conclude that the party agreed to do so,[140] and that neither silence nor ambiguity on the issue of class arbitration in the agreement to arbitrate provides a sufficient contractual basis to satisfy this inquiry.[141] The Eighth Circuit rejected the pharmacies’ argument that the Supreme Court had recognized that class arbitration may be implicitly authorized in some cases, finding that precedent held that consent to class-wide arbitrations cannot be inferred solely from the fact that the parties agreed to arbitrate.[142] Thus, the Eighth Circuit affirmed the District Court’s decision denying the pharmacies’ motion to compel class arbitration.
Marbaker v. Statoil USA Onshore Props., Inc., 801 F. App’x 56 (3d Cir. (Pa.) Feb. 13, 2020). Where a party has not yet moved to compel arbitration, the issue of whether the party has waived its right to arbitrate is not yet ripe. Further, neither silence on class arbitration nor a reference to the AAA Rules provide sufficient evidence of an agreement to arbitrate on a class-wide basis where the reference to the AAA Rules do not mention the AAA Supplementary Rules.
Landowners filed a class arbitration demand against Statoil USA Onshore Properties, Inc. (“Statoil”) for unpaid royalties allegedly owed to them under leases in which they agreed to allow oil and gas to be extracted from their property.[143] The landowners also filed a complaint in federal district court seeking declaratory judgment that the leases permitted class arbitration. Thereafter, the parties agreed to mediate, and the landowners voluntarily dismissed their lawsuit and agreed to stay the arbitration. When mediation broke down, the landowners refiled their declaratory judgment suit, now asking the court to declare either that Statoil waived its right to enforce the leases’ arbitration clauses, or that those clauses permit class arbitration. The District Court granted Statoil’s motion to dismiss the declaratory judgment suit in full, holding that the waiver issue was not ripe and that the leases did not permit class arbitration. The landowners appealed.[144]
The Third Circuit affirmed the District Court’s decision, first holding that the landowners were not entitled to a declaratory judgment that Statoil waived its arbitration right because the issue was not ripe.[145] To be sufficiently ripe for determination, the parties’ interests must be adverse, and the requisite adversity was not present here because Statoil had not yet moved to compel arbitration.[146]
The Third Circuit also affirmed the dismissal of the landowners’ request for judgment that the leases permitted class arbitration, holding that the leases did not contain the necessary evidence of an affirmative agreement to class arbitration.[147] In reaching this conclusion, the court cited to Lamps Plus, Inc. v. Varela and Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., in which the Supreme Court held that there must be an affirmative contractual basis from which to infer that the parties consented to class arbitration before a court can compel a party to arbitrate on a class-wide basis.[148]
The Third Circuit found that the leases at issue fell well short of this standard, as they did not mention class arbitration.[149] The court held that although it is not essential that an agreement contain the phrase “class arbitration,” the absence of a reference presents a challenge to demonstrating the requisite consent.[150] A review of the language actually used in the leases did not convince the court that the parties consented to class arbitration because they used bilateral language to describe the leases themselves, as well as the parties.[151] As a court sitting in diversity, the Third Circuit applied Pennsylvania law to reject the use of extrinsic evidence offered by the landowners because the leases were not ambiguous, as required to consider such evidence.[152]
Lastly, the Third Circuit rejected the landowners’ argument that the agreement to follow the AAA rules included an agreement to incorporate the AAA’s Supplementary Rules, which do refer explicitly to class arbitration.[153] In reaching this decision, the court applied its own precedent holding that a “short, general reference to the AAA’s rules does not ‘incorporate[ ] a panoply of collective and class action rules,” in light of the structure of the AAA rules, which bury the Supplementary Rules in a chain of cross-references.[154] It further held that the Supplementary Rules explicitly proscribe consideration of such references when determining whether an arbitration provision allows for class arbitration.[155]
§ 1.4.2 The Validity and Scope of an Arbitration Agreement and Arbitrability
SEIU Local 121RN v. Los Robles Reg’l Med. Ctr., 976 F.3d 849 (9th Cir. (Cal.) 2020). In all arbitrations, including labor arbitration disputes, absent clear and unmistakable evidence of the parties’ intent to have an arbitrator—rather than the court—decide an issue, the court is responsible for deciding that issue.
The collective bargaining agreement (“CBA”) between a hospital and union provided for a three-step procedure to address grievances, with arbitration as the final step.[156] The union filed a grievance asserting that the hospital placed certain types of patients with nurses who did not have the appropriate training to care for those patients.[157] The hospital took the position that the grievance appeared to be a staffing issue, expressly excluded from the grievance procedures under the CBA.[158] The union filed a complaint in federal court, followed by a motion to compel arbitration.[159] The District Court determined that the parties were bound by the arbitration provision, but that it had to first determine whether the arbitration provision gave an arbitrator—rather than the court—the authority to decide its own jurisdiction (i.e., to decide if the grievance was subject to the arbitration provision).[160]
The District Court then proceeded to engage in a thorough analysis of Supreme Court and Ninth Circuit precedent on the issue, including in particular its own precedent in United Bhd. of Carpenters & Joiners of Am., Local No. 1780 v. Desert Palace, Inc.[161] Although the District Court questioned whether Desert Palace was still good law in light of more recent Supreme Court decisions, the District Court concluded that it was bound by its precedent.[162] Applying Desert Palace, the District Court found that the arbitration provision in the CBA was broad enough to authorize the arbitrator—rather than the court—to determine whether the grievance was arbitrable and therefore granted the union’s motion to compel arbitration without reaching the question of arbitrability.[163] The hospital appealed.
On appeal, the Ninth Circuit held that the rationale in Desert Palace is “clearly irreconcilable with the reasoning or theory of intervening higher authority” set forth in Granite Rock Co. v. Int’l Bhd. Of Teamsters,[164] which expressly rejected the notion that labor arbitration disputes should be analyzed differently than commercial arbitration disputes.[165] The panel concluded that it was therefore not bound by Desert Palace. The dissent, on the other hand, saw no such conflict and construed Granite Rock to address only whether a specific issue is arbitrable, rather than the question of who decides.[166] The court applied the rule that absent clear and unmistakable evidence of the parties’ intent to have an arbitrator—rather than the court—decide whether SEIU’s grievance is arbitrable, the District Court is responsible for deciding that issue, and reversed and remanded.[167]
Gibbs v. Sequoia Capital Operations, LLC, 966 F.3d 286 (4th Cir. (Va.) 2020); Gibbs v. Invs., LLC, 967 F.3d 332 (4th Cir. (Va.) 2020). The question of enforceability of delegation provision was for the courts to decide, rather than the arbitrator, and the lower court properly determined the arbitration agreement was unenforceable where choice of law requiring tribal law amounted to a prospective waiver.
Groups of borrowers filed each of these suits against online payday lenders owned by a sovereign Native American tribe and others challenging the legality of the loans, and the defendants moved to compel arbitration.[168] Although the borrowers claimed the loans would be illegal under state and federal law, the loan agreements provided they would be governed by tribal law.[169] The agreements also contained a delegation clause stipulating that the parties would arbitrate “any issue concerning the validity, enforceability, or scope [of the loans]” and while borrowers could opt out of arbitration, any dispute resolution had to occur in the tribal court system.[170] The District Court concluded in each case that because the choice of law provisions would apply tribal law to exclude federal law, including federal statutory claims by the borrowers, the agreements violated the prospective waiver doctrine and were unenforceable.[171] The lenders appealed.
On appeal, the court first held in each case that because the borrowers sufficiently challenged the enforceability of the delegation clauses, the District Court was correct to consider the threshold enforceability of the arbitration agreements.[172] Additionally, because the challenge to the delegation provision necessarily encompassed and included arguments that related to the entire arbitration agreement, the District Court did not err by assessing those arguments.[173] As to the merits of the challenge, because the choice of law and venue provisions amounted to an illegal prospective waiver of a party’s right to pursue statutory remedies, the provision rendered the delegation clause, as well as the entire agreement, unenforceable.[174] The District Court’s judgment refusing to compel arbitration was affirmed in both cases.
Williams v. Medley Opportunity Fund II, LP, 965 F.3d 229 (3d Cir. (Pa.) 2020). Whether prospective waiver doctrine applied and rendered entire contract unenforceable, including the delegation clause, was for the court to decide.
Here, as in the Gibbs cases discussed above, borrowers obtained loans from online payday lenders pursuant to loan agreements that provide for mandatory application of tribal law, including in arbitration under the AAA or JAMS. The borrowers sued the lenders in federal court for violations of federal and Pennsylvania state law.[175] The choice of law provision called for application of tribal law and “such federal law as is applicable under the Indian Commerce Clause of the United States Constitution.”[176] The lenders moved to compel arbitration and the District Court denied the motion, ruling that the arbitration agreement was unenforceable because the choice of law would not permit the arbitrator to consider any of the borrowers’ claims based on federal and state law, effecting an impermissible prospective waiver; and that the choice of AAA or JAMS did not provide an available arbitral forum because the arbitrators were required to apply policies and procedures that would not contradict tribal law.[177]
On appeal, the court first held that the issue of enforceability was for the court because the borrowers contended that the entire contract, including the delegation clause, was unenforceable.[178] To determine whether the prospective waiver doctrine applied, the court examined the law of the forum to interpret the arbitration agreement to identify the law that would apply in arbitration under the agreement, and whether that law would preclude the borrower’s claims.[179] Under Pennsylvania law, the arbitration agreement clearly provided for application of tribal law.[180] As such, the arbitration agreement effects an impermissible waiver of statutory rights and is unenforceable.[181] While the lenders claimed that the borrowers could still pursue their federal racketeering claim in arbitration, the court disagreed that a racketeering claim would be recognized as one under the “federal law as is applicable under the Indian Commerce Clause of the United States Constitution,” which would not capture all federal laws.[182] Finally, the court held that the prospective waiver of statutory rights rendered the entire arbitration agreement (delegation clause included) unenforceable because the offending provisions were not severable, and affirmed the District Court’s order denying the motion to compel arbitration.[183]
Biller v. S-H OpCo Greenwich Bay Manor, LLC, 961 F.3d 502 (1st Cir. (R.I.) 2020). Issues of arbitrability, including whether the arbitration agreement survived termination, were for the court to decide, and the arbitration obligation did survive termination and was not unconscionable.
Plaintiffs, a former resident in a long-term care facility and her daughter and attorney-in-fact, sued the facility in state court for injuries caused by medication lapses.[184] The facility removed the action to federal court and sought to enforce the arbitration provision in the residency agreement. The District Court denied arbitration, reasoning that when the resident had moved from assisted living to a memory care unit, the original agreement terminated, no other agreement to arbitrate was signed, and thus there was no arbitration agreement to enforce.[185] The facility appealed.
On appeal, the court first held that the parties’ agreement, which provided that “disputes regarding interpretation, scope, enforceability, unconscionability, waiver, preemption and/or violability of this Agreement,” did not provide clear and unmistakable evidence that the parties agreed to have an arbitrator decide arbitrability, because it did not refer to disputes over the arbitration provision itself.[186] Accordingly, the court would interpret the arbitration clause to determine whether it gave the arbitrator the authority to decide when the agreement terminated, and the court concluded that it did.[187] To reach that conclusion, the court determined that the arbitration provision was severable and that the plaintiffs were challenging the entire contract on the grounds that the contract had terminated or that it was unconscionable.[188] The court also invoked the presumption that arbitration obligations survive termination of the underlying agreement.[189] However, the court reserved to itself the question of whether the parties had agreed to terminate the arbitration agreement by entering into a substitute agreement and, applying Rhode Island law, found a dearth of evidence to support the plaintiffs’ theory. Moreover, the claims of unconscionability failed because plaintiffs could not meet the “daunting” standard Rhode Island imposed to show substantive unconscionability.[190] Accordingly, the Court of Appeals reversed and remanded with a direction to compel arbitration.
Taylor v. Pilot Corp., 955 F.3d 572 (6th Cir. (Tenn.) 2020). Courts have the authority to determine whether an arbitration agreement was formed before compelling arbitration in accordance with that agreement, even where questions of arbitrability are delegated to the arbitrator.
Employees brought an action against their employer for overtime violations under the Fair Labor Standards Act (“FLSA”) and the District Court granted conditional certification to a collective action.[191] The employees then filed a motion to compel the employer to produce employment dates of all opt-in plaintiffs.[192] One week after the motion was filed, the parties reached a partial settlement that resolved the claims of many of the opt-in employee-plaintiffs, and the employer filed a motion to compel the remaining opt-in employee-plaintiffs to arbitrate their claims, based on arbitration agreements the employer claimed each of the opt-in employee-plaintiffs had signed at their time of hire.[193] There were a number of discrepancies in the information the employer provided, and the employees argued that there was no valid agreement to arbitrate where the opt-in employee-plaintiffs did not sign an arbitration agreement on the date the employer alleged they did. The District Court granted the employees’ motion to compel the employer to disclose employment dates, and ordered the employer to produce the dates within two weeks. However, instead of complying with that deadline, the employer filed a motion to reconsider the order compelling production of the dates, arguing that the purported arbitration agreements require the District Court to refer to the arbitrator whether it must produce employment dates and whether the arbitration agreements were validly formed.[194] The District Court denied the motion to reconsider, and the employer appealed. Thereafter, the court entered an order denying all outstanding motions by both parties, pending the resolution of the employer’s appeal, including the employer’s pending motion to compel arbitration.[195] The employer appealed from that order as well.
On appeal, the Sixth Circuit identified the “core” of the parties’ dispute as whether the opt-in employees signed the alleged arbitration agreements, an issue of contract formation.[196] Some number of employees claimed that they were not employees on the dates indicated on the alleged agreements and thus no binding arbitration agreement was formed. The employer maintained that because of the broad delegation clauses in the alleged agreements, only an arbitrator can decide this question and that the district court’s orders to the contrary were unlawful denials of its valid petition for arbitration.[197] Here, however, the court looked at the unusual status of the case and determined that it lacked jurisdiction under Section 16(a)(1)(B) of the FAA because the district court had not yet issued an order denying a petition to order arbitration to proceed, but merely delayed that decision pending the parties’ dispute regarding production of employment start dates.[198]
However, the court went on to discuss the current state of the law on contract formation issues. Under Henry Schein, Inc. v. Archer and White Sales, Inc.,[199] the court must determine whether a valid arbitration agreement exists before referring a matter to arbitration. And, under prior Supreme Court precedent, the district court “must resolve any issue that calls into question the formation or applicability of the specific arbitration clause that a party seeks to have the court enforce.”[200] Left unresolved by these decisions was the question of whether the parties can contractually deprive the court of authority to decide these issues.[201] Notwithstanding its decision to dismiss the appeal, the Sixth Circuit advised that the case law “strongly suggests” that even where agreements in this case purport to delegate the formation question to the arbitrator’s sole discretion, the precedent from the Supreme Court and the circuit indicate that the district court retains the authority to first satisfy itself that an agreement exists before granting a motion to compel arbitration.[202] Otherwise, “[t]he FAA’s demand for consent-based arbitration agreements would be severely undermined.”[203] Accordingly, the appeals were dismissed for want of jurisdiction and the matter was remanded to the District Court.[204]
Blanton v. Domino’s Pizza Franchising LLC, 962 F.3d 842 (6th Cir. (Mich.) 2020). Incorporation of the AAA Rules provides “clear and unmistakable” evidence that the parties agreed to arbitrate disputes regarding arbitrability.
An employee of one of Domino’s Pizza Franchising LLC’s (“Domino’s”) franchises filed a putative class action against Domino’s, alleging that its franchise agreement violated federal antitrust law and state law.[205] The employee contended that Domino’s requirement that its franchises agree not to solicit or hire employees from other franchises without the prior consent of their employer was unlawful. The employee, already employed at one franchise, had obtained a second job from a different Domino’s franchisee in the same area, and signed an arbitration agreement with the second franchise that required him to arbitrate the merits of certain claims relating to his employment according to the AAA National Rules for the Resolution of Employment Disputes (“AAA Employment Rules”). The first franchise terminated his employment, purportedly believing it was required to do so by Domino’s policy to allow him to work at the second franchise. Domino’s moved to compel arbitration under the FAA, and the plaintiffs opposed the motion and argued that Domino’s could not enforce the arbitration agreements because only the franchises, and not Domino’s, were parties to the agreements. The District Court held that employees had agreed to arbitrate both the merits of certain claims as well as the enforceability of the arbitration agreements, and ordered the employees to arbitration.[206]
The Sixth Circuit affirmed the District Court, holding that the parties clearly and unmistakably agreed to arbitrate questions of arbitrability.[207] First, the court found that Supreme Court precedent requires an arbitrator to resolve disputes regarding arbitrability when there is “clear and unmistakable evidence” that the parties agreed to have an arbitrator resolve such issues.[208] Here, the Sixth Circuit reasoned that the express incorporation of the AAA Employment Rules amounted to “clear and unmistakable” evidence because such rules provided that “[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement.”[209] In reaching this interpretation of the arbitration provision, the court also addressed the question of whether to invoke federal or state law: questions of contract formation and interpretation generally involve state law, while the question of whether a particular agreement satisfies the “clear and unmistakable” standard seems to be one of federal law.[210] However, the choice of law would not be dispositive here, because the relevant state law (from the state of Washington) had already found that the incorporation of the AAA Employment Rules provided the requisite clear and unmistakable evidence that the parties intended to arbitrate arbitrability.[211] The court rejected the employees’ argument that the agreements incorporate the AAA Employment Rules only as to claims that fall within the scope of the agreement, finding that the text of the agreements did not limit incorporation of the rules in this way and that the employees’ interpretation was superfluous as the agreements state the arbitrator only has the power to determine the scope of the agreement.[212] Accordingly, the decision of the District Court was affirmed.
Bowles v. OneMain Fin. Grp., 954 F.3d 722 (5th Cir. (Miss.) 2020). Where it is alleged that there was no meeting of the minds on an arbitration agreement, the challenge of formation under Mississippi law is properly determined by a court. However, a challenge that an arbitration agreement is procedurally unconscionable is an issue of enforceability under Mississippi law, which can be resolved by an arbitrator pursuant to a delegation clause.
A former employee of OneMain Financial Group (“OneMain”) was terminated for alleged inappropriate interactions with other employees under her supervision.[213] She filed suit in federal court alleging age discrimination. Prior to her termination, the former employee was required by OneMain to review and acknowledge its employment agreement, which provided that any employment-related dispute would be referred to arbitration. The agreement also contained a delegation clause that delegated responsibility to the arbitrator to resolve “any legal dispute … arising out of, relating to, or concerning the … enforceability … of this Agreement.”[214] The employee certified that she had reviewed the agreement and agreed to its terms. OneMain moved to compel arbitration. In opposition, the employee argued that a valid arbitration agreement was never formed because there was no meeting of the minds. She also argued that the circumstances surrounding the formation of the agreement rendered it procedurally unconscionable. The District Court rejected the meeting of the minds argument and held that her procedural unconscionability challenge must be decided by an arbitrator. The former employee appealed.[215]
The Fifth Circuit affirmed the District Court’s order, first holding that it was proper for the District Court to determine the contract formation issue.[216] The Fifth Circuit agreed that there was a meeting of the minds sufficient to support formation of an agreement to arbitrate under Mississippi law because it was clearly identified as an arbitration agreement, the former employee certified that she read and understood its terms, and her argument that she did not understand the agreement carried no weight because her unilateral lack of diligence did not preclude contract formation.[217] The Fifth Circuit further held that the District Court correctly referred the procedural unconscionability argument to the arbitrator for resolution.[218] This was a challenge of enforceability, rather than formation under Mississippi law, and thus the contractual delegation clause required the issue to be referred to the arbitrator.[219]
Fedor v. United Healthcare Inc., 976 F.3d 1100 (10th Cir. (N.M.) 2020). Whether an arbitration agreement exists in the first instance is a question to be resolved by the court, regardless of whether the alleged agreement contains a delegation clause or whether a party specifically challenges such a clause.[220]
Plaintiff worked as a care coordinator for United Healthcare, Inc. (“UHC”) from 2013 until 2016.[221] In 2017, she filed a collective suit alleging that UHC violated state and federal employment law, and eight other former employees of UHC joined her action. UHC moved to compel arbitration, claiming that the former employees were bound by its policy requiring all employees to settle employment-related claims through arbitration and demonstrating that each former employee had received and signed an arbitration policy when they commenced employment with UHC. The former employees commenced their employment in different years, and had signed four different versions of the agreements that were applicable at the various times. UHC claimed the version in effect when it moved to compel arbitration (the “2016 Version”) was the controlling policy. The 2016 Version contained a delegation clause providing that an arbitrator would resolve disputes regarding the policy’s “interpretation, enforceability, applicability, unconscionability, arbitrability or formation,” or whether the policy was “void or voidable.”[222] The other three relevant versions of the arbitration policy, which all preceded the 2016 Version, did not include a delegation clause. The prior versions also differed from the 2016 Version in that they each contained an amendment clause that allowed UHC to unilaterally alter the arbitration policy. The employees opposed UHC’s motion to compel, arguing that the amendment clause rendered the prior versions illusory, and that the 2016 Version was never agreed to because none of the plaintiffs ever saw or signed it. Although the District Court held that the prior versions were illusory, it nevertheless compelled arbitration based on the employees’ failure to challenge the delegation clause in the 2016 Version. The employees appealed, arguing that courts must first determine whether an arbitration agreement was formed before the court can compel arbitration of issues pursuant to a delegation clause.[223]
The Tenth Circuit vacated the District Court’s judgment and remanded, holding that the issue of whether an arbitration agreement was formed must always be decided by a court regardless of whether the alleged agreement contains a delegation clause or whether a party specifically challenges such a clause.[224] Here, the employees claimed that they never saw or agreed to any aspect of the 2016 Version, which the court found amounts to an issue of formation that cannot be delegated.[225] The Tenth Circuit reached this decision after considering Supreme Court precedent that held that a court must find that an agreement to arbitrate exists between the parties before it can send a claim to arbitration.[226] The court also rejected UHC’s argument to affirm on the alternate ground that the prior versions of the agreement were valid, holding that UHC did not file a cross-appeal.[227]
Lavigne v. Herbalife, Ltd., 967 F.3d 1110 (11th Cir. (Fla.) 2020). For a delegation clause to exist, the court must decide whether there is an agreement to arbitrate. Equitable estoppel will not apply to compel arbitration of claims against a non-party to an arbitration agreement when the claims against the non-party do not rely on the terms of the arbitration agreement or when the non-party’s misconduct is not founded in or intimately connected with such agreement.
A group of distributors of Herbalife Ltd. and its affiliates (“Herbalife”) filed a federal suit asserting racketeering claims against Herbalife and certain of its top distributors (the “Top Distributors”), alleging that the defendants were engaged in an enterprise to “disseminate misleading and fraudulent income claims,” to “recruit new members into the fraudulent business opportunity scheme,” and to “increase the investment and engagement of those already ensnared in the scheme.”[228] The Herbalife defendants filed a joint motion to compel arbitration, arguing that each of the agreements with the distributors included a provision incorporating the Herbalife Rules of Conduct (which contain an arbitration provision) and that three of the agreements contained their own arbitration clauses. The most recent version of the Herbalife Rules of Conduct provided that Herbalife and the distributor agree to arbitrate all disputes between them, including “claims arising out of or relating to any aspect of the relationship between Herbalife and [distributor],” as well as “claims by [distributor] against Herbalife or Herbalife against [distributor] which arise out of or relate in any way to any dispute between [distributor] and another Herbalife [distributor].”[229] Importantly, references to Herbalife in this clause included its “subsidiaries, affiliates, officers, directors, agents, employees, predecessors in interest, heirs, successors and assigns.”[230] Under the agreements, arbitration was to be governed by the AAA Rules. Herbalife prevailed on its motion to compel at the district court.[231] However, the District Court denied the motion to compel arbitration of the claims against the Top Distributors, who appealed from the District Court’s order.[232]
The Eleventh Circuit affirmed the District Court’s order to deny the Top Distributor’s motion to compel arbitration, holding that the Top Distributors could not enforce the arbitration clauses because they were not parties to any of the distributor agreements.[233] The court first found that the Top Distributors were not Herbalife’s “subsidiaries, affiliates, officers, directors, agents, employees, predecessors in interest, heirs, successors, or assigns” as those terms were used in the agreements.[234] Applying California contract law, the Eleventh Circuit then determined that the Top Distributors could not invoke the arbitration provisions in agreements to which they were not parties.[235]
The Eleventh Circuit also rejected the Top Distributors’ argument that the issue of whether there was an agreement to arbitrate claims was a threshold question of arbitrability that must be delegated to an arbitrator pursuant to the AAA Rules. The court held that because there was no agreement to arbitrate with the Top Distributors, there was nothing to delegate.[236] Lastly, the Eleventh Circuit held that the doctrine of equitable estoppel could not be invoked to compel arbitration of claims against the Top Distributors. The court found that, under California law, a non-signatory to an arbitration agreement can only invoke equitable estoppel to compel arbitration in one of two circumstances: “(1) when the plaintiff-signatory ‘must rely on the terms of the written agreement in asserting [its] claims,’; or (2) when the plaintiff-signatory alleges ‘substantially interdependent and concerted misconduct’ by the signatories and non-signatories, and such alleged misconduct is ‘founded in or intimately connected with the obligations of the underlying agreement.’”[237] Here, the Eleventh Circuit held that the distributors did not mention or discuss any terms of the agreements in the complaint and so were not relying on those agreements.[238] Second, the court further held that the Top Distributors’ alleged misconduct, which it identified as making misrepresentations in coordination with Herbalife to convince the plaintiffs to spend money, was at least one step removed from the distributor agreements, and thus was not founded in or intimately connected with the obligations of that contract.[239] Accordingly, the Top Distributors could not compel the distributors to arbitrate their claims.
MZM Construction Co., Inc. v. N.J. Building Laborers Statewide Benefit Funds, 974 F.3d 386 (3d Cir. (N.J.) 2020). Where the formation of an arbitration contract that contains a delegation provision has been placed in issue, the court must resolve the dispute unless there is clear and unmistakable evidence that the parties agreed to delegate formation disputes to an arbitrator.
MZM Construction Company (“MZM”) hired workers from a local labor union for a construction project at Newark Liberty International Airport.[240] MZM’s president signed a one-page, short-form agreement (“SFA”) with the union. The SFA incorporated by reference a 1999 collective bargaining agreement and its 2002 successor (the “1999 CBA” and “2002 CBA,” and collectively the “CBAs”). The 2002 CBA required MZM to make contributions to a statewide benefits fund. It also contained an arbitration clause requiring the parties to agree to arbitrate “questions or grievances involving the interpretation and application” of the agreement as well as a provision that further provided that “[t]he Arbitrator shall have the authority to decide whether an Agreement exists, where that is in dispute.”[241] After conducting an audit, the union determined that MZM owed about $230,000 in contributions to the union. When MZM questioned the basis for this alleged liability, the union produced the SFA executed by MZM’s president, as well as an unsigned copy of the 2002 CBA. The union unilaterally scheduled arbitration.
Thereafter, MZM filed a complaint in federal court seeking to enjoin arbitration and for a declaratory judgment that it was not a signatory to the CBA, had no obligation to arbitrate under any CBA, and was not liable to the union. The complaint alleged that the SFA was fraudulently executed, so the SFA and incorporation of the CBAs voided any agreement between SFA and the union. The union moved to dismiss and opposed the injunction, asking the District Court to refer the fraudulent execution claim to arbitration, along with the underlying collection dispute. The union also argued that MZM presented a claim for fraudulent inducement, not fraudulent execution, which presumes that an agreement exists but is voidable rather than void at the outset, and as such the dispute is required to be sent to an arbitrator. The District Court entered an order enjoining arbitration during the pendency of the action and denied the union’s motion to dismiss, and the union appealed.[242]
The Third Circuit considered whether the District Court had the power to resolve a question about the formation or existence of a contract where the contract contained a provision expressly delegating authority “to decide whether an Agreement exists” to an arbitrator.[243] In finding that it did, the Third Circuit noted its prior determination that “courts ‘should not assume that the parties agreed to arbitrate arbitrability unless there is clea[r] and unmistakabl[e] evidence that they did so.’”[244] The Third Circuit found that MZM had adequately stated a claim for fraudulent execution, which would render any arbitration agreement between the parties void.[245] The union could not establish clear and unmistakable evidence that the parties agreed to delegate questions of arbitrability to an arbitrator where MZM disputed the existence of such an agreement.[246] This triggered the authority of the District Court under Section 4 of the FAA to adjudicate the claim of fraudulent inducement.[247] The Third Circuit was further persuaded by the fact that many other circuits had reached similar determinations.[248]
Wiggins v. Warren Averett, LLC, No. 1170943, 2020 WL 597293 (Ala. Feb. 7, 2020) (unpub.). When an arbitration provision indicates that the AAA rules apply to the proceedings, substantive arbitrability decisions are to be made by the arbitrator, including whether the arbitration provision may be enforced against a non-signatory to the contract.
An individual physician filed a complaint against an accounting firm for accountant malpractice and the firm moved to compel arbitration, arguing that the individual physician was a third-party beneficiary to its contract with the medical practice requiring arbitration.[249] The individual physician was a shareholder and employee of the practice and the contract required the accounting firm to prepare the tax returns for the individual physicians.[250] The physician argued that the arbitration provision applied only to claims made by the practice against the accounting firm, and not to personal claims brought by the individuals.[251] The trial court granted the motion to compel, and the physician appealed.[252]
On appeal, the physician argued that the dispute was excluded from the scope of the arbitration agreement and the accounting firm argued that because the agreement incorporated the AAA rules, a determination as to whether the claim is subject to the arbitration clause is an issue for the arbitrator to decide, not the court.[253] The Supreme Court of Alabama held that when an arbitration provision indicates that the AAA rules apply to the proceedings, substantive determinations of arbitrability are to be made by the arbitrator, including whether the arbitration provision may be enforced against a non-signatory to the contract, and thus, the trial court properly granted the motion to compel.[254]
§ 1.4.3 Other Procedural Issues Related to Arbitration
Adams v. Postmates, Inc., 823 F. App’x 535 (9th Cir. (Cal.) 2020). An arbitration agreement delegates authority to the arbitrator to resolve disputes regarding potential violations of class action waiver that are not excluded from the delegation provision or the arbitration agreement.
Claimants commenced more than 5,000 individual arbitrations against Postmates, Inc. (“Postmates”) in simultaneous filings.[255] Postmates argued that its arbitration agreements with claimants contained class action waivers, and contended that the court must determine whether claimants had violated the waivers by the mass filings, which it contended amounted to de facto class-wide arbitration proceedings to which the parties had not agreed.[256] After finding that the arbitration agreement clearly delegated responsibility to the arbitrator to resolve whether the claimants’ conduct violated the class action waivers, the District Court ordered Postmates to proceed with more than 5,000 individual arbitrations. Postmates appealed.[257]
On appeal, Postmates argued that the arbitration agreement contained an exception to the delegation provisions that required a court to resolve disputes that arise from the class action waivers. The Ninth Circuit affirmed the District Court’s order, holding that the arbitration agreement delegated authority to the arbitrator to resolve the dispute over the class action waiver.[258] While the agreement excluded from the delegation provision claims that the class action waiver is “unenforceable, unconscionable, void, or voidable,” this did not cover the present dispute.[259] As there was no applicable exception to the delegation provision, the court of appeals affirmed the District Court’s conclusion that the arbitrator must determine whether claimants violated the class action waivers.[260]
§ 1.5 What Constitutes an Agreement to Arbitrate?
Baten v. Mich. Logistics, Inc., No. 19-55865, 2020 U.S. App. LEXIS 32558 (9th Cir. (Cal.) Oct. 15, 2020) (unpub.). Applying state law, court properly determined that no valid arbitration agreement ever existed where parties did not agree on the arbitrator selection process or the rules to govern arbitration process.
The parties entered into an agreement that provided that they would “resolve any disputes directly or with an agreed form of alternative dispute resolution.”[261] One party had proposed proceeding under the auspices of the AAA, but that proposal was not accepted. The District Court denied a motion to compel arbitration and this appeal followed.
The court of appeals first noted that it had jurisdiction to consider the interlocutory appeal under Section 16(a)(1)(B) of the FAA, even though the FAA was only invoked in supplemental briefing.[262] Next the court concluded that it would look to state law to determine whether an agreement to arbitration exists, noting that it was in a minority of circuits to do so, as the First, Second, Sixth and Tenth Circuits would apply federal common law.[263] Looking at the language in the parties’ contract, the court concluded that the reference to a “form of alternative dispute resolution” could mean other forms of ADR, such as mediation, and did not constitute an agreement to be bound to arbitrate disputes.[264] Looking at the parties’ communications after the dispute arose, the court similarly found that the requisite agreement to arbitrate was still lacking: the parties never agreed on material terms, such as the mechanism for choosing an arbitrator and the applicable rules governing the arbitration, including the payment of the arbitrator’s fees.[265] Finally, the court held that merely submitting a “demand to arbitrate” would not establish an implied-in-fact agreement to arbitrate, where the parties could not agree on how or where such an arbitration would proceed.[266] The majority affirmed the District Court’s denial of the application to compel arbitration, over a dissenting opinion that came to a different conclusion that “the most reasonable reading of ‘an agreed form of Alternative Dispute Resolution’ is that the parties agreed to arbitration,” because interpreting the reference to ADR to include mediation would create a “no man’s land where there is no binding way to resolve any disputes.”[267]
§ 1.5.1 Issues of Contract Formation
In multiple decisions interpreting the same arbitration provision in form contracts between consumers and AT&T Mobility (“AT&T”), the Fourth and Ninth Circuits came to conflicting decisions whether DIRECTV, which was subsequently acquired by AT&T’s parent, could require the consumer to arbitrate claims brought under the Telephone Consumer Protection Act (“TCPA”).[268] The contracts defined AT&T to includes its “affiliates” without specifying whether that term included after-acquired affiliates. These cases are discussed below.
Mey v. DIRECTV, LLC, 971 F.3d 284 (4th Cir. (W.Va.) 2020). In light of the expansive text of an agreement to arbitrate, and other context from the parties’ agreement, claims against an after-acquired affiliate were within the scope of the arbitration provision.
The District Court denied DIRECTV’s motion to compel arbitration of the consumer’s TCPA claims, concluding the dispute was outside of the agreement to arbitrate because the receipt of calls from DIRECTV was not an immediate and foreseeable result of the performance of the contract between the consumer and AT&T for cellular services, and the contract was susceptible of an interpretation imposing a limited duty to arbitrate disputes relating to such cellular services, noting that a construction that was not so limited might be unconscionably overbroad.[269]
On appeal, the court of appeals had no difficulty finding that there was an agreement to arbitrate, and held that there was no reason the term should be limited to only affiliates existing at the time the contract was entered into.[270] Indeed, the court found the contractual context suggests the opposite, pointing to language binding “successors and assigns,” and rejected the assertion that the contract was ambiguous.[271] Finally, the court looked at the scope of the agreement to arbitrate to see whether it covered these claims. Starting with the “heavy presumption” favoring arbitration, the court of appeals suggested that the District Court’s question whether the provision could be limited had asked the wrong question; the correct inquiry was whether the agreement was susceptible to an interpretation that covers the dispute.[272] In light of the expansive text of the arbitration agreement, requiring arbitration of “any and all disputes between us,” with no limiter to the services provided by AT&T, it did not exclude the TCPA claims against DIRECTV.[273] The court found additional support for its conclusion in broadly worded categories of claims the agreement specifically listed as included, the contractual instruction to interpret its provisions broadly, and references to permission to send electronic communications to customers.[274] The court did acknowledge that construing language broadly can lead in the abstract to “troubling hypothetical scenarios” but stressed that the question it was addressing was concrete rather than abstract, tethered to the facts of this dispute.[275]
The dissent would have held that there was no agreement to arbitrate, considering the language of the agreement as a whole, and interpreting the reference to “affiliate” to refer to those entities involved in some way in providing cellular phone services.[276] In the view of the dissent, the issue was not only about temporal limits on the term “affiliate” to exclude or include future affiliates, but rather that a reasonable person would not anticipate arbitrating with DIRECTV, whose later affiliation with AT&T was “happenstance” and fortuity unconnected to the provision of cell phone service under the contract.[277] The dissent cited as support the District Court’s decision in Revitch denying DIRECTV’s motion to compel, affirmed shortly thereafter by the Ninth Circuit as discussed immediately below.[278]
Revitch v. DIRECTV, LLC, 977 F.3d 713 (9th Cir. (Cal.) 2020). Disagreeing with the Fourth Circuit, Ninth Circuit held that there was no agreement to arbitrate claims against an after-acquired affiliate where contract interpretation supporting arbitration would lead to an absurd result.
The District Court denied DIRECTV’s motion to compel arbitration, concluding that the contract between the consumer and AT&T did not reflect an intent to arbitrate the claim now asserted against DIRECTV, and DIRECTV appealed.[279]
On appeal, the Court of Appeals issued three opinions: a majority, a concurrence, and a dissent. The majority looked to California state law (as provided in the AT&T contract) to answer the threshold issue of whether there is an agreement to arbitrate. Analyzing the reasonable expectations of the parties, the court concluded that the consumer could not have reasonably expected when he signed his contract with AT&T to obtain cell phone service that he could be forced to arbitrate an unrelated dispute with an entity that did not become affiliated with AT&T until years later.[280] Thus, this was a case that fell within the California rule that while courts normally look to “the written terms [of the contract] alone,” they will not do so if it would “lead to absurd results.”[281] While DIRECTV argued that the FAA preempts the absurd results canon under the Supreme Court decision in Lamps Plus, Inc. v. Varela, the majority disagreed.[282] Because the absurd results canon does not disfavor arbitration agreements compared to other contracts, it concluded that the canon would not be preempted by the FAA.
Significantly, the majority found that there was no agreement to arbitrate and thus never reached the question of the scope of the arbitration clause.[283] The Ninth Circuit acknowledged that it was creating a split with a recent Fourth Circuit decision that reached the opposite conclusion on nearly identical facts in Mey v. DIRECTV, LLC, discussed above.[284] The majority here reasoned that it was appropriate to consider hypothetical situations to bolster its conclusion that the parties’ intention was not to form an agreement to arbitrate of the kind that DIRECTV was urging.[285] Adopting a different approach, the concurrence focused on the language of Section 2 of the FAA, asking whether the underlying controversy to be settled by arbitration was one “arising out of” the contract or transaction in which the consumer agreed to arbitrate.[286] Concluding that it was not, the concurrence would affirm the District Court on that separate ground.[287]
Like the Fourth Circuit, the dissent here maintained that the issue was not about the existence of the agreement to arbitrate, but rather about the scope of that agreement.[288] In its view, the “affiliate” language was not ambiguous and, even if it were, any ambiguity should be resolved in favor of arbitration, rendering the absurd results canon inapplicable.[289] As such, the dissent would have reversed the District Court.
Given the split among the circuits over the rules of interpretation applicable to agreements to arbitrate, this issue may yet resurface.
Hill v. Emple. Res. Grp., LLC, 816 F. App’x 804 (4th Cir. (W.Va.) 2020). The court properly denied in part employer’s motion to compel arbitration because no reasonable jury could find that the proof satisfies the applicable heightened burden to show an agreement to arbitrate by clear and convincing evidence.
Employer sought arbitration of wage and hour claims of a class of plaintiffs, employees at Applebee’s restaurants, who had opted in to the class.[290] The employees opposed the motion, arguing that the employer was unable to produce agreements for at least 60 of the opt-in plaintiffs.[291] The District Court granted the motion only as to potential class members for whom the employer produced signed agreements and the employer appealed.[292]
The court of appeals reviewed the denial of the motion to compel de novo, applying a summary judgment standard to determine whether there were sufficient facts to support the denial, invoking general contract formation principles.[293] Because the employer asserted that contracts could not be found for certain opt-in employees, the court looked to the missing instruments law of the four states where the plaintiff-employees were employed, which all had heightened standards for proving the existence of missing or lost instruments through parole evidence.[294] Looking at the employer’s evidence in the record, consisting of an affidavit setting forth the standard corporate employment practice of requiring employees to sign agreements, and the existence of several hundred agreements signed by other class members, the court held that the employer had failed to meet its burden to demonstrate a material issue of fact as to whether the employees had signed agreements.[295] It had not, for example, provided sufficient context to demonstrate the rate of compliance across the system or testimony from the specific managers at the restaurants involved about individual compliance.[296] For these reasons, the court affirmed the District Court’s order.[297]
Bacon v. Avis Budget Grp., Inc., 959 F.3d 590 (3d Cir. (N.J.) 2020). Court properly denied motions to compel arbitration where proof did not show by undisputed facts that customers consented to arbitrate their disputes.
Plaintiff-customers brought putative class action against car rental company and licensees alleging consumer claims and the company moved to compel arbitration.[298] Some customers had rented cars in the U.S., where the arbitration provision is printed on a jacket into which the signed one-page agreement is folded and given to the customer; one had rented a car in Costa Rica, where the arbitration provision is on the back side of a two-page form, which the customer had not signed; and several plaintiffs had used websites that included an arbitration provision in the terms of use.[299] The District Court denied the initial motions and directed the parties to engage in discovery on the issue of arbitrability.[300] After discovery, the defendants filed a new joint motion for summary judgment on the issue of arbitrability. The District Court denied the motion, holding that the undisputed facts showed that the plaintiffs in the U.S. did not assent to the arbitration provision, a disputed factual issue existed as to whether the plaintiff renting in Costa Rica had reasonable notice of the arbitration provision, and the record for plaintiffs who rented on the website was not sufficiently developed concerning assent, allowing that the issue could be resolved after further discovery either on summary judgment or at trial.[301]
The Court of Appeals affirmed. First, it held that it had appellate jurisdiction because the District Court’s orders denied motions to compel arbitration, regardless of finality.[302] Turning to issues of contract formation, the court held the District Court properly denied the motions for summary judgment. As to the plaintiffs who rented cars in the U.S., the terms of the rental jackets were not adequately incorporated into the rental agreements to create contractual assent under either New Jersey or Florida law.[303] New Jersey law permits contract terms to be incorporated by reference from a separate document, where (1) the separate document “must be described in such terms that its identity may be ascertained beyond doubt” and (2) “the party to be bound by the terms must have had ‘knowledge of and assented to the incorporated terms.’”[304] While the Florida standard on incorporation by reference is more lenient than New Jersey law, the defendants’ proof did not meet either standard, in large part because customers did not receive or see the rental jacket until after they had signed the rental agreement.[305] For the Costa Rica customer, as New Jersey law requires the parties to have “reasonable notice” of the contract terms; the court held that the evidence did not indisputably show that the customer had reasonable notice of the arbitration provision printed on the back side of the rental form, where he had signed the front, but not the back, of the document.[306] As to customers who used the website, the court held the evidence supporting the motion was not properly authenticated, because the screen shots of the website did not show the sites as they existed when the customers made their reservations, but rather were from data grabs taken over a year later.[307] Accordingly, the orders denying summary judgment on the issue of arbitrability were affirmed.
Mason v. Midland Funding LLC, 815 F. App’x 320 (11th Cir. (Ga.) 2020) (per curiam). Presumption in favor of arbitration does not apply to disputes concerning whether an agreement to arbitrate has been made, which is a threshold question to be resolved as a matter of contract law, requiring a specific showing that the party assented to the agreement to arbitrate.
Cardholders brought a putative class action against credit card companies, who sought unsuccessfully to dismiss, and then to compel arbitration.[308] The cardholders had applied for credit online, a process that allegedly required them to accept terms and conditions including an arbitration agreement, which was then mailed to the cardholder along with their credit card. The District Court denied the motion.[309]
On appeal, the court distinguished between issues of the scope of an arbitration clause, where the FAA requires doubts to be resolved in favor of arbitration, and disputes concerning whether an agreement to arbitrate has been made, which are matters of contract.[310] Here, Utah law applied, and provided that a credit agreement is “enforceable without any signature as long as the ‘debtor is provided with a written copy of the terms of the agreement,’ the agreement states that ‘any use of the credit offered shall constitute acceptance of those terms,’ and the debtor ‘uses the credit offered.’”[311] The court reviewed the District Court’s decision de novo and held that, as to one plaintiff-cardholder, the submissions by the credit card companies fell short of showing that the form of application submitted in support of the motion was the actual application the cardholder accepted and that the online application contained an agreement to arbitrate.[312] Nor did the submission relating to that cardholder trigger the “mailbox rule” that creates a presumption of receipt where there is evidence of specific office procedures for preparing and mailing notices and receipt of mail from the purported sender at the same address because the proof was not based on personal knowledge where the mailing was conducted by outside vendors.[313] The District Court had properly employed a summary judgment standard, finding the credit card companies were not entitled to discovery when they did not request a trial and their submissions were insufficient to raise a dispute about any material fact.[314]
However, as to the other named cardholder, the submission did trigger the mailbox rule because the declarant had personal knowledge of the mailing and the cardholder did not rebut the presumption.[315] Accordingly, the District Court’s order was reversed as to the second named plaintiff-cardholder.
Nicosia v. Amazon.com, Inc., 815 F. App’x 612 (2d Cir. (N.Y.) June 4, 2020). Where a party has notice of the existence of an arbitration clause, and manifests assent to be bound by the clause through conduct, the party can be compelled to arbitrate. A consumer filed claims against Amazon.com, Inc. (“Amazon”) claiming that Amazon violated Washington state law and consumer protection laws based on two online purchases he made through Amazon in 2013 of a weight loss product that contained a controlled substance that had been banned by the Food and Drug Administration in 2010.[316] The District Court granted Amazon’s motion to compel arbitration and dismiss the case, based on an arbitration clause that has been included in Amazon’s online conditions of use since 2011. The consumer appealed, arguing that he was not bound by the arbitration clause because he never received notice of it or manifested his assent. The consumer further contended that through its conduct, Amazon waived its right to compel arbitration.[317]
The Second Circuit affirmed the district court’s judgment, holding that the consumer was bound by the arbitration agreement based on principles of notice and assent.[318] First, the court found that the question of whether the parties had agreed to arbitrate would be governed by Washington law, under which a party may be bound by an arbitration agreement through “inquiry notice,” even without actual notice of the contract term..[319] The Second Circuit then reasoned that the consumer’s admission that he made at least 27 purchases through Amazon after receiving such notice was a manifestation of assent to arbitration.[320] The Second Circuit also rejected the consumer’s waiver argument, finding that he failed to show any prejudice, such as specific cost, that resulted from Amazon’s delay in filing its motion to compel.[321] Thus, the consumer was bound by the agreement to arbitrate.[322]
Skuse v. Pfizer, Inc., 244 N.J. 30 (2020). Arbitration agreement is valid and binding on employee where employer disseminated notice of arbitration policy through a company-wide email informing employees that continuation of employment would be deemed acceptance of policy and waiver of right to pursue employment discrimination claims in court.
Pfizer, Inc. (“Pfizer”) notified employees through a companywide email of a new arbitration policy and attached a link to the agreement.[323] Under the policy, if an employee continued to work for Pfizer for 60 days after receipt of the agreement, the employee would be deemed to have accepted and consented to the terms of the agreement.[324] Plaintiff employee opened the email that attached the agreement, completed a “training module” regarding the arbitration provision, and clicked a box on her computer screen that asked her to “acknowledge” that she was required to assent to the agreement as a condition of her employment.[325] Plaintiff continued to work for Pfizer for 13 months and subsequently filed suit under New Jersey state discrimination law when her employment was terminated based on her refusal to be vaccinated on religious grounds.[326] The trial court granted Pfizer’s motion to dismiss the complaint and compel arbitration.[327] The intermediate appellate division reversed the trial court’s judgment, holding that the agreement was not agreed to, was unenforceable, and that “the wording and method of Pfizer’s training module” was “inadequate to substantiate an employee’s knowing and unmistakable assent to arbitrate and waive his or her rights of access to courts.”[328]
On appeal to the New Jersey Supreme Court, the court applied a de novo standard to its review of the trial court’s determination that the employee’s claims were subject to an enforceable arbitration agreement.[329] Following a discussion of relevant case law concerning waiver-of-right provisions, the court concluded that Pfizer had clearly informed the employee she would waive her right to pursue claims for employment discrimination in court by continuing her employment for 60 days following receipt of the agreement, noting that the employee was informed through a copy of the agreement itself, multiple emails, the “FAQs” document provided along with the agreement, and the training module.[330] The court also found that while employees receive large volumes of emails in the workplace that may not be thoroughly reviewed, the employee’s failure to review the communications from her employer did not invalidate the agreement.[331] Finally, the court found that neither Pfizer’s purportedly misleading labeling of materials provided to employees about the arbitration provision as “training,” nor the request that the employee “CLICK HERE to acknowledge” as opposed to “agree” to the agreement, invalidated the agreement.[332] In holding that the agreement was valid and binding, the court concluded that the agreement explained to the employee in “clear and unmistakable terms the rights she would forego if she assented to arbitration by remaining employed at Pfizer for sixty day … [the] e-mails, the link to the Agreement contained in those e-mails, the ‘FAQs’ page, and the summaries that appeared on the four pages collectively explained, with the clarity that our law requires, the terms of the Agreement to which [the employee] agreed by virtue of her continued employment.”[333] Accordingly, the Supreme Court reversed the intermediate court and reinstated the determination by the trial court.
Carrick v. Turner, 298 So.3d 1006 (Miss. 2020). Discrepancies within agreement do not impact the enforceability of the agreement to arbitrate where the parties’ intent to arbitrate claims is unambiguous.
A client filed a lawsuit against a securities broker and his employer alleging negligent misrepresentation and supervision.[334] In response, the brokerage moved to compel arbitration based upon its purported agreement with the client containing an arbitration provision.[335] The client had signed an application to open an account incorporating an account agreement that did not require signatures.[336] The application contained a clear reference to an arbitration provision in the account agreement, but may have referred to the provision by the wrong paragraph numbers (there were two versions of the account agreement, with the arbitration provision in different-numbered paragraphs, along with slight wording variations, and it was not clear which was provided to the client when she signed her application).[337] The trial court denied the motion to compel arbitration and the broker and brokerage appealed.[338]
On appeal, the Supreme Court of Mississippi described the two-prong analysis courts must conduct when determining the validity of a motion to compel arbitration under the FAA, asking first whether the parties intended to arbitrate the dispute and then whether any external legal constraints foreclose arbitration of the claims.[339] Here, despite a possible discrepancy in the numbered paragraph references, the language and execution of the application demonstrated the unambiguous intent of the parties to arbitrate this claim and thus, a valid arbitration agreement existed and the trial court should have compelled arbitration.[340] To that end, the Supreme Court of Mississippi remanded the case with directions to compel the parties to submit to arbitration and to attempt to determine which version of the agreement, if either, applies, noting that if the court was unable to determine which provision governed, the trial court was to refer to the FAA for guidance regarding specifics of the arbitration.[341]
Jorja Trading, Inc. v. Willis, 598 S.W.3d 1 (Ark. 2020). A self-help provision, class action waiver, and arbitrator-selection provision in an arbitration agreement did not destroy mutuality of obligation as to preclude formation of a valid contract.
Defendants purchased a car with an installment sales contract, failed to make payments, and surrendered the car.[342] Plaintiff Jorja Trading, Inc. (“Jorja”), the assignee of the financing contract, sued in small claims court for the remaining balance on the contract and obtained a judgment.[343] The purchasers appealed, counterclaimed for usury and UCC violations, and sought class certification. In response, Jorja filed a motion to compel arbitration.[344] The court denied the motion, holding that the arbitration agreement lacked mutuality of obligation because while it reserved the right to both parties to seek self-help remedies, only the lender would be able to resort to self-help to repossess the vehicle, the class action waiver only applied to limit the buyers’ rights (as only buyers would be pursuing claims as a class), and it allowed the lender to reject the purchasers’ appointment of an arbitrator, and because Jorja had waived its right to arbitration by proceeding in small claims court.[345]
On appeal, the Supreme Court of Arkansas applied ordinary state law principles governing contract formation. The court started its analysis with the premise that the agreement to arbitrate was bilateral, and that mutuality does not require that every provision within a contract be bilateral.[346] Requiring every provision in an arbitration agreement to be bilateral would hold arbitration agreements to a more stringent analysis than other contracts, in violation of the FAA.[347] The court held that the self-help provision in the installment-sales contract did not void the arbitration agreement or negate mutuality.[348] Likewise, as class action waiver provisions would not invalidate mutuality of obligations in other installment sales contracts, the provision cannot destroy the mutuality merely because it applies to arbitration.[349] The court disagreed with the lower court’s interpretation of the provision regarding the selection of the arbitrator as unilateral, and found that the arbitration agreement was valid.[350] Finally, the court found that the agreement specifically provided that a party may seek a monetary judgment in district court without waiving arbitration and, thus, Jorja did not waive the right to arbitrate and the motion to compel should have been granted.[351]
§ 1.5.2 Issues of FAA Preemption
Delisle v. Speedy Cash, 818 F. App’x 608 (9th Cir. (Cal.) 2020) (unpub.). Court properly applied California law to invalidate agreements to arbitrate that would waive the borrowers’ rights to seek public injunctive relief, but remands to examine McGill factors in light of subsequently enacted law to determine whether requested injunctive relief would still prevent a threat of future harm.
Borrowers requested an injunction under California law barring Speedy Cash from issuing loans greater than $2,500 with an annual percentage rate of interest (“APR”) over 90% and requiring Speedy Cash to issue “corrective advertising” about prior loans.[352] Speedy Cash sought an order requiring the borrowers to enforce an arbitration provision in the loan agreements that included a waiver of the borrower’ right to seek public injunctive relief in all forums.[353] The District Court held that the requested injunction would benefit the general public because it would prevent Speedy Cash from continuing to engage in unlawful conduct that threatens future harm and concluded that the plaintiffs had requested public injunctive relief that the California Supreme Court deemed non-waivable in McGill v. Citibank, N.A.[354] Accordingly, the District Court denied Speedy Cash’s motion to enforce the arbitration agreements and Speedy Cash appealed.
During the appeal, however, a California statute took effect that prohibited finance lenders from issuing certain loans.[355] The new law raised issues about whether the injunction was still necessary to prevent a threat of future harm.[356] Speedy Cash also contended that the District Court erred in applying California law to determine the enforceability of the arbitration provision because the loan agreement designated Kansas law as controlling. The Court of Appeals concluded that California law was properly applied, because California holds a materially greater interest in this litigation, the loans were negotiated and executed in California, the plaintiffs reside in California and California law invalidates contractual waivers of the right to seek public injunctive relief in all forums.[357] Accordingly, the District Court correctly applied California law, but the order was reversed and remanded in light of the new California statute’s further consideration of whether a public injunctive relief was warranted.
Roberts v. AT&T Mobility LLC, 801 F. App’x 492 (9th Cir (Cal.) 2020) (unpub.). Denial of arbitration would not be disturbed, as FAA does not preempt McGill rule invalidating agreements that would purport to waive the right to seek public injunctive relief as against public policy.
This case made its second appearance in the Ninth Circuit on an arbitration issue. Plaintiff-consumers had filed a class action lawsuit against AT&T Mobility LLC (“AT&T”) alleging AT&T used deceptive and unfair trade practices in marketing mobile service data plans as “unlimited.”[358] The consumers asserted AT&T’s practices violates several California laws and sought, among other remedies, public injunctive relief, which AT&T’s arbitration clause prohibits.[359] AT&T argued that the FAA preempts California’s public policy in favor of public injunctive relief. Four years earlier, the district court had compelled arbitration and the Ninth Circuit had affirmed, rejecting the consumer’ argument that compelling arbitration violated their First Amendment right to petition the government.[360] The consumers asked the District Court to reconsider based on the California Supreme Court’s supervening decision in McGill v. Citibank, N.A.,[361] which held that an agreement, like AT&T’s, that waives public injunctive relief in any forum is contrary to California public policy and unenforceable. On their motion for reconsideration, the consumers argued that McGill’s holding provided the District Court with a new, intervening basis to deny arbitration. The District Court agreed and granted the motion to reconsider and denied, in part, AT&T’s motion to compel arbitration.[362] AT&T appealed.
On appeal, AT&T argued that the appeal should be resolved on a procedural issue—that the district court abused its discretion in reconsidering its initial order compelling arbitration. The court of appeals disagreed, holding that this was the type of decision in which it should give the district court a substantial margin of discretion to decide the issue, and that the district court’s decision to grant rehearing was not “beyond the pale of reasonable justification,” illogical, implausible or without support.”[363]
Turning then to the merits of the District Court’s decision, the Ninth Circuit pointed to its recent decision in Blair v. Rent-A-Ctr., Inc., holding that the FAA does not preempt the McGill rule, on facts similar to this case.[364] There, the Court of Appeals held that because the McGill rule is a generally applicable contract defense derived from long-established California public policy in favor of public injunctive relief, the rule fell within the FAA’s saving clause at the first step of the preemption analysis.[365] Moreover, the McGill rule does not mandate procedures that interfere with arbitration, namely with arbitration’s informality.[366] Bound by its prior decision in Blair that clauses such as AT&T’s are unenforceable in California under McGill, the Ninth Circuit once again affirmed the District Court’s order, this time denying AT&T’s motion to compel arbitration[367].
Belton v. GE Capital Retail Bank, 961 F.3d 612 (2d Cir. (N.Y.) 2020). A dispute concerning the violation of a bankruptcy court’s discharge order framed as contempt is not arbitrable.
Two debtors opened credit card accounts with lenders (the “Banks”).[368] When the debtors fell behind on their credit card payments, the Banks eventually “charged off” the delinquent debt and reported the change in the status of the debt to major credit reporting agencies. In turn, those agencies updated the debtors’ credit reports to indicate their severely delinquent and outstanding credit card debt. Eventually, both debtors filed for bankruptcy. At the completion of the liquidation processes, the bankruptcy court entered a discharge order, which operated as an injunction against future collection attempts. Thereafter, the debtors initiated adversary proceedings against the Banks seeking a contempt citation and damages based on allegations that the Banks’ failure to update the debtors’ credit reports violated the bankruptcy court’s discharge order. In response, the Banks moved to enforce mandatory arbitration clauses in the debtors’ credit card account agreements. The bankruptcy court denied the Banks’ motions, finding that the dispute was not arbitrable because of an inherent conflict between the bankruptcy code and the FAA, and the District Court affirmed.[369] The Banks appealed, arguing that Supreme Court precedent rejected the notion that inherent conflict between statutory purpose and arbitration is independently sufficient to displace the FAA’s mandate that courts enforce arbitration agreements.[370]
The Second Circuit affirmed the district and bankruptcy courts’ orders denying the motion to compel the dispute over the discharge order.[371] The Second Circuit disagreed with the Banks’ interpretation that Supreme Court precedent held that inherent conflict is not sufficient by itself to displace the FAA.[372] The court found that, although the Supreme Court required courts to favor statutory text and legislative history over an inherent conflict when considering whether Congress intended to override the FAA’s mandate, Epic Sys. Corp. v. Lewis did not preclude the independent use of an inherent conflict to resolve such disputes when statutory text and legislative history are ambiguous.[373] The Second Circuit reasoned that here, the bankruptcy code was ambiguous as to whether disputes about discharge orders were arbitrable in the context of contempt proceedings.[374] Thus, the court found that it was bound by its own precedent in a nearly identical case that an inherent conflict did exist between the FAA and bankruptcy code with regard to discharge orders.[375] In In re Anderson, the Second Circuit had held that an inherent conflict existed because discharge orders are integral to the bankruptcy process, their enforcement requires continuing court supervision, and the bankruptcy court’s power to enforce its own orders is integral to the code’s central structure, without considering the bankruptcy code’s text or legislative history.[376] Bound by its precedent, the Second Circuit affirmed the District Court’s order denying the motions to compel arbitration.[377]
Robertson v. Intratek Computer, Inc., 976 F.3d 575 (5th Cir. (Tex.) 2020). The federal whistleblower statute does not contain a Congressional command to override the FAA’s mandate to enforce arbitration agreements, and claims under the whistleblower law that are within an arbitration agreement must be arbitrated.
Plaintiff employee signed an arbitration agreement as a condition to beginning employment with Intratek Computer, Inc. (“Intratek”), to provide information and technology services to United States Department of Veterans Affairs (“VA”).[378] The agreement required arbitration of any claims against Intratek and its officers, agents and employees relating to his employment. Intratek fired the employee, and shortly thereafter he filed a whistleblower complaint with the VA’s Office of the Inspector General alleging that Intratek’s CEO bribed VA officials to secure lucrative government contracts. The whistleblower complaint included allegations that Roger Rininger, a VA employee, had allegedly accepted the bribes.[379]
The employee filed suit in federal district court against Intratek, its CEO, and Rininger, alleging that Intratek violated the federal whistleblower statute[380] by firing him for reporting the bribes. Intratek and its CEO moved to stay the suit and compel arbitration, and the employee effectively agreed to stay the case as it pertained to Rininger. The District Court referred the matter to a magistrate judge who found that all of the employee’s claims, including those against Rininger, were subject to arbitration and should be dismissed. The District Court adopted the magistrate judge’s report and recommendation, and dismissed all of the employee’s claims in favor of arbitration.[381]
The Fifth Circuit affirmed the District Court’s decision to dismiss the claims against Intratek and its CEO pursuant to the arbitration agreement, holding that the whistleblower statute does not override the FAA’s mandate to enforce arbitration agreements.[382] The court, applying Supreme Court precedent, held that the employee must show “a contrary congressional command” in a purportedly conflicting federal statute to override the FAA’s mandate.[383] The Fifth Circuit rejected the employee’s urging to find such a mandate in the whistleblower statute provision allowing either party to seek a jury trial.[384] The court’s interpretation of the statute was that a jury trial is one way to vindicate a whistleblower’s statutory rights, but not itself a right or remedy created by the statute. The Fifth Circuit also determined that the whistleblower statute’s legislative history lacked any congressional command to avoid arbitration.[385] According to the court, the employee’s claims against Intratek and its CEO under the whistleblower statute, and for wrongful termination and tortious interference, were clearly covered by the arbitration agreement, which applied to any claims under federal and state law.[386]
However, the Fifth Circuit reversed the district court’s decision to dismiss the claims against Rininger, who, as a VA official, never signed an employment contract or any arbitration agreement with Intratek.[387] As there was no arbitration agreement to enforce and the employee had never moved to compel arbitration of the claims against Rininger, its decision compelling arbitration of those claims was clearly erroneous.[388]
Sparks v. Old Republic Home Protection Company, Inc., 467 P.3d 680 (Okla. 2020). Under reverse preemption of the McCarran-Ferguson Act, state law exempting contracts, which reference insurance from arbitration was enacted for the purpose of regulating insurance and preempts the application of the FAA.
Homeowners purchased a home warranty from Old Republic Home Protection (“OHRP”) that included a provision requiring disputes to be resolved by arbitration under the FAA.[389] After damage to their home, OHRP selected the repair company. Homeowners claimed the repairs were negligently performed, and filed a suit for breach of contract against OHRP.[390] OHRP moved to compel arbitration, and the trial court denied the motion.[391] After the motion was denied, OHRP amended its answer to allege that it was not an insurance company and the warranty contract was not an insurance contract.
OHRP appealed, arguing that the FAA controlled and preempted the application of Oklahoma Uniform Arbitration Act.[392] The intermediate Court of Civil Appeals affirmed the trial court’s order, concluding that the Oklahoma Uniform Arbitration Act[393] prevented the trial court from compelling arbitration because the contract “referenced insurance” within the meaning of the Oklahoma statute and did not intend to exempt contracts made pursuant to other laws governing home services.[394]
On a writ of certiorari to the Supreme Court of Oklahoma, the court analyzed the interplay between the McCarran-Ferguson Act,[395] which authorized reverse preemption of federal statutes giving individual states the right to enact laws to regulate insurance, and the FAA.[396] The court held that the Oklahoma Uniform Arbitration Act exempting contracts that reference insurance from arbitration is a state law regulating the business of insurance and thus, under the McCarran-Ferguson Act, the state law prevails over the FAA.[397] The Supreme Court of Oklahoma held that the home warranty plan met the definition of insurance and was therefore exempt from the application of the Oklahoma Uniform Arbitration Act, pursuant to the application of the McCarran-Ferguson Act.[398]
§ 1.6 Jurisdiction Under the Federal Arbitration Act
Burgess v. Lithia Motors, Inc., 196 Wn.2d 187 (2020). Once an arbitration begins under the FAA, judicial intervention is limited to ruling on gateway disputes, such as whether the arbitration clause is enforceable, and addressing the award at the conclusion of arbitration.
Plaintiff employee filed suit in state superior court against her former employer alleging discrimination, harassment, and wrongful termination.[399] The case was moved to arbitration on the employer’s request pursuant to the arbitration provision in the parties’ employment agreement.[400] During the arbitration, the employee claimed that the employer failed to timely respond to interrogatories and moved in the arbitration forum to compel discovery responses.[401] After the arbitrator denied the motion, the employee returned to state court and filed a motion to vacate the arbitrator’s order, terminate the arbitration, and issue a case scheduling order.[402] The employee argued that the employer had breached the arbitration agreement by failing to comply with discovery deadlines and the arbitrator had breached the arbitration agreement by failing to enforce the Federal Rules of Civil Procedure.[403] The state court denied the motion, holding that the enforceable arbitration clause deprived the court of jurisdiction to address the employee’s motion.[404]
The intermediate state court of appeals granted the employee’s request for review and certified the following question to the Washington Supreme Court: “Does the superior court have jurisdiction to address an employee’s contractual breach argument based upon acts alleged in the course of binding arbitration, or is the superior court’s jurisdiction in a contractual arbitration limited to issues occurring before and after—but not during—the proceeding…”[405] The Supreme Court analyzed a number of federal court cases that determined that the FAA generally restricts judicial involvement to the “bookends of arbitration” and precludes any judicial intervention once arbitration begins.[406] The court next analyzed the statutory provisions that govern the interplay between judicial and arbitration proceedings under the FAA, and rejected the employee’s argument that Section 2 of the FAA authorized the court to resolve a breach of the arbitration agreement challenge during ongoing arbitration.[407] The court concluded that once arbitration begins under the FAA, “the court’s authority to resolve the dispute is transferred to the arbitrator. Judicial intervention is generally precluded during arbitration proceedings.”[408] Because neither party challenged the validity of the arbitration agreement beforehand, and the final arbitration award had not yet been issued, the court could not intervene and rescind the arbitration agreement and thus, the superior court correctly determined that it was precluded from reviewing the employee’s motion.[409]
§ 1.6.1 Federal Appellate Jurisdiction Under Section 16 of the Federal Arbitration Act
Noe v. City Nat’l Bank, No. 20-1230, 2020 U.S. App. LEXIS 31088 (4th Cir. (W.Va.) Sept 30, 2020) (per curiam). Appellate jurisdiction existed where District Court denied request for alternative relief to stay the action pending arbitration, and to the extent that the motion presented unresolved factual questions, the court should have considered matters outside the pleadings and held a summary hearing to resolve any issues.
Bank customer brought a class action lawsuit challenging the imposition of overdraft fees.[410] In response, the bank moved to dismiss on the grounds that the pleading was insufficient and, in the alternative, asked the court to stay the action pending arbitration. The District Court denied the motion, based on a question whether subsequent agreements modified the obligation to arbitrate contained in the original depository agreement that the court deemed unfit for resolution on a motion to dismiss.[411]
On the bank’s appeal, the court first examined its jurisdiction and concluded that the bank’s alternative request that the “matter be stayed pending referral of the matter to arbitration” equated to a motion seeking enforcement of a purported arbitration agreement and, thus, appellate jurisdiction existed to review the denial of that request, under Section 16(a)(1)(b) of the FAA.[412] Proceeding to the merits of the appeal, the court held that the District Court had erred in denying the motion. If the District Court had treated the motion as one to compel and stay pending arbitration, the court would not have been limited to a review of the pleadings before it.[413] And, if after considering the bank’s evidence the District Court concluded that a genuine issue of material fact prevented it from deciding the issue of arbitrability, the court would have been required to hold a hearing to resolve the factual dispute.[414] Accordingly, the District Court erred in denying the motion without determining arbitrability and the Court of Appeals vacated the District Court’s order denying arbitration and remanded to the District Court to determine whether the claims should be referred to arbitration with the direction that, if there are unresolved questions of material fact, the court should hold “an expeditious and summary hearing” to resolve those issues.[415]
Hermosillo v. Davey Tree Surgery Co., 821 F. App’x 753 (9th Cir. (Cal.) 2020). District Court’s order compelling classwide arbitration staying non-arbitrable claims and neither explicitly dismissing nor staying the remainder of the claims failed to rebut the presumption that claims that were not explicitly dismissed by the District Court were stayed and thus, not final and immediately appealable under the FAA.
Employees brought claims in state court against employer, who removed the case to federal court and moved to compel arbitration pursuant to provision in employment applications and a stand-alone arbitration agreement.[416] The court granted the motion to compel arbitration on a classwide basis pursuant to the employment applications, but stayed claims that were not arbitrable under the California Private Attorney General Act (“PAGA”). The order did not explicitly stay or dismiss the arbitrable claims, but ordered the clerk to administratively close the file, and directed the parties to notify the court after the arbitration proceedings were completed.[417]. The employer appealed the portion of the order directing classwide arbitration, requesting reversal and an order compelling arbitration on an individual basis.
The court started with the rule that orders compelling arbitration are not immediately appealable under Section 16 of the FAA, unless the underlying claims are dismissed so that the order constitutes a final decision with respect to the arbitration.[418] Because the order in this case did not explicitly dismiss all of the claims, the court assumed the claims not dismissed were stayed, and that it lacked appellate jurisdiction.[419] While the employer argued that the order compelling class arbitration constitutes an order denying arbitration on an individual basis, the court disagreed because the court would then be required to consider the merits of the appeal, rendering the limitations on appellate jurisdiction meaningless.[420] Instead, the court held that the employer could have pursued an interlocutory appeal, or asked the District Court to reconsider its ruling or sought clarification, or it could have appealed that part of the order denying individual arbitration; instead, it appealed the portion of the order that required arbitration.[421] Accordingly, the appeal was dismissed for lack of appellate jurisdiction.
Torgerson v. LCC Int’l, No. 20-3020, 2020 U.S. App. LEXIS 25155 (10th Cir. (Kan.) 2020). There is no appellate jurisdiction over an order denying a motion to decertify collective claims in arbitration because the order staying the action pending arbitration was not final and the orders did not deny an application to compel arbitration.
Employees filed a lawsuit against employer alleging violations of the FLSA.[422] Based on the arbitration provision in the employment agreements, the employer filed a motion to dismiss or, in the alternative, to stay proceedings and compel arbitration. The District Court granted the employer’s request to stay the case and ordered the parties to arbitrate their dispute. However, the court declined to consider the employer’s request to decide whether the operative employee agreements permitted collective arbitration, as well as the employees’ motion for conditional certification of their FLSA class claims, as those were issues to be resolved by the arbitrator.[423]
The named employee then submitted a demand to the AAA, seeking to assert a collective action on behalf of himself and others similarly situated, and the employer filed a “Motion for Clause Construction” in the arbitration, asking the arbitrator to dismiss the collective action claims.[424] The arbitrator entered an order that the arbitration provision was valid and enforceable and covered the employees’ FLSA claims, and authorized the employees to proceed on a collective basis.[425] The arbitrator denied the employer’s request, describing the order as a non-final decision that pertains to opt-in collective action under the FLSA. Thus, it was not a final ruling under the AAA rules as to whether an arbitration may proceed as an opt-out class action, and the proceedings would not be stayed to permit judicial review.[426]
The employer filed a federal court action seeking to vacate the arbitrator’s “Clause Construction Award.” The District Court, citing Rule 3 of the AAA’s Supplementary Rules for Class Arbitrations, predicted that the court of appeals would conclude that a district court has jurisdiction to review an arbitrator’s order holding that the parties’ arbitration agreement allows a claimant to assert FLSA claims on a collective basis, but denied the petition to vacate, holding that the arbitrator had not exceeded his authority in concluding the parties’ agreement authorized collective arbitration of the employees’ FLSA claims.[427] The employer did not appeal that award.
The arbitrator issued an order conditionally certifying a class of employees, and also granted the employer’s motion dismissing several opt-in employees. Several months later, the employer filed a motion to decertify the class, citing the Supreme Court’s supervening decision in Lamps Plus, Inc. v. Varela.[428] The arbitrator denied that motion as well, holding that the arbitration provision at issue here unambiguously established the parties’ agreement to arbitrate on a collective basis. The employer returned to federal court, and asked the District Court to direct the parties to arbitrate on an individual and not collective basis. The District Court denied the motion.[429] The employer appealed.
On appeal, the court held that none of the subsections of Section 16 of the FAA authorized interlocutory review of the arbitrator’s refusal to decertify the FLSA class.[430] The district court case remained stayed pending arbitration and thus the order appealed from was not final within the meaning of Section 16(a)(3) of the FAA.[431]Lamps Plus did not apply because the district court did not “compel class arbitration”: it compelled arbitration, but left for the arbitrator to decide whether the employees could proceed collectively.[432] Further, the employer was not appealing the order compelling arbitration, but instead, the district court’s order denying its motion to vacate the arbitrator’s refusal to decertify collective arbitration of the FLSA claims, and so Section 16(a)(1)(C) would not provide a basis for appellate jurisdiction.[433] Finally, there was no jurisdiction under Section 16(a)(1)(D) because the employer was not appealing from the district court’s order refusing to vacate the arbitrator’s Clause Construction Award, but rather from the district court’s order denying its motion to vacate the arbitrator’s order refusing to decertify the collective arbitration, although the court declined to say whether such jurisdiction would have existed for such an appeal.[434]
Before dismissing the appeal for lack of jurisdiction, the court noted that, following the conclusion of the arbitration, any party could return to the district court to seek a review of the award under the criteria laid out in Section 10 of the FAA.[435]
Jin v. Parsons Corp., 966 F.3d 821 (D.C. Cir. 2020). Where a trial court finds that a genuine issue of material fact exists as to whether an arbitration agreement was ever formed, the FAA requires that the court proceed summarily to trial solely to resolve the issue of formation before granting or denying the motion to compel arbitration.
Jin O. Jin (“Jin”) was a long-time employee of Parsons Corporation (“Parsons”) who sued Parsons for employment discrimination in federal district court.[436] Parsons moved to compel arbitration, asserting that it instituted an Employee Dispute Resolution (“EDR”) program in 1998 that contained an agreement to arbitrate. Parsons also asserted that it had sent an email to its employees to notify them that it had updated the EDR and asked them to complete a certification that they received the arbitration agreement. The email also stated that continuing to work for Parsons after failing to sign the arbitration agreement constituted acceptance. Parsons presented evidence that it sent this email to Jin on four occasions and that, although Jin never signed the agreement, his continued employment with Parsons for years thereafter amounted to acceptance. Jin submitted as declaration evidence that he had no recollection of the EDR or receiving any emails from Parsons about an updated EDR, and that he never reviewed or signed the arbitration agreement. The District Court denied Parsons’ motion to compel, concluding that a genuine dispute of material fact existed as to whether Jin intended to be bound by the agreement to arbitrate, and thus, as to whether an agreement was ever formed between the parties. Parsons appealed.[437]
On appeal the Court acknowledged that Section 4 of the FAA requires a court to conduct a summary trial when the existence of a valid agreement to arbitrate is in issue.[438] The Court of Appeals held that the District Court erred by denying Parsons’ motion to compel before definitively resolving the issue of whether an arbitration agreement was formed and remanded with an order to hold the motion in abeyance pending resolution of the formation issue through a limited trial.[439] In reaching this decision, the D.C. Circuit first resolved a challenge to its jurisdiction over this interlocutory appeal from a decisions to deny a motion to compel arbitration.[440] While the District Court’s ruling had some similarities to a denial of a motion for summary judgment based on issues of fact, from which there is no right to take an interlocutory appeal, the court held that it had jurisdiction under the plain language of 9 U.S.C. §16(a)(1)(A)-(B), which provides a right to appeal from an order denying a petition under the FAA.[441] The court was also persuaded by similar interpretations from other circuits exercising jurisdiction in the same circumstances.[442]
INTL FCStone Fin. Inc. v. Jacobson, 950 F.3d 491 (7th Cir. (Ill.) 2020). Court’s order requiring arbitration, designating an arbitration forum, and staying the case to address related issues is not appealable.
Defendants, commodities futures investors, maintained trading accounts with INTL FCStone Financial Inc. (“FCStone”), a clearing firm that handled the confirmation, settlement, and delivery of transactions.[443] After extraordinary volatility in the natural gas market wiped out the investors’ account balances with FCStone, leaving some defendants in debt, lawsuits were filed.[444] The investors alleged Commodity Exchange Act violations against FCStone; FCStone sought payment from investors with negative balances. The investors filed arbitration proceedings against FCStone before the FINRA and FCStone responded with a declaratory judgment action claiming the parties must arbitrate their disputes before the National Futures Association, pursuant to the investors’ arbitration agreements and Commodity Futures Trading Commission (“CFTC”) regulations, arguing FINRA lacks jurisdiction over the underlying disputes, and seeking to compel arbitration under Section 4 of the FAA and enjoin the FINRA arbitrations.[445] The investors complained that FCStone was seeking an impermissible anti-arbitration injunction. The District Court ruled for FCStone (although it denied the request for injunctive relief) and directed the investors to arbitrate before the NFA.[446]
On appeal, the Seventh Circuit had no difficulty concluding that it had no jurisdiction over the appeal because it was not from a decision denying arbitration, but rather an order compelling arbitration.[447] Moreover, there was no jurisdiction under § 1292(a)(1) of the Judicial Code, allowing interlocutory appeals of orders granting injunctions, which is superseded by Section 16(b) of the FAA in any event.[448] Finally, as the action was stayed, there was no appellate jurisdiction under Section 16(a)(3).[449]
§ 1.7 Nonsignatories to an Arbitration Agreement
This past year, a number of cases were decided addressing whether corporate successor predecessors and after-acquired affiliates could compel, or be compelled, to arbitrate claims. In addition to the decisions discussed in this section, significant decisions touching this issue are discussed above in sections 1.5.1 and 1.8.2.
§ 1.7.1 Can Nonsignatories Compel Signatories to Arbitrate?
Hart v. Charter Communs., Inc., 814 F. App’x 211 (9th Cir. (Cal.) 2020). Successor by merger and its parent can enforce arbitration agreement between subscriber and predecessor internet provider where subscriber has reasonable notice of the agreement.
Plaintiff subscriber brought consumer claims in a putative class action against internet service provider and its parent alleging that the corporate predecessor misled consumers who enrolled in automatic bill payment.[450] Provider moved to compel arbitration. The District Court granted the motion, holding that the subscriber had had inquiry notice of the subscriber agreement with the predecessor through its billing statements and assented to the agreement by continuing to accept internet services and that the provider’s successor by merger and its parents could enforce the terms of the agreement, including the arbitration clause.[451]
The Court of Appeals held that the successor could enforce the arbitration agreements under California contract law, because there was “sufficient identity of parties.”[452] Under Delaware law (the law of incorporation of the corporate entities), the successor assumed all of the rights and obligations of the acquired entity and therefore it had the authority to enforce the arbitration agreement between plaintiff and the predecessor.[453] Its parent could also enforce the agreement because the consumer brought identical claims against each of them.[454] The subscriber was on reasonable inquiry notice of the agreement from references in billing statements that were sufficiently clear and conspicuous to provide a reasonably prudent subscriber with constructive notice of the contract terms.[455] Accordingly, the Court of Appeals affirmed the District Court’s order.
VIP, Inc. v. KYB Corp., 951 F.3d 377 (6th Cir. (Mich.) 2020). As arbitration is matter of contract, a court must resolve threshold questions of whether there is an agreement to arbitrate with a non-signatory.
Plaintiff-retailers stock and sell various automotive replacement parts online and in retail stores. They purchase shock absorbers manufactured and distributed by defendants through buying groups, and then resell the products to consumers.[456] The buying group agreements themselves do not contain an arbitration provision. However, the agreements require the retailers to honor the terms of the manufacturer’s limited warranty to consumers and the limited warranty mandates arbitration before the AAA.”[457] The retailers brought an action in federal court alleging that defendants and other shock absorber manufacturers engaged in a myriad of anticompetitive activities in the auto parts industry, and the defendants moved to compel arbitration under the terms of the limited warranty, arguing that the arbitrator should determine issues of arbitrability under the AAA Rules.[458] The district court disagreed and the defendants appealed.
On appeal, the court held that it is first required to satisfy itself that the agreement at issue encompasses the dispute between the parties before it, even assuming that the agreement the defendants were relying on unmistakably and clearly delegated issues of arbitrability to the arbitrator.[459] Where there is a dispute about the formation of the parties’ arbitration agreement, the court must resolve the disagreement.[460]
Applying state law principles of contract construction, the court of appeals held that there was no plain language reading of the arbitration provision in the limited warranty that evidenced an intent to bind anyone to arbitration other than “original retail purchasers.”[461] In fact, the warranty differentiated between “original retail purchasers” and “authorized [] product sellers.”[462] Accordingly, because the retailers, as product sellers, did not agree to any type of arbitration with the manufacturer, there was no agreement to arbitrate and no arbitration agreement to enforce.[463]
Landry v. Transworld Systems Inc., 485 Mass. 334 (2020). A non-party to an arbitration agreement must present clear and unmistakable evidence of an intent to be bound to enforce the provision as a third-party beneficiary.
A debtor filed a class action complaint against a debt collector that had acquired the debt asserting violations of the consumer protection act and debt collection regulations.[464] In response, the debt collector moved to compel arbitration, citing an arbitration provision in the agreement between the debtor and the original creditor that had assigned the debt to the collector.[465] The Superior Court denied the motion to compel, reasoning that the debt collector, a non-signatory, did not present clear and unmistakable evidence that the plaintiff had agreed to arbitrate his claims as against the debt collector.[466] The debt collector appealed.
The Supreme Court of Massachusetts analyzed the six theories under which a non-signatory may enforce a contract such as an arbitration agreement against a signatory.[467] The Supreme Court held that the arbitration provision at issue was, at a minimum, ambiguous as to whether or not the debt collector could enforce it and susceptible to multiple interpretations.[468] As a result, the debt collector was required to, and had not, put forth the clear and definite evidence of intent required to enforce the arbitration provision as a third-party beneficiary and thus the Superior Court properly denied the debt collector’s motion to compel.[469]
§ 1.7.2 Can Signatories Compel Nonsignatories to Arbitrate?
Burgess v. Johnson, No. 19-5098, 2020 U.S. App. LEXIS 34930 (10th Cir. (Okla.) 2020). Trustee cannot invoke permissive arbitration provision in trust agreement to compel beneficiaries to arbitrate disputes.
Beneficiaries of trust created under Oklahoma law sued trustee, alleging he had breached his fiduciary duty by converting trust assets.[470] The trustee moved to compel arbitration, based on a provision in the declaration of trust that conveyed to the trustee the power “[t]o compromise, contest, submit to arbitration or settle all claims by or against, and all obligations of, the Trust estate or the Trustees[.]”[471] The District Court denied the application and the trustee appealed.[472]
On appeal, the court reviewed the issue de novo, and applied the state law of contract construction. Noting that the provision tracked Oklahoma statutory language, the court cited to a Texas decision that had concluded that virtually identical language drawn from a Texas statute merely authorized a trustee to exercise a full range of options to protect the interests of the trust.[473] However, the language could not be construed to grant the trustee power to compel other parties to arbitrate their claims.[474] While the trust declaration could have included language requiring beneficiaries to arbitrate any disputes, this clause could not be interpreted to accomplish that result. Here, the District Court did not abuse its discretion by determining there were no triable issues. Accordingly, the order denying the motion to compel arbitration was affirmed.[475]
GGNSC Administrative Services LLC v. Schrader, 484 Mass. 181 (Mass. 2020). Claims against nursing home for wrongful death are derivative of claims the decedent would have had, and thus arbitration agreement executed by resident’s attorney in fact are binding on personal representative of estate and statutory beneficiaries.
After decedent died in the care of a nursing home, her daughter, as personal representative, brought a wrongful death claim against the nursing home.[476] The nursing home sued in federal court to compel arbitration and the daughter opposed, contending that the arbitration agreement was both procedurally and substantively unconscionable, and in the alternative that the agreement could not bind the decedent’s beneficiaries, who had not signed the contract.[477] The district court found that the agreement was valid and enforceable and that because the wrongful death action was derivative of the decedent’s own rights, the arbitration agreement bound the estate on behalf of the wrongful death beneficiaries.[478]
On appeal, the First Circuit certified two questions to the Massachusetts Supreme Judicial Court: first, whether the state wrongful death statute provides rights to statutory beneficiaries that are derivative of or independent from what would have been the decedent’s own action, and second, whether the decedent’s arbitration agreement binds the decedent’s statutory beneficiaries of the wrongful death action.
As a matter of first impression, the Supreme Judicial Court of Massachusetts held that a cause of action for wrongful death brought by a personal representative was derivative and not independent of the rights the decedent would have had to sue for the conduct, consistent with the majority of other states that have considered the question.[479] The court then determined that there were no contract defenses to enforcement and no bar to enforcement based on public policy or unconscionability. Finally, the court responded to the second certified question with the conclusion that the arbitration agreement signed by the decedent’s attorney in fact was binding upon the personal representative as well as the decedent’s statutory beneficiaries.[480]
§ 1.8 Scope of Arbitration Agreement
§ 1.8.1 Scope of Arbitration Clauses in Labor and Employment Actions
Numerous decisions in 2020 considered whether and to what extent delivery workers in the “gig economy,” and particularly those who carry goods the “last mile,” were within the scope of the residual clause of section 1 of the FAA[481] exempting from the Act contracts of “any other class of workers engaged in foreign or interstate commerce” as interpreted by the United States Supreme Court in Circuit City Stores, Inc. v. Adams.[482] These decisions are discussed below.
Grice v. United States Dist. Court, 974 F.3d 950 (9th Cir. (Cal.) 2020). District court’s decision that Uber drivers were not within the arbitration exemption in section 1 of the FAA was not clearly erroneous as required to obtain a writ of mandamus.
Uber drivers had filed a putative class action alleging that the company failed to safeguard the personal information of drivers and riders and mishandled a data security breach in which that information was stolen by online hackers.[483] Uber moved to compel arbitration under its agreements with the drivers, who argued that they fell within the exemption in Section 1 of the FAA for “any other class of workers engaged in foreign or interstate commerce.”[484] The District Court held that rideshare drivers who pick up and drop off passengers at airports do not fall within this residual category and therefore may be judicially compelled to arbitrate in accordance with the terms of their contracts[485]. The Uber drivers petitioned the appellate court for a writ of mandamus vacating the District Court’s decision.
First noting that a writ of mandamus is a drastic and extraordinary remedy requiring a showing that the District Court’s decision amounts to “clear error as a matter of law,”[486] the court went on to hold that where no prior binding authority prohibits the District Court’s ruling, or where the issue in question has not yet been addressed by any circuit court in a published opinion, the ruling cannot be clearly erroneous.[487] Turning to the prior decisions from district and circuit courts that have analyzed whether rideshare drivers fall within the scope of the residual clause in Section 1, the court emphasized that no circuit has held that rideshare drivers, as a class, are engaged in foreign or interstate commerce.[488] Based largely on the high bar required for a writ of mandamus, the Court of Appeals ruled that “even accepting that there are some tensions between the District Court’s ruling and recent circuit cases” regarding interpretation of the residual exemption in Section 1 of the FAA, that is not enough to render the District Court’s decision clear error as a matter of law, as required for mandamus.[489]
Rittmann v. Amazon.com, Inc., 971 F.3d 904 (9th Cir. (Wash.) 2020). Drivers involved in the “last mile” delivery of products were within the scope of residual clause of Section 1 of the FAA exempting transportation workers who are engaged in the movement of goods in interstate commerce, even if they do not cross state lines themselves.
Individual drivers who contract with Amazon to make “last mile” deliveries of products from Amazon warehouses to the customer’s location using their own transportation brought a class action challenging their classification as independent contractors rather than employees and alleging wage and hour violations.[490] Amazon moved to compel arbitration of the claims of those drivers who had not opted out of the arbitration provision in the contracts. The Amazon terms of service (TOS) provides that it is governed by “the law of the state of Washington without regard to its conflict of laws principles, except for [the arbitration provision], which is governed by the Federal Arbitration Act and applicable federal law.”[491] In denying Amazon’s motion to compel, the District Court concluded that the drivers fall within the scope of the FAA’s transportation worker exemption pursuant to § 1 because they deliver goods shipped from across the United States.[492] The court further held that as the TOS bars application of Washington state law to the arbitration provision, and the FAA did not apply, there was no valid agreement to arbitrate and denied the motion to compel.[493] Amazon appealed from the denial of the motion to compel arbitration.
On appeal, the panel agreed with the First Circuit and held that the delivery workers were exempt under the residual exception in Section 1 of the FAA because they were transportation workers engaged in interstate commerce when they made “last mile” deliveries of goods in the stream of interstate commerce.[494] Considering the plain meaning of the relevant statutory text, case law interpreting the exemption’s scope and application, and the construction of similar statutory language, the panel held that Section 1 of the FAA exempts transportation workers who are engaged in the movement of goods in interstate commerce, even if they do not cross state lines themselves.[495] The lengthy dissent took the opposite approach, reasoning that for the narrow exemption in Section 1 to apply, the worker must belong to a “class of workers” that crosses state lines in the course of making deliveries, based on statutory interpretation and problems of application that would result in inequities among similarly situated delivery workers.[496]
Amazon had also argued that, even if the workers were exempt from the FAA, the arbitration provisions could be enforced under Washington state law or other federal law. However, the panel additionally held that there were no other federal laws that would govern and, even under a severability analysis, the plain language of the TOS would prohibit applying Washington law to the arbitration provision.[497] In the absence of any law governing the arbitration provision, the court concluded there was no valid agreement and affirmed the District Court.[498]
Wallace v. Grubhub Holdings, Inc., 970 F.3d 798 (7th Cir. (Ill.) 2020). Contracts with drivers delivering meals locally were not within the exemption under Section 1 of the FAA because the interstate movement of goods was not a central part of the job description of the class of the drivers.
In two suits, drivers for Grubhub in various cities filed suit claiming wage and hour violations.[499] Grubhub moved to compel arbitration in each case based on agreements signed by the drivers, who contended that they fell within the scope of the residual clause in Section 1 of the FAA as “workers engaged in interstate commerce.”[500] Each of the district courts held that the drivers had to demonstrate that the interstate movement of goods was a central part of the job description of the class of workers to which they belonged, that the drivers had not done that and granted the motions to compel arbitration. The appeals from the two decisions were consolidated.
The Court of Appeals defined the issue as “not whether the individual worker actually engaged in interstate commerce, but whether the class of workers to which the complaining worker belonged engaged in interstate commerce.”[501] Describing the exception in Section 1 as narrow, it is not enough that the goods have moved across state lines in some way; rather, the workers must be connected not simply to the goods, but to the act of moving those goods across state or national borders.[502] As the drivers had not shown that the interstate movement of goods was a central part of the job description of the class of workers to which they belong, the contracts did not fall within the residual clause of section 1 and the district courts’ orders compelling arbitration were affirmed.[503]
Waithaka v. Amazon.com, Inc., 966 F.3d 10 (1st Cir. (Mass.) 2020). Last mile delivery driver for an e-retailer was within the category of transportation workers whose contracts were exempt from the FAA, and class action waiver was unenforceable under state law.
The facts of this case were identical to those in Rittman v Amazon, discussed above, as was the outcome. However, the reasoning of the First Circuit varied slightly from the Ninth Circuit.
Individual drivers who contract with Amazon to make “last mile” deliveries of products from Amazon warehouses to the products’ destinations using their own transportation brought a class action challenging their classification as independent contractors rather than employees and alleging wage and hour violations.[504] Amazon moved to compel arbitration of the claims of those drivers who had not opted out of the arbitration provision in the contracts or in the alternative to transfer the case to Washington, where similar other cases were pending.[505] The Amazon terms of service (TOS) provides that they are governed by “the law of the state of Washington without regard to its conflict of laws principles, except for [the arbitration provision], which is governed by the Federal Arbitration Act and applicable federal law.”[506] The TOS also contained a class-action waiver. The employee here delivered packages entirely within the state of Massachusetts and did not cross state lines in the course of his work.[507] The District Court concluded that the agreement was exempt from the FAA, that Massachusetts law therefore governed the enforceability of the arbitration provision, and that the provision was unenforceable based on Massachusetts public policy. However, the court granted Amazon’s alternative request to transfer the case, which has since occurred.[508] Amazon appealed.
On appeal, the court first concluded that the agreements were within the residual clause of section 1 of the FAA for “workers … engaged in interstate commerce,” focusing on the meaning of the phrase “engaged in.”[509] The court then delved an analysis of statutes contemporaneous with the FAA, the sequence of the text of the exemption, the FAA’s structure, and the purpose of the exemption and the FAA itself.[510] Using the nearly identical text of the Federal Employers’ Liability Act (FELA)[511] and the case law interpreting that statute, and the text, structure, and purpose of the FAA, the court concluded that the last-mile delivery workers who haul goods on the final legs of interstate journeys are transportation workers “engaged in . . . interstate commerce,” regardless of whether the workers themselves physically cross state lines, because their work transports goods or people “within the flow of interstate commerce” and their contracts were not governed by the FAA.[512]
Turning next to the class action waiver, the court determined that Massachusetts would treat the class waiver provisions in the agreement as contrary to its fundamental public policy and that, based on conflict-of-laws principles, the contractual choice of Washington law would be unenforceable if it would permit such waivers, and accordingly individual arbitration could not be compelled pursuant to the applicable state law.[513] Therefore, the District Court’s denial of the motion to compel arbitration was affirmed.[514]
Eastus v. ISS Facility Servs., 960 F.3d 207 (5th Cir. (Tex.) 2020). Airport services employee who supervised ticketing and gate agents line and incidentally handled baggage was not within the scope of the transportation worker exemption in Section 1 of the FAA and was required to arbitrate disputes with her employer.
Plaintiff employee was employed at an airport, where she primarily supervised airline ticketing and gate agents and occasionally handled baggage services.[515] She brought discrimination claims against her employer and the airlines and defendants moved to compel arbitration based on her employment contract. The employee argued that she was exempt from the FAA under the residual clause of Section 1.[516] The District Court held that plaintiff’s job was related to transporting passengers, that the handling of luggage was incidental to her primary duties, and that she herself was therefore not involved in the movement or transportation of goods in interstate commerce in the same way that railroad workers and seamen are, and ordered her to arbitrate her claims.[517]
On appeal, the court considered whether the employee was “engaged in interstate commerce” within the meaning of Circuit City, which it interpreted to exempt from the FAA “only contracts of employment of transportation workers.”[518] In the court’s view, based on precedent in the Fifth Circuit, the key question in the appeal was whether the worker needs to be engaged in the movement of goods; the panel concluded that element is required and that plaintiff could not meet that test, because while the passengers moved in interstate commerce, plaintiff’s role preceded that movement and, at most, could be construed as loading or unloading airplanes.[519] Accordingly, the exemption did not apply to her and the decision of the District Court was affirmed.[520]
Darrington v. Milton Hershey Sch., 958 F.3d 188 (3d Cir (Pa.) 2020). Where collective bargaining agreement clearly and unmistakably waived the employees’ right to sue in state or federal court for disputes alleging discrimination under either federal or state law, arbitration was required.
Former houseparents sued their former employer, a residential school, alleging discrimination under both federal and state law.[521] The CBA between the houseparents’ union and the school required arbitration of disputes.[522] The District Court denied the school’s motion to compel arbitration because it found that the CBA did not clearly and unmistakably waive the employees’ right to sue for discrimination in state or federal court.[523] The school appealed.
On appeal, the court first determined that the federal claims were within the scope of the CBA’s arbitration provision. A federal statutory discrimination dispute falls within the scope of a CBA’s arbitration provision “when (1) the arbitration provision clearly and unmistakably waives the employee’s ability to vindicate his or her federal statutory right in court; and (2) the federal statute does not exclude arbitration as an appropriate forum.[524] As the plaintiffs’ federal claims were arbitrable, they were within the scope of the provision.[525] As to the state law claims, because the FAA preempts any state rule that “facially or covertly” prohibits arbitration,[526] and Pennsylvania had not yet explained what standard would govern the waiver of a judicial forum, the court examined the most onerous standard available and asked whether the CBA contained a clear-and-unmistakable-waiver of a judicial forum.[527] To meet this standard, an arbitration provision’s waiver of a judicial forum for statutory claims must merely be “particularly clear” and “explicitly stated.”[528] Here, the broad terms of the CBA’s arbitration provision clearly and unmistakably included within its scope the plaintiffs’ claims, and the decision of the District Court denying the motion to compel arbitration was reversed.[529]
§ 1.8.2 Scope of Arbitration Clauses in other Contracts
Cordoba v. DIRECTV, LLC, 801 F. App’x 723 (11th Cir. (Ga.) 2020). Decision denying arbitration of claim based on nonconsensual disclosure of subscriber information in litigation reversed, because claim was derivative of, and thus arose out of, subscriber relationship and was arbitrable under subscriber agreement.
During the course of litigating a TCPA class action, DIRECTV allegedly shared its customers’ personal information with its expert witness.[530] The district court granted plaintiffs’ motion to add an additional plaintiff and class representative along with new claims by that representative that such disclosure was nonconsensual, and therefore, in violation of the Satellite Television Extension and Localism Act of 2010 (“STELA”).[531] DIRECTV responded by moving to compel arbitration under the arbitration provision in the customer agreement for “claims arising out of or relating to any aspect of the relationship between us, whether based in contract, tort, statute, fraud, misrepresentation or any other legal theory.”[532] The district court denied the motion, finding that “DIRECTV ha[d] not established that the claim arises from the customer agreement” and thus the STELA claim was not within the scope of the agreement’s arbitration provision.[533]
On appeal, the Eleventh Circuit reversed. Without addressing whether the relevant arbitration provision was so broad as to encompass “all claims and disputes” as DIRECTV contended, it held more narrowly that, based on the limited facts of this matter, the plaintiffs’ STELA claim indeed fell within its purview.[534] The claim was a direct derivative of the “relationship” with DIRECTV, because if not for the subscriber relationship with DIRECTV, the factual predicate for a STELA claim would not exist.[535] Necessarily then, the STELA claim arose out of the subscriber’s relationship with DIRECTV as contemplated by the arbitration clause and that claim was subject to arbitration.[536] Accordingly, the court reversed and remanded.
Solo v. United Parcel Serv. Co., 947 F.3d 968 (6th Cir. (Mich.) 2020). A party cannot be compelled to arbitrate under an arbitration clause that was not in effect at the time its dispute arose in the absence of agreement that such arbitration clause applies retroactively.
Several customers filed a putative class action against United Parcel Service Co. (“UPS”) seeking damages for, inter alia, breach of contract for allegedly overcharging for liability insurance in excess of the price set out in the UPS Terms and Conditions of Service (“TOC”).[537] UPS moved to dismiss the complaint on the grounds that there was no breach of the TOC. In the final paragraph of its motion, UPS stated that it reserved the right to move to compel arbitration and that its motion to dismiss did not waive its contractual right to arbitrate.[538] The version of the TOC in effect at the time the customers mailed the packages at issue did not contain an arbitration clause but UPS referenced an arbitration clause in an amended terms of service that became effective thereafter.[539] UPS also stated in its motion to dismiss that, because of the different versions of the TOC, it did not have sufficient information to know whether its arbitration clause could apply in this action.[540]
The District Court granted the motion to dismiss. On appeal, the Sixth Circuit reversed the dismissal and remanded, finding the language of the TOC was ambiguous. On remand, UPS filed an answer raising the obligation to arbitrate as its first affirmative defense, and sought limited discovery on the issue of arbitration. The District Court rejected any limitation on discovery, and after conducting six months of full discovery, UPS moved to compel arbitration. The District Court denied the motion, holding that UPS had waived its right to arbitrate. UPS appealed again.[541]
The Sixth Circuit affirmed the District Court’s decision, first holding that UPS could not compel arbitration because the arbitration clause in the Amended UPS Terms did not apply retroactively to cover the shipments at issue.[542] To find that the parties agreed to resolve their disputes under the arbitration clause, the court first had to find an agreement to arbitrate and then determine that this dispute was within its scope.[543] The Sixth Circuit reasoned that the arbitration clause did not apply retroactively here because both versions of the terms contained critical language that “the shipper agrees that the version of the Terms . . . in effect at the time of shipping will apply to the shipment and its transportation.”[544] The court rejected UPS’s argument that the boilerplate merger clauses in each document do not render an arbitration provision applicable from one contract to another.[545]
The Sixth Circuit further held that the evidence supported the district court’s finding that UPS waived its right to arbitrate.[546] “[A]lthough ‘we will not lightly infer a party’s waiver of its right to arbitration,’ we may find waiver if a party (1) ‘tak[es] actions that are completely inconsistent with any reliance on an arbitration agreement; and (2) ‘delay[s] its assertion to such an extent that the opposing party incurs actual prejudice.’”[547] The Sixth Circuit pointed to UPS’s motion to dismiss seeking a decision in court on the merits, which it vigorously litigated for two years as completely inconsistent with reliance on the arbitration clause.[548] The court also pointed to prejudice the plaintiffs who incurred the expenses of defending against the merits-based motion to dismiss, appealing that decision, and then engaging in months of full discovery.[549] The Sixth Circuit rejected UPS’s argument that it was plaintiffs who refused to limit discovery to arbitration issues, because UPS received the subject of the limited discovery after one month, but participated in another five months of merits discovery before moving to compel.[550]
§ 1.9 Validity or Invalidity of Various Provisions
Kramer v. Enter. Holdings, No. 19-16354, 2020 U.S. App. LEXIS 35671 (9th Cir. (Cal.) 2020). While California law forbids a contract that forces a party to waive the right to seek public injunctive relief in any forum, court properly compelled arbitration of claims requesting damages for class and seeking injunctive relief in only general terms.
Customer filed a class action complaint in California state court, alleging that Enterprise improperly stored personal data from class members’ cell phones and other mobile devices when they paired their devices with their rental cars. Enterprise removed the case to the District Court and moved to compel arbitration based on an arbitration provision in the rental agreement.[551] The District Court granted the motion and the customer appealed, arguing that the arbitration agreement is unenforceable under California law because it denies him the right to seek public injunctive relief.[552]
Under the “McGill rule,”[553] California law courts will not enforce a contract that requires a party to waive the right to seek public injunctive relief in any forum, including an arbitration forum. The rule is not preempted by the FAA.[554] Here, however, the court concluded that the complaint did not seek public injunctive relief within the meaning of McGill because it specifically requested damages and asked only for injunctive relief “as the Court deems appropriate.”[555] This remedy is in the nature of private, rather than public, injunctive relief.[556] As McGill did not apply, the arbitration agreement was enforceable and the court affirmed the order compelling arbitration.
Shivkov v. Artex Risk Sols., Inc., 974 F.3d 1051 (9th Cir. (Ariz.) 2020). Agreement to arbitrate will not be invalidated based on claims that purported fiduciaries had a duty under state law to point out the agreement, which survived termination of the underlying contract.
Plaintiffs were eighty-one individuals and companies that had entered into agreements with some of the defendants to create captive insurance companies that would purportedly bring tax benefits.[557] The IRS disagreed. Plaintiffs brought a putative class action and the defendants who established the structures moved to compel arbitration, relying on an arbitration clause in their agreements.[558] Plaintiffs argued the clauses were unenforceable, arguing the defendants were fiduciaries and had failed to point out and fully explain the clauses and also argued the clauses had not survived the termination of the individual agreements.[559] The District Court rejected these arguments and granted the motion to compel, ordering individual arbitrations and plaintiffs appealed.
On appeal, the court first addressed the enforceability of the arbitration provisions, and found no authority to suggest that these defendants had a fiduciary duty in connection with “purely commercial aspects” of an arbitration clause.[560]
Next, the court addressed the assertion that any agreement to arbitrate did not survive termination of the underlying agreements.[561] Although the Supreme Court has not addressed the issue of post-termination arbitration of disputes in the FAA context, it has addressed this issue in the collective bargaining context and recognized a “presumption in favor of post-expiration arbitration of matters unless ‘negated expressly or by clear implication’ [for] matters and disputes arising out of the relation governed by contract.”[562] The Supreme Court explained that “[w]e presume as a matter of contract interpretation that the parties did not intend a pivotal dispute resolution provision to terminate for all purposes upon the expiration of the agreement.”[563] To hold otherwise would mean that a party could simply wait “until the day after the contract expired to bring an action regarding a dispute that arose while the contract was in effect.”[564] The presumption applies where the parties’ dispute has “its real source in the contract.”[565] Five circuits have addressed the issue and agreed.[566] Turning to the case at hand, the Court of Appeals held that the presumption applied, notwithstanding the argument that the arbitration agreement was not expressly included in the list of provisions that would survive termination, looking at the agreement as a whole in light of the liberal policy favoring arbitration.[567]
Turning to the issue of class arbitration, the court followed numerous other courts of appeals that have held that the availability of class arbitration is a gateway issue for the court to decide.[568] Looking at the parties’ contracts, the court then concluded that a reference in the agreement to arbitrate to the AAA did not incorporate the rules of the AAA and did not provide clear and unmistakable evidence of an intent to delegate the gateway issue of class arbitration to the arbitrator.[569] As the agreements were silent regarding class arbitration, there was no agreement to arbitrate on a class wide basis and the court affirmed the District Court’s decision compelling individual arbitration.[570]
Stover v. Experian Holdings, Inc., 978 F.3d 1082 (9th Cir. (Cal.) 2020). Where plaintiff did not allege standing to pursue future injunctive relieve, California law against arbitration clauses that preclude public injunctive relief did not bar enforcement of an arbitration clause and class action waiver against a consumer attacking marketing of a credit scoring product.
In 2014, plaintiff signed up with Experian Holdings (“Experian”) for its “Experian Credit Score” service providing her with regular updates on her credit score as calculated by Experian. As part of her purchase, she agreed to Experian’s terms and conditions (and to any changes to them in the future if she accessed the “Product Website” at Experian).[571] The 2014 terms and conditions contained an arbitration clause providing that she would be required, “to the fullest extent permitted by law,” to arbitrate all claims arising out of her purchase of the service.[572] The clause also included a provision in which she waived any right to participate in a class action for such claims.[573]
One month after she signed up for the service, plaintiff cancelled her subscription. Four years later, she accessed the Experian website.[574] By that time, Experian had changed the arbitration clause to exclude from its coverage claims under the Fair Credit Reporting Act (“FCRA”)[575] and similar state or federal laws about information in credit reports.[576] The next day, the plaintiff sued Experian for allegedly violating the FCRA as well as California and Florida unfair competition laws.[577] She based her claims on the theory that Experian had marketed its credit score as information on which lenders would rely in making decisions about creditworthiness when, in fact, the score used a formula that very few or no lenders actually used.[578]
Experian moved to compel arbitration and the trial court agreed, applying the 2018 arbitration clause, but holding that the plaintiff’s claims did not involve information in a credit report, and therefore were not excluded from arbitration.[579] Plaintiff appealed, arguing that the 2018 carve-out applied or that, in any event, Experian’s earlier arbitration clause was unenforceable under California law because California forbids contract terms waiving a party’s right to seek public injunctive relief in court.[580]
The Ninth Circuit disagreed. First, the plaintiff had not shown that, simply by accessing the Experian website, she had agreed to the 2018 arbitration clause.[581] It therefore held that the trial court should have applied the 2014 arbitration clause (which contained no carve-out for FCRA claims).[582] Second, while the 2014 arbitration clause was broad, it did not (because of its “to the fullest extent provided by law” language) on its face prohibit judicial resolution of all claims for public injunctive relief from a court.[583] In addition, as applied, the clause would not bar the plaintiff from seeking public injunctive relief from a court, either. This was because the plaintiff had not alleged that she would desire, or be likely, to purchase the Experian Credit Score Service again (much less that if she did, she would be misled in doing so).[584] As a result, she had failed to allege Article III standing to seek an injunction against Experian’s allegedly deceptive future advertising.
While the plaintiff had made a request in her appellate reply brief for leave to amend her complaint to add allegations of Article III standing, the Ninth Circuit denied that request as untimely.[585] It also doubted that the plaintiff could validly amend to allege the necessary facts for such standing.[586]
B&S MS Holdings, LLC v. Landrum, 302 So.3d 605 (Miss. 2020). An arbitration provision and waiver contained in the operating agreement of an LLC is valid and enforceable.
A majority member of limited liability company (“LLC”) sought judicial dissolution and the minority member responded with a motion to dismiss, or in the alternative to compel arbitration in accordance with an arbitration provision contained in the entity’s operating agreement.[587] The majority member argued that Mississippi Code Section 79-29-123(3)(m) prohibited an operating agreement from contracting away the power of a court to decree dissolution.[588] The trial court held that operating agreements were to be treated like contracts and members of an LLC have the authority to agree to binding arbitration and to waive their right to judicial dissolution.[589] The Supreme Court of Mississippi affirmed, holding that while Mississippi Code Section 79-29-123 provides that an operating agreement may not vary the court’s power to decree dissolution in certain circumstances, Mississippi Code Section 79-29-803 states that a trial court may decree dissolution, not that it must do so.[590] Because the members agreed to expressly waive their right to maintain an action for a decree of dissolution in the LLC’s operating argument, the Supreme Court affirmed the order of the Chancery Court ordering the parties to submit to binding arbitration.[591]
§ 1.10 Class Actions and Arbitration
Class Action Waivers Enforceable or Unenforceable
Laver v. Credit Suisse Sec. (USA), LLC, 976 F.3d 841 (9th Cir. (Cal.) 2020). FINRA Rule prohibiting class arbitration and enforcement of arbitration agreements directed at members of putative or certified class claims does not apply to invalidate general class action waivers in an agreement that also contains a separate arbitration clause.
Plaintiff, a financial adviser formerly employed by Credit Suisse Securities, USA (“CSSU”), filed a putative class action against his former employer alleging breach of contract and other state law claims.[592] The employment contracts between CSSU and its financial advisers provided for deferred compensation unless the advisers resigned or were terminated for cause, and contained a “Change in Control” provision, which provided that they would retain their right to unvested deferred compensation in the event of certain corporate transactions.[593] CSSU entered into a “recruiting agreement” with Wells Fargo, shutting down the CSSU financial advisory operations, and providing that Wells Fargo would recruit financial advisers formerly with CSSU.[594] The plaintiff alleged that CSSU was circumventing the “Change in Control” provision in his employment contract as CSSU would only pay deferred compensation to those CSSU financial advisers Wells Fargo chose to hire.[595]
CSSU moved to dismiss the suit and compel arbitration, arguing that the financial advisers were bound by their agreement to CSSU’s Employee Dispute Resolution Program, which contained an arbitration clause and a general class waiver. The arbitration clause required CSSU employees to arbitrate employment related claims. The class waiver provided that: “An employee’s agreement to abide by the terms of the [CSSU program] includes an agreement not to serve as a class representative or class member or act as a private attorney general in any dispute with [CSSU].”[596] FINRA Rule 13204(a)(1) prohibits arbitration of class actions, and Rule 13204(a)(4) precludes enforcement of an arbitration agreement against a member of a certified or putative class action until certification is denied, the class is decertified, or the member opts out or is excluded from the class. The financial advisor argued that FINRA Rule 13204(a)(4) precluded CSSU’s motion to dismiss. The District Court disagreed with the financial adviser and dismissed the action in favor of arbitration.
The Eleventh Circuit affirmed, holding that the prohibition in FINRA Rule 13204(a)(4) was inapplicable here because CSSU was not attempting, in the first instance, to enforce the arbitration provision.[597] Rather, CSSU was seeking dismissal of the class action claims under the general class action waiver, which precluded class actions in any forum, and was a conceptually distinct agreement from an agreement to arbitrate.[598] Once the class action claims were dismissed, a motion to compel arbitration of individual claims would not run afoul of Rule 13204. According to the court, Rule 13204(a)(4) only bars agreements to arbitrate class actions.[599] As the general class action waiver here was not an agreement to arbitrate a class action, it was not barred under the text of Rule 13204(a)(1).[600]
On appeal, the Eleventh Circuit also disagreed with the financial consultant’s contention that Rule 13204 barred class action waivers, finding that such an interpretation would entirely bar the enforcement of agreements to arbitrate claims that could be maintained as part of a putative or certified class.[601] The Eleventh Circuit also found that the consultant failed to establish a clear and manifest intent that Rule 13204 prohibited class waivers, since it never mentions or addresses waivers. Moreover, Rule 13204’s final sentence that its provisions “do not otherwise affect the enforceability of any rights under the [FINRA] Code of Arbitration Procedure for Industry Disputes] or any other agreement,” evidenced a lack of clear and manifest intent to bar separate class waivers.[602]
As the class waiver was enforceable, the court held that the District Court had properly dismissed the class claims.[603] Left with only individual claims, the District Court correctly ordered arbitration of those claims. In reaching this decision, the Eleventh Circuit aligned itself with the Second Circuit, which came to a similar decision in a materially identical dispute.[604]
§ 1.11 Waiver of Arbitration
Brickstructures, Inc. v. Coaster Dynamix, Inc., 952 F.3d 887 (7th Cir. (Ill.) 2020). A party waives its right to arbitrate when it acts inconsistent with its right to pursue arbitration by withdrawing its request for arbitration and will generally not be permitted to rescind its waiver and renew its request.
Brickstructures, Inc. and Coaster Dynamix, Inc. joined forces to create a LEGO-compatible roller coaster set.[605] When the venture soured, Brickstructures filed a federal lawsuit and Coaster Dynamix unsuccessfully moved to dismiss and then raised the parties’ agreement to arbitrate on a second motion to dismiss as a challenge to venue.[606] When threatened with sanctions by Brickstructures, Coaster Dynamix withdrew its arbitration demand and the court denied the remainder of its motion to dismiss.[607] Coaster Dynamix moved shortly thereafter to compel arbitration and the District Court denied the resurrected request on the grounds that the earlier withdrawal amounted to a waiver of the right to arbitrate.[608]
On appeal, the Seventh Circuit agreed. Describing the question of waiver as a mixed question of fact and law, and granting deference to the district court’s assessment of the facts, the court held there was no clear error in the District Court’s finding that Coaster Dynamix waived its right to arbitrate.[609] While parties do not waive their right if they take certain actions before seeking to compel arbitration, such as moving to dismiss or requesting a transfer of venue, Coaster Dynamix voluntarily chose to withdraw its initial motion seeking arbitration and was not entitled to rescind that waiver based on these facts.[610]
Davis v. White, 795 F. App’x 764 (11th Cir. (Ala.) Jan. 7, 2020) (per curiam). Where a party files a motion to dismiss for failure to state a claim, it seeks judgment on the merits that is inconsistent with the intent to arbitrate and waives its right to pursue arbitration.
A local municipality entered into agreements with an outside individual to own and operate its sewer system through private sewer companies that would provide sewer services to homes through utility services agreements with residents.[611] The utility services agreements contained mandatory arbitration provisions.[612] Three families filed separate law suits against the individual and the sewer companies asserting, inter alia, violations of their civil rights by state actors under federal law,[613] state-law trespass, and state-law deprivation of property rights.[614] Among other things, the residents asserted claims alleging that that the sewer companies shut off the families’ water for delinquency by placing a lock on the water line, charged them substantial fees after falsely accusing them of tampering with the lock, and threatened them with criminal prosecution for failure to pay bills.[615]
The sewer Companies filed motions to dismiss, arguing that the residents failed to meet pleading standards for each claim and failed to state any plausible claim to relief.[616] The residents opposed the motion, and litigation proceeded over the course of approximately one year, including issuing scheduling order, selecting a bench trial date, litigating discovery disputes, and filing amended complaints, which the District Court deemed implied motions to amend. The District Court granted the implied motions to amend the complaints, found that they stated plausible claims to relief as amended, and terminated the sewer companies’ motions to dismiss as moot.[617] Instead of answering the amended complaints, the sewer companies immediately filed an appeal, which the Eleventh Circuit denied as premature. The residents then moved for the clerk’s entry of a default judgment against the sewer Companies for their failure to answer the amended complaint. In response, the sewer Companies indicated an intent for the first time to submit the disputes to arbitration. More than 18 months after the initial complaints were filed, the sewer Companies moved to compel arbitration and to stay proceedings pending arbitration.[618] The residents argued that the sewer Companies had waived any right to arbitration by substantially engaging in litigation and causing the residents prejudice.[619] The District Court agreed and denied the motions to compel and stay. The sewer companies appealed.[620]
The Court noted that in Johnson v. Keybank Nat’l Ass’n (In re Checking Account Overdraft Litig.),[621] the Eleventh Circuit had previously found that “[w]aiver occurs when, under the totality of the circumstances, ‘both: (1) the party seeking arbitration substantially participates in litigation to a point inconsistent with an intent to arbitrate; and (2) this participation results in prejudice to the opposing party.’”[622] The Eleventh Circuit applied this rule here and found that the sewer companies acted inconsistently with an intent to arbitrate by filing motions to dismiss for failure to state a claim, opposing the implied motions to amend, and filing a frivolous appeal to a ruling that was clearly not immediately appealable.[623] Although not every motion to dismiss is inconsistent with an intent to arbitrate, a motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6) is merits-based, and therefore inconsistent.[624] Further, the sewer companies’ extensive participation in litigating the claims prejudiced the residents by causing them to incur litigation costs that arbitration was designed to alleviate.[625] Accordingly, the court of appeals affirmed the District Court’s order denying the motions to compel.[626]
Jeoung Lee v. Evergreen Hospital Medical Center, 195 Wash. 2d 699 (2020). Party waived its right to compel arbitration by litigating the case in court for nine months before raising the issue of arbitration.
Employees brought a putative class action against employer for failure to give required rest and meal breaks.[627] Several months after the action was commenced, the employer moved to compel arbitration, arguing that the claims arose under the relevant collective bargaining agreement. The trial court denied the motion to compel arbitration and the Court of Appeals affirmed, holding that the employees’ claims were statutory and not subject to arbitration, and that the employer waived arbitration by litigating the case for nine months before moving to compel.[628] In affirming the Court of Appeals, the Supreme Court of Washington held that the employer knew of its right to arbitrate the employees’ claims, chose to litigate the case in court, and that transferring the case to arbitration at this point in the litigation would prejudice the plaintiffs.[629]
§ 1.12 Arbitration Agreements and Unconscionability
§ 1.12.1 Language or Agreement Not Unconscionable
Innovative Images, LLC v. Summerville, 848 S.E.2d 75 (Ga. 2020). Engagement letter for legal services containing a mandatory arbitration provision was neither unconscionable nor void as against public policy.
Plaintiff, a limited liability company, sued its former attorney for legal malpractice.[630] In response, the attorney moved to dismiss and compel arbitration in accordance with the parties’ engagement agreement, which included a mandatory arbitration clause. The trial court denied the attorney’s motion and held that the arbitration was “unconscionable” and unenforceable because it violated Rule 1.4(b) of the Georgia Rules of Professional Conduct.[631]
The Court of Appeals reversed the trial court’s ruling and held that the arbitration clause was not void against public policy or unconscionable.[632] In affirming the ruling of the Court of Appeals, the Supreme Court of Georgia held that regardless of whether the attorneys violated Georgia Rules of Professional Conduct 1.4(b) (“GRPC”) by entering into an engagement agreement with a mandatory arbitration clause without obtaining the client’s informed consent by explaining the advantages and disadvantages of the same to the client, the clause was not void as against public policy. The alleged failure to obtain informed consent went to the process of entering into the contract, and not the actual agreement.[633] As to the latter, binding arbitration agreements are generally not in contravention of the public policy of the state, as the Georgia Arbitration Code demonstrates a public policy favoring arbitration, and nothing about the attorney-client relationship would alter that policy, particularly as the State Bar and the courts established a fee arbitration program.[634] Moreover, the client had not sustained its burden to show that the arbitration provision was substantively or procedurally unconscionable. Even if the agreement involved a violation of the ethical rules, there was no evidence that it was procured by fraud, so the judgment of the Court of Appeals holding that the arbitration clause was enforceable was affirmed[635]
Goff v. Nationwide Mut. Ins., 825 F. App’x 298 (6th Cir. (Ohio) 2020). Arbitration agreement allowing employer to change the rules and procedures of the arbitration without notice to the employee was enforceable as the provision was not procedurally unconscionable because it did not pertain to the formation of the arbitration agreement.
Employee signed an agreement requiring arbitration of disputes and allowing the employer to change, alter, amend or otherwise modify the arbitration rules and processes at any time.[636] After he was terminated, the employee filed an action in federal court and the employer moved to compel arbitration, which the District Court granted.[637]
On appeal, applying Ohio law, the court limited its review to the issue of unconscionability, the sole defense that the employee raised in response to the employer’s motion to compel.[638] To invalidate the arbitration provision as unconscionable, Ohio law required the employee to demonstrate both procedural and substantive unconscionability. Procedural unconscionability requires a showing that the “totality of the circumstances indicate that ‘the individualized circumstances surrounding the contract were so unfair as to cause there to be no voluntary meeting of the minds.’”[639] “While the employee alleged there was an imbalance of power. the Court of Appeals affirmed the District Court, holding that any imbalance was not sufficient to warrant a finding of unconscionability based on the employee’s “relative sophistication,” ten-year employment history, and familiarity with the program.[640]
§ 1.12.2 Language or Agreement Unconscionable
A party attempting to prevent enforcement of an arbitration provision based on unconscionability has the heavy burden of showing both procedural and substantive unconscionability. Additional cases that rejected arguments of unconscionability are discussed above in Section 1.4.2. Choice of Law: § 1.4.2: The Validity and Scope of an Arbitration Agreement and Arbitrability.
§ 1.13 Other Procedural Issues in Arbitration
Wash. Nat’l Ins. Co. v. OBEX Grp. LLC, 958 F.3d 126 (2d Cir. (N.Y.) 2020). Federal court had subject matter jurisdiction over petition to enforce summonses to require non-parties to attend arbitration, based on diversity of citizenship between party enforcing subpoenas and the subpoenaed witnesses, the lack of diversity among the parties to the arbitration was no determinative.
Petitioner, one of the claimants in the underlying arbitration seeking reinsurance from several reinsurance companies, brought an action in district court to enforce subpoenas issued by the arbitration panel to testify and bring documents after respondents failed to appear under Section 7 of the FAA, invoking the court’s diversity jurisdiction.[641] The respondent-witnesses moved to dismiss the petition, arguing, first, that the court was required to “look through” the petition to the location of the parties to the underlying arbitration, who were not diverse.[642] The witnesses also argued that the additional parties to the arbitration were indispensable parties to the federal action to enforce the subpoenas and their joinder would destroy diversity.[643] Addressing the merits of the petition, the witnesses asserted that the subpoenas required impermissible pre-hearing discovery and privileged information, and were duplicative, overbroad, and burdensome.[644] In the underlying arbitration, after the claimants had served an initial subpoena, with which the witnesses complied and produced documents without a hearing, the claimants served further subpoenas directed to the witnesses to produce additional documents, returnable at a hearing.[645] In response, the witnesses demanded compensation, which claimants refused.[646] The witnesses did not appear at the noticed hearing and the panel issued an order granting leave to claimants to pursue judicial intervention to obtain compliance.[647] The District Court denied the witnesses’ motion to dismiss the petition and then denied their motions for reconsideration and to quash as well.[648] The witnesses ultimately produced responsive documents without a hearing in the arbitration and the parties to the underlying arbitration subsequently settled their dispute.[649]
Noting that the subsequent events had not mooted the dispute, the court held that the “look through” analysis applies only for those court proceedings predicated on federal question jurisdiction under 28 U.S.C.A. § 1331. Where diversity jurisdiction is invoked, diversity is to be determined based upon the citizenship of the parties in the action before it. In this case, the citizenship that was relevant was that of the petitioner who had issued the subpoena and the witnesses resisting the subpoena, as well as any indispensable parties.[650] The court then held that the other parties to the arbitration proceeding were not indispensable because the District Court could (and did) afford complete relief notwithstanding the absence of the other parties to the arbitration.[651] As to the argument that subpoenas may not be used to obtain pre-hearing discovery in arbitration, the court noted that the subpoenas were returnable at a noticed hearing that was dispensed with at the request of the witnesses.[652] Finally, as to the witnesses’ objections to the breadth of the subpoenas, the court held that Section 7 of the FAA did not require the District Court to evaluate the merits of those objections under the Federal Rules of Civil Procedure, without deciding whether the District Courts have the power to do so.[653]
§ 1.14 Confirmation and Vacatur of Arbitration Awards
American Intl. Specialty Lines Ins. Co. v. Allied Capital Corp., 35 N.Y.3d 64 (N.Y. 2020). Arbitration panel did not exceed its authority by reconsidering an initial determination titled “Partial Final Award” that addressed some of the issues submitted for arbitration, but not all, and without deciding whether the doctrine of functus officio was still valid, as the rule would not apply where reconsidered award did not resolve all of the issues in the arbitration.
Ciena Capital LLC and Allied Capital Corporation settled a federal qui tam action with the government involving allegations of loan origination fraud and subsequently sought payment from their insurer for their defense costs and indemnification for the settlement under two insurance policies issued by American International Specialty Lines Insurance Company (AISLIC).[654] AISLIC denied coverage and the insureds demanded arbitration under the arbitration clauses contained in the insurance policies, seeking damages for the refusal to defend and indemnify.[655] AISLIC argued that the amounts claimed were not a “loss” within the meaning the policies, and that the legal invoices submitted by the insureds appeared to be for unrelated legal work not covered by the policies.[656] The parties moved for summary disposition with the insureds noting that the exact amount owed to them for defense costs would be the subject of a subsequent evidentiary hearing should the panel determine that AISLIC was liable.[657] The parties and the panel never agreed to a partial summary disposition, but the panel issued a “Partial Final Award” holding that only the insurance policy covering Allied Capital was applicable, the federal settlement did not constitute a covered loss for which indemnification was available, and that Allied Capital was entitled to defense costs, and left the question of damages for defense costs to be resolved after a separate evidentiary hearing.[658] Prior to the evidentiary hearing, the insureds sought reconsideration of the Partial Final Award, arguing that the panel erred in concluding that the settlement did not constitute a covered loss and AISLIC opposed on both procedural grounds that the panel did not have the authority to reconsider the Partial Final Award under the doctrine of functus officio and on the merits.[659] The functus officio doctrine recognizes that the authority of arbitrators to take action terminates after issuing a final award. The panel issued a Corrected Partial Final Award holding that the settlement did constitute a covered loss and rejected AISLIC’s argument that functus officio precluded reconsideration.[660] The panel conducted an evidentiary hearing on damages and issued a Final Award granting Allied Capital damages for the settlement and defenses, less offsets paid to Ciena.[661]
AISLIC sought vacatur of the Corrected Partial Final Award and Final Award and reinstatement and confirmation of the original Partial Final Award, arguing that the doctrine of functus officio precluded the panel’s reconsideration of the Partial Final Award. The trial court denied the petition and confirmed the Final Award.[662] The intermediate Appellate Division reversed, with one justice dissenting, granted AISLIC’s petition and vacated the Corrected Partial Final Award and Final Award, holding that the parties agreed to a determination as to liability which they expected would be final and under the doctrine of functus officio it was improper and in excess of the panel’s authority to reconsider the Partial Final Award.[663]
The Appellate Division granted leave to the insureds to appeal to the Court of Appeals. On appeal, the Court of Appeals recognized New York’s strong public policy in favor of arbitration and the limitation imposed by CPLR Article 75 on judicial involvement in arbitration.[664] The Court of Appeals discussed the doctrine of functus officio, which has historically terminated the authority of arbitrators to take additional actions after issuing a final award.[665] The insureds argued on appeal that the doctrine of functus officio is no longer valid under New York law and was grounded upon anti-arbitration sentiments that are no longer valid under arbitration law.[666] The Court of Appeals did not decide whether the doctrine still existed under New York law, but held that if functus officio did apply, it would only apply after a final award and not to the issuance of a Partial Final Award, which was not final because it did not resolve the entire arbitration.[667] The court held that even if parties may agree to bifurcate arbitration proceedings and obtain awards that are final as to some issues but not others, that had not happened here, as AISLIC never consented to bifurcate the proceedings.[668] “Absent an express, mutual agreement between the parties to the issuance of a partial and final award, the functus officio doctrine would have no application in this case.”[669] The Court of Appeals therefore rejected the argument that the arbitration panel exceeded its authority by reconsidering the Partial Final Award, reversed the Appellate Division, and confirmed the Final Award.[670]
§ 1.14.1 Jurisdictional Issues
Transcon. Gas Pipe Line Co LLC v. Permanent Easement for 2.59 Acres, No. 19-2738 & 19-3412, 2020 U.S. App. LEXIS 33924 (3d Cir. (Pa.) Oct. 28, 2020). Court had jurisdiction to affirm vacatur under Section 10(a)(4) of the FAA because the arbitrator exceeded his powers where the parties never agreed to arbitrate.
The underlying litigation involved a condemnation dispute between Transcontinental Gas Pipeline Company (“Transco”), authorized by the federal government to construct a natural gas pipeline, and Regec, which owned properties condemned by Transco to obtain rights-of-way.[671] Regec, proceeding pro se, made multiple filings attacking the court and “questioning the premise of virtually every aspect of the proceedings.”[672] The District Court struck Regec’s multiple filings on several occasions and imposed sanctions. One of the struck filings included a copy of a “foreign final judgment via arbitration award” purportedly issued by an organization called the Healing My People Arbitration Association for approximately fifty million dollars.[673] Regec then sought to confirm the award, Transco moved to vacate the award, and the District Court granted Transco’s application “primarily on its conclusions that ‘the parties never agreed to arbitrate and so the arbitrator here had no jurisdiction,’ and that ‘Transco received no notice of the ex parte arbitration proceeding or opportunity to be heard, and . . . suffered prejudice as a result.’”[674] Regec appealed.
On appeal, the Court of Appeals first examined a number of jurisdictional issues, and concluded that the District Court had jurisdiction to consider the motion to vacate on several grounds including diversity jurisdiction, as well as supplemental jurisdiction under 28 U.S.C.A. §1376 (a) based on the original jurisdiction over the underlying claims brought under the Natural Gas Act. The court also examined whether Transco had properly served its motion to vacate, sent by email and first class mail, under Section 12 of the FAA, which requires service by a marshal.[675] Such service was not required here because Regec was already a party before the district court.
As to the merits, the appellate court considered the District Court’s conclusions as a ruling under Section 10(a)(4) that the arbitrator has exceeded his powers. Noting that “proving entitlement to relief under § 10(a)(4) will in the main be a terribly difficult task, for it is not enough to show that the arbitrator ‘committed an error—or even a serious error,’” the court found that the standard was easily satisfied in this case.[676] Without a valid agreement to arbitrate, the arbitrator had no power to act. The court also noted in dicta that it remains an open question whether manifest disregard of the law provides grounds for vacatur, in light of a split among the circuits not yet addressed by the Third Circuit, but did not need to reach that issue to affirm the District Court’s decision.[677]
Badgerow v. Walters, 975 F.3d 469 (5th Cir. (La.) 2020). Applying “look-through” analysis, federal courts have subject matter jurisdiction over a removed petition to vacate an arbitration award where the entire controversy between the parties is one over which they would have had jurisdiction.
A panel of FINRA arbitrators issued an award dismissing the employee’s claims against her employer and three of its principals.[678] The employee filed a petition in Louisiana state court to vacate that arbitration award, as to the principals only. The defendants in the state court proceeding removed the action to vacate to federal court, and the employee moved to remand, asserting that the federal court lacked subject matter jurisdiction over the petition to vacate, because the claims she had asserted in the arbitration against the principals were state law tort claims. The District Court held that it did have subject matter jurisdiction over the petition to vacate and denied remand and ruled on the merits of the petition to vacate, denying the employee’s claims with prejudice.[679] The employee appealed only the jurisdiction of the federal court over the petition to vacate.
In Vaden v. Discover Bank, the Supreme Court adopted the so-called “look-through” analysis for determining federal jurisdiction in actions to compel arbitration under Section 4 of the FAA.[680] The Fifth Circuit has held that applications brought under Sections 9, 10, and 11 of the FAA are also to be analyzed under the look-through approach endorsed in Vaden.[681]Vaden emphasizes a broad view of the underlying controversy, asking “whether the whole controversy between the parties—not just a piece broken off from that controversy—is one over which the federal courts would have jurisdiction.”[682] Applying the look-through analysis, the Court of Appeals held that the District Court correctly found that the employee’s claim against her employer in the FINRA arbitration was a federal law claim, that all of her claims against the principals and the employer in the arbitration arose from the same common nucleus of operative facts, and that under the principle of supplemental jurisdiction, federal jurisdiction exists over her state law tortious interference and whistleblower claims as well.[683] Therefore, the District Court properly held that the federal court had jurisdiction over the employee’s state court petition to vacate the award as to the principals, and affirmed the denial of remand to the state court.[684]
Teamsters Local 177 v. UPS, 966 F.3d 245 (3d Cir. (N.J.) 2020). Court has jurisdiction to confirm an arbitration award where employer has accepted award and agreed to abide by it, even in the absence of a live dispute, as the underlying dispute remains until an award is confirmed.
Union sought confirmation of an award in its favor, and the employer opposed confirmation and filed a cross-motion to dismiss, arguing that there was no subject-matter jurisdiction because the employer agreed to abide by the award and correct any subsequent violations and thus there was no case or controversy as required by Article III of the Constitution.[685] The District Court denied the union’s motion to confirm and granted the employer’s motion to dismiss on the ground that it lacked subject-matter jurisdiction, acknowledging a circuit split on whether a court may confirm an award absent an active dispute.[686]
On appeal, the Third Circuit agreed with the Second Circuit that FAA not only authorizes, but mandates, that district courts confirm arbitration awards by converting them into enforceable judgments through a summary proceeding, even in the absence of a new dispute[687] Rejecting the employer’s argument that the union has not suffered and will not suffer an injury where the employer has agreed to abide by the award, the appellate court held that under the FAA, a party’s injuries are only fully remedied by the entry of a confirmation order.[688] The court reversed and remanded to the District Court with instructions to confirm the award absent statutory grounds for vacatur.[689]S
§ 1.14.2 Standards for Affirmance or Vacatur of Arbitration Awards
EB Safe, LLC v. Hurley, No. 19-38592020, 2020 U.S. App. LEXIS 33066 (2d Cir. (N.Y.) Oct. 20, 2020) (unpub.). Court properly rejected challenge that the fee award in the parties’ arbitration was in manifest disregard of the law because it was clear that the arbitrators applied a reasonableness standard and provided a colorable justification for the fee award.
EB Safe, LLC (“EB Safe”), majority owner of Fiduciary Network, LLC (“Fiduciary”), commenced an arbitration against Mark Hurley, its former CEO and founder, seeking a declaration that Hurley was precluded from participating as a bidder in a process to sell Fiduciary under the Fiduciary LLC Agreement, and Hurley counterclaimed seeking a declaration regarding the authority of the committee tasked with supervising the sale.[690] During the arbitration, EB Safe asked the Fiduciary board to investigate Hurley, based on his recent arrest for domestic violence, and then called for his suspension. Hurley added claims to the arbitration challenging EB Safe’s contractual rights to investigate or suspend him.[691] The arbitrators issued a unanimous award determining that Hurley was not precluded from participating in the sale process, but finding the EB Safe board was not prohibited from investigating and suspending him.[692] The arbitrators also determined that Hurley was the prevailing party and awarded him fees under the Fiduciary LLC Agreement, but significantly reduced the amount he had requested. The District Court confirmed the award on the parties’ competing applications to confirm the parts of the award that favored them, denied EB Safe’s motion to vacate the fee award, and entered judgment for the fees the arbitrators had awarded.[693] EB Safe appealed, claiming that the award of fees was in manifest disregard of the law and that Hurley had procured the fee award by fraud through perjury during the arbitration.
Applying a de novo standard of review for findings of law and clear error to findings of fact, the Court of Appeals rejected both of EB Safe’s grounds for vacatur. As to manifest disregard, the court noted that manifest disregard of the law would be grounds for vacatur where “(1) ‘the law that was allegedly ignored was clear, and in fact explicitly applicable to the matter before the arbitrators,’ (2) ‘the law was in fact improperly applied, leading to an erroneous outcome,’ and (3) ‘the arbitrator [knew of the law’s] existence, and its applicability to the problem before him.’”[694] Granting deference to the arbitrators’ decision, the court found that the arbitrators applied a proper reasonableness standard in determining the amount of the fees awarded and had provided a colorable justification for their award.[695] The court had no issue rejecting EB Safe’s fraud argument. The standard for vacatur for fraud requires a showing of (1) fraudulent activity; (2) that could not have been discovered, even with the exercise of due diligence; and (3) materially related to an issue in the arbitration.[696] Vacatur for perjury should be granted only where it is “abundantly clear” that the award was obtained through perjury.[697] Here, the court concluded that inconsistencies in Hurley’s testimony had little or no significance in the arbitration and had not been shown to have resulted from intentional conduct, so the District Court’s judgment was affirmed.[698]
Salinas v. McDavid Houston-Niss, L.L.C., No. 20-20003, 2020 U.S. App. LEXIS 32842 (5th Cir. (Tex.) Oct. 13, 2020). Court properly confirmed arbitration award, including an award of fees where state law permitted prevailing party to recover fees.
Automobile dealership sought to confirm arbitration award against customer who claimed dealership had represented it would insure her vehicle, where the car was totaled in a collision just three days after it was purchased.[699] After the District Court confirmed the award, and denied the customer’s motion to vacate the award, the customer appealed.[700]
On appeal, the court methodically rejected each of the customer’s arguments, noting that the standard of review of arbitration awards is “exceedingly deferential,” resolving all doubts in favor of arbitration.[701] As the arbitration provision in the purchase agreement stated that “[e]ach party shall be responsible for its own attorney[’s] . . . fees, unless awarded by the arbitrator under applicable law,” the arbitrator had properly awarded the dealership its attorney’s fees pursuant to the Texas Civil Practice and Remedies Code, which allows the prevailing party to recover reasonable attorney’s fees for claims asserted in contract.[702] Accordingly, the decision of the District Court was affirmed.
Kohn Law Grp., Inc. v. Jacobs, 825 F. App’x 465 (9th Cir. (Cal.) 2020). Arbitration award properly confirmed over claims that arbitrator had exceeded her powers and acted in manifest disregard of the law.
Law firm appealed from the District Court’s decision confirming an arbitration award. On appeal, noting the deferential standard of review of arbitration decisions, the court rejected the law firm’s claims that the award should be vacated in part. Contrary to the firm’s objections, the arbitrator had not exceeded her authority by interpreting a provision in a different way than what the firm urged.[703] The Court of Appeals did not question whether manifest disregard of the law would be grounds to vacate an award, but explained that the party challenging an arbitration award must show that the arbitrator understood and correctly stated the law, but proceeded to disregard it.[704] That burden will not be sustained where the arbitrator thoughtfully examined the law and applied it to the facts, as had occurred in this arbitration. The court affirmed the judgment confirming the arbitration award.[705]
Floridians for Solar Choice, Inc. v. Paparella, 802 F. App’x 519 (11th Cir. (Fla.) 2020) (per curiam). Award was properly confirmed, including an award of attorneys’ fees entered after the 30-day deadline in the AAA Rules.
Consultant entered into a contract with Floridians for Solar Choice, Inc. (“FSC”) to obtain signatures to support a proposed ballot initiative for a solar energy amendment to the Florida Constitution.[706] A dispute arose over whether FSC agreed to pay the consultant for unexpected expenses, and after an arbitration under the AAA Commercial Rules, as their contract provided, the arbitrator ruled in favor of FSC. The District Court confirmed the award to PSC for damages, interest, costs and fees.[707]
On appeal, the court rejected the consultant’s argument that FSC had committed fraud by changing its theory of damages in its post-hearing brief hearing to increase the amount it sought.[708] The increase was supported by the record, and the arbitrator was not mislead where he had rejected the same objection on a post-award motion for rehearing.[709] Nor was there any merit to the consultant’s objection that it was entitled to a three-arbitrator panel under the AAA Rules based on the amount sought, where the parties had stipulated to a single arbitrator and the consultant did not object until FSC moved for an award of attorneys’ fees.[710] Finally, there was no error in the arbitrator’s belated award of attorneys’ fees. The initial award found that FSC was entitled to an award of its reasonable attorneys’ fees under a contractual prevailing party provision, and the parties agreed that the amount of the fees would be addressed after the hearing. At best, the failure to include an express reservation of jurisdiction in the award to address fees was a “clerical error” and the arbitrator was not deprived of authority to decide the issue of fees after the 30-day deadline in the AAA Rules to issue an award after a hearing.[711] As a matter that can be waived, forfeited or contracted around, that deadline is not jurisdictional, the parties had agreed that the matter of fees would be addressed after the hearing, and the arbitrator did not exceed his authority when he entered an award of attorneys’ fees more than 30 days after the hearing concluded.[712] Accordingly, the judgment of the district court was affirmed.
Auto Equity Loans of Delaware, LLC v. Baird, 232 A.3d 1293 (Del. 2020) (unpub.). Questionable legal support or a misreading of the law alone are insufficient to vacate an arbitration award.
Borrowers of high-interest loans invoked arbitration provision and brought three arbitrations against their lender, asserting claims that the loans were usurious under Pennsylvania law, the state where they all resided.[713] The lender claimed that the law of Delaware – where the loans were made – controlled, and that the loans were not usurious under Delaware law. The arbitrator applied Pennsylvania law, after acknowledging that he had changed his mind after ruling otherwise in a prior arbitration, declared the loans usurious and awarded damages to the borrowers. The lender brought an action in Delaware state court to vacate the three awards based on the arbitrator’s manifest disregard of the law. The Delaware court agreed with the lender, found that the arbitrator’s choice of law analysis was clearly erroneous and the legal errors amounted to a manifest disregard of the law and vacated two of the awards.[714] On appeal, the intermediate Superior Court reversed, finding that the arbitrator had some basis for applying Pennsylvania law and thus had not manifestly disregarded the law.
The Delaware Supreme Court affirmed the Superior Court decision, even though it found the choice-of-law analysis by the arbitrator and Superior Court “doubtful.”[715] Noting the deferential standard to be applied when reviewing arbitration awards, the court described the burden of demonstrating that an arbitrator exceeded his powers by manifestly disregarding the law to be a “steep hill to climb,” requiring a showing that “the arbitrator (1) knew of the relevant legal principle, (2) appreciated that this principle controlled the outcome of the disputed issue, and (3) nonetheless willfully flouted the governing law by refusing to apply it.”[716] The arbitrator’s analysis here may have been dubious, but questionable legal support or a misreading of the law are not sufficient to vacate an arbitration award.[717] On the basis that by choosing arbitration the lender had accepted the heavy burden required to vacate an arbitration award, the Supreme Court affirmed the Superior Court’s reinstatement of the two vacated awards.[718]
Cinatl v. Prososki, 307 Neb. 477 (2020). Courts are required to give extraordinary level of deference to arbitration awards, and have no discretion to deny confirmation under the Uniform Arbitration Act where there is no pending application for vacatur or modification of the award.
Buyer of orthodontics practice brought a claim against the estate of the seller, claiming fraud and seeking rescission of the acquisition.[719] After a hearing, the arbitrator issued an award in favor of the seller’s estate based largely on the seller’s continued operation of the practice for two years after the acquisition, and the buyer sought vacatur, arguing that the arbitrator exceeded his authority by rendering a decision based upon issues and defenses that had not been raised in the pleadings, including estoppel, laches, statute of limitations and waiver.[720] The trial court denied the application, holding that the arbitrator had not substantially relied on the equitable defenses cited by the buyer.[721] In its decision, the court noted that it did not have the written arguments the parties had presented to the arbitrator. The buyer then filed a motion seeking to vacate the court’s decision and for a new trial and a motion to prepare the record from the arbitration hearing, and the seller’s estate filed an application to confirm the arbitration award.[722] The trial court rejected the motion for a new trial, holding that the arbitrator’s decision was not necessarily grounded in the defenses of laches or estoppel, and confirmed the arbitration award.[723] The buyer appealed.[724]
On appeal, after addressing appellate jurisdiction issues, the Supreme Court of Nebraska addressed the grounds set forth in the Nebraska Uniform Arbitration Act (“UAA”) for vacatur, noting the “extraordinary level of deference” given to arbitration awards.[725] The Supreme Court held that the trial court properly denied vacatur as there was no merit to the argument that the arbitrator decided the matter based on unpleaded defenses and, even if he had, the court did not err in rejecting the application.[726] Having rejected the application for vacatur, the trial court had no discretion to refuse the application to confirm the award under the UAA, which uses mandatory language.[727] Accordingly, the judgment confirming the award was affirmed.
§ 1.14.3 Scope of Review of Award
Gherardi v. Citigroup Global Mkts., Inc., 975 F.3d 1232 (11th Cir. (Fla.) 2020). Judicial review of arbitration award does not permit the court to examine the legal merits of the arbitrators’ award where they arguably construed the contract.
Bank employee obtained a significant award from his former employer.[728] The employee moved to confirm and the employer moved to vacate the award. The bank argued that, as an at-will employee, the panel had exceeded their authority by ignoring the employment agreements and awarding the employee damages for wrongful termination.[729] The District Court determined that the arbitrators “exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made,” within the meaning of Section 10(a)(4) of the FAA,[730] and granted the motion to vacate.
The Court of Appeals reversed. Noting that § 10(a)(4)‘s language is to be interpreted “narrowly—very narrowly” and that judicial review of arbitration decisions is “among the narrowest known to the law,”[731] the sole question for the court was “whether the arbitrators (even arguably) interpreted the contract, not whether [they] got its meaning right or wrong.”[732] Because this was not a case where the arbitrators flagrantly defied the terms of the parties’ contract, nor an expansion beyond the arbitrable issues, the court reversed.[733] The dissent took a different view, reasoning that the arbitrators exceeded their powers by issuing an award that appeared to “flatly contradict” the express language of the employee handbook.[734]
Diverse Enters., Co., L.L.C. v. Beyond Int’l, Inc., No. 19-51121, 2020 U.S. App. LEXIS 29650 (5th Cir. (Tex.) Sept. 17, 2020). An award of attorneys’ fees at an hourly rate in excess of the actual amount charged did not exceed the arbitration panel’s contractual authority and was not grounds for vacatur.
Distribution agreement contained a broad arbitration clause as well as a provision granting the prevailing party its reasonable attorneys’ fees.[735] The panel ruled in favor of plaintiffs on virtually every issue and entered an award, including an amount for attorneys’ fees. Initially, the parties stipulated to an hourly rate for the plaintiffs’ fees that, unbeknownst to the defendant, exceeded the rate the plaintiffs were actually charged. When plaintiffs moved to confirm the award, defendant argued the arbitrators had exceeded their authority by awarding fees in excess of the amount actually incurred, and that the award contained “an evident material miscalculation of figures or evident material mistake” in violation of Section 11(a) of the FAA.[736] The District Court confirmed the award, concluding that the panel did not exceed its authority, noting the “exceedingly deferential” standard of review and the lack of limiting language in the parties’ agreement concerning the arbitrator’s authority.[737]
On appeal, the court stressed the limited role of the courts in reviewing arbitration awards, including the requirement to resolve all doubts about the authority of the arbitrators in favor of arbitration.[738] Based on the broad arbitration provision and the prevailing party clause, the court held that the word “reasonable” did not necessarily limit the authority of the arbitrators to only award the amount of fees that plaintiffs had actually incurred.[739] Accordingly, the Court of Appeals affirmed the decision confirming the award.[740]
Bay Shore Power Co. v. Oxbow Energy Sols., LLC, 969 F.3d 660 (6th Cir. (Ohio) 2020). Where parties’ agreement to arbitrate expressly excluded any determination of attorneys’ fees, but a separate contract provision allowed the prevailing party to seek reimbursement of its attorneys’ fees, the court was not precluded from considering an award of fees to prevailing party.
Customer brought an arbitration and obtained an arbitration award against supplier under a long-term supply agreement.[741] The arbitration provision expressly carved out and excluded attorneys’ fees from the damages and costs that the panel could award, and such fees were to be born equally by the parties.[742] However, a separate provision in the contract allowed the prevailing party to seek reimbursement of its attorneys’ fees.[743] The customer filed suit to confirm the award and recover its fees incurred in the arbitration under the prevailing party provision. The District Court confirmed the award but granted summary judgment to the supplier on the claim for attorneys’ fees, finding that the agreement was ambiguous as to whether an award of fees was available and thus there was no meeting of the minds allowing a prevailing party to recover fees.[744]
On appeal, the Court of Appeals first determined the threshold issue of arbitrability and the extent to which the parties had delegated authority to resolve their disputes to the arbitrator.[745] Because the parties did not delegate the issue of attorneys’ fees to the arbitrators’ discretion, the motion for attorneys’ fees was not an impermissible attempt to modify the panel’s binding arbitration award, but rather was an effort to vindicate a separate contract right with respect to an issue that was not delegated to the arbitrators.[746] The provisions of the contract could be reasonably read together to allow the court to consider an award of fees, and the District Court’s ruling to the contrary was accordingly reversed.[747]
Star Dev. Grp., LLC v. Darwin Nat’l Assur. Co., 813 F. App’x 76 (4th Cir. (Md.) 2020). Where the parties expressly reference state arbitration law in an agreement, that law applies to review of the arbitrator’s decision.
Property owner and construction and development manager brought an action in state court to recover delay damages from the general contractor and its surety they had incurred during the construction of a hotel.[748] The action was removed to federal court and moved to arbitration as the contract prescribed arbitration of disputes to be governed by the Maryland Uniform Arbitration Act. The arbitration panel issued an award in favor of the general contractor.[749] The parties then returned to federal court with competing petitions to confirm and vacate the award. The District Court confirmed the award, and granted the general contractor its fees for both the costs of the petition to confirm and the defense of the vacatur application.[750]
On appeal, the court first turned to the choice of law, and the District Court’s holding that the proceedings were governed by the Maryland state arbitration law, rather than the FAA. Reviewing the choice of law de novo, and applying the law of the forum, the Court of Appeals had little difficulty affirming the District Court. While a generic choice-of-law provision stating generally that a contract is subject to state law is typically insufficient to invoke state arbitration law, here, the choice of law provision expressly provided that the arbitration itself would be subject to the state arbitration statue and the parties’ choice of state law would not be preempted by the FAA.[751] As such, the state statute would govern the request for vacatur.
In addition to the grounds provided under the FAA, the Maryland statute allows vacatur (1) if the award “manifestly disregards” the law or (2) if the award is “completely irrational,”[752] although the scope of the latter ground has been cast into doubt.[753] Regardless, under any formulation of the standard, the arguments for vacatur fell far short.[754] The District Court’s decision was affirmed.
Mid Atl. Capital Corp. v. Bien, 956 F.3d 1182 (10th Cir. (Colo.) 2020). Court may correct only those miscalculations of figures that appear on the face of an arbitration award and cannot look beyond the face of the award.
FINRA arbitration panel issued an award in favor of investors and against brokerage for damages, attorneys’ fees and required the investors to reassign ownership of certain investments to the brokerage. The brokerage moved to amend the award based on “an evident material miscalculation of figures,” under Section 11(a) of the FAA, claiming that the award had double counted certain damages.[755] The District Court denied the motion because the alleged error did not appear on the face of the arbitration award. However, the District Court amended the award in several respects and both parties appealed.
In the amended final judgment, in addition to ordering the brokerage to pay the investors certain damages, the court ordered that prejudgment interest would accrue on the damages portion of the award and that post-judgment interest would accrue at the federal rate specified in 28 U.S.C.A. § 1961. Lastly, the court ordered the investors to reassign to the brokerage their ownership interests in the investments, including any distributions that they had received since the arbitration award due to the investments.
On appeal, the court held that § 11(a) embodies a face-of-the-award limitation, based on the FAA’s purpose, history, and structure, bolstered by the narrow and deferential standard of review of arbitration awards.[756] Here, the brokerage did not satisfy that burden to show an error; even if the panel inadvertently awarded damages on both measures of recovery presented as alternatives methods of calculating damages, that mistake was not evident on the face of the award.[757] As to the investors’ complaints regarding the assessment of interest and fees, the Court of Appeals held that these issues rested on the panel’s interpretation of the investors’ contract and were within the authority of the panel.[758] Finally, the District Court had not erred in applying the federal post-judgment interest rate or in requiring the investors to reassign post-award distributions to the brokerage, along with their investments.[759] Accordingly, the judgment was affirmed.[760]
Interactive Brokers LLC v. Saroop, 969 F.3d 438 (4th Cir. (Va.) 2020). When considering whether an arbitration panel manifestly disregarded the law, the court’s role is to determine whether the panel did its job, not how well it did its job.
A group of investors opened accounts with an online broker dealer, signing contracts with mandatory arbitration provisions that provided that “[a]ll transactions are subject to rules and policies of relevant markets and clearinghouses, and applicable laws and regulations.”[761] The investors hired a third-party investment manager, who executed trades of a certain high-risk security through the investors’ portfolio margin accounts with the broker, which executed the investment manager’s strategy.[762] FINRA Rule 4210(g) prohibits trades through portfolio margin accounts of the high-risk security traded here.[763] At first, the investment strategy was successful, but after a substantial drop in the market, the value of the investors’ margin accounts fell below the minimum required amounts. Pursuant to the parties’ contracts, the broker auto-liquidated the investors’ accounts, leaving the investors with an obligation to pay the broker $384,000 for the leverage the broker provided to acquire the now-liquidated investments.[764]
The investors filed an arbitration with FINRA to recover their claimed losses, but they did not assert a claim based on FINRA Rule 4210(g). The broker counterclaimed for payment of the debt. The parties did not request a reasoned decision from the panel. The arbitration panel found for the investors, awarding them the value of their accounts at the time of liquidation, but did not specify which cause of action formed the basis of liability. The panel dismissed the broker’s counterclaim based on its violation of FINRA Rule 4210(g).[765] The broker successfully challenged the award in District Court, and the panel issued a modified award with a brief explanation for the award of damages, which it calculated as the value of the account on a date when the account was holding cash, with no open investment positions, and rejecting the broker’s counterclaim based on the violation of Rule 4210(g).[766] The broker then returned to the District Court seeking vacatur of the modified award, and the District Court granted the broker’s motion to vacate, reasoning that there was a “a manifest disregard of the law because the law is clear that there is no private right of action to enforce FINRA rules.”[767] The investors appealed.
The Fourth Circuit vacated the District Court’s judgment, finding that it erred by vacating the modified arbitration award.[768] The court applied its own precedent to find that the manifest disregard standard is met only upon a showing that “(1) the disputed legal principle is clearly defined and is not subject to reasonable debate; and (2) the arbitrator refused to apply the legal principle.”[769] The Fourth Circuit found that the arbitration panel did not manifestly disregard the law for three reasons. First, the panel did not base its award on violation of a FINRA Rule for which there is no private right of action, but merely based its rejection of Broker’s counterclaim on such a violation.[770] Second, because the panel did not specify which cause of action the award was predicated on, the broker was required to show manifest disregard as to all of the causes of action, and the Fourth Circuit found that there was no manifest disregard as to the breach of contract cause of action because the parties’ contracts contained an obligation to comply with FINRA Rules.[771] Third, the arbitration panel did not manifestly disregard the law by awarding damages based on the value of the accounts on the date selected by the panel because this arguably returned the parties to the status quo before the broker’s alleged wrongful liquidation or high-risk trading, under Connecticut law, which governed the parties’ contracts.[772]
In addressing the dissent, the Fourth Circuit was careful to specify that although the arbitration panel’s application of damages law may not be the best reading of the law, the court’s job is to determine merely whether the panel did its job and not whether it did its job well.[773] The dissent would have affirmed the District Court’s order on the ground that his was a “rare circumstance” for vacatur because no theory of compensatory damages would have permitted an award based on the specific date selected by the panel with no sufficient explanation as to why or consideration as to what came before or after such date.[774]
Blondeau v. Baltierra, No. 20282, 2020 Conn. LEXIS 203 (Sept. 24, 2020). Judicial review of an arbitration award based on an unrestricted submission to arbitration is limited to a determination of whether the arbitrator exceeded her powers by issuing an award that fell outside of the scope of the submission or manifestly disregarded the law.
Spouses entered into a premarital agreement that included a French choice of law provision and an agreement to arbitrate any claim for marriage dissolution, to be guided by the laws of Connecticut except that the French Civil Code would apply to any claim regarding the enforceability of the premarital agreement and the determination of what property fell within the scope of the premarital agreement.[775] The arbitrator issued an opinion designating the parties’ home as joint property, applying Connecticut law to determine how equity in the home would be distributed and to his order for payment of the children’s living expenses as well as expenses of childcare, health insurance, and life insurance.[776] The wife moved before the arbitrator for articulation/clarification/reargument of the arbitration award, arguing that the arbitrator had failed to apply French law to the division of equity in the property, as the premarital agreement required, which the arbitrator denied.[777] The husband filed an application in court to confirm the award and the wife filed a motion to vacate, which the trial court granted, holding that the arbitrator exceeded her powers and manifestly disregarded the law by failing to comply with the parties’ arbitration agreement to apply the law of France to the division of property.[778]
The husband appealed, arguing that the trial court lacked subject matter jurisdiction to consider the wife’s motion to vacate on numerous grounds, including because the arbitrator neither exceeded her authority under the arbitration agreement nor manifestly disregarded the law.[779] The husband also argued that the wife was not aggrieved by some of the arbitrator’s award that she was now seeking to vacate. The court examined several jurisdictional challenges the parties raised, and concluded that any party to an arbitration agreement can seek vacatur of an arbitration award, regardless of whether the party is aggrieved.[780] Turning to the merits of the competing applications to vacate and confirm, the court differentiated between restricted and unrestricted submissions to arbitration. In the former, the breadth of issues delegated to the arbitrator is limited and subject to the court’s de novo review. In an unrestricted submission, the award is final and binding and not subject to review for errors of fact and law.[781] Applying the standards for an unrestricted submission, the Supreme Court held that judicial review of the arbitration award is limited to a determination of only whether the arbitrator exceeded her powers by issuing an award that fell outside of the scope of the submission or manifestly disregarded the law.[782] The Supreme Court held that neither ground for judicial intervention existed in this case, noting that although the wife’s legal interpretation may be correct, it is not “obviously correct based on the explicit requirements of the premarital agreement” as would be required to permit a court to vacate the arbitration award.[783] Finally, the court held that the wife did not and could not waive the state statutory prohibition against arbitration of issues related to child support and that portion of the award was severable and properly vacated, and in all other respects the decision of the trial court was reversed and the award confirmed.[784]
§ 1.15 Preclusive Effect of Arbitration Awards
Tex. Brine Co., L.L.C. v. Am. Arbitration Ass’n, Inc., 955 F.3d 482 (5th Cir. (La.) 2020). The FAA provides the exclusive remedy for claims arising from arbitral bias and seeking reimbursement for arbitration fees and expenses, and collateral attacks are not allowed.
In 1975, Texas Brine Company, L.L.C. (“Texas Brine”) entered into a contract to supply brine to a customer.[785] Many years later, the contract was amended to include an arbitration agreement, and the contract was thereafter assigned to Occidental Chemical Corporation (“Oxy”). After a dispute arose between Texas Brine and Oxy in 2012, Texas Brine invoked the arbitration clause. Three arbitrators were selected, and each was required to disclose conflicts of interest and acknowledge a continuing duty to disclose any further conflicts. Four years later, Texas Brine learned that one of the arbitrators failed to disclose that he was serving as counsel in an unrelated matter opposite Texas Brine’s arbitration attorneys. Texas Brine also learned that another of the arbitrators was representing the first conflicted arbitrator in a related legal malpractice action. Neither arbitrator had disclosed this information. Texas Brine moved to remove both arbitrators, and the AAA denied the motions. Eventually, the AAA removed one of the arbitrators after he made an offensive comment, Texas Brine renewed its urging to remove the other, and both remaining arbitrators resigned. Thereafter, Texas Brine filed a motion in Louisiana state court to vacate all rulings that had been issued by the arbitral panel and for reimbursement of fees and expenses paid to the AAA, and the state court granted the motion.
Texas Brine then filed suit against the AAA and the conflicted arbitrators in Louisiana state court, requesting more than $12 million in damages and equitable relief based on claims of fraud in connection with the arbitration proceedings. The AAA, the only out-of-state defendant, removed the case to federal court before the in-state defendants could be served, a process referred to as “snap removal,” and moved to dismiss. The District Court denied Texas Brine’s motion to remand based on a challenge to “snap removal,” and granted the motions to dismiss. Texas Brine filed the instant appeal.[786]
The Fifth Circuit affirmed the refusal to remand, following similar decisions in other circuits.[787] At the outset, it reasoned that the plain language of 28 U.S.C.A. § 144(a), known as the forum-defendant rule, prohibits removal when an in-state party has been “properly joined and served” as a defendant.[788] Here, because the in-state arbitrator defendants had not been served before the AAA removed the case, “snap removal” was permissible.[789]
The court also held that the Louisiana action amounted to an impermissible collateral attack on the arbitration award for three reasons.[790] First, it reasoned that Texas Brine’s allegations of wrongdoing relating to the conflicts of interest resembled the same wrongdoing that led the Louisiana court to vacate the arbitration award in the first state court proceeding.[791] The court ruled that a proceeding under section 10 of the FAA for vacatur based on evident arbitrator bias is a party’s exclusive remedy for undisclosed conflicts.[792] Second, section 10 provides the remedy for harm that manifests in the arbitration award.[793] Texas Brine’s argument that the conflict provided a strategic disadvantage and tainted the arbitration were the same kinds of harm that are remedied through vacatur under section 10.[794] Third, Texas Brine’s request for reimbursement of the costs and fees paid during arbitration amounted to a collateral attack on the award. Thus, the Fifth Circuit affirmed the District Court’s decision dismissing the action.[795]
Gulf LNG Energy, LLC v. Eni USA Gas Marketing LLC, No. 22, 2020, 2020 Del. LEXIS 380 (Nov. 17, 2020). Even where the parties have agreed to a broad arbitration clause, courts have jurisdiction to enjoin arbitration of claims that amount to an effort to collaterally attack a final award the court previously confirmed.
The parties entered into an agreement for the use of a facility to receive, store, regasify and deliver liquefied natural gas (“LNG”) that contained an arbitration clause.[796] In 2016, defendant Eni USA Gas Marketing LLC (“Eni”) filed the “First Arbitration” with the AAA, and the panel issued a final award finding that the purpose of the parties’ agreement had been substantially frustrated as a result of a radical and unforeseeable change in the domestic natural gas market, declaring that the agreement terminated as of March 1, 2016, and directing Eni to compensate plaintiff Gulf LNG Energy, LLC (“Gulf”) for the value of partial performance under the agreement.[797] Gulf sued in the Court of Chancery to confirm the award and the court entered judgment confirming the award.
A few months later, in June 2019, Eni filed a Second Arbitration against Gulf seeking declaratory relief and damages, alleging breaches of the agreement and negligent misrepresentation as a result of Gulf’s wrongful conduct in the First Arbitration.[798] Gulf responded by bringing an action in the Court of Chancery under the FAA and Delaware state law seeking a permanent injunction and a declaratory judgment that Eni was barred from pursuing the Second Arbitration.[799] The Court of Chancery rejected Eni’s arguments that it did not have jurisdiction to enjoin claims that it determined to be collateral attacks on the Final Award, and enjoined Eni from bringing the negligent misrepresentation claim, but entered judgment for Eni allowing it to pursue the breach of contract claims in the Second Arbitration.[800] The court reasoned that the panel in the First Arbitration never ruled on the merits of Eni’s contract claim, the claims were not an impermissible attack on the final award and it would be up to the panel in the Second Arbitration to determine whether the contract claim was arbitrable and whether it was precluded.
On appeal to the Delaware Supreme Court, Gulf argued that the Court of Chancery erred in refusing to enjoin all claims in the Second Arbitration as improper attacks on the final award, and Eni cross-appealed, contending that the Court of Chancery lacked jurisdiction to enjoin the Second Arbitration in light of the parties’ broad arbitration clause, and that the enjoined misrepresentation claims were not a collateral attack on the final award in the First Arbitration.[801] In finding that the court had jurisdiction to enjoin Eni from pursuing the Second Arbitration, the Supreme Court held that Sections 10 and 11 of the FAA provide the exclusive means to vacate, modify or correct a final arbitration award and thus courts can enjoin or dismiss follow-on proceedings instituted in court or arbitration, such as in the instant case, that constitute collateral attacks on a confirmed arbitration award in direct contravention of the FAA.[802] As the Supreme Court reasoned, “[w]hen the parties agreed that the FAA controls review of an arbitration award, they signed up for a court to apply an exclusive procedure and the restrictions that accompany it.”[803] Even where the parties have agreed to a broad arbitration clause, the courts retain jurisdiction “to dismiss litigation or enjoin a second round of arbitration to vindicate the policies of finality and limited review of arbitration awards embedded in the FAA . . . ”[804] The Supreme Court also rejected Eni’s characterization of its claims in the Second Arbitration as independent of the final award in the First Arbitration. Rather, modifying the judgment of the lower court, the Supreme Court found that Eni was seeking, through the Second Arbitration, to effectively appeal the final award outside of the FAA’s review process. It determined that the correct analysis was not whether res judicata applied, and the panel had addressed the claim Eni was pursuing, but instead whether Eni’s ultimate objective was to attempt to “rectify” a harm it suffered as a result of the final award in the First Arbitration.[805] Here, because Eni was attempting to litigate once again whether the agreement was terminated and the remedy for that termination, the Second Arbitration constituted an improper collateral attack on the final award.[806] The court concluded that because Eni’s claims sought to revisit the core issues addressed in the First Arbitration, and to modify the final award, the claims were a collateral attack on the final award and should be enjoined.[807] Over a dissent that would have referred all issues of arbitrability to the panel in the Second Arbitration, the Supreme Court affirmed in part, reversed in part and remanded to the Court of Chancery with instructions to enter an injunction preventing Eni from pursuing all claims in the Second Arbitration.[808]
§ 1.16 Mediation
Accent Delight Int’l Ltd. v. Sotheby’s, No. 18-CV-9011 (JMF), 2020 U.S. Dist. LEXIS 230272 (S.D.N.Y. Dec. 8, 2020). A party seeking discovery of private mediation materials must satisfy a heightened standard of need.
The plaintiffs (working for a Russian billionaire) hired a private art dealer, Yves Bouvier, to help the billionaire assemble a “world-class” art collection.[809] But Mr. Bouvier, rather than acting as an agent and advisor, “improperly and secretly, acting as a dealer,” allegedly bought some of that “art himself and [resold] . . . it to Plaintiffs at a higher price.”[810] One of those works was Leonardo da Vinci’s Christ as Salvator Mundi.
Plaintiffs claimed that the auction house Sotheby’s was part of this scheme. In particular they asserted that Sotheby’s had facilitated the sale of Christ as Salvator Mundi from a group of sellers to Mr. Bouvier for $83 million, and that Mr. Bouvier then sold the painting to the plaintiffs for $127.5 million.[811] Plaintiffs also alleged that Sotheby’s assisted Mr. Bouvier “to justify th[is] fraudulent price.”[812]
Sotheby’s had not waited for these claims before addressing the sale, however. In 2016 it had sued for a declaratory judgment that it had not breached its obligations to the original seller group in the sale to Mr. Bouvier. And even before that lawsuit, Sotheby’s had begun a mediation with that original seller group, using former United States District Court Judge Barbara Jones as their mediator. Sotheby’s, the original sellers, and Judge Jones agreed in writing that the mediation would be “a settlement negotiation deemed private and confidential.”[813]
The mediation was successful and led to a settlement agreement. In 2020, the plaintiffs suing Mr. Bouvier decided it would be to their advantage to see the settlement agreement and mediation materials in the mediation between Sotheby’s and the original sellers. They served a subpoena to that effect, which Sotheby’s moved to quash.[814]
The court quashed the subpoena as to the settlement agreement itself, but not the mediation materials requested. Sotheby’s then objected to the production of various documents, including communications between its counsel and counsel for the original sellers, and communications between it and the mediator. In reply, the plaintiffs moved to compel production of those documents.[815]
In deciding the motion to compel, the court first addressed whether a party seeking materials from a private mediation must meet the three-part test announced in In re Teligent,[816] for proof of “‘(1) a special need for the confidential material, (2) resulting unfairness from a lack of discovery, and (3) that the need for the evidence outweighs the interest in maintaining confidentiality.’”[817] In the In re Teligent case, the mediation in question had been court annexed and subject to an order of confidentiality.[818] Sotheby’s, in contrast, had only a private agreement as to confidentiality.[819]
The only two full decisions to have addressed whether the standard from In re Teligent applied to private mediations had reached different conclusions.[820] The court in Accent Delight sided with the decision in Dandong, for several reasons.
First, the “the Second Circuit itself has applied the heightened Teligent standard in relation to a confidential private mediation,” albeit in a summary order.[821] Second, the In re Teligent decision did not depend on the existence of a court order, but “on the rationale that promising confidentiality in mediation promotes the free flow of information that may result in the resolution of a dispute.”[822] Third, “providing weaker protections to communications during a confidential private mediation than to communications during a court-sponsored mediation would discourage parties from agreeing to engage in private mediation.”[823] According to the court, “in many cases, particularly more complex cases, private mediation (which is often conducted with a paid, highly experienced mediator who can devote more time to the matter) may be . . . more likely to succeed than[] . . . [court]-sponsored mediation,” and “when successful, [private mediation] lightens the court’s docket.”[824] (but citing no proof of different success rates between public and private mediation). Finally, applying a heightened standard would be consistent with decisions in other Circuits, both those that have formally created a general mediation privilege, [825] and those that have simply recognized a heightened standard for disclosure.[826]
Applying the heightened standard from In re Teligent meant that the plaintiffs would lose their motion to compel. The court emphasized that the plaintiffs had to show more than mere relevance.[827] While they had established that much, they had failed to show that they could not “obtain the information in [the] withheld documents”—not the documents themselves—from sources other than the mediation.[828] Because the plaintiffs had access to the actual parties to the mediation, and to those parties’ other documents, they could not meet this requirement.
§ 1.17 International Arbitration
In a series of cases in 2020, decisions from the Second, Fourth, Sixth and Seventh Circuits deepened the split among the Circuits over whether district courts have the authority to compel discovery for use in private foreign arbitrations under 28 U.S.C.A. § 1782(a), which authorizes a district court to order a person within the district to give testimony or provide evidence for use in foreign litigation, either in response to letters rogatory or on application of a person with an interest in the litigation “for use in a proceeding in a foreign or international tribunal.”[829] In March, the Fourth Circuit held that § 1782 should be interpreted to allow domestic discovery for use in a private arbitration in the United Kingdom.[830] Six months later, the Seventh Circuit reached the opposite conclusion, rejecting an application for discovery for use in the same underlying private arbitration.[831] In between these two cases, the Second Circuit examined the same issue and found no basis on which to disturb its prior precedent that no such authority exists. Finally, the Sixth Circuit joined the Fourth Circuit in holding that § 1782 may be used in aid of private tribunals. We discuss these cases below.
Servotronics, Inc. v. Rolls-Royce PLC, 975 F.3d 689 (7th Cir. (Ill.) 2020) (Servotronics I) and Servotronics, Inc. v. Boeing Co., 954 F.3d 209, 214 (4th Cir. (S.C.) 2020) (Servotronics II). Deepening a split among the Circuits, Seventh Circuit and Fourth Circuit reach different conclusions on whether district courts have authority to compel discovery for use in the same private foreign arbitration.
The underlying dispute in each of Servotronics I and II was a claim for indemnification for losses to a Dreamliner aircraft when its engine caught fire during testing in South Carolina. Boeing, the aircraft manufacturer, made a claim against Rolls-Royce, which manufactured the engine. After Boeing and Rolls-Royce settled, Rolls-Royce sought indemnification from Servotronics, which manufactured a valve in the engine. The contract between Rolls-Royce and Servotronics required arbitration in England under the auspices of the Chartered Institute of Arbiters (“CIArb”).[832] Servotronics sought discovery in the U.S. from Boeing in two locations, invoking 28 U.S.C. § 1782(a). In Servotronics I, Servotronics requested subpoenas to obtain testimony from Boeing employees located in South Carolina, which the District Court denied (Servotronics I).[833] In Servotronics II, Servotronics filed an ex parte application in the federal district court in Illinois asking the court to issue a subpoena to compel Boeing to produce documents located within the district for use in the British arbitration.[834] The court initially granted the application, and then, after Rolls-Royce moved to intervene and to quash the subpoena, joined belatedly by Boeing, the judge reversed course and quashed the subpoena after concluding that § 1782(a) did not authorize federal courts to provide discovery assistance to private foreign arbitrations.[835]
Section 1782 of Title 28 governs the authority of district courts to provide discovery assistance in litigation in foreign and international tribunals and empowers a district court to order a person within the district to give testimony or provide evidence for use in foreign litigation, either in response to letters rogatory or on application of a person with an interest in the litigation “for use in a proceeding in a foreign or international tribunal.”[836] As the applications at issue were filed by a party to a pending proceeding, and not by letters rogatory from the arbitral forum, both courts of appeals focused their inquiry on whether the reference to “tribunal” in Section 1782 includes private arbitral panels.[837]
The issue was one of first impression in each of the Fourth and the Seventh Circuit, but had been addressed by several other circuits–with conflicting results. In older decisions, the Second and Fifth Circuits had concluded that domestic federal courts may provide assistance only to state-sponsored foreign tribunals.[838] After those decisions, the Supreme Court decided Intel Corp. v. Advanced Micro Devices, Inc.,[839] which held that a U.S. District Court could entertain an application under § 1782 to assist proceedings before the Commission of the European Communities, a public entity. More recently, the Sixth Circuit concluded that Intel supported a broad statutory interpretation that would allow domestic discovery for use in private foreign arbitrations.[840] Servotronics argued in both cases that Intel interpreted Section 1782 broadly and flexibly, casting doubt on the continuing validity of the older cases. Boeing and Rolls-Royce took the opposite view, arguing that the potentially broad discovery available under Section 1782(a) would conflict with the narrow scope of discovery available in arbitrations under the FAA.[841]
Ultimately, the Fourth Circuit concluded that the CIArb was a foreign or international tribunal within the meaning of Section1782(a), because the UK law provides regulation and oversight of arbitrations such that the arbitration is the product of government-conferred authority to a potentially greater extent than in the U.S.[842] The Fourth Circuit also minimized Boeing’s concerns of conflict with the FAA, reasoning that the role of the district court is to function as a “surrogate” for the foreign tribunal, exercising its discretion to limit the evidence requested and to be received.[843] In fact, the court in Servotronics I questioned whether it could even consider the impact of Section 1782 on the FAA, interpreting Intel to reject any suggestion that an applicant “must show that United States law would allow discovery in domestic litigation analogous to the foreign proceeding.”[844] The court refused, however, to direct that Servotronics’ request be granted, and instead reversed and remanded to the district court to determine whether to issue the requested subpoenas, in the exercise of its discretion.
Six months later, the Seventh Circuit diverged from the reasoning of the Fourth Circuit and came to the opposite conclusion in Servotronics II. In the Seventh Circuit’s view, both common and legal parlance were not helpful, as the phrase “foreign or international tribunals” could be plausibly interpreted to support the position of either side.[845] However, “context” provided a different outcome: Section 1782 uses the phrase “foreign or international tribunal” three times, and harmonizing those uses “suggests that a more limited reading of § 1782(a) is probably the correct one: a ‘foreign tribunal’ in this context means a governmental, administrative, or quasi-governmental tribunal operating pursuant to the foreign country’s ‘practice and procedure.’”[846] Buttressing that conclusion, the court also pointed out that the narrow reading would avoid conflict with the FAA.[847] Finally, the Seventh Circuit rejected Servotronics’ argument that the Supreme Court in Intel adopted a broader view of “arbitral tribunals,” concluding that nothing signaled a view that arbitral tribunals should be read to include private arbitral tribunals.[848]
Hanwei Guo v. Deutsche Bank Sec., 965 F.3d 96 (2d Cir. (N.Y.) 2020). Based largely upon its own precedent, Second Circuit holds that Section 1782(a) did not authorize permit discovery for use in private international commercial arbitrations.
The petitioner (Hanwei Guo) had invested in companies through a series of transactions that he asserted were misleading, extortionate, and fraudulent[849]. Eventually, following a series of mergers, one of the investments became part of a global music streaming services company. Guo initiated arbitration against a number of entities before the China International Economic and Trade Arbitration Commission (“CIETAC”), and sought discovery from four investment banks related to their work as underwriters for the streaming services company. The respondents in the arbitration intervened to oppose the request. The District Court denied Guo’s application based on its conclusions that (1) it was bound by its precedent in Nat’l Broad. Co. v. Bear Stearns & Co. holding § 1782 does not apply to private foreign arbitrations,[850] which remained good law in the wake of the Supreme Court’s decision in Intel; and (2) CIETAC was “closer to a private arbitral body than it is to a ‘governmental . . . tribunal[]’ or ‘other state-sponsored adjudicatory bod[y].’”[851]
The Second Circuit agreed. Contrary to Guo’s insistence, it reasoned that NBC has not been overruled or otherwise undermined by the Supreme Court’s decision in Intel, and therefore remains good law.[852] Just as the Seventh Circuit would conclude in Servotronics II, the Second Circuit decided that Intel considered only whether the Directorate General-Competition, a public entity, qualified as a tribunal within § 1782(a) and had not addressed whether foreign private arbitral bodies would also qualify as tribunals under the statute. Moreover, the language that Guo, like Servotronics, relied on in Intel to support its argument is a passing reference in dicta, consisting of a parenthetical quotation of a footnote in an article by a law professor.[853] The court doubted that “such a fleeting reference in dicta could ever sufficiently undermine a prior opinion of this Court as to deprive it of precedential force,” noting that even the Sixth Circuit, in reaching an outcome contrary to NBC, refused to ascribe such significance to the language in question. [854]
The court then turned to consider whether CIETAC was a private tribunal, and held that it was “clear” that CIETAC arbitrations are private international commercial arbitrations falling outside the ambit of § 1782, in large part because they derive their jurisdiction exclusively from the agreement of the parties.[855]
Abdul Latif Jameel Transp. Co. v. FedEx Corp. (In re Application to Obtain Discovery for Use in Foreign Proceedings), 939 F.3d 710 (6th Cir. (Tenn.) 2019). A privately contracted-for commercial arbitration proceeding is a “foreign or international tribunal” as used in 28 U.S.C.A. § 1782(a), allowing an interested party to seek domestic discovery in the U.S.
Abdul Latif Jameel Transportation Company Limited (“ALJ”), a Saudi corporation, was involved in a foreign private commercial arbitration against FedEx Corporation (“FedEx”) and sought to subpoena FedEx documents and to depose one of its representatives in the United States.[856] ALJ filed an application in the United States District Court for the Western District of Tennessee invoking 28 U.S.C.A. § 1782(a).[857] The District Court denied the application, holding that the phrase “foreign or international tribunal” did not encompass the privately contracted-for commercial arbitration, which operated under the rules of the Dubai International Financial Centre-London Court of International Arbitration (“DIFC-LCIA”). ALJ appealed, arguing that the phrase “foreign or international tribunal” does include the arbitration at issue and that its discovery request should be granted.[858]
The Sixth Circuit reversed and remanded for the district court to determine whether the application for discovery should be granted.[859] The heart of the dispute, it found, centered not on whether the DIFC-LCIA arbitration was “foreign or international” in nature, but whether it involved a “tribunal.”[860] The court reasoned that the arbitration panel here fit the meaning of a “tribunal” as used in § 1782(a), based on the statutory text, the meaning of such text based on dictionary definitions and common usage, and the statutory context and history of the provision.[861] After finding that several legal and common dictionaries define “tribunal” broadly to include private arbitration but left room for interpretation, the court turned to common usage of the word in legal writing.[862] According to the court, American judges and lawyers have long used and understood “tribunal” to include privately contracted-for arbitral bodies with the power to bind contracting parties.[863] Lastly, Congress did not proscribe private arbitrations from the meaning of “tribunal” in its other usage of the word in the same legislative chapter that contains § 1782(a).[864] Thus, the statutory text of § 1782(a) was found to include privately contracted-for commercial arbitration.[865]
Further, the Sixth Circuit interpreted the Supreme Court’s decision in Intel Corp. v. Advanced Micro Devices, Inc. as determining that § 1782(a) provides for discovery in non-judicial proceedings.[866] The Sixth Circuit based its interpretation on the Supreme Court’s conclusion that an executive and administrative body of the European Union was a tribunal under § 1782(a).[867] It also pointed to the Supreme Court’s note that this provision was amended to replace “any judicial proceeding in any court in a foreign country” with the current language “in a proceeding in a foreign or international tribunal,” which it interpreted as Congress providing the possibility of U.S. judicial assistance in administrative and quasi-judicial proceedings.[868] Recognizing that its decision conflicts with decisions of the Fifth[869] and Second[870] Circuits, it was “unpersuaded” by the reasoning of those courts. Rather it supported its conclusion with an analysis of legislative history as well as policy and efficacy considerations. Having found that the District Court “may” order discovery, the court remanded to the District Court to consider what discovery was appropriate under the Intel factors.[871]
§ 1.17.1 Review of Awards in International Arbitration
Vantage Deepwater Co. v. Petrobras Am., Inc., 966 F.3d 361 (5th Cir. (Tex.) 2020). Public policy exception to confirmation of arbitral award did not apply where a party claimed that the underlying contract was procured by bribery, rather than that the award itself, or where enforcement of the award itself would not violate public policy.
Oil and gas companies entered into a contract to provide offshore drilling services. A Brazilian investigation subsequently revealed that the contractor’s shareholders had paid bribes to Petrobras to procure the contracts, as part of a larger scheme.[872] The project was subject to a series of contracts, the last of which was signed after an initial media article reporting allegations of bribery, and provided for arbitration of any disputes under the ICDR of the AAA with a purported waiver of any rights of “any form of appeal, review or recourse to any court or judicial authority.”[873] Petrobras terminated the contract, and the parties proceeded to arbitration. After the hearings began, Petrobras moved to disqualify one of the three arbitrators, claiming he appeared partial, had incorrectly summarized evidence, and had dozed off; the AAA investigated and denied the motion.[874] The hearings resumed and the panel issued an award against Petrobras, with one of the arbitrators dissenting and claiming unfairness in the proceedings that denied Petrobras fundamental fairness and due process.[875]
The parties filed competing motions to confirm and to vacate and Petrobras sought leave to depose the dissenting arbitrator and, two months later, requested leave to serve a subpoena on the AAA.[876] Petrobras claimed that the award violated public policy because the underlying contracts had been procured through bribery and that the panel had failed to issue a reasoned award, required by the contract, as to some of the claims.[877] The District Court denied the discovery and granted the petition to confirm the award and entered judgment on the award, relying on the arbitrators’ findings that, first, Petrobras had not proved bribery and, second, Petrobras had knowingly ratified the contract. Accepting those fact findings, the District Court rejected the public policy challenge because Petrobras had not met its burden to show that the tribunal’s contract interpretation violated public policy.
Petrobras appealed. The confirmation proceedings were subject to Sections 301-307 of the FAA, which govern nondomestic awards subject to the Inter-American Convention on International Commercial Arbitration of January 30, 1975 (the “Panama Convention”).[878] The Court of Appeals first addressed the validity of the contractual waiver of review or appeal.[879] Noting that waivers of all rights of federal court review are not enforceable, the court concluded that it did not need to decide the validity of the waiver if the District Court judgment could be affirmed on the merits.[880]
Turning then to the merits, the Panama Convention allows a country to refuse to recognize or execute an arbitration decision under the Convention if “the recognition or execution of the decision would be contrary to the public policy” of that country.[881] Petrobras renewed its public policy argument that the contract had been procured through bribery. Under the New York Convention, the tribunal’s rulings are entitled to deference; that standard applied here, where Petrobras’ claim was that the underlying contract violated public policy, as opposed to where the award itself, or enforcing the award, would violate public policy.[882] While Petrobras claimed that the panel had applied a flawed definition of ratification on which the District Court relied in rejecting the public policy defense, that claim is that the panel made a mistake of fact or law, which would not provide grounds to refuse to confirm the award.[883]
Finally, the court examined the challenge to the award based on the refusal to allow discovery of the dissenting arbitrator or the AAA, claimed to be necessary to resolve the claim the award should be vacated based on evident partiality and misconduct.[884] The court held that the District Court did not abuse its discretion in concluding that such discovery requests were barred by the rules of the forum, which were incorporated in the parties’ agreement to arbitrate.[885]
The review of the award itself was governed by the FAA, the law of the place where the award was made.[886] Examining each of the bases asserted for vacatur, including the claim that the award against the guarantor was not reasoned, purportedly in violation of the parties’ agreement, the court upheld and affirmed the District Court’s decision that vacatur was not warranted.[887]
EGI-VSR, LLC v. Coderch, 963 F.3d 1112 (11th Cir. (Fla.) 2020). Award properly confirmed under FAA and principles of international comity, with modifications to the calculations as permitted under the FAA.
Shareholder appealed from District Court judgment confirming an award of a Chilean arbitrator enforcing a shareholders’ agreement and requiring the controlling shareholders to buy back shares from EGI-VSR, LLC (“EGI”) under a contractual put provision.[888] The controlling shareholder challenged service of the confirmation proceeding in Brazil under Brazilian law, and claimed the relief the District Court ordered had improperly modified the award.[889]
Service of the confirmation proceeding had been made under the Inter-American Convention on Letters Rogatory (“Convention on Letters Rogatory”).[890] After several unsuccessful attempts to effect service, EGI obtained authority from a Brazilian court to make alternate service on the doorman at the shareholder’s residence.[891] On appeal, the Court of Appeals affirmed the determination of the District Court that it would be improper for an American court to review a decision by the Brazilian court that service of process was carried out in accordance with Brazilian law, under principles of international comity.[892] Turning to the merits of the decision to confirm the award, the court sustained in part the controlling shareholder’s objection that the District Court had erred when calculating the conversion of the price of EGI’s stock into U.S. dollars. Applying U.S. law, based upon the invocation of the FAA, the Court of Appeals held that the proper day to use to calculate the share price was the day the cause of action arose under the FAA, which was the day the award was issued.[893] Additionally, as the award was for specific performance directing the purchase of EGI’s shares, the court vacated the District Court’s order and remanded with instructions to recalculate the purchase price and require the parties to perform their obligations under the shareholders’ agreement by paying the purchase price and tendering the shares.[894]
Process & Indus. Devs. v. Fed. Republic of Nig., 962 F.3d 576 (D.C. Cir. 2020). District court erred in requiring Nigeria to brief the merits of a petition to confirm an arbitration award before addressing immunity under the collateral order doctrine where underlying claim of immunity was colorable.
A dispute between the Federal Republic of Nigeria and Process and Industrial Developments Ltd. (“P&ID”) arising out of the construction of a natural gas processing facility in the Federal Republic of Nigeria was arbitrated under the parties’ contract in London.[895] Nigeria unsuccessfully challenged the liability determination in the United Kingdom courts, and then in the Nigerian courts, which set it aside as inconsistent with Nigerian law.[896] P&ID, which did not appear in the Nigerian proceeding, asked the arbitral panel to hold that the Nigerian court had no jurisdiction, and the panel agreed, considered damages and entered an award in favor of P&ID. P&ID then filed a petition to confirm the award in the U.S. under the FAA, and Nigeria responded by invoking the Foreign Sovereign Immunities Act (“FSIA”).[897] The District Court granted P&ID’s request and ordered Nigeria to present all its defenses—both jurisdictional and merits—in a single response to the petition to confirm.[898] Nigeria appealed the briefing order, and P&ID then moved to dismiss the appeal for lack of jurisdiction.
On appeal, the court first determined that it had jurisdiction to review what P&ID characterizes as nothing more than a briefing order under the collateral order doctrine. Because the District Court conclusively rejected Nigeria’s assertion of immunity from having to defend the merits in this case by requiring consolidated briefing and Nigeria’s immunity defense is at least colorable enough to support appellate jurisdiction.[899] While the FAA seeks to streamline confirmation proceedings, “it does not prevent a foreign sovereign from seeking what the FSIA guarantees—resolution of an immunity assertion before the sovereign can be compelled to defend the merits.”[900] Because immunity would afford complete protection from suit, the colorable assertion of immunity must be resolved before a foreign sovereign may be required to address the merits.[901] Accordingly, the Court of Appeals denied the motion to dismiss the appeal and reversed the decision of the decision of the District Court.[902]
Earth Sci. Tech, Inc. v. Impact UA, Inc., 809 F. App’x 600 (11th Cir. (Fla.) 2020) (per curiam). By incorporating United Nations Commission on International Trade Law (UNCITRAL) rules into their arbitration agreement, the parties agreed to submit the issue of the arbitrability of their dispute to the arbitrators because UNCITRAL Rule 23 provides that the arbitral tribunal has the power to rule on its own jurisdiction.
An exclusive distribution agreement to provide CBD oil for distribution provided for international arbitration through JAMS International using UNCITRAL rules in New York, New York.[903] After a dispute arose, the supplier filed an arbitration demand, and distributor filed a state court action, which was removed to federal court, and stayed pending arbitration. The parties disputed whether tort claims for conversion and tortious interference were within the scope of their broad arbitration clause. The tribunal held the tort claims were arbitrable and proceeded, ultimately entering an award in favor of the supplier. Back in court, the distributor sought to vacate the award claiming, among other things, that the tort claims were beyond the scope of the agreement to arbitrate. The District Court granted the supplier’s motion to confirm the award.
On appeal, the court rejected the distributor’s challenge under Section 10(a)(4) of the FAA, because the arbitration is governed by the Panama Convention, which does not recognize § 10(a)(4) as a basis for refusing to enforce an arbitration award. Under Section 202 of the FAA,[904] arbitration awards arising out of commercial relationships that are not purely domestic are subject to the provisions of the applicable convention.[905] Section 302 of the FAA incorporates § 207, and requires federal courts to confirm an arbitration award unless it finds one of the grounds for refusal or deferral of recognition or enforcement of the award specified in the applicable convention.[906] Article 5 of the Panama Convention provides limited exceptions to object to confirmation of an arbitration award, and none of those grounds were applicable here.[907] As to the complaints about arbitrability, the parties agreed to submit the issue of arbitrability to the arbitrators by incorporation of the UNCITRAL rules, which empower tribunals to rule on their own jurisdiction.[908] Dismissing the distributor’s other complaints about the award as outside the scope of deferential permissible review of arbitration awards, the court affirmed the District Court’s judgment.[909]
OJSC Ukrnafta v. Carpatsky Petro. Corp., No. 19-20011, 2020 U.S. App. LEXIS 14264 (5th Cir. (Tex.) 2020). Federal court has jurisdiction to review international arbitration award, which is not subject to vacatur on any of the multiple challenges presented to contract formation, damages computation, and the preclusive effect of award.
Carpatsky Petroleum Corporation (“Carpatsky”), at the time a Texas company, signed a joint activity agreement (JAA) with Ukrnafta, Ukraine’s recently privatized state oil-and-gas enterprise, to develop a gas condensate field in Ukraine.[910] Ukrainian law governed the JAA, and any disputes would be resolved by an international commercial arbitration tribunal in Kiev. Thereafter, Carpatsky merged into a newly formed Delaware entity with the same name. A few years later, the parties amended the JAA to provide for arbitration in Stockholm; Carpatsky signed with the seal from its Texas predecessor.[911]
After disputes arose, Carpatsky filed an arbitration in Stockholm, describing itself as a Delaware corporation.[912] After initially answering the arbitration, Ukrnafta challenged jurisdiction, claiming that there was no agreement to arbitrate based on the change in Carpatsky entities, and filed suit in Texas state court, asserting claims of negligent misrepresentation, fraud, misappropriation of trade secrets, tortious interference with existing contracts, and unjust enrichment. Carpatsky removed the case to federal court, asserting that the suit related to an arbitration agreement falling under the New York Convention.[913] The federal court denied Ukrnafta’s attempt to seek injunctive relief and to remand the case to state court. In the meantime, the arbitration panel rejected the challenge to its jurisdiction. Ukrnafta then sued Carpatsky in Sweden and Ukraine, and obtained a ruling in Ukraine that the agreements executed after the change in Carpatsky entities were void, including the agreement to arbitrate in Stockholm. Undeterred, the Stockholm tribunal proceeded, entered an award in favor of Carpatsky, and held that the Carpatsky corporation formed in Delaware was a party to the JAA, as the successor to the original Texas company under Delaware law.[914] Carpatsky returned to the federal courts to confirm the award. After the Swedish courts ruled against Ukrnafta, the Texas federal court confirmed the arbitration award, rejecting numerous challenges, and granted summary judgment dismissing Ukrnafta’s state law claims on preclusion grounds.[915] Ukrnafta appealed both rulings.
On appeal, first considering Ukrnafta’s jurisdictional challenge, the Fifth Circuit reaffirmed the rule that federal jurisdiction exists whenever removal is based upon a “nonfrivolous connection” to an international arbitration agreement.[916] Section 205 of the FAA is “one of the broadest removal provisions . . . in the statute books,” and thus removal may be proper even where it turns out that there is no arbitration agreement.[917]
Next, the court methodically dismissed each of the challenges to the arbitration award, deciding that Sweden, the place of the arbitration, had primary jurisdiction, despite the Ukraine choice of law provision, which does not overcome the “strong presumption that designating the place of the arbitration also designates the law under which the award is made.”[918] With only secondary jurisdiction, the United States courts can deny enforcement of an award only on a ground set forth in Article V of the New York Convention.[919]
None of the challenges by Ukrnafta provided valid grounds to deny enforcement. Any challenge to jurisdiction of the tribunal was both without merit, as well as waived by Ukrnafta’s submission to the jurisdiction of the tribunal.[920] As to the merits of the award, the tribunal’s ruling that the JAA’s limitation of liability was unenforceable did not offend basic notions of due process or exceed the terms of the submission to the tribunal.[921] Arguments based on this determination, as well as the panel’s other conclusions, amounted to impermissible challenges to the tribunal’s decision on the merits of the dispute.[922]
Lastly, the court considered the argument that recognition of the awards would violate principles of comity because Ukrainian law would not enforce a contract that country’s courts have deemed illegal.[923] However, American policy favors arbitration, which “applies with special force in the field of international commerce.” [924] Giving a party’s home court veto power over a recognition action in the U.S. would undermine that policy.[925] Accordingly, the judgment was affirmed.
Soaring Wind Energy, L.L.C. v. Catic USA Inc., 946 F.3d 742 (5th Cir. (Tex.) 2020). Where domestic arbitration involve claims of breach by a foreign entity on foreign soil and where the award is rendered against foreign entities, U.S. Federal Courts have jurisdiction over applications to confirm and vacate awards, which awards may be afforded high deference based on agreement between the parties and general principles favoring arbitration.
Catic USA (“Catic”) and Tang Energy Group (“Tang”) formed Soaring Wind Energy, LLC (“Soaring Wind”) and entered into an agreement providing for arbitration of disputes.[926] The agreement provided that each member that is a party to the dispute could name its own arbitrator, and those selected as arbitrators would themselves choose an additional arbitrator (or two additional arbitrators if necessary to achieve an odd number of arbitrators).[927] The panel would have the authority to grant injunctive relief and enforce specific performance and to issue a final, court-enforceable decision, though it would lack authority to award “special, exemplary, punitive or consequential damages.”[928] A dispute arose over financing for Soaring Wind and Tang demanded arbitration against several members, including Catic, along with Catic’s Chinese affiliates, who had not signed the agreement. Seven arbitrators were selected by the parties, other than the Catic affiliates who refused to participate, and the seven arbitrators chose two additional arbitrators. Catic then sued preemptively in federal court, claiming the panel was improperly constituted, arguing both that fundamental fairness and the parties’ agreement required each side of the dispute to select an arbitrator, who would then select a third and final arbitrator.[929] The District Court dismissed those claims for lack of subject matter jurisdiction under the FAA. Catic made similar arguments before the arbitration panel, which determined for itself that it was constituted according to the agreement’s unambiguous terms.[930] The panel conducted hearings in Texas and awarded Soaring Wind $62.9 million in damages against Catic (and its Chinese affiliates) and ordered that Catic be divested of its shares in Soaring Wind without compensation.[931] The parties filed competing applications in federal court to vacate and confirm, and the court bifurcated the case against the Chinese affiliates upon Tang’s application and entered judgment confirming the award against Catic.
The Court of Appeals first turned to subject matter jurisdiction, sua sponte, asking whether the divestiture of Catic’s membership destroyed diversity jurisdiction over the action and whether jurisdiction existed under the New York Convention.[932] As to the latter inquiry, the court examined whether there was sufficient “foreign character” to the parties’ agreement, finding Catic’s status as an affiliate of a Chinese corporate empire beside the point.[933] This appeared to be a close question: the agreement itself made no reference to China or any Chinese citizen, place or entity.[934] Going beyond the face of the agreement, the court found there was a sufficient relation to China to establish federal jurisdiction under the New York Convention because the claimed breach was triggered by the actions of a Chinese entity on foreign soil and the award was against these Chinese affiliates.[935]
As to the merits of the arguments for confirmation or vacatur, the court granted the requisite deference to the panel’s findings, and held that the panel was constituted in accordance with the parties’ agreement.[936] Catic claimed that the arbitrators exceeded their authority by awarding lost profits and divestiture of its interest, because those damages were effectively punitive damages, which were precluded by the parties’ agreement.[937] But the agreement here permitted the arbitrators to award injunctive relief.[938] While conceding that Catic’s theory that divestment effectively doubled the damages and was therefore “substantively indistinguishable” from punitive damages was “well taken,” the broad scope of authority given to the panel, combined with the deference to arbitration, still warranted affirmance of the District Court’s decision confirming the award.[939]
[13] Dept. of Justice, Office of the Senior Counsel for Alternative Dispute Resolution, Policy on the Use of Alternative Dispute Resolution, and Case Identification Criteria for Alternative Dispute Resolution, 61 Fed. Reg. 36895 (July 15, 1996).
[14] Administrative Dispute Resolution Act of 1990, Pub- L. No. 101-551, 104 Stat. 2736-48.
[15] U.S. Dept. of Justice, Antitrust Division, Updated Guidance Regarding the Use of Arbitration and Case Selection Criteria (Nov. 12, 2020), https://www.justice.gov/atr/page/file/1336516/download.
[26]Compare 5 U.S.C.A. § 573(a) and Updated Guidance at 4.
[27]See Uniform Law Commission, Arbitration Act (2000), available at https://www.uniformlaws.org/viewdocument/final-act-1?CommunityKey=a0ad71d6-085f-4648-857a-e9e893ae2736&tab=librarydocuments (last visited Feb. 7, 2021).
[28]Id. See also Thomas E. Carbonneau, The Law and Practice of Arbitration 209 (5th ed. 2014).
[29] See Uniform Law Commission, Arbitration Act (2000), supra n.27.
[31]See Uniform Law Commission, Arbitration Act (2000) Enactment Map, available at https://www.uniformlaws.org/committees/community-home?communitykey=a0ad71d6-085f-4648-857a-e9e893ae2736&tab=groupdetails (last visited Feb. 7, 2021).
[32]See Commonwealth of Massachusetts (191th Gen. Ct.), Bill H. 49 (Mass. 2019), https://malegislature.gov/Bills/191/H59 (last visited Feb. 7, 2021).
[33]See Vermont General Assembly, Bill H.288 (Vt. 2019), https://legislature.vermont.gov/bill/status/2020/H.288 (last visited Dec. 20, 2020).
[34]See Uniform Law Commission, Uniform Mediation Act, available at https://www.uniformlaws.org/committees/community-home?CommunityKey=45565a5f-0c57-4bba-bbab-fc7de9a59110 (last visited Feb. 7, 2021).
[35] The Model Law on International Commercial Conciliation is a 2002 product of the United Nations Commission on International Trade Law (“UNCITRAL”). The 2003 amendment to the UMA provides that “unless there is an agreement otherwise, the UNCITRAL Model Act applies to any mediation that is an ‘international commercial mediation.’” Given the announcement and initial signature of the Singapore Convention on mediation, see infra § 1.2.7, it will be interesting to see if the UMA is amended to accommodate this development.
[37]Id. See also Commonwealth of Massachusetts (190th Gen. Ct.), Bill H. 60, https://malegislature.gov/Bills/191/H60 (last visited Feb. 7, 2021).
[38] The Singapore Convention is another product of UNCITRAL. The text is available at https://www.uncitral.org/pdf/english/commissionsessions/51st-session/Final_Edited_version_in_English_28-8-2018.pdf (last visited Feb. 7, 2021).
[39] The initial signatory States were: Afghanistan, Armenia, Belarus, Benin, Brunei Darussalam, Chad, Chile, China, Colombia, Congo, Democratic Republic of the Congo, Ecuador, Eswatini, Fiji. Gabon, Georgia, Grenada, Guinea-Bissau, Haiti, Honduras, India, Islamic Republic of Iran, Israel, Jamaica, Jordan, Kazakhstan, The Republic of Korea, Lao People’s Democratic Republic, Malaysia, Maldives, Mauritius, Montenegro, Nigeria, North Macedonia, Palau, Paraguay, Philippines, Qatar, Samoa, Saudi Arabia, Serbia, Sierra Leone, Singapore, Sri Lanka, Timor-Leste, Turkey, Uganda, Ukraine, United States of America, Uruguay, Bolivarian Republic of Venezuela.
[40]See United Nations, United Nations Commission on International Trade Law, available at https://uncitral.un.org/en/texts/mediation/conventions/international_settlement_agreements/status (last visited Feb. 7, 2021).
[41]See Carolyn G. Nussbaum and Christopher M. Mason, Alternative Dispute Resolution Law § 1.2.7, 2019 ANNUAL REVIEW OF RECENT DEVELOPMENTS IN BUSINESS AND CORPORATE LITIGATION (ABA 2020) (“2019 ADR Annual Review”).
[49] Convention on the Recognition and Enforcement of Foreign Arbitral Awards, June 10, 1958, 21 U.S.T. 2517.
[50]See 2019 ADR Annual Review, supra n.41 at § 1.2.8.
[51]Chamber of Commerce of the United States v. Becerra, 438 F. Supp. 3d 1078 (E.D. Cal. 2020).
[52]See California Legislative Information, text of Assembly Bill No. 51, available at https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201920200AB51 (last visited Feb. 7, 2021).
[58]See International Chamber of Commerce, 2021 Arbitration Rules, available at https://iccwbo.org/dispute-resolution-services/arbitration/rules-of-arbitration/rules-of-arbitration-2021/#article_b5 (last visited Feb. 7, 2021).
[63]Id.; see also International Chamber of Commerce, ICC Arbitration Rules 2017 & 2021 – Compared Version, available at https://iccwbo.org/content/uploads/sites/3/2020/12/icc-2021-2017-arbitration-rules-compared-version.pdf (last visited Feb. 7, 2021).
[73] International Swaps and Derivatives Association, Inc. ISDA 2020 IBOR Fallbacks Protocol (Oct. 23, 2020), available at http://assets.isda.org/media/3062e7b4/08268161-pdf/ (last visited Feb. 7, 2021).
[81]See International Swaps and Derivatives Association, Inc., 2018 ISDA Arbitration Guide (2018), available at https://www.isda.org/a/5kDME/ISDA-2018-Arbitration-Guide.pdf (last visited Jan. 15, 2021).
[87]See Stephen Trevis, Arbitration Trending in the Derivatives Context: Perspectives, Kluwer Arbitration Blog (March 7, 2020), available at http://arbitrationblog.kluwerarbitration.com/2020/03/07/arbitration-trending-in-the-derivatives-context-perspectives/ (last visited Feb.. 7, 2021).
[88]See 2019 ADR Annual Review, supra n.41 at § 1.3.
[89]GE Energy Power Conversion France SAS v. Outokumpu Stainless USA LLC, 140 S. Ct. 1637 (2020).
[90] Convention on the Recognition and Enforcement of Foreign Arbitral Awards, June 10, 1958, 21 U.S.T. 2517.
[100]See Yang v. Majestic Blue Fisheries, LLC, 876 F.3d 996, 1001-02 (9th Cir. (Guam) 2017).
[101]See Aggarao v. MOL Ship Mgmt. Co., 675 F. 3d 355, 375 (4th Cir. (Md.) 2012); Sourcing Unlimited, Inc. v. Asimco Int’l, Inc., 526 F.3d 38, 48 (1st Cir. (Mass.) 2008).
[102]SeeGE Energy, 140 S. Ct. at 1645 (citing, e.g., 9 U.S.C.A. § 2 (West 2020) and Volt Information Scis., Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U. S. 468, 474 (1989)).
[114]Id. (citing, e.g., 1 G. Born, International Commercial Arbitration § 10.02, at pp. 1418-84 (2d ed. 2014)). Justice Thomas and the Court did not decide whether the Executive Branch’s interpretation of the New York Convention “should affect our analysis,” however. Id. at 1647. Noting that “[w]e have never provided a full explanation of the basis for our practice of giving weight to” such interpretation, or “the limitations of this practice, if any,” the Court concluded that because its “textual analysis” of the New York Convention was consistent with the Executive branch’s interpretation, “there is no need to determine whether the Executive’s understanding is entitled to ‘weight’ or ‘deference.’” Id. (citation omitted).
[118]See 2019 ADR Annual Review, supra n.41 at § 1.3.
[119]Henry Schein Inc. v. Archer and White Sales Inc., 139 S. Ct. 524 (2019) (“Henry Schein I”).
[120]See Archer & White Sales, Inc. v. Henry Schein, Inc., 935 F.3d 274, 277 (5th Cir. (Tex.) 2019), cert. granted, 141 S. Ct. 107 (U.S. June 15, 2020) (No. 19‐963).
[127]See, e.g., More on Delegating the ‘Who Decides’ Question, 38 Alternatives 87, 89-90 (June 2020) (discussing Missouri and Florida decisions which held that incorporation by reference in arbitration rules is not clear enough to constitute delegation to an arbitrator of the issue of who decides).
[128]See, e.g., Brief for the Cross‐Respondent in Opposition, Archer and White Sales, Inc. v. Henry Schein, Inc., No. 19‐1080 (U.S. Apr. 1, 2020).
[304]Id. at 600 (citing and quoting Alpert, Goldberg, Butler, Norton & Weiss, P.C. v. Quinn, 410 N.J. Super. 510, 983 A.2d 604, 617 (N.J. Super. Ct. App. Div. 2009) (quoting 11 Samuel Williston & Richard A. Lord, A Treatise on the Law of Contracts § 30:25 (4th ed. 1999))).
[671]Transcon. Gas Pipe Line Co LLC v. Permanent Easement for 2.59 Acres, No. 19-2738 & 19-3412, 2020 U.S. App. LEXIS 33924, at *2 (3d Cir. (Pa.) Oct. 28, 2020).
[685]Teamsters Local 177 v. UPS, 966 F.3d 245, 248 (3d Cir. (N.J.) 2020).
[686]Id.; Teamsters Local Union No. 177 v. United Parcel Servs., 409 F. Supp. 3d 285 (D.N.J. 2019) (citing Derwin v. Gen. Dynamics Corp., 719 F.2d 484, 492-93 (1st Cir. (Mass.) 1983) and Zeiler v. Deitsch, 500 F.3d 157 (2d Cir. (N.Y.) 2007)).
[687]Teamsters Local 177, 966 F.3d at 248 (citing Florasynth, Inc. v. Pickholz, 750 F.2d 171, 176 (2d Cir. (N.Y.) 1984)).
[780]Id. (contrasting General Statutes § 522-418 (governing vacatur of arbitration awards) with General Statutes § 52-263 (providing the statutory right to appeal in civil actions)).
[804]Id. at *9 (quoting the Chancery Court opinion in Gulf LNG Energy, LLC v. Eni USA Marketing LLC, No. 2018-0700-AGB, 2019 WL 428633, at *10 (Del. Ch. Feb. 1, 2019)).
[820]Compare Rocky Aspen Mgmt. 204 v. Hanford Holdings, 394 F. Supp. 3d 461, 463-65 (S.D.N.Y. 2019) (no), with Dandong v. Pinnacle Performance Ltd., 10 Civ. 8086 (LBS), 2012 U.S. Dist. LEXIS 145454, at *4 (S.D.N.Y. Oct. 9, 2012) (yes).
[821]Accent Delight, 2020 U.S. Dist. LEXIS 230272, at *11 (citing In re Tremont Sec. Law, State Law & Ins. Litig., 699 F. App’x 8, 15 (2d Cir. (N.Y.) 2017)).
[825]See id. at *16 (citing Goodyear Tire & Rubber Co. v. Chiles Power Supply, Inc., 332 F.3d 976, 977 (6th Cir. (Ohio) 2003); Spruce Env’t Techs., Inc. v. Festa Radon Techs., Co., 370 F. Supp. 3d 275, 278-79 (D. Mass. 2019); ACQIS, LLC v. EMC Corp., Civil Action No. 14-cv-135602017, U.S. Dist. LEXIS 100856, at *2 (D. Mass. June 29, 2017); Folb v. Motion Picture Indus. Pension & Health Plans, 16 F. Supp. 2d 1164, 1181 (C.D. Cal. 1998), aff’d 216 F.3d 1082 (9th Cir. (Cal.) 2000); Sheldone v. Pa. Tpk. Comm’n, 104 F. Supp. 2d 511, 513 (W.D. Pa. 2000); In re RDM Sports Grp., Inc., 277 B.R. 415, 430 (Bankr. N.D. Ga. 2002)).
[826]See id. at *15 (citing United States ex rel. Strauser v. Stephen L. Lafrance Holdings, Inc., No. 18-CV-673-GKF-FHM, 2019 U.S. Dist. LEXIS 197688, at *2 (N.D. Okla. Nov. 14, 2019); Ford Motor Co. v. Edgewood Props., Inc., 257 F.R.D. 418, 423 (D. N.J. 2009); Lesal Interiors, Inc. v. Resol. Tr. Corp., 153 F.R.D. 552, 562 (D. N.J. 1994)).
[838]See In re Guo, 965 F.3d 96 (2d Cir. (N.Y.) 2020); Nat’l Broad. Co. v. Bear Stearns & Co., 165 F.3d 184, 191 (2d Cir. (N.Y.) 1999); Republic of Kazakhstan v. Biedermann Int’l, 168 F.3d 880, 883 (5th Cir. (Tex.) 1999).
[839]Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241 (2004) (“Intel”).
[840]SeeAbdul Latif Jameel Transp. Co. v. FedEx Corp. (In re Application to Obtain Discovery for Use in Foreign Proceedings), 939 F.3d 710, 714 (6th Cir. (Tenn.) 2019).
[853]Intel, 542 U.S. at 258 (emphasis added) (quoting Hans Smit, International Litigation Under the United States Code, 65 Colum. L. Rev. 1015, 1026 n.71 (1965)).
[854]Hanwei Guo, 965 F.3d at 104 (citing In re Application, 939 F.3d at 725 n.9 (“determining only that ‘the Supreme Court’s approving quotation of the Smit article . . . provides no affirmative support’ for a reading of the statute that excludes private arbitration”)).
[856]Abdul Latif Jameel Transp. Co. v. FedEx Corp. (In re Application to Obtain Discovery for Use in Foreign Proceedings), 939 F.3d 710 (6th Cir. (Tenn.) 2019).
[918]Id. at *11 (citing the New York Convention at Art. V(1)(e); Karaha Bodas Co. v. Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, 364 F.3d 274, 287-88 (5th Cir. (Tex.) 2004)).
There are a multitude of issues and terms to address when companies merge or when one company acquires another. One aspect of the deal that is often overlooked is insurance. Specifically, directors and officers liability insurance, also known as D&O insurance, is an essential part of any merger or acquisition and must be carefully considered in order to avoid significant liability down the road. Companies should not overlook the option of representations and warranties coverage when planning a merger or sale.
This is especially true in the current climate. Merger and acquisition activity since the latter half of 2020 has seen unprecedented growth. Some bankers have said that the M&A market has gone into “overdrive” and the number of mergers and acquisitions is “far beyond the historical norm.”[1] With this increased M&A activity, litigation resulting from the transaction – including shareholder lawsuits – is inevitable. According to Cornerstone Research, 82% of the significant deals announced in 2017 and 2018 were challenged by shareholders, resulting in roughly three lawsuits filed per challenged deal.[2]
Suffice it to say, the risk and exposure in a merger or acquisition is high, for the companies involved but also individual executives. This article addresses some of the key insurance issues that decision makers should keep in mind to mitigate that risk and maximize coverage.
D&O Insurance
D&O liability insurance is meant to protect directors and officers if they are named as individual defendants in lawsuits for acts taken in their roles as such. D&O insurance protects the insureds in the event of suits by plaintiffs such as employees, shareholders, competitors, investors, and customers. Some D&O policies also provide coverage for the company.
D&O policies usually provide coverage for legal fees incurred as well as amounts paid by the insureds in judgments or settlement disbursements. If the directors and officers are entitled to indemnification from the company by way of company bylaws or their employment contracts, that indemnity obligation is typically backed financially by a D&O policy.
Change in Control Provisions
D&O insurance policies typically insure against certain “Wrongful Acts” as defined by the policy that the company or other insureds allegedly commit. These policies often contain a “change in control” provision that limits the available coverage for these “Wrongful Acts” if there is a change in company ownership. Before any merger or acquisition, it is crucial to review and understand any change in control provisions and corresponding notice requirements to keep the intended insurance in place, uninterrupted, or secure new coverage.
Change in control provisions are generally triggered upon the happening of a named event (i.e., mergers, acquisitions, or change in voting control). When that triggering event occurs, coverage under the policy changes. While the change in coverage will depend on the specific policy language, the provisions typically provide that the policy will not insure “Wrongful Acts” that occur after the triggering event and will only cover acts that occurred prior to the change in control. That is, the policy will cover acts and omissions which occurred in the regular course of business, but not those after a change in control when circumstances (e.g. management, business goals, or other essential characteristics of the insured) have been altered. When the triggering event occurs and the coverage terminates, the policy is placed into run-off (discussed below). Note that the change in control provisions in some D&O policies are even stricter and eliminate all coverage, even for acts and omissions that predate the change in control.
Questions of change in control are highly fact-specific and are determined by the policy language, deal specifics, and the governing law. Therefore, it is important to understand these nuances before any deal, especially because once the provision is triggered, it can create unintended gaps or even eliminate all D&O coverage.
A change in control provision can also include notice conditions that require the insured to provide notice to the insurer within a specific time frame (either in advance of a deal or after its completion) to preserve coverage for the new entity. Like all notice requirements in an insurance policy, it is imperative that an insured not overlook these notice requirements, or the company risks losing coverage.
Tail or Runoff Coverage
D&O insurance policies are typically written on a “claims-made” basis, which generally means that the policy covers claims made while the policy is in effect. As addressed above, if a merger or acquisition triggers a policy’s change in control provision, then any claims based on conduct after the transaction date may not be covered and any claims presented for pre-transaction conduct will only be covered through the end of the policy period (likely a matter of months after the transaction). This creates a potential gap in coverage because the acquiring company’s policy will not respond on behalf the selling company’s directors and officers for pre-transaction conduct.
How, then, do you cover claims for pre-transaction conduct that are made after the policy expires? The answer is “tail” or “runoff” coverage. This coverage extends the D&O insurance policy for a certain period of time beyond the standard policy period. Essentially, the D&O insurance policy is held open for a certain number of years to address claims that may arise after the deal is closed. Typically, the tail or runoff period is six years.
Accounting for tail or runoff coverage is critical because it safeguards the directors and officers of the selling company in the event the acquiring company refuses to protect them or, in the case of bankruptcy, is not there to protect them. Accordingly, the purchase of a tail or runoff policy should be a critical deal point for the selling company in any negotiation.
Bump-Up Clauses
Following a merger or acquisition, it is not uncommon for shareholders of the purchased entity to file suit claiming that the consideration paid for the purchased shares was inadequate and seeking recovery of the difference between the amount they received in the transaction and what they claim is the actual value of those shares. Such a claim may implicate the “bump-up” clause found in many D&O policies. “Bump-up” provisions are generally found in the policy’s definition of Loss, and state that Loss does not include those amounts of any judgment or settlement that represent the amount by which the consideration paid in connection with the purchase of securities is increased.
Although such provisions are common, they vary substantially from policy to policy. For example, many bump-up provisions do not bar coverage for defense costs for claims asserting inadequate consideration. Others apply only to claims made under specific insuring clauses;[3] and yet others apply only when the amount representing the increase in consideration is paid by the insured corporation, and not by any director or officer.[4] Therefore, it is worthwhile to take a careful took at any D&O policy’s definition of “Loss,” both at the time of negotiation of the policy and in connection with any claims under the policy.
R&W Insurance: Coverage for the Merger or Acquisition Itself
While insurance considerations in corporate transactions are often focused on ensuring that there is adequate and available coverage in place if a company or other insured faces potential liability, insurance coverage is also available for the deal itself. This kind of insurance is called Representation and Warranties (R&W) insurance. Like the name suggests, R&W insurance protects a buyer or seller in a corporate transaction, like a merger or acquisition, from losses arising from inaccurate representations or warranties made by the seller or target company during the transaction. For example, a buyer-side R&W policy can protect the buyer by paying losses if the target company presents inaccurate information, misrepresents information, or fails to disclose particular liabilities. R&W insurance can also mitigate risk if a seller offers little or no indemnity protection for the deal itself.
[3]See, e.g.,Genzyme Corp. v. Federal Ins. Co., 622 F.3d 62, 72 (1st Cir. 2010) (“bump-up” provision applied only to Insurance Clause 3).
[4]See, e.g., Arch Ins. Co. v. Murdock, 2019 WL 2005750, at *9 (Del. Super. Ct., May 7, 2019) (definition of Loss did not include “any amount representing the increase in the consideration paid (or proposed to be paid) by the Policyholder in connection with its purchase of any securities or assets”).
Non-disclosure agreements (“NDAs”) serve a pivotal role in advancing research and development. NDAs enable parties to collaborate using information that its owners would otherwise be unwilling to share absent the protections NDAs afford. While NDAs can take many forms and be individually tailored to each situation, the basic premise is typically the same: at least one party possesses confidential information (for example, a new product, valuable research, special know-how, etc.) that it will share with the other party in furtherance of a common goal (producing the product, using the research, performing a task requiring the know-how, etc.). In exchange, the receiving party agrees to keep that information secret and not otherwise take the knowledge for its own use without permission. Sometimes the collaboration is successful; but other times, despite the parties’ best efforts, the project stalls and the sides part ways – amicably or not.
As with any contract, disputes may occur, particularly when the results fall short of the goal. Litigation is sure to arise when, a year or two later, a company announces a product that its former collaborator finds a bit too similar to the aborted joint project. No one likes to be sued, but being accused of (and possibly found liable for) misusing someone else’s confidential information can be especially troublesome for a business. The other company is a thief in the plaintiff’s eyes (and pleadings) – an accusation that can turn away customers or investors, and generate negative public opinion. Even if the breach resulted from a misunderstanding, others may now be reluctant to share sensitive material with the accused company for fear of being its next “victim,” which can harm sales, development, and more.
The potential for this public relations headache is why extra care and attention should be paid to ensuring compliance with an NDA. Unfortunately, various factors can make this task difficult, particularly in larger companies that handle numerous NDAs or where a great number of people may be involved. Below are some suggestions your company can take when entering and working under an NDA that may strengthen certain defenses in a later litigation, or hopefully help avoid a dispute altogether.
1. Make Employees Aware
An NDA’s terms most directly apply to the engineers, scientists, technicians, or others actually working with the received confidential information. But many of them never actually see the document, which is often signed and retained by an executive or general counsel. This is a critical mistake – those with the greatest need for the information should be aware of their responsibilities in protecting it. Provide a copy of the NDA to any employee you expect will access the received confidential information and get at least a written acknowledgement from those employees that they have received and reviewed the agreement. This can even be made mandatory within the NDA itself. For example, a form to be executed by the receiving employee may be included as an Appendix to the agreement. The employee can sign and return the form upon receipt. Copies of such acknowledgements can also be exchanged among the parties.
This practice serves several purposes. First and foremost, it lessens inadvertent disclosure by employees, who are now explicitly aware of their obligations not to misuse or divulge confidential information. A better-informed employee can more easily avoid information-sharing mistakes. Second, requiring written acknowledgements may limit the number of employees exposed to the confidential information. Employees (or their supervisors) with only a tangential or trifling need to see the material may decide it is not worth the effort of complying with the rigid formalities of the NDA, thereby shrinking the potential pool of responsible employees to only those truly requiring access. Finally, obtaining written acknowledgements is a great way to track viewers or custodians of the confidential information. For example, if materials need to be collected for return to the disclosing party, the signed forms provide a self-contained list of employees who should be asked for such documents to return. You will also know exactly who your most likely witnesses are should a dispute arise.
2. Set Automatic Calendar Reminders
An NDA seldom includes only a single date or deadline. In addition to an expiration date for the agreement, the NDA will typically recite another (usually later) date when confidentiality obligations cease. For example, although the NDA’s basic terms could expire (or be cancelled) tomorrow, the parties may still have to avoid disclosing or using confidential information for another three years. An NDA can also have deadlines for renewing or extending the agreement (e.g., thirty days before expiration), for returning or destroying confidential information in the receiving party’s possession (e.g., ten days after expiration), and for submitting notices to the other side regarding various aspects of the agreement, among other things. So, there are potentially many dates to track from a particular NDA, and if your company sees hundreds of agreements a year, remembering all those dates is impossible.
Every company has a computerized calendar in some form, but people do not often think to input contract dates in their calendars, particularly for NDAs. Setting automated reminders for as many of these dates as possible is a great way to make sure your company does not miss an important milestone and potentially expose the company to litigation. Having calendar alerts also minimizes the possibility of entirely overlooking actions that need to be performed. Many agreements expire long after work on the project has already ceased, so deadline actions triggered by the expiration date might otherwise slip through the cracks because the NDA or the disclosing party is no longer front of mind. For example, forgetting to return confidential material to the disclosing party can create long term issues for potential dispute, either by creating implications that your company used the information still in its possession or by providing an opportunity to mistakenly use it contrary to the agreement. Rather than simply executing the NDA and filing it away, automated reminders should be set for your company’s protection.
3. Centralize Storage
Not all confidential information warrants protection by armed security guards and simultaneous key turning (although the disclosing party may believe differently), but the concept of centralizing and limiting access to the received materials is instructive. Accidental disclosure or misuse is more likely to occur when access is unfettered and employees have documents lying unsecured on their desks. When possible, physical embodiments of the confidential information (e.g., printed documents, prototypes, samples) should be kept in a single, preferably securable location, such as a lockable cabinet. It may also be advisable to have employees sign in and out when removing and returning the materials. That way, it can be easier to track who has what and where.
Digital information is trickier, but comparable procedures can be implemented to secure the material. Many companies (particularly after COVID-19 accelerated the transformation to remote work) now have centralized servers or cloud-based document storage options. If the disclosing party allows, it is preferable to set up a folder or other similar structure in the server or cloud and encourage employees to store documents referencing or relating to the confidential information in that location, rather than on their local hard drives. This reduces unnecessary and uncontrolled proliferation and lessens the danger from localized security breaches; it is, however, crucial that these central locations have appropriate security safeguards to prevent unauthorized outside access – so it is ideal to have the folders containing confidential information password protected or restricted to particular internal users. Many document management software programs can limit access to specified folders to select individuals or groups, and wall off others. In some of these programs, the very existence of the file or folder may be invisible to employees without proper credentials. In short, it is much easier to maintain control over confidential information when it resides in one or two known and secured locations, as opposed to being scattered between offices or individual personal computers.
4. Document Interaction
Make sure at least one person involved with the confidential information is a good note taker. Work performed under an NDA often involves multiple meetings, telephone calls, and/or video conferences, both internally and with the disclosing party. It is important to document these calls/meetings carefully and contemporaneously, and then store those notes safely. The minutes should ideally list all of the attendees and the subject matter discussed. For instance, issues may arise when it is discovered for the first time during a deposition years later that Bob, an employee unaware of the NDA, showed up at just one of many meetings about the confidential information and then started using what he learned there in his own work. By tracking attendees, your company can know who was at the meetings and whether follow-up is needed with them to emphasize their responsibilities under the NDA (and obtain a signed acknowledgement, as discussed above).
Moreover, some confidential information may only be communicated verbally during one of these meetings, rather than in a document or physical manifestation. Meeting notes help establish whether (or not), when, and to whom such information was communicated. Without a document trail showing the receipt (or non-receipt) of confidential information, these notes may be the only physical evidence available regarding information exchange. If a disclosing party claims they told your company’s employees of their special widget during a meeting and legitimate documentation from that meeting exists indicating the contrary, your company is already in a better position than engaging solely in a battle of employee memories. Of course, when technically possible and if all parties agree, recording a meeting via audio/visual means can accomplish this task as well.
5. Demand Clarity
Many NDAs require that information deemed confidential be marked as such – for example, by placing a “Confidential” or similar label on appropriate documents. The receiving party benefits from this requirement because it allows the receiving party to clearly distinguish between information that needs protection and information that does not. But these NDAs are usually very forgiving for the disclosing party if they forget to label – unmarked information must typically be treated as confidential regardless, and if specifically brought to its attention, the disclosing party has a grace period to revise labels as appropriate.
It is in your company’s own best interest to make sure a disclosing party is following the rules. If information is received that may only arguably be confidential and is not marked, bring it to the disclosing party’s attention and get the issue resolved right away. The disclosing party may otherwise believe the information is confidential, the receiving party may believe it is not based on the lack of marking, and now a fact-finder or jury is deciding who is right. Avoid that later dispute and make the disclosing party be clear up front.
6. Proactively Limit Overreach
A disclosing party’s solution to the above problem might be to mark everything confidential and save themselves the trouble. But this overreach can be just as difficult for a receiving party as a lack of sufficient marking, since it inhibits clarity on what is permissible under the agreement. An NDA always defines the scope of confidential information, and usually excludes information previously publicly available or already known to the receiving party. To protect your company from overreach, search for articles, published patent applications, advertisements, or other similar publicly available information relevant to the project. Better still, request copies of that information from the disclosing party. Collect all of it, preferably before the collaboration gets heavily underway, and store it in a secure place with date stamps.
This research serves two primary purposes. First, having it on hand during the collaboration helps those working on the project to know, at the time, which received information needs protection and dissuades the disclosing party from over-designating. Second, doing the research up front shows diligence from the start, which will have better appeal to a fact-finder or jury in the event of a dispute. Third parties (judges, arbitrators, jurors) may perceive research conducted after the fact as an effort to excuse a breach, whereas early research can lessen the impression of wrongdoing.
7. Exercise Your Rights
Perception can have a powerful impact on a fact-finder or jury. When the evidence suggests one side received everything and gave nothing, the odds of successfully defending a breach suit may drop, even if – technically – that side is right under the letter of the contract. There is a worthwhile benefit in being able to show some important contribution to the project. Accordingly, particularly when the NDA is mutual, be sure your company is protecting its own information. For example, conspicuously label your company’s own confidential information appropriately when sharing it with the other side, and remember to request return or destruction of any of your company’s confidential information in the other side’s possession. Even when the NDA is not mutual, be sure to contemporaneously document everything your company gives to, or shares with, the other side during development to establish that the flow of information is not a one-way street. Juries are more willing to side with a party that actively collaborated in the process than a party that sat back and raked in the other side’s content.
There are no guarantees when it comes to litigation. But by following these steps before, during, and after an NDA’s term, your company can reduce the opportunities for breach (or perceived breach) and bolster its defenses with diligence.
Thryv, Inc. v. Click-to-Call Techs., LP, 140 S.Ct. 1367 (2020)
Facts: This case concerns whether a party may appeal a decision by the Patent Trial and Appeal Board (“Board”) as to whether institution of inter partes review is permissible under 35 U.S.C. § 315(b)’s “time bar” provision.
Click-to-Call owns a patent claiming technology for anonymous phone calls. In 2001, the exclusive licensee of Click-to-Call’s patent sued a predecessor of Thryv for patent infringement. The suit was voluntarily dismissed without prejudice. Twelve years later, in 2013, Thryv petitioned the Board to institute inter partes review of the patent. In opposing the petition, Click-to-Call argued that the prior 2001 lawsuit triggered § 315(b)’s time bar on the institution of inter partes review, which prohibits review “if the petition requesting the proceeding is filed more than one year after the date on which the petitioner, real party in interest, or privy of the petitioner is served with a complaint alleging infringement of the patent.” 35 U.S.C. § 315(b).
The Board rejected Click-to-Call’s argument and instituted inter partes review, holding that § 315(b)’s time bar did not apply when a complaint is dismissed without prejudice. The Board decided the merits of the inter partes review, and Click-to-Call appealed to the Federal Circuit. The Federal Circuit dismissed the appeal for lack of jurisdiction, holding that 35 U.S.C. § 314(d)’s bar on appeal of the Board’s institution decisions precludes judicial review of the Board’s application of § 315(b). After the Supreme Court addressed the scope of § 314(d) in Cuozzo Speed Technologies v. Lee, 136 S. Ct. 2131 (2016), however, the Court granted certiorari, vacated the judgment, and remanded to the Federal Circuit.
The Federal Circuit panel reached the same decision on remand, but after a split court decided en banc in another case that time-bar determinations under § 315(b) are appealable, the Click-to-Call panel granted panel rehearing and held that the Board should have declined to institute the inter partes review because the 2001 patent infringement complaint triggered § 315(b)’s one-year time bar. Thryv then filed a petition for certiorari, and the Supreme Court granted review.
Held: The Board’s decision as to whether institution of inter partes review is time-barred by § 315(b) is final and not appealable.
Reasoning: The Court held that § 315(b)’s time limitation on the filing of a petition for institution of inter partes review provides an integral condition on institution. The Court noted that the language of § 315(b) itself provides a circumstance in which “[a]n inter partes review may not be instituted.” Because § 315(b) merely places a condition on institution, disputes about whether a petition fails to comply with § 315(b) raise an ordinary dispute as to whether the Board should institute inter partes review. Such ordinary disputes fall within the ambit of the Court’s holding in Cuozzo that § 314(d) bars review of matters “closely tied to the application and interpretation” of statutes related to the institution decision.
The Court found that its conclusion was consonant with the purpose and design of the America Invents Act to reform the patent system to efficiently weed out bad patent claims. The Court noted that appeals of § 315(b) decisions would unwind the Board’s merits decision on patentability; since a patentee would only need to appeal on § 315(b) grounds when it lost on the merits of its patent, § 315(b) appeals would only save patents that the Board would have canceled. The Court further noted that because § 315(b) does not bar all review of a patent, merely review by a certain petitioner, it was unsurprising that a statutory scheme so consistently elevating resolution of patentability over a petitioner’s compliance with § 315(b) would preserve the Board’s adjudication of patentability by making § 315(b) decisions unappealable.
Justice Gorsuch dissented, joined in part by Justice Sotomayor. The dissent would have adopted a narrower interpretation of § 314(d), in which the only final and unappealable decision related to institution would be the Board’s finding that a petitioner has or has not shown a “reasonable likelihood” that a challenged patent is unpatentable.
Facts: This case concerns the patent eligibility of patent claims purportedly directed to a natural phenomenon.
Illumina owns patents directed to methods for preparing a fraction of cell-free DNA that is enriched in fetal DNA. Illumina sued Ariosa Diagnostics for infringement of these patents, and Ariosa moved for summary judgment that the asserted claims were invalid under 35 U.S.C. § 101. The district court granted Ariosa’s motion, holding the claims patent-ineligible. On appeal, the Federal Circuit reversed, finding the claims were directed to a patent-eligible “method of preparation.” The panel granted rehearing and issued a modified opinion retaining its original holding.
Held: Patent claims reciting physical steps changing the composition of a naturally occurring mixture of DNA based on human-engineered parameters, rather than merely observing the composition, are not directed to a natural phenomenon, and are thus eligible for patenting under 35 U.S.C. § 101.
Reasoning: The court highlighted two key points of the claims-at-issue that distinguished them from claims merely directed to a patent-ineligible natural phenomenon. First, the claims recited a “method of preparation,” analogous to a method of treatment in that the claims are not directed to a natural phenomenon, but rather to a patent-eligible method using the natural phenomenon. The claims used the natural phenomenon because they required discriminating and removing certain DNA fragments based on human-engineered size thresholds to optimize the sample for genetic testing, not merely observing the size of the DNA fragments. Second, the court found that the discriminating and removing steps not only apply the natural phenomenon, but also do so in concrete, physical process steps changing the composition of the DNA mixture. Both factors distinguished the case from Ariosa Diagnostics, Inc. v. Sequenom, Inc., 788 F.3d 1371 (Fed. Cir. 2015), which found a method of detecting fetal DNA patent-ineligible; the court explained that, in contrast to this case, Ariosa involved a patent directed to merely detecting a natural phenomenon after a sample had been prepared or extracted.
Judge Reyna dissented. In his view, the claims were patent-ineligible because the claimed advance was a natural phenomenon, and the method steps did not transform the nature of the claims into patent-eligible subject matter. He argued that the claimed method steps that the majority found to concretely apply the natural phenomenon were routine and conventional, and that the patent’s written description described the claimed advance forming the basis of the present invention as the discovery of the natural phenomenon. According to Judge Reyna, Ariosa was decided on the same considerations, and thus bound the panel to conclude that the claims-at-issue in this case were patent ineligible.
Facts: This case concerns the patent eligibility of patent claims purportedly directed to a natural law.
American Axle owns a patent claiming methods for manufacturing automobile driveline propeller shafts (i.e. shafts that transmit power from the engine to the wheels) with liners to attenuate vibrations transmitted through the shaft assembly. American Axle sued Neapco for patent infringement, and Neapco moved for summary judgment that the claims were patent ineligible under 35 U.S.C. § 101. The district court granted Neapco’s motion, holding the claims patent ineligible. On appeal, the Federal Circuit initially affirmed the district court’s grant of summary judgment in its entirety, but the panel granted rehearing and revised its decision to vacate and remand the district court’s decision as to certain claims.
Held: Patent claims reciting a mere result from applying a natural law, without limiting the claims to particular methods of achieving the result, are not eligible for patenting under 35 U.S.C. § 101.
Reasoning: The court found the claim that it held ineligible to merely claim a desired result from applying a natural law. The court noted that Supreme Court and Federal Circuit precedent have consistently rejected claims that state a goal without a solution as patent ineligible—claims must have the specificity to transform the claim from reciting merely a result, to reciting a specific way of achieving the result. The court explained that, while this concept has typically applied to cases holding claims ineligible as directed to abstract ideas, the principle necessarily applies to other categories of patent-ineligible subject matter. The court rejected the patentee’s arguments that persons of ordinary skill in the art would find applying the natural law difficult in practice, and that the claims were thus not merely directed to claiming a result, and found that the patentee had failed to claim the physical structure or steps needed to achieve the result.
Judge Moore dissented. She would have held that the claims, in fact, contain a specific, concrete solution to a problem, and that any need for trial and error in performing the method raised an enablement problem under 35 U.S.C. § 112, not a § 101 patent ineligibility problem. Judge Moore argued that because the claims, specification, and prosecution history did not mention the name or formula of the asserted natural law, the claims could not properly be considered directed to the natural law.
Facts: This case concerns whether prior art disclosing the administration of a biological substance when made by one process, anticipates a method of treatment patent claim reciting the administration of the same biological substance when made from another process.
Biogen owns a patent claiming a method for immunomodulating, or treating a viral condition by administering “a recombinant polypeptide produced by a non-human host.” Biogen sued Serono for patent infringement. A jury found Biogen’s patent invalid as anticipated, but the district court granted Biogen’s post-trial motion for judgment as a matter of law that the patent was not anticipated, finding as one ground that the “produced by a non-human host” limitation overcame shortcomings in the prior art. On appeal, the Federal Circuit vacated and remanded.
Held: Under the product-by-process doctrine, method of treatment claims may not be distinguished from the prior art based on the manufacturing process of the administered drug product.
Reasoning: The court noted that the product-by-process doctrine has long held that old products are not patentable, even when made by a new process. The court then rejected Biogen’s arguments that this doctrine is limited to composition claims, and thus not applicable to the method of treatment claims at issue here. The court explained that no logical reason exists for why nesting a product-by-process limitation within a method of treatment claim, rather than a composition claim, should change how the novelty of the limitation is evaluated, especially when neither the composition nor the method of administration of the composition are novel. The court noted that, when the novelty of a method of treatment claim rests entirely on the novelty of the composition administered, which in turn rests on the novelty of a product-by-process limitation, the anticipation analysis for the composition and for the method of treatment will necessarily result in the same conclusion.
GlaxoSmithKline, LLC, v. Teva Pharms. USA, Inc., 976 F.3d 1347 (Fed. Cir. 2020)
Facts: This case concerns whether a generic drug company induces infringement of patents claiming certain methods of administering a drug, when the generic drug’s label does not specify those uses.
GlaxoSmithKline (GSK) owns a patent on a method for using a drug (that was originally approved for treating hypertension) to treat congestive heart failure. GSK sued Teva for patent infringement. The jury found that Teva had induced infringement of GSK’s patent, but the district court granted Teva’s motion for judgment, as a matter of law, that it had not induced infringement. The district court reasoned that GSK had not sufficiently proved that Teva’s actions caused physicians to administer the generic drug to treat congestive heart failure simply because physicians would have known of the possible uses of the generic drug from GSK’s promotion of the branded drug. On appeal, the Federal Circuit reversed the grant of JMOL and reinstated the jury verdict.
Held: Promotion of a generic drug’s therapeutic equivalence to the branded drug can provide sufficient evidence to find that the generic drug company induced infringement of patents claiming uses of the drug that are not present on the generic drug’s label.
Reasoning: Noting that a plaintiff can prove the intent element of induced infringement through circumstantial evidence, the court held that GSK had presented sufficient evidence from which the jury could have reasonably issued its verdict of induced infringement. The court highlighted in particular several Teva press releases and reference documents for physicians that emphasized that Teva’s drug was an AB-rated equivalent of the branded drug, and the testimony of a physician that this equivalence would lead a physician to prescribe the generic drug for all uses of the branded drug, not just the uses on the generic drug’s label. The court held that the district court had applied an incorrect legal standard when it granted JMOL, because when the provider of an identical product knows of and markets the same product for intended direct infringement activity, the criteria of induced infringement are met.
Chief Judge Prost dissented. She would have affirmed the district court’s ruling because, in her view, GSK presented no evidence establishing that Teva actually caused the infringement of the patent method, and because the record established that doctors relied on other sources of information, not Teva, in deciding to prescribe the generic drug for the patented method of treatment. Chief Judge Prost argued that the majority’s holding improperly nullified the practice of “skinny labeling” under 32 U.S.C. § 355(j)(2)(A)(viii), in which a generic drug manufacturer can “carve out” certain patented uses of a drug from its labeling, so that it may sell a drug for unpatented uses without risking liability for still-patented uses.
Personalized Media Commc’ns, LLC, v. Apple Inc., 952 F.3d 1336 (Fed. Cir. 2020)
Facts: Personalized Media Communications (PMC) owns a patent claiming methods for enhancing broadcast communications with user-specific data. Apple petitioned for inter partes review of the patent, and the Patent Trial and Appeal Board found the claims unpatentable. PMC challenged the Board’s claim construction on appeal, and the Federal Circuit reversed the Board’s decision as to the improperly-construed claim.
Held: A patent applicant’s repeated and consistent remarks can define a claim term, even if those statements are not a clear and unmistakable surrender of claim scope sufficient to rise to the level of disclaimer.
Reasoning: The court explained that the Board erred in finding the prosecution history irrelevant because it did not clearly and unmistakably surrender claim scope. The court noted prior holdings that prosecution history is relevant to the meaning of disputed claim terms, even where prosecution history statements do not rise to the level of unmistakable disavowal. The court noted that here, where the claim term had no plain or ordinary meaning, and where the specification provided no clear interpretation of the claim, repeated and consistent remarks in the prosecution history would be especially relevant to the claim’s interpretation, and, in fact, decisive as to the meaning of the claim.
Godo Kaisha IP Bridge 1 v. TCL Commc’n Tech. Holdings, Ltd., 967 F.3d 1380 (Fed. Cir. 2020)
Facts: This case addresses whether proof of compliance with a technical standard can be used to show infringement of a standard-essential patent.
Godo Kaisha IP Bridge 1 (IP Bridge) owns two patents essential to the LTE wireless communication standard. It sued TCL for infringement of these patents. At trial, IP Bridge introduced evidence showing that the asserted claims are essential to mandatory sections of the LTE standard, and that the accused products comply with the LTE standard. The jury found that TCL infringed the patents. On appeal, the Federal Circuit affirmed.
Held: Proof of compliance with a technical standard can be used to show infringement of a mandatory standard-essential patent, and is a question to be resolved by the trier of fact.
Reasoning: The court noted that in, Fujitsu Ltd. v. Netgear Inc., 620 F.3d 1321 (Fed. Cir. 2010), the court held that a district court may rely on an industry standard in assessing infringement. The court highlighted Fujitsu’s note that, although a patent’s claims cover an industry standard, the claims might not cover all implementations of the standard, so the accused product’s standard compliance alone might not provide sufficient evidence to establish the accused product’s infringement. The court pointed out that in cases like this one, where a patent covers mandatory aspects of a standard, however, infringement can be proved by merely showing compliance with the standard. The court rejected TCL’s argument that the district court must determine, as a matter of law, and a part of claim construction, whether the scope of the claims includes any device that practices the standard. Instead, the issue of whether the asserted claims are, in fact, essential to all implementations of an industry standard, was a question to be resolved by the trier of fact, in the context of an infringement trial.
Facts: This case addresses whether a patent license agreement applies to child patents of the licensed patents.
Cheetah Omni owns patents directed to optical communication networks. Cheetah sued AT&T for patent infringement. AT&T’s supplier of the accused products, Ciena, moved to intervene, and, after the district court granted the motion to intervene, moved for summary judgment that Cheetah’s prior license agreement with Ciena included an implied license to the patents-in-suit, which were a continuation, and a continuation-in-part of an expressly licensed patent. The district court granted the motion for summary judgment. On appeal, the Federal Circuit affirmed.
Held: Granting a license for a parent patent creates an implied license for a child patent.
Reasoning: The court noted that in TransCore, LP v. Electric Transaction Consultants Corp., 563 F.3d 1271 (Fed. Cir. 2009), the doctrine of legal estoppel required that a licensee received an implied license to a related, later-issued patent that was broader than and necessary to practice an expressly licensed patent. The court extended this holding to expressly apply to continuation patents with narrower claims than the parent patent in General Protecht Group, Inc. v. Leviton Manufacturing Co., 651 F.3d 1355 (Fed. Cir. 2011). The court rejected Cheetah’s arguments that General Protecht applied only to licenses executed before the continuation patent was issued; the court explained that the timing of the patent issuance was not essential to General Protecht’s rationale, and, in fact, the policy concerns made General Protecht’s rationale more appropriate for already-issued continuation patents. Finally, the court noted that the naming of certain patents expressly in the license agreement did not evince a clear mutual intent to exclude other unnamed patents from falling within the general definitions in the agreement.
Hologic, Inc. v. Minerva Surgical, Inc., 957 F.3d 1256 (Fed. Cir. 2020)
Facts: This case addresses whether the doctrine of assignor estoppel applies to prevent the assignor from raising as a defense that the patentee is collaterally estopped from asserting claims found unpatentable in an inter partes review.
Hologic owns patents claiming methods for determining the presence of uterine perforations prior to performing endometrial ablation of a uterus. Hologic sued Minerva Surgical for infringement of these patents. The district court granted Hologic’s motion for summary judgment that assignor estoppel barred Minerva Surgical’s invalidity defenses to Hologic’s patent infringement claims because Minerva Surgical’s founder assigned both of the patents-in-suit to Hologic’s predecessor.
In parallel, Minerva Surgical petitioned for inter partes review of one of the patents. The Patent Trial and Appeal Board found those claims unpatentable, and the Federal Circuit affirmed. The district court applied collateral estoppel to give the Board’s decision as to these claims preclusive effect in the district court suit. On appeal, Hologic argued that this decision would allow the America Invents Act (which established inter partes review proceedings) to abrogate the assignor estoppel doctrine in district court patent infringement suits. The Federal Circuit disagreed and affirmed the district court’s decision.
Held: Assignor estoppel does not bar challenges of a patent’s validity in inter partes review proceedings, nor does it bar the application of collateral estoppel in a parallel district court proceeding to foreclose the patentee’s assertion of claims cancelled in inter partes review.
Reasoning: The court noted that the Federal Circuit has repeatedly upheld the applicability of the assignor estoppel doctrine, but noted that the doctrine only bars assignors from challenging the validity of a patent-in-suit. For example, under the Federal Circuit’s precedent, an assignor could argue that the patentee is collaterally estopped from asserting a patent found invalid in a prior proceeding. Because the Federal Circuit had previously held that an assignor who is no longer the owner of a patent may file a petition for inter partes review of the patent, and that an assignor can assert that a prior holding of invalidity collaterally estops the assertion of those claims, the district court did not err here. It affirmed that assignor estoppel did not prevent Minerva Surgical from asserting that Hologic was collaterally estopped from asserting the claims held invalid and cancelled in the inter partes review.
Judge Stoll, who wrote the court’s opinion, wrote in a separate opinion that she believed that the court should reconsider its precedent on the application of assignor estoppel en banc to resolve the contradiction that assignor estoppel bars assignors from challenging the validity of the assigned patent in district court, but not in Patent Office proceedings. However, the en banc court denied rehearing. The Supreme Court recently granted certiorari to further review this decision.
In re PersonalWeb Techs., LLC, 961 F.3d 1365 (Fed. Cir. 2020)
Facts: This case relates to the application of the Kessler doctrine to bar suits against an accused infringer’s customers after the accused infringer prevails in a patent infringement suit.
PersonalWeb owns several patents directed to creating unique identifiers for data stored on a computer to avoid storage of duplicate data with different file names. In 2011, PersonalWeb sued Amazon.com, Inc. and Amazon Web Services, Inc., as well as one of Amazon’s customers, Dropbox, Inc., for patent infringement. After claim construction, PersonalWeb stipulated to the dismissal of all claims against Amazon with prejudice, and the court entered final judgment against PersonalWeb.
Later, beginning in January 2018, PersonalWeb filed dozens of new lawsuits against website operators, many of whom were Amazon’s customers. Amazon intervened in defense of its customers, and the cases were consolidated by the Judicial Panel on Multidistrict Litigation. The district court granted Amazon’s motion for summary judgment, holding that claim preclusion barred PersonalWeb’s infringement claims based on activity occurring prior to the final judgment in the 2011 suit, and that the Kessler doctrine barred PersonalWeb’s infringement claims based on activity occurring after the final judgment in the 2011 suit. On appeal, the Federal Circuit affirmed.
Held: The Kessler doctrine, which gives a “limited trade right” to continue to sell a product adjudged as non-infringing without being subject to additional harassing suits alleging continuing sale of the product infringes, applies even to cases voluntarily dismissed with prejudice by the patentee, and blocks subsequent allegations of infringement against the original defendant and its customers.
Reasoning: The court held that claims of noninfringement or invalidity do not have to be actually litigated before the Kessler doctrine can be invoked. Federal Circuit precedent holds that the Kessler doctrine is a close relative of claim preclusion, without the temporal limitations of claim preclusion, rather than an early version of non-mutual collateral estoppel. PersonalWeb’s stipulation to dismiss its suit against Amazon with prejudice, and the final judgment based on that stipulation, adequately stood as an adjudication on the merits for preclusion purposes that Amazon was not liable for the acts of infringement alleged by PersonalWeb. That final judgment established a right protecting Amazon’s product from subsequent infringement challenges—directed both at Amazon itself and Amazon’s customers. The court explained that holding otherwise would leave the patentee free to engage in the same type of harassment the Supreme Court sought to prevent in Kessler.
In re Google LLC, 949 F.3d 1338 (Fed. Cir. 2020)
Facts: This case addresses whether the mere presence of third-party data centers hosting a company’s servers within a district counts as a “regular and established” place of business within the district to establish patent venue under 28 U.S.C. § 1400(b).
Super Interconnect Technologies LLC (SIT) sued Google for patent infringement in the Eastern District of Texas. SIT asserted that venue was proper in that district under 28 U.S.C. § 1400(b) because Google had committed acts of infringement in the district and had a regular and established place of business in the district. SIT claimed that the regular and established place of business was Google’s servers within the district, which Google used to provide local caches for its data.
The servers were not hosted within data centers owned by Google. Instead, Google contracted with internet service providers (ISPs) to host Google’s servers within the ISP’s data center; Google’s servers were installed in the ISP’s server racks within the data center. The ISPs provided power and network access for the servers, installed the servers on racks of their choice, and maintained the servers; no Google employee installed, maintained, or physically accessed any of the Google servers in the ISP data centers.
Google moved to dismiss the complaint for improper venue. The district court denied the motion, finding that the servers qualified as a regular and established place of business. Google petitioned the Federal Circuit for a writ of mandamus; the court granted the writ.
Held: To have a “regular and established place of business” in a judicial district, a defendant need not own real property or have a leasehold interest in real property; leased server rack space may serve as a place of business. However, an employee or agent of the defendant must be conducting business at the purported “place of business” for it to count as a “place of business” for patent venue. The court determined that the Eastern District of Texas was not a proper venue for this dispute.
Reasoning: The court noted that In re Cray, Inc., 871 F.3d 1355 (Fed. Cir. 2017) held that to establish a “regular and established business” in a district for patent venue purposes, a defendant must have a physical, geographic location in the district, from which the business of the defendant is carried out. The court agreed with prior district court decisions that leased shelf space or server rack space can serve as such a place.
As to the presence of an employee or agent, the court explained that 28 U.S.C. § 1400(b), the patent venue statute, must be read in conjunction with 28 U.S.C. § 1694, the service statute for patent cases, together compelling that a “regular and established place of business” within the meaning of the venue statute only exists if the defendant also has an “agent . . . engaged in conducting such business.” The court further noted that the statute required any agent to be conducting the defendant’s business. Likewise, these statutes compel the conclusion that the agent must be regularly, physically present at the place of business. Thus, a third party taking actions on behalf of the defendant, such as maintenance, that are merely connected to the defendant’s conduct of business—but do not themselves constitute the defendant’s conduct of business in the sense of production, storage, transport, and exchange of goods and services—would not make the third party an agent for purposes of establishing venue. The court left open the question of whether a machine could be an “agent” for purposes of establishing venue.
Judge Wallach concurred to note his view that Google’s end users in the district could count as agents of Google’s business in the district if their voluntary or involuntary sharing of information generated on Google’s servers provides data that Google monetizes as the core aspect of its business model in the district. He encouraged the district court to consider this question.
Valeant Pharms. N. Am. LLC v. Mylan Pharms. Inc., 978 F.3d 1374 (Fed. Cir. 2020)
Facts: Mylan Pharmaceuticals Inc. (“MPI”), a West Virginia-based corporation, sought to market a generic version of a drug sold by Valeant Pharmaceuticals North America LLC, Valeant Pharmaceuticals Ireland Ltd., Dow Pharmaceutical Sciences, Inc. (“Dow”), and Kaken Pharmaceuticals Co., Ltd. (collectively “Valeant”), who reside in a number of locations, including Japan, Ireland, and Delaware. Valeant sued MPI and related companies, Mylan Inc. (a Pennsylvania corporation) and Mylan Laboratories Ltd. (“MLL”) (a corporation based in India) for infringement in the U.S. District Court for the District of New Jersey.
MPI sought dismissal on venue grounds. Valeant’s justification for bringing suit in New Jersey was the planned marketing and sale of MPI’s product in the district if MPI’s product was approved. The District Court found in favor of MPI, dismissing the relevance of planned future acts of infringement to the venue analysis in ANDA cases. Valeant appealed.
Held: Venue in Hatch-Waxman cases is proper only in districts where actions related to the Abbreviated New Drug Application (“ANDA”) submission occur.
Reasoning: The Federal Circuit affirmed the District Court’s decision that venue was not proper in New Jersey for MPI and Mylan Inc., but reversed and remanded as to foreign defendant MLL. The Federal Circuit held that venue under 28 U.S.C. § 1400(b), the venue statute for patent cases, requires a past act of infringement and cannot be premised on future acts of infringement, such as where a product is likely to be distributed. The Federal Circuit held that the Hatch-Waxman Act defines only one act of infringement—an ANDA submission. As a result, venue is proper only where acts related to the ANDA submission took place. Because the District Court found that no act related to MPI’s ANDA submission took place in New Jersey, the Federal Circuit affirmed the District Court’s decision. With respect to MLL, the Federal Circuit held that venue was proper because MLL was subject to venue in any judicial district as a foreign entity. The Federal Circuit remanded for the District Court to address the substance of MLL’s motion to dismiss under Rule 12(b)(6).
Facts: Rovi Corporation and Rovi Guides, Inc. (collectively “Rovi”) filed a complaint with the International Trade Commission (“ITC”) arguing that Comcast, its customers and related companies infringe Rovi’s patents and should be barred from importing its X1 system set-top boxes under Section 337 of the Tariff Act of 1930. Rovi’s patents are directed towards an interactive TV guide system for remote access to television programs similar to that used by Comcast’s X1 system, and the key piece of that system is Comcast’s X1 set-top box.
Comcast imported the X1 set-top box through two other companies, ARRIS and Technicolor, and then distributed them to its customers. The Administrative Law Judge, affirmed by the full commission, found that the set-top boxes violated Section 337 because Comcast’s customers directly infringed Rovi’s patents. The Commission issued a limited exclusion order barring the importation of Comcast’s set-top boxes – including importation by ARRIS and Technicolor on behalf of Comcast.
Comcast appealed the Commission’s order on the grounds that exclusion was improper because the set-top boxes did not infringe Rovi’s patents at the time of importation and only did so later when they were connected to Comcast’s domestic servers and used by customers.
Held: Importation of a good can violate Section 337 of the Tariff Act of 1930 even if the actual infringement is not present at the time of importation.
Reasoning: On appeal, Comcast argued that in order to infringe Rovi’s patents, the X1 set-top boxes must be connected to Comcast’s domestic servers and its users’ mobile devices. Therefore, at the time of importation, Comcast’s set-top boxes were non-infringing. Comcast relied on Suprema, Inc. v. U.S.Int’l Trade Comm’n, 796 F.3d 1338 (Fed. Cir. 2015), which found that the importation of a product could be blocked where that product will infringe after importation. Comcast argued that Suprema should be limited to its facts and that Comcast’s case was distinguishable because its set-top boxes do not necessarily have to infringe after importation.
The Federal Circuit, however, affirmed the decision of the ITC and reasoned that the principle laid out in Suprema included Comcast products because the set-top boxes were specifically designed to be used in conjunction with the X1 system.
The Federal Circuit further declined Comcast’s motion to dismiss the appeal on the grounds that the patent had already expired. The Court agreed with Rovi that, because the Federal Circuit decision on the appeal impacted other pending matters, the Court should decide the appeal.
§ 1.2 Copyright Cases
§ 1.2.1 Supreme Court decisions
Georgia v. Public.Resource.Org, Inc., 140 S.Ct. 1498 (2020)
Facts: The case concerns whether the government edicts doctrine, which states that “officials empowered to speak with the force of law” cannot claim copyright in materials they create in the course of their official duties, renders a state’s official code annotations uncopyrightable.
The Official Code of Georgia Annotated (“OCGA”) comprises every active Georgia statute along with annotations, such as summaries of judicial decisions applying to specific provisions, lists of law review articles, and other reference materials. Under a work-for-hire agreement, the GA Code Revision Commission commissioned Matthew Bender & Co. to prepare the OCGA.
Without permission, Public.Resource.Org (“PRO”) distributed copies of the OCGA and posted the OCGA online, where the public could download copies free of charge. Georgia then sued PRO in district court, and the district court entered a permanent injunction against PRO to cease distribution activities and remove the online copies. The Eleventh Circuit reversed and the Supreme Court granted certiorari.
Held: The Court held that the OCGA annotations are ineligible for copyright protection.
Reasoning: The Court held that “[u]nder the government edicts doctrine, … legislators may not be considered the ‘authors’ of the works they produce in the course of their official duties as … legislators.” This holding was based on precedent, which explained work product generated by judges in the course of their official duties was not copyrightable. This was juxtaposed to precedent in which official reporters had obtained copyrights in explanatory materials for judicial opinions, because the reporters had “no authority to speak with the force of law.” The policy behind the holding here is that “no one can own the law” and “because officials are …empowered to make and interpret law … their ‘whole work’… must be ‘free for publication to all.’”
First, the Court determined that the purported author, the GA Code Revision Commission, was a legislator. The Court determined that, although the Commission was not identical to the Georgia legislature, the Commission functioned “as an arm of [the legislature] for the purpose of producing the annotations.” The Court also noted that the Commission was created by the legislature and consisted largely of legislators, received funding and staff from the legislature, and obtained approval of the annotations from the legislature. The Georgia Constitution stated that the work of the Commission “is within the sphere of legislative authority.”
Additionally, the Court concluded the annotations were created in the scope of the Commission’s official duties. Although the annotations did not purport to provide authoritative explanations of the law, the Commission’s preparations of the annotations were nonetheless drafted under the umbrella of Georgia’s legislative authority, and thus fell under the government edicts doctrine.
§ 1.2.2 Circuit Court decisions
Skidmore v. Led Zeppelin, 952 F.3d 1051 (9th Cir. 2020) (en banc)
Facts: In the late 1960s, Randy Wolf obtained a copyright on his song “Taurus” which he had written for his band, Spirit. Years later, after Wolf had passed away, the trustee of his estate, Michael Skidmore, brought suit against the famed rock band Led Zeppelin for copyright infringement. Skidmore alleged that Led Zeppelin’s hit song “Stairway to Heaven” infringed the first few bars of “Taurus”.
At the time, the two bands had played at the same venues and knew of each other. Moreover, Led Zeppelin’s members admitted to owning a copy of an album that contained “Taurus”. The copyright obtained for Wolf, however, was for an unpublished version of the song and consisted of a single sheet of transcribed music deposited with the Copyright Office.
At trial the Court limited the scope of the Taurus Copyright to the one page of sheet music deposited with the Copyright Office rather than the full version released on the album. As a result, during trial the District Court declined to allow Skidmore to play a full version of the song. Additionally, the District Court declined to give the “inverse ratio rule” instruction to the jury. This instruction states that when there is a large amount of evidence supporting “access” to the subject work, the burden of proof required for showing that there is “substantial similarity” between the subject work and the alleged copy is reduced. The jury ultimately found in favor of Led Zeppelin. Skidmore appealed, arguing to the Ninth Circuit that the district court’s actions were improper and warranted reversal.
Held: The decision of the district court is affirmed and the Ninth Circuit’s precedential acceptance of the “inverse ratio rule” is overruled.
Reasoning: On the issue of the scope of the copyright, the Ninth Circuit found that the district court did not err in limiting the scope of the copyright to the transcribed sheet deposited at the time of the registration of the copyright. The Copyright Act of 1909 provided no protection for recorded works and thus was limited to either published musical notation or, if the copyrighted material was unpublished, the transcription of the music deposited with the Copyright Office.
Addressing the “inverse ratio rule,” the Ninth Circuit realized it was one of only two circuits still upholding the use of the rule and decided to reexamine whether it should continue to do so. The Ninth Circuit concluded the logic upholding the “inverse ratio rule” was flawed and unfairly favored certain copyright owners. Specifically, the Ninth Circuit reasoned that, logically, while increased access presented more opportunity to copy a work, that does not inherently mean that it is more likely that any one work is a copy or is substantially similar to the copyrighted work. Additionally, the rule inherently favored more notable copyright holders. The “inverse ratio rule” effectively lowered the bar for showing someone had infringed a work that was better known. For these reasons, the Ninth Circuit overruled its prior holdings relying on the inverse ratio rule.
Corbello v. Valli, Case No. 17-16337 (9th Cir. 2020)
Facts: In the late 1980s, Rex Woodward collaborated with a member of the band The Four Seasons and wrote a factual autobiography telling the “whole story” of The Four Seasons. After completing the book and years of attempting to sell it, the pair were unable to sell it to a publisher. In the early 2000s, a musical called Jersey Boys was released on Broadway, which depicted the life and careers of The Four Seasons. Woodward’s widow Donna Corbello learned that the creators of Jersey Boys had access to Woodward’s manuscript while they created Jersey Boys. Corbello brought suit against 14 defendants (including the original members of The Four Seasons) and alleged copyright infringement, among 20 other causes of action in the District Court for the District of Nevada. After a lengthy procedural history, the District Court granted the defendants’ motion for judgment as a matter of law finding no copyright infringement.
Held: The court affirmed the District Court’s judgment as a matter of law.
Reasoning: In analyzing the claim of copyright infringement, the court focused on whether the two works were similar and whether the defendants had copied any protectable aspects of Woodward’s book. In analyzing the similarities between Woodward’s book and Jersey Boys, the court employed the Extrinsic Test analysis, wherein: (1) the plaintiff identifies the similarities between the copyrighted work and the accused work; (2) of those similarities, the court disregards any that are based on unprotectable material or authorized use; and (3) the court must determine the scope of protection to which the remainder is entitled “as a whole.” Of the six similarities that Corbello identified, the court determined that each similarity failed the Extrinsic Test because they were all primarily composed of non-protectable elements of the work, such as historical facts, common phrases, and scenes-a-faire.
Facts: This case is an appeal from a suit brought by a group of aerosol artists, headed by Jonathan Cohen, against a land owner on whose property they had, for years, been producing aerosol art. The space in question, known as 5Pointz, was owned and operated by G&M Realty, but had been a largely undeveloped collection of old warehouses for many years. Seeking to make some money off the property, the owner rented it to a group of aerosol artists. Over the course of several years, the artists turned 5Pointz into a mecca for the aerosol art form, attracting international recognition and many tourists every year.
The dispute began when the land owner, having an opportunity to develop the property into luxury apartments, declined to renew the artists’ lease and expressed a desire to demolish the structures which the aerosol art now adorned. Not wanting to see their art destroyed, the artists made several efforts to obtain ownership of the property, ultimately filing suit under the Visual Artists Right Act (“VARA”) to prevent the destruction of their work. The act grants artists “moral rights” in their work and allows them to prevent use of the art in a way that would harm their reputation and prevent the art’s destruction if it has achieved “recognized stature.”
The artists were able to obtain a temporary restraining order banning the art’s destruction early on in the case, but when the TRO expired, the district court declined to grant the artists a preliminary injunction barring its destruction. The land owner then whitewashed and demolished the aerosol art of 5Pointz.
At trial, the district court concluded that many pieces of art had in fact achieved recognized stature and that the defendants had acted willfully in their destruction of the art when they did not give the artists an opportunity to remove and preserve their pieces prior to demolishing the structures. The district court granted the artists statutory damages of $6,750,000. The defendants appealed to the Second Circuit.
Held: The district court did not err in finding the aerosol art had achieved “recognized stature” or in awarding statutory damages to the artists.
Reasoning: The Second Circuit reviewed the district court’s determination that the aerosol art had achieved “recognized stature” for clear error. The property owner’s main argument was that the district court failed to take into account the temporary nature of the aerosol art. The Second Circuit, however, concluded that the specificity of the drafting of VARA makes plain that it does not bar temporary works from achieving “recognized stature.” Further, recent examples, such as the temporary sculpture “The Gates” in New York City’s Central Park or the works of Banksy, the critically acclaimed street artist whose works were frequently only meant to be temporary, had nonetheless achieved “recognized stature.” Thus, defendants’ argument that the art was temporary was not enough to show clear error in the district court’s decision.
The Second Circuit further dismissed defendants’ argument that because the artists knew the buildings would be torn down eventually, the artists cannot claim to be wronged by their destruction. The Second Circuit countered by noting that VARA accounts for this eventuality by clearly requiring that, where art is built into the structure of a building, the owner must obtain written understanding from the artist(s) that their art may be destroyed if the building is. Where that is not in place, the owner must provide the artist(s) 90 days to remove the art. Defendants, in this case, did not afford the artists such an opportunity.
The Second Circuit found no issue with the district court’s reliance on expert testimony based on images of the art, rather than the works themselves. Likewise, the Second Circuit found no clear error in the district court’s consideration of the fact that Jonathan Cohen “curated” 5Pointz by pre-selecting artists who painted, even though such curation took place prior to the creation of the actual works. The Second Circuit also dismissed concern over the district court’s focus on the stature of 5Pointz as a whole in addition to the individual works. The Second Circuit reasoned that a work’s stature can certainly be improved by hanging in the Louvre, thus 5Pointz can have a similar effect on aerosol art.
Finally, the Second Circuit reviewed the district court’s damages award for clear error and found none. The district court was justified in finding defendants’ destruction of the art willful, because defendants were well aware of the artists’ VARA claims at the time of destruction and seemed to have needlessly and maliciously whitewashed the art as quickly as possible rather than affording the artists 90 days to remove their art. Moreover, the district court did not err in finding that the artists were entitled to the full statutory damages for each work of art, despite previously finding that the artists’ actual damages were too difficult to calculate. Such a determination did not mean the artists were not likely to get any revenue for their works, it simply meant they were hard to determine.
David Zindel v. Fox Searchlight Pictures Inc. et al., Case No. 18-56087 (9th Cir. 2020)
Facts: This case addresses whether questions of substantial similarity in copyright infringement may be properly decided at the pleadings stage on a motion to dismiss, without additional evidence such as expert testimony.
David Zindel (“Zindel”) alleged copyright infringement of his father Paul Zindel’s play, “Let Me Hear You Whisper,” by Fox Searchlight Pictures’ (“Fox”) film and book, “The Shape of Water.” According to the complaint, Zindel’s play tells the story of a lonely cleaning woman who works the graveyard shift at a scientific laboratory conducting experiments on animals for military purposes during the Cold War. She forms an emotional bond with one of the creatures after discovering that it chooses to communicate exclusively with her. Upon learning that the laboratory plans to vivisect the creature for research, she decides to free the creature into the ocean via a rolling laundry cart.
The complaint alleged that “The Shape of Water” similarly centered on a cleaning woman named Elisa working at a laboratory performing experiments for ominous military purposes in the Cold War era. Elisa discovers an aquatic creature of heightened intelligence stored in a glass tank. Elisa begins a romantic relationship with the creature after discovering it chooses to communicate only with her. As in Zindel’s play, protagonist Elisa hatches a plan to free the creature into the ocean via a laundry cart when she learns the scientists in the lab plan to cut it open for research.”
The district court dismissed Zindel’s complaint, finding that the plot of Zindel’s play was too general for copyright protection, and that the two works were not substantially similar as a matter of law.
Held: The Ninth Circuit reversed and remanded, finding that at the pleadings stage, reasonable minds could differ on the substantial similarity of Zindel’s and Fox’s works.
Reasoning: The Ninth Circuit found that the district court dismissed Zindel’s action prematurely. The court found that “reasonable minds could differ” on whether “Let Me Hear You Whisper” and “The Shape of Water” shared substantial similarities at the pleadings stage. The court found that additional evidence, such as expert testimony, would aid in the necessary literary analysis for determining the “extent and qualitative importance” of the commonalities Zindel alleged the two works shared. Thus, additional evidence could clarify whether the alleged similarities constituted copyright infringement or were unprotectable literary tropes.
Daniels v. Walt Disney Co., Case No. 18-55635 (9th Cir. 2020)
Facts: This case addresses the viability of copyright protection and subsequent infringement claims in connection with “lightly sketched characters.”
Emotional intelligence and child development expert Denise Daniels (“Daniels”) created “The Moodsters,” five color-coded anthropomorphic characters each correlated with a human emotion. Daniels’ entity, The Moodsters Company, published a “bible” for The Moodsters in 2005. The bible serves as a pitchbook for media and entertainment companies. The Moodsters Company went a step further and posted a YouTube pilot episode of “The Moodsters” with the same characters in 2007. Daniels pitched The Moodsters to Disney, among other entertainment companies. Disney did not pick up The Moodsters. In 2015, Disney released the film “Inside Out,” which was about five anthropomorphized characters correlated with human emotions living inside the mind of an 11-year-old girl.
Daniels and her company filed suit against Disney, alleging copyright infringement of the individual Moodsters characters and the ensemble of characters as a whole. The district court granted Disney’s motion to dismiss, finding that Daniels failed to show that The Moodsters met the necessary standard for copyright in a character. In reaching its ruling, the district court applied the Towle test (DC Comics v. Towle, 802 F.3d 1012 (9th Cir. 2015)) for the copyrightability of graphically depicted characters. Daniels appealed to the Ninth Circuit.
Held: The Ninth Circuit affirmed the district court’s ruling, finding that The Moodsters characters did not meet the threshold for copyright protection under the Towle test, and further failed to meet the standard for protection outlined in the Warner Bros. “story being told” test (Warner Bros. v. CBS, 216 F.2d 945 (9th Cir. 1954)).
Reasoning: The Towle test affords a character copyright protection if the character (1) has “‘physical as well as conceptual qualities,’” (2) is “‘sufficiently delineated to be recognizable as the same character whenever it appears’ and ‘display[s] consistent, identifiable character traits and attributes,’” and (3) is “‘especially distinctive’ and ‘contain[s] some unique elements of expression.’” The district court and Ninth Circuit agreed that The Moodsters characters met prong one of the test. The Ninth Circuit found that the second prong was an “insurmountable hurdle” for Daniels. The court explained that characters lacking “a core set of consistent and identifiable character traits and attributes” are not protectable, because they are “not immediately recognizable as the same character[s] whenever [they] appear.” The court further clarified that characters “too lightly sketched” could not be protected by copyright. The court analyzed the consistency in the depiction of The Moodsters’ physical appearance, character traits, and other attributes over time to determine if The Moodsters were sufficiently delineated. The court found that they were not, because the significant changes in the characters’ physical appearances over time made it difficult to conclude that The Moodsters in 2005 versus 2015 were the same set of characters. The Moodsters also did not have consistent character traits and attributes. While the characters represented five consistent emotions, their degree of consistency was insufficient to afford them copyright protection. The Ninth Circuit further found that The Moodsters did not meet the third Towle prong because each Moodster character merely represented a single emotion with generic characteristics that were not “especially distinctive.”
Finally, the Ninth Circuit analyzed The Moodsters using the Warner Bros. “story being told” test. The court explained its choice by noting the Towle test was not the exclusive test for determining the copyrightability of a character. The “story being told” test affords characters copyright protection if they constitute “the story being told” in a work, not as “‘only the chessman in the game of telling the story’ but one that ‘so dominate[s] the story such that it becomes essentially a character study.’” The court found that The Moodsters lacked character development and necessary character study since they were introduced only in a pitchbook, with even less development in the YouTube pilot. The Ninth Circuit determined that The Moodsters were more like “chessmen” telling the story, unqualified for copyright protection themselves. Thus, the Ninth Circuit affirmed the district court’s granting of the motion to dismiss.
Tresóna Multimedia, LLC v. Burbank High School Vocal Music Association, et al., Case No. 17-56006 (9th Cir. 2020)
Facts: This case clarifies (1) whether a licensee of a single copyright co-owner possesses standing to sue for copyright infringement and (2) whether rearrangements of short song segments in a transformative performance piece constitute a fair use.
Burbank High School’s music department includes nationally recognized show choirs, rumored to have inspired the television series “Glee.” The school’s music director, Brett Carroll, hired a music arranger to create custom sheet music for two shows performed by one of the show choirs, “In Sync.” The shows included stanzas from several songs, including “Magic,” “(I’ve Had) The Time of My Life,” “Hotel California,” and “Don’t Phunk With My Heart.” In Sync performed shows with arrangements of these four songs on several occasions.
After In Sync’s performances, licensing company Tresóna Multimedia, LLC (“Tresóna”) sued Carroll, Burbank High School, the Burbank High School Vocal Music Association Boosters Club and several individual Boosters Club parents (collectively, “Burbank High”) for copyright infringement. Tresóna alleged that the Burbank High show choir failed to obtain licenses for their use of segments of the four pieces of copyrighted sheet music. Tresóna claimed it possessed the exclusive right to license sheet music for the four songs. While Tresóna was assigned the rights to “Magic” from the song’s sole owner, Tresóna’s rights to the other three songs were assigned from fewer than all the co-owners of those songs. Both parties moved for summary judgment.
The district court held that Tresóna lacked standing to sue for copyright infringement of the three songs for which it did not possess a license from all co-owners of the copyright interest in the songs. For the “Magic” claim, the district court determined that Carroll was entitled to qualified immunity. It further found that the other named defendants could not be held liable for direct or secondary copyright infringement, but did not grant Burbank High’s request for attorneys’ fees. Both parties appealed.
Held: The Ninth Circuit affirmed the district court’s ruling on summary judgment in favor of Burbank High, but reversed the district court’s denial of attorneys’ fees, remanding for a calculation. The court affirmed that Tresóna lacked standing to sue for copyright infringement on “Magic,” and found that In Sync’s arrangements and performances of all songs constituted a fair use.
Reasoning: The Ninth Circuit affirmed the grant of summary judgment as to “(I’ve Had) The Time of My Life,” “Hotel California,” and “Don’t Phunk With My Heart.” The court cited Ninth Circuit precedent holding that when a single copyright co-owner independently attempts to grant an exclusive license, the licensee does not have standing to sue alleged third-party infringers. The court explained that this rule is intended to prevent one joint owner’s assignment from limiting the rights of joint co-owners without their consent.
With respect to “Magic,” the court focused on fair use rather than qualified immunity, noting the limited applicability of qualified immunity doctrine. Carroll used “Magic” in his capacity as a music teacher and transformed it significantly from its original use in a film. Thus, the educational and transformative nature of the use at a non-profit school weighed in favor of fair use on the factor relating to the purpose and character of the use. On the factor relating to the nature of the copyrighted work, the court weighed this against a finding of fair use given the creative nature of “Magic.” With respect to the third factor, substantiality of portion used, the court found Burbank High’s use of only 22 seconds of the song weighed in favor of fair use. Finally, the court also found the fourth factor, the market effect of the use, weighed in favor of fair use. The Ninth Circuit explained that the small excerpt of the song used was not a substitute for the entire song, and the song’s use in an educational environment served a different function. Therefore, Burbank High’s use of “Magic” was a fair use and did not constitute copyright infringement.
Finally, the Ninth Circuit decided that attorneys’ fees were warranted because Tresóna misrepresented the nature of its copyright interest in three of the songs, made objectively unreasonable arguments, and the fair use determination was sufficient on the merits to qualify Burbank High for an award of attorneys’ fees.
Charles v. Seinfeld, 803 F. App’x 550 (2d Cir. 2020)
Facts: This case clarifies when copyright infringement claims begin accruing if copyright ownership is itself disputed.
Producer and director Christian Charles (“Charles”) allegedly worked with comedian Jerry Seinfeld (“Seinfeld”) to develop the pilot for the television series “Comedians in Cars Getting Coffee” in 2011. In February 2012, Seinfeld rejected Charles’ request for back-end compensation in connection with the series. Seinfeld asserted and clarified that Charles’ involvement with the series was on a work-for-hire basis. “Comedians in Cars Getting Coffee” premiered in July 2012 and did not credit Charles.
In 2018, Charles brought suit against Seinfeld and others associated with the series, alleging copyright infringement based on his claimed authorship of the show. Seinfeld moved to dismiss Charles’ claim, arguing that it was time-barred under the Copyright Act. The district court agreed and granted the motion to dismiss. Charles appealed to the Second Circuit.
Held: The Second Circuit affirmed the district court’s ruling, holding that claims of copyright ownership accrue “when a reasonably diligent plaintiff would have discovered that ownership was disputed.” The court held that if copyright ownership is the central issue in an infringement case and the ownership claim is time-barred, “the infringement claim itself is also time-barred, even if any allegedly infringing activity occurred within the limitations period.”
Reasoning: The Second Circuit held that the dispositive issue in Charles’ claim was copyright ownership. This was evidenced in his own filing, which explained that “[r]esolution of this case depends upon the answer to one simple question: who is the author of the [‘Comedians in Cars Getting Coffee’] Pilot?” Hence, Charles’ copyright infringement claim accrued when he was put on notice that his claim of ownership was disputed. Charles was put on notice as to the dispute in 2012, when Seinfeld (1) rejected Charles’ request for back-end compensation, (2) told Charles that his contributions were made on a work-for-hire basis, and (3) the show premiered without crediting Charles. Thus, Charles’ 2018 copyright infringement claim was time-barred by the Copyright Act’s three-year statute of limitations.
Facts: The case concerns whether the district court abused its discretion when refusing to allow a subpoena of an alleged online copyright infringer’s internet service provider (“ISP”) to discover the identity of the alleged online copyright infringer.
Strike 3 is an adult film producer and distributor that faces “rampant online piracy.” In order to police infringement, Strike 3 uses investigators and forensic software to monitor peer-to-peer file sharing networks and determine IP addresses engaging in acts of infringement. Strike 3 then files lawsuits against “John Doe” defendants based on the IP addresses. However, since ISPs are the only entities that can link an IP address to its subscriber, Strike 3 cannot serve its copyright infringement complaints without first subpoenaing the subscriber’s ISP for information identifying the anonymous defendant. Accordingly, Strike 3 filed a Rule 26(d)(1) motion seeking leave to subpoena Comcast for records identifying the subscriber linked to a particular IP address.
The district court denied Strike 3’s motion after applying a multi-factor balancing test and found that Strike 3’s need for the subpoenaed information was outweighed by a privacy interest in view of the “particularly prurient pornography.” Additionally, the district court characterized Strike 3 as a “copyright troll” and stated it would not indulge Strike 3’s “feigned desire for legal process” by “oversee[ing] a high-tech shakedown.” The district court denied Strike 3’s motion and dismissed the complaint without prejudice. Strike 3 appealed, and the D.C. Circuit reversed the denial of the Rule 26(d)(1) motion and remanded.
Held: The D.C. Circuit found that the district court abused its discretion in denying Strike 3’s Rule 26(d)(1) motion.
While the D.C. Circuit recognized that courts have broad discretion over discovery, the district court abused its discretion in three aspects. First, the D.C. Circuit held that the content of a work is per se irrelevant to a Rule 26(d)(1) motion. The Court stated that a “mere fact that a defendant may be embarrassed to have his name connected to pornographic websites is not a proper basis on which to diminish a copyright holder’s otherwise enforceable property rights.”
The second abuse was the district court’s reasoning that even if the motion was granted, Strike 3 could not “identify a copyright infringer who can be sued” for purposes of stating a plausible claim against the IP subscriber. The D.C. Circuit stated that the “mere possibility that an unnamed defendant may defeat a complaint at a later stage is not a legitimate basis to deny a Rule 26(d)(1) motion,” and that at this stage of discovery, a court need not rule on the claim’s plausibility. Rather, Strike 3 should have the opportunity to name the defendant.
Third, the district court “failed to afford Strike 3 the benefit of all reasonable inferences, and instead relied on extra-record sources to question Strike 3’s motivation in seeking the requested discovery.” Rather than giving reasonable inferences to the facts before it, the district court instead looked outside of the record to determine Strike 3’s “copyright troll” behavior.
Estate of Smith v. Graham, 799 Fed. Appx. 36 (2d. Cir. 2020)
Facts: This case concerns whether defendants’ sampling of “Jimmy Smith Rap” (“JSR”) in “Pound Cake/Paris Morton Music 2” (“Pound Cake”) constitutes fair use.
In 1982, Jimmy Smith recorded an album containing a spoken-word track recording titled “Jimmy Smith Rap” (“JSR”). On September 24, 2013, Cash Money Records and Universal Republic Records released the album Nothing Was the Same (the “Album”) by Aubrey Drake Graham, a/k/a Drake. The last song on the Album is “Pound Cake/Paris Morton Music 2.” The opening to “Pound Cake” samples about 35 seconds of JSR. While some words from JSR were rearranged or deleted, no words were added.
The district court granted defendants’ motion for summary judgment on the grounds that the alleged copyright infringement was fair use. Plaintiffs appealed, and the Second Circuit affirmed.
Held: Drake’s sampling of JSR is fair use since it is a transformative new use of the old material.
Reasoning: The Second Circuit found Drake’s use of JSR was transformative and held that “Pound Cake,” unlike JSR, sends “a counter message—that it is not jazz music that reigns supreme, but rather all ‘real music,’ regardless of genre. …‘Pound Cake’ emphasizes that it is not the genre but the authenticity of the music that matters. In this manner, ‘Pound Cake’ criticizes the jazz-elitism that the ‘Jimmy Smith Rap’ espouses.” By doing so, it uses the copyrighted work for “a purpose, or imbues it with a character, different from that for which it was created.” The Second Circuit also held that Drake’s sampling was reasonable in relation to the transformative purpose of the copying. Lastly, the Second Circuit held there was no evidence that “Pound Cake” usurped demand for JSR or otherwise caused a negative market effect.
§ 1.2.3 Notable district court decisions
Sinclair v. Ziff Davis, LLC, 18-CV-790 (KMW), 2020 WL 3450136 (S.D.N.Y. June 24, 2020)
Facts: Stephanie Sinclair is a photographer who advertises her work on her own website and Instagram. Ziff Davis is a digital media company that owns multiple online brands and print tiles including Mashable, a media and entertainment content platform. Sinclair posted a copyrighted photo on her Instagram account which she set to be publicly viewable. Sinclair was subsequently contacted by Mashable who was interested in using her photo in an article about female photographers. Mashable offered Sinclair $50 for a license to use her photo, but Sinclair declined.
Despite Sinclair’s declination, Mashable used an embedded link to display the photo in its story. The embedded link allowed Mashable to display Sinclair’s Instagram content on its own website using Instagram’s API (application programming interface) without actually having Sinclair’s photo on Mashable’s own servers. Instead, the embedded link allowed Mashable to retrieve content directly from Instagram’s servers and display it in its article.
Sinclair brought suit against Mashable and Ziff Davis for copyright infringement, and the defendants moved to dismiss. In its first pass, the District Court for the Southern District of New York dismissed Sinclair’s complaint. The court found that Sinclair had agreed to Instagram’s terms and conditions, which granted Instagram a partial license and ability to sublicense any content Sinclair publicly posted on Instagram. Instagram’s Platform Policy with users of its API further granted API users a sublicense to “embed” any content that was publicly available on Instagram.
After the decision, Sinclair brought a motion for reconsideration on the grounds that Instagram’s Platform Policy was not sufficiently clear for the court to grant a motion to dismiss.
Held: Instagram’s policies were insufficiently clear for the court to grant a motion to dismiss.
Reasoning: Instagram’s Platform Policy, on which defendants relied to show they had a sublicense to “embed” Instagram’s content, stated that Instagram “provide[s] the Instagram APIs to help broadcasters and publishers discover content, get digital rights to media, and share media using web embeds.” On review, the court concluded that while this statement could be interpreted to grant API users the right to embed Instagram’s publicly available content, there are other interpretations. This ambiguity prevented the court from deciding the issue on a motion to dismiss. The court, therefore, reversed its prior dismissal of Sinclair’s claims against Mashable.
The court, however, maintained its dismissal of claims against Ziff Davis, LLC. The court’s above reasoning did not change its earlier conclusion that Sinclair needed to plead Ziff Davis, LLC had “substantial continuing involvement” in Mashable, rather than mere control.
McGucken v. Newsweek LLC et al.,No. 1:19-cv-09617-KPF (S.D.N.Y. 2020)
Facts: This case addresses the viability of a copyright infringement claim arising out of the use of embedded social media content.
Photographer Elliot McGucken (“McGucken”) posted a photograph of a lake in Death Valley, California, to his public Instagram account. Newsweek published an article about the same lake the following day. As part of its article, Newsweek embedded McGucken’s Instagram photograph without obtaining his permission to do so. McGucken registered the photograph with the Copyright Office and sent Newsweek a cease-and-desist letter for its use of his photograph. When the article remained live with McGucken’s embedded Instagram photograph, he filed suit.
Newsweek moved to dismiss the suit, arguing that (1) by posting his photograph on a public Instagram account, McGucken granted Newsweek a sublicense to use the photograph via Instagram’s embedding feature, and (2) use of the embedded photograph constituted a fair use as a matter of law.
Held: The district court denied the motion to dismiss, finding that there was no evidence of a sublicense between Instagram and Newsweek and that Newsweek’s actions did not constitute a fair use of McGucken’s photo.
Reasoning: The court considered its previous decision in Sinclair v. Ziff Davis in reaching a conclusion regarding Newsweek’s sublicense arguments. While the court agreed with the general principle that Instagram possesses the right to sublicense publicly posted photographs to other users, it found no evidence of a sublicense between Instagram and Newsweek in this case. Next, the court determined there was no evidence of an implied license between the parties. Finally, the court looked at terms and policies outlined by Instagram and found no term expressly granting a sublicense to those who embed publicly posted content. Thus, the court held that there was not enough evidence to dismiss the suit at this stage, while acknowledging the possibility that Instagram’s “Terms of Use” may provide a sublicense for embedded photos.
Regarding Newsweek’s fair use argument, the court analyzed the required four factors laid out in 17 U.S.C. § 107: (1) the purpose and character of the use; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used; and (4) the effect of the use upon the potential market for or value of the copyrighted work. On the first factor, the court held that “the mere addition of some token commentary is not enough to transform the use of the photograph when that photograph is not itself the focus of the article.” On the second factor, the court found the nature of the work was neutral. On the third factor, the court also found this factor neutral because while the entire photograph was used, it would be difficult to use less than the full photograph given the nature of embedding content. Finally, the court found in McGucken’s favor on the fourth factor. The court cited to a Supreme Court ruling finding a presumption of market harm “when a commercial use amounts to mere duplication of the entirety of an original.” Thus, Newsweek’s motion to dismiss on fair use grounds was denied.
§ 1.3 Trademark Cases
§ 1.3.1 Supreme Court decisions
Romag Fasteners, Inc. v. Fossil Group, Inc., et al., 140 S. Ct. 1492 (2020)
Facts: This case concerns whether willful infringement is a prerequisite to an award of a trademark infringer’s profits.
Romag Fasteners, Inc. (“Romag”) and Fossil, Inc. (“Fossil”) entered into an agreement whereby Fossil was permitted to use Romag’s fasteners on Fossil’s leather goods. Upon Romag’s discovery that the foreign factories manufacturing Fossil’s products were using counterfeit fasteners that bore Romag’s “ROMAG” trademark, Romag filed a complaint with the U.S. District Court for the District of Connecticut alleging trademark infringement pursuant to 15 U.S.C. § 1125(a) based on Fossil’s alleged use of counterfeit metal fasteners.
At trial, Romag moved for an award of Fossil’s profits. While the jury awarded Romag $6.7 million of Fossil’s profits due to Fossil’s “callous disregard,” the district court declined to award Fossil’s profits to Romag because the jury did not find that Fossil acted willfully, which was a requirement for an infringer’s profits award under Second Circuit precedent. Romag appealed this decision to the Federal Circuit, which affirmed the district court’s ruling.
Held: The Supreme Court reversed the Federal Circuit and resolved a circuit split by holding that “willfulness” is not required as a precondition to an award of a trademark infringer’s profits.
Reasoning: In analyzing whether an award of an infringer’s profits requires a finding of willfulness, the court first examined the textual language of 15 U.S.C. § 1125(a). The relevant provisions covering remedies for trademark violations do not make a showing of willfulness a precondition to a profit award when the plaintiff proceeds under § 1125(c), as Romag did here.
Second, the court addressed Fossil’s reliance on language from the Lanham Act stating that an award of the defendant’s profits is “subject to the principles of equity,” and thus contains an implicit willfulness requirement. Fossil argued that historically, equity courts required a showing of willfulness before authorizing a profits remedy. The court rejected Fossil’s “principles of equity” argument and reasoned that the historical use of this phrase, as well as its use within other parts of the Lanham Act, does not read in a willfulness requirement.
Third, acknowledging the Lanham Act’s text does not have a willfulness requirement, the court reviewed the Lanham Act’s predecessor legislation, the Trademark Act of 1905. Given that many early trademark cases are still interpreted under the Trademark Act of 1905, the court deemed the Act’s textual implications relevant to Fossil’s arguments. Cases interpreted under the Trademark Act of 1905 inconsistently either read in or read out a willfulness requirement. Regardless, the previous Act’s language did not require willfulness for the award of an infringer’s profits.
Finally, the court grappled with both pre- and post-Lanham Act interpretations of “courts of equity” and the appropriate weight to give an infringer’s mens rea in determining whether or not to award an infringer’s profits. Based on this review, the court recognized that an infringer’s mental state is no doubt relevant to the decision whether or not to award profits; however, whether or not the infringement was willful is not an inflexible precondition to recovery of an infringer’s profits.
United States PTO v. Booking.com B.V., 140 S. Ct. 2298 (2020)
Facts: This case concerns whether the addition of “.com” to an otherwise generic term may create a protectable trademark under the Lanham Act.
Since 2006, Booking.com has managed a website where users can make reservations for travel and lodging. In 2012, Booking.com filed four trademark applications using “BOOKING.COM” as a word mark and for stylized versions of the mark.
The USPTO examiner rejected Booking.com’s application on the grounds that BOOKING.COM was generic based on the services for which it registered, namely online travel reservations. While the Lanham Act allows for “descriptive” terms that have a “secondary meaning” or a perceived designation in the minds of prospective customers, the examiner determined the marks were merely descriptive and lacked secondary meaning.
On appeal, the examiner’s decision was upheld by the Trademark Trial and Appeal Board (“TTAB”) and Booking.com appealed the TTAB’s decision to the U.S. District Court for the Eastern District of Virginia. The district court ruled that the addition of the top-level domain (TLD) of “.com,” implying an online internet commerce site, made the mark no longer generic. Specifically, the district court relied on Booking.com’s evidence that 75% of customers surveyed recognized “Booking.com” as a specific brand.
The USPTO appealed the district court decision to the Fourth Circuit, which upheld the district court’s ruling. The Fourth Circuit considered whether the term “booking.com” could be non-generic when it was a composite of two generic terms, “booking” and “.com.” The Court concluded that it could be considered non-generic because the composite was recognized by customers as a unique online service rather than a range of services. The USPTO appealed the Fourth Circuit’s decision to the U.S. Supreme Court.
Held: A term styled “generic.com” is a generic name for a class of goods or services only if the term has that generic meaning to consumers.
Reasoning: The Court concluded BOOKING.COM was not a generic term by laying out three guideposts for its reasoning: 1) a generic term names a class of goods or services, rather than any particular feature; 2) the distinctiveness of a compound term depends on its meaning as a whole, not its individual parts; 3) the relevant meaning of a term is its meaning to its consumers.
Applying these guideposts, the Court reasoned that in order to disallow BOOKING.COM as a trademark, the Court would have to find that the mark identified a class of online hotel reservation services. Because both parties agreed this was not the case, the Court reasoned BOOKING.COM cannot be considered generic.
Instead, the USPTO argued for a general rule that a generic name combined with a top-level domain (such as “.com”) makes the resulting combination generic. The USPTO’s argument equated the addition of “.com” to the addition of “Company” which was rejected by the Supreme Court as a means for making a term non-generic in an 1888 decision, Goodyear’s India Rubber Glove Mfg. Co. v. Goodyear Rubber Co., 9 S. Ct. 166 (1888). The Court rejected this argument because domain names such as “generic.com” can only be possessed by a single entity and therefore often signify a particular brand. The Court, however, stopped short of saying a “generic.com” domain was inherently non-generic. Instead, an applicant seeking a “generic.com” trademark must still show the mark is distinctive in the eyes of consumers.
Finally, the USPTO raised concerns that such a trademark would limit competition in the online hotel and travel reservation business by stifling the use of similar marks and domains using the term “booking”. The Court reasoned that because BOOKING.COM is a descriptive mark, it is harder to show a likelihood of confusion, thus making it easier to use similar marks and domains. Therefore, existing trademark law mitigates this issue. The Court further added that a competitive advantage is not a bar to a trademark registration.
Lucky Brand Dungarees Inc., et al. v. Marcel Fashions Group Inc., 140 S. Ct. 1589 (2020)
Facts: This case addresses whether res judicata encompasses “defense preclusion” when a trademark litigation defendant raises a new defense in litigation that it could have raised in previous trademark litigation between the same parties.
Marcel Fashion Group, Inc., (“Marcel”) sued Lucky Brand Dungarees, Inc., (“Lucky Brand”) for infringing its trademark in 2001. The parties entered into a settlement agreement that released Lucky from specific trademark claims in the future. Marcel sued Lucky Brand for trademark violations again in 2005. During the 2005 lawsuit, Lucky Brand did not raise a defense based on the previously negotiated release, and Marcel prevailed. Marcel sued Lucky a third time for ongoing trademark infringement in 2011. Lucky Brand moved for summary judgment, arguing that Marcel’s claims were precluded by res judicata on the basis of the final judgment in the 2005 lawsuit.
The district court granted Lucky Brand’s summary judgment motion, but the Second Circuit reversed. The Second Circuit held that Marcel’s alleged infringement occurred after the 2005 judgment (and therefore could not have been part of the 2005 judgment).
Held: The Supreme Court reversed and remanded the Second Circuit’s ruling, finding that Marcel’s 2011 lawsuit involved different conduct and claims than its 2005 lawsuit. Thus, Marcel was unable to preclude Lucky Brand from raising new defenses.
Reasoning: The Supreme Court has “never explicitly recognized ‘defense preclusion’ as a standalone category of res judicata,” and issue preclusion could not bar Lucky Brand’s unlitigated defense. Thus, the question before the Court was whether the 2011 suit and the 2005 suit involved the same claim. A unanimous Supreme Court concluded that “the two suits here were grounded on different conduct, involving different marks, occurring at different times. They thus did not share a ‘common nucleus of operative facts.’”
The Court reasoned that while Marcel’s claims in the 2005 and 2011 suits both involved trademark infringement claims by Marcel against Lucky Brand, the 2011 action did not involve alleged use of the “Get Lucky” mark. Additionally, the conduct at issue in the 2011 action occurred after the conclusion of the 2005 action. The Court noted claim preclusion generally “does not bar claims that are predicated on events that postdate the filing of the initial complaint.” The Court found that because Marcel could not be barred from suing Lucky Brand for infringing the same mark based on different infringing conduct, Lucky Brand could not be prevented from raising a similar (yet previously unused) defense to that different conduct.
Facts: This case addresses whether multi-color trademarks and product packaging marks that employ color without a well-defined peripheral shape or border can be inherently distinctive and thus registerable on the Principal Register without need for proof of acquired distinctiveness.
Forney Industries applied for a mark for use on the packaging of the welding and machining tools and accessories that it sells. Forney described the mark as consisting of “the colors red into yellow with a black banner located near the top as applied to packaging for the goods.” The examining attorney refused to register the mark, asserting that it was not inherently distinctive, and the Trademark Trial and Appeal Board affirmed the examining attorney’s decision. The Board held that no legal distinction existed between a mark consisting of a single color, and a mark consisting of multiple colors without additional elements. The Board then held that marks for colors applied to products and colors applied to product packaging are analyzed the same, and that under Supreme Court precedent, a particular color on a product or its packaging can never be inherently distinctive. The Board further held that a color may only be inherently distinctive when used in conjunction with a distinctive peripheral shape or border. On appeal, the Federal Circuit reversed.
Held: Multi-color trademarks on packaging can be inherently distinctive and thus registerable on the Principal Register without being associated with a well-defined peripheral shape or border.
Reasoning: The court explained that the controlling Supreme Court precedent held that trade dress can be inherently distinctive. And contrary to the Board’s interpretation of the precedent, while precedent held that color marks applied to product designs cannot be inherently distinctive because product design almost invariably serves purposes other than source identification, product packaging marks are more like trade dress and most often used to identify the source of a product. The court held that Forney’s multi-color product packaging mark was more akin to trade dress than product design marks, and accordingly could be inherently distinctive. The court noted that the Tenth Circuit had come to the same conclusion.
The court also explained that inherent distinctiveness turns on whether a mark makes such an impression on consumers that they will assume the trade dress is associated with a particular source. Multi-color marks such as Forney’s do not attempt to preempt all use of certain colors, but merely the particular combination of colors arranged in a particular design, which makes the mark not just a color mark, but also a symbol that could be source identifying. The source-identifying nature of the combination of colors in a particular design meant that the mark could therefore be inherently distinctive.
Future Proof Brands, LLC v. Molson Coors Bev. Co., Case No. 20-50323 (5th Cir. 2020)
Facts: This case concerns whether the product names “BRIZZY” and “VIZZY” are confusingly similar in connection with hard seltzer beverages.
Future Proof Brands, LLC (“Future Proof”) and Molson Coors (“Coors”) both sell hard seltzer beverages named after a variation of the word “fizzy.” Future Proof’s product is called “BRIZZY,” while Coors’ product is named “VIZZY,” to amalgamate its attributes of being fizzy and containing Vitamin C. Future Proof sought an injunction against Coors’ VIZZY product and asserted trademark infringement in the District Court for the Western District of Texas. The district court denied Future Proof’s motion for preliminary injunction.
Held: The Fifth Circuit Court of Appeals affirmed and held that Future Proof failed to prove the requisite elements for a preliminary injunction.
Reasoning: In analyzing whether Future Proof was entitled to a preliminary injunction against Coors, the court focused on whether Future Proof had demonstrated a substantial likelihood of success on the merits. The district court reviewed all eight likelihood of confusion factors. Future Proof challenged the district court’s ruling on factors one, two, six, seven, and eight.
Factor One: Type of Infringed Mark: The court affirmed the district court’s finding that this factor weighs against granting an injunction. The court found that Future Proof’s “BRIZZY” mark was suggestive, rather than descriptive; however, the court disagreed with Future Proof’s assertion that “BRIZZY” was strong. After reviewing evidence of third-party uses of other “IZZY” formative marks for beverages, the court determined that the district court’s conclusion that “BRIZZY” is a weak trademark was not clear error.
Factor Two: Similarity Between the Marks: Future Proof argued that the district court incorrectly determined that the second factor “only marginally” weighed in favor of granting an injunction. Future Proof primarily argued that the district court incorrectly weighted the importance of the “aural similarities of ‘brizzy’ and ‘vizzy.’” Future Proof stressed that aural similarities of the marks are important because alcoholic beverages are often ordered via verbal request, such as in a bar. However, Future Proof could not provide any evidence showing that their “BRIZZY” drinks are sold in bars or restaurants, where aural similarities could be an issue. Instead, Future Proof’s products are only available to buy at retail locations, where aural similarities would not cause confusion. The court upheld the district court’s finding that this factor weighed only marginally in favor of granting an injunction.
Factor Six: Defendant’s Intent: Future Proof argued that the district court’s finding that this factor goes against granting an injunction was in error. Future Proof argued that Coors’ executives were aware of Future Proof’s “BRIZZY” product. However, knowledge alone does not establish bad intent. Future Proof bore the burden to produce evidence showing Coors’ bad intent. Without such evidence, the court concluded that this factor did not support granting an injunction.
Factor Seven: Evidence of Actual Confusion: The district court dismissed Future Proof’s one example of consumer confusion and ruled that this factor did not favor an injunction. Future Proof presented evidence of a wholesaler mixing up the names “BRIZZY” and “VIZZY.” The court found that the district court incorrectly excluded this evidence because it ruled a “wholesaler” was not a regular consumer for confusion evidence purposes. Notwithstanding this limited reversal, the court affirmed the district court’s finding that a simple and “fleeting” mix-up of names does not constitute actual confusion; therefore, this factor weighed against granting an injunction.
Factor Eight: Degree of Care Exercised by Potential Purchasers: Future Proof disagreed with the district court’s finding that this factor does not favor an injunction. Future Proof advanced arguments that the goods at issue are relatively low cost (a 12-pack of Brizzy sells for $14.99) and that the consumers often purchase the goods in snap decisions. However, Future Proof did not produce any evidence or affidavits showing that the goods are often purchased in a snap decision, nor that Future Proof’s products were available in bars or restaurants where snap purchasing decisions are common.
The court found that the district court did not commit clear error in concluding Future Proof failed to show a likelihood of success on the merits.
VIP Products LLC v. Jack Daniel’s Properties, Inc., Case No. 18-16012 (9th Cir. 2020)
Facts: VIP Products LLC (“VIP Products”) produces and sells a novelty dog toy modeled after Jack Daniel’s Properties, Inc.’s (“Jack Daniels”) trademarked trade dress and bottle design. VIP Products’ toy was called “Bad Spaniel’s” instead of “Jack Daniel’s.” Jack Daniels sent VIP Products a cease and desist letter demanding VIP Products stop making the Bad Spaniel’s toy. In response, VIP Products filed a declaratory judgment action in the District Court for the District of Arizona requesting: (1) a finding of non-infringement, or in the alternative, (2) a finding that Jack Daniel’s trademark and trade dress were not entitled to protection. After a bench trial, the District Court found in favor of Jack Daniels and issued an injunction against VIP Products.
Held: While affirming the rulings regarding Jack Daniel’s trademarks and trade dress validity, the court reversed the district court’s finding against VIP Products for trademark dilution and infringement. The court reversed on grounds that VIP Products’ “Bad Spaniel’s” product is an expressive work entitled to First Amendment protection.
Reasoning: First, in addressing the validity of Jack Daniel’s trade dress and trademarks, the court focused on whether the designs were distinctive and non-functional. Considering the Jack Daniel’s trade dress as a whole, the court affirmed the district court’s finding that the designs were non-functional and distinctive.
Second, the court addressed VIP Products’ assertion of a nominative fair use defense. The court dismissed this defense because nominative fair use only applies in situations where the marks at issue are identical.
Third, the court addressed VIP Products’ First Amendment defense to trademark infringement and dilution. While the likelihood of confusion test usually applies for trademark infringement inquiries, the test may be inappropriate when works containing artistic expression are involved. In determining whether VIP Products’ “Bad Spaniel’s” toy was an expressive work, the court ruled that, while the toy was “not the equivalent of the Mona Lisa,” it was an expressive work nonetheless. In coming to their decision, the court likened this expressiveness inquiry to a similar case of Louis Vuitton Malletier S.A. v. Haute Diggity Dog, LLC. In Louis Vuitton, the defendants created novelty dog toys in the shape of purses bearing the name “Chewy Vuitton.” The Fourth Circuit held that the “Chewy Vuitton” toys were expressive, and this court found that a similar outcome for VIP Products’ “Bad Spaniel’s” toy was required. Given the expressive nature of VIP Products’ toy, the district court erred in not requiring Jack Daniels to satisfy the Rogers test. The Rogers test (derived from Rogers v. Grimaldi) involves showing that the defendant’s use of the mark is either (1) not artistically relevant to the underlying work, or (2) explicitly misleads consumers as to the source or content of the work, before trademark infringement can be found.
Accordingly, the court reversed and remanded the district court’s finding of trademark infringement pending resolution of the Rogers test inquiry.
Ezaki Glico Kabushiki Kaisha v. Lotte International America Corp., 977 F.3d 261 (3d. Cir. 2020)
Facts: This case concerns whether Ezaki Glico’s (“EG”) trade dress registration for its chocolate-dipped cookie sticks is functional.
EG, a Japanese confectionary company, is the creator of the famous Pocky stick cookies. The stick-shaped cookies are partially dipped in chocolate and have an uncoated end, which serves as a handle. In order to protect itself from competitors, EG filed for and received trademark and trade dress registrations and a method patent. As early as 1993, EG demanded that Lotte cease selling Lotte’s Peperro sticks, which were similar to EG’s Pocky product. In 2015, EG brought trade dress infringement and unfair competition claims against Lotte in New Jersey District Court. The district court granted summary judgment for Lotte, holding that the Pocky product trade dress was functional and not protectable. The Third Circuit affirmed.
Held: The Third Circuit held that the Pocky design trade dress registrations were invalid because the design was functional.
Reasoning: The Third Circuit emphasized that patent law, not trademark law, protects useful designs, and the functionality doctrine prevents trademark law from usurping patent law. EG argued that functional features needed to be essential before the functionality doctrine applies. However, the Third Circuit held that precedent defined functional as merely useful, not essential, and looked to evidence of functionality.
Although EG’s trade dress registrations were presumed valid, evidence showed that EG designed the Pocky product so that people could consume an easy-to-hold cookie without getting chocolate on their hands. The design also allowed EG to package multiple cookies in a box in order to promote sharing. Evidence also showed that EG promoted the Pocky sticks’ “convenient design.” Even though EG pointed to evidence of alternative designs, this was not dispositive to show the Pocky design was non-functional. Although immaterial to the outcome, the Third Circuit also held that the district court erroneously considered Lotte’s argument that EG’s method patent was evidence of functionality. EG’s “central advance” of the method patent did not overlap with the trade dress.
Tiffany and Company v. Costco Wholesale Corporation, 971 F.3d 74 (2d. Cir. 2020)
Facts: This case concerns whether the district court improperly granted summary judgment of trademark infringement to Tiffany in connection with Costco’s use of the term “Tiffany” in describing its engagement rings.
Tiffany, a producer of fine jewelry, owns numerous trademark registrations for “TIFFANY” and other related marks for jewelry-related goods. Tiffany raised, inter alia, trademark infringement claims against Costco when it learned that Costco began displaying engagement rings next to signs stating the rings had a Tiffany-style ring setting. Costco argued that its use of the term “Tiffany” was not infringing, and raised a fair use defense because the term was used “otherwise than as a mark … [and] in good faith only to describe” its ring setting. Costco pointed out that Charles Tiffany, the founder of Tiffany, created the Tiffany-style ring settings in the late 19th century. Costco’s rings were also unbranded, and the ring displays at issue resembled Costco’s other point-of-sale signs which listed ring-setting information.
The district court granted summary judgment to Tiffany because Costco’s fair use defense failed as a matter of law, and Costco failed to raise a genuine issue of material fact under any of the relevant Polaroid factors of actual confusion, good faith, and consumer sophistication. Costco appealed, and the Second Circuit vacated and remanded.
Held: Costco raised triable issues of material facts with regard to the Polaroid factors and, by extension, the ultimate issue of whether Costco’s actions generated a likelihood of customer confusion. Costco also raised triable questions as to the other factors pertinent to the fair use defense.
Reasoning: With regard to the Polaroid factor of actual confusion, the district court had found the testimony of six Costco customers and Tiffany’s survey expert on customer confusion to be unrebutted. However, the Second Circuit held that Costco had rebutted Tiffany’s evidence. Costco argued the testimony of the six customers out of the 3,349 customers who purchased Tiffany-style set rings was only de minimis evidence of confusion, and Costco’s own expert criticized the survey methodology and results of Tiffany’s expert. The Second Circuit held that the district court, in concluding otherwise, observed that these criticisms went to the weight of Tiffany’s evidence rather than its admissibility and that Costco’s expert did not perform his own survey to demonstrate affirmatively that Costco’s customers were not confused. However, the Second Circuit held the weight to be given to a particular piece of evidence could be determinative of whether a jury could find a genuine issue of material fact. Similarly, with regard to the Polaroid factor of consumer sophistication, the Second Circuit also held that the district court’s attribution of Costco’s competing expert report to “the weight that Tiffany’s evidence should be accorded” and its conclusion that Costco failed to provide competing affirmative evidence” was improper.
With regard to the Polaroid factor of good faith, the Second Circuit disagreed with the district court’s holding that no reasonable jury could have found Costco acted with good faith. Costco provided contrary evidence that it never attempted to adopt the TIFFANY mark, that its signs used the term “Tiffany” as a brand-independent description of a type of ring setting and merely reflected information provided by vendors.
The district court resolved Costco’s fair use defense on the basis of good faith alone for the same reasons that underpinned its analysis of the Polaroid good faith factor. Thus, the district court did not consider the other factors in Costco’s fair use defense. The Second Circuit held that Costco’s proffered evidence of its signs could allow a reasonable jury to conclude that Costco did not use the term “Tiffany” as a trademark. Rather, a reasonable jury could conclude that Costco used the term “Tiffany” to describe a ring setting.
§ 1.3.3 Other notable decisions
In re Stanley Brothers Social Enterprises, LLC, 2020 USPQ2d 10658 (TTAB 2020)
Facts: The United States Patent and Trademark Office (“USPTO”) denied Stanley Brothers’ trademark application for “CW” covering “hemp oil extracts sold as an integral component of dietary and nutritional supplements.” The USPTO reasoned that Stanley Brothers’ goods were per se unlawful under the Food, Drug, and Cosmetics Act (“FDCA”) and Controlled Substances Act (“CSA”). The FDCA prohibits “[t]he introduction or delivery for introduction into interstate commerce of any food to which has been added . . . a drug or biological product for which substantial clinical investigations has been made public . . .” The USPTO’s position was that Stanley Brothers’ “hemp oil extracts” are food to which CBD has been added, and that CBD was the subject of clinical investigations during prosecution of its trademark application. Stanley Brothers appealed this refusal to the Trademark Trial and Appeal Board (“TTAB”) arguing that its goods were permissible under the FDCA and CSA; therefore, refusal of its trademark application should be withdrawn. Stanley Brothers relied on three arguments: (1) the Industrial Hemp Provision of the 2014 and 2018 Farm Bills excludes industrial hemp from the FDCA sections at issue; (2) its goods are dietary supplements, not food, and are not subject to regulation by the FDCA; and (3) its goods fall under an FDCA exception that allows their use because they were incorporated into food products before any substantial clinical investigations involving the drug began.
Held: The TTAB rejected Stanley Brothers’ arguments and affirmed the USPTO’s refusal of Stanley Brothers’ trademark application.
Reasoning: First, the TTAB recognized that the Industrial Hemp Provisions of the Farm Bills permits authorized entities to grow and/or cultivate industrial hemp. However, there are no explicit allowances for entities to distribute or sell CBD or food products with CBD, such as Stanley Brothers’ oils. The TTAB thus rejected Stanley Brothers’ first argument.
Second, the TTAB addressed whether Stanley Brothers’ goods were correctly considered food products. Under the FDCA, “food” means “articles used for food or drink for man or other animals . . . and articles used for components of any such article.” Citing evidence that Stanley Brothers’ oils are marketed to be used in consumer beverages, the TTAB ruled that they are considered food products. Therefore, the TTAB rejected Stanley Brothers’ second argument that the products were dietary supplements rather than food.
Third, the TTAB addressed whether Stanley Brothers’ goods were marketed in food before any substantial clinical investigations began involving CBD. After finding that Stanley Brothers did not introduce any persuasive or probative evidence to support this last argument, the TTAB rejected it.
The TTAB affirmed that Stanley Brothers’ goods are per se unlawful under the FDCA. Because of this ruling, the TTAB did not reach whether or not the goods are also illegal under the CSA.
AM General LLC v. Activision Blizzard, et al., No. 17 Civ. 8644 (GBD) (S.D.N.Y. 2020)
Facts: This case addresses the balance between (1) First Amendment expression in artistic works (video games) using registered trademarks and (2) registered mark-holder rights granted by the Lanham Act.
AM General designs and manufactures military-grade vehicles branded as “Humvee.” The United States Armed Forces, as well as the militaries of numerous countries, routinely use Humvee vehicles as part of their operations. AM General holds a trademark registration for the HUMVEE word mark and asserts trade dress rights in design elements of the Humvee vehicle itself.
Activision Blizzard (“Activision”) makes Call of Duty, a highly successful and well-known first-person shooter video game franchise. Call of Duty comprises cinematic depictions of warfare intended to simulate military combat. Activision uses the Humvee vehicle as part of its video game design. Call of Duty players can even drive a Humvee. Activision also uses the Humvee as part of its advertising campaigns for Call of Duty games.
AM General brought suit against Activision for trademark infringement and trade dress infringement (among several other claims) in connection with Activision’s use of the Humvee vehicles. Activision filed a motion for summary judgment on all claims.
Held: The district court granted Activision’s motion for summary judgment on all claims, applying the Rogers v. Grimaldi test and finding that Activision’s use of the Humvee (1) had artistic expression related to the underlying work and (2) did not expressly mislead as to the source or content of the work.
Reasoning: The court applied the two-prong test in Rogers v. Grimaldi (875 F.2d 994 (2d Cir. 1989)) to analyze whether the Lanham Act should be interpreted narrowly in light of protected expression under the First Amendment. Under the two-prong Rogers test, courts in the Second Circuit must determine whether the use of the trademark (1) has any “artistic relevance to the underlying work whatsoever,” and (2) “explicitly misleads as to the source or the content of the work.” On the first prong, the court found that “[f]eaturing actual vehicles used by military operations around the world in video games about simulated modern warfare surely evokes a sense of realism and lifelikeness to the player who ‘assumes control of a military soldier and fights against a computer-controlled or human-controlled opponent across a variety of computer-generated battlefields.’” The court determined such depiction constituted artistic relevance.
In analyzing the second prong, the court applied the “Polaroid factors” (Polaroid Corp. v. Polaroid Electronics Corp., 287 F.2d 492, 495 (2d Cir. 1961)) for a likelihood of confusion determination. It found that six out of the eight factors weighed in Activision’s favor, or against a likelihood of confusion. The “evidence of actual confusion” factor weighed only “slightly” in favor of AM General. AM General’s consumer survey “found that 16% of consumers shown actual video game play from Activision’s games were confused as to AM General’s association with Call of Duty.” The court determined this survey was evidence of “some” confusion “at most.” Overall, the court found that the countervailing First Amendment consideration weighed against heavily considering the actual confusion evidence. AM General failed to show Activision’s uses of Humvee vehicles misled Call of Duty players as to the source of the Humvee mark and design. Thus, the court ruled in Activision’s favor.
Illinois’ Biometric Information Privacy Act, 740 ILCS 14/1 et seq. (BIPA) establishes safeguards and procedures relating to the retention, collection, disclosure, and destruction of biometric data. 740 ILCS 14/15. Passed in October 2008, BIPA is intended to protect a person’s unique biological traits – the data encompassed in a person’s fingerprint, voice print, retinal scan, or facial geometry. Id. But in the last few years, BIPA – with its statutory penalties of $1,000 for each negligent violation and $5,000 for each intentional or reckless violation – has quickly become the bane of corporate defendants. The situation became even worse after the Illinois Supreme Court’s decision in Rosenbach v. Six Flags Entm’t Corp., 2019 IL 123186. In Rosenbach, the Court held that a “violation [of BIPA], in itself, is sufficient to support the individual’s or customer’s statutory cause of action.” Rosenbach at ¶33 (emphasis added). In other words, a bare statutory violation confers standing on a BIPA plaintiff. See id.
What Would the Amendments Do?
The Illinois Legislature is currently considering three bills that would amend BIPA in several significant ways. Illinois House Bill 559 would protect companies that store an individual’s biometric information in the form of indecipherable mathematical representations or encrypted algorithms. Under HB 559, biometric information would, by definition, not include “biometric information that cannot be used to recreate the original biometric identifier.” HB 559 would also establish a one-year statute of limitations, beginning from the date that the “cause of action accrued,” and also establish a 30-day period in which the company could cure any alleged violation. If the private entity “actually cures the noticed violation” and provides notice to the aggrieved person, then the individual would no longer be able to bring an “action for individual statutory damages or class-wide statutory damages…” Illinois House Bill 559. These “statutory damages” have also been redlined. Under HB 559, aggrieved individuals would no longer be entitled to the statutory damages of $1,000 and $5,000. Instead, negligent violations would permit a plaintiff to recover only their “actual damages,” and willful violations would permit a plaintiff to recover their “actual damages plus liquidated damages up to the amount of actual damages.” Illinois House Bill 559. HB 559 has advanced out of the Judiciary Committee and has been placed on the calendar for debate before the House.
Illinois House Bill 560, meanwhile, would eliminate BIPA’s private right of action and would vest the state of Illinois (through the Attorney General, the appropriate State’s Attorney’s Office, or the Department of Labor) with the power to enforce the BIPA’s provisions. Illinois House Bill 560. HB 560 has not advanced out of the Rules Committee. Illinois Senate Bill 330 largely replicates the amendments found in HB 559, but provides definitions for what it means to cure the violation and for when a claim accrues. Senate Bill 330 remains in the Judiciary Committee.
Would Any of These Amendments Be Retroactive?
There are hundreds (if not a few thousand) of BIPA suits currently pending in the Illinois state and federal courts. If any of these amendments become law, the critical question would be which of these amendments are retroactive and could have an impact on the pending lawsuits?
Illinois has adopted the first step of the United States Supreme Court’s retroactivity analysis. People v. Stefanski, 2019 IL App (3d) 160140, ¶12 (citing Landgraf v. USI Film Products, 511 U.S. 244 (1994)). Under Landgraf, the first question is whether the legislature has clearly indicated the statute’s “temporal reach.” Id. If it has, and assuming there is no constitutional prohibition, then the legislature’s intent will be given effect. Id. If the legislature’s intent is not clear, then Illinois courts bypass the Landgraf analysis and proceed to determine whether the statutory amendments are procedural or substantive. Id. at ¶13. Procedural changes to a statute will be applied retroactively, while substantive changes will be applied prospectively. Id. The court in Perry v. Dep’t of Fin. & Pro. Regul. noted that distinguishing between procedural and substantive changes is not always easy, of course. Perry v. Dep’t of Fin. & Pro. Regul., 2018 IL 122349, ¶69. There is also a general presumption that an amended statute is “not to be applied retroactively.” Stefanski, 2019 IL App (3d) 160140, ¶13.
None of the three bills contains any statement on retroactivity. The Illinois courts, would therefore need to determine whether the amendments are procedural or substantive in nature. House Bill 560’s elimination of a private right of action would be a substantive amendment because it is an amendment that “creates, defines, and regulates the rights, duties, and powers of the parties.” Perry, 2018 IL 122349, ¶70. House Bill 559’s amendment to the definition of “biometric information” would likely also be viewed as a substantive change to the law, since it would eliminate an entire class of devices and conduct that were not previously immune from suit. Perry, 2018 IL 122349 at ¶71 (“Because [these amendments] alter the scope of information that is accessible, both amendments are substantive changes . . . [and] may not be retroactively applied…”).
The other amendments are not so clear. The amendment establishing a one-year statute of limitations could have retroactive application. Amendments which change “statutes of limitations are considered procedural,” which means they “may be given retroactive effect.” Wanless v. Burke, 253 Ill. App. 3d 211, 215 (3rd Dist. 1993). This can be especially true where the amendments affect a statutory right of action and not a common law right. See Stanley v. Denning, 130 Ill. App. 2d 628, 632 (2d Dist. 1970) (“In determining whether a statute is intended to operate retroactively, we believe that there is an important distinction between an amendment reducing an existing time limitation which affects rights, statutory in origin, as opposed to those originating in the common law.”). Where the legislature has created the right, it has the power to withdraw it. Orlicki v. McCarthy, 4 Ill. 2d 342, 351 (1954). The amendment to add a BIPA statute of limitations, if passed, could impact the limitations period for current and future cases, particularly because the current applicable limitations period is unsettled.[1]
The elimination of liquidated damages could also have a retroactive application. Statutory amendments that impact available remedies are often seen as procedural and not substantive. Dardeen v. Heartland Manor, Inc., 186 Ill. 2d 291, 299 (1999). Amendments to remedies may, therefore, be applied to a pending suit, “irrespective of when the cause of action accrued or the complaint was filed.” Id. In Dardeen, the Illinois Supreme Court held the repeal of a treble damage provision related solely to a remedy and was therefore procedural in nature. Id. A plaintiff has no vested right to “exemplary, punitive, vindictive or aggravated damages.” Id. Fifteen years later, though, the Illinois Supreme Court held that an amendment related to remedies was substantive because it created an “entirely new type of liability.” People ex rel. Madigan v. J.T. Einoder, Inc., 2015 IL 117193, ¶36. In Einoder, the Illinois Supreme Court held that the amendment could not be applied retroactively because it created a “substantive change in the law” by imposing “new liability on defendants’ past conduct.” Id. Whether the repeal of liquidated damages is seen as relating solely to a remedy (Dardeen) or as imposing a new burden on plaintiffs (Einoder) presents an intriguing question.
Conclusion
The proposed amendments to BIPA are intended to provide clarity and relief to corporate defendants. But even if passed, the amendments generate further questions about their retroactivity and the full extent of the relief that they might provide defendants.
[1] BIPA does not include a statute of limitations. Defendants have argued the one-year statute of limitations for privacy claims should apply (735 ILCS 5/13-201), while plaintiffs have argued for the five-year catchall limitations period (735 ILCS 5/13-205). The Illinois Court of Appeals is poised to decide what limitations period applies to BIPA claims in Tims v. Black Horse Carriers, Inc., Case No. 1-20-0563 (1st Dist.).
This article first appeared in the Banking Law Committee Journal. We invite you to read the rest of our Spring 2021 Edition.
On January 1, 2021, Congress enacted the Anti-Money Laundering Act (AMLA). The AMLA establishes new whistleblower protections for employees of financial services institutions. General counsel, employment attorneys, and human resource professionals need to be aware of these changes.
In recent years, the United States has seen many compliance personnel bring retaliation and whistleblower claims against their employers. The actions of financial institutions with respect to their compliance personnel are often under a microscope, as these institutions may be operating under a Consent Decree (or the threat of a Consent Decree) by virtue of regulators’ concerns about compliance with risk-related laws and regulations.
Nevertheless, while courts (and regulators) are protective of whistleblower rights, they also understand and are respectful of an employer’s right to remove personnel when the employer can demonstrate that the employee is indeed incompetent or insubordinate, and may even be an impediment to effective regulatory compliance.
The challenge for a financial services employer, then, is to establish that discipline against an employee in a compliance role was based on the employee’s incompetence or other inappropriate behavior, and that any whistleblowing activity he or she engaged in was not a consideration.
1. Principal Financial Services-Related Whistleblower Laws
A. Bank Secrecy Act
The Bank Secrecy Act (“BSA”), 31 U.S.C. 5323 et seq., prohibits financial institutions from discharging or otherwise discriminating against an employee because the employee (or any person acting pursuant to the request of the employee) provided information to any federal supervisory agency regarding a possible violation by the financial institution or any director, officer or employee of the financial institution of certain specified laws. The BSA also authorizes government payments to whistleblowers who provide original information leading to the government’s collection of fines, civil penalties or forfeitures relating to BSA violations.
The BSA, prior to passage of the AMLA, protected only complaints to the government, as opposed to internal complaints. Any employee or former employee has two years from the date of the alleged retaliatory act to file a civil complaint in federal district court. Remedies include reinstatement, compensatory damages, and any other “appropriate actions” to remedy the past discrimination.
These protections do not apply to any employee who deliberately causes or participates in the alleged violation, or who knowingly or recklessly provides substantially false information in the employee’s report. Further, these protections do not apply to FDIC insured banks.
Pre-AMLA, the BSA capped government payments at $150,000, however, and affords the Treasury Department discretion in deciding whether to issue an award in any amount up to that limit. These aspects have curtailed the impact of the BSA on money-laundering enforcement and made it much less effective than the bounty program established by the SEC under the Dodd-Frank Act (DFA).
B. FDIA
The Federal Deposit Insurance Act (“FDIA”) provides that no Federal banking agency, Federal home loan bank, Federal reserve bank, or any person who is performing, directly or indirectly, any function or service on behalf of the [FDIC] may discharge or otherwise discriminate against any employee with respect to compensation, terms, conditions, or privileges of employment because the employee (or any person acting pursuant to the request of the employee) provided information to any such agency or bank or to the Attorney General regarding any possible violation of any law or regulation, gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health or safety. 31 U.S.C. § 5328
C. FIRREA
The Financial Institutions Reform, Recovery, and Enforcement Act, 12 U.S.C. § 1831k (“FIRREA”), enacted during the savings and loan crisis of the late 1980s, permits a whistleblower to file a declaration with the U.S. Department of Justice (DOJ) describing one or more violations of FIRREA “affecting” a depository institution insured by the FDIC or any other agency or entity of the U.S. The declaration is not filed in court and is kept confidential by the DOJ for at least one year (and maybe longer). The DOJ is charged with investigating and (if successful and eligible for an award) the whistleblower can receive 20%-30% of any recovery up to the first $1 million recovered, 10%-20% of the next $4 million recovered, and 5%-10% of the next $5 million recovered.
In a FIRREA case, the Attorney General also has the discretion to award a whistleblower a portion of any criminal recovery under FIRREA, in addition to or instead of a civil penalty.
D. Dodd Frank
The Dodd-Frank Wall Street Reform and Consumer Protection Act, 15 U.S.C. § 78u-6(a)(6), protects whistleblowers who provide information regarding (or cooperate in the investigation of) any potential violation of U.S. securities laws. An employer may not discharge, demote, suspend, threaten, or harass, directly or indirectly, or in any other manner discriminate against an individual based on his or her whistleblowing.
Dodd-Frank only protects the employee against retaliation if the federal violation falls within the SEC’s jurisdiction. Examples of violations that fall within the SEC’s jurisdiction include accounting fraud, providing false information, insider trading and other violations of securities law. The statute of limitations is six years. Remedies include reinstatement, double the back pay owed, plus interest, reasonable attorneys’ fees, litigation costs, and expert witness fees.
E. Sarbanes Oxley
The anti-retaliation protections of the Sarbanes-Oxley Act (“Sarbanes Oxley” or “SOX”) protect employees of public companies[1] against retaliation in the terms and conditions of employment as a result of their providing information, causing information to be provided, or otherwise assisting in an investigation of alleged violations of mail fraud, wire, radio, or television fraud, bank fraud, securities fraud, any rule or regulation of the Securities and Exchange Commission (“SEC”), or any provision of federal law relating to fraud against shareholders. 18 U.S.C. § 1514A(a)(1)
To be protected, an employee must provide such information or assistance to, or the investigation must be conducted by, a Federal regulatory or law enforcement agency; any member or committee of Congress; or a person with supervisory authority over the employee (or other such person working for the employer who has authority to investigate, discover, or terminate misconduct).
An employee is not required to demonstrate that a violation has actually occurred. Rather, in order to be protected, an employee must demonstrate that he or she “reasonably believes” that a violation is occurring.
In Lawson v. FMR LLC, 134 S. Ct. 1158 (2014), the Supreme Court held that SOX may also provide whistleblower protection to employees of private contractors of publicly traded companies and their subsidiaries. Since Lawson, courts have generally limited the ruling’s application, holding that the contractor must have been integrally involved in the transaction to be covered by SOX.[2]
F. Federal False Claims Act and New York False Claims Act and the New York False Claims Act
The federal False Claims Act prohibits the knowing submission of false or fraudulent claims to the United States, or to a third party if the government has provided a portion of the money or will reimburse the third party. 31 U.S.C. § 3729. The application of this statute depends on the degree to which a bank is engaged in business with the federal government. Banks with government insured loans are covered by the FCA.
The NY False Claims Act closely tracks the federal FCA. It imposes penalties and fines on individuals and entities that file false or fraudulent claims for payment from any state or local government. N.Y. Fin. L. 91
2. Burdens of Proof
Generally speaking, a plaintiff in a whistleblower retaliation claim, a plaintiff must show that: 1) he or she was retaliated against for reporting inappropriate activity; 2) he or she reported that information to the employer and/or the government, depending on the particular statute’s purview; 3) the disclosure was required or protected by that law, rule or regulation within the SEC’s jurisdiction. Further, the employee must establish that he or she had a subjectively and objectively reasonable belief that the conduct in question violated the law.
If a Bank has entered into a consent decree, and if the compliance whistleblower raises issues around alleged inappropriate activity that was the subject of the consent decree, it is likely that a court would grant that the employee indeed had both a subjectively and objectively reasonable belief that unlawful conduct took place.
In most instances, an employee need only establish that his or her protected activity was a contributing factor, not necessarily a motivating factor, to the adverse employment action. The words “contributing factor” mean any factor which, alone or in connection with other factors, tends to affect in any way the outcome of the decision.
On the other hand, an employer can normally avoid liability if it can establish by “clear and convincing” evidence that it would have taken the same adverse action against a complainant absent his or her protected activity. Thus, even if the employee can establish that he or she was retaliated against in violation of these laws, the employer can prevail if it demonstrates that it would nevertheless have taken the same action against the employee because of conduct unrelated to their whistleblower activities.
In essence, this reverses the normal burden of proof under discrimination actions in which the burden always remains on the plaintiff.
Regardless of the test, for an employer to prevail in a whistleblower claim, it will need to establish that it took adverse action against the alleged whistleblower for reasons unrelated to any protected whistleblower activities in which she may have engaged. Instead, the employer will need to argue that any disciplinary action the Bank takes taken against the employee was based upon job performance problems or other non-protected activities.
Depending on the particular statute, a whistleblower who prevails in a retaliation claim can recover lost wages, the value of benefits, attorney’s fees, expert witness fees, compensation for emotional distress, punitive damages, liquidated damages, and, under some statutes, a percentage of any recovery the Government obtains in a criminal prosecution against the employer. Additionally, a court can order a terminated employee reinstated.
3. The AMLA
The AMLA bars employers from discharging, demoting, threatening or harassing employees who provide information relating to money laundering and BSA violations to the attorney general, secretary of the treasury, regulators and others, including their own employer.
The AMLA strengthens the incentive program because it (1) narrows the government’s discretion to pay an award, (2) increases the potential amount of whistleblower awards, and (3) implements protections specific to money-laundering whistleblowers, in a manner largely modeled after Dodd-Frank.
The AMLA covers a wide range of financially based organizations, including banks, branches and agencies of foreign banks, broker-dealers, insurance companies, operators of credit card systems, mutual funds, certain casinos, and travel agencies, among the twenty-six covered categories. (The full list of covered entities appears at 31 U.S.C. §5312.)
In addition, the law now places under the BSA’s purview any person or business that engages in the transmission of currency, funds or value that substitutes for currency, meaning that organizations dealing in cryptocurrency now come within the statute’s reach. Persons involved in the sale of antiquities are also now covered.
A. AMLA Whistleblowing Protection and Procedure
The AMLA defines “whistleblower” as any individual (or two or more people acting jointly) “who provides information relating to a violation of this subchapter … to the employer of the individual or individuals, including as part of the job duties of the individual or individuals, or to the [Treasury] Secretary or the Attorney General.”[3]
In other respects, the anti-retaliation provisions resemble protections under Dodd-Frank and the Sarbanes-Oxley Act. Complaints are filed initially with the Department of Labor and if they are not resolved within six months (assuming that the delay was not caused by claimant’s bad faith), employees can file actions in federal court and have a jury trial. Available relief can include reinstatement with no loss in seniority, compensatory damages, counsel fees, double back pay with interest added, and other appropriate remedies regarding the prohibited conduct.
B. Expanded Financial Incentives for Whistleblowers
The new statute provides that the secretary of the treasury “shall” pay an award to those who provide original information leading to successful enforcement of various money-laundering laws, if the SEC obtains sanctions of $1 million or more. As with Dodd-Frank, certain individuals, like regulatory and law enforcement officials and those who participated in the wrongdoing, are prohibited from receiving an award. To incentivize reporting, the AMLA replaced the BSA’s $150,000 award cap, which was discretionary in any event, with a payment ceiling of 30% of the government’s collection, if the monetary sanctions imposed exceed $1 million and which is now mandatory unless the reporting individual is disqualified.
Again, like Dodd-Frank, factors to be taken into consideration by the government when deciding the amount of the award include the significance of the information, the degree of assistance provided and the programmatic interest of Treasury in deterring violations. Treasury retains the discretion to make nominal payments, and there is no right to appeal the amount awarded. However, the “monetary sanctions” figure on which the reward will be based excludes forfeiture, restitution and victim compensation payments, and since the government frequently seeks large forfeiture judgments when resolving money-laundering actions, this provision may significantly limit whistleblower awards.
C. Importance of Investigation and Corporate Compliance Programs
Federal and state regulators have made clear, in recent years, that employers must implement and follow well designed investigation protocols to root out claims of retaliation and protect whistleblowers.
In January 2019, the New York State Department of Financial Services (“DFS”) issued a new directive on whistleblower policies (“DFS Guidance”). A few short months later, the U.S. Department of Justice Criminal Division (“DOJ”) issued an “updated” Evaluation of Corporate Compliance Programs Guidance (“DOJ Guidance”).
The DOJ Guidance emphasizes that there are three main questions for prosecutors to consider during a criminal investigation:
1) Was there a well-designed compliance program?
2) Was the compliance program effectively implemented?
3) Did the compliance program work as intended?
Prosecutors assess, among other things, whether policies, training and communication are sufficiently robust to encourage a culture of compliance and responsibility.
The company’s reporting process should emphasize disclosure of suspected misconduct and dissuade any fear of retaliation. There is also an emphasis on confidential reporting options.
The DFS Guidance articulated ten “pillars,” emphasizing the need to have in place reporting channels that are independent, well-publicized, easy to access, and consistent, with strong protections for a whistleblower’s anonymity.
The DFS Guidance also requires that the employer have in place established procedures for identifying and managing potential conflicts of interest, and that staff members are adequately trained to receive whistleblowing complaints, determine a course of action, and competently manager any investigation, referral, or escalation.
Further, the DFS Guidance demands that employers establish procedures for investigating allegations of wrongdoing, ensuring appropriate follow-up to valid complaints, protecting whistleblowers from retaliation, and providing confidential treatment of these complaints.
The DFS Guidance recommends, as well, that regulated employers give appropriate oversight of the whistleblowing function to senior management, internal and external auditors, and the Board of Directors. Perhaps most important, the DFS Guidance demands that the employer have in place a top-down culture of support for the whistleblowing function.
D. Importance of Documentation of Performance Problems
The relevant cases underscore the importance of documenting performance or disciplinary issues before taking adverse action against an employee who may have engaged in protected activity. In Johnson v. ACE Limited, ARB Case No. 10-052 (Jan. 30, 2012), a case brought under Sarbanes-Oxley, the Department of Labor Arbitration Review Board (“ARB”) found that although the complainant had engaged in protected activity, the employer had demonstrated by clear and convincing evidence that it would have fired him anyway because of his incompetence, his outside business interests and his insubordinate behavior when questioned about the outside business.
In Giurovici v. Equinix, Inc., ARB Case No. 07-027 (Sept. 30, 2008), the ARB found that even if the former employee could establish that he had engaged in protected activity, his claim would have failed because the company offered clear and convincing evidence it would have fired him anyway because of his well-documented record of poor performance and insubordination.
Similarly, in Pardy v. Gray, 2008 U.S. Dist. LEXIS 53997, at **17–18 (S.D.N.Y. July 15, 2008), the court held that the employer company established by clear and convincing evidence that it discharged employee for undisputed record of poor performance.
An assessment of the strength of the anticipated defense therefore must take into account the quality of contemporaneous documentation of the alleged whistleblower’s performance issues.
[1] Companies with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, or which are required to file reports under Section 15(d) of the Securities Exchange Act of 1934.
[2] We can posit a scenario where a bank is financing a transaction for a publicly traded company, and a bank employee claims that there is securities fraud in the processing of the transaction—for example, he or she could claim that individuals at the bank are using confidential information to engage in insider trading around the transaction. In that case, the employee reporting that activity might be a protected whistleblower under SOX.
[3] Institutions that are insured by the Federal Deposit Insurance Corporation (FDIC) and Federal Credit Union Act (FCUA) are exempt from these new protection provisions, but employees of those entities can still rely on existing whistleblower protections, like those provided by the Federal Deposit Insurance Act and the Federal Credit Union Act, when seeking redress from suspected retaliation.
This article first appeared in the Banking Law Committee Journal. We invite you to read the rest of our Spring 2021 Edition.
On December 15, 2020, the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“FRB”) (together the “Agencies”) issued a notice of proposed rulemaking (“Proposed Rule”) that would significantly update the Agencies’ guidance on data breach response. The Proposed Rule would impose prompt reporting requirements on banking organizations and their service providers with respect to certain data breaches and other cyber events.
Specifically, the Proposed Rule would require banking organizations to notify their primary federal regulators within 36 hours of becoming aware of a “computer-security incident” that rises to the level of a “notification incident.” In addition to covering incidents involving unauthorized access to customer information, it would apply to some events where data was rendered temporarily unavailable, such as ransomware and distributed denial-of-service attacks.
The rule would also require bank service providers to notify “at least two individuals” at an affected banking organization-customer immediately after experiencing a computer-security incident that it believes “in good faith could disrupt, degrade, or impair services provided for four or more hours.” A 36-hour deadline appears to be one of the most rigorous timeframes of any U.S. breach reporting scheme.
Below we provide context for the Proposed Rule and outline its key features.
Background
Banking organizations already are subject to reporting obligations of cyber events and data breaches under applicable federal and state laws. Notably, the new proposal would blow the dust off the federal interagency guidance—issued in 2005 and never before updated—that interprets the Gramm-Leach-Bliley Act and its Security Guidelines (“GLBA”) to require banks to develop and implement a response program to address unauthorized access to, or use of customer information that could result in “substantial harm or inconvenience to a customer.” This guidance only requires banking organizations (as defined therein) to report incidents to federal banking regulators where certain customer personal data is exposed.
In addition, the Bank Secrecy Act requires banking organizations, and other financial institutions, to file suspicious activity reports (“SARs”) under certain circumstances. In 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued an advisory instructing financial institutions with SAR filing obligations to file SARs for cyber-events and cyber-enabled crime. The SAR filing requirements are designed to detect cyber-related crimes and money laundering but not report cyber incidents more broadly. Further, banking organizations that experience a computer-security incident that may be criminal in nature are expected to contact relevant law enforcement or security agencies, as appropriate, after the incident occurs.
At the state level, some banking organizations are subject to more recent and specific reporting requirements. For example, the New York State Department of Financial Services (“NYDFS”) adopted a cybersecurity regulation in 2017, known as Part 500. Part 500 requires covered entities, including New York state-chartered banks and other financial organizations licensed by the NYDFS to conduct business, to implement an incident response plan as part of their cybersecurity program and to notify the NYDFS no later than 72 hours after determining that a cybersecurity event has (1) impacted the entity and notice is required to be provided to another regulator, or (2) a reasonable likelihood of materially harming a material part of the normal operation of the entity.
Banking organizations are also potentially subject to state breach notification laws that apply to businesses generally in all 50 states, although some of those requirements under state law can be satisfied by GLBA. California, for example, requires persons conducting business in California to notify California residents if their unencrypted personal information is acquired or is reasonably believed to have been acquired by an unauthorized person. If a single breach requires such a notification to more than 500 California residents then a business must submit a sample security breach notification to the California Attorney General. Many other states’ laws are modeled on California’s law.
OVERVIEW OF BANKING ORGANIZATION NOTIFICATION REQUIREMENT
The Proposed Rule would require banking organizations to notify their primary federal regulator of cyber incidents that amount to “notification incidents” no later than 36 hours after determining in “good faith” that a notification incident has occurred. The notification requirement is meant to serve as an “early alert” to regulators and is not intended to provide an “assessment of the incident,” which is all that can be reasonably expected in 36 hours.
Definitions of Banking Organizations
The Proposed Rule applies to “banking organizations,” as defined by the applicable federal regulator. For foreign banks, the Proposed Rule would only apply to their U.S. operations. Further, under the Proposed Rule if a banking organization is the subsidiary of another banking organization subject to notification requirements (e.g., a bank is a subsidiary of a bank holding company), the subsidiary banking organization is expected to alert its parent—in addition to notifying its primary federal regulator—of a notification incident “as soon as possible.” The parent banking organization must then determine whether it also has suffered an incident that requires notification.
On the other hand, the Proposed Rule does not require subsidiaries or banking organizations not subject to the notification requirement (e.g., nonbank subsidiaries of bank holding companies) to implement separate notification requirements. Instead, the Agencies expect that the parent banking organization of such subsidiary will appropriately notify its primary federal regulator if the incident at the subsidiary constitutes a notification incident for the parent.
Definition of Computer-Security Incident and Notification Incident
Under the Proposed Rule, a computer-security incident is an occurrence “that (i) results in actual or potential harm to the confidentiality, integrity, or availability of an information system or the information the system processes, stores, or transmits; or (ii) constitutes a violation or imminent threat of violation of security policies, security procedures, or acceptable use policies.”
A “notification incident” is a type of computer-security incident that “a banking organization believes in good faith could materially disrupt, degrade, or impair (i) the ability of the banking organization to carry out banking operations, activities, or processes, or deliver banking products and services to a material portion of its customer base, in the ordinary course of business; (ii) any business line of a banking organization, including associated operations, services, functions and support, and would result in a material loss of revenue, profit, or franchise value; or (iii) those operations of a banking organization, including associated services, functions and support, as applicable, the failure or discontinuance of which would pose a threat to the financial stability of the United States.”
For purposes of determining whether a computer-security incident falls under the definition of notification incident, “business line” is defined as “products or services offered by a banking organization to serve its customers or support other business needs.” The Agencies note that all banking organizations are expected to have a “sufficient understanding of their lines of business to be able to notify the appropriate agency of notification incidents that could result in a material loss of revenue, profit, or franchise value to the banking organization.” The Proposed Rule also includes a non-exhaustive list of events that would meet the definition of “notification incident,” such as a failed system upgrade or change that results in widespread customer or employee outages.
Timing of Notification Requirements
As noted above, the Proposed Rule requires banking organizations to notify their primary federal regulator within 36 hours of a “good faith determination” that a notification incident has occurred. In that regard, the Agencies recognize that the banking organization would not be able to determine whether an event meets the notification incident standard immediately upon becoming aware of the incident, particularly outside of normal business hours. As a result, banking organizations may take a “reasonable amount of time” to determine whether a computer-security incident meets the notification incident standard. Once a banking organization has made a determination that a computer-security incident meets the notification incident standard, then the 36-hour clock begins to run.
Contents and Format of Notification
The Proposed Rule neither prescribes the contents to be included in the notice nor requires that notification be given in any particular format. Any form of written or oral communication, via any technological means (e.g., email or phone call) or other means (e.g., live conversation) to a designated point of contact identified by the applicable primary federal regulator is sufficient. Any information provided by the banking organization related to the notification incident is subject to the Agencies’ confidentiality rules, meaning that confidential supervisory information will be protected.
IMPACT OF PROPOSED RULE
The Agencies do not believe that the Proposed Rule will impose significant burdens on banking organizations. They estimate that roughly 150 incidents rising to the level of “notification incidents” may occur on an annual basis, and believe that the communications leading to the determination of a “notification incident” would occur regardless of the Proposed Rule. Moreover, the notice requirements for banking organizations should not include the level of detail required for an SAR, though the Agencies expect banking organizations that experience a potentially criminal computer-security incident to contact relevant law enforcement or security agencies after the incident occurs.
The Proposed Rule affects state reporting requirements as well. For example, Part 500 requires banking organizations to report to the NYDFS if reporting of a cybersecurity event is required to another regulator, such as one of the Agencies. In light of NYDFS’s broad definition of “cybersecurity event,” any “notification incident” will almost certainly qualify as a “cybersecurity event.” Thus, any such notification incidents reported to the FDIC, OCC or FRB must also be reported to the NYDFS if the banking organization is subject to NYDFS supervision, though subject to the NYDFS’s 72-hour timeframe.
SERVICE PROVIDER NOTIFICATION REQUIREMENT
The Proposed Rule also imposes reporting requirements on “bank service providers,” defined as companies or persons providing services that are subject to the Bank Service Company Act to banking organizations. Specifically, if the bank service provider has a good faith belief that a computer-security incident could disrupt, degrade or impair services, including back office services, provided to a banking organization for four or more hours, the bank service provider would be required to immediately report the incident to any affected banking organization-customers. Additionally, bank service providers must notify at least two individuals at an affected banking organization, to ensure notice is received. The Agencies would aim to enforce these notification requirements directly against bank service providers. Indeed, any failure by a bank service provider to comply with the Proposed Rule would not be cited against the banking organization.
Overall, these notification requirements could impose significant obligations on banking organizations and their service providers. The greatest challenge may be figuring out how to meet the 36-hour standard. Further, there is a risk that increased regulatory visibility into potential cyber breaches may lead to increased scrutiny on banking organizations’ cyber practices. The Agencies seek comment on the proposal and outline some detailed questions for commenters. For example, the Agencies seek comments on the definitions as drafted, whether the 36-hour notification timeline should be adjusted, whether the “good faith” standard for banking organizations and bank service providers to notify the appropriate party is appropriate, among other questions. Comments must be submitted no later than 90 days after the publication of the Proposed Rule in the Federal Register.
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