For the last several years, noncompete agreements have been under attack in the United States by regulators, legislators, and the courts. For example, late last year, Massachusetts joined a number of states by enacting a law regulating noncompete agreements, including making them inapplicable to “nonexempt” employees. Courts do not favor noncompetes and will limit them or invalidate them completely. Regardless, noncompete agreements are here to stay, and businesses continue to rely on them as one way to protect customer goodwill along with confidential and proprietary information, which is why it’s important for counsel (in-house and outside) to take steps to ensure the noncompete agreements used by their clients have the best chance of surviving regulatory and judicial scrutiny. Here are some tips:
What is a noncompete agreement? A noncompete agreement is a contract entered into by an employer and an employee whereby the employee agrees that if their employment terminates (usually for any reason), then the employee will not—for some period of time and within some geographic boundary—compete directly with or go to work for a company that competes directly with the employer. Most U.S. courts will enforce noncompete agreements if they are reasonable as to geography and time and there is a legitimate business interest at stake.
Keep the group small. One controversial area is the extension of noncompete agreements to all the employees of a company, including administrative assistants and minimum wage workers. When reviewing a noncompete dispute, courts will review whether the employee has access to sensitive customer information and/or any other specialized or confidential information that could harm the employer if that employee started a competing business or went to work for a competitor. Tailor your agreement to the applicable employees and their particular circumstances.
Keep the restrictions reasonable and narrow. Courts will review a noncompete to ensure it does not interfere with the public interest (as set out in state law/state court decisions) or impose an undue hardship on the employee. This analysis includes reviewing the noncompete agreement for reasonableness as to geography and time. If either is overly broad, the court will not enforce the agreement. For example, a worldwide, five-year noncompete is unlikely to survive. Your noncompete stands a much better chance if the restrictions are narrowly drawn to the minimum necessary to protect the company. A one-year noncompete, limited to the state/geography where the company is based/competes will likely withstand scrutiny.
Provide consideration for the agreement. A noncompete, like any other contract, requires consideration to create a valid, enforceable agreement. If you require employees to sign your noncompete as part of their initial job offer, that is sufficient consideration. If you attempt to require an existing employee to sign a noncompete or else they lose their job, that is not sufficient consideration. If the agreement is part of a promotion, stock grant, special bonus payment, or similar offering, however, then the consideration element is satisfied.
Get it in writing. Relying on common law rights around noncompetition versus a clear contractual obligation is playing with fire. All noncompetes should be set out in writing and signed by both parties. Include a provision that gives the employee time to consult with an attorney to review the agreement before a signature is required (including a place for the employee to initial that section).This will help with enforcement.
Prepare multiple versions if necessary. Utilizing a single noncompete template is a bad idea unless your employees work only in one state or one country and work under similar circumstances; otherwise, be prepared to customize your noncompete template based on the laws of each jurisdiction where your employees work. Avoid using one template and finding out it’s unenforceable somewhere when you actually need to enforce it.
Concede choice of law/forum. Choice of law and choice of forum should get extra attention. If enforcement of your noncompete requires the employee to travel long distances at their expense (time and money) or if it imposes the law of a state or country that conflicts with rights the employee enjoys where he or she lives, you can run into problems. Balance and reasonableness are key.
Provisions to include. In addition to choice of law and forum, there are three basic clauses that you should include in every noncompete agreement:
Injunctive relief. Include a clause that expressly provides for injunctive relief as a remedy in the event of a breach. This clause should also provide that if there is a breach, there is a presumption of irreparable harm and consent to injunctive relief.
Attorney’s fees. Your noncompete should provide for an award of attorney’s fees and costs to the prevailing party.
Savings clause. This clause provides that if a court should render any clause in the noncompete invalid, the remaining contract clauses survive intact.
Use other types of agreements. Consider utilizing other types of agreements that might be less draconian than a noncompete but provide some of the same protections, e.g., nonsolicitation agreements (customers and employees) and nondisclosure agreements (protecting confidential information of the company).
Be prepared to enforce it. Nothing puts people on notice about the consequences of violating a noncompete like knowing you will file a lawsuit to enforce it. If you are going to use noncompete agreements, be prepared to enforce them in court.
Imagine that you are a plaintiff in a lawsuit, and you just settled your case for $1,000,000.[1] Your lawyer takes 40 percent ($400,000), leaving you the balance. Most plaintiffs assume their worst-case tax exposure would be paying tax on $600,000, but today, you could pay taxes on the full $1,000,000. Welcome to the crazy way legal fees are taxed.
In Commissioner v. Banks,[2] the Supreme Court held that plaintiffs in contingent-fee cases must generally recognize income equal to 100 percent of their recoveries. This is so even if the lawyer is paid directly by the defendant, and even if the plaintiff receives only a net settlement after fees. This harsh tax rule usually means plaintiffs must figure a way to deduct those fees.
Until 2018, there were two ways to deduct: above the line or below the line. Below-the-line (also called miscellaneous itemized) deductions, where plaintiffs historically deducted most legal fees, were disallowed for 2018 through 2025.[3] Thus, beginning in 2018, above the line is the only remaining choice, if you qualify. The above-the-line tax deduction is for employment, civil rights, and whistleblower legal fees, and is more important than ever. Qualifying for it means that in our example, at most you are taxed on $600,000.
Physical Injury Recoveries
You might think there would be no tax issues in physical injury cases, where damages should be tax free, but section 104 (the tax exclusion section for physical injury recoveries) applies only to compensatory damages, not to punitive damages or interest. What if a case has some of each?
Example: You are injured in a car crash and sue the other driver. Your case settles for $2 million—50 percent compensatory for physical injuries and 50 percent punitive damages. There is a 40-percent contingent fee. That means you net $1.2 million. However, the IRS divides the $2 million recovery in two and allocates legal fees pro rata. You claim $600,000 as tax free for physical injuries, but you are taxed on $1 million and cannot deduct any of your $800,000 in legal fees.
“Unlawful Discrimination” Recoveries
The above-the-line deduction applies to attorney’s fees paid in “unlawful discrimination” cases. The tax code defines a claim of unlawful discrimination with a long list of claims brought under:
The Civil Rights Act of 1991
The Congressional Accountability Act of 1995
The National Labor Relations Act
The Fair Labor Standards Act of 1938
The Age Discrimination in Employment Act of 1967
The Rehabilitation Act of 1973
The Employee Retirement Income Security Act of 1974
The Education Amendments of 1972
The Employee Polygraph Protection Act of 1988
The Worker Adjustment and Retraining Notification Act
The above-the-line deduction applies to whistleblowers who were fired or retaliated against at work. However, what about whistleblowers who obtain awards outside this context? The deduction applies to federal False Claims Act cases and was later amended to cover state whistleblower statutes as well. It applies to IRS tax whistleblowers and in 2018 was extended to SEC and Commodities Futures Trading Commission whistleblowers.
Catchall Employment Claims
Arguably the most important item in this list is a catchall provision for claims under:
[a]ny provision of federal, state or local law, or common law claims permitted under federal, state or local law, that provides for the enforcement of civil rights, or regulates any aspect of the employment relationship, including claims for wages, compensation, or benefits, or prohibiting the discharge of an employee, discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law.[5]
This is broad and should cover employment contract disputes even where no discrimination is alleged.
Civil Rights Claims
The catchall language in section 62(e)(18) also provides for deduction for legal fees to enforce civil rights. This unlawful discrimination deduction is arguably even more important than the deduction for fees relating to employment cases. What exactly are civil rights, anyway? You might think of civil rights cases as those brought under section 1983. However, the above-the-line deduction extends to any claim for the enforcement of civil rights under federal, state, local, or common law.[6] Civil rights is not defined for the purposes of the above-the-line deduction, nor do the legislative history or committee reports help. Some general definitions are broad, indeed, including:
a privilege accorded to an individual, as well as a right due from one individual to another, the trespassing upon which is a civil injury for which redress may be sought in a civil action. . . . Thus, a civil right is a legally enforceable claim of one person against another.[7]
In an admittedly different context (charitable organizations), the IRS itself has generally preferred a broad definition of civil rights. In a General Counsel Memorandum, the IRS stated that it “believe[s] that the scope of the term ‘human and civil rights secured by law’ should be construed quite broadly.” Could invasion of privacy cases, defamation, debt collection, and other such cases be called civil rights cases? Possibly.
What about credit reporting cases? Don’t those laws arguably implicate civil rights as well? Might wrongful death, wrongful birth, or wrongful life cases also be viewed in this way? Of course, if all damages in any of these cases are compensatory damages for personal physical injuries, then the section 104 exclusion should protect them, making attorney’s fee deductions irrelevant.
However, what about punitive damages? In that context, plaintiffs may once again be on the hunt for an avenue to deduct their legal fees. Reconsidering civil rights broadly might be one way to consider fees in the new environment. In any event, the scope of the civil rights category for potential legal fee deductions merits separate treatment in a forthcoming article.
Business Expenses
If sections 62(a)(20) and 62(e) are not fertile grounds for legal fee deductions, is anything else available? Can legal fees be a business expense? Of course they can. Business expense deductions were largely unaffected by the 2017 tax changes, other than the Weinstein provision restricting deductions in confidential sexual harassment cases.[9]
In a corporation, LLC, partnership, or sole proprietorship, business expenses are above-the-line deductions. Of course, one must ask whether one’s activities are sufficient to be considered really in business, and whether the lawsuit really is related to that business. If one can answer both of these questions in the affirmative, all is well.
However, a plaintiff filing his or her first Schedule C as a proprietor for a lawsuit recovery probably may not be convincing. Before the above-the-line deduction was enacted in 2004, some plaintiffs argued their lawsuits were business ventures. Plaintiffs usually lost these tax cases.[10] The repeal of miscellaneous itemized deductions until 2026 may revive such attempts.
Some may push the envelope about what is a trade or business and how their lawsuit is inextricably connected to it. Some plaintiffs may consider filing a Schedule C even if they have never done so before. Schedule C is historically more likely to be audited and draws self-employment taxes.
Capital Gain Recoveries
If your recovery is capital gain, you arguably could capitalize your legal fees and offset them against your recovery. You might regard the legal fees as capitalized or as a selling expense to produce the income. Thus, the new “no deduction” rule for attorney’s fees may encourage some plaintiffs to claim that their recoveries are capital gain, just (or primarily) to deduct or offset their attorney’s fees.
Exceptions to Banks
The remaining ideas in this article address attempting to keep attorney’s fees out of the plaintiff’s income in the first place. Technically, falling within one of the exceptions to the Banks case is not a way of deducting legal fees, but of avoiding the fees as income. In Banks, the Supreme Court laid down the general rule that plaintiffs have gross income on contingent legal fees. General rules have exceptions, however, and the court alluded to situations in which this general 100-percent gross income rule might not apply.
Separately Paying Lawyer Fees
Some defendants agree to pay the lawyer and client separately. Do two checks obviate the income to plaintiff? According to Banks, they do not. Still, separate payments cannot hurt, and perhaps Forms 1099 can be negated in the settlement agreement.
The Form 1099 regulations generally require defendants to issue a Form 1099 to the plaintiff for the full amount of a settlement, even if part of the money is paid to the plaintiff’s lawyer. Even so, a defendant might agree to issue a Form 1099 only to the plaintiff for the net payment. Banks seems to dictate there is gross income anyway, but the plaintiff might feel comfortable reporting only the net.
Fees for Injunctive Relief
The Supreme Court suggested that legal fees for injunctive relief may not be income to the client. If the plaintiff receives only injunctive relief, but plaintiffs’ counsel is awarded large fees, should the plaintiff be taxed on those fees? Arguably not. However, if there is a big damage award with small injunctive relief, will that take all the lawyer’s fees from the client’s tax return? That seems unlikely, although the documents might help finesse it.
Court-Awarded Fees
Court-awarded fees may also provide relief, depending on how the award is made and the nature of the fee agreement. Suppose that a lawyer and client sign a 40-percent contingent-fee agreement providing that the lawyer is also entitled to any court-awarded fees. A verdict for plaintiff yields $500,000, split 60/40. The client has $500,000 in income and cannot deduct the $200,000 paid to his or her lawyer. However, if the court separately awards another $300,000 to the lawyer alone, that should not have to go on the plaintiff’s tax return. What if the court sets aside the fee agreement and separately awards all fees to the lawyer?
Class-Action Fees
There has long been confusion about how legal fees in class actions should be taxed. Historically, there was a difference between the tax treatment of opt-in cases and opt-out cases. In more recent years, however, the trend appears to be away from taxing plaintiffs on legal fees in class actions of both types.
That is fortunate because the legal fees in class actions generally dwarf the amounts plaintiffs take home. It is an over-generalization, but most plaintiffs in most class actions generally assume that they will not be taxed on the gross amount (or even their pro rata amount) of the legal fees paid to class counsel. Optimally, the lawyers will be paid separately under court order.
Statutory Attorney’s Fees
If a statute provides for attorney’s fees, can this be income to the lawyer only, bypassing the client? Perhaps in some cases, although contingent-fee agreements may have to be customized. In Banks, the court reasoned that the attorney’s fees were generally taxable to plaintiffs because the payment of the fees discharged a liability of the plaintiffs to pay their counsel under their fee agreements. In statutory fee cases, a statute (rather than a fee agreement) creates an independent liability on the defendant to pay the attorney’s fees. If the statutory fees were not awarded, the plaintiff may not be obligated to pay any additional amount to his or her attorney.
Accordingly, some attorneys seem to assume that if a statute calls for attorney’s fees, the general rule of Banks can never apply. Arguably, though, more may be needed. If the contingent-fee agreement is plain vanilla, the fact that the fees can be awarded by statute may not be enough to distance the client from the fees. As the Banks decision notes, the relationship between lawyer and client is that of principal and agent. The fee agreement and the settlement agreement may need to address the payment of statutory fees.
Lawyer-Client Partnerships
A partnership of lawyer and client arguably should allow each partner to pay tax only on that partner’s share of the profits. The tax theory of a lawyer-client joint venture was around long before the Supreme Court decided Banks in 2005. Despite numerous amicus briefs, however, the Supreme Court expressly declined to address this long-discussed topic and whether it would sidestep the holding of Banks.
A mere fee agreement is surely not enough to suggest a partnership, but with appropriate documentation, one can argue that the lawyer contributes legal acumen and services, whereas the client contributes the legal claims. Lawyer purists will note the ethical rules that suggest this cannot be a true partnership because lawyers are generally not allowed to be partners with their clients. Yet, tax law is unique and sometimes at odds with other areas of law.
Could a lawyer-client partnership agreement provide that it is a partnership to the maximum extent permitted by law? Partnership nomenclature and formalities matter, and lawyer-client partnerships rarely seem to be attempted with conviction. A partnership tax return with Forms K-1 to lawyer and client might be difficult for the IRS to ignore. So far, however, lawyer-client partnerships do not look terribly promising.[11]
Conclusion
Returning to our $1,000,000 recovery with $400,000 in fees, no plaintiff will think it is fair to pay taxes on $400,000 paid directly to his or her lawyer. Increase these numbers, and emotions may run higher still. In the old days, alternative minimum tax and phased-out deductions often limited the efficacy of legal-fee deductions. There was plenty of grousing about those rules, but it was relatively rare for them to result in truly catastrophic tax positions. Nevertheless, there were a few cases in which plaintiffs lost money after tax.[12] Today, entirely disallowed legal fee deductions are less likely to be easily endured. Some plaintiffs may aggressively plan or report around this unjust landmine. They may try to gerrymander their settlement agreements to avoid receiving gross income on their legal fees. If plaintiffs cannot credibly argue that they avoided the gross income, they may go to new lengths to try to deduct or offset the fees. The bigger the numbers and the higher the contingent-fee percentage, the more creative and assertive the plaintiff may be. Good luck out there!
[9]See Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13307 (2017); see also Robert W. Wood, Taxing Sexual Harassment Settlements and Legal Fees in a New Era, 158 Tax Notes 4, 545 (Jan. 22, 2018).
[10]See Alexander v. Comm’r, 72 F.3d 938 (1st Cir. 1995).
[11] Allum v. Comm’r, T.C. Memo 2005-117, aff’d, 231 F. App’x 550 (9th Cir. 2007), cert. denied, 128 S. Ct. 303 (2007).
[12]See Spina v. Forest Preserve District of Cook County, 207 F. Supp. 2d 764 (N.D. Ill. 2002), as reported in 2002 National Taxpayer Advocate Report to Congress, at 166; see also Adam Liptak, Tax Bill Exceeds Award to Officer in Sex Bias Case, N.Y. Times, Aug. 11, 2002, at 18.
Most companies and the boards that govern them like to think their operations and supply chains are free of human rights abuses, yet of the 40 million estimated people enslaved worldwide, 16 million are working in forced labor within company operations and supply chains. Millions more work under dangerous and sometimes brutal conditions, toiling for up to 19 hours a day and subject to physical abuse at the hands of their supervisors. The eighth edition of the List of Goods Produced by Child Labor or Forced Labor and the 17th annual edition of the Findings on the Worst Forms of Child Labor published in September 2018 by the U. S. Department of Labor’s Bureau of International Labor Affairs (ILAB) highlight specific industry sectors in which child labor or forced labor persists. Abused workers can be found around the world, including within the United States. According to the human rights group Walk Free Foundation, an estimated 400,000 people are believed to be trapped in trafficking and modern slavery in the United States. If for no reason other than brand protection, there is a need for immediate proactive corporate initiatives in this context. To eradicate modern slavery, the C-suite must be encouraged by business lawyers to actively engage in supporting meaningful upstream and downstream change in identifying and remediating modern slavery.
The federal Trafficking Victims Protection Act of 2000 (TVPRA), 18 U.S.C. §1589(a)(4) (originally enacted as Victims of Trafficking and Violence Protection Act, Pub. L. No. 106-386, §112, 114 Stat. 1464, 1487 (2000)), defines labor trafficking as “the recruitment, harboring, transportation, provision, or obtaining of a person for labor or services, through the use of force, fraud, or coercion for the purpose of subjection to involuntary servitude, peonage, debt bondage, or slavery.” 22 U.S.C. §7101(9).
The reality is that publishing a policy or two on the company website does not accomplish anything to tackle modern slavery or other abuses of labor standards. The growing development of legislative and investor focus on human rights issues is pushing larger companies to report on what, if anything, they are doing to tackle these problems at every tier of their supply chain. The United Kingdom’s Home Office estimates between 9,000 to 11,000 companies are required to report under the UK Modern Slavery Act alone. The reporting requirements recognize that modern slavery cannot be addressed without direct, private-sector participation. The work necessary for coordination of the efforts of the company’s internal legal, compliance, and procurement departments, however, can be daunting. Corporate resistance and real challenges encountered in drafting human rights policies and contract provisions, including greater exposure to the risk of litigation, must be addressed.
Human rights violations in the work force (including exorbitant recruitment fees and room and board fees, little to no pay, dangerous hourly demands, toxic exposure on the job site, and/or dangerous housing conditions, etc.) most often appear to involve the lower or lowest rung of a multi-tier international supply chain. Typically, this is the result of a breakdown in the company’s internal controls and due diligence processes. Red flags slip through the cracks and go unresolved, causing legal, financial, and reputational damage that cannot always be fully repaired. As more and more countries outside of the United States adopt laws to fight human rights violations, properly assessing the risk of human rights violations within the company’s supply chain and implementing an effective vendor risk-management program to assure compliance is essential to ensure that goods are not tainted by modern slavery, child labor, or other human rights violations.
The development of an enterprise-wide culture is essential, along with an understanding of, and commitment to, human rights (health and safety requirements, anti-forced labor, child labor, and indentured labor constraints). Supply chain mapping, integrated human rights due diligence, engagement with suppliers and workers, identification of root causes such as recruitment fees imposed on workers, and clear processes to remediate breaches when found are recognized as essential good practice if a company is trying to take their anti-slavery and worker abuse elimination seriously. Market-specific approaches must be identified and optimized.
The following diagrams attempt to capture the possible spectrum of diverse corporate cultures in this context and the degree of responsibility undertaken to mitigate or remediate human rights abuses caused, directly or indirectly, by their activities.
The role of U.S. Customs and Border Protection (CBP) to mitigate the risk of forced labor-produced goods from entering the United States under the Tariff Act of 1930, as amended by the Trade Facilitation and Trade Enforcement Act of 2015, should be recognized. The CBP has the authority to detain goods by issuing withhold release orders (WROs) at ports of entry if information reasonably, but not conclusively, indicates that merchandise is made with indentured, forced, or child labor. On September 30, 2019, CBP issued five WROs, effective immediately: garments produced by Hetian Taida Apparel Co., Ltd. in Xinjiang, China; disposable rubber gloves produced in Malaysia by WRP Asia Pacific Sdn. Bhd; gold mined in artisanal small mines in eastern Democratic Republic of the Congo; rough diamonds from the Marange Diamond Fields in Zimbabwe; and bone black manufactured in Brazil by Bonechar Carvão Ativado Do Brasil Ltda. The Reasonable Care September 2017 publication from CBP and its extensive series of questions (pages 8–15) should be routinely referenced because those questions can be easily modified for use by any company serious about supply chain due diligence. The publication also provides a good road map of what CPB auditors look for in trying to determine whether imported goods are tainted by convict, forced, or indentured labor and informs of the kind of documentation CPB (or other governmental units) will ask a company to produce in any forced labor inquiry.
A November 2016 publication born out of a collaboration between the Global Compact Network Netherlands, Oxfam, and Shift entitled How to do business with respect for human rights is a guidance tool for companies that is also extremely helpful as a starting point resource. It is an introduction to the core concepts in the UN Guiding Principles on Business and Human Rights, and includes some practical steps to prevent, address, and remedy human rights abuses committed in business operations. Similarly, the Business & Human Rights Resource Centre has a number of reporting guidance resources, including The Modern Slavery Registry, to address and report on modern slavery in the context of a broader human rights due diligence. Verité, a civil society organization that promotes workers’ rights in global supply chains through research, consulting, training, assessments, and policy advocacy, has also published a number of research reports and white papers that can provide the information necessary to identify complex labor problems and design tools to address those problems. Offering assessment and training, Verité and other consultants work with governments and companies to develop policy and launch compliance initiatives.
Many companies, however, are still under the impression that there are not enough concrete tools to implement human rights policies. The Business Law Section’s Uniform Commercial Code Working Group (Working Group) published their “2018 Report and Model Contract Clauses for International Supply Contracts” in both the Fall 2018 issue of The Business Lawyer (Vol. 73, No. 4) and Business Law Today, November 28, 2018. The aim of the Working Group in drafting the Model Contract Clauses (MCCs) was to use the leverage of Western buyers and the legal force of contract documents to help eradicated forced labor and risks to worker health and safety by creating legally effective and operationally likely provisions. Since publication, there has been widespread interest in the MCCs, some movement toward adoption, and significant constructive feedback that the Working Group has embraced.
During the Business Law Section Annual Meeting in Washington, D.C., the Working Group, along with the Corporate Social Responsibility Committee’s Subcommittee to Implement the ABA Model Principles on Labor Trafficking and Child Labor, decided to use the next six months to a year to determine how best to incorporate in the MCCs much of the constructive feedback received since the initial publication in the Fall of 2018. The idea is to publish a version 1.1. One suggestion is to provide a further explanation of what is referred to in the MCCs as “the Schedule P strategy.” The idea of the Working Group was to encourage any company using the MCCs to incorporate into their supply chain contracts by attachment human rights policies the company developed specific to its industry and operations. Schedule P was to be another set of specifications the goods had to satisfy to be conforming. That is still the idea, but many found vague references to a Schedule P confusing and called for specific examples or references to policies like the UN Guiding Principles on Business and Human Rights or the ABA Model Principles on Labor Trafficking and Child Labor. Another recommendation is for the MCCs to address buyers’ role in the creation of human rights violations with unrealistic delivery targets, last-minute changes to orders, and low price point expectations. The addition of buyers’ representations and warranties within the MCCs has been suggested, along with reference to a “responsible buyer” code of conduct. Turning to the MCCs’ current emphasis on buyer’s termination rights upon discovery of defective goods (defined in the MCCs to include goods that were perfect in every way except for the abuse of human rights in their manufacture, distribution, or shipping), commentators since the MCCs’ publication propose an acknowledgment of buyers’ high switching costs in many industries and stress the benefits of remediation and specific performance as opposed to termination. These alternatives to termination, it has been argued, must be acknowledged as better for the workers as well as for the companies that employ and engage them. Each of these points is to be considered in preparing version 1.1 of the MCCs, along with the addition of an optional arbitration clause to address disputes.
Given the ethical, business, social, and moral issues that are implicated along with the ever-growing international legal requirements, commercial lawyers certainly now have an obligation to advise every business client with complex (multitier) operations of the variety of human rights abuses that may be hidden in their supply chains. The potential liability for exploitative labor practices (legal, moral, and social) require increased vigilance as well as thoughtful analysis of traditional confidentiality obligations and historic ownership of the attorney-client privilege. After discovery of a human rights violation in the audit or due diligence process, what reporting obligations does the discovering company, and its counsel, have to the CBP, local authorities, or the DOJ? The crime/fraud exception to the attorney-client privilege must be addressed by counsel with reference to both state specific and ABA Model Rules 1.6(b)(1), 1.13(c), and 1.16(b)(4) and 2. Such an analysis is especially significant in the context of a merger or acquisition when the buying company uncovers wrongdoing in advance of, or subsequent to, an acquisition and wishes to secure DOJ cooperation credit for successor liability after the transaction.
In 2003, TVPRA was expanded to allow civil causes of action for money damages against traffickers in federal courts and, since 2008, against anyone involved in the list of trafficking-related offenses “whomsoever knowingly benefits, financially or be receiving anything of value from participation in a venture which that person knew or should have known has engaged in an action in violation . . .” of Chapter 77 of Title 18. See William Wilberforce Trafficking Victims Protection Reauthorization Act of 2008, Pub. L. No. 110-457,122 Stat. 5067, tit. ll, § 221(2) (2008), as amended by Justice for Victims of Trafficking Act of 2015, Pub. L. No. 114-22, 129 Stat. 247, tit. l, § 120(2015). TVPRA permits both compensatory and punitive damages as well as attorney’s fees. Plaintiffs frequently file other claims alongside TVPRA, including claims under the Fair Labor Standards Act, state wage and hour laws, common law theories of intentional infliction of emotional distress, false imprisonment, conversion, and breach of contract, according to the Human Trafficking Legal Center’s study Federal Human Trafficking Civil Litigation; 15 Years of the Private Right of Action. Although many settlement amounts are undisclosed, known settlement and damage awards since 2003 total in excess of $108,657,000, according to the same study. In the meantime, every state has passed laws targeting trafficking activities to varying degrees. Delaware, New Jersey, and Washington have laws fulfilling all 10 categories of laws that Polaris, a nonprofit organization dedicated to the global fight to eradicate modern slavery, determined are critical to a basic legal framework that combats human trafficking, punishes traffickers, and supports survivors.
The risk of criminal or civil litigation under applicable international, federal, or state law against a company that knowing produces, or allows affiliates to produce, goods that are the product of modern slavery (or other human rights abuses) is very real and mounting. Addressing the possibility of such a taint at any point in supply chains with the highest degree of corporate leadership, persistence, and transparency is both virtuous and strategic.
The American Bar Association’s Business Law Section recently issued a letter in response to a request for comments from the International Organization of Security Commissions (IOSCO) on its May 2019 Consultation Report addressing “Issues, Risks and Regulatory Considerations Relating to Crypto-Assets Trading Platforms” (IOSCO Report or Report).[1] The IOSCO Report, citing “the emergence of crypto-assets [as] an important area of interest for regulatory authorities,” provided guidance concerning oversight of secondary markets and the trading platforms that facilitate secondary trading of crypto-assets (Crypto-Asset Trading Platforms or CTPs). Members of the ABA Derivatives and Futures Committee’s Subcommittee on Innovative Digital Products and Processes (IDPPS) prepared the comment letter to highlight the need to evaluate whether new regulations are necessary to fit crypto-assets and CTPs within current regulatory frameworks, to consider the viability and potential of self-regulatory organizations (SROs), and to encourage an economic cost-benefit analysis of any new regulations.[2]
The IOSCO Report focuses on several major issues and considerations associated with regulating CTPs and provides helpful toolkits to assist regulatory authorities in analyzing these issues, with a goal of balancing regulatory oversight with fostering innovation. The IDPPS, with its comment letter, aims to provide helpful insight regarding striking the right balance.
The Report’s key considerations include: (1) access to CTPs; (2) safeguarding participant assets; (3) conflicts of interest; (4) CTP operations; (5) market integrity; (6) price discovery; (7) technology (systems resiliency, reliability, and integrity, as well as cybersecurity and resilience); and (8) custody, clearing, and settlement. The Report analyzes these issues with an eye toward promoting IOSCO’s core objectives regarding securities regulation, which include protecting investors and ensuring that the markets are fair, efficient, and transparent.
The Report also discusses certain of the currently operational CTP models, describes the risks and issues identified by regulatory authorities, and examines how such risks and issues have been, or could be, addressed. The IDPPS comment letter, in turn, encourages IOSCO and its members to consider what types of regulation are appropriate for CTPs, and poses the following questions:
Would it be appropriate to regulate the CTP market through an SRO model, or would a mix of SRO with some form of regulatory oversight be appropriate? What types of considerations should local jurisdictions consider when structuring such a regulatory framework?
Separately, would regulation by enforcement be sufficient, and what would be the key considerations in order to make such a determination?
As noted in the comment letter, the market is tackling not only the question of whether and what additional regulation is necessary, but also how to adapt existing regulations to cover these new risks in a regulatory framework that is not prohibitively expensive. Accordingly, SROs are an important means to balance these considerations, especially given the unique features of CTPs and the rapidly evolving crypto-asset markets. In particular, IOSCO, in its previously issued Model for Effective Self-Regulation, endorsed the use of SROs as having the potential to harness industry knowledge, respond quickly to marketplace changes, and potentially facilitate cross-border information sharing.
Crypto-assets, distributed ledger technology, and innovations in financial technology more broadly have the potential to significantly reshape the financial markets. The IDPPS agrees with IOSCO that “fostering innovation should be balanced with the appropriate level of regulatory oversight” and encourages IOSCO to continue engaging with industry participants, including technologists, to understand both the risks and the benefits of new technologies. As the Report recognizes, CTPs and crypto-asset trading generally will operate in ways not contemplated by existing financial regulatory frameworks. The comment letter encourages IOSCO to remain open to differing approaches to achieving regulatory objectives concerning crypto-assets and CTPs. With the rapid pace of technological advances, it also urges financial regulatory authorities to continue improving cost-benefit analyses to account for not only the direct impact of the rules being analyzed, but also the indirect burdens associated with a given rule and whether more flexible or less burdensome requirements can achieve the same or similar objectives.
The IDPPS was established in March 2018 and has over 80 members, comprised of attorneys who work extensively in the areas of derivatives and securities law, FinTech, and related areas. It is organized into three working groups: the Jurisdiction Working Group, the Blockchain Modality Working Group, and the SRO Working Group. In March 2019, IDPPS published a paper prepared by members of the Jurisdiction Working Group and their colleagues that provides a comprehensive survey of the regulation of cryptocurrencies and other digital assets at the federal and state levels in the United States, along with summaries of key initiatives outside the United States. IDPPS is undertaking other projects through its working groups as well. The Blockchain Modality Working Group is considering commercial and regulatory issues relating to application of blockchain technology in the financial markets and financial services industry, and the SRO Working Group is considering issues for potential implementation of self-regulation with respect to CTPs and digital assets markets.
[1] Special thanks to Paul Hastings Associate Andrew Sterritt for his assistance with this article.
[2] The IDPPS Subcommittee wishes to thank Yvette Valdes, Gavin Fearey, and Aaron Friedman for their contributions to the comment letter.
The Rooker-Feldman doctrine[1] is a legal precept invoked by defendants to strip federal district and bankruptcy courts of their subject matter jurisdiction over suits that can be characterized as appeals or reconsideration of state court judgments. This article discusses the nature of the Rooker-Feldman doctrine and its limitations under the Bankruptcy Code when asserted as a defense to the prosecution of avoidance actions.
Under the Bankruptcy Code, avoidance actions consist of the prosecution of preference claims and fraudulent transfers claims. Avoidance actions permit a trustee, a debtor in possession, or the representative of a debtor’s estate to recover assets that were transferred out of the debtor’s estate prior to the commencement of a bankruptcy case for the benefit of the debtor’s creditors. The avoidance powers under the Bankruptcy Code promote the “prime bankruptcy policy of equality of distribution among creditors by ensuring that all creditors of the same class will receive the same pro rata share of the debtor’s estate.”[2] The right to avoid such transfers protects the interests of the debtor’s general body of creditors by maximizing the assets available for distribution to such creditors, thus placing creditors in a more favorable position to recover on their claims against the debtor.
The policy underlying the Rooker-Feldman doctrine is based on the concept that a litigant should not be able to challenge state court orders in federal courts as a means of relitigating matters that already have been considered and decided by a court of competent jurisdiction. The Rooker-Feldman doctrine also applies where a lower federal court is asked to conduct a review of a state court judgment for errors in construing federal law or constitutional claims that are inextricably intertwined with, or impacts the validity of, the state court judgment.[3] The litmus test that a federal court must apply is whether the relief requested in the federal action would effectively reverse the state court decision or void its ruling.
In bankruptcy cases, the Rooker-Feldman doctrine has been applied in cases involving, by way of example, the estimation of a judgment creditor’s claim that arose from a pre-petition state court judgment against a debtor;[4] attacking a state court judgment for lack of procedural due process;[5] dismissing an adversary proceeding challenging a foreclosure judgment; [6] a marital dispute concerning exempt property and discharge in the face of a state court judgment;[7] and a state court’s adjudication of the automatic stay.[8] In these cases, the doctrine was invoked to maintain the separation of federal and state courts and to protect and enforce state court judgments.
However, application of the Rooker-Feldman doctrine is subject to limitations. In Exxon Mobil Corp. v. Saudi Basic Indus. Corp.,[9] the Supreme Court recognized that the Rooker-Feldman doctrine is a narrow jurisdictional bar to litigation where the losing party “repairs to federal court to undo the [state court] judgment in its favor.”[10] The Supreme Court cautioned that “Rooker-Feldman does not otherwise override or supplant preclusion doctrine or augment the circumscribed doctrines that allow federal courts to stay or dismiss proceedings in deference to state-court actions.”[11] The Supreme Court noted that, “[i]f a federal plaintiff ‘present[s] some independent claim, albeit one that denies a legal conclusion that a state court has reached in a case to which he was a party . . . , then there is jurisdiction and state law determines whether the defendant prevails under principles of preclusion.”[12] An important factor in Exxon Mobil is that the plaintiff was not seeking to overturn the state court.
A number of courts examining the reach of the Rooker-Feldman doctrine in bankruptcy cases have concluded that it has little or no application in the context of avoidance actions, which are independent claims under the Bankruptcy Code.[13] Recently, the Third Circuit adopted this position in its decision in the Philadelphia Entertainment[14] bankruptcy case in which the court limited the application of the Rooker-Feldman doctrine to an avoidance action under sections 544 and 548 of the Bankruptcy Code.
In Philadelphia Entertainment, the debtor, which owned a gaming business, was awarded a state license to operate slot machines. Prior to the debtor’s commencement of its chapter 11 case, the state gaming authority revoked the gaming license for the debtor’s failure to comply with its past orders and demonstrate financial suitability. The debtor appealed the revocation order to the state court and lost.
After the confirmation of the debtor’s chapter 11 plan, the litigation trustee commenced an adversary proceeding before the bankruptcy court to avoid the revocation of the license as a constructively fraudulent transfer. Specifically, the debtor claimed that the revocation of the license was a transfer for which the debtor received no value from the state. The bankruptcy court invoked the Rooker-Feldman doctrine to dismiss the trustee’s lawsuit, finding that the doctrine divested the court of subject matter to consider the avoidance claim. The district court affirmed, adopting the bankruptcy court’s Rooker-Feldman conclusions.
The Third Circuit reversed the lower courts concluding that the bankruptcy court erred when it held that the Rooker-Feldman doctrine barred its review of the fraudulent transfer claims. The court noted that the doctrine applies when four requirements are met: (1) the federal plaintiff lost in state court, (2) the plaintiff complains of injuries caused by the state court judgment, (3) that judgment issued before the federal suit was filed, and (4) the plaintiff invites the district court to review and reject the state court judgment. The Third Circuit found that the fourth requirement was not met. Relying on Exxon Mobile, the Third Circuit ruled that so long as federal court litigation does not concern “the bona fides of the prior judgment,” the federal court “is not conducting appellate review, regardless of whether compliance with the second judgment would make it impossible to comply with the first judgment.”[15]
The court further noted that the bankruptcy court applied the Rooker–Feldman doctrine too broadly in finding that the fraudulent transfer claims required the federal courts to void the state court order. In particular, the court found that the litigation trustee was not complaining of an injury caused by the state court judgment and thus was not seeking a review and rejection of that judgment. In particular, the trustee’s fraudulent transfer claims did not require the bankruptcy court to conduct an appellate review of the order revoking the gaming license. An important consideration for the Third Circuit was that “a federal court can address the same issue ‘and reach[] a conclusion contrary to a judgment by the first court,’ as long as the federal court does not reconsider the legal conclusion reached by the state court.”[16] In other words, the Rooker-Feldman doctrine should not apply when a federal statute, in this case the avoidance statutes under the Bankruptcy Code, specifically authorizes a lower court to vitiate a state court judgment.
The exception for avoidance actions under the Rooker-Feldman doctrine is important for debtors in possession and trustees in bankruptcy cases because the prosecution of these claims can be highly valuable for creditor recoveries. As noted, one of the key policy objectives of bankruptcy is the maximization of creditor recoveries, which is often achieved through the prosecution of avoidance actions. Although the Rooker-Feldman doctrine operates to protect the integrity of state court judgments attacked in federal courts, the doctrine does not survive this policy objective under the Bankruptcy Code.
[1] The Rooker-Feldman doctrine derives its name from two U.S. Supreme Court cases, Rooker v. Fidelity Trust Co., 263 U.S. 413 (1923), and District of Columbia Court of Appeals v. Feldman, 460 U.S. 462 (1983). The Ninth Circuit decision in In re Gruntz, 202 F.3d 1074 (9th Cir. 2000), contains an extensive discussion of the origins of the doctrine and its intersection with title 28 of the United States Code.
In a recent decision from Minnesota, a limited partnership was ordered to be dissolved in an action brought by the assignees of the limited partners. Storeland v. Nordic Townhomes Limited Partnership, A18-1564, 2019 WL 1983500 (Minn. Ct. App. May 6, 2019).
Nordic Townhomes was originally organized with three limited partners and three general partners. With the passage of time, all of the original limited partners died. No new limited partners were admitted, and the heirs of the various limited partners became transferees of their respective interests in the partnership. The partnership agreement of Nordic Townhomes and the present situation were summarized by the court as:
[O]nce Nordic did not have any limited partners, the partnership was to dissolve, liquidate, and cease doing business. Despite the fact that Nordic does not have any limited partners, it continued to exist as an entity and conduct business.
The plaintiffs, they being some of the transferees of now deceased limited partners, filed a complaint seeking that Nordic Townhomes wind up its business, satisfy its debts and obligations, and distribute the net proceeds to those holding the economic rights in the partnership. The limited partnership responded by claiming that the plaintiffs did not have standing to seek either judicial or nonjudicial dissolution of the partnership on the basis that they were neither limited or general partners. The trial court granted the plaintiffs’ summary judgment, in effect finding that they could enforce the provision of the limited partnership agreement with respect to the partnership’s dissolution. This appeal followed.
Applying an “injury-in-fact” paradigm, the Minnesota Court of Appeals found that the assignees of the limited partners had standing to enforce that provision of the limited partnership agreement directing that the partnership be dissolved upon having no limited partners:
Here, respondents suffered an injury-in-fact sufficient to give them standing to ask the district court to enforce the partnership agreement. The partnership agreement is clear: Nordic was to be dissolved when there were no longer any limited partners. That process involves liquidating assets, and respondents are entitled to their share of any profits remaining once partnership obligations are resolved. See Minn. Stat. § 321.0702(b)(2) (2018) (stating that “upon the dissolution and winding up of the limited partnership’s activities [a transferee is entitled to] the net amount otherwise distributable to the transferor”). Because respondents are entitled to their share of that money, and because Nordic refused to take steps to dissolve the partnership and liquidate assets, respondents suffered an injury-in-fact sufficient to confer standing.
Further rejecting the claim that the court was allowing a nonpartner to move for judicial dissolution, the court observed that, “respondents’ action is more properly characterized as seeking enforcement of the partnership agreement rather than seeking judicial dissolution of the partnership. And because we conclude that respondents have standing because they suffered an injury-in-fact, respondents do not need a statutory basis to have standing.” Still on that same point, the court wrote:
[T]he partnership agreement clearly states that Nordic was to be dissolved when there were no limited partners. Accordingly, as transferees, respondents had standing to ask the district court to enforce the partnership agreement and the district court correctly required Nordic to follow the partnership agreement’s mandate of dissolution and liquidation.
Finally, although our opinion rests on our application of the law, we observe that adopting Nordic’s position could effectively result in no one having standing to seek enforcement of the partnership agreement. We do not discern the Minnesota law leaves transferees like respondents without redress in cases where remaining general partners fail to abide by the partnership agreement.
I find this decision somewhat troubling. Yes, all the court is doing is enforcing the agreement, but it is enforcing the agreement on behalf of persons who are not parties to it. As transferees of economic interests in the limited partnership, the plaintiffs in this action have no right to participate in the limited partnership’s management. Although the original limited partners would have been parties to the limited partnership agreement and in that role had the capacity to bring an action for its enforcement, that right did not devolve to the transferees upon the deaths of the limited partners. They are not parties to the limited partnership agreement, and for that reason an “injury-in-fact” paradigm fails; the failure of strict compliance with the limited partnership agreement gave no rise to an injury in the transferees because they were never parties to that agreement to begin with. In effect, the court is allowing nonparties to an agreement to insist upon its enforcement. What about the requirement of privity before bringing an action for enforcement? What about the provision of the Minnesota Limited Partnership Act (Minn. Code § 321.0702(a)(3)) that provides a transferee has no right to participate in the partnership’s management?
At its April meeting, the Advisory Committee on Civil Rules approved a proposed amendment to Federal Rule of Civil Procedure 7.01 that, if adopted, will require that each party to a lawsuit in federal court where jurisdiction is conditioned upon diversity jurisdiction (28 U.S.C. § 1332) file a statement setting forth the information necessary to determine each parties’ citizenship.
For purposes of federal diversity jurisdiction, no plaintiff may have the same citizenship as any defendant. See, e.g., OnePoint Solutions, LLC v. Borchert, 486 F.3d 342, 346 (8th Cir. 2007) (complete diversity “exists where no defendant holds citizenship in the same state where any plaintiff holds citizenship.”). In the case of a natural person, one is a citizen of the state in which one is domiciled. Although there can be disputes as to a person’s domicile (see, e.g., Art Van Furniture LLC v. Zimmer, 2019 WL 2433245 (E.D. Mich. June 11, 2019)), seldom will that occur. A corporation (private, nonprofit, professional service, etc.) is a citizen of its jurisdiction of incorporation and a citizen of the state in which it maintains its principal place of business (see 28 U.S.C. 1332(c)(1)), the latter determined under the “nerve center” test. See Hertz Corp. v. Friend, 559 U.S. 77, 130 S. Ct. 1181 (2010) (decision adopting and explaining the “nerve center” test). Although there may be more dispute as to the location of a corporation’s principle place of business than the domicile of an individual, the dispute and confusion is, again, unlikely.
Things become more complicated for other business organizations, including partnerships, limited partnerships, LLCs, and business trusts. In each of those instances, the organization itself has no citizenship. Indeed, the state of organization and location of the principal place of business play no role in determining the citizenship of these organizations. See, e.g., Citizens Bank v. Plasticware, LLC, 2011 WL 5598883 (E.D. Ky 2011); Hale v. MasterSoft Int’l Pty. Ltd., 93 F.Supp.3d 1108 (D. Colo. 2000). Rather, the organization’s citizenship is the citizenship of each of its “members.” In the case of a partnership or limited partnership, the members are, for these purposes, every general partner and every limited partner. See Carden v. Arkoma Assoc., 494 U.S. 185 (1990). In the case of a limited liability company, it will be deemed to have the citizenship of every one of its members. See, e.g., Cosgrove v. Bartoletta, 150 F.3d 729 (7th Cir. 1998). A business trust will have the citizenship of every one of its beneficial owners. See Conagra Foods, Inc. v. Americold Logistics, LLC, 136 S. Ct. 1012 (2016). Whether it will as well have the citizenship of any trustee who is not also a beneficial owner is something of an open question. See Thomas E. Rutledge & Christopher E. Schaefer, The Trust as an Entity and Diversity Jurisdiction: Is Navarro Applicable to the Modern Business Trust?, 48 Real Property, Trust & Estate L. J. 83 (Spring 2013). This means that an unincorporated business organization may be a citizen of numerous states, perhaps even every state if its membership is large enough. See, e.g., Reisman v. KPMG Peat Marwick LLP, 965 F.Supp. 165 (D. Mass. 1997 (noting that the then-“Big Six” accounting firms are “effectively immunized” from being subject to diversity jurisdiction).
The proposed amendments to Rule 7.01, if adopted, would require unincorporated business organizations to file with the court information as to the citizenship of each of its partners/members/beneficial owners. Recall that in many instances business organizations are in turn owned by other business organizations. For example, consider an LLC in which one of the members is a limited partnership. It will now be necessary that the LLC, in order to satisfy the proposed rule, list the partners, both general and limited, of that limited partnership. Ultimately, that LLC (or other unincorporated organization) must drill down through all of its layers of ownership until it reaches natural persons (who have their own citizenship), corporations (again, who have a recognized citizenship), and other structures, an example being a decedent’s estate, that, again, have their own citizenship. See, e.g., Delay v. Rosenthal Collins Group, LLC, 585 F.3d 1003, 1005 (6th Cir. 2009) (“When diversity jurisdiction is invoked in a case in which a limited liability company is a party, the court needs to know the citizenship of each member of the company. And because a member of a limited liability company may itself have multiple members—and thus may itself have multiple citizenships—the federal court needs to know the citizenship of each ‘sub-member’ as well.”).
Although this may seem burdensome at first blush, this proposed rule (and at this juncture it is only a proposal) would require nothing more than is already required; the parties to the dispute and the court have an obligation to confirm that diversity jurisdiction exists. Thus, at some juncture (and that juncture should be early) there must be scrutiny of the parties’ citizenship. See, e.g., Four Winds Distrib., LLC v. Cincinnati Ins. Co., 2019 WL 3940936 (D. Colo. Aug. 20, 2019) (“delay in addressing the issue only compounds the problem if, despite much time and expense having been dedicated to the case, a lack of jurisdiction causes it to be dismissed.”). Parties (particularly their attorneys) fail to engage in this analysis at their peril. See, e.g., Belleville Catering Co. v. Champaign Marketplace, LLC, 350 F.3d 691 (7th Cir. 2003) (case then on appeal on the merits to the Seventh Circuit Court of Appeals remanded to state court where diversity jurisdiction was in fact not present, depriving federal courts of jurisdiction; counsel ordered to relitigate dispute in state court pro bono on behalf of clients as sanction for this “doomed foray into federal court”). The proposed amendment to Rule 7.01, if adopted, will streamline the process, requiring each party to make a declaration to the court rather than leaving the determination of citizenship to the discovery process. Moreover, this proposed rule change may eliminate oft-seen gamesmanship as to the availability of diversity jurisdiction, particularly with respect to facial attacks. See, e.g., Lincoln Benefit Life Co. v. AEI Life, LLC, 800 F.3d 99 (3d Cir. Sept. 2, 2015) (court ordered jurisdictional discovery when defendant asserted a facial attack on the plaintiff’s position that diversity jurisdiction existed, trying to defeat the jurisdictional statement while denying information as to its citizenship, which was not publicly available).
This change (again assuming its adoption) will perhaps reduce the initial burden on a plaintiff filing in or a defendant removing to federal court. It is rare that the membership of an unincorporated entity available in the public record. This objective fact has necessitated allegations of diversity based upon “information and belief.” See, e.g., Wright, Federal Practice & Procedure § 1224 (pleading diversity jurisdiction on the basis of “information and belief” is a “practical necessity.”). There are, however, a number courts that have rejected allegations of diversity based on information and belief. See, e.g., Pharmerica Corp. v. Crestwood Care, LLC, 2015 WL 1006683 (N.D. Ill. Mar. 2, 2015); Principal Solutions LLC v. Feed.Ing BV, 2013 WL 2458630 (E.D. Wisc. June 5, 2013). Assuming that the party bringing the action to federal court has a good-faith basis for the assertion that diversity exists, and as that assertion will be quickly tested against the other parties’ citizenship disclosure, perhaps any bar against information and belief pleading should be reduced.
Haben Girma shows what an attorney with a disability can accomplish. She’s both deaf and blind, and her new memoir, Haben: The Deafblind Woman Who Conquered Harvard Law, has many stories about her facing challenges, and showing the world that her challenges didn’t limit her. As she writes in the introduction, “This book takes readers on a quest for connection across the world, including building a school under the scorching Malian sun, climbing icebergs in Alaska, training with a guide dog in New Jersey, studying law at Harvard, and sharing a magical moment with President Obama at the White House.”
Haben Girma is the daughter of parents from two different African countries; her father is from Ethiopia, and her mother is from Eritrea. Although Haben herself was born and grew up in California, that perspective influences how she takes on the world. The memoir opens with a harrowing story of her father being taken off an airplane by Ethiopian soldiers during her childhood. In reference to her background, this memoir discusses the complicated and historic relationship between the people of Ethiopia and Eritrea.
She also discusses the reality of growing up as a child with a disability in the United States and going to a mainstream school. She shows that these challenges can be confronted head-on and handled with attention and care (as well as reasonable accommodations), not by ignoring them and pretending they don’t exist. A theme running through the memoir is the importance of independence and obliterating misconceptions about what people with disabilities can and cannot do. The data clearly shows that the vast majority of disabilities are invisible and people often hide a key aspect of him or herself.
Like many children with disabilities, she challenges her parents to allow her to do things, such as travel. She also faces colleagues and mentors who underestimate and look down on her. Throughout the story, she endeavors to break down the myths of what she unable to accomplish, while never falling into the untrue and damaging myth of “overcoming” disability. As research shows, disability inclusion provides an advantage for those organizations that work to include people with disabilities, such as Accenture, Microsoft, and Sidley Austin (all three have been recognized by the ABA for including attorneys with disabilities).
In Haben’s case, she is a Harvard Law School graduate with international experience. She writes that society treats “people with disabilities as incapable of contributing, and yet these kids [in Eritrea] treat me like someone with gifts to share and lessons to teach.” In her discussion of her experience at Harvard Law School, she explained that she used communication devices to interact with other students, professors, and people at networking events. In particular, she discussed using her Braille computer to network. (“Tactical sign language is our backup plan” was decided during a strategy meeting.)
Dancing salsa allows her to use her sense of touch to manage her lack of vision and lack of hearing a beat. She describes using the skills she has to manage the senses she doesn’t have. For example,she also describes using her sense of touch to volunteer to build houses in Mali. Building houses helped prove that she could still make a worthwhile contribution and have a disability at the same time. Her disability allows her to perceive problems that others don’t even notice.
The memoir also makes clear that a disability rights legal practice also provides her with great legal training. For example, she discussed an attorney with a disability that was the best litigator she’s ever witnessed: “Disability Rights hero Daniel Goldstein grips the court’s attention. He stands at the lectern before Judge William K. Sessions, III, in the district court for the district of Vermont.”
As a Skadden fellow after law school, she operated a disability rights practice. As discussed above, the disability rights legal practice helped develop her legal skills and gave her front line access to top lawyers.
“As a public service lawyer, my salary is far below what a Harvard Law graduate would typically make, but still exceeds the average income for blind Americans, 70 percent of whom struggle with unemployment,” writes Haben. The memoir then explains that disability rights are civil rights, and she shows that the ADA is federal legislation that offers protections that help businesses reach a “giant” market.
In conclusion, this is a worthwhile book that you should read to better understand the challenges of the disabled. Haben gives concrete examples of her youth, her perspective, and the excellent legal training she received. The book discusses the value for business organizations and law firms to include people with disabilities; her unique voice brings us just a glimpse into how disabilities can be an asset to businesses. The memoir shows the level of talent and size of the potential market that businesses could reach by including persons with disabilities.
A new California law related to the processing of personal data will go into effect in July 2020. The California Consumer Privacy Act (CCPA) (California Civil Code §§ 1798.100 to 1798.199) is currently the most comprehensive privacy legislation in the United States, with extensive new compliance requirements and liabilities. Although the law was drafted with threshold requirements for application, it will have significant reach given California’s undeniably large global economic impact. If you are a for-profit business doing business in California or you are collecting California consumers’ personal information, this is one law you cannot ignore.
In short, the CCPA grants California residents new rights with respect to the collection of their personal information, including, among other things, the right to be forgotten (deletion of information), the right to opt-out of the sale of their personal information, and the right to know what information a business collects about them. All of this creates new operational challenges for businesses that must be addressed in advance of the law taking effect. To further complicate matters, there are several open questions about the law, including the application of several amendments recently passed by the California state legislature, and whether preemptive federal legislation may be passed. In the meantime, companies should prepare themselves for the most monumental shift in domestic privacy legislation in decades.
Background of the Passage of the CCPA
General elections in California often include voting on legislative ballot initiatives, some of which are drafted and proposed by California citizens. Prior to the passage of the CCPA, real estate developer Alastair Mactaggart set out to place an initiative on the ballot regulating the collection of personal information by businesses. The idea quickly gained steam, and within a few months a consumer-friendly privacy initiative co-drafted and funded by Mactaggart gathered what appeared to be more preliminary signatures than necessary to qualify for the November 2018 statewide ballot. Initiatives that pass via the ballot process are notoriously more difficult to amend, modify, or repeal, typically requiring another initiative or a 70-percent majority in the California legislature. In order to avoid the passage of a law that would have been immensely difficult to change, the California legislature brokered a deal with Mactaggart and his team and hastily passed Assembly Bill 375, now known as the CCPA. The proposed legislation, although in the works for some time, reportedly received only a few days of debate and virtually no input from industry before it was passed and signed into law. As a result of the deal and signed legislation, Mactaggart agreed to withdraw his ballot initiative only hours before the final deadline to withdraw.
Not surprisingly, this unusually swift process resulted in drafting errors, inconsistencies, ambiguities, and confusion as to the law’s potential reach and application. Indeed, several weeks after its initial passage, the legislature amended the new law with the passage of SB 1121. Intended to correct certain drafting errors and clarify certain provisions, the amendment still left several glaring inconsistencies and ambiguities. Several additional amendments have passed through the legislature and are currently pending before Governor Newsom. It is anticipated that there may be additional amendments proposed after the CCPA takes effect in 2020.
Threshold Application of the CCPA
The CCPA applies generally to for-profit businesses and sets threshold requirements for its application. The CCPA will apply to businesses around the world if they exceed one of the following thresholds:
annual gross revenues of $25 million;
annually buy, sell, receive, or share for commercial purposes the personal information of 50,000 or more consumers, households, or devices; or
derive 50 percent or more of its annual revenues from selling consumers’ personal information.
Notably, parent companies and subsidiaries sharing the same branding must also comply even if they themselves do not exceed the applicable thresholds.
At this point, there are some ambiguities as to how the thresholds can be met. For example, a common question is whether the $25 million limit for annual gross revenues is met with California revenue alone or if it is met with global revenue. The answer to this question is unclear and may or may not be resolved before the law goes into effect, meaning that, ultimately, the courts may be the ones to resolve this issue.
Who Is Affected and What Is Protected?
Under the CCPA, consumers can exercise their rights with respect to any information that relates to them and that is held by a business. The term “consumer” is broadly defined to include any California resident (see Cal. Civ. Code § 1798.140(g) (defining “consumer” as any “natural person who is a California resident”)). An amendment known as AB 25 currently on the governor’s desk would redefine “consumers” to omit employee personal information to the extent the person’s personal information is collected and used only by the business in that context. The provision will sunset after one year.
A consumer’s “personal information” is broadly defined to include information that identifies, relates to, describes, or could reasonably be linked, directly or indirectly to a particular consumer or household. As the law exists currently, personal information includes, but is not limited to, the following:
identifiers such as a real name, alias, postal address, unique personal identifier, online identifier, internet protocol address, e-mail address, account name, Social Security number, driver’s license number, passport number, or other similar identifiers;
characteristics of protected classifications under California or federal law;
commercial information, including records of personal property; products or services purchased, obtained, or considered; or other purchasing or consuming histories or tendencies;
biometric information;
internet or other electronic network activity information, including, but not limited to, browsing history, search history, and information regarding a consumer’s interaction with an internet web site, application, or advertisement;
geolocation data;
audio, electronic, visual, thermal, olfactory, or similar information;
professional or employment-related information;
education information;
inferences drawn from any of the information collected to create a profile about a consumer reflecting the consumer’s preferences, characteristics, psychological trends, preferences, predispositions, behavior, attitudes, intelligence, abilities, and aptitudes.
Specifically excluded from the definition of “personal information” is any information publicly available, meaning any information that is lawfully made available from state, federal, or local government records. “Publicly available” does not mean biometric information collected by a business about a consumer without the consumer’s knowledge.
How Will the CCPA Be Enforced?
Under the CCPA, the California attorney general can bring civil actions for injunctions or civil penalties of $2,500 per violation under the statute and up to $7,500 for any intentional violation. A business is in violation of the statute if it fails to cure an alleged violation within 30 days after being notified of alleged noncompliance.
The CCPA also includes a limited private right of action for consumers for violations of the statute’s data security requirements. Specifically, a consumer can institute a civil action if nonencrypted or nonredacted personal information (as defined under California’s data breach notification statute, California Civil Code, § 1798.81.5(d)(1)) is subject to unauthorized access and exfiltration, theft, or disclosure as a result of a business’s failure to maintain reasonable security procedures.
The security provision refers to a business’s “duty to implement and maintain reasonable security procedures and practices.” Although “reasonable security” is not defined in the statute, it is worth noting that in February 2016 the California attorney general released the California Data Breach Report, which makes five recommendations regarding data security, including an explicit endorsement of the Center for Internet Security’s Critical Security Controls as a minimum threshold for reasonable security. It is also worth noting that the CCPA’s security provision does include a proportionality element providing that it is the duty of the business to maintain reasonable security procedures and practices “appropriate to the nature of the information.”
In an interesting twist, another proposed amendment to the CCPA, SB 561, which would expand the private right of action to any violation of the CCPA and remove the ability to cure within 30 days of notification, was killed during the recent legislative session. The bill had the backing of Attorney General Xavier Becerra, but on April 29, 2019, the California Senate Appropriations Committee placed this bill on the “suspense file,” which is a way to consider the fiscal impact of the bill to the state. Shortly thereafter, the bill was taken under submission, which means it was blocked and is effectively dead. Given that the legislative session in California has ended, it appears that there will not be an expansion of the private right of action this year. California has a two-year legislative session, however, so this bill can be raised again next year without the need to be reintroduced.
How Does the CCPA Compare to the GDPR?
You may have heard of Europe’s General Data Protection Regulation (GDPR) and wonder how it compares to the CCPA. Notably, it is difficult to make generalities about the differences or similarities between the laws because some provisions in the laws closely align, whereas others do not.
Both laws are generally intended to provide privacy protections to individuals by granting them control and access to their personal information. Additionally, both the GDPR and CCPA focus on transparency obligations. To achieve their objectives, each requires contracts between businesses and service providers, detailed privacy notices, and similar grants to individuals with respect to the control over their information. The devil, as they say, is in the details in that each law sets out different compliance and applicability requirements.
Fundamentally, the GDPR and CCPA also differ in many aspects, including that the GDPR anchors itself with the concept that a business must have a “legal basis” to process personal information, otherwise the processing is not permitted. The CCPA has no such requirement and instead creates a mechanism for consumers to opt-out of the sale and disclosure of their information or to request deletion.
The CCPA also explicitly excludes from its scope certain broad categories of personal information altogether, including medical information covered by the Confidentiality of Medical Information Act and the Health Insurance Portability and Accountability Act and personal information under the Gramm-Leach-Bliley Act. The GDPR excludes no specific categories of information from its scope.
What Must Your Business Do Now?
Review Your Data Privacy Practices. It is always a good starting point to take stock of your data. Determine what data (including personal information and sensitive or confidential information) your business is collecting, what you are doing with the data (including with whom it is being shared), and where the data resides. The CCPA gives consumers new rights over their information and, as a result, organizations must be prepared to comply with requests that may come from consumers beginning January 1, 2020. The new rights include the right to request from a business:
categories and specific pieces of personal information collected;
categories of sources from which the personal information is collected;
the business or commercial purpose for collecting or selling the personal information;
categories of third parties with whom the business shares personal information; and
deletion of personal information about the consumer that the business has collected, subject to some important exceptions.
The information must be delivered free of charge to the consumer, in a format that is portable, and typically within 45 days. The first step to complying with any requests from consumers is understanding your current data practices.
Review Your Policies. If you have a privacy policy in place, it will likely need updating before January 1, 2020, even if you prepared for the GDPR. The CCPA provides for new disclosure requirements that must be included in a privacy policy or notice. At or before the time of collection, a business must disclose the categories of personal information to be collected and the purpose for which the information is used. The notice must also separately list the categories of personal information collected, sold, or disclosed for a business purpose in the preceding year and explicitly state if the personal information has not been sold or disclosed. The new disclosures can be made part of an existing privacy policy, or a separate policy can be maintained for California residents.
Businesses should also analyze whether they are “selling” personal information to third parties. Where a consumer’s personal information is sold as defined by the statute, the consumer has the right to opt-out of the sale of their personal information. A clear and conspicuous link on the business’s internet homepage, titled “Do Not Sell My Personal Information,” must be made available, and the link must enable consumers to opt-out of the sale of their personal information. The business must wait at least 12 months before requesting to sell the personal information of any consumer who has opted out.
Review Third-Party Agreements. Take the time to identify vendors or third parties that receive personal information from your business. Once identified, consider adding appropriate contract terms to address the CCPA, including terms regarding the use or disclosure of personal information received from your business, to clarify that you are not “selling” personal information to vendors, or to increase transparency with regard to the privacy and data security practices of your vendors.
Conclusion
Business leaders can anticipate that the CCPA will continue to evolve over the coming year, and that this will not be the end of data privacy regulation in California or the United States. Indeed, several states are currently considering their own privacy regulations. Given that regulatory change in this area will be ongoing for some time, it is best to build a flexible, dynamic privacy program that can adapt to changes as they occur.
In Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), the U.S. Supreme Court answered what has been called the most important unresolved question in trademark licensing and resolved a decades-long division among the lower courts on a foundational question of bankruptcy law. Specifically, Mission held that when the licensor of a trademark files for bankruptcy, its “rejection” of the trademark license agreement under section 365 of the Bankruptcy Code does not terminate the licensee’s rights in the mark.
Mission is a critically important decision for trademark licensing, and practitioners in that area have welcomed it, because it makes clear that a licensee’s rights will not evaporate if the licensor files for bankruptcy and rejects the parties’ license agreement. That greater certainty will affect the negotiation and terms of trademark licenses because it makes trademark rights more valuable to the licensee (and, as a corollary, makes licenses more profitable for the licensor). It is also a highly significant decision for the bankruptcy bench and bar because it clarifies long-standing confusion regarding one of the Bankruptcy Code’s central concepts: the concept of rejection.
By way of background, section 365 of the Bankruptcy Code permits a trustee or debtor-in-possession in bankruptcy to “assume or reject any executory contract”—that is, any contract the debtor entered before bankruptcy in which each party still owes a duty of performance to the other. 11 U.S.C. §365(a). Briefly, section 365 permits the bankruptcy estate to assume an executory contract and perform the debtor’s future obligations under that contract if doing so will be profitable for the estate, and to reject the contract if performing would not be profitable. Mission, 139 S. Ct. at 1658. The Bankruptcy Code provides that rejection “constitutes a breach” of the rejected contract that is deemed to have occurred before bankruptcy, 11 U.S.C. §365(g), entitling the counterparty to a claim in the bankruptcy case (which will typically be paid at cents on the dollar) for damages stemming from the debtor’s failure to perform. However, courts have not always agreed on the precise consequences of rejection. Is rejection merely the equivalent of a breach of contract outside bankruptcy, or does it terminate all the counterparty’s rights? That was the core question in Mission.
The seeds for Mission were sown in 1985 when the Fourth Circuit addressed the same question in the context of a patent license. Lubrizol Enters. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Lubrizol held that the debtor-licensor’s rejection of the license agreement enabled the estate to take back the patent rights the debtor had granted to the licensee before bankruptcy and sell or license those rights to a third party. See id. at 1047-48. In response, Congress amended section 365 by adding a new provision governing rejection of licenses of “intellectual property,” which provided that licensees could choose either to treat such licenses as terminated or to retain their rights (and obligations) under the licenses. 11 U.S.C. §365(n). Congress defined “intellectual property” to include patents, copyrights, and trade secrets, id. §101(35A), but omitted trademarks, meaning that section 365(n), by its terms, does not apply to trademark licenses. After section 365(n) was enacted, courts divided over whether Lubrizol was still good law for trademark licenses. Some lower courts concluded that the omission of trademark licenses from section 365(n) meant that Congress had implicitly endorsed Lubrizol’s reasoning in the trademark licensing context. In 2012, however, the Seventh Circuit held to the contrary, reasoning that under section 365, rejection is simply a breach and, like a breach outside bankruptcy, cannot take away the licensee’s rights in the mark. See Sunbeam Prods., Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).
That was where matters stood when the Mission case originated. Tempnology had developed a patented technology for cooling fabric to be used in sportswear, towels, and the like, marketed under the COOLCORE trademark. In 2012, it licensed its patents and trademark to Mission, granting Mission the exclusive right to distribute certain COOLCORE products in the United States. In 2014, Tempnology filed a Chapter 11 petition and rejected the license agreement with Mission, contending that rejection terminated Mission’s right to use the trademark. Ultimately, the First Circuit agreed with Tempnology and split with the Seventh Circuit’s decision in Sunbeam, reasoning that allowing Mission to continue using the mark would be too burdensome for Tempnology and could impair its ability to reorganize. The Supreme Court granted Mission’s petition for certiorari to resolve the circuit split. Mission, 139 S. Ct. at 1658-60.
After rejecting Tempnology’s argument that the case was moot, see id. at 1660-61, the Court turned to the fundamental question presented: “What is the effect of a debtor’s . . . rejection of a contract under Section 365 of the Bankruptcy Code?” Id. at 1661. The Court’s answer was unequivocal: “Rejection of a contract—any contract—in bankruptcy operates not as a rescission but as a breach.” Id. Accordingly, rejection “leave[s] intact the rights the counterparty has received under the contract.” Id. “Both Section 365’s text and fundamental principles of bankruptcy law command [that] approach.” Id.
Beginning with the text, the Court observed that section 365 provides that rejection “‘constitutes a breach’” of the rejected contract. Id. Outside bankruptcy, one party’s breach of contract does not terminate the other party’s rights. The Court used the example of a contract in which a dealer leases a photocopier to a law firm and agrees to service the copier monthly. If the dealer stops servicing the machine, materially breaching the contract, the law firm may choose to terminate the contract, but the dealer cannot do so. “The contract gave the law firm continuing rights in the copier, which the dealer cannot unilaterally revoke.” Id. at 1662. Rejection in bankruptcy works the same way, for a trademark license as well as a photocopier lease: “The debtor can stop performing its remaining obligations under the agreement. But the debtor cannot rescind the license already conveyed. So the licensee can continue to do whatever the license authorizes.” Id. at 1662-63. That reading of section 365, the Court explained, “reflects a general bankruptcy rule: The estate cannot possess anything more than the debtor itself did outside bankruptcy,” at least absent a successful preference or fraudulent conveyance action by the trustee. Id. at 1663.
The Court found Tempnology’s contrary arguments unpersuasive. Tempnology had contended that because section 365(n) specifies that counterparties may retain their rights after rejection, one should draw the negative inference that “the ordinary consequence of rejection” is termination of those rights. Id. at 1663. After examining the history and context of section 365(n), however, the Court concluded that “no negative inference arises.” Id. at 1665. “Congress did nothing in adding Section 365(n) to alter the natural reading of Section 365(g)—that rejection and breach have the same results.” Id. Rather, section 365(g) could be read to “reinforce or clarify the general rule that contractual rights survive rejection.” Id. at 1664.
Finally, the Court dismissed Tempnology’s contention that if trademark licensees retained their rights after rejection, the debtor’s ability to reorganize would be impeded because the debtor would need to continue to exercise quality control over the goods bearing the mark or else risk losing the mark. See id. at 1665. As an initial matter, the Court noted that there was no support in the text of the Bankruptcy Code for a trademark-specific rule of rejection. Id. Moreover, Tempnology’s argument proved too much: The Code “aims to make reorganizations possible,” “[b]ut it does not permit anything and everything that might advance that goal.” Id.
The Mission decision has many significant aspects, three of which are noted here. First, as the Court expressly stated, its holding—that rejection has the same consequences as breach—is not limited to trademark licenses, but applies to all executory contracts. Mission thus has the potential to simplify what has become an extraordinarily complex and confused area of the law. Courts often conduct lengthy analyses of whether a particular contract is executory, at times seemingly doing so to avoid the draconian consequences that rejection would have if it terminated the counterparty’s rights. See, e.g., In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010) (holding that trademark license agreement was not executory, and licensor therefore could not reject it and terminate licensee’s right to use the mark); id. at 967-68 (Ambro, J., concurring) (noting the inequity of using rejection “to let a licensor take back trademark rights it bargained away”); see generally Michael T. Andrews, Executory Contracts in Bankruptcy: Understanding ‘Rejection,’ 59 U. Colo. L. Rev. 845 (1988). Once rejection is correctly understood as the bankruptcy analogue of breach, and not as a special power to terminate the other party’s rights under a contract, courts should no longer need to rely on the highly malleable test for executoriness to ensure a just result.
Second, Mission reaffirms that in deciding any question arising under the Bankruptcy Code, the Code’s language comes first, but Mission approaches that language contextually. As the Court observed, section 365’s statement that rejection “constitutes a breach” “does much of the work” in the Court’s analysis. Mission, 139 S. Ct. at 1661. That is not surprising. As Justice Kagan, who wrote the Court’s opinion, said in another context, “We’re all textualists now.” SeeThe Scalia Lecture: A Dialogue with Justice Elena Kagan on the Reading of Statutes (Nov. 17, 2015). Significantly, however, the Court did not limit its inquiry to the text of section 365 considered in isolation, as it has at times in past bankruptcy cases. See, e.g., RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645-49 (2012). Rather, it also relied on the “fundamental principle[]” that the estate has no greater rights in property than the debtor had before bankruptcy—a principle reflected in the overarching structure of the Code and its various provisions governing the estate and its property—to confirm its interpretation. Mission, 139 S. Ct. at 1661; see id. at 1663. That willingness to grapple with the overall architecture of the Code—also reflected in the Court’s decision two years ago in Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017)—is a promising sign for the Court’s bankruptcy jurisprudence.
Finally, Mission once again confirms that to understand the workings of the Bankruptcy Code, one must start with the parties’ rights and obligations outside bankruptcy. To be sure, the Code can and sometimes does alter those rights and obligations, but the Court will not be quick to jump to the conclusion that Congress intended such an alteration unless the Code clearly indicates it. Likewise, the interpretation of the Code that best promotes reorganization will not always be the correct interpretation; the Code carefully balances the interests of different constituencies, and courts must respect the balance Congress struck. In short, as the Court has now held repeatedly in various contexts, the Bankruptcy Code gives debtors specific tools that can be used to maximize the value of the estate, but it does not grant either the debtor or the bankruptcy court any general power to alter the parties’ background entitlements in the service of reorganization or of an equitable resolution more broadly. See, e.g., Czyzewski, 137 S. Ct. 973 (when dismissing a Chapter 11 case, bankruptcy courts lack the power to order a distribution of estate assets that would violate the priority scheme applicable to a Chapter 11 plan). Although the Court’s view of the bankruptcy power as tied closely to the provisions of the Code may be more constrained than some bankruptcy practitioners would prefer, the Court has now made that view inescapably clear.
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