When the Court of Appeals for the Ninth Circuit recently stated that a payment deduction sought by the State of California “would obliterate the distinction between recoupment and setoff,” it expressed a sentiment shared by many experienced bankruptcy practitioners confounded by the inability to separate the two doctrines.  The Bankruptcy Code permits – but narrowly confines – a creditor’s exercise of its common law right of setoff.  Only pre-petition debts and claims can be offset and the act of making the deduction is subject to the automatic stay.  Recoupment, on the other hand, is a defense embedded within a debt and is both exempt from the automatic stay and its exercise can cross the petition date divide.  Naturally, then, if an offset can be recast as a recoupment, there are significant advantages to the creditor.  Over time, as more and more offsets are labeled recoupments, the distinction between the two doctrines has been seriously eroded.  The Ninth Circuit’s decision in In re Gardens Regional Hospital, 975 F.3d 926 (9th Cir. 2020), has finally restored the proper boundaries between recoupment and setoff.

By way of background, a brief glossary will be useful.  The Bankruptcy Code defines a “claim” broadly to include every right to payment, whether or not reduced to judgment, liquidated or unliquidated, fixed or contingent, matured or unmatured.  A creditor is an entity that holds a claim against the debtor that arose prior to the commencement of the bankruptcy case.  A “debt,” on the other hand, is a liability on a claim.  For purposes of setoff, the Code treats an obligation owed by a creditor to the debtor as a debt, whereas the obligation owed by the debtor to the creditor is a claim.  Usually it will be advantageous for a creditor to reduce its debt by deducting the amount of its claim because a debt is payable in full to the estate, whereas a claim may receive only a negligible dividend from the estate.  As the Supreme Court succinctly stated, setoff allows entities that owe each other money to apply their mutual debts again each other, “thereby avoiding the absurdity of making A pay B when B owes A.”  Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18 (1995).

Setoff is derived from common law rules of pleading under which parties to litigation are permitted to assert opposing claims.  Recoupment, on the other hand, is an equitable doctrine that is intended to compute the “proper amount” of a particular claim.  Section 553 of the Bankruptcy Code ensconces the right of setoff in all bankruptcy cases, subject to three key limitations.  First, the offsetting obligations (the debt and the claim) must each have arisen before the bankruptcy petition is filed.  A creditor cannot acquire, post-petition, a claim for purposes of offset.  See Bankruptcy Code § 553(a)(2) (setoff prohibited to the extent that the claim against the debtor was transferred to the creditor owing a debt to the debtor “after the commencement of the case.”).

Second, each of the obligations must be mutual – that is, they must be held by the creditor and the debtor standing in the same bilateral right and capacity.  For example, if the creditor owes a debt wearing a “fiduciary” hat, yet holds a claim wearing a “vendor” hat, the required mutuality will be lacking.  For the same reason, a “triangular” setoff (A owes Debtor, Debtor owes B, A offsets against B), will also fail.  Similarly, each entity within a corporate family is treated separately for purposes of mutuality – if a corporate parent owes $10 to the debtor, but the debtor owes an affiliate or subsidiary of the parent $10, the parent may not satisfy the $10 debt by deduction against its affiliate’s claim.  (The agencies and branches of the U.S. government, however, are considered a “unitary” creditor.)  Private contracts can neither create mutuality (for purposes of Section 553), nor opt-out of the mutuality requirement.  In re Orexigen Therapeutics, 990 F.3d 748 (3^rd Cir. 2021).

Third, the exercise of the right of setoff is subject to the automatic stay.  In order to actually make a permanent deduction, the creditor must first seek relief from the stay.  The Supreme Court in Strumpf permitted a creditor to temporarily “freeze” countervailing obligations (i.e., preserve the status quo as of the petition date) without violating the stay until the outcome of a subsequent motion to lift the stay.  Such an administrative hold, pending further instructions from the court or the parties, does not result in the permanent settlement of accounts that is needed for a setoff to actually occur.

Recoupment, unlike setoff, does not involve the netting of independent obligations but rather the determination of the proper liability on a claim.  The competing obligations that give rise to recoupment must arise from the same transaction or occurrence.  In order to meet this requirement, courts typically assess whether there is a “logical relationship” between the obligations.  That test does not measure temporal proximity (i.e., did the claims arise contemporaneously), but whether they are logically connected.  If so, recoupment may be used to recover across the petition date divide and without any automatic stay perils.

Virtually every recoupment decision acknowledges that, as an equitable exception to the automatic stay, the doctrine must be “narrowly construed.”  Neither a single contract, nor the same parties, nor a similar subject matter, nor a shared legal framework necessarily satisfies the ‘same transaction test’ to permit recoupment.  In re University Medical Center, 973 F.2d 1065 (3rd Cir. 1992).  Nor, as Gardens has now established, will a statutory right of deduction of “any” debts or claims between two parties meet the same transaction test. 

As might be apparent from the foregoing, applying these principles to varying factual patterns can lead to rather disparate results.  Over time, the line separating setoff from recoupment has blurred.  Now, Gardens teaches that one cannot “cross the payment streams” (to borrow a classic phrase from Ghostbusters).  The payment streams must arise from the “very same acts” to meet the logical relationship test for recoupment.  The mere fact that dueling payment streams can be cabined within a single contract, a single statute or even a single commercial relationship, is insufficient to qualify for recoupment.

The facts in Gardens were not complicated.  The debtor operated Gardens Regional Hospital, a private, not-for-profit acute care hospital located in Hawaiian Gardens, California.  The hospital participated in the State of California’s Medicaid program, known as Medi-Cal.  Under the Medi-Cal relationship, the hospital was paid for medical services under a fee-for-service (“FFS”) model.  Under that model, the State of California would retrospectively reimburse the hospital for the cost of treatment (either at negotiated rates, or pursuant to a regulatory scheme) provided by the hospital to Medi-Cal patients.  (By contrast, under a managed care model, the State prospectively remits a fixed capitation payment to a hospital provider regardless of the ensuing need for, or actual cost of, care given to patients.) 

As is common under the FFS model, from time to time in the normal course of business, the State might occasionally make an overpayment to a hospital provider.  Overpayments can be due to patient ineligibility, inadvertent double-payments or inaccurate coding, among other reasons.  Under the Medi-Cal system, the State is entitled to deduct overpayments mistakenly paid to the hospital from future FFS reimbursements due to a hospital.  These overpayment adjustments, based on a constant account balancing process (i.e., recurring payments due to and from a hospital for the provision of medical services), fit within the classic parameters of recoupment and, typically, continue unabated and unchallenged in most bankruptcy cases.

Separately, the hospital was also entitled to receive a supplemental Medi-Cal payment based on the State’s assessment of a tax (specifically, a hospital quality assurance fee, or “QAF”) on non-public acute care hospitals in the State.  The QAF revenues were deposited in a segregated fund and later redistributed to a variety of beneficiaries (such as public hospitals, or health coverage for low-income children), including some of the same private hospitals that had contributed to the fund by paying the QAF assessments.  Under the QAF program, the State was entitled to deduct any unpaid QAF assessments against any State payments owed to the hospital, whether or not derived from the QAF program.

At the time Gardens Regional Hospital filed its Chapter 11 case, it owed the State about $700,000 in missed QAF assessments.  The State used this claim to reduce its Medi-Cal debts owed to the hospital, including the supplemental Medi-Cal payments the hospital was entitled to receive under the QAF program and the FFS reimbursements that it had earned.  The hospital later filed a motion to compel payment of the withheld amounts because the State had violated the automatic stay by making an impermissible setoff across the petition date divide.  The State countered that its deductions were recoupment and thereby exempt from the automatic stay. 

At the outset, the Gardens court recognized that properly delimiting the border between setoff and recoupment would have important consequences in bankruptcy cases.  As noted, recoupment is neither subject to the automatic stay nor restricted to pre-petition debts and claims (i.e., it may be deployed across the petition date).  A setoff typically arises from separate and distinct transactions.  Recoupment, however, must arise from the same transaction or occurrence.  A setoff entails the net adjustment of independent obligations.  On the other hand, recoupment is a right to reduce the common nucleus of a single obligation.

The traditional test for recoupment asks whether the countervailing obligations enjoy a “logical relationship.”  In the Ninth Circuit, temporal immediacy has neither been required nor dispositive to qualify for recoupment.  The Ninth Circuit, however, has also rejected, as overly restrictive, the “single integrated transaction” test adopted in the Third Circuit.  But, the Gardens court cautioned that the test should not be applied “so loosely that multiple occurrences in any continuous commercial relationship would constitute one transaction.”  Indeed, to stretch the doctrine too far would impair a fundamental policy of bankruptcy law to promote equality of treatment among creditors.

The Gardens court dispatched the notion that a contract alone could provide the necessary linkage to permit the reduction of a post-petition debt on account of a pre-petition claim.  That justification was rejected by the court in Orexigen in the setoff context and, now, by Gardens in the recoupment context.  As the Ninth Circuit warned, by that logic, virtually any obligations referenced under a contractual umbrella could be recoupable – the exception (recoupment) would thus swallow the rule (Section 553).  Similarly, a statutory right of deduction of “any” debts or claims is also insufficient, on its own, to create a right of recoupment. 

So, what is the dividing line?  According to the Gardens court, the crucial question is whether the two obligations at issue arise “from the very same acts.”  Coupled with other factors (such as a contractual relationship), this can create the “intertwined” legal and factual connections to permit recoupment.  Applying that standard, the court had little difficulty concluding that the State’s claim for unpaid QAF assessments was logically related to the State’s debt for supplemental Medi-Cal payments.  The deposit of QAF receipts into the QAF fund for distribution to QAF participants created a direct factual and legal “linkage between these two streams of money.”  Indeed, the circularity of the QAF program was unique, even though the amounts of the QAF assessment and the Medi-Cal supplemental payment were each independently calculated under separate, complex formulas.  The QAF assessments were “paid by hospitals into the segregated funds and the supplemental payments [were] made to hospitals from those same funds.” (emphasis in original).

On the other hand, the deduction of the unpaid QAF assessments against the FFS reimbursements was not a permissible recoupment.  The FFS payments were not drawn from the same fund as the supplemental Medi-Cal payments, nor was there any “unique linkage” between the QAF program and the Med-Cal system – the court noted that the “fee-for-service system was an established part of California’s Medi-Cal plan long before the QAF program, with its segregated funding, was established.”  Most importantly, however, the countervailing obligations did not arise from the “same acts.”  The QAF program was a self-contained, specialized and continuous funding vehicle with a distinct objective (to obtain greater federal Medicaid matching funds).  The Medi-Cal system, by contrast, was based on differing medical services provided to individual patients from time to time pursuant to an autonomous rate structure. 

According to the court, neither a statutory (i.e., the State’s right to offset any amount due to a State agency from any person or entity) nor a contractual underpinning (i.e., the hospital’s form provider agreement with the State) was enough to overcome the Bankruptcy Code.  The court explained: “were we to accept California’s contention that its statutory assertion of such a sweeping right of setoff alone establishes a sufficient logical relationship to warrant recoupment, we would effectively obliterate the distinction between recoupment and setoff and thereby exempt California entirely from the Bankruptcy Code’s restrictions on setoffs.”  The court stressed that a factual link was critical – the competing obligations must arise from the same underlying actions.

One aspect of the Gardens decision that may prove helpful to debtors is the treatment of subrogation claims.  As we know from Section 553(a)(2) of the Bankruptcy Code, the post-petition act of acquiring the pre-petition claim of another creditor, whether by transfer, subrogation or otherwise, does not permit the use of that claim for purposes of setoff.  This result should also, practically by definition, establish the absence of the factual link needed for recoupment.  After all, if the creditor/subrogee hadn’t voluntarily inserted itself into the debtor-creditor relationship (the relationship between the debtor and the creditor/subrogor) there would be no factual connection at all between the debt and the new claim that the creditor might seek to recoup.

The Gardens court’s refusal to further “expand the concept of recoupment” has reinforced the narrow strictures of recoupment.  To supply the necessary logical relationship for recoupment, a creditor must demonstrate both a legal and factual connection between the competing obligations.  Otherwise, the ability to recoup would encroach upon and undermine the core purposes of the Bankruptcy Code’s limitations on setoff.  At last, bankruptcy practitioners have a coherent and rigorous basis to disentangle setoff from recoupment.

Introduction

Secured creditors in bankruptcy often face the prospect of recovering less than the full value of their claims against the debtor.  This frequently arises when the creditor’s collateral is worth less than the amount of its claim, an “undersecured claim” in bankruptcy parlance.  Undersecured claims are bifurcated into two separate claims: a secured claim for the value of the collateral, and an unsecured claim for the remainder of the creditor’s claim.[1]  Secured claims are typically paid in full, while creditors often receive little or nothing on unsecured claims. Because the value of a secured creditor’s collateral may fluctuate in response to market conditions—say, for example, a systemic housing market crash or a pandemic-induced recession—it can be left with an artificially low secured claim in some cases.  Coupled with the likelihood of receiving little to nothing on the unsecured portion of its claim, these secured creditors are left with a bitter pill to swallow. However, in chapter 11 cases, a secured creditor has the option of avoiding the bifurcation of its claim entirely. That is, the secured creditor can elect to have the entire amount of its allowed claim treated as secured, even if the amount of the claim far exceeds the value of the collateral.[2]

This election, found in § 1111(b) of the U.S. Bankruptcy Code,[3] can be a boon to an undersecured creditor in some circumstances. However, it may not always be the best course of action. Understanding the requirements, effects, and limitations of § 1111(b) is key to using it strategically to maximize the recovery for an undersecured creditor.

Requirements

There are several threshold requirements for a secured creditor to be eligible to make the § 1111(b) election, most of which are set forth in the statute itself. First, if the debtor sells or intends the sell the creditor’s collateral through the bankruptcy case or under the plan, the election is not available (unless the claim arises from a non-recourse obligation, where the creditor may look only to the collateral for repayment).[4]  Second, the creditor’s secured claim in the collateral cannot be of “inconsequential value.”[5]  This requirement has generated conflicting caselaw regarding when a secured creditor may make the § 1111(b) election.  Some courts will compare the value of the collateral to the amount of the creditor’s total claim, and deem the collateral of “inconsequential value” if it represents a small proportion of the creditor’s total claim, typically less than 10%.[6]  Other courts have held that the correct approach is to compare the value of the creditor’s secured claim to the value of the collateral.[7]  This approach is relevant for a secured creditor holding a junior lien, but would probably never bar a secured creditor with a first priority lien from making the election.  Still other courts have held, in the context of chapter 11 cases proceeding under the recently-enacted subchapter V, that the court should take the purpose and policy behind the statute into account in conducting its analysis.[8]  Finally, a creditor must generally make the election prior to the conclusion of the hearing on the debtor’s disclosure statement.[9]  Thus, in subchapter V cases, where no disclosure statement is required,[10] creditors should take care to ensure that a deadline for making the election has been set by the court, and request the imposition of such a deadline if it has not been set. 

Effects

Making the § 1111(b) election has three important effects on the creditor’s claim.  First, it makes the entire claim a secured claim, which means the creditor will have no unsecured claim in the case.  Second, it entitles the creditor to retain its lien on its collateral, in the full amount of its claim, until paid in full.  This can be particularly valuable where the creditor believes there is a high likelihood of the debtor defaulting under the plan.  Third, it entitles the creditor to specific plan treatment.  Unless the creditor accepts less favorable treatment, the plan must provide for payments to the creditor with a present value (as of the effective date of the plan) equal to the amount the creditor’s secured claim would have been had it not made the § 1111(b) election.[11]  Further, the plan must propose to pay the entire claim in full, over time.[12]  For example, if a creditor has a claim for $100,000 secured by collateral worth only $40,000, and it makes the § 1111(b) election, the plan must propose to pay the creditor payments with a present value (e.g. with interest to compensate for the time-value of money if paid over time) of $40,000, and the total payments the creditor receives under the plan must total at least $100,000.

Limitations

The first drawback to the § 1111(b) election is that there is little restriction on how the debtor pays the entire claim over time. Using the example above, the debtor could propose to pay $40,000 in cash on the effective date, and then pay the remaining $60,000 with no interest over 20 or 30 years.  If the collateral is real property, many courts would likely conclude that such treatment is fair and equitable.[13]  Another major limitation on the election is the elimination of the electing creditor’s unsecured deficiency claim.  If the debtor’s plan proposes a substantial payout to creditors holding general unsecured claims, it may be in the creditor’s best pecuniary interest to forego the election in favor of realizing a recovery on its deficiency claim.  Similarly, in cases where the creditor making the election is the largest creditor in the case and is projected to have a substantial deficiency claim, it may be preferable to forego the election in order to be in a position to carry the vote of the general unsecured class.  This may put the creditor in a position to block confirmation and leverage more favorable plan treatment from the debtor. 

Conclusion

The § 1111(b) election provides a useful tool for a secured creditor in chapter 11 cases.  It can provide some insurance for creditors who believe that the debtor (or market conditions) has under-valued their collateral, or who believe that the debtor is unlikely to fully perform its obligations under the plan.  However, in some circumstances it can provide an undersecured creditor with a smaller recovery than opting to have a bifurcated claim.  In order to maximize its recovery, an undersecured creditor must consider the nature of its collateral, the likelihood of the debtor performing under the plan, and the alternative stream of cashflows which may be realized by foregoing the election and retaining an unsecured claim.

[1] 11 U.S.C. § 506(a).

[2] 11 U.S.C. § 1111(b)(2).

[3] 11 U.S.C. § 101 et seq.

[4] 11 U.S.C. § 1111(b)(1)(B)(ii).

[5] 11 U.S.C. § 1111(b)(1)(B)(i).

[6] See, e.g., In re Wandler, 77 B.R. 728 (Bankr. D.N.D. 1987).

[7] See McGarey v. MidFirst Bank (In re McGarey), 529 B.R. 277, 284 (D. Ariz. 2015) (“Thus, in order to determine ‘inconsequential value’, Section 1111(b) directs that we compare the lien value to the asset value. Nothing in Section 1111(b) suggests that it would be appropriate to compare the lien value to the total value of the creditor’s claim.”).

[8] See In re Body Transit, Inc., 619 B.R. 816, 836 (Bankr. E.D. Pa. 2020) (“The key point here is that the ‘inconsequential value’ determination is not a bean counting exercise; the determination cannot be based solely on a mechanical, numerical calculation. Some consideration must be given to the policies underlying both the right to make the § 1111(b) election and the exception to that statutory right.”).

[9] Fed. R. Bankr. P. 3014.

[10] See 11 U.S.C. §§ 1125 and 1181(b).

[11] 11 U.S.C. § 1129(a)(7)(B).

[12] 11 U.S.C. § 1129(b)(2)(A)(i)(II).

[13] See, e.g., In re Velazquez, No. 18-02209-EAG11, 2020 Bankr. LEXIS 1387, 2020 WL 4726199 (Bankr. D.P.R. May 27, 2020) (confirming plan proposing to pay secured claim subject to § 1111(b) over 20 years when the collateral was real property).

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§1.1 Introduction

This chapter summarizes significant legislative and case law developments in 2020 concerning the indemnification of directors, officers, employees and agents by the corporations or other entities they serve, as well as the rights of such persons to the advancement of litigation expenses before final resolution of the litigation.[1] This chapter also refers to legislative developments under Delaware law and the Model Business Corporation Act.

§1.2 Indemnification and Advancement – 8 Del. C. § 145

The Delaware General Corporation Law (“DGCL”),[2] codified at 8 Del. C. § 145, authorizes (and at times requires) a corporation to indemnify its directors, officers, employees, and agents for certain claims brought against them. Section 145 also allows a corporation to advance funds to those persons for expenses incurred while defending such claims. Specifically, Sections 145(a) and (b) broadly authorize a Delaware corporation to indemnify its current and former corporate officials for expenses incurred in legal proceedings to which a person is a party “by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise.” Upon successfully defending against a legal proceeding brought “by reason of the fact” that the person is or was a director or officer of the corporation, § 145(c) requires the corporation to indemnify that person for expenses (including attorneys’ fees) reasonably incurred in connection with the defense. “For indemnification with respect to any act or omission occurring after December 31, 2020, references to ‘officer’ for purposes of” § 145(c) “shall mean only a person who at the time of such act or omission is deemed to have consented to service by the delivery of process to the registered agent of the corporation.”  With respect to persons “not a present or former director or officer of the corporation,” the corporation “may indemnify” them “against expenses (including attorneys’ fees) actually and reasonably incurred . . . to the extent he or she has been successful on the merits . . . .”

Pursuant to § 145(e) the corporation also may advance “expenses (including attorneys’ fees)” incurred by a corporate official to defend against an investigation or lawsuit prior to final disposition.

The Model Business Corporation Act (MBCA) contains similar provisions, as do alternative entity statutes of Delaware and many other jurisdictions. For example, 6 Del. C. § 18-108 provides that “[s]ubject to such standards and restrictions, if any, as are set forth in its limited liability company agreement, a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.” Similarly, Delaware’s Revised Uniform Limited Partnership Act states “[s]ubject to such standards and restrictions, if any, as are set forth in its partnership agreement, a limited partnership may, and shall have the power to indemnify and hold harmless any partner or other person from and against any and all claims and demands whatsoever.” 6 Del. C. § 17-108. Thus, limited liability companies and partnerships have a “wider freedom of contract to craft their own indemnification” and advancement schemes “than is available to corporations under § 145 of the DGCL.” Weil v. Vereit Operating P’ship, L.P., C.A. No. 2017-0613-JTL, 2018 Del. Ch. LEXIS 48, *9-10 (Del. Ch. Feb. 13, 2018) (unpublished). As a result, prospective and current partners, members, and managers of alternative entities should pay close attention to advancement and indemnification rights granted by operating and/or partnership agreements and react accordingly.

Not only are officers and directors often entitled to advancement and indemnification under the codified provisions of Delaware law and the MBCA, but many corporations provide their officers with additional rights to advancement and indemnification. These provisions are often set forth in company charters and bylaws or included in agreements between companies and their officers, directors, and employees. These provisions can, and often do, make indemnification and advancement mandatory under circumstances specifically stated in the agreements.

§1.2.1 Legislative Developments

The Delaware General Assembly made several revisions to 8 Del. C. § 145 during 2020, effective July 16, 2020. Providing greater clarity to who qualifies as an “officer” entitled to mandatory indemnification, the General Assembly amended § 145(c) as follows (amendments in italics):

(c)

(1) To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection therewith. For indemnification with respect to any act or omission occurring after December 31, 2020, references to “officer” for purposes of this paragraphs (c)(1) and (2) of this section shall mean only a person who at the time of such act or omission is deemed to have consented to service by the delivery of process to the registered agent of the corporation pursuant to § 3114(b) of Title 10 (for purposes of this sentence only, treating residents of this State as if they were nonresidents to apply § 3114(b) of Title 10 to this sentence).

(2) The corporation may indemnify any other person who is not a present or former director or officer of the corporation against expenses (including attorneys’ fees) actually and reasonably incurred by such person to the extent he or she has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein.

Additionally, the General Assembly made a small revision to § 145(f). Although § 145(f) previously stated that the right to indemnification could not be eliminated after the fact by an amendment to a certificate of incorporation or bylaw, the revised § 145(f) went further to state that the right to indemnification could not be eliminated after an occurrence by repeal or elimination of the certificate of incorporation or bylaw.

The American Bar Association did not make any changes to the indemnification and advancement provisions of the MBCA during 2020.

§1.2.2 Case Law Developments

§1.2.2.1 Brick v. Retrofit Source, LLC[3]

Brick v. Retrofit Source, LLC presented an interesting question regarding advancement of legal fees from two related limited liability companies. The requesting party, Nathan Brick, had served as the Chief Operating Officer of The Retro Source, LLC (“Opco”), which was wholly owned by TRS Holdco, LLC (“Holdco”). In addition to serving as COO of Opco, Brick also served as a member of the board of TRS Holdco, LLC (“Holdco”). Both companies were Delaware LLCs (the “Companies”). Holdco owned membership interests in Opco and managed Opco. The question presented was ultimately whether Brick was entitled to advancement and indemnification as a member of the Holdco board when his challenged conduct was on behalf of Opco.

The dispute between Brick and the Companies arose after Opco’s Vice President of Finance discovered that Opco had been underpaying Customs duties for years pursuant to a “double-invoicing” scheme. Although certain parties, including Brick, contested who was responsible for the scheme, there was no dispute that Brick played some role in it. Opco voluntarily disclosed to U.S. Customs that Opco suspected it had been underpaying Customs duties, and Opco engaged counsel to conduct an investigation. Counsel conducted an audit of Opco’s customs policies and issued a report to U.S. Customs and Border Protection. According to Brick, this exposed him and others to civil and criminal liability.

During the course of the dispute, the Holdco Board ultimately decided to terminate Brick’s employment, with one Board member claiming that Brick had mislead them. Brick refused to sign a separation agreement, and instead resigned all of his positions with Holdco and Opco. He then retained counsel to represent him against claims made by Opco and in proceedings involving U.S. Customs and Board Protection. When Holdco and Opco rejected Brick’s claim to advancement and indemnification, Brick filed suit.

At the outset, the court recognized that “the stated policy of the Delaware LLC Act is ‘to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.’  ‘When interpreting advancement and indemnification provisions in a limited liability company agreement, a Delaware court will follow ordinary contract interpretation principles.’”  Thus, where clear and unambiguous, courts honor the intent of the parties. Nevertheless, “the LLC Act is ‘less paternalistic’ than the corporate code in that it ‘defers completely to the contracting parties to create and limit rights and obligations with respect to indemnification and advancement.’”

Based on Delaware law, the court analyzed the Holdco LLC Agreement. Based on the language of the agreement, “indemnification for officers [was] discretionary and indemnification for Holdco Board members [was] mandatory.”  The Holdco Board had previously decided to deny Brick advancement in his capacity as COO of Opco, that the court determined Brick was not a covered person under the Agreement. Additionally, although Brick was a member of the Holdco Board, the Companies had submitted detailed evidence demonstrating that Brick’s relevant conduct occurred in connection with his role as COO of Opco, not in his capacity as a Board member. Brick failed to dispute these material facts on summary judgment, and the court concluded Brick’s claim for advancement was solely related to his capacity as COO of Opco. Consequently, the court rejected Brick’s claim for advancement as a matter of law.

§1.2.2.2 Westchester Fire Ins. Co. v. Schorsch[4]

In Westchester Fire Ins. Co., the Supreme Court of New York, Appellate Division, answered a question of first impression: whether a D&O liability policy’s bankruptcy exception, which allows claims asserted by the bankruptcy trustee or “comparable authority,” applies to claims raised by a Creditor Trust, as a post-confirmation litigation trust, to restore D&O coverage removed by the policy’s insured vs. insured exclusion. In concluding that the bankruptcy exception does apply, the court interpreted the broad term “comparable authority,” “to encompass a Creditor Trust that functions as a post-confirmation litigation trust, given that such a Creditor Trust is an authority comparable to a ‘bankruptcy trustee’ or other bankruptcy-related or ‘comparable authority’ listed in the bankruptcy exception.”

This case arose out of RCS Capital Corporation’s (“RCAP”) chapter 11 bankruptcy proceedings, which created a Creditor Trust. Pursuant to the bankruptcy court’s order confirming the bankruptcy plan, the Creditor Trust could “enforce, sue on, settle, or compromise … all Claims, rights, Causes of Action, suits, and proceedings … against any Person without the approval of the Bankruptcy Court [and] the Reorganized Debtors.” In March of 2017, the Creditor Trust brought suit against the former directors and officers of RCAP (“defendant insureds”), alleging that they had breached their fiduciary duties to RCAP (the “Creditor Trust Action”), which ultimately caused defendants insureds to seek coverage and indemnification under RCAP’s D&O liability insurance policy. The policy included an insured vs. insured exclusion, which eliminated coverage for “any Claim made against an Insured Person … by, on behalf of, or at the direction of the Company or Insured Person.” The policy also included a bankruptcy exception to the insured vs. insured exclusion, which restored coverage for claims “brough by the Bankruptcy Trustee or Examiner of the Company or any assignee of such Trustee or Examiner, or any Receiver, Conservator, Rehabilitator, or Liquidator or comparable authority of the Company.”

Westchester Fire Insurance Co. (“Westchester”), which provided RCAP with an excess liability D&O policy, initiated the instant case, seeking a declaratory judgment, arguing that because the Creditor Trust Action was brought on behalf of RCAP against its own directors and officers, Westchester had no coverage obligations pursuant to the policy’s insured vs. insured exclusion, or, alternatively, other policy exclusions. Defendant insureds answered and filed three counterclaims (1) for breach of contract with respect to excess insurers’ coverage obligations, (2) alleging bad faith breach, and (3) seeking a declaration of coverage, defense, and attorney’s fees, all of which Westchester moved to dismiss. The trial court denied Westchester’s motion and granted partial summary judgment to defendant insureds on their counterclaim for breach of contract regarding defense, liability coverage, attorney’s fees, and cost of defense.

On appeal, the court held that the language “the Bankruptcy Trustee or … comparable authority” in the bankruptcy exception restored coverage that was otherwise barred by the insured vs. insured exclusion. The court noted that the plain language of the policy did not indicate an intent to bar coverage for D&O claims brought by the Creditor Trust, reasoning that

[t]o begin, the policy included the crucial language brought by or on behalf of in the insured vs. insured exclusion and the bankruptcy exception. Thus, the exclusion and exception both focused on the identity of the party asserting the claim, not on the nature of the claim being brought. Moreover, the policy included the debtor corporation, or DIP, as an insured under the insured vs. insured exclusion, but did not to include the DIP under the bankruptcy trustee and comparable authorities exception. Thus, when read together, the bankruptcy exception restores coverage for bankruptcy-related constituents, such as the bankruptcy trustees and comparable authorities, and the insured vs. insured exclusion precludes the possibility of a lawsuit by a company as DIP, or by individuals acting as proxies for the board or the company.

Moreover, the court explained that concluding that the bankruptcy exception did not apply to the Creditor Trust would ignore the rationale and purpose for post-confirmation litigation trusts, which allow the reorganized debtor’s management to focus on running the business post-bankruptcy and another entity to pursue litigation. Especially in these types of situations, where the litigation often involves claims against directors and officers which management may be reluctant to pursue.

Although the court determined that the insured vs. insured exclusion did not bar coverage in the Creditor Trust Action, it also determined that factual disputes remained regarding the application of Westchester’s other defenses and therefore partial declaratory judgment to defendant insureds’ claims for breach of contract on the coverage obligations and declaration of coverage should not have been granted by the trial court. Moreover, the trial court should not have declared that the excess insurers were obligated to pay for all indemnity costs or award defendants insureds attorney’s fees incurred in defending the instant action. The court, however, did determine that the defendant insureds were entitled to the advancement of defense costs in defending the Creditor Trust Action, noting that

the policies issued by the excess insurers provide a broad right to the provision of defense costs subject to repayment in the event and to the extent that the loss “is not covered under this Policy.” The policies further provide that the carrier will advance defense costs for any claim “before the disposition.” This Court’s finding that the Creditor Trust action “may reveal” that defendants insureds’ claim is not covered necessarily means that there is a possibility of coverage under the policies for the advancement of defense costs for defendants insureds.

Therefore, the court modified the trial court’s order to deny defendant insureds’ motion for partial summary judgment on their first counterclaim, to vacate the declaration that excess insurers are obligated to pay for indemnity costs incurred in the Creditor Trust Action, and to vacate the award of attorney’s fees incurred by defendant insureds in the instant action, but affirmed the trial court’s Order in all other respects.

§1.2.2.3 Dolan as Trustee of Charles B. Dolan Revocable Trust v. DiMare[5]

This case arose out of a dispute concerning the business affairs of multiple closely-held, family-run corporations. Dolan brought derivative claims on behalf of the parent company DiMare, Inc., and two of its subsidiaries DiMare Brothers, Inc. and AD Share Capital, Inc. against Paul DiMare. Paul managed the two subsidiaries and was the president and director of all three corporations. Paul contended that Dolan could not properly assert derivative claims. The trial court, however, determined that Dolan could assert the derivative claims, and in doing so, addressed the requirements for shareholders to bring derivative claims under Delaware law.

First, the court noted that Dolan had standing to bring derivative claims as trustee of a trust that owned shares of DiMare, Inc., a Delaware corporation, and that under Delaware law, “a shareholder of a parent corporation may bring suit derivatively to enforce the claim of a wholly owned corporate subsidiary, where the subsidiary and its controller parent wrongfully refuse to enforce the subsidiary’s claim directly.” Second, the court explained that a corporate shareholder may not bring a derivative action unless he/she made a demand on the corporation to institute such an action or can demonstrate that such a demand would be futile. To demonstrate futility, the allegations must “create a reasonable doubt that … the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” The court found that Dolan had met this requirement by alleging that half of the board of directors consisted of Paul, his two sons, and his brother and that Paul caused the business to pay these directors substantial salaries over a long period of time. Last, the court stated that “[a] shareholder may not commence or maintain a derivative proceeding unless the shareholder … fairly and adequately represents the interests of the corporation in enforcing the right of the corporation.”

In addition to his derivative claims, Dolan sought to bar any use of the assets of DiMare Brothers, Inc. or AD Share Capital, Inc. for the indemnification or advancement of legal expenses incurred by Paul in defending the derivative claims. The court concluded that this claim failed as a matter of law, recognizing that DiMare, Inc.’s bylaws provide for the indemnification and advancement of legal expenses incurred by its directors and officers. Moreover, DiMare Brothers, Inc. is a wholly-owned subsidiary of DiMare, Inc., and in turn, AD Share Capital, Inc., is a wholly-owned subsidiary of DiMare Brothers, Inc. Therefore, the parent corporation, DiMare, Inc., is “entitled to use the resources of its direct and indirect wholly-owned subsidiaries to carry out any lawful purpose of the parent[.]”—i.e., indemnification and advancement.

§1.2.2.4 Ironwood Capital Partners, LLC et al. v. Jones[6]

This case illustrates the impact that an automatic stay in a bankruptcy proceeding can have on a director’s or officer’s indemnification rights. In Ironwood, Timbervest, LLC and its four officers, Jones, Shapiro, Boden, and Zell entered into a settlement agreement with AT&T to resolve various claims of fraud and misuse of assets pursuant to ERISA. Thereafter, Jones sought, inter alia, a declaratory judgment stating that he was entitled to indemnification for the portion of the settlement for which he might be liable. Timbervest, the three other officers, and other related corporations counterclaimed, seeking to have Jones pay his pro rata share of the settlement. The trial court granted Jones’s motion for declaratory judgment regarding indemnification and dismissed most of the counterclaims. While the appeal was pending, Shapiro petitioned for chapter 7 bankruptcy.

Because of Shapiro’s bankruptcy petition, the court found that Jones’s claim for declaratory relief against all defendants seeking indemnification constituted a judicial action against the debtor, which was subject to the automatic stay. The court explained that the “filing of a bankruptcy petition automatically operates as a stay of ‘the commencement or continuation … of a judicial … action or proceeding against the debtor.” Moreover, “[a]ny orders or judgments entered in violation of an automatic bankruptcy stay are void; they are deemed without effect and are rendered an absolute nullity.” The court also found that while automatic stay provisions generally do not extend to third parties, “any action for declaratory relief against Shapiro is inextricably intertwined with action for declaratory relief against the other co-defendants such that we cannot resolve any of the numerations of error regarding the declaratory judgment with the automatic stay in place.” Therefore, the court remanded the case with instructions for the trial court to enter a stay pending the resolution of Shapiro’s bankruptcy proceedings. The court noted, however, that once Shapiro’s bankruptcy proceedings were resolved or the bankruptcy court lifted the automatic stay, the defendants could reinstitute the appeal.

§1.2.2.5 LZ v. Cardiovascular Research[7]

In LZ v. Cardiovascular Research, the California Court of Appeal illustrated the importance of specificity when drafting director and officer indemnification language, in order to prevent the drafting of a clause that provides indemnification well beyond the intended scope. In LZ, employees of Cardiovascular Research Foundation (“CRF”) were staying at a Marriot Hotel while attending a nearby conference. While cleaning the room of a CRF executive, housekeeper L.Z. was sexually assaulted and battered by another CRF employee who happened to walk by the room. L.Z. brought a breach of contract action against CRF, alleging that CRF was liable for the harm caused by its employee pursuant to an indemnification clause contained in a contract between CRF and the Marriot. The indemnification clause at issue stated:

Each party to this Agreement shall, to the extent not covered by the indemnified party’s insurance, indemnify, defend, and hold harmless the other party and its officers, directors, agents, employees, and owners from and against any and all demands, claims, damages to persons or property, losses, and liabilities, including reasonable attorneys’ fees (collectively, ‘Claims’), arising solely out of or solely caused by the indemnifying party’s negligence or willful misconduct in connection with the provisions and use of [the Marriott] as contemplated by [the CRF-Marriot Contract].

CRF moved for summary judgment, arguing that the indemnification clause did not cover an employee’s conduct that fell outside the scope of employment. The trial court granted the motion.

On appeal, the court affirmed the judgment of the trial court, concluding that because CRF and the Marriott intended the word “party” to mean CRF or the Marriott, the express language of the indemnification clause limited coverage to the negligence or willful misconduct attributable to only CRF or the Marriott. Therefore, the court noted that throughout the contract and specifically in the indemnification clause, the use of the word “party” referred only to CRF and the Marriot, not their employees. “In fact, CRF and the Marriott’s use of the phrase ‘party and its officers, directors, agents, employees, and owners’ in one part of the indemnification clause supports a determination that they intended to distinguish between ‘party’ on the one hand and ‘officers, directors, agents, employees, and owners’ on the other.” Therefore, CRF was not liable for its employee’s misconduct, which fell outside the scope of his employment.

§1.2.2.6 Xtreme Limo, LLC v. Antill[8]

The takeaway from the Xxtreme Limo decision is that, at least under Ohio law, a corporation’s By-Laws may provide discretion for the Board to advance litigation expenses to employees who are not directors or officers, but unless that discretion is explicit, an employee has no advancement rights. In Xtreme Limo, Antill was an employee of US Tank Alliance, Inc., managing one of its affiliates, Xtreme Limo, LLC. At some point, Antill left US Tank and began working for an alleged competitor of Xtreme Limo. A month later, US Tank and Xtreme Limo sued Antill for breach of fiduciary duty, breach of contract, unjust enrichment, tortious interference with business relationships, conversion, and misappropriation of trade secrets. Antill moved to require US Tank to advance him litigation expenses, pursuant to his employer’s By-Laws. The trial court denied that motion.

On interlocutory appeal, Antill argued not that he was entitled to the mandatory advancement of litigation expenses as a director or officer of US Tank under Ohio law, but, rather, that he was entitled to advancement contractually, based on US Tank’s By-Laws. The court affirmed the trial court’s decision, concluding that neither the law nor US Tank’s By-Laws required the advancement of litigation expenses to Antill. Section 5.04 of US Tank’s By-Laws stated that US Tank shall make the advancement of litigation expenses “incurred by a director or officer in defending a lawsuit upon receipt of an undertaking by … the director to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the corporation as authorized in Article V.” The court explained that the “[By-Law] entitlement to advance payments therefore is limited to directors or officers, as Section 5.04 further underscores by providing that ‘other employees and agents may be so paid upon such terms and conditions, if any, as the Board of Directors deems appropriate.’” Although Antill’s title was President of Xtreme Limo, the court found that he was not a director or officer of US Tank and, therefore, was not entitled to the advancement of litigation expenses under US Tank’s By-Laws.

Xtreme Limo demonstrates that a corporation’s By-Laws may provide discretion for the Board to advance litigation expenses to employees, even if the employee is not an officer or director. It is important when drafting By-Laws to use specific language outlining the boundaries for the advancement of litigation expenses and indemnification, such that only intended categories of corporate membership are included within that scope.

§1.2.2.7 VBenx Corporation v. Finnegan[9]

In VBenx Corp. v. Finnegan, the Massachusetts Superior Court illustrated that an officer or director who was advanced litigation expenses pursuant to the corporation’s By-Laws may have to repay part of that advancement if he or she is only partially successful in defending the claims asserted against him or her.

VBenx arose after myriad litigation, including two trials and two appeals. As a result of that litigation, the jury returned verdicts in favor of VBenx on its claims against Finnegan for breach of fiduciary duty, aiding and assisting that breach, and malicious prosecution. Finnegan did, however, successfully defend himself against a conspiracy claim and other counterclaims related to him and other defendants. In VBenx, VBenx moved for the repayment of funds, in the amount of $618,044 plus interest, that it had advanced to Finnegan for the defense of certain counterclaims asserted against him, based on his position as a former director and officer of VBenx. VBenx’s motion was opposed by Finnegan, who argued that he was successful in the dismissal of the conspiracy claim and the exclusion of VBenx’s damages expert’s $21 million lost profit analysis.

In reviewing VBenx’s motion, the court noted that under Delaware law:

[F]unds are advanced if a corporate official is called upon to defend himself in a civil or criminal proceeding in which the claims asserted against him are “ ‘by reason of the fact’ that [he] was a corporate officer, without regard to [his] motivation for engaging in that conduct.” Tafeen, 888 A.2d at 214. Whether the officer/director can, however, retain advanced funds, as relevant to this case, depends upon whether he was “successful on the merits or otherwise in defense of any … suit, or in defense of any claim, issue or matter therein.” 8 Del. Corp. § 145(c). In a case in which a defense is partially, but not wholly, successful: “the burden is on the [former officer] to submit a good faith estimate of expenses incurred relating to the indemnifiable claim.” May v. Bigmar, Inc., 838 A.2d 285, 290 (Del. Ch. 2003). It is therefore necessary to separate the “winning issues from the losing ones.” Id. at 291. Whether a corporate officer may have won “a battle” in the course of a litigation, but “lost the war,” i.e., was generally unsuccessful in the litigation, is an important consideration in apportioning fees. Id.

The court in VBenx also noted that the successful defense of any claims that resulted from Finnegan’s conduct occurring after he was no longer an officer or director would be uncovered claims, and would not included in offsetting the advancement that he was ordered to repay. Ultimately, the court held that VBenx was entitled to the repayment of advancement funds in the amount of $583,044.22, plus interest, which was offset by Finnegan’s successful defense of three counterclaims. The court determined that Finnegan, however, was not entitled to an offset for the defense of the conspiracy claim nor the exclusion of the expert witness’s lost-profit analysis, because both of those claims pertained to Finnegan’s conduct that occurred after he was no longer an officer or director for VBenx.

In finding Finnegan liable for the repayment of the advancement amounts, the court in VBenx explained that pursuant to VBenx’s By-Laws, Finnegan executed an “Undertaking of Repay Advanced Funds,” if it was determined that he was not entitled to indemnification. The court further explained:

[I]f the prosecution of the plaintiff in the underlying proceeding established that the indemnitee acted in bad faith, particularly through a showing that the indemnitee knew that his actions were damaging to the company or that his conduct was unlawful, “that would be conclusive evidence that the [indemnitee] is not entitled to indemnification.”

The court found that Finnegan had a non-indemnifiable state of mind based on the jury’s finding that he breached his fiduciary duty to VBenx and that he attempted to gain control of VBenx from its majority shareholders while he was still chairman of the company.

§1.2.2.8 Clarkwestern Dietrich Building Systems, LLC v. Certified Steel Stud Association, Inc.[10]

This Ohio Court of Appeals decision addresses the priority of a company’s duty to indemnify directors and/or officers over that of general creditors, after a lawsuit settlement.

In Clarkwestern Dietrich Building Systems, LLC v. Certified Steel Stud Ass’n, Inc., Clarkwestern Dietrich Building Systems (“ClarkDietrich”) previously brought multiple claims against Certified Steel Stud Association, Inc. (“the Association”). After an eleven-week jury trial, on the eve of closing arguments, ClarkDietrich offered to dismiss with prejudice the claims against the Association, which the Association rejected. The jury returned a verdict in favor of ClarkDietrich, awarding it $43 million. The Association stipulated that it had insufficient tangible assets to satisfy the judgment. Thereafter, the trial court appointed a receiver (the “Receiver”), on ClarkDietrich’s motion, to investigate and pursue any claims against the Association’s officers and directors arising from their decision to reject ClarkDietrich’s dismissal offer. Upon his appointment, the Receiver filed a complaint against the Association’s four directors. At some point during litigation, the Receiver and Director Jung reached a settlement agreement, requiring Jung to pay $550,000 in exchange for the dismissal of the claims against him. The trial court subsequently granted ClarkDietrich’s motion to distribute the settlement funds in order to pay the outstanding $43-million-dollar judgment owed by the Association, which the Association opposed, arguing that its duty to indemnify its directors took priority over repayments to creditors such as ClarkDietrich.

On appeal, the court affirmed the trial court’s decision to release the settlement funds to ClarkDietrich for multiple reasons. First, the court concluded that because the Association failed to seek a stay before the settlement funds were distributed, its appeal was moot. The court explained that

[w]here the trial court rendering judgment has jurisdiction of the subject matter of the action and of the parties, and where fraud has not intervened, and the judgment is voluntarily paid and satisfied, payment puts an end to the controversy and takes away from the defendant the right to appeal or prosecute error or even to move for vacation of judgment.

Moreover, the court concluded that even if the appeal was not moot, the Receiver was not authorized to pay indemnification claims. The court noted that the trial court’s receivership order clearly stated that the Receiver was appointed for the limited purpose of investigating claims against the Association’s directors and officers and to bring, prosecute, and manage those claims. This limited authority never authorized the Receiver to pay indemnification claims to directors. The court explained that “[a]ny decision otherwise would have been contrary to the trial court’s intended purpose in creating the receivership and inconsistent with the plain language of the receivership order.” Finally, the court found that the remaining directors’ claims were pending before the Ohio Supreme Court, making any right to indemnification merely speculative. The court reasoned that even if the remaining directors were successful in their indemnification claims against the Association, the Association was still operating and could indemnify the directors with alternate funds.

As shown by this case, courts strictly interpret receivership orders. In situations such as this, directors and officers must address ambiguities in receivership orders early, especially where indemnity claims have been made or are anticipated.

§1.2.2.9 Revolutionar, Inc. v. Gravity Jack, Inc.[11]

The court in Revolutionar, Inc. v. Gravity Jack, Inc., essentially ruled that indemnity may apply to a claim brought by a company against its own directors and officers—i.e., indemnity rights are not limited to third-party claims, unless the language of the indemnification clause is clear and unambiguous.

The Revolutionar case arose out of a business dispute between RevolutionAR and its CEO, Joshua Roe, and Gravity Jack and its President, Luke Richey. RevolutionAR was formed to develop and market “custom interacting learning, process, training, and maintenance applications using augmented reality technology.” Roe was named the CEO and Richey a member of the board of directors. RevolutionAR executed three contracts with Gravity Jack which covered “Gravity Jack’s development of software for RevolutionAR’s interactive augmented reality applications for learning and training.” Years later, RevolutionAR and Roe sued Gravity Jack and Richey, alleging that “Gravity Jack used the content the company developed for RevolutionAR’s prototype application when Gravity Jack marketed and sold augmented reality software content to its other clients.” RevolutionAR and Roe also alleged that Gravity Jack stole business from RevolutionAR. Moreover, RevolutionAR and Roe alleged that Richey, through Gravity Jack, “breach representations, utter false and misleading statements about RevolutionAR, dissuaded investors from backing RevolutionAR, and discouraged customers from conducting business with RevolutionAR.”

Gravity Jack and Richey moved for summary judgment, contending that the contract language released them from any liability, and neither RevolutionAR nor Roe had a legally protected interest in the augmented-reality prototype prepared by Gravity Jack. The trial court granted summary judgment, dismissed all claims, and awarded Gravity Jack and Richey reasonable attorney’s fees and costs.

On appeal, in relevant part, Richey contended that the indemnification clause in RevolutionAR’s articles of incorporation, benefiting RevolutionAR’s board of directors, shielded Richey from liability, because he was a director. RevolutionAR argued that the indemnification clause applied only to third-party claims brought against members of its board of directors. The court in Revolutionar concluded that RCW 23B.08.510 permitted corporations to indemnify the members of its board of directors in limited circumstances, and RevolutionAR’s articles of incorporation indemnified its directors “from ‘all liability, damage, or expense resulting from the fact that such person … was a director, to the maximum extent and under all circumstances permitted by law,’ except when grossly negligent.” Explaining that the indemnification clause did not solely apply to third-party claims against directors, the court in RevolutionAR reasoned that

[t]he broad language of the indemnification provision does not limit its import to third party claims, but instead extends to the maximum protection allowed by law. Indemnification may be sought in many types of proceedings, whether third-party actions or actions by or in the right of the corporation. 18B AM. JUR. 2D Corporations § 1628 (2020). Accordingly, a corporation may be required to indemnify an officer for expenses incurred in successfully defending against an action by the company. Truck Components Inc. v. Beatrice Co., 143 F.3d 1057, 1061 (7th Cir. 1998).

The court, however, agreed with RevolutionAR that indemnification did not extend to claims brought by the corporation against Richey for breaches of his duties to the corporation, because as a director and advisor of RevolutionAR, Richey had a duty of good faith and to act in the best interest of the company.

The RevolutionAR decision illustrates the importance of crafting an indemnification clause to specifically limit indemnification of third-party claims against members of the corporation’s board of directors,if that is the intended purpose. If the indemnification clause lacks specificity, courts may interpret the broad language to require corporations to indemnify members of its board of directors against claims brought by third-parties and even the corporation itself.

[1] The views reflected herein are those of the author(s) and may not reflect those of any law firm or its clients.

[2] The DGCL is found in Title 8 of the Delaware Code.

[3] C.A. No. 2020-0254, 2020 Del. Ch. LEXIS 266 (Del. Ch. Aug. 18, 2020).

[4] 186 A.D.3d 132 (N.Y. App. Div. 2020).

[5] No. 1984CV03525BLS2, 2020 WL 4347607 (Mass. Super. June 15, 2020).

[6] 844 S.E.2d 245 (Ga. Ct. App. 2020).

[7] No. A155721, 2020 WL 2520114 (Cal. Ct. App. May 18, 2020) (unpublished).

[8] 2020 WL 5250390 (Ohio Ct. App. Apr. 9, 2020).

[9] 2020 WL 2521297 (Mass. Super. Apr. 9, 2020).

[10] 2020 WL 1847478 (Ohio Ct. App. Apr. 13, 2020).

[11] 13 Wash.App.2d 1044 (Wash. Ct. App. 2020) (unpublished).

Editors

Chelsea Mikula

Tucker Ellis LLP
950 Main Avenue, Suite 1100
Cleveland, OH 44113
216-696-2476
[email protected]

Giovanna Ferrari

Seyfarth Shaw LLP
560 Mission Street, Suite 3100
San Francisco, CA 94105
415-544-1019
[email protected]

§1.1 Introduction

Trial lawyers eagerly anticipate the day they begin opening statements in the courtroom and get to take their client’s matter to trial. With a trial comes a lot of hard work, preparation, and navigation of the civil rules and local rules of the jurisdiction. This chapter provides a general overview of issues that a lawyer will face in a courtroom, either civil or criminal. The authors have selected cases of note from the present United States Supreme Court docket, the federal Circuit Courts of Appeals, and selected federal District Courts, that provide a general overview, raise unique issues, expand or provide particularly instructive explanations or rationales, or are likely to be of interest to a broad cross section of the bar. It is imperative, however, that prior to starting trial, the rules of the applicable jurisdiction are reviewed.

§1.2 Pretrial Matters

§ 1.2.1 Pretrial Conference and Pretrial Order

Virtually all courts require a pretrial conference at least several weeks before the start of trial. A pretrial conference requires careful preparation because it sets the tone for the trial itself. There are no uniform rules across all courts, so practitioners must be fully familiar with those that affect the particular courtroom they are in and the specific judge before whom they will appear.

According to Federal Rule of Civil Procedure 16, the main purpose of a pretrial conference is for the court to establish control over the proceedings such that neither party can achieve significant delay or engage in wasteful pretrial activities.[1] An additional goal is facilitating settlement before trial commencement.[2] Following the pretrial conference, the judge will issue a scheduling order, which “must limit the time to join other parties, amend the pleadings, complete discovery, and file [pre-trial] motions.”[3]

A proposed pretrial conference order should be submitted to the court for review at the conference. Once the judge accepts the pre-trial conference order, the order will supersede all pleadings in the case.[4] The final pretrial conference order is separate from pretrial disclosures, which include all information and documents required to be disclosed under Federal Rule of Civil Procedure 26.[5]

§ 1.2.2 Motions in Limine

A motion in limine, which means “at the threshold,”[6] is a pre-trial motion for a preliminary decision on an objection or offer of proof. Motions in limine are important because they ensure that the jury is not exposed to unfairly prejudicial, confusing, or irrelevant evidence, even if doing so limits a party’s defenses.[7] Thus, a motion in limine is designed to narrow the evidentiary issues for trial and to eliminate unnecessary trial interruptions by excluding the document before it is entered into evidence.[8]

In ruling on a motion in limine, the trial judge has discretion to either rule on the motion definitively or postpone a ruling until trial.[9] Alternatively, the trial judge may make a tentative or qualified ruling.[10] While definitive rulings do not require a renewed offer of proof at trial,[11] a tentative or qualified ruling might well require an offer of evidence at trial to preserve the issue on appeal.[12] A trial court’s discretion in ruling on a motion in limine extends not only to the substantive evidentiary ruling, but also the threshold question of whether a motion in limine presents an evidentiary issue that is appropriate for ruling in advance of trial.[13]

Motions in limine are not favored and many courts consider it a better practice to deal with questions as to the admissibility of evidence as they arise at trial.[14]

§1.3 Opening Statements

One of the most important components of any trial is the opening statement—it can set the roadmap for the jury of how they can find in favor of your client. The purpose of an opening statement is to:

“acquaint the jury with the nature of the case they have been selected to consider, advise them briefly regarding the testimony which it is expected will be introduced to establish the issues involved, and generally give them an understanding of the case from the viewpoint of counsel making a statement, so that they will be better able to comprehend the case as the trial proceeds.”[15]

It is important that any opening statement has a theme or presents the central theory of your case. As a general rule, a lawyer presents facts and evidence, and not argument, during opening statements. Being argumentative and introducing statements that are not evidence can be grounds for a mistrial.[16] It is also important that counsel keep in mind any rulings on motions in limine prohibiting the use of certain evidence. Failure to raise an objection to matters subject to a motion in limine or other prejudicial arguments can result in the waiver of those rights on appeal.[17] And the “golden rule” for opening statements is that the jurors should not be asked to place themselves in the position of the party to the case.[18]

§1.4 Selection of Jury

§1.4.1 Right to Fair and Impartial Jury

The right to a fair and impartial jury is an important part of the American legal system. The right originates in the Sixth Amendment, which grants all criminal defendants the right to an impartial jury.[19] However, today, this foundational right applies in both criminal and civil cases.[20] This is because the Seventh Amendment preserves “the right of trial by jury” in civil cases, and an inherent part of the right to trial by jury is that the jury must be impartial.[21] Additionally, Congress cemented this right when it passed legislation requiring “that federal juries in both civil and criminal cases be ‘selected at random from a fair cross section of the community in the district or division where the court convenes.’”[22]

Examples of ways that jurors may not be impartial include: predispositions about the proper outcome of a case,[23] financial interests in the outcome of a case,[24] general biases against the race or gender of a party,[25] or general biases for or against certain punishments to be imposed.[26]

Over the years, impartiality has become more and more difficult to achieve. This is due mainly to citizens’ (potential jurors) readily available access to news, and the news media’s increased publicity of defendants and trials.[27] In Harris, the Ninth Circuit analyzed whether pre‑trial publicity of a murder trial biased prospective jurors and prejudiced the defendant’s ability to receive a fair trial.[28] The court recognized that “[p]rejudice is presumed when the record demonstrates that the community where the trial was held was saturated with prejudicial and inflammatory media publicity about the crime.”[29] However, the court found that despite immense publicity prior to trial, because the publicity was not inflammatory but rather factual, there was no evidence of prejudice in the case.[30]

§1.4.2 Right to Trial by Jury

All criminal defendants are entitled to a trial by jury and must waive this right if they elect a bench trial instead.[31] However, a criminal defendant does not have a constitutional right to a bench trial if he or she decides to waive the right to trial by jury.[32] In civil cases, the party must expressly demand a jury trial. Failure to make such a demand constitutes a waiver by that party of a trial by jury.[33] For example, in Hopkins, the Eleventh Circuit explained that a plaintiff waived his right to trial by jury in an employment discrimination case when he made no demand for a jury trial in his Complaint and did not file a separate demand for jury trial within 14 days after filing his complaint.[34]

Additionally, not all civil cases are entitled to a trial by jury. First, the Seventh Amendment expressly requires that the amount in controversy exceed $20.[35] Additionally, only those civil cases involving legal, rather than equitable, issues are entitled to the right of trial by jury.[36] Equitable issues often arise in employment discrimination cases where the plaintiff seeks backpay or another sort of compensation under the ADA, ERISA, or FMLA.[37]

Another issue that arises in civil cases is contractual jury trial waivers. Most circuits permit parties to waive the right to a jury trial through prior contractual agreement.[38] Generally, the party seeking enforcement of the waiver “must show that consent to the waiver was both voluntary and informed.”[39]

§1.4.3 Voir Dire

Voir dire is a process of questioning prospective jurors by the judge and/or attorneys who remove jurors who are biased, prejudiced, or otherwise unfit to serve on the jury.[40] The Supreme Court has explained that “voir dire examination serves the dual purposes of enabling the court to select an impartial jury and assisting counsel in exercising peremptory challenges.”[41]

Generally, an oath should be administered to prospective jurors before they are asked questions during voir dire.[42] “While the administration of an oath is not necessary, it is a formality that tends to impress upon the jurors the gravity with which the court views its admonition and is also reassuring to the litigants.”[43] Moreover, jurors under oath are presumed to have faithfully performed their official duties.[44]

Federal trial judges have great discretion in deciding what questions are asked to prospective jurors during voir dire.[45] District judges may permit the parties’ lawyers to conduct voir dire, or the court may conduct the jurors’ examination itself.[46] Although trial attorneys often prefer to conduct voir dire themselves, many judges believe that counsel’s involvement “results in undue expenditure of time in the jury selection process,” and that “the district court is the most efficient and effective way to assure an impartial jury and evenhanded administration of justice.”[47]

“[I]f the court conducts the examination it must either permit the parties or their attorneys to supplement the examination by such further inquiry as the court deems proper or itself submit to the prospective jurors such additional questions of the parties or their attorneys as the court deems proper.”[48] However, a judge still has much leeway in determining what questions an attorney may ask.[49] For example, in Lawes, a firearm possession case, the Second Circuit found that it was proper for a trial judge to refuse to ask jurors questions about their attitudes towards police.[50] If, on appeal, a party challenges a judge’s ruling from voir dire, the party must demonstrate that trial judge’s decision constituted an abuse of discretion.[51] Thus, it is extremely difficult to win an appeal regarding voir dire questioning.[52]

§1.4.4 Ground for Challenge

A challenge “for cause” is a request to dismiss a prospective juror because the juror is unqualified to serve, or because of demonstrated bias, an inability to follow the law, or if the juror is unable to perform the duties of a juror. 18 U.S.C. § 1865 sets forth juror qualifications and lists five reasons a judge may strike a juror: (1) if the juror is not a citizen of the United States at least 18 years old, who has resided within the judicial district at least one year; (2) is unable to read, write, or understand English enough to fill out the juror qualification form; (3) is unable to speak English; (4) is incapable, by reason of mental or physical infirmity, to render jury service; or (5) has a criminal charge pending against him, or has been convicted of a state or federal crime punishable by imprisonment for more than one year.[53]

In addition to striking a juror for these reasons, an attorney may also request to strike a juror “for cause” under 28 U.S.C. § 1866(c)(2) “on the ground that such person may be unable to render impartial jury service or that his service as a juror would be likely to disrupt the proceedings.”[54]

A challenge “for cause” is proper where the court finds the juror has a bias that is so strong as to interfere with his or her ability to properly consider evidence or follow the law.[55] Bias can be shown either by the juror’s own admission of bias or by proof of specific facts that show the juror has such a close connection to the parties, or the facts at trial, that bias can be presumed. The following cases illustrate examples of challenges for cause:

• S. v. Price: The Fifth Circuit explained that prior jury service during the same term of court is not by itself sufficient to support a challenge for cause. A juror may only be dismissed for cause because of prior service if it can be shown by specific evidence that the juror has been biased by the prior service.[56]
• Chestnut v. Ford Motor Co.: The Fourth Circuit held that the failure to sustain a challenge to a juror owning 100 shares of stock in defendant Ford Motor Company (worth about $5000) was reversible error.[57]
• United States v. Chapdelaine: The First Circuit found that it was permissible for trial court not to exclude for cause jurors who had read a newspaper that indicated co‑defendants had pled guilty before trial.[58]
• Leibstein v. LaFarge N. Am., Inc.: Prospective juror’s alleged failure to disclose during voir dire that he had once been defendant in civil case did not constitute misconduct sufficient to warrant new trial in products liability action.[59]
• Cravens v. Smith: The Eighth Circuit found that the district court did not abuse its discretion in striking a juror for cause based on that juror’s “strong responses regarding his disfavor of insurance companies.”[60]

§1.4.5 Peremptory Challenge

In addition to challenges for cause, each party also has a right to peremptory challenges.[61] A peremptory challenge permits parties to strike a prospective juror without stating a reason or cause.[62] “In civil cases, each party shall be entitled to three peremptory challenges. Several defendants or several plaintiffs may be considered as a single party for the purposes of making challenges, or the court may allow additional peremptory challenges and permit them to be exercised separately or jointly.”[63]

Parties can move for additional peremptory challenges.[64] This is common in cases where there are multiple defendants. For example, in Stephens, two civil codefendants moved for additional peremptory challenges so that each defendant could have three challenges (totaling six peremptory challenges for the defense).[65] In deciding whether to grant the defendants’ motion, the court recognized that trial judges have great discretion in awarding additional peremptory challenges, and that additional challenges may be especially warranted when co-defendants have asserted claims against each other.[66] The court in Stephens ultimately granted the defendants’ motion for additional challenges.[67]

Parties may not use peremptory challenges to exclude jurors on the basis of their race, gender, or national origin.[68] Although “[a]n individual does not have a right to sit on any particular petit jury, . . . he or she does possess the right not to be excluded from one on account of race.”[69] When one party asserts that another’s peremptory challenges seek to exclude jurors on inappropriate grounds under Batson, the party challenged must demonstrate a legitimate explanation for its strikes, after which the challenging party has the burden to show that the legitimate explanation was pre-textual.[70] The ultimate determination of the propriety of a challenge is within the discretion of the trial court, and appellate courts review Batson challenges under harmless error analysis.[71]

Finally, some courts have found that it is reversible error for a trial judge to require an attorney to use peremptory challenges when the juror should have been excused for cause. “The district court is compelled to excuse a potential juror when bias is discovered during voir dire, as the failure to do so may require the litigant to exhaust peremptory challenges on persons who should have been excused for cause. This result, of course, extinguishes the very purpose behind the right to exercise peremptory challenges.”[72] However, courts also acknowledge that an appeal is not the best way to deal with biased jurors. The Eighth Circuit recognized that “challenges for cause and rulings upon them . . . are fast paced, made on the spot and under pressure. Counsel as well as court, in that setting, must be prepared to decide, often between shades of gray, by the minute.”[73]

§1.5 Examination of Witnesses

§1.5.1 Direct Examination

Direct examination is the first questioning of a witness in a case by the party on whose behalf the witness has been called to testify.[74] Pursuant to Fed. R. Evid. 611(c), leading questions, i.e., those suggesting the answer, are not permitted on direct examination unless necessary to develop the witness’ testimony.[75] Leading questions are permitted as “necessary to develop testimony” in the following circumstances:

• To establish undisputed preliminary or inconsequential matters.[76]
• If the witness is hostile or unwilling.[77]
• If the witness is a child, or an adult with communication problems due to a mental or physical disability.[78]
• If the witness’s recollection is exhausted.[79]
• If the witness is being impeached by the party calling him or her.[80]
• If the witness is frightened, nervous, or upset while testifying.[81]
• If the witness is unresponsive or shows a lack of understanding.[82]

Additionally, it is improper for a lawyer to bolster the credibility of a witness during direct examination by evidence of specific instances of conduct or otherwise.[83] Bolstering occurs either when (1) a lawyer suggests that the witness’s testimony is corroborated by evidence known to the lawyer, but not the jury,[84] or (2) when a lawyer asks a witness a question about specific instances of truthfulness or honesty to establish credibility.[85] For instance, in Raysor, the Second Circuit found that it was improper for a witness to bolster herself on direct examination by testifying about her religion or faithful marriage.[86]

When a party calls an adverse party, or someone associated with an adverse party, the attorney has more leeway during direct examination. This is because adverse parties may be predisposed against the party direct-examining him. Because of this, the attorney may ask leading questions, and impeach or contradict the adverse witness.[87] Courts have broadened who they consider to be “associated with” or “identified with” an adverse party. Employees, significant others, and informants have all constituted adverse parties for purposes of direct examination.[88] Further, even if the witness is not adverse, an attorney may also ask leading questions to a witness who is hostile. In order to ask such leading questions, the direct examiner must demonstrate that the witness will be resistant to suggestion. This often involves first asking the witness non-leading questions in order to show that the witness is biased against the direct examiner.[89]

When a witness cannot recall a fact or event, the lawyer is permitted to help refresh that witness’s memory.[90] The lawyer may do so by providing the witness with an item to help the witness recall the fact or event. Proper foundation before such refreshment requires that:

the witness’s recollection to be exhausted, and that the time, place and person to whom the statement was given be identified. When the court is satisfied that the memorandum on its face reflects the witness’s statement or one the witness acknowledges, and in his discretion the court is further satisfied that it may be of help in refreshing the person’s memory, the witness should be allowed to refer to the document.[91]

However, the item/memorandum does not come into evidence.[92] In Rush, the Sixth Circuit found that although the trial judge properly permitted defense counsel to refresh a witness’s memory with the transcript of a previously recorded statement, the trial judge erred in allowing another witness to read that transcript aloud to the jury.[93]

Further, sometimes the party calling a witness wishes to impeach that witness. Generally, courts are hesitant to permit parties to impeach their own witnesses because the party who calls a witness is vouching for the trustworthiness of that witness, and allowing impeachment may confuse the jury or be unfairly prejudicial.[94] Prior to adoption of the Federal Rules of Evidence, a party could impeach its own witness only when the witness’s testimony both surprised and affirmatively damaged the calling party.[95]

However, Federal Rule of Evidence 607 states that “the credibility of a witness may be attacked by any party, including the party calling the witness.”[96] The Advisory Committee Notes of Rule 607 indicate that this rule repudiates the surprise and injury requirement from common law.[97] A party can impeach a witness through prior inconsistent statements, cross-examination, or prior evidence from other sources.[98] However, a party may not use Rule 607 to introduce otherwise inadmissible evidence to the jury.[99] Additionally, a party may not call a witness with the sole purpose of impeaching him.[100] Further, even courts that don’t permit a party to impeach its own witness still permit parties to contradict their own witnesses through another part of that witness’s testimony.[101]

§1.5.2 Cross-Examination

Cross-examination provides the opposing party an opportunity to challenge what a witness said on direct examination, discredit the witness’s truthfulness, and bring out any other testimony that may be favorable to the opposing party’s case.[102] Generally under the federal rules, cross-examination is limited to the “subject matter” of the direct examination and any matters affecting the credibility of the witness.[103] The purpose of limiting the scope of cross-examination is to promote regularity and logic in jury trials, and ensure that each party has the opportunity to present its case in chief. However, courts tend to liberally construe what falls within the “subject matter” of direct examination.[104] For example, in Perez-Solis, the Fifth Circuit found that a witness’s brief reference to collecting money from a friend permitted opposing counsel to cross-examine him on all of his finances.[105] Additionally, the language of Fed. R. Evid. 611(b) states that although cross-examination “should not” go beyond the scope of direct examination, the court may exercise its discretion to “allow inquiry into additional matters as if on direct examination.”[106] However, if the questioning goes beyond the subject matter, it generally should not include leading questions.

One of the main goals of cross-examination is impeachment. The Federal Rules of Evidence explain three different methods of impeachment: (1) impeachment by prior bad acts or character for untruthfulness,[107] (2) impeachment by prior conviction of a qualifying crime,[108] and (3) impeachment by prior inconsistent statement.[109] Additionally, courts still apply common law principles and permit impeachment through three additional methods as well: (1) impeachment by demonstrating the witness’s bias, prejudice, or interest in the litigation or in testifying, (2) impeachment by demonstrating the witness’s incapacity to accurately perceive the facts, and (3) impeachment by showing contradictory evidence to the witness’s testimony in court.[110] The following present case examples of each of the six methods of impeachment:

• Prior bad Act or Dishonesty: In O’Connor v. Venore Transp. Co.,[111] the First Circuit found that trial judge did not abuse discretion when he allowed defense counsel to cross-examine plaintiff with his prior tax returns with the purpose of demonstrating dishonesty.
• Conviction of qualifying crime: In Smith v. Tidewater Marine Towing, Inc.,[112] the Fifth Circuit found that, in Jones Act action arising from injuries plaintiff received while working on a tugboat, defense counsel permissibly crossed the plaintiff about his prior convictions.
• Prior inconsistent statement: In Wilson v. Bradlees of New England, Inc.,[113] a product liability case, the First Circuit found that defense counsel appropriately crossed plaintiff with an inconsistent statement made in a complaint filed in a different case against a different defendant.
• Bias or prejudice: In Udemba v. Nicoli,[114] the First Circuit found that it was permissible for defense counsel to cross-examine the plaintiff’s wife about domestic abuse to show bias in a case involving excessive force claims against the police.
• Incapacity to accurately perceive: In Hargrave v. McKee,[115] the Sixth Circuit found that the trial court should have permitted defense counsel to question a victim about how her ongoing psychiatric problems affected her perception and memory of events.
• Contradictory evidence: In Barrera v. E. R. DuPont De Nemours and Co., Inc.,[116] the Fifth Circuit held, in a personal-injury action, that the trial judge erred in denying the use of evidence showing that plaintiff received over $1000 per month in social security benefits because the evidence was admissible to contradict defendant’s volunteered testimony on cross-examination that he did not have a “penny in his pocket.”

Once the right of cross-examination has been fully and fairly exercised, it is within the trial court’s discretion as to whether further cross-examination should be allowed.[117] In order to recall a witness, the party must show that the new cross-examination will shed additional light on the issues being tried or impeach the witness. Further, it is helpful if the party seeking recall demonstrates that it came into possession of additional evidence or information that it did not have when it previously crossed that witness.[118] Further, it is difficult to succeed on an appeal of a trial court’s failure to permit recall for further cross‑examination. This is because courts review a trial judge’s decision for abuse of discretion, and often find that the lack of recall was a harmless error.[119]

§1.5.3 Expert Witnesses

Experts are witnesses who offer opinion testimony on an aspect of the case that requires specialized knowledge or experience. Experts also include persons who do not testify, but who advise attorneys on a technical or specialized area to better help them prepare their cases. A few key criteria should be considered at the outset when choosing an expert. First is the level of relevant expertise and the ability to have the expert’s research, assumptions, methodologies, and practices stand up to the scrutiny of cross-examination. Many law firms, nonprofits, commercial services, and government agencies maintain lists of experts categorized by the expertise; those lists are a helpful place to begin. Alternatively, counsel may begin by researching persons who have spoken or written about the subject matter that requires expert testimony. An Internet search is, in many cases, the place to start when developing a list. Counsel also might consider using a legal search engine to identify persons who have provided expert testimony on the subject matter in the past. Westlaw and LexisNexis both maintain expert databases.

Any expert who is on counsel’s list of candidates should produce, in addition to his or her curriculum vitae (CV), a list of prior court and deposition appearances, as well as a list of publications over the last 10 years. In federal court, this information must be disclosed in the expert report, per Federal Rule of Civil Procedure 26(a)(2).[120]

Another consideration when retaining an expert is whether he or she will be a testifying expert, or whether the expert will only act in a consulting role in preparing the case for trial (non-testifying expert) because this will determine the discoverability of the expert’s opinions. Testifying experts’ opinion are always discoverable, while consulting experts’ opinions are nearly always protected from discovery.

A testifying expert must be qualified, and the proponent of an expert witness bears the burden of establishing the admissibility of the expert’s testimony by a preponderance of the evidence. Federal Rule of Evidence 702 sets forth a standard for admissibility, wherein a witness may be qualified as an expert by knowledge, skill, experience, training or education and may testify in the form of an opinion if they meet certain criteria. It is for the trial court judge to determine whether or not “an expert’s testimony both rests on a reliable foundation and is relevant to the task at hand,” thereby making it admissible.[121]

§1.6 Evidence at Trial

§1.6.1 Authentication of Evidence

With the exception of exhibits as to which authenticity is acknowledged by stipulation, admission, judicial notice, or exhibits which are self-authenticating, no exhibit will be received in evidence unless it is first authenticated or identified as being what it purports to be. Under the Federal Rules of Evidence, the authentication requirement is satisfied when “the proponent . . . produce[s] evidence sufficient to support a finding that the item is what the proponent claims it is.”[122]

When an item is offered into evidence, the court may permit counsel to conduct a limited cross-examination on the foundation offered. In reaching its determination, the court must view all the evidence introduced as to authentication or identification, including issues of credibility, most favorably to the proponent.[123] Of course, the party who opposed introduction of the evidence may still offer contradictory evidence before the trier of fact or challenge the credibility of the supporting proof in the same way that he can dispute any other testimony.[124] However, upon consideration of the evidence as a whole, if a sufficient foundation has been laid in support of introduction, contradictory evidence goes to the weight to be assigned by the trier of fact and not to admissibility.[125] It is important to note that many courts have held that the mere production of a document in discovery waives any argument as to its authenticity.[126]

While there are many topics to discuss regarding authentication of evidence, this section will focus on electronically stored information. Proper authentication of e-mails and other instant communications, as well as all computerized records, is of critical importance in an ever-increasing number of cases, not only because of the centrality of such data and communications to modern business and society in general, but also due to the ease in which such electronic materials can be created, altered, and manipulated. In the ordinary course of events, a witness who has seen the e-mail in question need only testify that the printout offered as an exhibit is an accurate reproduction.

• Web print out – Printouts of Internet website pages must first be authenticated as accurately reflecting the content of the page and the image of the page on the computer at which the printout was made before they can be introduced into evidence; then, to be relevant and material to the case at hand, the printouts often will need to be further authenticated as having been posted by a particular source.[127]
• Text message – When there has been an objection to admissibility of a text message, the proponent of the evidence must explain the purpose for which the text message is being offered and provide sufficient direct or circumstantial corroborating evidence of authorship in order to authenticate the text message as a condition precedent to its admission; thus, authenticating a text message or e-mail may be done in much the same way as authenticating a telephone call.[128]
• Social networking services – Proper inquiry for determining whether a proponent has properly authenticated evidence derived from social networking services was whether the proponent adduced sufficient evidence to support a finding by a reasonable jury that the proffered evidence was what the proponent claimed it to be.[129]

§1.6.2 Objecting to Evidence

Objections must be specific. The party objecting to evidence must make known to the court and the parties the precise ground on which the objecting party is basing the objection.[130] The objecting party must also be sure to indicate the particular portion of the evidence that is objectionable.[131] However, a general objection may be permitted if the evidence is clearly inadmissible for any purpose or if the only possible grounds for objection is obvious.[132]

The purpose of a specific objection to evidence is to preserve the issue on appeal. On appeal, the objecting party will be limited to the specific objections to evidence made at trial. However, an objection raised by a party in writing is sufficiently preserved for appeal, even if that same party subsequently failed to make an oral, on-the-record objection.[133]

Objections to evidence must be timely so as to not allow a party to wait and see whether an answer is favorable before raising an objection.[134] Failure to timely object results in the evidence being admitted. Once the evidence is admitted and becomes part of the trial record, it may be considered by the jury in deliberations, the trial court in ruling on motions, and a reviewing court determining the sufficiency of the evidence.[135] In some instances, the trial judge may prohibit counsel from giving descriptions of the basis for his or her objections. However, the attorney must still attempt to get in the specific grounds for the objection on the record.[136]

§1.6.3 Offer of Proof

If evidence is excluded by the trial court, the party offering the evidence must make an offer of proof to preserve the issue on appeal.[137] For an offer of proof to be adequate to preserve an issue on appeal, counsel must state both the theory of admissibility and the content of the excluded evidence.[138] Although best practice is to make an offer of proof at the time an objection is made, an offer of proof made later in time, even if it is made at a subsequent conference or hearing, may be acceptable.[139] An offer of proof can take several different forms:

• A testimonial offer of evidence, whereby counsel summarizes what the proposed evidence is supposed to be. Attorneys using this method should be cautious, however, as the testimony may be considered inadequate.[140]
• An examination of a witness, whereby a witness is examined and cross-examined outside of the presence of a jury.[141]
• A written statement by the examining counsel, which describes the answers that the proposed witness would give if allowed to testify.[142]
• An affidavit, taken under oath, which summarizes a witness’s expected testimony and is signed by the witness.[143] However, this use of documentary evidence should be marked as an exhibit and introduced into the record for identification on appeal.[144]

There are exceptions to the offer of proof requirement. First, an offer of proof is unnecessary when the content of the evidence is “apparent from the context.”[145] Second, a cross-examiner who is conducting a proper cross-examination will be given more leeway by a court, since oftentimes the cross-examiner does not know what a witness will say if permitted to answer a question.[146]

§1.7 Closing Argument

Different than an opening statement, closing argument is the time for advocacy and argument on behalf of your client. It is not an unfettered right, however, and there are certain rules to remember about closing argument. First, present only that which was presented in evidence and do not deviate from the record.[147] You also do not want to comment on a witness that was unable to testify or suggest that a defendant’s failure to testify results in a guilty verdict.[148] Further, an attack on the credibility or honesty of opposing counsel is considered unethical.[149] But that does not mean lawyers cannot comment on the credibility of evidence and suggest reasonable inferences based on the evidence.[150] And keep in mind, generally, courts are “reluctant to set aside a jury verdict because of an argument made by counsel during closing arguments.”[151]

§1.8 Judgment as a Matter of Law

Federal Rule of Civil Procedure 50 governs the standard for judgment as a matter oflLaw, sometimes referred to as a directed verdict in state court matters.[152] A motion for  judgment as a matter of law “may be made at any time before the case is submitted to the jury” and the motion “must specify the judgment sought and the law and facts that entitle the movant to the judgment.”[153] But, “[a] motion under this Rule need not be stated with ‘technical precision,’” so long as “it clearly requested relief on the basis of insufficient evidence.”[154] Although it may be “better practice,” there is no requirement that the motion be made in writing.[155] The 6th Circuit Court of Appeals has even held that it is “clearly within the court’s power” to raise the motion “sua sponte.”[156]

Importantly, Rule 50 uses permissive, not mandatory, language, which means “while a district court is permitted to enter judgment as a matter of law when it concludes that the evidence is legally insufficient, it is not required to do so.” The Supreme Court has gone as far as to say “the district courts are, if anything, encouraged to submit the case to the jury, rather than granting such motions.”[157] There is a practical reason for this advice: if the motion is granted, then overturned on appeal, a whole new trial must be conveyed. Conversely, if the case is allowed to go to the jury, a post-verdict motion or appellate court can right any wrong with more ease.

In entertaining a motion for judgment as a matter of law, courts should review all of the evidence in the record, but, in doing so, the court must draw all reasonable inferences in favor of the nonmoving party, and it may not make credibility determinations or weigh the evidence.[158] Credibility determinations, the weighing of the evidence, and the drawing of legitimate inferences from the facts are jury functions, not those of a judge.[159] The question is not whether there is literally no evidence supporting the party against whom the motion is directed but whether there is evidence upon which the jury might reasonably find a verdict for that party. Since granting a judgment as a matter of law deprives the party opposing the motion of a determination of the facts by a jury, it is understandable that it is to be granted cautiously and sparingly by the trial judge.

§1.9 Jury Instructions

§1.9.1 General

The purpose of jury instructions is to advise the jury on the proper legal standards to be applied in determining issues of fact as to the case before them.[160] The court may instruct the jury at any time before the jury is discharged.[161] But the court must first inform the parties of its proposed instructions and give the parties an opportunity to respond.[162] Although each party is entitled to have the jury charged with his theory of the case, the proposed instructions must be supported by the law and the evidence.[163]

§1.9.2 Objections

Federal Rule of Civil Procedure 51 provides counsel the ability to correct errors in jury instructions.[164] The philosophy underlying the provisions of Rule 51 is to prevent unnecessary appeals of matters concerning jury instructions which should have been resolved at the trial level. An objection must be made on the record and state distinctly the matter objected to and the grounds for the objection.[165] Off-the-record objections to jury instructions, regardless of how specific, cannot satisfy requirements of the rule governing preservation of such errors.[166] A party may object to instructions outside of the presence of the jury before the instructions and arguments are delivered or promptly after learning that the instructions or request will be, or has been, given or refused. [167] Even if the initial request for an instruction is made in detail, the requesting party must object again after the instructions are given but before the jury retires for deliberations, in order to preserve the claimed error.[168]

Whether a jury instruction is improper is a question of law reviewed de novo.[169] Instructions are improper if, when viewed as a whole, they are confusing, misleading, and prejudicial.[170] If an instruction is improper, the judgment will be reversed, unless the error is harmless.[171] A motion for new trial is not appropriate where the omitted instructions are superfluous and potentially misleading.[172]

Further, while some courts have been lenient on whether objections are made in accordance with Rule 51, many courts hold that one who does not object in accordance with Rule 51 is deemed to have waived the right to appeal. A patently erroneous instruction can be considered on appeal if the error is “fundamental” and involves a miscarriage of justice, but the movant claiming the error has the burden of demonstrating it is a fundamental error.[173]

§1.10 Conduct of Jury

§1.10.1 Conduct During Deliberations

Jury deliberations must remain private and secret in order to protect the jury’s deliberations from improper, outside influence.[174] Control over the jury during deliberations, including the decision whether to allow the jurors to separate before a verdict is reached, is in the sound discretion of the trial court.[175] During this time, a judge may consider the fatigue of the jurors in determining whether the time of deliberations could preclude effective and impartial deliberation absent a break.[176] Although admonition of the jury is not required, one should be given if the jury is to separate at night and could potentially interact with third parties.[177]

The only individuals permitted in the jury room during deliberations are the jurors. However, in the case of a juror with a hearing or speech impediment, the court will appoint an appropriate professional to assist that individual and the presence of that professional is not grounds for reversal so long as the professional: (1) does not participate in deliberations; and (2) takes an oath to that effect.[178]

Courts have broad discretion in determining what materials will be permitted in the jury room.[179] Materials received into evidence are generally permitted,[180] including real evidence,[181] documents,[182] audio recordings,[183] charts and summaries admitted pursuant to Federal Rule of Evidence 1006,[184] video recordings,[185] written stipulations,[186] depositions,[187] drugs,[188] and weapons.[189] Additionally, jurors are typically permitted to use any notes he or she has taken over the course of trial.[190] Pleadings, however, are ordinarily not allowed.[191]

§1.10.2 Conduct During Trial

Traditionally, the trial judge has discretion to manage the jury during trial.[192] To ensure the jurors are properly informed, the court may, at any time after the commencement of trial, instruct the jury regarding a matter related to the case or a principal of law.[193] If a party wishes to present an exhibit to the jurors for examination over the course of trial, counsel should request that the court admonish the jury not to place undue emphasis on the evidence presented.[194] Additionally, the trial court may, in its informed discretion, permit a jury view of the premises that is the subject of the litigation.[195]

During trial, the court may allow the jury to take notes and dictate the procedure for doing so.[196] The trial court may permit note-taking for all of the trial or restrict the practice to certain parts.[197] A concern of permitting note-taking during trial is that jurors may place too much significance on their notes and too little significance on their recollection of the trial testimony.[198] To mitigate this risk, a judge should give a jury instruction informing each juror that he or she should rely on his memory and only use notes to assist that process.[199]

Allowing a juror to participate in examining a witness is within the discretion of the trial court,[200] although some courts have strongly opposed the practice.[201] If allowed, procedural protections should be encouraged to mitigate the risks of questions.[202] Additionally, the court should permit counsel to re-question the witness after a juror question has been posed.[203]

While trial is ongoing, jurors should not discuss the case among themselves[204] or share notes[205] prior to the case being submitted for deliberations. The same rule applies to communication between jurors and trial counsel[206] or jurors and the parties,[207] although accidental or unintentional contact may be excused.[208]

§1.11 Relief from Judgment

§1.11.1 Renewed Motion for Judgment as a Matter of Law

Pursuant to Federal Rule of Civil Procedure 50(b) a party may file a “renewed” motion for judgment as a matter of law, previously known as a “motion for directed verdict,” asserting that the jury erred in returning a verdict based on insufficient evidence.[209] However, in order to file a renewed motion, a party must have filed a Rule 50(a) pre-verdict motion for judgment as a matter of law before the case was submitted to the jury.[210] The renewed motion is limited to issues that were raised in a “sufficiently substantial way” in the pre-verdict motion[211] and failure to comply with this process often results in waiver.[212] The renewed motion must be filed no later than 28 days after the entry of judgment.[213]

The standard for granting a renewed motion for judgment as a matter of law mirrors the standard for granting the pre-suit motion under Rule 50(a).[214] A party is entitled to judgment only if a reasonable jury lacked a legally sufficient evidentiary basis to return the verdict that it did.[215] In rendering this analysis, a court may not weigh conflicting evidence and inferences or determine the credibility of the witnesses.[216] Upon review, the court must:

“(1) consider the evidence in the light most favorable to the prevailing party, (2) assume that all conflicts in the evidence were resolved in favor of the prevailing party, (3) assume as proved all facts that the prevailing party’s evidence tended to prove, and (4) give the prevailing party the benefit of all favorable inferences that may reasonably be drawn from the facts proved. That done, the court must then deny the motion if reasonable persons could differ as to the conclusions to be drawn from the evidence.”[217]

The analysis reflects courts’ general reluctance to interfere with a jury verdict.[218]

§1.11.2 Motion for New Trial

Federal Rule of Civil Procedure 59 permits a party to file a motion for new trial, either together with or as an alternative to a 50(b) renewed motion for judgment as a matter of law.[219] Like a renewed motion for judgment as a matter of law, a motion for new trial must be filed no later than 28 days after an entry of judgment.[220]

Rule 59 does not specify or limit the grounds on which a new trial may be granted.[221] A party may move for a new trial on the basis that “the verdict is against the weight of the evidence, that the damages are excessive, or that, for other reasons, the trial was not fair . . . and may raise questions of law arising out of alleged substantial errors in admission or rejection of evidence.”[222] Other recognized grounds for new trial include newly discovered evidence,[223] errors involving jury instruction,[224] and conduct of counsel.[225] Courts often grant motions for new trial on the issue of damages alone.[226]

Unlike when reviewing a motion for judgment as a matter of law, courts may independently evaluate and weigh the evidence.[227] Additionally, the Court, on its own initiative with notice to the parties and an opportunity to be heard, may order a new trial on grounds not stated in a party’s motion.[228]

When faced with a renewed judgment as a matter of law or a motion for new trial, courts have three options. They may (1) allow judgment on the verdict, if the jury returned a verdict; (2) order a new trial; or (3) direct the entry of judgment as a matter of law.[229]

§1.11.3 Clerical Mistake, Oversights and Omissions

Federal Rule of Civil Procedure 60(a) provides that “the court may correct a clerical mistake or a mistake arising from oversight or omission whenever one is found in a judgment, order, or other part of the record. The court may do so on motion or on its own, with or without notice.” This rule applies in very specific and limited circumstances, when the record makes apparent that the court intended one thing but by mere clerical mistake or oversight did another; such mistake must not be one of judgment or even of misidentification, but merely of recitation, of the sort that clerk or amanuensis might commit, mechanical in nature.[230] It is important to note that this rule can be applied even after a judgment is affirmed on appeal.[231]

§1.11.4 Other Grounds for Relief

Federal Rule of Civil Procedure 60(b) provides for several additional means for relief from a final judgment:

• mistake, inadvertence, surprise, or excusable neglect;
• newly discovered evidence that, with reasonable diligence, could not have been discovered in time to move for a new trial under Rule 59(b);
• fraud (whether previously called intrinsic or extrinsic), misrepresentation, or misconduct by an opposing party;
• the judgment is void;
• the judgment has been satisfied, released or discharged; it is based on an earlier judgment that has been reversed or vacated; or applying it prospectively is no longer equitable; or
• any other reason that justifies relief.

Courts typically require that the evidence in support of the motion for relief from a final judgement be “highly convincing.”[232]

§1.12 Virtual Hearings and Trials

In the wake of the COVID-19 pandemic and numerous government shut downs, hearings and trials in both criminal and civil matters have been proceeding electronically. It may be necessary, now and in the future, to submit an application for a trial to proceed remotely.[233]

And while trials always present unique and challenging issues, virtual trials present a new set of challenges, especially jury trials. It brings about a whole new set of factors—what makes for a successful trial in person can be very different from a successful trial over a virtual platform. There are new considerations for testimony by witnesses who are no longer in the same room as counsel, presentation of evidence when counsel can no longer bring binders or large boards, jury selection, and a myriad of other issues. What remains the same, however, is that preparation and practice are key. Being familiar with the local court’s practice and working out any technology issues in advance are critical to ensuring a successful virtual trial.

To date, the Courts have not created consistent rules for remote trials; every judge has their preferred procedures and technology.  Accordingly, it is important to review judge and court rules regarding remote proceedings.  For example, many judges have rules that prohibit the coaching of witnesses through off-screen methods, dictate courtroom behavior and appearance, limit public access and recording, and provide guidance on presentation of documents including documents that are filed under seal,[234] These rules not only dictate how the trial proceeds day-to-day, but may provide a basis for motions in limine and should be discussed with your judge in the pre-trial conference.

[1] See Fed. R. Civ. P. 16.

[2] Id.

[3] Id.

[4] See Basista v. Weir, 340 F.2d 74, 85 (3d Cir. 1965)

[5] See Fed. R. Civ. P. 26.

[6] Luce v. United States, 429 U.S. 38, 40 n.2 (1984).

[7] United States v. Romano, 849 F.2d 812, 815 (3d Cir. 1988).

[8] Frintner v. TruPosition, 892 F. Supp. 2d 699 (E.D. Pa. 2012).

[9] United States v. LeMay, 260 F.3d 1018, 1028 (9th Cir. 2001).

[10] Wilson v. Williams, 182 F.3d 562, 565-66 (7th Cir. 1999).

[11] Id. at 566 (“Definitive rulings, however, do not invite reconsideration.”).

[12] Fusco v. General Motors Corp., 11 F.3d 259, 262-63 (1st Cir. 1993).

[13] Flythe v. District of Columbia, 4 F. Supp. 3d 222 (D.D.C. 2014).

[14] U.S. v. Denton, 547 F. Supp. 16 (E.D. Tenn. 1982).

[15] Henwood v. People, 57 Colo 544, 143 P. 373 (1914). An opening statement presents counsel with the opportunity to summarily outline to the trier of fact what counsel expects the evidence presented at trial will show. Lovell v. Sarah Bush Lincoln Health Center, 397 Ill. App. 3d 890, 931 N.E.2d 246 (4th Dist. 2010).

[16] Testa v. Mundelein, 89 F.3d 445 (7th Cir. 1996) (“being argumentative in an opening statement does not necessarily warrant a mistrial, but being argumentative and introducing something that should not be allowed into evidence may be a predicate for a mistrial.”).

[17] Krengiel v. Lissner Copr., Inc., 250 Ill App. 3d 288, 621 N.E.2d 91 (1st Dist. 1993) (“party whose motion in limine has been denied must object when the challenged evidence is presented at trial in order to preserve the issue for review, and the failure to raise such an objection constitutes a waiver of the issue on appeal.”).

[18] Forrestal v. Magendantz, 848 F.2d 303, 308 (1st Cir. 1988) (suggesting to jury to put itself in shoes of plaintiff to determine damages improper because it encourages the jury to depart from neutrality and to decide the case on the basis of personal interest and bias rather than on the evidence.).

[19] U.S. CONST. amend. VI.

[20] See Kiernan v. Van Schaik, 347 F.2d 775, 778 (3d Cir. 1965); McCoy v. Goldston, 652 F.2d 654, 657 (6th Cir. 1981).

[21] U.S. CONST. amend. VII; Kiernan, 347 F.2d at 778.

[22] Fleming v. Chicago Transit Auth., 397 F. App’x 249, 249-50 (7th Cir. 2010) (quoting Jury Selection & Serv. Act of 1968, 28 U.S.C. §§ 1861-74 (2006)).

[23] Irvin v. Dowd, 366 U.S. 717, 727 (1961).

[24] Zia Shadows, L.L.C. v. City of Las Cruces, 829 F.3d 1232 (10th Cir. 2016).

[25] Turner v. Murray, 476 U.S. 28 (1986).

[26] Wainwright v. Witt, 469 U.S. 412, 423 (1985).

[27] Harris v. Pulley, 885 F.2d 1354, 1361 (9th Cir. 1988).

[28] Id. at 1362.

[29] Id. at 1361.

[30] Id.

[31] People v. Jordan, 2019 IL App (1st Dist.) 161848.

[32] Singer v. United States, 380 U.S. 24, 36 (1965) (finding that it is constitutionally permissible to require prosecutor and judge to consent to bench trial, even if the defendant elects one); United States v. Talik, No. CRIM.A. 5:06CR51, 2007 WL 4570704, at *6 (N.D.W. Va. Dec. 26, 2007).

[33] Fed. R. Civ. P. 38; Hopkins v. JPMorgan Chase Bank, NA, 618 F. App’x 959, 962 (11th Cir. 2015).

[34] Hopkins, 618 F. App’x at 962.

[35] U.S. Const. amend. VII.

[36] Lorillard v. Pons, 434 U.S. 575, 583 (1978).

[37] See Lutz v. Glendale Union High Sch., 403 F.3d 1061, 1069 (9th Cir. 2005) (“[W]e hold that there is no right to have a jury determine the appropriate amount of back pay under Title VII, and thus the ADA, even after the Civil Rights Act of 1991.  Instead, back pay remains an equitable remedy to be awarded by the district court in its discretion.”); see also Bledsoe v. Emery Worldwide Airlines, 635 F.3d. 836, 840-41 (6th Cir. 2011) (holding “statutory remedies available to aggrieved employees under the Worker Adjustment and Retraining Notification (WARN) act provide equitable restitutionary relief for which there is no constitutional right to a jury trial.”).

[38] K.M.C. Co. v. Irving Tr. Co., 757 F.2d 752, 758 (6th Cir. 1985); Leasing Serv. Corp. v. Crane, 804 F.2d 828, 832 (4th Cir. 1986); Telum, Inc. v. E.F. Hutton Credit Corp., 859 F.2d 835, 837 (10th Cir. 1988).

[39] Zaklit v. Glob. Linguist Sols., LLC, 53 F. Supp. 3d 835, 854 (E.D. Va. 2014); see also Nat’l Equip. Rental, Ltd. v. Hendrix, 565 F.2d 255, 258 (2d Cir. 1977).

[40] United States v. Steele, 298 F.3d 906, 912 (9th Cir. 2002) (“The fundamental purpose of voir dire is to ‘ferret out prejudices in the venire’ and ‘to remove partial jurors.’”) (quoting United States v. Howell, 231 F.3d 615, 627-28 (9th Cir. 2000)); Bristol Steel & Iron Works v. Bethlehem Steel Corp., 41 F.3d 182, 189 (4th Cir. 1994) (stating that the purpose of voir dire is to ensure a fair and impartial jury, not to operate as a discovery tool by opposing counsel).

[41] Mu’Min v. Virginia, 500 U.S. 415, 431 (1991).

[42] United States v. Piancone, 506 F.2d 748, 751 (3d Cir. 1974).

[43] Id.

[44] United States v. Delgado, 668 F.3d 219, 228 (5th Cir. 2012).

[45] Finks v. Longford Equip. Int’l, 208 F.3d 225, at *2 (10th Cir. February 25, 2000).

[46] Fed. R. Civ. P. 47(a).

[47] Hicks v. Mickelson, 835 F.2d 721, 726 (8th Cir. 1987).

[48] U.S. v. Lewin, 467 F.2d 1132 (7th Cir. 1972) (citing Fed. R. Crim. P. 24(a)).

[49] U.S. v. Lawes, 292 F.3d 123, 128 (2d Cir. 2002); Hicks v. Mickelson, 835 F.2d 721, 723-26 (8th Cir. 1987).

[50] Lawes, 292 F.3d at 128 (noting that “federal trial judges are not required to ask every question that counsel—even all counsel—believes is appropriate”).

[51] Finks v. Longford Equip. Int’l, 208 F.3d 225, at *2 (10th Cir. 2000).

[52] Mayes v. Kollman, 560 Fed. Appx. 389, 395 n.13 (5th Cir. 2014); Richardson v. New York City, 370 Fed. Appx. 227 (2d Cir. 2010); c.f. Kiernan v. Van Schaik, 347 F.2d 775, 779 (3d Cir. 1965) (finding that judge’s refusal to ask prospective jurors questions about connection to insurance companies constituted reversible error).

[53] See 28 U.S.C. § 1865(b).

[54] 28 U.S.C. § 1866.

[55] United States v. Bishop, 264 F.3d 535, 554-55 (5th Cir. 2001).

[56] United States v. Price, 573 F.2d 356, 389 (5th Cir. 1978).

[57] Chestnut v. Ford Motor Co., 445 F.2d 967 (4th Cir. 1971); c.f. United States v. Turner, 389 F.3d 111 (4th Cir. 2004) (finding that district court was within its discretion in failing to disqualify jurors who banked with a different branch of the bank that was robbed).

[58] United States v. Chapdelaine, 989 F.2d 28 (1st Cir. 1993).

[59] Leibstein v. LaFarge N. Am., Inc., 767 F. Supp. 2d 373 (E.D.N.Y. 2011), as amended (Feb. 15, 2011).

[60] Cravens v. Smith, 610 F.3d 1019, 1032 (8th Cir. 2010).

[61] See 28 U.S.C. § 1866 (stating that a juror may be “excluded upon peremptory challenge as provided by law”).

[62] Swain v. Alabama, 380 U.S. 202, 220, (1965) (“The essential nature of the peremptory challenge is that it is one exercised without a reason stated, without inquiry and without being subject to the court’s control.”).

[63] 28 U.S.C. § 1870; see also Fedorchick v. Massey-Ferguson, Inc., 577 F.2d 856 (3d Cir. 1978).

[64] Stephens v. Koch Foods, LLC, No. 2:07-CV-175, 2009 WL 10674890, at *1 (E.D. Tenn. Oct. 20, 2009).

[65] Id.

[66] Id.

[67] Id.

[68] See Batson v. Kentucky, 476 U.S. 79 (1986) (race); J.E.B. v. Alabama ex rel. T.B., 511 U.S. 127 (1994) (gender); Rivera v. Nibco, Inc., 372 F. App’x 757, 760 (9th Cir. 2010) (national origin).

[69] Powers v. Ohio, 499 U.S. 400, 409 (1991).

[70] Robinson v. R.J. Reynolds Tobacco Co., 86 F. App’x 73, 75 (6th Cir. 2004).

[71] Rivera v. Illinois, 556 U.S. 148 (2009); see also King v. Peco Foods, Inc., No. 1:14-CV-00088, 2017 WL 2424574 (N.D. Miss. Jun. 5, 2017).

[72] Kirk v. Raymark Indus., Inc., 61 F.3d 147, 157 (3d Cir. 1995) (holding, in asbestos litigation, that trial court’s refusal to remove two panelists for cause was error, and the party’s subsequent use of peremptory challenges to remedy the judge’s mistake required per se reversal and a new trial) (citations omitted).

[73] Linden v. CNH Am., LLC, 673 F.3d 829, 840 (8th Cir. 2012).

[74] Black’s Law Dictionary 460 (6th ed. 1990).

[75] Fed. R. Evid. 611(c).

[76] McClard v. United States, 386 F.2d 495, 501 (8th Cir. 1967).

[77] Rodriguez v. Banco Cent. Corp., 990 F.2d 7, 12-13 (1st Cir. 1993).

[78] United States v. Rojas, 520 F.3d 876, 881 (8th Cir. 2008) (citing U.S. v. Butler, 56 F.3d 941, 943 (8th Cir. 1995)).

[79] United States v. Carpenter, 819 F.3d 880, 891 (6th Cir. 2016), reversed and remanded on other grounds, 138 S.Ct. 2206, 201 L. Ed. 2d 507 (2018).

[80] U.S. v. Hernandez-Albino, 177 F.3d 33, 42 (1st Cir. 1999).

[81] United States v. Grassrope, 342 F.3d 866, 869 (8th Cir. 2003) (permitting leading questions when examining a sexual assault victim).

[82] U.S. v. Mulinelli-Navas, 111 F.3d 983, 990 (1st Cir. 1997).

[83] See United States v. Lin, 101 F.3d 760, 770 (D.C. Cir. 1996).

[84] United States v. Jacobs, 215 Fed. Appx. 239, 241 (4th Cir. 2007) (citing United States v. Lewis, 10 F.3d 1086, 1089 (4th Cir. 1993)).

[85] Raysor v. Port Authority of New York & New Jersey, 768 F.2d 34, 40 (2d Cir. 1985).

[86] Id.

[87] Elgabri v. Lekas, 964 F.2d 1255, 1260 (1st Cir. 1992).

[88] See Rosa-Rivera v. Dorado Health, Inc., 787 F.3d 614, 617 (1st Cir. 2015) (employees); United States v. Bryant, 461 F.2d 912, 918-19 (6th Cir. 1972) (informants); United States v. Hicks, 748 F.2d 854, 859 (4th Cir. 1984) (girlfriend).

[89] See U.S. v. Cisneros-Gutierrez, 517 F.3d 751, 762 (5th Cir. 2008).

[90] Fed. R. Evid. 612 authorizes a party to refresh a witness’s memory with a writing so long as the “adverse party is entitled to have the writing produced at the hearing, to inspect it, to cross-examine the witness thereon, and to introduce in evidence those portions which relate to the testimony of the witness.”

[91] Rush v. Illinois Cent. R. Co., 399 F.3d 705, 715-22 (6th Cir. 2005).

[92] Rush v. Illinois Cent. R. Co., 399 F.3d 705, 715-22 (6th Cir. 2005).

[93] Id. at 718-19.

[94] United States v. Logan, 121 F.3d 1172, 1175 (8th Cir. 1997).

[95] United States v. Lemon, 497 F.2d 854, 857 (10th Cir. 1974).

[96] See Fed. R. Evid. 607.

[97] Id.

[98] Util. Control Corp. v. Prince William Const. Co., 558 F.2d 716, 720 (4th Cir. 1977).

[99] United States v. Gilbert, 57 F.3d 709, 711 (9th Cir. 1995).

[100] United States v. Finley, 708 F. Supp. 906 (N.D. Ill. 1989).

[101] United States v. Finis P. Ernest, Inc., 509 F.2d 1256, 1263 (7th Cir. 1975); United States v. Prince, 491 F.2d 655, 659 (5th Cir. 1974).

[102] See Davis v. Alaska, 415 U.S. 308, 316, 94 S. Ct. 1105, 1110, 39 L. Ed. 2d 347 (1974) (“Cross-examination is the principal means by which the believability of a witness and the truth of his testimony are tested.”).

[103] See Fed. R. Evid. 611(b) (effective December 1, 2011) (“(b) Scope of Cross-Examination. Cross-examination should not go beyond the subject matter of the direct examination and matters affecting the witness’s credibility. The court may allow inquiry into additional matters as if on direct examination.”).

[104] See United States v. Perez-Solis, 709 F.3d 453, 463-64 (5th Cir. 2013); see also United States v. Arias-Villanueva, 998 F.2d 1491, 1508 (9th Cir. 1993) (cross-examination is within the scope of direct where it is “reasonably related” to the issues put in dispute by direct examination); United States v. Moore, 917 F.2d 215 (6th Cir. 1990) (subject matter of direct examination under Rule 611(b) includes all inferences and implications arising from the direct); United States v. Arnott, 704 F.2d 322, 324 (6th Cir. 1983) (“The ‘subject matter of the direct examination,’ within the meaning of Rule 611(b), has been liberally construed to include all inferences and implications arising from such testimony.”).

[105] Perez-Solis, 709 F.3d at 464.

[106] Id; see also MDU Resources Group v. W.R. Grace and Co., 14 F.3d 1274, 1282 (8th Cir. 1994), cert. denied, 513 U.S. 824, 115 S. Ct. 89, 130 L. Ed. 2d 40 (1994) (“When cross-examination goes beyond the scope of direct, as it did here, and is designed, as here, to establish an affirmative defense (that the statute of limitations had run), the examiner must be required to ask questions of non-hostile witnesses as if on direct.).

[107] Under Fed. R. Evid. 608, if the witness concedes the bad act, impeachment is accomplished. If the witness denies the bad act, Rule 608(b) precludes the introduction of extrinsic evidence to prove the act. In short, the cross-examining lawyer must live with the witness’s denial.

[108] To qualify, “the crime must have been a felony, or a misdemeanor that has some logical nexus with the character trait of truthfulness, such as when the elements of the offense involve dishonesty or false statement. The conviction must have occurred within ten years of the date of the witness’s testimony at trial, or his or her release from serving the sentence imposed under the conviction, whichever is later, unless the court permits an older conviction to be used, because its probative value substantially outweighs any prejudice, and it should, in the interest of justice, be admitted to impeach the witness. If the prior conviction is used to impeach a witness other than an accused in a criminal case, its admission is subject to exclusion under Rule 403 if the probative value of the evidence is substantially outweighed by the danger of unfair prejudice, delay, confusion or the introduction of unnecessarily cumulative evidence. If offered to impeach an accused in a criminal case, the court still may exclude the evidence, if its probative value is outweighed by its prejudicial effect.” Behler v. Hanlon, 199 F.R.D. 553, 559 (D. Md. 2001).

[109] Fed. R. Evid. 608 (bad acts or character of untruthfulness); Fed. R. Evid. 609 (qualifying crime); Fed. R. Evid. 613 (prior inconsistent statement).

[110] Behler, 199 F.R.D. at 556.

[111] 353 F.2d 324, 325-26 (1st Cir. 1965).

[112] 927 F.2d 838, 841 (5th Cir. 1991).

[113] 250 F.3d 10, 16-17 (1st Cir. 2001).

[114] 237 F.3d 8, 16-17 (1st Cir. 2001).

[115] 248 Fed. Appx. 718, 726 (6th Cir. 2007).

[116] 653 F.2d 915, 920-21 (5th Cir. 1981).

[117] United States v. James, 510 F.2d 546, 551 (5th Cir. 1975).

[118] United States v. Blackwood, 456 F.2d 526, 529-30 (2d Cir. 1972).

[119] Id.

[120] FED. R. CIV. P. 26(a)(2).

[121] Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 597 (1993).

[122] Fed. R. Evid. 901.

[123] U.S. v. Goichman, 547 F.2d 778, 784 (3d Cir. 1976) (“[T]here need be only a prima facie showing, to the court, of authenticity, not a full argument on admissibility . . . .  [I]t is the jury who will ultimately determine the authenticity of the evidence, not the court.”).

[124] Id.

[125] Fed. R. Evid. 803(6), 902(11); United States v. Senat, 698 F. App’x 701, 706 (3d. Cir. 2017).

[126] See, e.g., Stumpff v. Harris, 31 N.E.3d 164, 173 (Ohio App. 2 Dist. 2015) (“Numerous courts, both state and federal, have held that items produced in discovery are implicitly authenticated by the act of production by the opposing party); Churches of Christ in Christian Union v. Evangelical Ben. Trust, S.D. Ohio No. C2:07CV1186, 2009 WL 2146095, *5 (July 15, 2009) (“Where a document is produced in discovery, ‘there [is] sufficient circumstantial evidence to support its authenticity’ at trial.”).

[127] In re L.P., 749 S.E.2d 389, 392-392 (Ga. Ct. App. 2013).

[128] Rules of Evid., Rule 901(a). Idaho v. Koch, 334 P.3d 280 (Idaho 2014).

[129] State v. Smith, 2015-1359 La. App. 4 Cir. 4/20/16, 2016 WL 3353892, *10-11 (La. Ct. App. 4th Cir. 2016); see also OraLabs, Inc. v. Kind Group LLC, 2015 WL 4538444, *4, Fn 7  (D. Colo. 2015) (in a patent and trade dress infringement action, the court admitted, over hearsay objections, Twitter posts offered to show actual confusion between the plaintiff’s and defendant’s products.).

[130] Jones v. U.S., 813 A.2d 220, 226-227 (D.C. 2002).

[131] Dente v. Riddell, Inc., 664 F.2d 1, 2 n.1 (1st Cir. 1981).

[132] Mills v. Texas Compensation Ins. Co., 220 F.2d 942, 946 (5th Cir. 1955).

[133] U.S. v. Gomez-Alvarez, 781 F.3d 787, 792 (5th Cir. 2015).

[134] Jerden v. Amstutz, 430 F.3d 1231, 1237 (9th Cir. 2005).

[135] See, e.g., Hastings v. Bonner, 578 F.2d 136, 142-143 (5th Cir. 1978); United States v. Johnson, 577 F.2d 1304, 1312 (5th Cir. 1978); United States v. Jamerson, 549 F.2d 1263, 1266-67 (9th Cir. 1977).

[136] See United States v. Henderson, 409 F.3d 1293, 1298 (11th Cir. 2005).

[137] Inselman v. S & J Operating Co., 44 F.3d 894, 896 (10th Cir. 1995).

[138] See United States v. Adams, 271 F.3d 1236, 1241 (10th Cir. 2001) (“In order to qualify as an adequate offer of proof, the proponent must, first, describe the evidence and what it tends to show and, second, identify the grounds for admitting the evidence.”).

[139] Murphy v. City of Flagler Beach, 761 F.2d 622 (11th Cir. 1985).

[140] See id. at 1241-42 (“On numerous occasions we have held that merely telling the court the content of . . . proposed testimony is not an offer of proof.”).

[141] Fed. R. Evid. 103(c) (The trial court “may direct an offer of proof be made in question-and-answer form.”). See, e.g., United States v. Yee, 134 F.R.D. 161, 168 (N.D. Ohio 1991) (stating that “hearings were held for approximately six  weeks” on whether DNA evidence was admissible).

[142] Adams, 271 F.2d at 1242.

[143] Id.

[144] Palmer v. Hoffman, 318 U.S. 109, 116 (1943).

[145] Fed. R. Evid. 103(a)(2); Beech Aircraft v. Rainy, 488 U.S. 153 (1988).

[146] Alford v. United States, 282 U.S. 687, 692 (1931).

[147] United States v. Harris, 536 F.3d 798, 812 (7th Cir. Ill. Aug. 6, 2008).

[148] See, e.g., United States v. St. Michael’s Credit Union, 880 F.2d 579 (1st Cir. 1989); Griffin v. California, 380 U.S. 609, 615 (Apr. 28, 1965).

[149] Model Rule of Professional Conduct Rule 3.4(e).

[150] Jones v. Lincoln Elec. Co., 188 F.3d 709, 731 (7th Cir. 1999) (“We find nothing improper in this line of argument. Closing arguments are the time in the trial process when counsel is given the opportunity to discuss more freely the weaknesses in his opponent’s case.”).

[151] Vineyard v. County of Murray, Ga., 990 F.2d 1207, 1214 (11th Cir. 1993).

[152] See, Fed. R. Civ. P. 50(a)(1) (“If a party has been fully heard on an issue during a jury trial and the court finds that a reasonable jury would not have a legally sufficient evidentiary basis to find for the party on that issue, the court may: (A) resolve the issue against the party; and (B) grant a motion for judgment as a matter of law against the party on a claim or defense that, under the controlling law, can be maintained or defeated only with a favorable finding on that issue.”).

[153] Fed. R. Civ. P. 50(a)(2).

[154] Arch Ins. Co. v. Broan-NuTone, LLC, 509 F. App’x 453, fn. 5 (6th Cir. 2012) (quoting Ford v. Cnty. of Grand Traverse, 535 F.3d 483, 492 (6th Cir. 2008).

[155] U. S. Indus., Inc. v. Semco Mfg., Inc., 562 F.2d 1061, 1065 (8th Cir. 1977).

[156] Am. & Foreign Ins. Co. v. Gen. Elec. Co., 45 F.3d 135, 139 (6th Cir. 1995).

[157] Unitherm Food Sys., Inc. v. Swift-Eckrich, Inc., 546 U.S. 394, 405 (2006).

[158] Reeves v. Sanderson Plumbing Prod., Inc., 530 U.S. 133, 120 S. Ct. 2097, 147 L. Ed. 2d 105 (2000); citing Lytle v. Household Mfg., Inc., 494 U.S. 545, 554-555, 110 S.Ct. 1331, 108 L.Ed.2d 504 (1990); Liberty Lobby, Inc., supra, at 254, 106 S.Ct. 2505; Continental Ore Co. v. Union Carbide & Carbon Corp., 370 U.S. 690, 696, n.6, 82 S.Ct. 1404, 8 L.Ed.2d 777 (1962).

[159] Id.

[160] Daly v. Moore, 491 F.2d 104 (5th Cir. 1974) (explaining that a court should refuse instructions not applicable to the facts).

[161] Fed. R. Civ. P. 51(b)(3).

[162] Fed. R. Civ. P. 51(b) (1)-(2); see also Vialpando v. Cooper Cameron Corp., 92 F. App’x 612 (10th Cir. 2004) (explaining that “a district court can no longer give mid-trial instructions without first advising the parties of its intent to do so and giving the parties an opportunity to object to the proposed instruction.”).

[163] Apple Inc. v. Samsung Elecs. Co., No. 11-CV-01846-LHK, 2017 WL 3232424 (N.D. Cal. July 28, 2017); see also Daly, 491 F.2d.104 (affirming court’s omission of instructions on the due process requirements of the Fourteenth Amendment since no facts supported a violation).

[164] Fed. R. Civ. P. 51.

[165] Estate of Keatinge v. Biddle, 316 F.3d 7 (1st Cir. 2002).

[166] Positive Black Talk Inc. v. Cash Money Records, Inc., 394 F.3d 357, 65 Fed. R. Evid. Serv. 1366 (5th Cir. 2004).

[167] Fed. R. Civ. P. 51(c)(2); Fed. R. Crim. P. 30(d); see also Abbott v. Babin, No. CV 15-00505-BAJ-EWD, 2017 WL 3138318, at *3 (M.D. La. May 26, 2017) (explaining that upon an untimely objection courts may only consider a plain error in the jury instructions).

[168] Fed. Rules Civ. Proc. Rule 51; Foley v. Commonwealth Elec. Co., 312 F.3d 517, 90 Fair Empl. Prac. Cas. (BNA) 895 (1st Cir. 2002).

[169] Chuman v. Wright, 76 F.3d 292, 294 (9th Cir. 1996).

[170] Benaugh v. Ohio Civil Rights Comm’n, No. 104-CV-306, 2007 WL 1795305 (S.D. Ohio June 19, 2007), aff’d, 278 F. App’x 501 (6th Cir. 2008).

[171] Chuman v. Wright, 76 F.3d 292, 294 (9th Cir. 1996) (reversing judgment since the instructions could allow a jury to find the defendant liable based on premise unsupported by law).

[172] United States v. Grube, No. CRIM C2-98-28-01, 1999 WL 33283321 (D.N.D. Jan. 16, 1999) (denying motion for new trial since the omitted instructions were superfluous and potentially misleading); see also Cupp v. Naughten, 414 U.S. 141, 94 S. Ct. 396, 397, 38 L. Ed. 2d 368 (1973); Lannon v. Hogan, 555 F. Supp. 999 (D. Mass.), aff’d, 719 F.2d 518 (1st Cir. 1983) (generally cannot seek such relief based on a claim of improper jury instructions, unless the error “so infect[ed] the entire trial that the resulting conviction violated the requirements of Due Process Clause and the Fourteenth Amendment.”).

[173] Fashion Boutique of Short Hills, Inc. v. Fendi USA, Inc., 314 F.3d 48 (2d Cir. 2002) (failure to make specific objections to jury instructions before jury retires to deliberate results in waiver, and Court of Appeals may review the instruction for fundamental error only.).

[174] United States v. Olano, 507 U.S. 725, 737 (1993).

[175] Cleary v. Indiana Beach, Inc., 275 F.2d 543, 545-46 (7th Cir. 1960); Sullivan v. United States, 414 F.2d 714, 715-16 (9th Cir. 1969).

[176] Cleary, 275 F.2d at 546; Magnuson v. Fairmont Foods Co., 442 F.2d 95, 98-99 (7th Cir. 1971).

[177] See United States v. Williams, 635 F.2d 744, 745-46 (8th Cir. 1980) (“It is essential to a fair trial, civil or criminal, that a jury be cautioned as to permissible conduct in conversations outside the jury room. Such an admonition is particularly needed before a jury separates at night when they will converse with friends and relatives or perhaps encounter newspaper or television coverage of the trial.”); United States v. Hart, 729 F.2d 662, 667 n.10 (10th Cir. 1984) (“[A]n admonition . . . should be given at some point before jurors disperse for recesses or for the day, with reminders about the admonition sufficient to keep the jurors alert to proper conduct on their part.”).

[178] United States v. Dempsey, 830 F.2d 1084, 1089-90 (10th Cir. 1987).

[179] United States v. Gross, 451 F.2d 1355, 1359 (9th Cir. 1971).

[180] United States v. Williams, 87 F.3d 249, 255 (8th Cir. 1996).

[181] Taylors v. Reo Motors, Inc., 275 F.2d 699, 705-06 (10th Cir. 1960).

[182] United States v. DeCoito, 764 F.2d 690, 695 (9th Cir. 1985).

[183] United States. v. Welch, 945 F.2d 1378, 1383 (7th Cir. 1991).

[184] Pierce v. Ramsey Winch Co., 753 F.2d 416, 431 (5th Cir. 1985).

[185] United States v. Chadwell, 798 F.2d 910, 914-15 (9th Cir. 2015).

[186] United States v. Aragon, 983 F.2d 1306, 1309 (4th Cir. 1993).

[187] Johnson v. Richardson, 701 F.2d 753, 757 (8th Cir. 1983).

[188] United States v. de la Cruz-Paulino, 61 F.3d 986, 997 (1st Cir. 1995).

[189] United States v. Gonzales, 121 F.2d 928, 945 (5th Cir. 1997).

[190] United States v. Anthony, 565 F.2d 533, 536 (8th Cir. 1977); Unites States v. Johnson, 584 F.2d 148, 157-58 (6th Cir. 1978).

[191] McGowan v. Gillenwater, 429 F.2d 586, 587 (4th Cir. 1970).

[192] United States v. Weisner, 789 F.2d 1264, 1268 (7th Cir. 1986).

[193] Fed. R. Civ. P. § 51(b)(3).

[194] United States. v. Venerable, 807 F.2d 745, 747 (8th Cir. 1986).

[195] United States v. Gray, 199 F.3d 547, 550 (1st Cir. 1999).

[196] United States v. Scott, 642 F.2d 791, 797 (9th Cir. 2011); United States v. Bassler, 651 F.2d 600, 602 n.3 (8th Cir. 1981).

[197] See, e.g., United States v. Darden, 70 F.2d 1507, 1537 (8th Cir. 1995) (court permitted note-taking while examining exhibits only); United States v. Porter, 764 F.2d 1, 12 (1st Cir. 1985) (court permitted note-taking only during opening statements, closing statements, and jury charge).

[198] United States v. Scott, 642 F.3d 791, 797 (9th Cir. 2011).

[199] See United States v. Rhodes, 631 F.2d 43, 45-46 (5th Cir. 1980) (“The court should also explain that the notes taken by each juror are to be used only as a convenience in refreshing that juror’s memory and that each juror should rely on his or her independent recollection of the evidence rather than be influenced by another juror’s notes.”).

[200] United States v. Richardson, 233 F.3d 1285, 1288-1289 (11th Cir. 2000).

[201] United States v. Rawlings, 522 F.3d 403, 408 (D.C. Cir. 2008); United States v. Bush, 47 F.3d 511, 514-516 (2nd Cir. 1995); DeBenedetto by DeBenedetto v. Goodyear Tire & Rubber Co., 754 F.2d 512, 516 (4th Cir. 1985).

[202] Perhaps the most important protection is a screening mechanism where questions are submitted to a judge and reviewed by counsel prior to the question being posed. Rawlings, 522 F.3d at 408; United States v. Collins, 226 F.3d 457, 463 (6th Cir. 2000).

[203] Collins, 226 F.3d at 464.

[204] Charlotte Cty. Develop. Co. v. Lieber, 415 F.2d 447, 448 (5th Cir. 1969).

[205] United States v. Balsam, 203 F.3d 72, 86 (1st Cir. 2000).

[206] Budoff v. Holiday Inns, Inc., 732 F.2d 1523, 1527 (6th Cir. 1984).

[207] United States v. Barfield Co., 359 F.2d 120, 123-24 (5th Cir. 1966).

[208] Dennis v. General Elec. Corp., 762 F.2d 365, 367 (4th Cir. 1985).

[209] Fed. R. Civ. P. 50(b).

[210] Exxon Shipping Co. v. Baker, 554 U.S. 471, 486, 128 S. Ct. 2605, 2617 n.5, 171 L. Ed. 2d 570 (2008).

[211] CFE Racing Prod., Inc. v. BMF Wheels, Inc., 793 F.3d 571, 583 (6th Cir. 2015).

[212] Id. (explaining that the waiver rule serves to protect litigants’ right to trial by jury, discourage courts from reweighing evidence simply because they feel the jury could have reached another result, and prevent tactical victories at the expense of substantive interest as the pre-verdict motion enables the defending party to cure defects in proof) (quoting Libbey-Owens-Ford Co. v. Ins. Co. of N. Am., 9 F.3d 422, 426 (6th Cir. 1993)).

[213] Bowen v. Roberson, 688 F. App’x 168, 169 (3d Cir. 2017).

[214] McGinnis v. Am. Home Mortg. Servicing, Inc., 817 F.3d 1241, 1254 (11th Cir. 2016).

[215] Bavlsik v. Gen. Motors, LLC, 870 F.3d 800, 805 (8th Cir. 2017).

[216] McGinnis, 817 F.3d at 1254.

[217] Id.

[218] See, e.g., Stragapede v. City of Evanston, Illinois, 865 F.3d 861, 866 (7th Cir. 2017), as amended (Aug. 8, 2017) (upholding jury verdict in favor of plaintiff for ADA violation when challenged in renewed 50(b) motion on grounds that the jury properly discounted employer’s evidence).

[219] Fed. R. Civ. P. 59.

[220] Fed. R. Civ. P. 59(b).

[221] Molski v. M.J. Cable, Inc., 481 F.3d 724, 729 (9th Cir. 2007) (noting that federal courts are guided by the common law’s established grounds for permitting new trials).

[222] Montgomery Ward & Co. v. Duncan, 311 U.S. 243, 251, 61 S.Ct. 189, 85 L.Ed. 147 (1940).

[223] Kleinschmidt v. United States, 146 F. Supp. 253, 257 (D. Mass. 1956) (explaining that a party seeking new trial on ground of newly discovered evidence has substantial burden to explain why the evidence could not have been found by due diligence before trial).

[224] Gross v. FBL Fin. Servs., Inc., 588 F.3d 614, 617 (8th Cir. 2009) (granting new trial in age discrimination case where jury instruction improperly shifted the burden of persuasion on a central issue).

[225] Warner v. Rossignol, 538 F.2d 910, 911 (1st Cir. 1976) (counsel’s conduct in going beyond the pleadings and evidence to speculate and exaggerate the plaintiff’s injuries, despite repeated warnings from the trial judge, warranted new trial).

[226] See, e.g., Bavlsik v. Gen. Motors LLC, No. 4:13 CV 509 DDN, 2015 WL 4920300, at *1 (E.D. Mo. Aug. 18, 2015) (granting new trial on issue of damages and rejecting defendants’ argument that the record demonstrated a compromised verdict).

[227] McGinnis, 817 F.3d at 1254.

[228] Fed. R. Civ. P. 59(d).

[229] Fed. R. Civ. P. 50(b).

[230] In re Transtexas Gas Corp., C.A.5 (Tex.) 2002, 303 F.3d 571.

[231] U.S. v. Mansion House Center North Redevelopment Co., C.A.8 (Mo.) 1988, 855 F.2d 524, certiorari denied 109 S.Ct. 557, 488 U.S. 993, 102 L.Ed.2d 583 (district court had jurisdiction to modify judgment, even after it was affirmed on appeal, in order to clarify its intentions and conform judgment to parties’ pretrial stipulation).

[232] See United States v. Cirami, 563 F.2d 26, 33 (2d Cir. 1977).

[233] Flores v. Town of Islip, No. 18-CV-3549 (GRB)(ST), 2020 WL 5211052, at *1 (E.D.N.Y. Sept. 1, 2020) (the court granted a motion to proceed with a virtual trial but required counsel and the court staff to have a pre-trial conference to discuss the logistics of a virtual trial).

[234] See, e.g., New Jersey Federal Bankruptcy Court Zoom Trial Guidelines.

In November 2017, the ABA’S Business Law Section unveiled its new format for Business Law Today: a dynamic website that would cover every practice area in the business law arena and provide monthly updates and analytical articles on critical issues and substantive topics in business law. The unveiling of www.businesslawtoday.org witnessed the culmination of two years of intense planning and development that was spearheaded by Chris Rockers, former BLS chair and current delegate to the ABA House of Delegates, and Jonathan Rubens, the BLT website’s first Editor-in-Chief.

But one ingredient was the key to the BLT website’s success: the staff editor who would guide, nurture, and grow the content. The Business Law Section was fortunate in finding for its first editor, Sarah Claypoole.    

A recent graduate of the University of Chicago, Sarah joined the staff in January 2018 and quickly began to familiarize herself with the various topic areas of business law and demonstrated the valuable traits of an editor who must adhere to quality standards of writing while also balancing deadlines and schedules.

“The new Business Law Today is one of the content offerings of which I’m most proud,” said Norm Powell, Business Law Section Content Officer. “Designed based on significant polling from Section members, it has steadily increased in popularity since the launch. Sarah’s been a huge part of that success. She has shared and delivered on the vision that we were creating a virtual hub (a coffee shop, if you will), where folks regularly pop in to see what’s happening in their worlds.”

During Sarah’s tenure, hundreds of articles and month-in-briefs have published, as well as videos, podcasts, and, most recently, an ambitious content offering of recent developments in business and commercial litigation. The shear amount and quality of content is a reflection on Sarah and her eclectic, analytical approach to subject matter and her appreciation of fine writing.

Her interest in business law was the catalyst for Sarah to consider a career as a lawyer, and, in May 2021, she committed to attend the Duke University School of Law, and will leave as editor of www.businesslawtoday.org in July to make her new home in Durham, North Carolina.

“Sarah has been an integral part of every decision made at BLT since BLT was re-launched as an online platform in 2018,” said Lisa Stark, current Editor-in-Chief. “Sarah’s contributions to BLT have been crucial to BLT’s success.  Sarah also is an amazing person and will be sorely missed.”

A new BLT editor will improve on Sarah’s accomplishments and continue the tradition of quality content that has been a hallmark of the Business Law Section’s content offerings.  Yet, Sarah Claypoole has left her mark on the BLT website and the BLS content members and leadership wish her continued success in law school and in her future career as a lawyer.

Editor

Kathleen Cahill Slaught (Chair)

Seyfarth Shaw LLP
560 Mission Street
31st Floor
San Francisco, CA 94105
(415) 397-2823
[email protected]
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Contributors

To Disclose Or Not During ERISA Administrative Review —

Jon Karelitz
Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]
www.seyfarth.com

Stunning Development – The Ninth Circuit Enforces an ERISA Plan Arbitration and Class Action Waiver Provision

Michael W. Stevens
Jonathan A. Braunstein

Seyfarth Shaw LLP
560 Mission Street
31st Floor
San Francisco, CA 94105
(415) 397-2823
[email protected]
[email protected]
www.seyfarth.com

Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

ERISA Preemption – The Courts of Appeal Continue to Rule as They Await Further Supreme Court Attempts to Define, Once and For All, Its Limiting Principles

Mark Casciari
Ian Morrison

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]
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The Trump Administration Wants You to Know, Guidance is NOT Law!

Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

No Partnership, No Common Control, No Withdrawal Liability: Private Equity Funds Not Liable for Portfolio Company’s Multiemployer Plan Withdrawal Liability

Jessica Stricklin

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
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(312) 460-5000

Alan Cabral
Ryan Tzeng

Seyfarth Shaw LLP
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Suite 3500
Los Angeles, California 90067-3021
(310) 277-7200
[email protected]
[email protected]
www.seyfarth.com

Beware of the “Overshare”: Construe Requests for ERISA Plan Documents Narrowly!

Mark Casciari
Sarah Touzalin

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]
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Supreme Court Remands Case Back Seeking Clarification of the Dudenhoeffer Pleading Standard

Jim Goodfellow

Seyfarth Shaw LLP
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(312) 460-5000
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Kathleen Cahill Slaught

Seyfarth Shaw LLP
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(415) 397-2823
[email protected]
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Supreme Court’s Sulyma Ruling Toughens ERISA’s “Actual Knowledge” Standard & Makes Dismissal of Fiduciary Breach Actions More Unlikely

Ian Morrison

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
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Will the ACA Case Now Before the Supreme Court Make it Harder for ERISA Fiduciary Breach Plaintiffs to Establish Standing?

Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

ERISA Fee Motions After COVID-19 — A Substantive and Procedural Review

Rebecca Bryant
Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]
www.seyfarth.com

Whose Law? Where? When? — Risk Management for ERISA Plans in Uncertain Times

Richard Loebl

Seyfarth Shaw LLP
620 Eighth Avenue
New York, New York 10018-1405
(212) 218-3319
[email protected]
www.seyfarth.com

Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

The Supreme Court Further Narrows Federal Court Jurisdiction Over an ERISA Complaint, Relying on Article III of the Constitution

Michael W. Stevens

Seyfarth Shaw LLP
560 Mission Street
31st Floor
San Francisco, CA 94105
(415) 397-2823
[email protected]
www.seyfarth.com

Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

Limits To ERISA’s Equitable Remedies — What The Supreme Court’s Latest Securities Act Decision Tells Us

Michael W. Stevens

Seyfarth Shaw LLP
560 Mission Street
31st Floor
San Francisco, CA 94105
(415) 397-2823
[email protected]
www.seyfarth.com

Mark Casciari

Seyfarth Shaw LLP
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(312) 460-5000
[email protected]
www.seyfarth.com

The 10th Circuit’s New Interpretation of What is Mandated under ERISA’s Notice Requirements May have Far Reaching Effects On Plan Administrator’s Duties

Rebecca K. Bryant
Ian H. Morrison
Sam M. Schwartz-Fenwick

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
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(312) 460-5000
[email protected]
[email protected]
[email protected]
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Transgender Patients Remain Protected: District Court Blocks HHS Rule From Taking Effect

Emily Miller

Seyfarth Shaw LLP
Seaport East
Two Seaport Lane, Suite 300
Boston, MA 02210-2028
(617) 946-4800
[email protected]
www.seyfarth.com

Ben Conley
Sam Schwartz-Fenwick

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]

Countdown to the Supreme Court’s ERISA Preemption Oral Argument in Rutledge — Two Noteworthy Case Developments

Jules Levenson
Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
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(312) 460-5000
[email protected]
[email protected]
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How to Minimize Judicial Review of ERISA Fiduciary Decisions

Ronald Kramer
Mark Casciari

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
[email protected]
www.seyfarth.com

First Circuit Rules That Private Equity Funds Are Not Responsible For Portfolio Company Withdrawal Liability

Bryan M. O’Keefe

Seyfarth Shaw LLP
975 F Street, N.W.
Washington, DC 20004-1454
(202) 463-2400
[email protected]
www.seyfarth.com

Ronald Kramer

Seyfarth Shaw LLP
233 South Wacker Drive
Suite 8000
Chicago, Illinois 60606-6448
(312) 460-5000
[email protected]
www.seyfarth.com

Samuel Rubinstein

Seyfarth Shaw LLP
620 Eighth Avenue
New York, New York 10018-1405
(212) 218-3340
[email protected]
www.seyfarth.com

§1.1 To Disclose Or Not During ERISA Administrative Review — The Fourth Circuit Weighs In With An Affirmative Answer

In Odle vs. UMWA 1974 Pension Plan, the Court of Appeals for the Fourth Circuit reversed a district court’s decision on summary judgment in favor of a pension plan’s fiduciaries (in this case, the board of trustees for a coal industry multiemployer fund).  The case involved a dispute over service credit towards a deceased participant’s pension.  The plan fiduciaries had denied a claim by the participant’s surviving spouse, concluding that 13.5 years of the participant’s service was actually performed in a position that was not classified as eligible under an industry-wide union agreement.  The administrative record indicated that the fiduciaries based their denial, in part, on an audit of employer timesheet records that was not disclosed to the claimant.  The claimant alleged as well that she requested the audit records, and the plan refused to provide them.  The Fourth Circuit held that “by failing to disclose that audit during the administrative process, the Plan denied [the claimant] the ‘full and fair review’ of her claim that she was entitled to under ERISA.”

The regulations under ERISA Section 503 require that a claimant “be given reasonable access to documents relevant to her claim,” The regulations provide that documents, records and other information are “relevant” if they are “submitted, considered, or generated in the course of making the benefit determination.”

Under the Odle holding, a fiduciary should disclose all documents upon which a claim or appeal decision was based, unless there is a good reason not to.  Such disclosure should provide the claimant with an opportunity to consider all relevant information, and use that information in making arguments in support of the claim.  Of course, there may be compelling reasons not to disclose, under certain circumstances, and Odle does not address all possible arguments that cut against disclosure.

Jon Karelitz and Mark Casciari

§1.2 Stunning Development — The Ninth Circuit Enforces an ERISA Plan Arbitration and Class Action Waiver Provision

In Dorman v. Charles Schwab Corp., No. 18-15281, 934 F.3d 1107 and 2019 WL 3939644 (Aug. 20, 2019), the Ninth Circuit reversed course, overruled precedent, and enforced an arbitration provision in an ERISA 401(k) plan that mandated individual, and not class, arbitration of ERISA § 502(a)(2) and (3) claims.

In Dorman, a 401(k) participant brought suit on behalf of a putative class of plan participants and beneficiaries, alleging that the fiduciaries had breached their fiduciary duties by investing assets in the funds affiliated with the defendant.  However, nine months prior to the named plaintiff’s termination of employment and nearly a year before his account withdrawal, the plan was amended to expressly include an arbitration provision binding the plan to arbitration, and forbidding class actions.

The defendant moved to compel arbitration.  The district court denied the motion on multiple grounds, ruling that ERISA claims cannot be subject to mandatory arbitration; the arbitration provision was added after the named plaintiff’s participation in the plan began; and the plaintiff’s claims were brought on “behalf of the plan,” rather than as an individual, and thus could not be subject to the plan’s arbitration clause.

Thirty-five years ago, in Amaro v. Continental Can Co., 724 F.2d 747 (9th Cir. 1984), the Ninth Circuit had held that ERISA claims were not subject to arbitration.  Amaro reasoned that an arbitral forum may “lack the competence of courts to interpret and apply statutes as Congress intended.” In Dorman, however, the Ninth Circuit recognized that later Supreme Court cases, including American Express Co. v. Italian Colors Restaurant, 570 U.S. 228 (2013), had held that arbitrators were competent to interpret and apply federal statutes.  Thus, Dorman expressly overruled Amaro.

In an unpublished companion opinion, the Ninth Circuit addressed and reversed other holdings by the Dorman district court.  Although the Ninth Circuit had recently held, in Munro v. Univ. of S. Cal., 896 F.3d 1088 (9th Cir. 2018), that Section 502(a)(2) claims belong to the plan, rather than the individual, the critical difference in Dorman was that the plan had been amended to include an arbitration provision binding the plan.  Thus, the Ninth Circuit found, the plan “expressly agreed” that all ERISA claims should be arbitrated.  The Ninth Circuit also held, citing LaRue v. DeWolff Boberg & Assocs., Inc., 552 U.S. 48 (2008), that although a § 502(a)(2) claim may belong to the plan, losses are inherently individualized in the context of a defined contribution plan such as the one at issue.  The Ninth Circuit reversed and remanded with instructions to the district court to compel arbitration.

The Dorman plaintiff filed a petition for en banc review, so it remains to be seen whether the latest Dorman decisions will stand.  On October 2, 2019, the Ninth Circuit ordered the defendants to respond to Dorman’s Petition.  This indicates that the Ninth Circuit may agree to rehear its prior decision that sent Dorman’s claims to arbitration, on an individual basis.

The Ninth Circuit has been the most hostile to arbitration, so Dorman (unless vacated) is a monumental change that could be the start of trend favoring ERISA plan arbitration.  Arbitration in lieu of court litigation has pros and cons that need to be considered carefully before mandating arbitration and a class action waiver in ERISA plans, even though the court most hostile to forced arbitration now seems to allow it.

Michael W. Stevens, Jonathan A. Braunstein and Mark Casciari

§1.3 ERISA Preemption — The Courts of Appeal Continue to Rule As They Await Further Supreme Court Attempts To Define, Once and for All, Its Limiting Principles

The federal Employee Retirement Income Security Act (ERISA) has been effective, as a general matter, since 1974.  Its section 514 preempts state laws that “relate to” ERISA plans.  The United States Supreme Court has wrestled, in 18 cases, with how to define, and thus limit, “relate to,” as everything can be said to be related to everything else.  Compounding matters is that section 514 lists specific exceptions to “relate to” preemption.  It is our expectation that the Supreme Court will agree to hear more ERISA preemption cases in the future.

In the meantime, the Courts of Appeal continue to rule on the limits to ERISA preemption, often with opposite results.

In Rudel v. Hawai’i Management Alliance Ass’n, 2019 U.S. App. LEXIS 27371 (9th Cir. Sept. 11, 2019), an ERISA plan participant received ERISA medical plan benefits after a motorcycle accident.  Plan terms allowed it to seek reimbursement from a third party tortfeasor, to the extent the tortfeasor paid general damages, up to the amount of the plan payout.  The participant sued to clarify the plan’s reimbursement right, or lack thereof to be more precise, relying on a Hawai’i statute that invalidated general damage insurance reimbursement rights.  The Ninth Circuit said that the state law “related to” an ERISA plan, but found no preemption, relying on the statutory exemption to ERISA preemption in favor of state laws that regulate insurance.

The Ninth Circuit found that the Hawai’i statute regulated insurance because it was directed at insurance reimbursement rights.  The Court added that the state statute affected the risk pooling arrangement between the insurer and the insured by impacting the terms by which insurance providers must pay plan members.

In Dialysis Newco, Inc. v. Cmty. Health Sys. Grp. Health Plan, 2019 U.S. App. LEXIS 27418 (5th Cir. Sept. 11, 2019), however, the Court of Appeals for the Fifth Circuit found ERISA preemption.  The ERISA medical plan at issue contained a valid anti-claim assignment provision.  A third party health care provider sued to recover on what it claimed was a valid assignment of plan benefits, by relying on a state statute requiring plan administrators to honor assignments made to healthcare providers.

The Fifth Circuit found that the state statute “related to” the ERISA plan because it impacted a “central matter of plan administration” and interfered with “nationally uniform plan administration.” The Court said, because states could—and seemingly already do—impose different requirements on when such assignments would be honored, permitting one state law to govern the plan would interfere with nationally uniform plan administration.

These two cases show how the courts continue to grapple with the nearly infinite nuances of ERISA’s remarkably broad preemption provision.  Given the historic interest of the Supreme Court on ERISA preemption, it is likely only a matter of time until this or a related ERISA preemption question is again before that Court.  ERISA preemption is bound to get more interesting before it gets boring.

Mark Casciari and Ian Morrison

§1.4 The Trump Administration Wants You to Know, Guidance is NOT Law!

Employee benefit lawyers, including employee benefit litigators, have historically been inclined to rely on federal agency guidance that does not technically have the force of law.  Lawyers have followed this practice to appease the agency—the first line of potential opposition—and thus allow a client to re-focus quickly on business goals.  Another reason is that the federal courts have for years given deference to federal agencies.  So why not reflexively back away from a fight when the agency is likely to win in court anyway?

The difficulty with a “guidance-as-gospel” approach is that federal agency officials and regulators are not elected and thus cannot enact legislation.  Deference may operate as a shield for guidance that is outside what Congress has legislated, and is based on an executive-branch political agenda.

This is the view of the Trump administration.

One of the new executive orders attempts to stop reliance on guidance that goes beyond a statute, or notice and comment regulations (which have the force of law, if consistent with the governing statute).  The other order requires agencies to establish a single, searchable toolbar that links to all of the already issued guidance.  Additionally, the website must note that the guidance does not have the force and effect of law, unless as authorized by law or incorporated into a contract.  The new executive orders direct that enforcement action cannot be based only on guidance.  Enforcement must be based on the governing statute.

The force of the new executive orders may extend beyond the life of the Trump administration.

Federal courts increasingly question the wisdom of the historic deference given to guidance.  Noteworthy is Kisor v. Wilkie, 139 S. Ct. 2400 (2019), wherein a veteran sought PTSD disability benefits from the Department of Veterans Affairs.  The agency partially denied his claim and the Court of Appeals for the Federal Circuit affirmed by deferring to the agency’s interpretation of what it said was an ambiguous regulation.  The Supreme Court reversed and remanded the case back to the Court of Appeals.  Justice Elana Kagan wrote the majority opinion, and stated that a court should defer to the agency only after satisfying itself that the regulation is “genuinely” ambiguous, and if so, “reasonable.” The Court added that the agency’s interpretation must be an official position, as opposed to an ad hoc statement, must implicate its substantive expertise, and be otherwise “fair and considered.”

To be sure, Kisor does not involve guidance, but its holding—federal courts must not reflexively defer to agency action—applies with the same (or greater) force to guidance.  So, employers and fiduciaries should rely only on guidance they believe is fully consistent with a careful analysis of the governing statutory law.

Mark Casciari

§1.5 No Partnership, No Common Control, No Withdrawal Liability: Private Equity Funds Not Liable for Portfolio Company’s Multiemployer Plan Withdrawal Liability

In a 2013 decision, the District Court of Massachusetts found that the two Sun Capital PE funds were not only engaged in “trade or business,” but also were a partnership acting under “common control” with a bankrupt portfolio company, and therefore, liable for the portfolio company’s $4.5 million withdrawal liability to a multiemployer pension plan incurred upon its bankruptcy.  Under ERISA, the common control standard is met if there is an 80% ownership interest.  The district court found that even though the two PE funds had individual investment stakes in the portfolio company of only 70% and 30% respectively, they were acting as a partnership and so their ownership interests should be aggregated, thereby exceeding the 80% threshold.

The PE funds appealed the decision and the First Circuit reached its decision: no partnership, no common control, no withdrawal liability.  Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 16-1376, 2019 WL 6243370 (1st Cir. Nov. 22, 20190.  The First Circuit applied factors derived from an old tax court case, Luna v. Commissioner, and concluded that the PE funds’ activities did not rise to the level of a partnership.  Among the factors considered, the PE funds were not acting in concert when making investments, conducted business under separate names, filed separate tax returns, kept separate books, and disclaimed any sort of partnership.  The court also noted the fact that the PE Funds were formed as LLCs further demonstrated an intent not to form a partnership.

Importantly, the court stated that it was reluctant to impose withdrawal liability on the PE funds when there was no clear congressional intent to do so, and no guidance from the PBGC.

But beware: While this is a significant victory for PE funds in general, the court’s decision was very fact specific, and it did not “reach other arguments that might have been available.” It will be interesting to see if other circuit courts follow this precedent.

Ryan Tzeng, Jessica Stricklin, and Alan Cabral

§1.6 Beware of the “Overshare”: Construe Requests for ERISA Plan Documents Narrowly!

Section 104(b)(4) of ERISA requires that plan administrators provide certain plan documents to a participant or beneficiary (or their authorized personal representative) upon written request, including copies of the summary plan description, plan document, annual report, trust agreement, contract and bargaining agreement, as well as documents that fall within a catch-all of “other instruments under which the plan is established or operated.” When document requests are received, it’s not at all uncommon for the request to include a long list of documents, often times repetitive, leaving the plan administrator to weed through the request and identify the documents that must be provided under ERISA.

In Theriot v. Building Trades United Pension Trust Fund, et al. (E.D. La. Nov. 4, 2019), plaintiff alleged that the defendants, a multi-employer pension fund and its trustees, failed to timely produce plan documents in violation of Section 104(b)(4), entitling the plaintiff to statutory penalties of up to $110 per day.

In 2017, the plaintiff requested “a complete copy of the plan agreement, including [her deceased mother’s] application and all other correspondence from her to the Fund.” The defendants provided a copy of the plan document, current through 2017.  The plaintiff alleged that the defendants should have known that she was also requesting other plan documents, including an outdated version of the plan document and summary plan description, even though she did not specifically request them.

In 2018, the plaintiff made a second request, also including a long list of additional plan documents.  The defendants provided only copies of the 2017 plan document, trust agreement and summary plan description in effect as of the dates specifically requested, as well as copies of Forms 5500 and attachments.  Plaintiff, however, alleged that the defendants failed to produce any of the other documents from the 2018 request.  The court determined that certain of the document requests were not sufficiently clear, some of the requested documents did not exist and some were not relevant to the plaintiff understanding her rights under the plan.  The court also determined that a reasonable plan administrator would not have known that the plaintiff was requesting other documents beyond the 2017 plan document.  And notably, the court agreed with the majority of other circuits that Section 104(b)(4) did not encompass the fidelity bonding policy, any errors and omissions insurance policy or any fiduciary insurance policy.

Takeaway: The Theriot case shows that narrowly construing Section 104(b)(4) can be defensible.  It also can be advisable.  Any lawsuit challenging fiduciary conduct must allege plausible facts to survive a motion to dismiss and enter into expensive discovery.  There is no sound reason to make the plaintiff’s task in this regard easier by over-producing documents under Section 104(b)(4).

Sarah Touzalin and Mark Casciari

§1.7 Supreme Court Remands Case Back Seeking Clarification of the Dudenhoeffer Pleading Standard

In Retirement Plans Committee of IBM v. Jander, the Supreme Court, in a unanimous opinion, clarified the its opinion in Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014), which set forth the duties that administrators of Employee Stock Ownership Plans (“ESOP”) owe to participants, and when they are required to act on inside information.

In this case, plaintiffs alleged that the IBM’s ESOP fiduciaries violated their duty of prudence under ERISA by continuing to invest the plan’s funds in IBM’s stock even though they knew the stock’s market price was artificially inflated.  Under Dudenhoeffer, a plaintiff bringing such a claim must allege that a fiduciary in the same position could not have concluded that taking a different action “would do more harm than good to the fund.” The question presented to the Court in Jander was whether the plaintiffs’ complaint can survive a motion to dismiss when they make only general allegations that the costs of undisclosed fraud grow over time.

Though the Court agreed to take the case, it ultimately declined to opine on the issue presented.  Rather, it remanded the matter to the Second Circuit for further consideration of the SEC’s position on whether an ERISA based duty to disclose inside information, that is not otherwise required to be disclosed by the securities laws, would otherwise conflict with the objectives of the insider trading and corporate disclosure requirements contained in the securities laws.  IBM argued that ERISA imposed no duty to act on inside information.

Thus, the Supreme Court left unresolved the question presented regarding the pleading standard.  It did, however, provide some helpful guidance to fiduciaries of ESOP plans in that it emphasized that ERISA’s duty of prudence does not require a fiduciary to break the law.  Thus, if taking an action on inside information would violate the securities law, there is no violation of ERISA for not taking that action.  But we will also wait to see how the SEC views ERISA’s duty of prudence in this context.

Jim Goodfellow and Kathleen Cahill Slaught

§1.8 Supreme Court’s Sulyma Ruling Toughens ERISA’s “Actual Knowledge” Standard & Makes Dismissal of Fiduciary Breach Actions More Unlikely

Plaintiff Christopher Sulyma filed a putative class action in October 2015, alleging that Intel’s investment committee and other plan administrators breached their fiduciary duties by utilizing “alternative investments” that lagged behind high-performing index funds.  The Northern District of California granted summary judgment to the committee based on plan disclosures that clearly revealed the disputed investments and were published more than three years before the plaintiff filed suit.  The Ninth Circuit reversed the ruling, finding that Sulyma’s deposition testimony that he did not recall reviewing plan disclosures created a dispute of fact as to his “actual knowledge” and precluded summary judgment.

Affirming the Ninth Circuit, the Supreme Court unanimously found in an opinion authored by Justice Alito that although ERISA does not define “actual knowledge,” it plainly requires awareness of the “relevant facts” provided in the plan’s disclosures.  In addition, Congress’s language in ERISA clearly identifies whether a particular statute of limitations is triggered by what a plaintiff actually knows or what he reasonably should know.  The language in § 1113(2), however, clearly notes that only a plaintiff’s “actual knowledge” triggers the 3-year limitations period for a fiduciary breach action, rather than what he should have known from disclosures provided to him.

Justice Alito, however, stressed that that a participant’s assertion that he did not know about the disclosed information related to the alleged breach might not be the end of the story.  “Actual knowledge” may be proved through inference from circumstantial evidence.  For instance, electronic records may show that a plaintiff reviewed plan disclosures and acted in response.  If a plaintiff’s denial of knowledge is “blatantly contradicted” by the factual record, the Supreme Court instructed trial courts to act accordingly.

The case provides succor to the plaintiffs’ bar because the Court could have found that mere delivery of plan disclosures triggers the three-year limitations period.  While disclosures are not an automatic shield, they form an important part of the defense in most cases.  To rebut claims of lack of knowledge, plans may wish to consider adopting electronic procedures to confirm that participants have reviewed disclosures, such as requiring participant acknowledgments.

Ian H. Morrison

§1.9 Will The ACA Case Now Before The Supreme Court Make It Harder For ERISA Fiduciary Breach Plaintiffs To Establish Standing?

On March 2, 2020, the United States Supreme Court granted certiorari in California v. Texas, No. 19-840, which appeals the decision of the Court of Appeals for the Fifth Circuit that struck down the individual mandate to the Affordable Care Act (ACA).

In Texas v. United States (as the case was styled previously), the Fifth Circuit held that the two individual plaintiffs who were self-employed residents of Texas had standing to challenge the ACA, despite not being subject to a financial penalty.  There was no penalty because the 2017 Tax Cuts and Jobs Act (TCJA) set the penalty for not maintaining individual health insurance at zero dollars.  According to the Fifth Circuit, the individual plaintiffs had standing because they demonstrated the “increased regulatory burden” that the individual mandate imposes.

The Supreme Court is keenly interested whether a federal court plaintiff has a sufficient injury to sue in a federal forum when she can show no other harm besides a technical statutory violation.  In Spokeo v. Robbins, the Supreme Court held that, although Congress can create federal claims, those claims can only be litigated in federal court as long as the plaintiff alleges a “concrete” injury (i) that affects the plaintiff in a personal and individual way, (ii) that is traceable to the defendant, and (iii) that is repressible by the federal judge.

It is possible that the Supreme Court may dismiss the individual plaintiffs in Texas v. United States for lack of standing, finding that they have not been harmed by a mere obligation to maintain individual health insurance without a corresponding penalty.  Such a ruling would seemingly comport with Spokeo, which suggests that private plaintiffs may not sue to enforce statutory obligations when they have not yet been harmed by violations of those obligations.  ERISA fiduciaries thus might expect a drop in class action filings, especially as all private claims for breaches of fiduciary duty under Section 502(a)(2) and (a)(3) may be brought only in federal court, and not in a state court.  A technical ERISA statutory violation may not be found “concrete and particularized,” or “actual or imminent,” and may instead be considered “conjectural” or “hypothetical,” buzz words used to determine the outcome of Spokeo arguments to dismiss.

Mark Casciari

§1.10 ERISA Fee Motions After COVID-19 — A Substantive and Procedural Review

Two interesting lower court decisions on attorney fee motions were recently issued from Judge Susan Brnovich of the federal District of Arizona and Judge Beau Miller in the District Court of Harris County, Texas of the 190th Judicial District.  One decision presents a refresher course on the merits of ERISA fee motions and the other used the novel procedural approach of conducting a Zoom video hearing in lieu of live appearances.

The first decision, United Air Ambulance LLC, v. Cerner Corporation, et al., Case No. CV-17-04016 (U.S. Dist. Ct. D. Ariz., Apr. 14, 2020), addressed when prevailing ERISA plaintiffs may recover fees as instructed by the Court of Appeals for the Ninth Circuit.  Judge Brnovich denied ERISA Section 502(g)(1) fees after carefully considering the following factors: (1) degree of the opposing party’s culpability or bad faith, (2) the ability of the opposing party to satisfy an award of fees, (3) whether an award of fees against the opposing party would deter others from acting under similar circumstances, (4) whether the party seeking fees sought to benefit all participants and beneficiaries under an ERISA plan or to resolve a significant ERISA legal question, and (5) the relative merits of the parties’ positions.  The Court found that these factors split evenly, save for two, which tipped the scales against an award of fees to the plaintiff.  The deterrence factor weighed against plaintiff because the case involved a unique set of facts, so no one else was likely to encounter the scenario at issue.  The resolution of the case was not a benefit to all participants under the plan and resolved no significant legal question about ERISA, as it focused on procedural shortcomings.  This decision is a reminder that, unlike the case with other federal statutes such as Title VII of the Civil Rights Act of 1964, ERISA fee motions by prevailing a plaintiff (or defendant) should not always be given a presumption of success.

In Ahmed v. Texas Fair Plan Assoc., Case No. 2016-09336, Judge Miller considered whether to grant a fee motion in an insurance case.  Following the Texas Supreme Court’s order mandating that all hearings be conducted remotely, the Court held a one-day bench trial via Zoom.

The post–COVID-19 world will present many new ways of doing business, and we can foresee federal judges experimenting with Zoom hearings in lieu of expensive and now unwelcome travel.  A good place to start may be with fee motions, as they are ancillary to the merits of the case.  Video hearings will present new challenges for lawyers and clients, not the least of which are video quality and reliability, and maintaining eye contact in a virtual world.  Savvy ERISA attorneys are likely to improve their command of video appearances and confront the unique challenges of video persuasion, as we enter the brave, new world of the e-trial attorney.

Rebecca Bryant & Mark Casciari

§1.11 Whose Law? Where? When? — Risk Management for ERISA Plans in Uncertain Times

The COVID-19 pandemic seems likely to spawn many claims for ERISA benefits, whether under health, retirement or disability plans, and now is the time to consider anew proactive risk management steps.  A recent decision from the Court of Appeals for the Tenth Circuit, Ellis v. Liberty Life, No. 19-1074 (10th Cir. May 13, 2020), illustrates the particular importance of the risk management tool of including a favorable choice of law provision in an ERISA long-term disability plan that provides benefits through an insurance policy.

The issue in Ellis was whether the federal district court’s review of the plan administrator’s denial of long-term disability benefits was subject to an abuse of discretion standard or subject to de novo review.  The lawsuit was filed in Colorado.  Colorado’s insurance regulations, like those in many states, forbid insurance policies from giving insurers, plan administrators or claims administrators discretion to interpret the policy’s terms in making benefits decisions.  Such laws have been challenged by relying on ERISA’s general preemption of state law that relates to an ERISA plan, but that preemption provision contains an exception for state laws regulating insurance.

However, the plan here contained a choice of law provision stating that if there was an issue of state law, then Pennsylvania law governed.  The employer was both incorporated and headquartered in Pennsylvania.  Unlike Colorado, Pennsylvania does not have an insurance law that prohibits discretionary clauses in insurance policies.  The question was whether the choice of law provision should be honored.

The Court held that such a clause should be enforced so long as the chosen state has a valid connection to the plan.  As the employer was both incorporated and headquartered in Pennsylvania, the Court found the choice of law provision applied and thus reviewed the claim for abuse of discretion.  Applying this standard, the Court affirmed the decision of the insurer.

Employers should take the opportunity now to review their ERISA plans to consider adding risk management provisions.  And such provisions may go beyond a choice of law.  For example, we cannot but wonder if the Ellis case would have proceeded more smoothly to its ultimate conclusion if there had been a forum selection clause mandating that the litigation be held in Pennsylvania.  In addition, the defendant likely could have avoided this entire inquiry if the plan sponsor had drafted a plan document, separate from the insurance certificate, that vested the insurer with discretion.  There are other plan-based risk management tools, such as plan limitations or arbitration provisions, which might be applied in other situations.

Richard Loebl and Mark Casciari

§1.12 The Supreme Court Further Narrows Federal Court Jurisdiction Over an ERISA Complaint, Relying on Article III of the Constitution

In Thole v. U.S. Bank et al., No. 17-1712 (June 1, 2020), the U.S. Supreme Court affirmed dismissal of ERISA claims brought on behalf of participants in a defined benefit pension plan.  The participants alleged financial mismanagement, but suffered no financial loss.  The question was the following: may the participants sue in federal court for monetary relief because of the alleged mismanagement?  The relief demanded by the participants in their complaint was substantial — $750 million and $31 million in lawyer’s fees.

In a 5-4 decision, the majority reasoned that the plaintiffs “would still receive the exact same monthly benefit” even if they won in court, and thus had no concrete injury under the Constitution’s Article III that would allow for the lawsuit (and consequent expensive discovery and possible settlement).  It thus is important to note these controlling preconditions to any lawsuit in federal court that were reiterated in Thole:  (1) a concrete injury, (2) caused by the defendant, that is (3) redressable by the requested judicial relief.

The Article III stakes are high, because the tougher the preconditions for establishing standing to sue in federal court, the harder it will be for class actions to proceed there.  ERISA makes the Thole holding even more consequential because state courts have no jurisdiction to resolve claims of fiduciary breach under ERISA.  That means that plaintiffs cannot resort to state court to avoid Thole when alleging claims to recover excessive 401(k) fees and claims of mere statutory violations.

The majority did say plan participants, in another case, might be able to establish Article III standing if they plausibly allege “that the alleged mismanagement of the plan substantially increased the risk” that benefits would not be paid.  The precise meaning of this proviso will need to be developed in later litigation.  The Court also emphasized that the plan at issue provided a defined benefit, and that a defined contribution plan participant alleging the same wrongdoing might attain Article III standing.

Of note as well is that Justice Thomas, joined by Justice Gorsuch, said that ERISA case law is too tightly bound to the common law of trusts.  This may portend a new line of analysis by the Court in future ERISA cases.  The Court may focus more on the plain reading of the statute, as opposed to traditional notions of trust law not grounded in that statutory language.  Also of note is that Thole represents another effort by the Court, and especially Chief Justice Roberts, to limit federal jurisdiction generally.

The decision is good news for ERISA plans and their sponsors, as it will be more difficult for participants to bring individual or class actions for mere statutory violations that have not impacted benefits.

Michael W. Stevens and Mark Casciari

§1.13 Limits To ERISA’s Equitable Remedies — What The Supreme Court’s Latest Securities Act Decision Tells Us

ERISA’s civil enforcement provisions generally allow the federal courts to award appropriate “equitable” relief.  A permissible equitable remedy is disgorgement, which, in the ERISA context, is restoration to the affected plan of fiduciary profits that were illegally earned with plan assets.

Not much has been written about disgorgement, but Liu v. SEC, 591 U.S. ___, No. 18-1501 (June 22, 2020), a Supreme Court decision interpreting the federal Securities and Exchange Act, offers some insight on its meaning.  (The Court has already ruled that ERISA equitable relief does not permit extra-contractual or punitive damages.  See Mass. Mut. Life Ins. Co. v. Russell, 473 U.S. 134 (1985).  So, a disgorgement remedy cannot include extra-contractual or punitive damages.)

In Liu, an 8-1 majority held that “disgorgement” is a permissible equitable remedy in securities’ cases.  The Court observed that disgorgement can be seen as imposing a constructive trust or an accounting, and is equitable in nature even if not specifically mentioned in a statute.  The Court added that disgorgement is not joint and several, and is not limited to cases involving fiduciary breaches.  The Court held that district courts thus may enter disgorgement awards as part of equitable relief, as long as they target net profits, after deducting legitimate expenses.

Justice Thomas dissented, writing that disgorgement is not a traditional form of equitable relief.  He added that a disgorgement remedy, if ordered, must go to the plan participants victimized by the breach, and not to the government.

Notably, Justice Thomas cited ERISA for the proposition that the Supreme Court has never considered general statutory grants of equitable authority as giving federal courts a freewheeling power to fashion new forms of equitable remedies.  He said that the contours of equitable relief were transplanted to our country from the English Court of Chancery in 1789, in contradistinction to remedies at law, which turn on the words used in statutes.

It thus is worth noting that the parameters of ERISA’s equitable relief provisions will continue to be defined by the federal courts.  But it is now clear that disgorgement is an equitable remedy, even if not specifically mentioned in the statute, as long as it is net of legitimate expenses.  Look for more litigation in an appropriate case on the meaning of “profits” and “legitimate expenses.”  And attorneys for plans and plan sponsors should expect the ERISA plaintiff bar to seek disgorgement whenever possible.  Finally, ERISA practitioners should continue to pay close attention to securities’ decisions from the Supreme Court, as the Court continues to address the overlap between the two statutes.  See Retirement Plans Committee of IBM v. Jander, 573 U.S. __, No. 18-1165 (Jan. 14, 2020) (ERISA stock drop decision).

Mark Casciari and Michael W. Stevens

§1.14 The 10th Circuit’s New Interpretation of What is Mandated under ERISA’s Notice Requirements May have Far Reaching Effects On Plan Administrator’s Duties

In ERISA benefit claim litigation, where there is a sufficient delegation of discretionary authority to an administrator in the governing plan document, a court reviewing an administrator’s decision will generally employ the highly deferential abuse of discretion standard of judicial review rather than the de novo standard of review.

In a recent mental health treatment case, the Tenth Circuit added additional requirements before a court will apply the abuse of discretion standard to analyze a benefit claim determination.  Lyn M.; David M., as Legal Guardians of L.M., a minor v. Premera Blue Cross, No. 18-4098, __ F.3d __.  The court ruled that despite a grant of discretion to the administrator in the governing plan document, the deferential standard of review could not apply in litigation as there was no evidence demonstrating plan participants knew that the employer’s plan document containing the discretionary authority clause existed.  Rather, the participants had received only an SPD, which was silent as to discretionary authority.  The Court determined that proper notice requires the plan administrator to either (1) actually disclose its discretionary authority or (2) explicitly disclose the existence of the plan document containing information about the discretionary authority.  The court found that the fact that the governing plan document was available to participants on request was insufficient this new disclosure requirement.

In a biting dissent, Judge Allison H. Eid reasoned that the SPD sufficiently alerted participants that other plan documents existed and were available.  Judge Eid criticized the majority for imposing a duty on plan administrators, found nowhere in ERISA or case law, “to specifically inform members that documents exist that could affect judicial review.”  The dissent correctly noted that while SPDs must be provided and include certain mandatory information regarding benefit eligibility and claim procedures, there is no duty under ERISA to specifically notify participants of documents that may affect the judicial standard of review should their claims be decided in court.

This decision is a significant departure from the standard principle that the standard of review employed by a reviewing court does not turn on whether the document containing that standard was provided to participants during the claim review process.  Only time will tell if other courts will adopt the Tenth Circuit’s position.  For now, benefit plans operating in the Tenth Circuit should evaluate their claim procedures in light of this decision.

Rebecca K. Bryant, Sam M. Schwartz-Fenwick, and Ian H. Morrison

§1.15 Transgender Patients Remain Protected: District Court Blocks HHS Rule From Taking Effect

A Federal Court has temporarily enjoined the Trump administration from putting into effect its recent rule that strips the Affordable Care Act of its gender identity protections.

The section of the final rule on Section 1557 of the Affordable Care Act that stripped the regulations of their gender identity protections was slated to take effect yesterday.  But it did not.

Rather, on August 17, 2020, a federal judge in the Eastern District of New York issued a stay that blocked that portion of the U.S. Department of Health and Human Services’ final rule from taking effect.  (Tanya Asapansa-Johnson Walker and Cecilia Gentili v. Azar M. Azar II, and the U.S. Dept. of Health and Human Services, Case No. 20-CV-2834, United States District Court, E.D. of NY, August 17, 2020).  The Court only addressed the final rule’s interpretation of “discrimination on the basis of sex” in its stay and did not address the other changes ushered in under the Department’s final rule.  Those other changes took effect on August 18, 2020.

Section 1557 of the ACA prohibits health programs and activities that receive federal financial assistance from discriminating on the basis of race, color, national origin, disability, age, or sex.  Section 1557 takes its prohibition against discrimination on the basis of sex from its reference to Title IX of the Education Amendments of 1972 (Title IX).  Since its inception, Section 1557 has prohibited discrimination on the basis of gender identity in healthcare through its prohibition against discrimination on the basis of sex.

On June 12, 2020, the Department issued its final rule on Section 1557 – explicitly removing protection from discrimination on the basis of gender identity from its prohibition against discrimination on the basis of sex.  This meant that, once the final rule took effect, covered entities could discriminate against transgender patients without violating Section 1557.

On June 15, 2020, in Bostock v. Clayton County, the Supreme Court held that Title VII’s prohibition against discrimination on the basis of sex captures within it a prohibition against discrimination on the bases of sexual orientation and gender identity.  Specifically, the Court held that “it is impossible to discriminate against a person for being homosexual or transgender without discriminating against that individual based on sex.”

And so, we found ourselves in an accordion-like quagmire where “on the basis of sex” included gender identity under Title VII and but was still interpreted by at least one executive branch agency to exclude gender identity under Section 1557 vis-à-vis Title IX.

The injunction signals that a resolution to this quagmire may be on the horizon.

In his ruling, Judge Frederic Block found the Department knew that the then-forthcoming decision in Bostock could have “ramifications” for its final rule given that both Title VII and Title IX prohibit discrimination “on the basis of sex” but “was apparently confident that the Supreme Court would endorse the Administration’s interpretation of sex discrimination…” The Court wryly noted that the Department’s “confidence was misplaced” and held that once the Supreme Court issued Bostock, the Department had to consider its implications for its final rule.  As Judge Block stated: “Instead it did nothing….  Since [the Department] has been unwilling to take that path voluntarily, the Court now imposes it.” The final rule cannot take effect until a court decides what the decision in Bostock means for Section 1557.

And so, the portion of the final rule that would have allowed for discrimination on the basis of gender identity in health programs and activities did not take effect yesterday, and transgender patients remain protected while the litigation challenging the final rule continues.  We will continue to follow this case with interest.

Emily Miller, Ben Conley, and Sam Schwartz-Fenwick

§1.16 Countdown to the Supreme Court’s ERISA Preemption Oral Argument in Rutledge — Two Noteworthy Case Developments

The Supreme Court has agreed to hear Arkansas’s challenge to a decision by the Court of Appeals for the Eighth Circuit holding that ERISA preempts an Arkansas law regulating prescription drug reimbursement.  Merits briefing is now complete and oral argument is set for October 6, 2020 in Rutledge v. Pharmaceutical Care Management Association, (No. 18-540).

The Supreme Court’s decision in Rutledge will have resounding implications on ERISA plans.  fiduciaries and administrators.  Not only are state laws regulating pharmaceutical benefits (the subject matter of Rutledge) widespread, states have also taken to regulating a host of other benefit matters, presenting high hurdles for multi-state employers, fiduciaries and administrators seeking to establish uniform nationwide procedures.

So the precise location of where the Supreme Court draws the line on preemption will likely cause ripple effects well beyond pharmaceutical benefits.  And the Court’s line-drawing reasoning is important given that the statute preempts all state laws “relating” to employee benefit plans regulated by ERISA.

Two recent case developments underscore Rutledge’s importance, both in the pharmaceutical benefits realm and beyond.

First, the Eighth Circuit held that a North Dakota law regulating pharmaceutical benefits is preempted by ERISA because the law’s “provisions apply to plans subject to ERISA regulation and therefore the law cannot function irrespective of any ERISA plan.” Pharm. Care Mgmt. Ass’n v. Tufte, No. 18-2926, 2020 WL 4554980, at *1 (8th Cir. Aug. 7, 2020) (internal quotation marks omitted).  The Court relied on its prior decisions (including Rutledge) striking down similar laws.

Additionally, in another case (filed in the U.S. District Court for the District of New Jersey), an employer trade association is alleging that New Jersey’s WARN Act expansion requiring mandatory severance payments for certain employees is preempted by ERISA.  The ERISA Industry Comm. v. Angelo, No. 20-cv-10094 (D.N.J. Aug. 6, 2020).  The plaintiff contends that the severance obligation requires the creation of a benefit plan that has ongoing administrative obligations and requires the use of discretion in determining benefit eligibility.  The plaintiff alleges that this sort of plan would be governed by ERISA and therefore that the New Jersey law impermissibly “relates” to an ERISA plan.  The plaintiff also alleges that the New Jersey law creates the sort of state-by-state regulatory patchwork that ERISA was designed to avoid.

Jules Levenson and Mark Casciari

§1.17 How to Minimize Judicial Review of ERISA Fiduciary Decisions

One of the enduring paradoxes of ERISA litigation is the judicial standard of review of fiduciary decisions.  The standard of review is important because an easier standard will uphold more fiduciary decisions in court and encourage more individuals to serve as fiduciaries.  No one who acts in good faith—as the vast majority of ERISA fiduciaries do—likes to make tough decisions and be sued or reversed.

On the one hand, the courts frame their review of fiduciary decisions in exacting terms.  For example, in Donovan v. Bierwirth, 680 F.2d 263 (2d Cir. 1982), the Court of Appeals for the Second Circuit said that the ERISA fiduciary’s duty of loyalty to plan participants and beneficiaries is “the highest known to the law.”

But, in Bator v. District Council 4, Graphic Communications Conf., No. 18-cv-1770 (7th Cir. Aug. 27, 2020), the court proffered another viewpoint.  It considered whether ERISA fiduciaries violated their duties by undercutting the financial health of the pension plan they managed.  The plaintiffs alleged that the fiduciaries breached their duties by not enforcing the contribution terms of the Trust Indenture when they allowed one participating local union’s members at one company to contribute to the plan at lower rates than other members form the same local at another company.  Notably, the case did not involve a review of a claim for benefits, and the court’s decision did not turn on claim review.

The Bator court upheld the fiduciary decision by reasoning that the fiduciary interpretation of the governing plan document “falls comfortably within the range of reasonable interpretations” and “is compatible with the language and the structure” of that document.  The Court did so even though it recognized that the plaintiffs’ interpretation of the Trust Indenture was equally reasonable.

So, how can these very different standards of judicial review be reconciled?

Yes, reconciliation is possible.  ERISA’s core focus is the governing plan documents.  If, as in Bator, they provide the fiduciary with broad discretion to interpret their terms, and provide that the fiduciary decision shall be final and binding, the court should give the fiduciary the benefit of the doubt.

One final point is worth noting.  Plaintiffs often argue that equitable principles should govern judicial review of fiduciary decisions.  However, as Justice Thomas said recently in his concurrence in Thole v. U.S. Bank, 140 S.Ct. 1615 (2020), the common law of trusts is not the starting point for interpreting ERISA.  The starting point is the statute itself, and the statute commands that the courts honor ERISA plan terms, including terms that give interpretative discretion to fiduciaries.

Our take away is—there is no substitute for good drafting of ERISA plan terms.

Mark Casciari and Ronald Kramer

§1.18 First Circuit Rules that Private Equity Funds Not Liable for Portfolio Company’s Multiemployer Plan Withdrawal Liability

In a decision published on November 22, 2019, the First Circuit reversed a district court’s prior decision and held two Sun Capital private equity funds were not liable for the withdrawal liability incurred when a jointly owned portfolio company declared bankruptcy and withdrew from a union pension fund.  Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 16-1376, 2019 WL 6243370 (1st Cir. Nov. 22, 2019).

The case arose after a brass manufacturing company, Scott Brass, Inc. (SBI), filed for bankruptcy following the decline of copper prices.  In connection with the bankruptcy, SBI withdrew from a multiemployer pension plan, incurring $4.5 million in withdrawal liability.  At the time of bankruptcy, SBI was a portfolio company owned by a holding company that itself was jointly owned by two private equity funds, Sun Capital Partners III, LP (Sun Fund III) and Sun Capital Partners IV, LP (“Sun Fund IV” and, collectively, the “Sun Funds”).  The Sun Funds were sponsored and managed by a private equity firm, Sun Capital Advisors, Inc.  The multiemployer pension plan assessed withdrawal liability against both SBI and the Sun Funds on the grounds that the Sun Funds were a partnership exercising common control over SBI.

Under ERISA, as amended by the Multiemployer Pension Plan Amendments Act of 1980, when an employer exits a multiemployer pension plan, the plan may assess withdrawal liability on the employer for the employer’s share of unfunded vested benefits.  ERISA provides that, when “trades or businesses” are under “common control,” they are treated as a single employer.  It follows, then, that trades or businesses under common control are jointly and severally responsible for any withdrawal liability incurred by one of the trades or businesses.  With respect to “common control,” for purposes of withdrawal liability, the Pension Benefit Guaranty Corporation (PBGC) adopted regulations that generally mirror IRS controlled group regulations: common control exists if there is individual or aggregated ownership of at least 80%.

In 2013 and 2016, the District Court of Massachusetts found that the Sun Funds were not only “trades or businesses,” but also a partnership-in-fact (i.e., a partnership under common law) acting under “common control” with SBI.  Sun Fund III and Sun Fund IV had individual investment stakes in the portfolio company of only 70% and 30%, respectively, so the strict common control ownership threshold was not met.  However, the critical partnership-in-fact finding meant those individual ownership stakes were nevertheless aggregated for determining common control.  Narrowly, those rulings meant the Sun Funds were jointly and severally liable for SBI’s withdrawal liability.  More broadly, those rulings threatened the fundamental way private equity funds are established, funded, and operated.

Because the First Circuit had previously ruled that Sun Fund III was a trade or business (and, on remand, the lower court found the same for Sun Fund IV), the outstanding issue on appeal was whether the Sun Funds had indeed formed a partnership-in-fact that caused the Sun Funds’ individual ownership stakes in SBI to be aggregated.  In the absence of formal guidance from the PBGC on determining when separate entities are considered to be a partnership-in-fact, the First Circuit turned to the partnership factors articulated in an old tax court case, Luna v. Commissioner¹ for its analysis.  Those factors are:

1. The agreement of the parties and their conduct in executing its terms;
2. The contributions, if any, which each party has made to the venture;
3. The parties’ control over income and capital and the right of each to make withdrawals;
4. Whether each party was a principal and co-proprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income;
5. Whether business was conducted in the joint names of the parties;
6. Whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers;
7. Whether separate books of account were maintained for the venture; and
8. Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.

Applying these Luna factors, the First Circuit noted that some facts supported a partnership-in-fact between the Sun Funds.  For instance, the Sun Funds scouted potential portfolio companies, and essentially the same two individuals ran both the Sun Funds.  However, the First Circuit found facts supporting the opposite finding more compelling.  That is, the Sun Funds expressly disclaimed any sort of partnership with each other in their respective limited partnership agreements and each was created as a separate LLC; they filed separate tax returns and maintained separate books and bank accounts; most of the 230 limited partners in Sun Fund IV were not also limited partners in Sun Fund III; and the Sun Funds did not invest in parallel in the same portfolio companies.

In the end, the First Circuit recognized conflicting policy goals—on the one hand, the need “to ensure the viability of existing pension funds,” and, on the other hand, the need “to encourage the private sector to invest in, or assume control of, struggling companies with pension plans[.]” The court also stated it was reluctant to impose withdrawal liability on the Sun Funds when there was neither clear congressional intent to do so nor formal guidance from the PBGC.

While this is certainly a positive outcome for private equity funds, the First Circuit’s decision was very narrow and fact specific—the court did not reverse the district court’s earlier decision that the Sun Funds were “trades or businesses,” and the court noted that it did not “reach other arguments that might have been available to the parties.” This suggests that had the facts been different, the court could have ruled the other way.

Bryan M. O’Keefe, Ronald Kramer, and Samuel Rubinstein

Editor

Bradford K. Newman

Principal, Litigation
Chair of North America
Trade Secrets Practice
Baker McKenzie
600 Hansen Way
Palo Alto, CA 94304
(650) 856-5509
[email protected]

Assistant Editor

Adam Aft

Partner, IPTech
Co-Chair Global Technology Transactions
Baker McKenzie
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Chicago, IL 60001
(312) 861-2904
[email protected]

Contributor, Legislation Section

Yoon Chae

Senior Associate, IPTech
Baker McKenzie
1900 N. Pearl Street, Suite 1500
Dallas, TX 75201
(214) 965-7204
[email protected]

Introduction

We are pleased to present the inaugural Chapter on Artificial Intelligence.  For years, I have been at the forefront of advocating for rational federal regulation of AI and have published on AI ethics and fairness.I frequently represent clients with legal issues related to both commercial and embedded AI.  Additionally, I am the host of the ABA’s AI.2day Podcast.  In 2018, my proposed legislation, The AI Data Protection Act, was formalized into a House of Representatives Draft Discussion Bill.  In 2021, the ABA will publish my book which is designed to be an AI field guide for business lawyers. 

So I was thrilled when the Section agreed that the Annual Review should include a new Chapter devoted entirely to AI.  Before any substantive federal legislation is enacted, many legal issues related to AI will play out in state and federal courts around the country.  As applications of artificial intelligence, including machine learning, continue to be deployed in a myriad of ways that impact our health, work, education, sleep, security, social interaction, and every other aspect of our lives, many critical questions do not have clear cut answers yet.  Companies, counsel, and the courts will, at times, struggle to grasp technical concepts and apply existing law in a uniform way to resolve business disputes.  Thus, tracking and understanding the emerging body of law is critically important for business lawyers called on to advise clients in this area.  As with other areas of emerging technology, the courts will be faced with applying legal doctrines in new ways in view of the nature of the technology ranging from the use of AI in criminal cases to the impact of AI on patentable subject matter.

The goal of this Chapter is to serve as a useful tool for those business attorneys who seek to be kept up to date on a national basis concerning how the courts are deciding cases involving AI.  Micro and macro trends can only be identified by surveying cases around the country.  We confidently predict the cases we report will increase exponentially year over year.

As this is our first installment of the AI Chapter in a burgeoning field, we made some editorial decisions: (i) we included a few cases older than the past year; (ii) unlike other Chapters, we have included cases of note recently filed in the lower courts which we will track in subsequent editions; and (iii) we included legislation and pending legislation in our summary.

We also made certain judgments as to what should be included.  A notable example is facial recognition.  Due to the nature of the underlying technology and the complexity of facial recognition, the subject matter necessarily involve issues of algorithmic/artificial intelligence.  However, we did not include every case that references facial recognition when the issue at bar pertained to procedural aspects such as class certification (e.g., class action lawsuits filed under the Illinois Biometric Information Privacy Act (BIPA) (740 ILCS 14).

Finally, I want to thank my two colleagues, Adam Aft and Yoon Chae, for their assistance in preparing this inaugural chapter.  Adam and Yoon are both knowledgeable and accomplished AI attorneys with whom I frequently collaborate.  We are excited to add many colleagues from other firms around the country to next year’s Chapter.

We hope this Chapter provides useful guidance to practitioners of varying experience and expertise and look forward to tracking the trends in these cases and presenting the cases arising in the next several years.

Bradford Newman

United States Supreme Court

There were no qualifying decisions by the United Sates Supreme Court.  We note the Court has heard a number of cases foreshadowing the types of issues that will soon arise with respect to artificial intelligence, such as United States v. Am. Library Ass’n (539 U.S. 194 (2003)), in which a plurality of the Court upheld the constitutionality of filtering software that libraries had to implement pursuant to the Children’s Internet Protection Act, and Gill v. Whitford (138 S. Ct. 1916 (2017)), in which, if the plaintiffs had standing, the Justices may have had to evaluate the use of sophisticated software in redistricting (a point noted again in Justice Kagan’s express reference to machine learning in her dissent in Rucho v. Common Cause (139 S. Ct. 2484 (2019))).  The Court had previously concluded that a “people search engine” site presenting incorrect information that prejudiced a plaintiff’s job search was a cognizable injury under the Fair Credit Reporting Act in Spokeo, Inc. v. Robins (136 S. Ct. 1540 (2016)).  These cases are representative of the type of any number of cases that are likely to make their way to the Court in the near future that will require the Justices to contemplate artificial intelligence, machine learning, and the impact of the use of these technologies.

First Circuit

There were no qualifying decisions within the First Circuit.

Second Circuit

Force v. Facebook, Inc., 934 F.3d 53 (2d Cir. 2019). Victims, estates, and family members of victims of terrorist attacks in Israel alleged that Facebook was a provider of terrorist postings where they developed and used algorithms designed to match users’ information with other users and content.  The court held that Facebook was a publisher protected by Section 230 of the Communications Decency Act and that the term “publisher” under the Act was not so limited that Facebook’s use of algorithms to match information with users’ interests changed Facebook’s role as a publisher.

Additional Cases of Note

Calderon v. Clearview AI, Inc., 2020 U.S. Dist. LEXIS 94926 (S.D.N.Y. 2020) (stating the court’s intent to consolidate cases against Clearview based on a January 2020 New York Times article alleging defendants scraped over 3 billion facial images from the internet and scanned biometric identifiers and then used those scans to create a searchable database, which defendants then allegedly sold access to the database to law enforcement, government agencies, and private entities without complying with BIPA); see also Mutnick v. Clearview AI, Inc., 2020 U.S. Dist. LEXIS 109864 (N.D. Ill. 2020).

People v. Wakefield, 175 A.D.3d 158 (N.Y. App. Div. 2019) (concluding no violation of the confrontation clause where the creator of artificial intelligence software was the declarant, not the “sophisticated and highly automated tool powered by electronics and source code”); see also People v. H.K., 2020 NY Slip Op 20232, 130 N.Y.S.3d 890 (Crim. Ct. 2020) (following Wakefield in concluding that, where software was “acting as a highly sophisticated calculator,” the analyst using the software was still a declarant and the right to confrontation was preserved).

Vigil v. Take-Two Interactive Software, Inc., 235 F. Supp. 3d 499 (S.D.N.Y. 2017) (affirmed in relevant part by Santana v. Take-Two Interactive Software, Inc., 717 Fed.Appx. 12 (2d Cir. 2017)) (concluding that BIPA doesn’t create a concrete interest in the form of right-to-information, but instead operates to support the statute’s data protection goal; therefore, defendant’s bare violations of the notice and consent provisions of BIPA were dismissed for lack of standing).

LivePerson, Inc. v. 24/7 Customer, Inc., 83 F. Supp. 3d 501 (S.D.N.Y. 2015) (determining plaintiff adequately pleaded possession and misappropriation of a trade secret where plaintiff alleged its “predictive algorithms” and “proprietary behavioral analysis methods” were based on many years of expensive research and were secured by patents, copyrights, trademarks and contractual provisions).

Third Circuit

Zaletel v. Prisma Labs, Inc., No. 16-1307-SLR, 2017 U.S. Dist. LEXIS 30868 (D. Del. Mar. 6, 2017).  The plaintiff had a “Prizmia” photo editing app.  The plaintiff alleged trademark infringement based on the defendant’s “Prisma” photo transformation app.  In reviewing the Third Circuit’s likelihood of confusion factors, the court considered the competition and overlap factor.  The court concluded that, “while plaintiff broadly describes both apps as distributing photo filtering apps, the record demonstrates that defendant’s app analyzes photos using artificial intelligence technology and then redraws the photos in a chosen artistic style, resulting in machine generated art.  Given these very real differences in functionality, it stands to reason that the two products are directed to different consumers.”

Fourth Circuit

Sevatec, Inc. v. Ayyar, 102 Va. Cir. 148 (Va. Cir. Ct. 2019).  The court noted that matters such as data analytics, artificial intelligence, and machine learning are complex enough that expert testimony is proper and helpful and such testimony does not invade the province of the jury.

Fifth Circuit

Aerotek, Inc. v. Boyd, 598 S.W.3d 373 (Tex. App. 2020).  The court expressly acknowledged that one day courts may have to determine whether machine learning and artificial intelligence resulted in software altering itself and inserting an arbitration clause after the fact.

Additional Cases of Note

Bertuccelli v. Universal City Studios LLC, No. 19-1304, 2020 U.S. Dist. LEXIS 195295 (E.D. La. Oct. 21, 2020) (denying a motion to disqualify an expert the court concluded was component to testify in a copyright infringement case after having performed an “artificial intelligence assisted facial recognition analysis” of the plaintiff’s mask and the alleged infringing mask).

Sixth Circuit

Delphi Auto, PLC v. Absmeier, 167 F. Supp. 3d 868 (E.D. Mich. 2016).  Plaintiff employer alleged defendant former employee breached his contractual obligations by terminating his employment with the plaintiff and accepting a job with Samsung in the same line of business.  Defendant worked for the plaintiff as director of its labs in Silicon Valley, managing engineers and programmers on work related to autonomous driving.  Defendant had signed a confidentiality and noninterference agreement.  The court concluded that the plaintiff had a strong likelihood of success on the merits of its breach of contract claim.  Therefore, the court granted the plaintiff’s motion for preliminary injunction with certain modifications (namely, limiting the applicability of the non-compete provision to the field of autonomous vehicle technology for one year because the Court determined that autonomous vehicle technology is a “small and specialized field that is international in scope” and, therefore, a global restriction was reasonable).

Additional Cases of Note

In re C.W., 2019-Ohio-5262 (Oh. Ct. App. 2019) (noting that “[p]roving that an actual person is behind something like a social-networking account becomes increasingly important in an era when Twitter bots and other artificial intelligence troll the internet pretending to be people”).

Seventh Circuit

Bryant v. Compass Group USA, Inc., 958 F.3d 617 (7th Cir. 2020).  Plaintiff vending machine customer filed class action against vending machine owner/operator, alleging violation of BIPA when it required her to provide a fingerprint scan before allowing her to purchase items.  The district court found defendant’s alleged violations were mere procedural violations that cause no concrete harm to plaintiff and, therefore, remanded the action to state court.  The Court of Appeals held that a violation of § 15(a) (requiring development of a written and public policy establishing a retention schedule and guidelines for destroying biometric identifiers and information) of BIPA did not create a concrete and particularized injury and plaintiff lacked standing under Article III to pursue the claim in federal court.  In contrast, the Court of Appeals held that a violation of § 15(b) (requiring private entities make certain disclosures and receive informed consent from consumers before obtaining biometric identifiers and information) of BIPA did result in a concrete injury (plaintiff’s loss of the power and ability to make informed decisions about the collection, storage and use of her biometric information) and she, therefore, had standing and her claim could proceed in federal court.[1]

Rosenbach v. Six Flags Entertainment Corporation, 129 N.E.3d 1197 (Ill. 2019).  Rosenbach is a key Supreme Court of Illinois case answering whether one qualifies as an “aggrieved” person for purposes of BIPA and may seek damages and injunctive relief if she hasn’t alleged some actual injury or adverse effect beyond a violation of her rights under the statute.  Plaintiff purchased a season pass for her son to defendant’s amusement park.  Plaintiff’s son was asked to scan his thumb into defendant’s biometric data capture system and neither plaintiff nor her son were informed of the specific purpose and length of term for which the son’s fingerprint had been collected.  Plaintiff brought suit alleging violation of BIPA.  The Supreme Court of Illinois held that an individual need not allege some actual injury or adverse effect, beyond violation of his or her rights under BIPA, to qualify as an “aggrieved” person under the statute and be entitled to seek damages and injunctive relief.  The court reasoned that requiring individuals to wait until they’ve sustained some compensable injury beyond violation of their statutory rights before they can seek recourse would be antithetical to BIPA’s purposes.  The court found that BIPA codified individuals’ right to privacy in and control over their biometric identifiers and information.  Therefore, the court found also that a violation of BIPA is not merely “technical,” but rather the “injury is real and significant.”

Additional Cases of Note

Kloss v. Acuant, Inc., 2020 U.S. Dist. LEXIS 89411 (N.D. Ill. 2020) (applying Bryant v. Compass Group (summarized in this chapter) and concluding that the court lacked subject-matter jurisdiction over plaintiff’s BIPA § 15(a) claims because a violation of § 15(a) is procedural and, thus, does not create a concrete and particularized Article III injury).

Acaley v. Vimeo, 2020 U.S. Dist. LEXIS 95208 (N.D. Ill. June 1, 2020) (concluding that parties made an agreement to arbitrate because defendant provided reasonable notice of its terms of service to users by requiring users to give consent to its terms when they first opened the app and when they signed up for a free subscription plan, but the BIPA violation claim alleged by the plaintiff was not within the scope of the parties’ agreement to arbitrate because the “Exceptions to Arbitration” clause excluded claims for invasion of privacy).

Heard v. Becton, Dickinson & Co., 2020 U.S. Dist. LEXIS 31249 (N.D. Ill. 2020) (concluding that, for § 15(b) to apply, an entity must at least take an active step to “collect, capture, purchase, receive through trade, or otherwise obtain” biometric data and the plaintiff did not adequately plead that defendant took any such active step where the complaint omitted specific factual detail and merely parroted BIPA’s statutory language and the plaintiff failed to adequately plead possession because he failed to sufficiently allege that defendant “exercised any dominion or control” over his fingerprint data).

Rogers v. CSX Intermodal Terminals, Inc., 409 F. Supp. 3d 612 (N.D. Ill. 2019) (denying defendant’s motion to dismiss and relying on the Illinois Supreme Court’s holding in Rosenbach (summarized in this chapter) to conclude that plaintiff’s right to privacy in his fingerprint data included “the right to give up his biometric identifiers or information only after receiving written notice of the purpose and duration of collection and providing informed written consent”).

Neals v. PAR Technology Corp., 419 F. Supp. 3d 1088 (N.D. Ill. 2019) (concluding that BIPA does not exempt a third-party non-employer collector of biometric information when an action arises in the employment context, rejecting defendant’s argument that a third-party vendor couldn’t be required to comply with BIPA because only the employer has a preexisting relationship with the employees).

Ocean Tomo, LLC v. PatentRatings, LLC, 375 F. Supp. 3d 915, 957 (N.D. Ill. 2019) (determining that Ocean Tomo training its machine learning algorithm on PatentRatings’ patent database violated a requirement in a license agreement between the parties that prohibited Ocean Tomo from using the database (which was designated as PatentRatings confidential information) from developing a product for anyone except PatentRatings).

Liu v. Four Seasons Hotel, Ltd., 2019 IL App(1st) 182645, 138 N.E.3d 201 (Ill. 2019) (noting that “simply because an employer opts to use biometric data, like fingerprints, for timekeeping purposes does not transform a complaint into a wages or hours claim”).

Eighth Circuit

There were no qualifying decisions within the Eighth Circuit.

Ninth Circuit

Patel v. Facebook, Inc., 932 F.3d 1264 (9th Cir. 2019).  Facebook moved to dismiss plaintiff users’ complaint for lack of standing on the ground that the plaintiffs hadn’t alleged any concrete injury as a result of Facebook’s facial recognition technology.  The court concluded that BIPA protects concrete privacy interests, and violations of BIPA’s procedures actually harm or pose a material risk of harm to those privacy interests.

WeRide Corp. v. Kun Huang, 379 F. Supp. 3d 834 (N.D. Cal. 2019).  Autonomous vehicle companies brought, inter alia, trade secret misappropriation claims against former director and officer and his competing company.  The court determined the plaintiff showed it was likely to succeed on the merits of its trade secret misappropriation claims where it developed source code and algorithms for autonomous vehicles over 18 months with investments of over $45M and restricted access to its code base to on-site employees or employees who use a password-protected VPN.  Plaintiff identified its trade secrets with particularity where it described the functionality of each trade secret and named numerous files in its code base because plaintiff was “not required to identify the specific source code to meet the reasonable particularity standard.”

Additional Cases of Note

Hatteberg v. Capital One Bank, N.A., No. SA CV 19-1425-DOC-KES, 2019 U.S. Dist. LEXIS 231235 (C.D. Cal. Nov. 20, 2019) (relying on advances in technology, including use of artificial intelligence to “deepfake” audio, as a basis for denying defendant’s argument that a plaintiff must plead to a higher standard alleging specific indicia of automatic dialing to survive a motion to dismiss in a Telephone Consumer Protection Act case).

Williams-Sonoma, Inc. v. Amazon.com, Inc., No. 18-cv-07548-EDL, 2019 U.S. Dist. LEXIS 226300, at *36 (N.D. Cal. May 2, 2019) (denying Amazon’s motion to dismiss Williams-Sonoma’s service mark infringement case noting “it would not be plausible to presume that Amazon conducted its marketing of Williams-Sonoma’s products without some careful aforethought (whether consciously in the traditional sense or via algorithm and artificial intelligence)”).

Nevarez v. Forty Niners Football Co., LLC, No. 16-cv-07013-LHK (SVK), 2018 U.S. Dist. LEXIS 182255 (N.D. Cal. Oct. 16, 2018) (determining that protections exist such as protective orders and the Federal Rules of Evidence that prohibit a party from using artificial intelligence to identify non-responsive documents without identifying a “cut-off” point for some manner of reviewing the alleged non-responsive documents).

Tenth Circuit

There were no qualifying decisions within the Tenth Circuit.

Eleventh Circuit

There were no qualifying decisions within the Eleventh Circuit.

D.C. Circuit

Elec. Privacy Info. Ctr. v. Nat’l Sec. Comm’n on Artificial Intelligence, No. 1:19-cv-02906 (TNM), 2020 U.S. Dist. LEXIS 95508 (D.D.C. June 1, 2020).  The court concluded that the National Security Commission on Artificial Intelligence is subject to both the Freedom of Information Act and the Federal Advisory Committee Act.

Court of Appeals for the Federal Circuit[2]

McRO, Inc. v. Bandai Namco Games America, Inc., 837 F.3d 1299 (Fed. Cir. 2016).  Patent litigation over a patent which claimed a method of using a computer to automate the realistic syncing of lip and facial expressions in animated characters.  The plaintiff owners of the patents brought infringement actions, and defendants argued the claims were unpatentable algorithms that merely took a preexisting process and made it faster by automating it on a computer.  The court held that the patent claim was not directed to ineligible subject matter where the claim involved the use of automation algorithms and was specific enough such that the claimed rules would not prevent broad preemption of all rules-based means of automating facial animation.

Filed Cases

• Kraus v. Cegavske, No. 82018, 2020 Nev. Unpub. LEXIS 1043 (Nov. 3, 2020). A lawsuit filed challenging, on behalf of President Trump, use of AI to authenticate ballot signatures.
• Williams-Sonoma Inc. v. Amazon.com, Inc. (N.D. Cal. 3:18-cv-07548). Williams-Sonoma asserted a copyright infringement claim against Amazon related to how Amazon sells Williams-Sonoma’s products.  Amazon argued that Williams-Sonoma didn’t state a claim for direct copyright infringement because it didn’t plead that Amazon engaged in “volitional conduct” where the algorithm chooses the disputed images.  Williams-Sonoma argued that the Copyright Act covers “anyone” who violates it and the term encompasses artificial intelligence and “software agents.”
• Asif Kumandan et al. v. Google LLC (N.D. Cal. 5:19-cv-04286). Plaintiff Google Assistant users filed a wiretapping class action against Google, alleging they were recorded without their consent or knowledge when the artificial intelligence voice recognition program allegedly recorded their conversations when plaintiffs never uttered the trigger words.
• Vance et al v. Amazon.com, Inc. (W.D. Wa. 2:20-cv-01084); Vance et al v. Facefirst, Inc. (C.D. Cal. 2:20-cv-06244); Vance et al v. Google LLC (N.D. Cal. 5:20-cv-04696); and Vance et al v. Microsoft Corporation (W.D. Wa. 2:20-cv-01082). Chicago residents Steven Vance and Tim Janecyk filed four nearly identical proposed class actions against Amazon.com, Inc., Google LLC, Microsoft Corp., and a fourth company called Facefirst Inc., alleging the companies violated Illinois’ Biometric Information Privacy Act by “unlawfully collecting, obtaining, storing, using, possessing and profiting from the biometric identifiers and information” of plaintiffs without their permission.  Plaintiffs allege that the tech companies used the dataset containing their geometric face scans to train computer programs how to better recognize faces.  These companies, in an attempt to win an “arms race,” are working to develop the ability to claim a low identification error rate.  Allegedly, the four tech giants obtained plaintiffs’ face scans by purchasing a dataset created by IBM Corp. (the subject of another suit brought by Janecyk).
• Janecyk v. IBM Corp. (Cook County Cir. Ct. Ill. 2020CH00833). IBM Corp. was accused in an Illinois state court lawsuit of violating the state’s biometrics law when it allegedly collected photographs to develop its facial recognition technology without obtaining consent from the subjects to use biometric information.  Plaintiff Janecyk, a photographer, said that at least seven of his photos appeared in IBM’s “diversity in faces” dataset.  The photos were used to generate unique face templates that recognized the subjects’ gender, age and race, and were given to third parties without consent.  IBM allegedly created, collected and stored millions of face templates—highly detailed geometric maps of the face—from about a million photos that make up the “diversity in faces” database. Janecyk claimed that IBM obtained the photos from Flickr, a website where users upload their photos.  IBM obtained photos depicting people Janecyk has photographed in the Chicago area whom he had assured he was only taking their photos as a hobbyist and that their images wouldn’t be used by other parties or for a commercial purpose.
• Jordan Stein v. Clarifai, Inc. (Cook County Cir. Ct. Ill. 2020CH01810). Clarifai, Inc., an artificial intelligence company, allegedly violated Illinois’ privacy law when it captured and profited from the profile photos of OKCupid Inc. users without their permission or knowledge, according to a lawsuit filed in Illinois state court.  The company allegedly harvested the profile photos of tens of thousands of users, scanned the facial geometry to create face templates, and used the data to develop and train its facial recognition technology.
• K. et al v. Google, LLC (N.D. Cal. 5:20-cv-02257). A proposed class action filed in California federal court alleged that Google violated federal privacy laws by selling and distributing Chromebooks that collect and store students’ facial and voice data.  The complaint alleged that Google violated BIPA and the federal Children’s Online Privacy Protection Act (COPPA).  Chromebooks come with a “G Suite for Education” platform through which Google collects face templates, or scans of a person’s face, as well as voice data, location data and search histories without permission, the complaint says.  Google never informed the parents of the purpose and length of term for which their children’s biometric identifiers and information would be collected, stored and used.  The complaint proposes two classes: (1) a BIPA class and (2) a COPPA class.  The BIPA class seeks an injunction requiring Google to comply with BIPA and destroy data it has collected, plus monetary damages.  The COPPA class seeks an injunction requiring Google to obtain parental consent to collect biometric data and delete data already collected without consent.  The plaintiffs have moved to dismiss the case without prejudice.
• Williams et al. v. PersonalizationMall.com LLC (N.D. Ill. 1:20-cv-00025). An online gift platform, PersonalizationMall.com, owned by Bed Bath & Beyond, moved to dismiss or stay an action against it accusing the online retailer of violating its rights under BIPA.  Plaintiffs allege that they were never informed in writing that PersonalizationMall.com was capturing, collecting, storing or using their biometric information and they never signed a release consenting.  The company moved for dismissal or, in the alternative, moved for the court to stay the case pending Illinois’ Appellate Court decision on whether the Illinois Workers’ Compensation Act (IWCA) preempts claims under BIPA.  The company argues that plaintiffs’ claims clearly arose from their employment because they are challenging PersonalizationMall.com’s requirement that warehouse workers use their fingerprints to track hours and breaks.

Legislation

We organize the enacted and proposed legislation into (i) policy (e.g., executive orders); (ii) algorithmic accountability (e.g., legislation aimed at responding to public concerns regarding algorithmic bias and discrimination); (iii) facial recognition; (iv) transparency (e.g., legislation primarily directed at promoting transparency in use of AI); and (v) other (e.g., other pending bills such as federal bills on governance issues for AI).

Policy

• [Fed] Maintaining Am Leadership in AI (Feb 2019). Executive order 13859 (Feb. 2019) launching “American AI Initiative” intended to help coordinate federal resources to support development of AI in the US.
• [Fed] H R Res 153 (Feb 2019). Legislation to support the development of guidelines for ethical development of artificial intelligence.
• [Fed / NIST] US Leadership in AI (Aug 2019). NIST to establish standards to support reliable, robust and trustworthy AI.
• [CA] Res on 23 Asilomar AI Principles (Sep 2018). Adopted state resolution ACR 215 (Sept. 2018) expressing legislative support for the Asilomar AI Principles as “guiding values” for AI development.

Algorithmic Accountability

• [Fed] Algorithmic Accountability Act (Apr 2019). Bills S 1108, HR 2231 (Apr. 2019) intended to require “companies to regularly evaluate their tools for accuracy, fairness, bias, and discrimination.”
• [NJ] New Jersey Algorithmic Accountability Act (May 2019). Require that certain businesses conduct automated decision system and data protection impact assessments of their automated decision system and information systems.
• [CA] AI Reporting (Feb 2019). Require California business entities with more than 50 employees and associated contractors and vendors to each maintain a written record of the data used relating to any use of artificial intelligence for the delivery of the product or service to the public entity.
• [WA] Guidelines for Gov’t Procurement and Use of Auto Decision Systems (Jan 2019). Establish guidelines for government procurement and use of automated decision systems in order to protect consumers, improve transparency, and create more market predictability.
• [NY] NYC (Jan 2018). —“A local law in relation to automated decision systems used by agencies” (Int. No. 1696-2017) required the creation of a task force for providing recommendations on how information on agency automated decision systems may be shared with the public and how agencies may address situations where people are harmed by such agency automated decision systems.

Facial Recognition Technology

• [Fed] Commercial Facial Recognition Privacy Act (Mar 2019). Bill S 847 (Mar. 2019) intended to provide people information and control over how their data is shared with companies using facial recognition technology.
• [Fed] FACE Protection Act (July 2019). Restrict federal government from using a facial recognition technology without a court order.
• [Fed] No Biometric Barriers to Housing Act (July 2019). Prohibiting owners of certain federally assisted rental units from using facial recognition, physical biometric recognition, or remote biometric recognition technology in any units, buildings or grounds of such project.
• [CA] Body Camera Account Act (Feb 2019). Bill A.B. 1215 was introduced to prohibit law enforcement agencies and officials from using any “biometric surveillance system,” including facial recognition technology, in connection with an officer camera or data collected by the camera.
• [MA] An Act Establishing a Moratorium on Face Recognition (Jan 2019). Senate Bill 1385 was introduced to establish a moratorium on the use of face recognition systems by state and local law enforcement.
• [NY] Prohibits Use of Facial Recog. Sys. (May 2019). Senate Bill 5687 was introduced to propose a temporary stop to the use of facial recognition technology in public schools.
• [SF and Oakland, CA] City ordinances were passed to ban the use of facial recognition software by the police and other government agencies (June, July 2019).
• [Somerville, MA] City ordinance was passed to ban the use of facial recognition technology by government agencies (July 2019).

Transparency

• [CA] B O T Act – SB 1001 (effective July 2019). Enacted bill SB 1001 (eff. July 2019) intended to “shed light on bots by requiring them to identify themselves as automated accounts.”
• [CA] Anti- Eavesdropping Act (Assemb. May 2019). Prohibiting a person or entity from providing the operation of a voice recognition feature within the state without prominently informing the user during the initial setup or installation of a smart speaker device.
• [IL] AI Video Interview Act (effective Jan 2020). Provide notice and explainability requirements for recorded video interviews.

Other

• [Fed] FUTURE of AI Act (Dec 2017). Requiring the Secretary of Commerce to establish the Federal Advisory Committee on the Development and Implementation of Artificial Intelligence.
• [Fed] AI JOBS Act (Jan 2019). Promoting a 21st century artificial intelligence workforce.
• [Fed] GrAITR Act (Apr 2019). Legislation directed to research on cybersecurity and algorithm accountability, explainability and trustworthiness.
• [Fed] AI in Government Act (May 2019). Instructing the General Services Administration’s AI Center of Excellence to advise and promote the efforts of the federal government in developing innovative uses of AI to benefit the public, and improve cohesion and competency in the use of AI.
• [Fed] AI Initiative Act (May 2019). Requiring federal government activities related to AI, including implementing a National Artificial Intelligence Research and Development Initiative.

[1] As noted in our introduction, we made certain judgment calls with respect to which cases to include. For example, we omitted certain BIPA cases that did not add any additional information to those we have presented in this Chapter. See, e.g., Darty v. Columbia Rehabilitation and Nursing Center, LLC, 2020 U.S. Dist. LEXIS 110574 (N.D. Ill. 2020); Figueroa v. Kronos Incorporated, 2020 U.S. Dist. LEXIS 64131 (N.D. Ill. 2020); Namuwonge v. Kronos, Inc., 418 F. Supp. 3d 279 (N.D. Ill. 2019); Treadwell v. Power Solutions International Inc., 427 F. Supp. 3d 984 (N.D. Ill. 2019); Kiefer v. Bob Evans Farm, LLC, 313 F. Supp. 3d 966 (C.D. Ill. 2018); Rivera v. Google Inc., 238 F. Supp. 3d 1088 (N.D. Ill. 2017); In re Facebook Biometric Information Privacy Litigation, 185 F. Supp. 3d 1155 (N.D. Cal. 2016); Norberg v. Shutterfly, Inc., 152 F. Supp. 3d 1103 (N.D. Ill. 2015).

[2] As noted in our introduction, we made certain judgment calls with respect to which cases to include. For example, we omitted several patent cases directed to subject-matter eligibility that we felt did not substantiate additional insight to those we have presented in this Chapter. See, e.g., Kaavo Inc. v. Amazon.com, Inc., 323 F. Supp. 3d 630 (D. Del. 2018); Hyper Search, LLC v. Facebook, Inc., No. 17-1387, 2018 U.S. Dist. LEXIS 212336 (D. Del. Dec. 18, 2018); Purepredictive, Inc. v. H20.AI, Inc., No. 17-cv-03049, 2017 U.S. Dist. LEXIS 139056 (N.D. Cal. Aug. 29, 2017); Power Analytics Corp. v. Operation Tech., Inc., No. SA CV16-01955 JAK, 2017 U.S. Dist. LEXIS 216875 (C.D. Cal. July 13, 2017); Nice Sys. v. Clickfox, Inc., 207 F. Supp. 3d 393 (D. Del. 2016); eResearch Tech., Inc. v. CRF, Inc., 186 F. Supp. 3d 463 (W.D. Pa. 2016); Neochloris, Inc. v. Emerson Process Mgmt. LLP, 140 F. Supp. 3d 763 (N.D. Ill. 2015).

Editor

Tim Farahnik

Partner, Seyfarth Shaw LLP
601 South Figueroa Street Suite 3300
Los Angeles, CA 90017-5793
(213) 270-9656 phone
[email protected]

Introduction

The ongoing coronavirus pandemic has impacted nearly every aspect of Americans’ lives since mid-March, and the virus’s disruption to the world of real estate has been especially large and widespread.  Governmental authorities at all levels and in all areas of the country began taking swift and decisive measures to respond to the emergency at hand, often requiring citizens to shelter at home and ordering non-essential businesses of all types to close their doors or otherwise substantially scale back their operations.  In order to protect the interests of people who had lost their jobs and the businesses who could not operate at full capacity, many jurisdictions also imposed temporary eviction and foreclosure moratoria to stay in effect during the pandemic.  The effects of these actions on the basic functioning of the real estate market has been dramatic.  Many businesses and people could not meet their rent and mortgage obligations.  Landlords could no longer, for the most part, evict their tenants for nonpayment of rent.  Ongoing real estate purchase and financing transactions were put on hold indefinitely.  The ability to hold foreclosure sales was made much more difficult.  Real estate attorneys very quickly needed to become experts on the doctrine of force majeure.

As with any disruptive force, the COVID-19 pandemic soon resulted in a wave of lawsuits by individuals, companies and organizations who were negatively impacted by it.  This article will take an in-depth look at several of the prominent lawsuits that have thus far been fought and decided in the wake of the pandemic, to see how courts from all around the nation have tried to find the right balance between the interests of various parties who have been affected by these unprecedented events.

Part I – State and Local Challenges

As authorities at each of the federal, state, county and local levels enacted a broad range of measures to combat the spread of COVID-19 in their communities and to mitigate the negative effects of lockdowns and business closures on their citizens, many of these governmental regulations specifically targeted the rights and obligations of owners and renters of real property.  Not surprisingly, several parties who were especially harmed by these emergency regulations and who felt that their rights were being violated sought help from the courts to protect their interests, challenging the constitutionality of these laws, ordinances and orders.  Part I of this article will examine several significant decisions handed down in lawsuits challenging state and local COVID-19 regulations.

Elmsford Apartment Associates, LLC v. Cuomo

In Elmsford Apartment Associates, LLC v. Cuomo, three residential landlords brought suit in the United States District Court in New York seeking an injunction against Executive Order No. 202.28 on the grounds that the Executive Order violated their rights under the Takings Clause, Contracts Clause, Due Process Clause and Petition Clause of the United States Constitution.[1]

On March 2, 2020, in response to the first reported cases of COVID-19 in New York state, the legislature passed Senate Bill S7919, giving Governor Andrew Cuomo the power to suspend statues or regulations and issue accompanying directives “necessary to cope with the disaster,” provided that such measures are “in the interest of the health or welfare of the public,” “reasonably necessary to aid the disaster effort,” and “provide for minimum deviation” from existing laws.[2]  On March 20, 2020, Governor Cuomo issued Executive Order 202.8, the first of several orders issued to temporarily prohibit evictions and foreclosures of residential and commercial tenants.  One such subsequent order, Executive Order 202.28 (“EO 202.28”), was issued on May 7, 2020, allowing any tenant to use its security deposit (and any interest accrued on the deposit) as payment for rent under such tenant’s lease, and also suspending landlords’ ability to commence eviction proceedings for nonpayment of rent.[3]  The plaintiffs in Elmsford brought suit to challenge the constitutional validity of EO 202.28.

The Elmsford court first dismissed the plaintiffs’ claim that the eviction moratorium constitutes a physical taking of their property.  Citing various precedent from both the U.S. Supreme Court and the Second Circuit, the court reasoned that “[g]overnment action that does not entail a physical occupation, but merely affects the use and value of private property, does not result in a physical taking of property,” and that “a state does not commit a physical taking when it restricts the circumstances in which tenants may be evicted.”[4]  Importantly, because the eviction moratorium is “temporary on its face, and does not disturb the landlords’ ability to vindicate their property rights”[5]  at a later time (since rent arrearages will continue to accrue during such period and landlords will be able to evict their tenants once the moratorium expires), EO 202.28 does not constitute a physical taking of the plaintiffs’ property.

The court then concluded that EO 202.28 also does not constitute a regulatory taking of the plaintiffs’ property.  Regulatory takings fall into two categories – categorical and non-categorical.  A categorical regulatory taking occurs only when no productive or economic use of a property is permitted.  Since the plaintiffs still enjoyed many economic benefits of ownership, the court easily concluded that EO 202.28 is not a categorical taking.  As for a non-categorical taking, the court employed the three-pronged test established in Penn Central Transportation Co. v. New York City, weighing: (i) the economic impact of the regulation, (ii) the extent to which the regulation interferes with investment-backed expectations, and (iii) the character of the governmental action.[6]

The court’s evaluation of the economic impact of EO 202.28 was somewhat inconclusive, stating that “[i]t is difficult to quantify the precise economic impact that the eviction moratorium and security deposit provisions have had on Plaintiffs’ property,”[7]  while also recognizing that the Order did not prevent the plaintiffs from making any economic use of their property.  With regard to the plaintiff’s investment-backed expectations, the court noted that the plaintiffs understood that residential real estate is a heavily regulated industry with a broad range of pre-existing laws and rules governing all manners of the landlord-tenant relationship.  As such, “[t]he Order’s temporary adjustment of those rules, which does nothing more than defer the ability of the landlord to collect (or obtain a judgment for) the full amount of the rent the tenant freely agreed to pay, does not disrupt the landlords’ investment-backed expectations.”[8]  Finally, with respect to the character of the government action, the court concluded that “state governments may, in times of emergency or otherwise, reallocate hardships between private parties, including landlords and their tenants, without violating the Takings Clause.”[9]  Based on these evaluations, the Elmsford court also dismissed the plaintiffs’ claims that EO 202.28 constitutes a taking of their property.

The court then turned to the plaintiffs’ Contract Clause claims.  While the U.S. Constitution does prohibit states from passing any law “impairing the Obligation of Contracts,”[10] the Contracts Clause’s prohibition “does not trump the police power of a state to protect the general welfare of its citizens, a power which is ‘paramount to any rights under contracts between individuals.’”[11]  Here the court employed another three-pronged test, this one established under Buffalo Teachers Federation v. Tobe, asking whether: (i) the contractual impairment is substantial, (ii) the law serves a legitimate public purpose, and (iii) the means chosen to accomplish this purpose are reasonable and necessary.[12]

The Elmsford court again noted that because residential real estate is a heavily regulated industry, it is foreseeable that the state may impose future regulations on the industry and these potential future regulations are therefore “priced into [any] contracts formed under the prior regulation,”[13] and that “the foreseeability of additional regulation allows states to interfere with both past and future contracts.”[14]  The court went on to reason that EO 202.28 also sufficiently safeguards the plaintiffs’ ability to realize the benefit of their bargain.  With regard to the security deposit provisions of EO 202.28, since “the Order does not displace the civil remedies always available to landlords seeking to recover the costs of repairs or unpaid rents still owed at the end of a lease term,”[15] the security deposit provisions therefore “do not prevent Plaintiffs from ‘safeguarding or reinstating [their rights]’ as soon as the Order expires.”[16]  As it relates to the eviction moratorium portion of EO 202.28, the court concluded that it merely postpones but does not eliminate a landlord’s ability to seek eviction as a remedy, and also does not eliminate a tenant’s obligations under their lease, such that “the landlord may obtain a judgment for unpaid rent if tenants fail to honor their obligations.”  For these reasons, the court also concluded that EO 202.28 does not violate the Contracts Clause.

Finally, the Elmsford court quickly rejected both the plaintiffs’ Due Process and Petition Clause claims.  On the Due Process claim, the court reasoned that the plaintiffs failed to demonstrate substantial impairment of their property rights, as a mere potential decrease in value of such property is not sufficient to prevail on a due process claim.  Further, since the plaintiffs will be able to initiate new legal proceedings with respect to their leases once EO 202.28 is no longer in effect, they have also not been denied due process on this basis.  Similarly, the plaintiff’s Petition Clause claim failed since “mere delay to filing a lawsuit cannot form the basis of a Petition Claus violation when the plaintiff will, at some point, regain access to legal process”[17] and the “Plaintiffs’ right to collect both the monetary remedies and injunctive relief they would seek through an eviction proceeding has not been completely foreclosed.”[18]

Auracle Homes, LLC v. Lamont

In Auracle Homes, LLC v. Lamont, the United States District Court in Connecticut considered a similar challenge to the one decided by the Elmsford court.  In this case, numerous owners of residential property in Connecticut challenged the state’s Executive Order Nos. 7G, 7X and 7DDD on the grounds that they violate the Takings Clause, Contracts Clause and Due Process Clause of the U.S. Constitution.[19]

On March 10, 2020, Connecticut Governor Ned Lamont issued a declaration of public health and civil preparedness emergencies and proclaimed a state of emergency due to the COVID-19 outbreak in Connecticut and the United States, allowing the Governor to modify any statute that the Governor finds to be “in conflict with the efficient and expeditious execution of civil preparedness functions or the protection of public health.”[20]  On March 19, 2020, Governor Lamont issued Executive Order 7G, which suspended non-critical court operations.[21]  On April 10, 2020, Governor Lamont issued Executive Order 7X, which (i) temporarily bars residential landlords from delivering a notice to quit to their tenants or from serving any action for nonpayment of rent in most situations, (ii) provides for an automatic sixty-day grace period for April rents and a sixty-day grace period for May rents upon request, and (iii) allows renters who paid a security deposit of more than one month’s rent to apply such portion in excess of one month’s rent to any rent due for April, May or June.[22]  On June 29, 2020, Governor Lamont issued Executive Order 7DDD, which extends and expands the notice to quit prohibition and the security deposit provision of Executive Order 7X.[23]  In seeking to enjoin application of the Executive Orders, the plaintiffs in Auracle Homes argued that the “complete ban on all residential eviction proceedings imposed by Defendant’s Executive Orders nullifies Connecticut’s established statutory eviction procedures,”[24] having the effect of “leaving the Plaintiffs with no recourse, no process to follow, no venue to have their rights adjudicated, and nowhere to appeal.”[25]  The plaintiffs further argued that the Governor’s actions were “unreasonable and inappropriate” since the State “is fully capable or providing monetary relief to those tenants who are ultimately unable to pay on-going rent, either through direct payments to landlords, or by grants to tenants.”[26]

As in Elmsford, the Auracle Homes court quickly ruled out the possibility of a categorical regulatory taking and moved to an analysis of a non-categorical taking by applying the Penn Central factors described above.  Citing Elmsford, the court concluded that the plaintiffs’ claims did not “support a finding that the Executive Orders have a ‘constitutionally significant economic impact.’”[27]  As for the plaintiffs’ investment-backed expectations, the court reasoned that the Executive Orders merely regulate the terms governing how the plaintiffs may use their property as previously planned during a pandemic, and since the Executive Orders do not permanently relieve tenants from their obligations under their leases, “[t]he Executive Orders are a temporary adjustment of the status quo, and only defer the ability of residential landlords like Plaintiffs to collect, or obtain a judgment for, the full amount of rent the tenants agreed to pay.”[28]  As to the third prong of the Penn Central test, the court concluded that “the character of the governmental action also weighs against a finding that Plaintiffs have suffered a regulatory taking, because the Executive Orders are ‘part of a public program adjusting the benefits and burden of economic life to promote the common good.’”[29]  For all of these reasons, the court rejected the plaintiffs’ Takings Clause claims.

Turning next to the plaintiffs’ Contracts Clause claims, the Auracle Homes court also applied the Buffalo Teachers test to the Connecticut Executive Orders.  In deciding against substantial impairment of the plaintiffs’ rental contracts, the court again concluded that because residential real estate is a heavily regulated industry, some sort of legislative action in this field was foreseeable, and therefore both the eviction moratorium and the security deposit provisions could not be wholly unexpected.[30]  Further, as to the eviction moratorium, “the Executive Orders do not eliminate Plaintiffs’ contractual remedies for evicting nonpaying tenants; Plaintiffs instead have to wait” before taking action.[31]  In determining the second part of the Buffalo Teachers test as to whether the Executive Orders serve a legitimate public purpose, the court evaluated whether the state was “acting like a private party who reneges to get out of a bad deal, or is governing, which justifies its impairing the plaintiff’s contracts in the public interest.”[32]  Since the Executive Orders impair private contracts that do not directly involve the State, the court accorded “substantial deference” to the State’s stated reasoning that it was acting to promote the public interest.[33]  Therefore, even if the Executive Orders did create a substantial impairment of the plaintiffs’ leases, their claims would nevertheless fail because the Executive Orders promote a significant public purpose.  In determining the third and final factor in the Buffalo Teachers test as to whether the State acted reasonably in issuing the Executive Orders, the court argued that when governmental entities undertake actions “in areas fraught with medical and scientific uncertainties, their latitude must be especially broad.”[34]  Since there was “nothing in the record to suggest that Governor Lamont acted unreasonably,” the plaintiffs also failed this part of the analysis.  For all of the reasons summarized above, the Auracle Homes court wholly rejected the plaintiffs’ Contracts Clause claim.

The final analysis came with respect to the plaintiffs’ substantive and procedural Due Process claims, and much like the Elmsford court, the Auracle Homes court quickly rejected these claims.  Because the plaintiffs “failed to demonstrate a substantial impairment of their property rights”[35] or “an independent liberty or property interest”[36] requiring protection, the safeguards afforded by the principles of both substantive and procedural due process did not apply to the plaintiffs’ claims.

HAPCO v. City of Philadelphia

In HAPCO v. City of Philadelphia, an association of Philadelphia residential property owners and managers brought suit to enjoin the City of Philadelphia from implementing several temporary emergency laws enacted in response to the COVID-19 pandemic.[37]  On July 1, 2020, Philadelphia Mayor James Kenney signed into law a series of five separate bills collectively known as the Emergency Housing Protection Act (“EHPA”), which (i) temporarily prohibits landlords from evicting residential tenants and small business commercial tenants that can provide a certificate of hardship due to COVID-19, (ii) allows tenants who prove they have suffered a financial hardship due to COVID-19 to be able to pay past due rent on a set plan through May 31, 2021, (iii) requires landlords to attend mediation before taking steps to evict residential tenants who have suffered a financial hardship due to COVID-19, and (iv) temporarily bars landlords from charging late fees and interest to residential tenants who have suffered a financial hardship due to COVID-19.[38]  The plaintiffs sought to invalidate the EHPA on the grounds that it violates the Takings Clause, Contracts Clause and Due Process Clause of both the U.S. and Pennsylvania Constitutions.

The HAPCO court did not rule on the plaintiffs’ likelihood on the merits of its Takings Clause claims.  It ruled that, even if the plaintiffs were able to successfully argue that the EHPA constituted a governmental taking, the plaintiffs would be able to obtain other relief from the government in the form of just compensation for such taking, making an injunction on this basis inapplicable.

The plaintiffs argued that the EHPA violates the Contracts Clause because it compel[s landlords] to enter into contractual arrangements [the City has] devised, give up rights [landlords] had negotiated in pre-existing leases, and surrender their right to seek redress in a court of law.”[39]  The court applied the two-part Contracts Clause test set forth by the U.S. Supreme Court in Sveen: (i) whether the state law has created a “substantial impairment of a contractual relationship”[40], and (ii) if it has, then “whether the state law is drawn in an appropriate and reasonable way to advance a significant and legitimate public purpose.”[41]  Like Elmsford and Auracle Homes before it, the HAPCO court relied on the fact that real estate is a heavily regulated industry at each of the federal, state and local levels, subject to the real possibility of ongoing legislation, which should be foreseeable to the parties to any contract involving real property.[42]  Further, considering that the provisions of the EHPA are temporary in nature, meaning that “the tenants are still bound to their contracts, the contractual bargain is not undermined and landlord rights are safeguarded.”[43]  Given these factors, the court did not find a substantial impairment of the contractual relationship existed.  The court in HAPCO further concluded that, even if a substantial impairment had existed, the EHPA “is a reasonable way to advance a significant and legitimate purpose” to address the housing and public health emergency caused by the COVID-19 pandemic.[44]  Finally, the court reasoned that the EHPA is “an appropriate and reasonable way to advance the City’s purpose,” especially “[c]onsidering the deference owed to [the] legislative judgment” of the City to address the current emergency.[45]

Turning to the plaintiffs’ Due Process Clause claim, the court in HAPCO reasoned that this clause “generally does not prohibit retrospective civil litigation, unless the consequences are particularly harsh and oppressive,”[46] and that “state laws need only be rational and non-arbitrary in order to satisfy the right to substantive due process.”[47]  Because the EHPA meets all of these requirements, the court denied the plaintiffs’ due process claims as well.

Baptiste v. Kennealy

In Baptiste v. Kennealy, three landlords filed for a preliminary injunction with the United States District Court, District of Massachusetts, against the “Act Providing for a Moratorium on Evictions and Foreclosures during the COVID-19 Emergency,” enacted by the Massachusetts state legislature on April 20, 2020.[48]  The Act (i) prohibits all “non-essential evictions,” including residential evictions for a tenant’s failure to pay rent (without a tenant needing to certify that they are unable to pay rent due to the coronavirus pandemic), (ii) prohibits landlord from sending tenants notices to quit or any notices requesting or demanding that a tenant who has not paid rent leave the premises, and (iii) prohibits Massachusetts courts from accepting for filing any eviction case or taking any action in any pending eviction case.[49]  The plaintiffs brought suit, alleging that the Act violates the Takings Clause, Contracts Clause and Petition Clause of the U.S. Constitution, as well as the First Amendment to the U.S. Constitution because of the limits placed by the Act on the types and subject matter of notices that landlords could send to their tenants (which First Amendment arguments will not be analyzed here, as they are outside the scope of this article).[50]

With regard to the plaintiffs’ Takings Clause claim, the Baptiste court applied the same three-factor Penn Central test as used in Elmsford, Auracle Homes and HAPCO, and largely came to the same conclusions that: (i) no physical taking occurred[51], (ii) the economic impact of the Act does not support the finding of a taking because the effect on the plaintiffs’ property was only temporary and that “mere diminution in the value of property…is insufficient to demonstrate a taking,”[52] and (iii) the character of the government action does not support the finding of a taking because the moratorium is a “public program adjusting the benefits and burdens of economic life to promote the common good.”[53]  The only place in the takings analysis where the Baptiste court differed from the decisions reached in Elmsford, Auracle Homes and HAPCO was that the Baptiste court concluded that the moratorium does significantly interfere with the plaintiff’s investment-backed expectations, since “a reasonable landlord would not have anticipated a virtually unprecedented event like the COVID-19 pandemic and the ensuing six-month ban on evicting and replacing tenants who do not pay rent.”[54]  Despite this difference, however, the court in Baptiste ultimately reached the same conclusion reached in Elmsford, Auracle Homes and HAPCO that the Act did not constitute a regulatory taking of the plaintiffs’ property.[55]

In analyzing the plaintiffs’ Contracts Clause claim, the court applied the same two-factor test as the Elmsford, Auracle Homes and HAPCO cases summarized above, but noted that “[i]t is a close question whether the Moratorium substantially impairs the contracts that plaintiffs’ leases represent,” and also “a close question whether the Moratorium is a reasonable means of addressing the undisputed significant and legitimate need to combat the spread of the COVID-19 virus.”[56]  Regarding the substantial impairment question, the court also noted here that residential real estate is a heavily regulated industry, but also (in departing from the Elmsford, Auracle Homes and HAPCO courts’ analyses) that “a reasonable landlord would not have anticipated a virtually unprecedented event such as the COVID-19 pandemic that would generate a ban on even initiating eviction actions against tenant.”[57]  Regarding the reasonableness question, the Baptiste court recognized that the Act was more burdensome to landlords than the laws enacted in New York (as affirmed by Elmsford), Connecticut (as affirmed by Auracle Homes), and Philadelphia (as affirmed by HAPCO), leading to the conclusion that Massachusetts could have enacted a less restrictive law.[58]  In the final analysis, however, the court in Baptiste dismissed the plaintiffs’ Contracts Clause claim, citing the fact that the moratorium is only temporary, recognizing that the proper standard to judge the reasonableness of the law is whether there was a rational basis for enacting it rather than requiring the law to be drafted in the least restrictive way possible, and further reasoning that, because in the case at hand “the state is not an interested party, courts give deference to elected officials as to what is reasonable and appropriate.”[59]

Other Takings and Contracts Clause Suits

Several other lawsuits in various jurisdictions have also been filed to challenge the constitutionality or authority of state and local orders, law and restrictions enacted to combat the COVID-19 pandemic that do not directly involve regulation of real estate-related matters, but which lawsuits have asserted Takings Clause claims.  For instance, in TJM 64, Inc. v. Harris, filed in the United States District Court in the Western District of Tennessee, Western Division, several owners of bars and limited-service restaurants brought an action against officials in Shelby County, Tennessee challenging an order issued by the County Health Department requiring all such bars and limited service restaurants to close in an effort to combat the COVID-19 pandemic.[60]  In Friends of Danny DeVito v. Wolf, filed with the Supreme Court of Pennsylvania, several business owners and one individual in Pennsylvania filed an emergency ex parte application challenging Governor Tom Wolf’s March 19, 2020 Executive Order requiring the closure of the physical operations of all non-life-sustaining businesses in order to reduce the spread of the coronavirus within the State.[61]  In Lebanon Valley Auto Racing Corp. v. Cuomo, filed with the United States District Court in the Northern District of New York, five operators of outdoor auto racing facilities in the State of New York sought to invalidate Executive Order 202.32, which included a ban on spectators at racetracks in the state, on a Takings Clause claim.[62]  Finally, in Blackburn v. Dare County, filed in the United States District Court in the Eastern District of North Carolina – Northern Division, a couple who lived in Virginia but owned a vacation home in North Carolina brought suit against Dare County and several towns within the County to overturn a County declaration prohibiting nonresident visitors from entering the County in an effort to slow the spread of the coronavirus, by declaring that such prohibition constituted a taking of their private property.[63]

One additional suit of note that did directly implicate real estate was filed in California in San Francisco Apartment Association v. City and County of San Francisco, challenging Ordinance No. 93-20 enacted by the San Francisco Board of Supervisors that, among other things, permanently protects tenants from eviction for nonpayment of rent that was unpaid due to COVID-19 if the rent became due between March 16, 2020 and September 30, 2020.  In a one-page order, the judge in this case dismissed the plaintiffs’ Takings Clause and Contracts Clause claims along similar lines as the cases discussed above, as “a reasonable exercise of police power to promote public welfare.”[64]

All of the lawsuits noted above met the same fate as the Elmsford, Auracle Homes, Baptiste and HAPCO cases summarized above – namely, their Takings Clause claims were rejected, and the validity and authority of all of the laws or orders being challenged were upheld.  The analyses in these additional cases followed a similar track as the cases summarized above, in which the respective courts analyzed the Penn Central factors and reached the overarching conclusion that, since the contested laws or orders were temporary in nature, were an exercise of the governmental authority’s police power, were enacted with the intention of providing a public benefit and protecting citizens, and were drafted to be reasonably related to these goals, that they were all constitutionally valid.

Interestingly, each of the courts reached the same ultimate decision to uphold the laws or orders as written, even though certain courts differed on specific elements of the Penn Central analysis.  For instance, in TJM 64, the court concluded that the closure orders did “interfere in a significant way with Plaintiffs’ investment-backed expectations in their properties, despite their status as highly regulated entities.”[65]  However, even though the court conceded “that Plaintiffs will suffer devastating economic impacts if the Closure Orders remain in effect,”[66] the court nonetheless determined that such impacts did not rise to the level of a taking because of the government’s fundamental interest in promoting the common good, and recognizing that [l]abeling Defendants’ Order a taking would require the state to compensate every individual or property owner whose property use was restricted for the purpose of protecting public health [emphasis in original].”[67]  In Friends of Danny DeVito, the court convincingly distinguished between a government taking and the government’s legitimate use of its police power, stating that “[e]minent domain is the power to take property for public use…The police power, on the other hand, involves the regulation of property to promote the health, safety and general welfare of the people.”[68]  In Lebanon Valley, the court concluded that the economic impact of the regulation on the plaintiffs was substantial enough to weigh in favor of allowing the takings claim to proceed on that factor.[69]  However, because the state has issued the order to promote the common good in order to address an existing public health emergency, “[t]he character of the relevant governmental action therefore strongly favors Defendants.”[70]  Finally, the Blackburn court sided with the plaintiffs on the first two prongs of the Penn Central test, concluding that “plaintiffs do allege some unspecified amount of economic loss, which…would provide some support of plaintiffs’ takings claim,”[71] and that “Defendant County’s regulation did temporarily interfere with plaintiffs’ right to personally travel to their vacation property, diminishing plaintiffs’ right to use the property.”[72]  In the final analysis, however, the County’s interest in reducing the spread of the coronavirus and the reasonable relation of the declaration to this objective superseded the individual property rights that were negatively impacted by such regulation: “Defendant County’s concededly legitimate exercise of its emergency management powers under North Carolina law to protect public health in the ‘unprecedented’ circumstances presented by the COVID-19 pandemic, weighed against loss of use indirectly occasioned by preventing plaintiffs from personally accessing their vacation home for 45 days, does not plausibly amount to a regulatory taking of plaintiffs’ property.”[73]

Part II – Challenging The CDC Moratorium

On September 4, 2020, the Centers for Disease Control and Prevention (“CDC”), a division of the Department of Health and Human Services (“HHS”), issued a temporary eviction moratorium through December 31, 2020 with the intent of helping to prevent the spread of COVID-19 in the United States.  Although the moratorium prohibits evictions of certain renters covered by the order, it also “does not relieve any individual of any obligation to pay rent, make a housing payment, or comply with any other obligation that the individual may have under a tenancy, lease or similar contract.”[74]  Since the CDC order was enacted, “an array of lawyers and lobbyists have inundated federal, state and local courts” with lawsuits challenging the validity of the moratorium as well as HHS’s and the CDC’s authority in issuing it.[75]  While many of these lawsuits remain pending at this time (including a recent case filed by the National Association of Home Builders in the Northern District of Ohio), Part II will discuss the most prominent case that has been brought and adjudicated with respect to the CDC moratorium.

Richard Lee Brown v. Alex Azar

The plaintiffs in Richard Lee Brown v. Alex Azar, made up of the National Apartment Association (representing a membership group of 85,000 landlords nationwide) and four landlords in different states seeking to evict tenants from their respective properties, brought suit in the United States District Court in the Northern District of Georgia, Atlanta Division, to enjoin enforcement of the CDC order.  The plaintiffs’ suit alleged that the CDC order (i) lacks a statutory and regulatory basis, (ii) is arbitrary and capricious, and (iii) violates the plaintiffs’ rights to access the courts.[76]

The plaintiffs first contended that “the CDC acted without statutory and regulatory authority because (1) the Order is not reasonably necessary to prevent the spread of the disease; and (2) the Order does not show that the state and local laws were insufficient to prevent the spread of the disease.”[77]  On the first point above, the court ruled that, since Congress gave the Secretary of HHS (and by extension the CDC) broad power to issue regulations to prevent the spread of diseases, and because the CDC’s order is necessary to help control the COVID-19 pandemic, the CDC was authorized to issue it.[78]  Regarding the second point above, so long as the CDC reasonably determines that the measures taken by any local state or local government are insufficient to prevent the spread of the disease, the court will give deference to the CDC’s determination and confirm its statutory and regulatory authority on these grounds.[79]

The court next analyzed the plaintiffs’ claim that the issuance of the CDC order was arbitrary and capricious.  The plaintiffs argued that “the Order is arbitrary and capricious because it is not supported by substantial evidence or relevant data” to demonstrate that the eviction moratorium would help to prevent the spread of COVID-19 or to demonstrate that existing state and local measures were insufficient to prevent such spread.[80]  The court disagreed with this argument, noting that “the Order explains, in detail, why a temporary eviction moratorium is reasonably necessary.”[81]  Specifically, the CDC order notes that as many as 30 to 40 million people in the U.S. could be at risk of eviction without a moratorium in place, which would result in many more people who would move to shared housing or other congregate settings or who would become homeless, which increases the risk of spread of the virus.[82]  Based on this evidence, the court concluded that “the CDC has shown what it needs to: that an eviction moratorium for individuals likely to be forced into congregate living situations is an effective public health measure that prevents the spread of communicable diseases because it aids the implementation of stay-at-home and social distancing directives.”[83]  The court then disagreed with the plaintiffs’ assertion that the CDC did not show that existing measures taken by state and local government were insufficient.  To the contrary, “the Order plainly states that the measures in state and local jurisdictions that do not provide protections for renters equal to or greater than the protections provided for in the Order are insufficient to prevent the spread of COVID-19.”[84]  In fact, “the CDC did analyze each state’s eviction restrictions, and the evidence suggested that in the absence of eviction moratoria, tens of millions of Americans could be at risk of eviction on a scale that would be unprecedented in modern times.”[85]

Finally, the plaintiffs then argued that the CDC order unlawfully strips them of their constitutional right to access the courts.  The court, however, pointed out that “the Order does not apply to every person renting a property,” “does not apply to every reason a landlord may evict a tenant,” “does not prohibit Plaintiffs from seeking a different remedy to recover their losses,” and “does not apply to all procedural aspects of the eviction proceedings,” since landlords may still serve notices to quit and commence eviction proceedings under the CDC order; rather, “[t]he Order only delays the actual eviction.”[86]  Citing both the Elmsford and Baptiste decisions (which the court also noted involved state orders that were more restrictive against landlords than the CDC order), the court concluded the CDC order does not violate the plaintiffs’ constitutional right to access the courts because (i) a landlord maintains the right to pursue other legal remedies against a non-paying tenant, such as a breach of contract claim, and (ii) the eviction moratorium is only temporary, and mere delay does not amount to a denial of a landlord’s rights when they will “at some point, regain access to legal process.”[87]

Part III – Force Majeure, Impossibility and Frustration of Purpose

With the COVID-19 pandemic forcing most retail and restaurant businesses either to temporarily shut down altogether or otherwise significantly reduce their operations, it has become nearly impossible for many of these businesses remain profitable, in turn making it much more difficult for such businesses to stay current on their lease and mortgage payments.  Many of these struggling companies have taken the position that the pandemic (and the shutdowns ordered in response to it) constitute a force majeure event, excusing their obligations to pay rent under their leases (or other payment obligations under instruments such as mortgages and purchase agreements).  In addition to the force majeure argument, many renters have also invoked the legal concepts of impossibility and frustration of purpose to make the case that their rent payment obligations should be suspended during the pandemic.  For their part, landlords have fought back to enforce the terms of their leases as written.  Part III will discuss several notable cases in which tenants (and in one case, a buyer under a purchase contract) have attempted to assert one or more of the force majeure, impossibility and frustration of purpose defenses for their benefit.

In Re: Hitz Restaurant Group

A creditor under the above-named bankruptcy case petitioned the United States Bankruptcy Court in the Northern District of Illinois – Eastern Division, to enforce the obligation of debtor Hitz Restaurant Group to pay post-petition rent and to modify the automatic stay.  The debtor argued that its obligation to pay any post-petition rent was excused by the force majeure clause contained in the lease between the debtor and such creditor and by the creditor’s failure to make necessary repairs to the leased premises.[88]  The debtor argued that the lease’s force majeure clause was triggered on March 16, 2020, when Illinois Governor J.B. Pritzker issued Executive Order 2020-7 to mitigate the effects of the coronavirus pandemic in the state.[89]  The Executive Order stated, in part, that “all businesses in the State of Illinois that offer food or beverages for on-premises consumption…must suspend service for and may not permit on-premises consumption.  Such businesses are permitted and encouraged to serve food and beverages so that they may be consumed off-premises.”[90]

The Hitz court concluded that the Executive Order did in fact trigger the force majeure clause under the lease, which clause reads as follows: “Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by…laws, governmental action or inaction, orders of government….Lack of money shall not be grounds for Force Majeure.”[91]  The court reached its conclusion that “[t]he force majeure clause in this lease was unambiguously triggered by”[92] the Executive Order because the Order “unquestionably constitutes both ‘governmental action’ and issuance of an ‘order’ as contemplated by the language of the force majeure clause,”[93] the Order “unquestionably ‘hindered’ Debtor’s ability to perform,”[94] and the Order “was unquestionably the proximate cause of Debtor’s inability to pay rent.”[95]

In response to the creditor’s position that the lease’s force majeure clause was not triggered because the Executive Order did not shut down the banking system or post offices in Illinois, meaning that the debtor was still physically able to send rental payments to the creditor, the court called this argument “specious” and rejected it “out of hand.”[96]  The court also rejected the creditor’s argument that the debtor’s failure to perform arose merely from a lack of money, which was expressly carved out of the force majeure provision in the lease.  The court instead agreed with the debtor’s position that the proximate cause of the tenant’s failure to pay rent was not mere lack of money, but rather the Executive Order’s shutdown of most of the debtor’s business that was the proximate cause of the debtor’s inability to generate revenue and therefore pay rent.[97]  However, because the Executive Order did not completely stop the debtor from conducting its business, since carry-out, delivery and pickup services were still allowed, the court concluded that the debtor was responsible for partial payment of its rent in proportion to the amount of the leased space that was still usable under the Executive Order for such allowed services (i.e., the kitchen), which amounted to 25% of the space (and therefore 25% of the rent owed).[98]

Martorella v. Rapp

Martorella v. Rapp arises from a case originally filed in the Massachusetts Land Court in 2017 entitled Stark v. Martorella, which was an action for the partition of real property located at 15 Wigwam Road in Nantucket.[99]  Defendant Stuart Rapp was the court-appointed commissioner in Stark, tasked with recommending the best way to partition the Wigwam Road property.[100]  Commissioner Rapp conducted a public auction of the property on February 14, 2020, at which the plaintiff Christopher Martorella was the winning bidder.[101]  The terms of Mr. Martorella’s winning bid, as memorialized in a purchase and sale agreement signed upon the conclusion of the auction, provided for him to pay an initial deposit at the time of the auction and a second deposit four days later, with the remaining balance of the purchase price in the amount of $1,644,300 to be paid “at the time of the delivery of the Deed.”[102]  Pursuant to the terms of the purchase agreement, the delivery of such Deed was to have occurred on March 16, 2020 (which was later extended to March 23, 2020 and then April 6, 2020 upon the mutual agreement of the parties), and the agreement did not provide for any financing or other contingencies to the completion of the sale in Mr. Martorella’s favor, nor did the agreement confer any unilateral right upon Mr. Martorella to extend the time for his performance thereunder.[103]

Due to the effect of the coronavirus pandemic on the economic markets, Mr. Martorella experienced difficulty obtaining financing for the purchase and requested to postpone the closing again to May 5, 2020, which the Land Court in Stark denied.[104]  Mr. Martorella then brought the entitled action against Commissioner Rapp, claiming the doctrine of impossibility due to the COVID-19 pandemic.  The Martorella court reasoned that the core of the question of impossibility is the determination “whether the risk of intervening circumstance was one which the parties may be taken to have assigned between themselves.”[105]  In answering this question, the court referenced Massachusetts case law stating that “[o]nce one party has made itself responsible for the disposition of the subject matter of a contract, it cannot later claim that the occurrence in question was not in the contemplation of the parties at the time of contract.”[106]  Therefore, since the purchase agreement contained no contingencies to Mr. Martorella’s obligation to perform thereunder, which he acknowledged, Mr. Martorella “knowingly assumed the risk of delivering $1,644,300 at closing.”[107]  As such, the court ruled that Mr. Martorella was not excused from performing under the purchase agreement due to impossibility, and deemed him to be in default under the agreement.[108]

Other Notable Cases

Richards Clearview, LLC v. Bed Bath & Beyond, Inc. involved a commercial eviction proceeding by the owner of an indoor shopping mall in Metairie, Louisiana against tenant Bed Bath & Beyond, which paid only partial rent in April, 2020 and no rent in May, 2020 after the Governor of Louisiana issued Emergency Proclamation 33 JBE 2020 ordering all malls to close, “except for stores in a mall that have a direct outdoor entrance and exit that provide essential services and products.”[109]  Even though the tenant believed its rent was partially excused due to the force majeure provision in its lease, the tenant did attempt to pay all of its stated rent in full after it received a notice of default from its landlord; however, the landlord refused to accept such late payments and moved to terminate the lease.[110]  The court here invoked the Louisiana doctrine of “judicial control,” which is “an equitable doctrine by which courts will deny cancellation of a lease when the lessee’s breach is of minor importance, is caused by no fault of his own, or is based on a good faith mistake of fact.”[111]  Because (i) there was a good faith question in the lease as to how much rent was owed (due to certain ambiguous co-tenancy clauses in the lease), (ii) the tenant attempted to remedy the default in a reasonable amount of time given the circumstances caused by the COVID-19 pandemic, (iii) the tenant was continuing to sell certain essential products such as soap, hand sanitizer and first aid equipment to the public during the pandemic, and (iv) the landlord was not materially harmed by the delay in payment, the court elected to exercise judicial control and ruled against cancellation of the lease.[112]

In Palm Springs Mile Associates, Ltd. v. Kirkland’s Stores, Inc., the owner of a shopping center in Hialeah, Florida sued its tenant for past due amounts and accelerated rent under its lease after the tenant stopped paying rent under the lease, with the tenant arguing that the restrictions against non-essential activities and business operations put in place by Miami-Dade County were a force majeure event that suspended its obligation to pay rent.[113]  In ruling in favor of the landlord, the court explained that “force majeure clauses are narrowly construed, and “will generally only excuse a party’s nonperformance if the event that caused the party’s nonperformance is specifically identified.’”[114]  Because the tenant failed to explain how the regulations actually and directly resulted in its inability to pay rent, the court ruled that there was no force majeure event under the lease.[115]

In BKNY1, Inc., d/b/a 132 Lounge v. 132 Capulet Holdings, LLC, a New York landlord sued to terminate its tenant’s lease of for failure to pay rent, which tenant argued that the state’s Executive Order No. 202.3 requiring its restaurant business to close excused it from its obligation to pay rent under the doctrines of frustration of purpose and impossibility.[116]  The court first addressed the tenant’s frustration of purpose defense.  Citing the principle that “financial hardship does not excuse performance of a contract,” the court concluded that the two-month temporary closure of the tenant’s business required by the Executive Order could not have frustrated the overall purpose of the lease with a term of nine years.[117]  In also rejecting the tenant’s impossibility defense, the court quoted the express language of the lease, which stated in part that the tenant’s obligation to pay rent “shall in no wise be affected, impaired or excused because Owner is unable to fulfill any of its obligations under this lease…by reason of…government preemption or restrictions.”

Part IV – Seeking Equitable Remedies

Much like COVID-19’s far-reaching effects on the daily lives of people across the United States, the pandemic has also had far-reaching effects on jurisprudence and the disposition of legal cases in many different areas of law, whether directly or only tangentially involving real estate.  Whether relating to bankruptcy cases, home purchases, or UCC foreclosure sales, no part of the law has been able to avoid the need to account for COVID-19 in determining just outcomes for those individuals and companies utilizing the court system during these times.  Part IV of this article will look at several different courts’ attempts to grapple with this very question of how to deal with the pandemic’s effects to arrive at equitable answers for those affected by it.

In Re: Dudley

The debtor in a Chapter 7 bankruptcy case filed in the United States Bankruptcy Court in the Eastern District of California petitioned the court for an extension of the six-month statutory reinvestment period for debtors to use proceeds from the sale of exempt homestead property in order to acquire another homestead property.  When Clay Dudley, the debtor in the above-referenced bankruptcy case, sold his residence in Chico, California on February 7, 2020, by statute he had six months to reinvest those sale proceeds in another residence to maintain the homestead exemption on the initial sale of his residence.[118]  The debtor claimed that he intended to purchase a replacement property and had been diligent in his efforts to do so, but that his efforts were severely hindered by the COVID-19 pandemic[119] and the State of California’s response to the pandemic, including specifically the statewide “stay at home” order issued by Governor Gavin Newsom under Executive Order N-33-20.[120]

California exercised an option under the Federal Bankruptcy Code to opt out of certain federal bankruptcy exemptions and adopt its own exemptions in their place, which California did in providing for a six-month reinvestment period for the homestead exemption.  Therefore, the bankruptcy court in Dudley applied California state law to determine whether the reinvestment period could be tolled or otherwise extended once it started to run.[121]  Although the court did not find (and the debtor did not cite) any California statutory authority to permit an extension or tolling of the six-month reinvestment period, since the trustee of the bankruptcy estate did not oppose the debtor’s request for such extension, the court looked to equitable remedies to determine whether an extension would be warranted.[122]

The court cited several prior instances under California case law where the six-month reinvestment period was equitably tolled when, through no fault of their own, claimants lacked possession or control over homestead proceeds following an involuntary or voluntary sale of the homestead, or when circumstances beyond the debtor’s control prevented the reinvestment of homestead proceeds within the six-month timeframe.[123]  In referencing these prior decisions, the Dudley court recognized California’s intent to create a liberal construction homestead statute for the benefit of debtors to ensure people’s homes are not lost through a technicality.[124]  Turning to the case at hand, the Dudley court also concluded that the unique circumstances surrounding the current pandemic warranted an equitable extension of the six-month reinvestment period for the homestead exemption, consistent with prior California case law and equitable principles, “reflect[ing] a public policy and legislative effort to protect real property interests, generally, and, specifically, to prevent the loss of residential occupancy and ownership rights due to the COVID-19 pandemic and resulting state of emergency.”[125]

In Re: Pier 1 Imports, Inc.

Pier 1 Imports, Inc. and certain of its related entities, the debtors under a Chapter 11 filing in the United States Bankruptcy Court in the Eastern District of Virginia – Richmond Division, filed their voluntary bankruptcy petition on February 17, 2020, and then saw “their stores shuttered [and their] revenue dr[y] up overnight” during the COVID-19 pandemic.[126]  As a result, the debtors took various actions to preserve their liquidity, but “found that they needed additional relief from the Court to reduce outgoing expenses even further and to preserve the status quo.”[127]  The debtors proposed a temporary period of limited business operations in which only enumerated critical expenses would be paid, meaning that rent payments to certain landlords would be temporarily deferred or reduced during this period, with all accrued rent being paid back over time after the conclusion of the limited business operations period.[128]  Several landlords objected to this proposal.

In considering the debtors’ motion, the court noted that the affected landlords may be entitled to “adequate protection” under the Federal Bankruptcy Code, which is “designed to compensate a non-debtor to the extent any proposed lease ‘results in a decrease in the value of such entity’s interest in such property.’”[129]  However, the court concluded that the “Debtors’ deferred payment of rent while they continue use of the leased premises, does not decrease the value of any Lessor’s interest in the property”[130] since all “insurance payments, security obligations, utility payments, and other similar obligations of the Debtors typically made in the ordinary course of business are continuing to be made by the Debtors.”[131]

In the court’s final conclusion in approving the debtors’ motion, the court recognized the dire situation brought about by the COVID-19 pandemic, stating that “[t]here is no feasible alternative to the relief sought in the Motion.  The Debtors cannot operate as a going concern and produce the revenue necessary to pay rent because they have been ordered to close their business.  The Debtors cannot effectively liquidate the inventory while their stores remain closed….Any liquidation efforts would be ineffective and potentially squander assets that could otherwise be administered for the benefit of all creditors in this case.”[132]

1248 Assoc Mezz II LLC v. 12E48 Mezz II LLC

In 1248 Assoc Mezz II LLC v. 12E48 Mezz II LLC, the New York Supreme Court ruled that Executive Order 202.8 (described above in this article under the discussion of the Elmsford Apartment Associates case), which placed a moratorium on the “foreclosure of any residential or commercial property for a period of ninety days,”[133] did not apply to a proposed foreclosure of an equity interest in a mezzanine borrower entity to be conducted under the Uniform Commercial Code.[134]

The original mezzanine UCC foreclosure sale that was scheduled for May 1, 2020 was temporarily enjoined by the New York Supreme Court on April 30, 2020 on the grounds that the terms of the foreclosure sale were not commercially reasonable in light of the coronavirus pandemic and that Executive Order 202.8’s prohibition on foreclosures extends to UCC foreclosures of mezzanine debt.  The court then issued a final decision in 1248 Assoc Mezz II LLC on May 18, 2020, vacating its prior temporary restraining order and ruling that the scheduled UCC foreclosure could move forward, as it was not prohibited by Executive Order 202.8.[135]  The court reached this conclusion by noting that, “had the Executive Order intended to prohibit sales of collateralized assets…governed by the UCC, such prohibition would have been explicitly provided for within that Executive Order.”[136]  The court then went on to concur with the mezzanine lender’s argument that the foreclosure of a mortgage is “a judicial proceeding, whereas the proposed (and Noticed) sale addresses a disposition of collateral pursuant to Article 9 of the UCC, a non-judicial proceeding,”[137] ultimately concluding that Executive Order 202.8 “addresses enforcement of a judicially ordered foreclosure,”[138]  which does not cover foreclosures conducted under the UCC.

D2 Mark LLC v. Orei VI Investments LLC

In D2 Mark LLC v. Orei VI Investments LLC, the court considered the question of what constitutes a commercially reasonable UCC foreclosure sale in light of the COVID-19 pandemic.  The action involved the Mark Hotel located on the Upper East Side of Manhattan, which was subject to a senior mortgage loan serviced by Wells Fargo Bank, and where 100% of the equity interest in D2 Mark Sub LLC, which was the indirect owner of the hotel, was pledged to the defendant pursuant to a mezzanine loan made by the defendant to the plaintiff.  [139]The hotel “suffered significant financial hardship as a result of the COVID-19 pandemic when it was forced to temporarily close on March 27, 2020,”[140] resulting in the plaintiff missing its April and May loan payments under the senior loan and triggering a default under both the senior loan and the defendant’s mezzanine loan.[141]

On May 18, 2020, the defendant gave notice of a UCC foreclosure sale of the plaintiff’s 100% membership interest in D2 Mark Sub LLC, which sale was to occur on June 24, 2020, which was 36 days from the date of the notice of sale.[142]  On June 8, 2020, New York City entered Phase I of reopening, which allowed the hotel to eventually reopen on June 15, 2020, which in turn allowed potential foreclosure auction bidders to tour and inspect the hotel premises prior to the sale.  New York City then entered Phase II of reopening on June 22, 2020, two days before the scheduled auction, allowing for expanded operations within the hotel and increased ability for potential bidders to perform due diligence on the hotel premises.

The plaintiff filed suit against the defendant mezzanine lender alleging, among other things, that the terms of the proposed UCC foreclosure auction were unreasonable in light of the coronavirus pandemic and seeking to enjoin the sale until September 8, 2020.  In evaluating whether such foreclosure sale terms were reasonable, the court cited the text of the Uniform Commercial Code requiring that “[e]very aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.”[143]

Given the totality of the facts and circumstances involving the proposed foreclosure sale, including the pandemic’s effect on bidding on and buyers performing due diligence on the property, the D2 Mark court concluded that such proposed sale was in fact not commercially reasonable and granted a preliminary injunction to delay the sale.[144]  Specifically, the court agreed with the analysis of plaintiff’s UCC foreclosure sale expert, who opined that UCC foreclosure sales for complex commercial assets such as the hotel would typically provide for 60 to 90 days’ notice (as opposed to the 36 days’ notice provided by the defendant), and that the property would not sell at close to its maximum price without potential buyers being afforded a reasonable opportunity to perform in-person due diligence and inspections on the property, which opportunity was severely affected by the coronavirus pandemic and the business closures that the pandemic necessitated.[145]  The court further agreed with the expert’s assertion that the foreclosure sale was “‘rigged’ so that, as a practical matter, only defendant can obtain the Collateral.”[146]  Examples of such rigging include the fact that the entire purchase price for the hotel was to be due and payable within 24 hours of the completion of the auction, and that plaintiff was barred from participating in the auction, “which is per se unreasonable.”[147]  Additionally, the fact that only two out of 115 potential bidders submitted financial statements to the defendant in connection with the proposed auction sale gave further credence to the conclusion that the terms of the foreclosure sale were unreasonable.[148]

Conclusion

There are presently dozens, if not hundreds, of other lawsuits throughout the United States currently being litigated relating to the coronavirus pandemic, which will provide us with many more answers on how COVID-19 is changing the legal landscape of the country.  However, even with so much being unknown at this time as to the contents of these future decisions, orders and opinions to be written, several discernible patterns have emerged from the cases that have been decided thus far and discussed above in this article.  Courts have clearly given deference to federal, state and local lawmakers to enact laws and regulations to protect the community at large, both from a public health perspective in preventing the spread of the virus, as well as from the perspective of protecting those individuals and businesses who have been hurt financially by the virus and its ripple effects.  Given this well-deserved deference, any current or future litigation challenging the authority or constitutionality of such laws and regulations will face a steep uphill climb to have them overturned.

Similarly, in cases involving contracts between private parties, courts have generally given deference to the terms of those agreements and have avoided reading generous force majeure clauses into them or applying broad interpretations of impossibility or frustration of purpose to them.  While the Hitz case stands out as a clear anomaly of this group, many legal scholars have opined that the result in Hitz was mostly the result of the odd formulation of the force majeure language in that particular lease, which allowed force majeure to be applied more broadly than one would typically see, as opposed to a more common description of force majeure in leases and contracts stating that a force majeure event does not excuse any payments due under such lease or contract.  Therefore, the specific wording of a lease’s or other contract’s force majeure clause will be a key factor in whether a court will provide relief to a tenant or other party to a contract based on such clause.  In furtherance of this point, we note that as of the writing of this article, a partial ruling just issued by a bankruptcy court in Texas (ruling on a lease governed by California law) held that the lease’s force majeure clause which included the term “unusual government restriction, regulation or control” warranted a reduction in rent under the tenant’s lease.[149]

When courts have had more leeway to apply equitable principles in their cases, they have generally given a certain amount of latitude to those parties who have been negatively affected by the pandemic, recognizing the sheer unforeseeability of our current situation.  The bankruptcy cases and the two UCC foreclosure cases discussed above bear this out.  This latitude was also demonstrated in the Richards Clearview case, which, although it was decided in favor of the tenant, was notable in that (a) the court applied the equitable concept of judicial control in its decision, and (b) the court did not conclude that the tenant’s rent was suspended or reduced by a force majeure event, but rather that the lease could stay in place since the tenant attempted to repay all of the prior rent that had not been paid.

As future real estate-related cases involving COVID-19 are litigated and decided, we expect these same three patterns of deference to lawmakers’ regulation, deference to existing written contracts, and application of equitable principles when available, to continue.

[1] Elmsford Apartment Associates, LLC v. Cuomo, 2020 WL 3498456, at *1.

[2] N.Y. Exec. Law Art. 2-B § 29-a.

[3] Elmsford, at *3.

[4] Id. at *7.

[5] Id. at *8.

[6] Penn Central Transportation Co. v. New York City, 438 U.S. 104, 98 S. Ct. 2646, 57 L.Ed.2d 631 (1978).

[7] Elmsford, at *10.

[8] Id. at *11.

[9] Id. at *12.

[10] U.S. Const. Art. I § 10, cl. 1.

[11] Buffalo Teachers Federation v. Tobe, 464 F.3d 362, 367 (2d. Cir. 2006) (quoting Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 240, 98 S.Ct. 2716, 57 L.Ed.2d 727 (1978)).

[12] Id. at 368.

[13] Elmsford, at *12.

[14] Id. at *13.

[15] Id. at *14.

[16] Id. (quoting Sveen v. Melin, 138 S.Ct. 1815, 1822, 201 L.Ed. 2d 180 (2018)).

[17] Id. at *16.

[18] Id.

[19] Auracle Homes, LLC v. Lamont, 2020 WL 4558682, at *1.

[20] Conn. Gen. Stat. § 28-9(b)(1).

[21] Auracle Homes, at *2.

[22] Id. at* 3.

[23] Id. at *4.

[24] Id. at *6 (quoting Plaintiffs’ Memorandum).

[25] Id. at *7 (quoting Plaintiffs’ Memorandum).

[26] Id. (quoting Plaintiffs’ Memorandum).

[27] Id. at *15 (quoting Elmsford).

[28] Id. at *16.

[29] Id. (quoting Sherman v. Town of Chester, 752 F3d 554, 565 (2d Cir. 2014)).

[30] Id. at *17.

[31] Id.

[32] Id. at *18 (quoting Sullivan v. Nassau County Interim Financial Authority, 959 F.3d 54, 65 (2d. Cir. 2020)).

[33] Id.

[34] Id. (quoting Marshall v. U.S., 414 U.S. 417, 427, 94 S.Ct. 700, 38 L.Ed.2d 618 (1974)).

[35] Id. at *19.

[36] Id. at *20.

[37] HAPCO v. City of Philadelphia, C.A. No. 20-3300, 2020 WL 5095496.

[38] Id. at *2 and *4.

[39] Id. at *5 (quoting Plaintiff’s Reply Memorandum in Further Support of Motion for Preliminary Injunction).

[40] Sveen, at 1821-22.

[41] Id.

[42] HAPCO, at *6.

[43] Id. at *8.

[44] Id.

[45] Id. at *9 and *10.

[46] Id. at *11

[47] Id. (quoting Usery v. Turner Elkhorn Mining Co., 428 U.S. 1, 15, 96 S.Ct. 2882, 49 L.Ed.2d 752 (1976)).

[48] Baptiste v. Kennealy, 2020 WL 5751572.

[49] Id. at *2.

[50] Id. at *3.

[51] Id. at *20.

[52] Id. at *21.

[53] Id. at 22 (quoting Penn Central, at 124).

[54] Id.

[55] Id.

[56] Id. at *14.

[57] Id. at *16.

[58] Id. at *18.

[59] Id. at *14 and *18.

[60] TJM 64, Inc. v. Harris, 2020 WL 4352756.

[61] Friends of Danny DeVito v. Wolf, 227 A.3d 872 (2020).

[62] Lebanon Valley Auto Racing Corp. v. Cuomo, 2020 WL 4596921.

[63] Blackburn v. Dare County, 2020 WL 5535530.

[64] San Francisco Apartment Association v. City and County of San Francisco, Order, San Francisco County Superior Court, Case No. CPF-20-517136.

[65] TJM 64, at *6.

[66] Id. at *7.

[67] Id.

[68] Friends of Danny DeVito, at 894.

[69] Lebanon Valley, at *8.

[70] Id. at *9.

[71] Blackburn, at *5.

[72] Id. at *6.

[73] Id. at *8.

[74] Richard Lee Brown v. Alex Azar, in his official capacity as Secretary, U.S. Department of Health & Human Services, 2020 WL 6364310, at *1.

[75] “Landlords, lobbyists launch legal war against Trump’s eviction moratorium, aiming to unwind renter protections,” by Tony Romm, The Washington Post, October 12, 2020.

[76] Brown, at *6.

[77] Id.

[78] Id. at *7.

[79] Id. at *9.

[80] Id. at *11.

[81] Id. at *12.

[82] Id. (citing Temporary Halt in Residential Evictions to Prevent the Further Spread of COVID-19 (the “CDC Order”), 85 Fed. Reg. at 55,295).

[83] Id. at *13.

[84] Id. (citing the CDC Order at 55,296).

[85] Id. (citing the CDC Order at 55,295-96).

[86] Id. at *14-15.

[87] Id. at *16 (quoting Elmsford at *16).

[88] In re Hitz Restaurant Group, No. 20-B-05012, 2020 WL 2924523, at *2 (Bankr. N.D. Ill. June 2, 2020).

[89] Id.

[90] Ill. Exec. Order 2020-7 § 1.

[91] In re Hitz Restaurant Group, at *2 (quoting Dkt. No. 21, Part 2, pp. 9 & 10).

[92] Id. at *4

[93] Id.

[94] Id.

[95] Id.

[96] Id.

[97] Id. at *5.

[98] Id. at *6.

[99] Martorella v. Rapp, 2020 WL 2844693, at *2.

[100] Id.

[101] Id. at *3.

[102] Id.

[103] Id. at *3 and *5.

[104] Id. at *5.

[105] Id. at *8.

[106] Id. at *9 (quoting Winchester Gables, Inc. v. Host Marriott Corp., 70 Mass. App. Ct. 585, 596 (2007)).

[107] Id.

[108] Id. at *10.

[109] Richards Clearview, LLC v. Bed Bath & Beyond, Inc., 2020 WL 5229494, at *1.

[110] Id. at *5.

[111] Id. (quoting W. Sizzlin Corp. v Greenway, 36,088 (La. App. 2 Cir. 6/12/02), 821 So. 2d 594, 601).

[112] Id. at *4 and *7-8.

[113] Palm Springs Mile Associates, Ltd. v. Kirkland’s Stores, Inc., 2020 WL 5411353., at *1.

[114] Id. at *2 (quoting ARHC NVWELFL01, LLC v. Chatsworth at Wellington Green, LLC, No. 18-80712, 2019 WL 4694146, at *3 (S.D. Fla. Feb. 5, 2019)).

[115] Id.

[116] BKNY1, Inc., d/b/a 132 Lounge v. 132 Capulet Holdings, LLC, 2020 WL 5745631.

[117] Id. at *2.

[118] In re Dudley, 617 B.R. 149, 151 (2020).

[119] Id.

[120] Id.

[121] Id. at 153.

[122] Id. at 154.

[123] Id.

[124] Id.

[125] Id. at 156.

[126] In re Pier 1 Imports, Inc., 615 B.R. 196, 198 (2020).

[127] Id.

[128] Id. at 199.

[129] Id. at 203 (quoting 11 U.S.C. § 361(2)).

[130] Id.

[131] Id.

[132] Id.

[133] New York Executive Order No. 202.8, “Continuing Temporary Suspension and Modification of Laws Relating to the Disaster Emergency.”

[134] 1248 Assoc Mezz II LLC v. 12E48 Mezz II LLC, N.Y.Sup. Index No. 651812/2020.

[135] Id. at 3.

[136] Id. at 2.

[137] Id.

[138] Id.

[139] D2 Mark LLC v. Orei VI Investments LLC, 2020 WL 3432950, at *1.

[140] Id. at *3.

[141] Id.

[142] Id. at *4.

[143] Uniform Commercial Code § 9-610[b].

[144] D2 Mark, at *8.

[145] Id. at *9.

[146] Id. at *10.

[147] Id.

[148] Id.

[149] “How Force Majeure Was Successfully Used by a Tenant in Court,” by Patrick Trostle and Alan Gamza, www.globest.com, November 19, 2020 (discussing In Re: CEC Entertainment, Inc., Ch. 11 Case No. 20-33163 (MI) (Bankr. S.D. Tex.)).

Editor

Jason Twinning

Attorney in Washington, DC and Maryland

§ 1.1 Introduction

“The hand of history lies heavy upon the tort of conversion.”  Prosser, The Nature of Conversion, 42 Cornell LQ 168, 169 (1957).  With roots dating back to the Norman Conquest of England in 1066, the cause of action had its original underpinnings as an alternative to deciding rightful ownership of disputed property by “wager of battle”—a physical altercation or duel between alleged victim and thief.  Ames, The History of Trover, 11 Harv. L. Rev. 277, 278 (1897).

While life-and-death duels aren’t required anymore to ascertain ownership, the stakes of modern litigation over disputed property interests often carry existential consequences for the parties’ business interests.  Despite being an ancient cause of action, conversion claims continue to impact present-day business disputes.  Dozens of purported class action lawsuits pending in multiple jurisdictions seek to use the tort of conversion as a mechanism for adjudicating the proper ownership of billions of dollars the federal government paid for Paycheck Protection Program (PPP) loans pursuant to the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  Some courts have begun to assess how conversion claims may apply to disputes over blockchain cryptocurrencies.  Still other recent decisions assess the cause of action’s applicability to everything from membership interests in limited liability companies, to theft of a manuscript that played a key role in exposing movie producer Harvey Weinstein’s history of committing sexual assault and rape.

§ 1.2 The Development of the Cause of Action

§ 1.2.1 Brief History of Conversion, and Its Gradual Expansion to Include Some Forms of Intangible Property.

Conversion is an intentional act of “dominion or control over a chattel which so seriously interferes with the right of another to control it that the actor may justly be required to pay the other the full value of the chattel.”  Restatement (Second) of Torts § 222A[1] (1965).  Originally, this meant interferences with or misappropriation of only tangible “goods”—personal property capable of being lost or stolen.  See W. Page Keeton et al., Prosser & Keeton on the Law of Torts § 15, at 90 (5th ed. 1984).  Because intangible rights could not be “lost or found” in the eyes of the common law, the general rule was that “an action for conversion [would] not normally lie, when it involves intangible property” because there was no physical item that could be misappropriated.  See Sporn v. MCA Records, 58 N.Y.2d 482, 489, 462 N.Y.S.2d 413, 448 N.E.2d 1324 (1983).

Despite this long-standing reluctance to expand conversion beyond the realm of tangible property, most courts have determined there was “no good reason for keeping up a distinction that arose wholly from that original peculiarity of the action” and allowed conversion claims to reach “things represented by valuable papers, such as certificates of stock, promissory notes, and other papers of value.”  See Ayres v. French, 41 Conn. 142, 150, 151 (1874) (emphasis added).  This, in turn, led to recognition of conversion when an intangible property right can be united—or “merged”—with a tangible object.  New York’s highest court explained:

[F]or practical purposes [the shares] are merged in stock certificates which are instrumentalities of trade and commerce…. Such certificates ‘are treated by business men as property for all practical purposes.’ … Indeed, this court has held that the shares of stock are so completely merged in the certificate that conversion of the certificate may be treated as a conversion of the shares of stock represented by the certificate.

See Agar v. Orda, 264 N.Y. 248, 251, 190 N.E. 479 (1934); see also Sporn, 58 N.Y.2d at 489, 462 N.Y.S.2d 413, 448 N.E.2d 1324 (plaintiff could maintain conversion claim where defendant infringed plaintiff’s “intangible property right to a musical performance by misappropriating a master recording—a tangible item of property capable of being physically taken”).

To some courts, the “lack of a compelling reason to prohibit conversion for redress of a misappropriation of intangible property underscores the need for reevaluating the appropriate application of conversion.”  Thyroff v. Nationwide Mut. Ins. Co., 8 N.Y.3d 283, 291, 864 N.E.2d 1272, 1277 (2007).  This reevaluation has led some courts to hold that conversion claims can embrace purely intangible property.  See, e.g., Kremen v. Cohen, 337 F.3d 1024, 1033–1034 (9th Cir. 2003) (internet domain name; applying California law); Shmueli v. Corcoran Group, 9 Misc.3d 589, 594, 802 N.Y.S.2d 871 (Sup. Ct., N.Y. County 2005) (computerized client/investor list); Town & Country Props., Inc. v. Riggins, 249 Va. 387, 396–397, 457 S.E.2d 356, 363–364 (1995) (person’s name).

The Restatement (Second) of Torts recognizes this development, noting as to “Conversion of Documents and Intangible Rights”:

• Where there is conversion of a document in which intangible rights are merged, the damages include the value of such rights.
• One who effectively prevents the exercise of intangible rights of the kind customarily merged in a document is subject to a liability similar to that for conversion, even though the document is not itself converted.

Restatement (Second) of Torts § 242 (1965).  Yet, the restatement cautions that this “final step” in the law of conversion “does not accord very well with the traditional common law limitations of conversion; and courts which prefer to adhere to the older theory may prefer to regard the liability as one for an intentional inference with the right, which is not identical with conversion, but is similar to it in its nature and legal consequences.”  Id. § 242, comment e.

Prosser and Keeton similarly recognize “[t]here is perhaps no very valid and essential reason why there might not be conversion of” intangible property.  Prosser & Keeton § 15, at 91–92.  Yet they admonish that although “[t]he American economy has experienced an increasing use of intangible ideas. … it would seem preferable to fashion other remedies, such as unfair competition, to protect people from having intangible values used and appropriated in unfair ways.”  Id. at 92.

Accordingly, some courts still insist that conversion claims cannot reach purely intangible rights.  See, e.g., Allied Inv. Corp. v. Jasen, 354 Md. 547, 562, 731 A.2d 957, 965 (1999) (secured interests in corporation stock, collateral assignment of a partnership interest, and proceeds from each); Northeast Coating Tech., Inc. v. Vacuum Metallurgical Co., Ltd., 684 A.2d 1322, 1324 (Me. 1996) (interest in information contained in prospectus); Montecalvo v. Mandarelli, 682 A.2d 918, 929 (R.I. 1996) (partnership interest).  Even courts that adhere to this more traditional view, however, frequently recognize exceptions—for example, “when a plaintiff can allege that the defendant converted specific segregated or identifiable funds, a conversion claim for money may survive.”  See, e.g., Sage Title Grp., LLC v. Roman, 455 Md. 188, 203, 166 A.3d 1026, 1035 (2017) (citation, internal quotation marks omitted).  However, a claim for conversion will fail if the plaintiff cannot establish his right to the funds held in the segregated account.  See, e.g., Cumis Ins. Soc., Inc. v. Citibank, N.A., 921 F. Supp. 1100, 1110 (S.D.N.Y. 1996) (dismissing conversion claim where “there is no allegation of any wrongful or improper act of dominion by [defendant] in contravention of [plaintiff’s] rights.  The alleged acts constituting a conversion are specifically permitted under U.C.C. Article 4–A.”).  Moreover, if a defendant diverts funds from a segregated account, the plaintiff proves his right to those funds, but the defendant satisfies an adverse judgment through use of other funds; there is no liability for conversion, because the plaintiff has suffered no damages.  See Patel v. Strategic Grp., LLC, — N.E.3d —, 2020 WL 6193637, at *8 (8th Dist. Ct. Cuyahoga Cty. Ohio, Oct. 22, 2020) (“Once the trial court returned the full value of the alleged converted property to Patel — as occurred when the trial court awarded Patel $50,000 on his breach of contract claim — Patel suffered no damages pursuant to his conversion action.”).

§ 1.2.2 Elements, Defenses, and Available Remedies

A common thread runs through each jurisdiction’s unique recitation of the elements of conversion—“a wrongful taking, detention, or interference with, or an illegal assumption of ownership or possession, or illegal use or misuse, of the personal property of another.  The gist of the tort is the exercise, or intent to exercise, dominion or control over the property of another in denial of, or inconsistent with, his or her rights in the property.”  7 American Law of Torts § 24:1.  At its most basic, conversion is “any distinct act of dominion wrongfully exerted over the property of another, in denial of the plaintiff’s right, or inconsistent with it.”  Mian v. Sekerci, No. CV N17C-05-585 JRJ, 2019 WL 4580024, at *4 (Del. Super. Ct. Sept. 13, 2019).

The two “key elements” of conversion are (1) the plaintiff’s possessory right or interest in the property and (2) a defendant’s dominion over the property or interference with it, in derogation of plaintiff’s rights.  Palermo v. Taccone, 79 A.D.3d 1616, 913 N.Y.S.2d 859 (4th Dep’t 2010); see also Burlesci v. Petersen (1998) 68 Cal.App.4th 1062, 1066, 80 Cal.Rptr.2d 704 (elements are “(1) the plaintiff’s ownership or right to possession of the property; (2) the defendant’s conversion by a wrongful act or disposition of property rights; and (3) damages”).

Some jurisdictions additionally require that the plaintiff must have demanded return of the property, and the defendant refused.  See Cypress Creek EMS v. Dolcefino, 548 S.W.3d 673 (Tex. App. Houston 1st Dist. 2018), petition for review filed, (July 17, 2018) (listing elements).  Under that analysis, without a demand for possession there’s been no deprivation, and accordingly no harm.  Community Bank, Ellisville, Mississippi v. Courtney, 884 So. 2d 767 (Miss. 2004).

Other courts require demand and refusal only when the defendant’s original possession came about lawfully.  See In re Rausman, 50 A.D.3d 909, 910, 855 N.Y.S.2d 263, 265 (2008) (absent some indication that defendant’s original withdrawal of funds from a Swiss bank account pursuant to the power of attorney was unlawful, conversion claim could not have accrued until a demand was made); Lange-Fitzinger v. Lange, No. A153791, 2019 WL 3424959, at *5 (Cal. Ct. App. July 30, 2019). (“when the defendant’s original possession of the property was not tortious … plaintiff must prove that defendant refused to return the property after a demand for its return”).  But even then, exceptions may apply.  Cuprys v. Volpicelli, 170 A.D.3d 1477, 1478, 97 N.Y.S.3d 325, 327 (2019) (“If possession of the property is originally lawful, a conversion occurs when the defendant refuses to return the property after a demand or sooner disposes of the property.”) (emphasis added); see also CIT Commc’ns Fin. Corp. v. Level 3 Commc’ns, LLC, No. CIV.A.06C-01-236 JRS, 2008 WL 2586694, at *2 (Del. Super. Ct. June 6, 2008) (although “Delaware law does support the notion that if a party was once in lawful possession of the plaintiff’s property, the plaintiff must first make a demand … for return of the property[, t]his requirement is excused when the alleged wrongful act is of such a nature as to amount, in itself, to a denial of the rights of the real owner.”) (internal quotation marks omitted).

Just as in any other tort action, a plaintiff alleging conversion bears the burden of proving the extent of the damages he or she suffered.  Dileo v. Horn, 189 So. 3d 1189 (La. Ct. App. 5th Cir. 2016).  Damages awarded in an action for conversion are determined by the value of the property converted, and if disputed, the plaintiff bears the burden of proof.  Gould v. Ochsner, 2015 WY 101, 354 P.3d 965 (Wyo. 2015).  See Restatement (Second) of Torts § 242, Comment e (in cases involving intangible property there is “very little practical importance whether the tort is called conversion, or a similar tort with another name” because “[i]n either case the recovery is for the full value of the intangible right so appropriated”).

When it comes to defenses, “[c]onversion is a strict liability tort.  The foundation of the action rests neither in the knowledge nor the intent of the defendant.  Instead, the tort consists in the breach of an absolute duty; the act of conversion itself is tortious.  Therefore, questions of the defendant’s good faith, lack of knowledge, and motive are ordinarily immaterial.”  Pegues v. Raytheon Space & Airborne Sys., No. 217CV05420DSFGJSX, 2018 WL 8062690, at *3 (C.D. Cal. Dec. 3, 2018) (quoting Burlesci v. Petersen, 68 Cal. App. 4th 1062, 1066 (1998)).  Nor, generally, can an after-the-fact attempt to return converted property “cure” the conversion.  IBM Corp. v. Comdisco, Inc., 1993 Del. Super. LEXIS 183, *41, 1993 WL 259102.

Actual consent or acquiescence is a complete defense to a claim of conversion.  In re CIL Limited, 582 B.R. 46 (Bankr. S.D.N.Y. 2018), amended on reconsideration, 2018.  Absence of damage to the plaintiff is a good defense, see Baye v. Airlite Plastics Co., 260 Neb. 385, 618 N.W.2d 145 (2000), as is abandonment of the property by the plaintiff.  Toll Processing Services, LLC v. Kastalon, Inc., 880 F.3d 820 (7th Cir. 2018); Boaeuf v. Memphis Station, L.L.C., 107 N.E.3d 817 (Ohio Ct. App. 8th Dist. Cuyahoga County 2018); Lowe v. Rowe, 173 Wash. App. 253, 294 P.3d 6 (Div. 3 2012); Greenpeace, Inc. v. Dow Chemical Co., 97 A.3d 1053 (D.C. 2014).  Similarly, a defendant who possessed the property to accommodate plaintiff has a complete defense to conversion when the property was wrongfully removed by a third person.  Williams v. Edwards, 82 Ga. App. 76, 60 S.E.2d 538 (1950).

Other defenses which may mitigate the damages, but do not constitute a complete defense, include:

• possession originally acquired in a lawful manner,
• bona fide purchase without notice,
• lack of profit or benefit to the defendant,
• benefits conferred by the defendant on the plaintiff by making voluntary payments on the plaintiff’s obligations,
• reasonable care in handling the property by the defendant,
• defendant’s failure to use the property,
• plaintiff’s indebtedness to the defendant,
• plaintiff’s intention prior to the conversion to use the property unlawfully, or
• negligence on the part of the plaintiff.

90 C.J.S. Trover and Conversion § 68.  “Other claims which are not a defense include that the defendant is not in possession of the property sued for, the property is in legal custody, advice of counsel, contributory negligence, the First Amendment, lack of consideration, and commingling of the property with other property before the conversion.”  Id.

§ 1.3 Recent Case Developments

As conversion claims grew to encompass intangible property, the Restatement noted “[t]he law is evidently undergoing a process of expansion, the ultimate limits of which cannot as yet be determined.”  Restatement (Second) of Torts § 242 (1965).  It remains so, as new cases seek to apply the ancient cause of action to pressing modern circumstances.

COVID-19, the CARES Act, and PPP Reimbursement Litigation

As noted above, dozens of purported class action lawsuits pending in multiple jurisdictions seek to use the tort of conversion as a mechanism for adjudicating the proper ownership of billions of dollars the federal government paid for Paycheck Protection Program (PPP) loans pursuant to the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  See, e.g., In re Paycheck Prot. Program Agent Fees Litig., No. MDL 2950, 2020 WL 4673430, at *1 (U.S. Jud. Pan. Mult. Lit. Aug. 5, 2020) (denying consolidation of 62 federal lawsuits pending in 26 districts).

To assist businesses struggling with the effects of the COVID-19 pandemic, Congress sought to incentivize those businesses to keep workers on their payroll by guaranteeing PPP loans made through Small Business Administration (“SBA”)-approved lenders (and offering forgiveness under certain conditions).  “Congress didn’t create the PPP from whole cloth.  Rather, it ‘temporarily add[ed] a new product,’” to the SBA’s “existing [Section] 7(a) Loan Program.”  Lopez v. Bank of Am., N.A., No. 20-CV-04172-JST, 2020 WL 7136254, at *1 (N.D. Cal. Dec. 4, 2020) (citing Business Loan Program Temporary Changes; Paycheck Protection Program Interim Final Rule (the “SBA Rule”), 85 Fed. Reg. 20811 (Apr. 15, 2020)).[1]

However, the CARES Act created an unorthodox system for paying “agents” who assisted the small businesses in obtaining a PPP loan (e.g., attorneys; accountants; consultants; brokers; other persons or entities who prepare an applicant’s application for financial assistance, or who assist a lender with originating, disbursing, servicing, liquidating, or litigating SBA loans).  See, e.g., U.S. Dep’t of Treasury, PPP Information Sheet Lenders, https://home.treasury.gov/system /files/136/PPP%20Lender%20Information%20Fact%20Sheet.pdf (last visited Jan. 12, 2021).

To further assist distressed businesses, the CARES Act prohibited agents from collecting fees directly from any PPP applicant.  But rather than have the SBA compensate those agents directly, the Act required the SBA to pay processing fees to the lenders according to a sliding percentage driven by the loan’s size, and for agents to then pursue payment from those lenders out of the fees the lenders received from the SBA.  According to SBA guidance (id.):

Processing fees will be based on the balance of the financing outstanding at the time of final disbursement.  SBA will pay lenders fees for processing PPP loans in the following amounts:

• Five (5) percent for loans of not more than $350,000;
• Three (3) percent for loans of more than $350,000 and less than $2,000,000; and
• One (1) percent for loans of at least $2,000,000.

Agent fees will be paid out of lender fees.  The lender will pay the agent.  Agents may not collect any fees from the applicant.  The total amount that an agent may collect from the lender for assistance in preparing an application for a PPP loan (including referral to the lender) may not exceed:

• One (1) percent for loans of not more than $350,000;
• 50 percent for loans of more than $350,000 and less than $2 million; and
• 25 percent for loans of at least $2 million.

Unsurprisingly, disputes arose between lenders and agents over how much, if at all, various agents were entitled to be paid out of funds the lenders had received from the SBA.  Those disputes led to a blizzard of litigation, in which the agents advanced conversion claims as one theory of recovery, alleging that the CARES Act and related SBA regulations gave agents “a right to immediate possession of the agent fees,” out of funds that lenders “refused to provide … to Plaintiff and the class….”  See Prinzo & Assoc’s, LLC v. BMO Harris Bank, N.A., Case No. 1:20-cv-3256 (N.D. Ill. 2020) (Complaint, ¶¶ 86–92).  “By withholding these fees,” the lenders were alleged to have “maintained wrongful control over [agents’] property inconsistent with [agents’] entitlements under the SBA regulations,” amounting to “civil conversion by retaining monies owed to Plaintiff and Class members.”  Id.

In Leigh King Norton & Underwood, LLC v. Regions Fin. Corp., No. 2:20-CV-00591-ACA, 2020 WL 6273739, at *12 (N.D. Ala. Oct. 26, 2020), the court dismissed plaintiffs’ conversion claims.  The court noted that “under Alabama law, a conversion claim for money will survive only if “the money itself, not just the amount of it, [is] specific and capable of identification.”  Id. at *11 (quoting Edwards v. Prime, Inc., 602 F.3d 1276, 1303 (11th Cir. 2010) (alteration in original)).  And to be capable of identification, the money must be “traceable to a special account” or come from “segregated sources.”  Id.  Plaintiffs contended that because the funds “emanated” from a specifically identified source—i.e., the processing fees the SBA pays lenders under the PPP—the funds were sufficiently specific and identifiable.  The court disagreed, holding “the fact that money ‘emanates’ from a specific source is not enough; the funds themselves must be identifiable, either because they are physically identifiable or because they have been entirely sequestered from all other funds.”  Id. at *12 (emphasis added).  Accordingly, the court dismissed plaintiffs’ conversion claims.

Similar lawsuits saw the courts dismiss plaintiffs’ conversion claims on the ground that where agents failed to comply with separate SBA rules, neither the CARES Act nor any SBA rule implementing the PPP created an entitlement to the fees—and without an immediate right to possession, conversion claims cannot stand.  For example, in Lopez v. Bank of Am., N.A., supra, a sole proprietor bookkeeper helped his client apply for a PPP loan by compiling the client’s payroll information, reviewing the numbers to determine the appropriate loan amount, and filling out an application with Bank of America on his client’s behalf.  2020 WL 7136254 at *4.  His client received a PPP loan in the amount of $70,243, and he sought to recover his fee ($702.43, or 1%) from Bank of America out of the origination fee it had received from the government.  Id.

Bank of America refused, arguing that plaintiff never entered into a compensation agreement with Bank of America, and neither the CARES Act nor the SBA Rule entitled an agent to fees from a lender in the absence of such a direct agreement between agent and lender.  Id. at *7.  Plaintiff therefore sued on behalf of a purported class, alleging that the defendant lender was “obligated to set aside money to pay, and to pay, agents in accordance with PPP Regulations for work performed on behalf of a client in relation to the preparation and/or submission of a PPP loan application that resulted in a funded PPP loan.”  Id. at *5.

The court disagreed.  Pre-existing SBA rules required an agent “must execute and provide to SBA a compensation agreement,” which “governs the compensation charged for services rendered or to be rendered to the Applicant or lender in any matter involving SBA assistance.”  Id. at *2 (citing 13 C.F.R. § 103.5(a)).  And because nothing in the CARES Act superseded this rule, the court “conclude[d] that the CARES Act and the SBA Rule do not require lenders to pay agent fees for assistance with PPP loan applications, except as required under a written compensation agreement.”  Id. at *8.  Accordingly, because the plaintiff “was not entitled to agent fees under the CARES Act or SBA Rule, he had no ‘right to possession of the property,’” without which the conversion claim necessarily failed.  Id. at *9.

Several other courts have employed a similar analysis.  See Am. Video Duplicating Inc. v. Citigroup Inc., No. 20-cv-03815-ODW (AGRx), 2020 WL 6712232, at *4 (C.D. Cal. Nov. 16, 2020) (citing Sanchez, PC v. Bank of S. Tex., No. CV-20-00139, 2020 WL 6060868 (S.D. Tex. Oct. 14, 2020); Johnson v. JPMorgan Chase Bank, N.A., No. CV-20-4100 (JSRx), ––– F.Supp.3d ––––, 2020 WL 5608683 (S.D.N.Y. Sept. 21, 2020); Sport & Wheat, CPA, PA v. ServisFirst Bank, Inc., No. 20-cv-05425-TKW-HTC, ––– F.Supp.3d ––––, 2020 WL 4882416 (N.D. Fla. Aug. 17, 2020)).

Cryptocurrency Disputes

A Bitcoin is a unit of virtual currency, or “cryptocurrency” that exists only on the internet, without direct ties to any single nation’s monetary systems (though Bitcoins are regularly exchanged for sovereign currencies like the U.S. Dollar and the British Pound).  Bitcoins are stored in virtual “wallets” created by the official Bitcoin software, which can store Bitcoins of a single user, or of multiple users using built-in “Accounts” functionality that tracks each user’s Bitcoin balance independently.

The currency is highly volatile—on March 12, 2020, as the COVID-19 pandemic first began to impact the United States, one Bitcoin traded for $3,858; on January 12, 2021, it traded briefly for more than $36,604 per Bitcoin.  See https://www.coinbase.com/price/bitcoin (last visited Jan. 12, 2021).  The currency is based upon a blockchain[2] that contains a public ledger of all the transactions in the Bitcoin network.  Initial interest in the currency was small, limited initially to those seeking to engage in transactions that could not be easily traced.  Over time, as the currency gained wider exposure, retailers opened up to using bitcoin in 2012 and 2013.  See https://www.investopedia.com/articles/forex/121815/bitcoins-price-history.asp (last visited Jan. 12, 2021).

Bitcoin is now traded on a number of non-centralized independent exchanges, and the currency can also be bought and sold through broker-dealers.  Id.  As Bitcoin has become more prevalent, courts are being asked to resolve whether it’s something that conversion claims can reach, which requires asking (and beginning to answer) questions as foundational as: is Bitcoin tangible, or intangible, property?

Ox Labs, Inc. v. Bitpay, Inc., No. CV 18-5934-MWF (KSX), 2020 WL 1039012, at *5–6 (C.D. Cal. Jan. 24, 2020).[3]  Bitcoin is quasi-tangible property.

Plaintiff provided an advanced trading platform to exchange cryptocurrency, including Bitcoin.  Defendant’s business involved regularly purchasing and selling Bitcoins—including on plaintiff’s platform—to enable other businesses to accept the cryptocurrency for online payments.  At the conclusion of several transactions, plaintiff inadvertently credited Defendant with 200 additional Bitcoins.  The error went unnoticed for over a year, when plaintiff realized approximately 200 Bitcoins were missing from its accounts, but could not locate the source of the missing Bitcoins.  Months later, defendant also identified the error as part of an internal accounting review, and alerted the plaintiff.  Negotiations ensued as to the correct valuation of the 200 Bitcoins, which had appreciated substantially since the initial error—on the date of the error the value was about $260-$300 per Bitcoin on the markets; when the error was identified by defendant, the value was about $1,050 per Bitcoin.  Defendant offered payment based on the lower amount, but plaintiff refused.  By the time plaintiff filed suit, nearly three years after the initial error, the value was more than $6,623 per Bitcoin.

Because California’s statute of limitations for conversion is longer for tangible property (3 years) than intangible property (2 years), the court had to decide a fairly metaphysical question: what sort of thing is Bitcoin, really?  Defendant argued that Bitcoin is intangible property (and thus subject to a shorter limitations period), “because it is a digital currency without a tangible form.”  But according to plaintiff, “Bitcoins do not exist in the detached realm of ideas; rather, they are digital currencies that rely on a shared public ledger … which records all confirmed transactions.”  Plaintiff relied on Fabricon Products v. United California Bank, 264 Cal. App. 2d 113, 70 Cal. Rptr. 50, 53 (1968), where the California Court of Appeal determined that a check for money is tangible property subject to the three-year statute of limitations.

The court agreed with plaintiff, stating: “Bitcoin is not merely an ‘idea’ that is entirely divorced from any physical form.  Rather, it is dependent on blockchain, a public ledger which records all the transactions.”  The Court also found support in another decision that concluded Bitcoins are commodities that can be regulated by the Commodities Futures Trading Commission.  See CFTC v. McDonnell, 287 F. Supp. 3d 213, 228 (E.D.N.Y. 2018) (“Virtual currencies are ‘goods’ exchanged in a market for a uniform quality and value.  They fall well-within the common definition of ‘commodity’ as well as the [Commodity Exchange Act]’s definition of ‘commodities’ as ‘all other goods and articles … in which contracts for future delivery are presently or in the future dealt in.’”).  Accordingly, the longer limitations period applied.

BDI Capital, LLC v. Bulbul Investments LLC, 446 F. Supp. 3d 1127 (N.D. Ga. 2020).  Unlike money, Bitcoin is “specific intangible property” which can be recovered under a conversion theory.

In this case, an owner of Bitcoin sued the operator of a cryptocurrency exchange, alleging that the defendant unlawfully retained plaintiff’s Bitcoin, and asserting a claim for conversion.  Defendant operated a trading platform that allowed its users to buy and sell Bitcoins against U.S. Dollars.  In 2013, plaintiff set up an account on defendant’s trading platform.  In 2017, plaintiff attempted to withdraw all of its Bitcoins stored on defendant’s platform, but was met with error messages.  After various unsuccessful efforts to resolve the issue, plaintiff learned that defendant was in the process of shutting down or had already shuttered its trading platform.  Defendant allegedly decided to close its trading platform because the banks it used had elected to discontinue their business with entities involved with cryptocurrencies.

Plaintiff, through counsel, issued a demand letter to defendant for all balances in plaintiff’s virtual wallet.  When defendant failed to respond to the letter, plaintiff filed suit, arguing defendant should be held liable for conversion because it failed to return plaintiff’s Bitcoin upon demand.  Noting that no Georgia court had addressed “whether bitcoins, as virtual, intangible cryptocurrency, may be the subject of a conversion action at all,” the court noted potential analogues—although generally “specific intangible property may be the subject for an action for conversion, … as fungible intangible personal property, money, generally, is not subject to a civil action for … conversion.” (citations omitted).  The court accordingly inquired whether Bitcoins were “money” (and thus incapable of recovery through a conversion theory) or something different.  The court ultimately was persuaded that Bitcoins could be the subject of a conversion action, because of each Bitcoin’s specificity and identity—the Bitcoin blockchain providing “a giant ledger that tracks the ownership and transfer of every Bitcoin in existence.”  (quoting Kleiman v. Wright, No. 18-CV-80176, 2018 WL 6812914, 2018 U.S. Dist. LEXIS 216417 (S.D. Fla. Dec. 27, 2018)).  According to the court, Bitcoins therefore are sufficiently identifiable to be considered “specific intangible property” subject to an action for conversion.

Other Notable Decisions

McGowan v. Weinstein, No. 219CV09105ODWGJSX, 2020 WL 7210934 (C.D. Cal. Dec. 7, 2020).  In this case the court found a private espionage operation that stole an advance copy of Rose McGowan’s memoir exposing Harvey Weinstein as a rapist—for the purpose of informing a public relations effort to discredit McGowan—did not state a claim for conversion of her intellectual property.

For many years, the defendant used his power in the movie industry to sexually victimize women.  According to the plaintiff, when defendant learned that plaintiff planned to expose him as her rapist in her memoir, Brave, he and his agents mobilized a complex scheme to protect his reputation.  Part of the alleged scheme included using a private intelligence company, known as Black Cube, to obtain the content of Brave before its publication to help inform the smear campaign against its author.

Plaintiff alleged that the defendants were liable for conversion (among other counts) because they “planned to and did implement a scheme to obtain as much of Brave as possible before the book was published, causing interference with [McGowan]’s possession of the confidential manuscript.”  Defendants moved to dismiss on grounds that (1) plaintiff failed to allege a complete dispossession of the manuscript; and (2) her claim was preempted by the Copyright Act.  In opposition, McGowan argued that (1) intangible property can be subject to conversion even if it can be duplicated; and (2) a conversion claim did not require her to have been completely dispossessed of her copy of the manuscript.  According to plaintiff, when Black Cube stole a copy of much of her manuscript—“and was apparently paid handsomely for that theft”—it disturbed and disrupted her right to maintain sole and exclusive possession of the intellectual property until its publication.

The court found plaintiff’s conversion claim preempted by the federal Copyright Act.  “[W]here a plaintiff is only seeking damages from a defendant’s reproduction of a work—and not the actual return of a physical piece of property—the claim is preempted.”  Because “the essence of her claim is that Defendants made an unlawful reproduction of her manuscript of Brave and interfered with her right to be the only person in possession of a copy,” plaintiff’s claim sounded in copyright.  “[W]rongful possession of copies does not typically give rise to a conversion claim if the rightful owner retains possession of the original or retains access to other copies.”  According to the court, “possession of copies of documents—as opposed to the documents themselves—does not amount to an interference with the owner’s property sufficient to constitute conversion.”  And where “the alleged converter has only a copy of the owner’s property and the owner still possesses the property itself, the owner is in no way being deprived of the use of h[er] property.”

Mahon v. Mainsail LLC, No. 20-CV-01523-YGR, 2020 WL 6750150, at *9 (N.D. Cal. Nov. 17, 2020).  An unfulfilled demand for return of unauthorized copies of intellectual property can overcome Copyright Act preemption concerns, regardless of whether the demand came before filing suit.

An independent filmmaker who created the film “Strength and Honor” entered into an agreement with defendant to distribute the film and provided master copies of the film.  However, the Film was released with unauthorized covers and trailers, which plaintiff alleged violated the agreement.  Plaintiff immediately sent “cease and desist” letters instructing defendant to remove the film from distribution.  The Film continued to be distributed around the world, which Mahon claims could only occur based on master copies provided to defendant.  Indeed, plaintiff learned that defendant’s subcontractor had shipped copies of the film to companies around the world, on defendant’s instruction, after plaintiff’s “cease and desist” letter.

Plaintiff filed suit, asserting claims for direct and contributory copyright infringement, illicit trafficking in counterfeit labels, fraud, and conversion against Mainsail.  The Court initially dismissed the conversion claim as preempted by the Copyright Act, because it was based solely on conversion of intangible property (copyrights).  The Court noted, however, that “claims for conversion of intangible property that includes an ‘extra element,’ such as demand for return of tangible property, [are] not preempted.”  Plaintiff amended his complaint reasserting the conversion claim, but added allegations that defendant obtained master copies (i.e., tangible property) of the film and never returned them.  According to the court, this sufficiently stated a claim for an “extra element”—allowing plaintiff to seek recovery of tangible property (the master copies), as opposed to merely asserting unauthorized copying of the intangible property.

Still, defendant argued that plaintiff’s conversion claim should fail because plaintiff purportedly authorized defendant’s use of the master copies.  The court rejected this argument, noting that even if plaintiff initially authorized defendant to use master copies “it strains credulity that [defendant] could have innocently relied on that authorization [through seven years] of litigation and numerous ‘cease and desist’ letters from the [plaintiff].”  Moreover, the court “fail[ed] to see any law … that requires [plaintiff] to have asked [defendant] for return of the property before filing his suit.”  Accordingly, the Court denied defendant’s motion to dismiss the amended conversion claim.

Bamford v. Penfold, L.P., No. CV 2019-0005-JTL, 2020 WL 967942 (Del. Ch. Feb. 28, 2020).  In this case Delaware’s Chancery Court confirmed that conversion claims may encompass membership interests in a limited liability company, no differently than stock in a corporation.

The defendant was plaintiff’s financial advisor and longtime friend—“a relationship that was closer than most brothers,” according to the complaint.  Because of his great trust in the defendant, plaintiff did not inquire further when the defendant (falsely) advised him to waive the conversion feature in debt issued by the entity they co-owned in connection with a reorganization.  Through that reorganization, the defendant obtained complete control of the entity, and, the plaintiff alleged, engaged in misappropriation and self-dealing.

Plaintiff asserted that the defendant’s actions amounted to conversion of plaintiff’s membership interests in the LLC.  Defendant moved to dismiss, arguing that the intangible property at issue should be treated differently than other intangibles, such as shares of stock, of the kind customarily held to have been merged into a tangible document. 

The court disagreed, holding “[t]here is no basis for treating a share of stock in a corporation and a membership interest in an LLC differently for purposes of conversion.  A share of stock represents a bundle of rights defined by the laws of the chartering state and the corporation’s certificate of incorporation and bylaws.  A membership interest in an LLC represents a bundle of rights defined by the laws of the chartering state, any substantive provisions in the certificate of formation (typically none), and the LLC agreement.  Just as a share of stock is subject to conversion, so too is a membership interest in an LLC.”

Voris v. Lampert, 7 Cal. 5th 1141, 1153, 446 P.3d 284, 292 (2019), reh’g denied (Oct. 23, 2019).  Lost wages are not recoverable under a theory of conversion.

For over a year, plaintiff worked alongside defendant to launch three start-up ventures, partly in return for a promise of later payment of wages.  After a falling out, plaintiff was fired and the promised compensation never materialized.  Plaintiff sued the companies and won, successfully invoking both contract-based and statutory remedies for the nonpayment of wages.  He then sought to hold defendant personally responsible for the unpaid wages on a theory of common law conversion.  Plaintiff asserted that by failing to pay the wages, the companies converted his personal property to their own use and that defendant was individually liable for the companies’ misconduct.

The Superior Court for Los Angeles County entered judgment on the pleadings for defendant.  On appeal, California’s Supreme Court further affirmed the trial court, finding that conversion “is not the right fit for the wrong that [plaintiff] alleges, nor is it the right fix for the deficiencies [plaintiff] perceives in the existing system of remedies for wage nonpayment.”  Plaintiff asserted “a right to money that did once exist, but which he believes was squandered.  At least in such cases, [he] argues, the nonpayment of wages should be treated as a conversion of property, not as a failure to satisfy a ‘mere contractual right of payment.’”

The Court refused to endorse this logic, because it “would require us to indulge a similar fiction: namely, that once [plaintiff] provided the promised services, certain identifiable monies in his employers’ accounts became [his] personal property, and by failing to turn them over at the agreed-upon time, his employers converted [his] property to their own use.”  Distinguishing a previous decision that suggested a common law claim such as conversion might lie “under appropriate circumstances” for an employer’s misappropriation of gratuities left for employees, the Court stated “an employer’s misappropriation of gratuities is not the same as an employer’s withholding of promised wages.  When a patron leaves a gratuity for an employee (or employees), it arguably qualifies as a specific sum of money, belonging to the employee, that is capable of identification and separate from the employer’s own funds; indeed, the employee (or employees) for whom it was left has ownership of the gratuity by statute. … Unpaid wages are different in each of these respects.”  A claim for unpaid wages “simply seeks the satisfaction of a monetary claim against the employer, without regard to the provenance of the monies at issue.  In this way, a claim for unpaid wages resembles other actions for a particular amount of money owed in exchange for contractual performance—a type of claim that has long been understood to sound in contract, rather than as the tort of conversion.”

Am. Lecithin Co. v. Rebmann, No. 12-CV-929 (VSB), 2020 WL 4260989 (S.D.N.Y. July 24, 2020).  Although domain names are intangible property, New York allows conversion claims for interference with one’s right to “possession” of the name.

Plaintiffs’ company brought suit in connection with defendant’s registration of certain domain names, and his retention of those domain names after plaintiffs terminated his employment.  Plaintiffs alleged that while defendant was one of plaintiffs’ officers, he “registered under his own name, or transferred to his own name” the eight domain names identical in substance to a trademark that had been previously registered by plaintiffs.  After terminating defendant’s employment, plaintiffs directed him to turn over all company property, but defendant did not transfer the domain names despite multiple demands.

Plaintiffs alleged conversion based on defendant’s transferring the domain names to his own name and continuing to retain them.  Defendant argued that the domain names were intangible property incapable of conversion under New York law.  Recognizing New York’s long-standing hesitancy to allow conversion claims for intangible property, the court nonetheless traced an ongoing trend away from such rigidity, as the law seeks to adapt to an increasingly electronic, computerized information economy.

The court highlighted C.D.S., Inc. v. Zetler, 298 F. Supp. 3d 727, 759 (S.D.N.Y. 2018) (finding, after bench trial, that when defendant changed the registration of various domain names belonging to plaintiff to his own LLC, he “interfered with [plaintiff’s] possessory interest” in the property, and was liable for conversion), and Triboro Quilt Mfg. Corp. v. Luve LLC, No. 10 Civ. 3604, 2014 WL 1508606, at *9 (S.D.N.Y. Mar. 18, 2014) (“New York courts recognize exceptions [to the normal rule that only physical property can be converted] when the rightful owner of intangible property is prevented from creating or enjoying a ‘legally recognizable and protectable property interest in his idea’ such as by being prevented from registering the domain name for a website or being denied access to a database he created.”).  Because “domain names also have inherent value, particularly where they implement an intellectual property right like a trademark,” the court, “motivated by the need for the common law to respond … to the demands of commonsense justice in an evolving society,” the Court concluded that New York law permits a plaintiff to sue for conversion based on interference with a domain name. (quoting Thyroff v. Nationwide Mut. Ins. Co., 8 N.Y.3d 283, 289 (2007).

[1] “Section 7(a) of the Small Business Act … permits extension of financial assistance to small businesses when funds are ‘not otherwise available on reasonable terms from non-Federal sources.’”  United States v. Kimbell Foods, Inc., 440 U.S. 715, 719 n.3, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979).

[2] Blockchain is a specific type of database that stores data in a particular way—as new data comes in, it is entered into a fresh block; once the block is filled with data, it is chained onto the previous block, which makes the data chained together in chronological order.  Blockchain databases are most commonly used as a ledger for transactions.  In Bitcoin’s case, blockchain is used in a decentralized way so that no single person or group has control—rather, all users collectively retain control.  Decentralized blockchains are immutable, which means that the data entered is irreversible.  For Bitcoin, this means that transactions are permanently recorded and viewable to anyone.  See https://www.investopedia.com/terms/b/blockchain.asp (last visited Jan. 12, 2021).

[3] An earlier order from the same case reviews the facts that gave rise to the dispute.  See Ox Labs, Inc. v. Bitpay, Inc., No. CV 18-5934-MWF (KSX), 2019 WL 6729667, at *4 (C.D. Cal. Sept. 27, 2019).