In 2026, the Canadian mergers and acquisitions market will reward certainty of execution over transaction speed. Domestic transactions will continue to anchor activity as foreign capital faces heightened scrutiny under Canada’s Investment Canada Act (“ICA”) and a revamped Canadian Competition Act. Government priorities spanning defense readiness, energy transition, critical minerals, and sovereign artificial intelligence infrastructure will direct capital flows. Private equity will deploy with discipline. Success will depend on structuring deals around regulatory presumptions, securing capital beyond traditional channels, and aligning with federal industrial policy.
Federal industrial policy is expected to drive sustained capital flow into defense and critical minerals over the coming decade. Domestic transactions will dominate as foreign buyers face longer approval timelines and higher rejection risk. For dealmakers, regulatory preparedness and strategic clarity will determine outcomes.
Capital diversification and the Canada-Gulf corridor
The Canada-U.S. corridor remains vital but no longer exclusive. Trade friction and rigorous ICA enforcement are prompting diversification. While the U.S. Supreme Court’s February 20, 2026, ruling struck down tariffs imposed under emergency powers, uncertainty persists as alternative statutory frameworks for tariffs remain available, creating a window of regulatory uncertainty. We expect Canadian companies to continue to pursue defensive acquisitions within the United States. Simultaneously, sovereign wealth funds from the United Arab Emirates, Qatar, and Saudi Arabia are deploying capital into critical minerals, healthcare platforms, and digital infrastructure. Capital from these allied nations is increasingly replacing investment from restricted sources, positioning Gulf funds as preferred partners for strategic infrastructure projects.
This diversification aligns with Canada’s Defence Industrial Strategy (“Strategy”), launched in February 2026, which commits CAD 180 billion in procurement by 2035 and targets 70 percent of defense acquisitions to Canadian industry across nine sovereign capability areas, including aerospace, ammunition, digital systems, sensors, and advanced manufacturing. The Strategy’s BUILD-PARTNER-BUY framework prioritizes domestic consolidation, structured partnerships with allied firms, and foreign acquisitions only under conditions requiring meaningful Canadian reinvestment. Canada’s alignment with NATO capabilities is driving acquisitions, with companies increasingly looking to European markets for procurement partnerships rather than relying exclusively on U.S. suppliers. Defense readiness acquisitions will intensify throughout 2026 as companies acquire capabilities responsive to emerging operational requirements.
The regulatory fortress: Competition and national security scrutiny
The Competition Act transformation represents a structural shift in deal risk. Mergers in concentrated markets are now presumed anti-competitive unless the parties prove otherwise. Acquirers in telecommunications, banking, grocery, retail, and related sectors must now prove their transactions will not substantially lessen competition, requiring extensive economic analysis and extending timelines. New provisions targeting misleading environmental claims impose liability on parties making unsubstantiated sustainability representations. The burden of proof rests with businesses to demonstrate environmental claims are based on adequate and proper testing. The Competition Bureau is testing its expanded enforcement powers.
The ICA is being enforced with unprecedented rigor. Mandatory pre-closing filing requirements for investments in prescribed business activities, including sensitive technologies, critical minerals, and personal data infrastructure, will introduce regulatory delays that create market risk. The expanded net benefit test effectively freezes capital from non-allied nations in strategic sectors. With foreign capital restricted, domestic buyers and allied sovereign funds face less competition for critical assets, creating pricing advantages for buyers who can move with certainty.
Private equity: Deployment pressure and exit discipline
Private equity sponsors carry record uninvested capital and face intense pressure to deploy and exit assets. In Canada, this will likely lead to disciplined add-on acquisitions and selective exits as holding periods will continue to be extended. Sponsors are crystallizing returns through secondary buyouts and take-private transactions of undervalued public companies. Sponsors dominate the mid-market, particularly in transactions valued between CAD 25 million and CAD 500 million. Growing use of continuation vehicles offers alternatives to traditional exits, enabling sponsors to hold winners longer while delivering distributions to limited partners.
As in 2025, the frequency of carve-out transactions is continuing. Portfolio rationalization is accelerating as companies look to simplify operations under geopolitical pressure and AI disruption. Corporate sellers are divesting non-core assets to refocus on strategic priorities. Private equity buyers are increasingly viewing carved-out divisions as prime deployment opportunities with embedded operational improvement potential. Although carve-out transactions often create complexity due to operational disentanglement, IT and data separation, and standalone cost structure modeling, these challenges primarily create execution risk. For sponsors with operational expertise and patient capital to manage transition services and post-separation integration, carved-out transactions offer differentiated entry points with less competitive tension than traditional auction processes.
Private credit will continue to be an active player in mid-market financing in 2026. With traditional lenders remaining risk-averse, private lenders are well positioned to finance deals between CAD 25 million and CAD 500 million, offering higher leverage multiples and greater structural flexibility. Private credit will continue to see material growth in sponsor-backed transactions. For sellers, this means buyers can move faster and with more certainty. For buyers, it means accessing leverage that traditional lenders will not underwrite.
Sector concentration: Infrastructure, defense, critical minerals, and technology
Federal nation-building priorities are driving M&A in infrastructure, energy transition assets, defense, and critical minerals. Transactions are motivated by scale, supply chain security, and long-term capital deployment. Mining M&A is expected to lead public transaction volume, driven by lithium, copper, nickel, and rare earth demand. Federal investments are supporting domestic digital capabilities and M&A activity across the AI stack—encompassing data centers, cybersecurity, and energy systems supporting advanced computing—is accelerating. Sovereign AI, referring to domestic control over AI infrastructure and capabilities essential to national security, has become a strategic priority.
Technology remains the most active sector by volume, with particular interest in software-as-a-service, data centers, and AI-enabled services. With IPO markets constrained, M&A remains the primary exit route for Canadian technology companies. Canadian and international buyers now collectively exceed U.S. buyers in technology exits, demonstrating that liquidity no longer requires exclusive reliance on U.S. capital.
Wealth management consolidation is accelerating as intergenerational wealth transfer reshapes the advisory landscape. Independent registered investment advisors are being acquired by banks and financial sponsors seeking to expand fee-generating businesses. Higher interest rates are forcing distressed transactions in certain sectors, such as real estate and other capital-intensive sectors, creating opportunities for sponsors to acquire assets at distressed valuations.
Execution discipline: Structure, diligence, and certainty
Deal structures will continue to be materially more sophisticated. Earnouts, vendor take-back financing, and milestone-based payments are expected to be standard mechanisms as buyers and sellers bridge valuation differences and share post-closing risk. Enhanced due diligence now determines transaction viability, covering cybersecurity; environmental, social, and governance (“ESG”) compliance; antitrust risk; and supply chain vulnerabilities. Certainty of execution, rather than headline price, is the decisive differentiator. In addition, representations and warranties insurance will likely continue to be widely deployed, providing risk transfer mechanisms that facilitate cleaner deal structures.
The interim period between signing and closing continues to lengthen due to regulatory scrutiny, raising the cost of capital and integration risk. Sellers now prioritize buyers who can deliver regulatory certainty and compressed timelines. Strong antitrust analysis at the letter of intent stage, pre-cleared financing, and credible ICA navigation plans provide material competitive advantages in contested processes.
The path forward
The 2026 Canadian M&A market will reward strategic clarity, regulatory preparedness, and execution discipline. Strong private capital reserves and supportive government investment could continue to create opportunities, but regulatory complexity and geopolitical uncertainty demand sophisticated navigation. In this environment, certainty outweighs speed. Success requires conducting due diligence that withstands enforcement scrutiny, accessing capital beyond traditional sources, and recognizing that certainty is the most valuable asset in an environment of strategic complexity.
This article is Part X of the Musings on Contracts series by Glenn D. West, which explores the unique contract law issues the author has been contemplating, some focused on the specifics of M&A practice, and some just random.
Introduction—The Muddy Wellies I Abandoned in the London Office
In 2009, I was shooting at the Downton Estate (a year before they started filming the “Downton Abbey” series that made Highclere Castle and its estate famous worldwide). At the end of a great day, I changed out of my shooting clothes and put my muddy Wellies in a plastic bag, which I brought back to London. I was dropped off at the London office because I needed to pick up some work stuff before heading back to my hotel to pack for my trip home to the U.S. As I thought about how I would clean those muddy Wellies and pack them with my clothes, I decided that, as much as I loved my Wellingtons, it was simply too much trouble. So, I left them at the office with instructions that anyone who wanted my muddy, but otherwise perfectly good, Wellies could have them. And a few years ago, I was told by the London partner who claimed them that they were still in use. Wellies are apparently very durable (although I am confident that the London partner has not put the same wear and tear on them that a farmer would).[1]
The Company Responsible for Creating My Wellingtons Is No More
Despite the durability of Wellington boots, the company that created them, Hunter Boots Limited, was not as resilient. Supply chain issues, inflation, and drier weather all contributed to the company’s deteriorating financial condition. But the pandemic may have been the final nail in the coffin. It seems that Wellingtons serve as both a fashion statement and a necessity in muddy conditions at outdoor events (and concertgoers tend to impulse-buy Wellies to attend such events). When the pandemic hit, and all outdoor concerts were canceled (including the famous Glastonbury Festival for both 2020 and 2021), this may have worsened Hunter Boots Limited’s financial situation. Hunter Boots Limited went into administration on June 5, 2023, and sold all its assets to pay off its £112 million of debt. In other words, the iconic, 167-year-old British company that held two Royal Warrants from Queen Elizabeth II no longer exists. However, because you can still purchase Hunter Boots–branded Wellies, you might not have realized that the company itself is no longer in business.
The Assets Sold Through the Administration
Among the assets sold through Hunter Boots Limited’s administration were the assets of its U.S. subsidiary, Hunter Boot USA LLC (“Hunter Boot USA”). Importantly, it was the assets of Hunter Boot USA that were sold by Hunter Boot USA, not the equity of Hunter Boot USA by its owner, Hunter Boots Limited, even though Hunter Boot USA did not itself file a bankruptcy petition under U.S. bankruptcy law.
Hunter Boot USA leased part of the seventeenth floor and the entire nineteenth and twentieth floors of a well-known office building in New York City at 57 West 57th Street. The purchase of Hunter Boot USA’s assets was structured as a typical asset deal, with two separate buyers collectively acquiring substantially all its assets. Neither buyer, however, assumed the 57 West 57th Street lease.
One of the buyers was Marc Fisher LLC, which purchased all of Hunter Boot USA’s footwear inventory, removable fixtures from 57 West 57th Street, and a piece of equipment. The other buyer was Authentic Brands Group LLC, which acquired Hunter Boot USA’s trademarks and domain names, along with certain non-footwear apparel and accessories. Additionally, Authentic Brands had separately acquired all of Hunter Boots Limited’s intellectual property, including the brand, directly from Hunter Boots Limited. Marc Fisher LLC reportedly now manages the operational side of the Hunter footwear category for Authentic Brands in the U.S.
The Asset Buyers Are Alleged to Have Successor Liability for the 57 West 57thStreet Lease
Within a few months after Marc Fisher LLC and Authentic Brands acquired its assets, Hunter Boot USA stopped paying rent to the landlord of 57 West 57th Street. The landlord then sued Marc Fisher LLC and Authentic Brands, as “successors” to Hunter Boot USA, for all unpaid rent through the end of the lease term. The trial court dismissed the landlord’s complaint on the simple basis that the buyers had bought assets and did not assume the tenant’s obligations under the lease. But in a recent New York case, Avamer 57 Fee LLC v. Hunter Boot USA LLC,[2] the appellate court overruled the trial court’s dismissal of the landlord’s complaint, holding that the landlord had plead sufficient facts for the case to proceed to trial based on the “mere continuation” theory of successor liability.
The General Rule—No Successor Liability for Buyers of Assets—and Its Exceptions
Buyers purchase assets from a company rather than acquiring the equity of the company, so they can leave unassumed liabilities with the selling company. However, as with most general rules, the law has long recognized several ways in which a selling company’s liabilities can be imposed on the buyer of its assets, even when the buyer has not explicitly assumed those liabilities.
The means by which a buyer of assets can become responsible for the liabilities of the selling company are generally described as being based on any one of four exceptions:
(1) the [buyer] expressly or impliedly assumes the liability of the [selling company], (2) the transaction is a de facto merger or consolidation, (3) the [buyer] is a mere continuation of the [selling company], or (4) the transaction is a fraudulent effort to avoid liabilities of the [selling company].[3]
Given the vagaries of the standards used to impose liabilities under the “mere continuation” and the “de facto merger” exceptions, particularly with respect to tort liabilities, Texas has eliminated those two exceptions by statute.[4] But most states, including New York, continue to recognize all four exceptions. And contrary to popular belief, these exceptions are not limited to imposing successor liability upon a buyer for product liability claims; they can also be used to impose ordinary contractual liabilities of the selling company on the buyer(s) who only purchased assets.
While New York recognizes all four exceptions to the general rule against successor liability for asset buyers, the court found three of them inapplicable in Avamer 57. First, there was no claim by the landlord that the asset purchase agreements included any assumption of Hunter Boot USA’s liabilities under the lease or otherwise by the buyers, which effectively ruled out the express or implied assumption theory of successor liability (exception 1). Likewise, there was no continuity of ownership between the selling company, Hunter Boot USA, and the buyers, Authentic and Fisher. As a result, the landlord apparently conceded that the de facto merger theory (exception 2) was unavailable as a basis to hold the buyers liable under the lease as Hunter Boot USA’s successors.[5] There was also no indication that the consideration paid by the buyers to Hunter Boot USA was less than the fair market value of the assets purchased, nor that the sale had been concealed, nor that there was any other indicator of fraud, so the court did not believe that the fraudulent avoidance theory of successor liability (exception 4) was available.[6] That left the mere continuation theory (exception 3) as a possible exception to the general rule that a purchaser of assets does not have successor liability.
Digging into the “Mere Continuation” Doctrine
When you understand the factors that New York courts consider in applying the mere continuation theory, you may better appreciate why the Texas Business Law Foundation, a nonprofit group formed by large Texas law firms to “help create a favorable business climate in the State of Texas,”[7] pushed for the elimination of the mere continuation theory (as well as the de facto merger theory) as exceptions to the general rule that buyers of assets do not have successor liability.
In Avamer 57, the court noted that in New York,
courts determining whether a [buying entity] is a “mere continuation” of [the selling entity] have considered [a number of factors, including] whether: (1) all or substantially all assets are transferred to the successor corporation; (2) the predecessor corporation has been effectively extinguished following the transaction; (3) the successor has assumed an identical or nearly identical name; (4) the successor has retained one or more of the same corporate officers, directors, and/or employees; and (5) the successor has continued the same business.[8]
Obviously, all of those factors are present in nearly any asset sale of an entire business. Regarding the first factor, the court noted that the landlord had plead that the buyers in fact purchased substantially all of Hunter Boot USA’s assets and even sought to lease from the landlord the same premises Hunter Boot USA had leased. Concerning the second factor, Hunter Boot USA had informed the landlord that they “would ‘imminently dissolve and wind up their affairs’ and that [they] did ‘not have sufficient funds to make any further payments, including rent.’” Regarding the third factor, the buyers had actually “purchased the Hunter Boot brand, goodwill, intellectual property, and the ability to use the Hunter Boot name” (though the main brand was purchased directly from Hunter Boots Limited). As for the fourth factor, the court noted that the buyers had apparently announced that, in connection with the purchase of Hunter Boot USA’s assets, they did not plan any leadership changes, suggesting they would retain at least some key Hunter Boot USA employees (though rehiring employees of the selling company in an acquisition of a business through an asset transaction is common). Finally, regarding the fifth factor, the court indicated that the fact that the buyers continued to use the leased premises at 57 West 57th Street for a few months after the transaction closed, while Hunter Boot USA continued paying rent and while Fisher was trying to negotiate a new lease with the landlord, constituted continued operations of Hunter Boot USA’s business at the same location by the buyers.[9] (Hmm.)
While the Avamer 57 court was only overruling the trial court’s dismissal on the pleadings, and there will now be a full fact-finding trial, it still raises a host of concerns as to the reliability of using an asset sale to avoid the liabilities of a selling entity where the mere continuation theory is an available exception. Presumably, a UK administration does not provide the same protections to a buyer as a U.S. bankruptcy proceeding with a § 363 sale might have.[10]
Concluding Thoughts
If this transaction had been governed by Texas law, the dismissal of the complaint based on the pleadings would likely have been upheld because the mere continuation and de facto merger exceptions to the general rule protecting asset buyers from successor liability have been removed. And even though Delaware apparently recognizes the mere continuation exception, it appears to be much more constrained in its application:
The mere continuation exception requires that “the purchaser of the assets to be a continuation of ‘the same legal entity,’ not just a continuation of the same business in which the seller of the assets engaged.” “The ‘primary elements’ of being the same legal entity have been said to include ‘the common identity of the officers, directors, or stockholders of the predecessor and successor corporations, and the existence of only one corporation at the completion of the transfer.’”[11]
But a recent decision by the federal district court of New Jersey suggests that New Jersey law, like New York’s, does not consider the continuity of ownership or management a necessary requirement for the invocation of the mere continuation exception.[12]
While there are certainly actions the buyers here could have taken to potentially reduce the applicability of the mere continuation theory under New York law, it is hard to see how one could fully eliminate it. However, if successor liability theories can be likened to a muddy field after a rain, you are well advised to carefully consider how to metaphorically “put on your Wellies” before traversing through it.
Avamer 57 Fee LLC v. Hunter Boot USA LLC, 241 N.Y.S.3d 181 (N.Y. App. Div. 1st Dep’t 2025). ↑
Gary Matsko, De Facto Merger: The Threat of Unexpected Successor Liability, Bus. L. Today (Mar. 14, 2018) (quoting Milliken & Co. v. Duro Textiles, LLC, 451 Mass. 547, 556, 887 N.E.2d 244, 254 (2008) (quoting Guzman v. MRM/Elgin, 409 Mass. 563, 566, 567 N.E.2d 929, 931 (1991))). ↑
Tex. Bus. Orgs. Code § 10.254(b). Indeed, “only express assumption is grounds for successor liability under Texas law.” In re 1701 Com., LLC, 511 B.R. 812, 824 (Bankr. N.D. Tex. 2014). While fraudulent transfer may invalidate the sale, it is apparently not a separate basis under Texas law for imposing successor liability on the buyer. Id. ↑
I have previously written about the de facto merger doctrine. See Glenn D. West, An Asset Purchase That Wasn’t—Beware the De Facto Merger Doctrine in Distressed M&A, Weil Glob. Priv. Equity Watch (May 4, 2020). But note that the holding of the court I discuss there has been subsequently reversed, although the discussion remains valid. See New Nello Co., LLC v. CompressAir, 168 N.E.3d 238 (Ind. 2021). ↑
There is some confusion as to how the purchase price paid by the buyers for the assets was used. Apparently, rather than Hunter Boot USA retaining the purchase price, it may have been used to repay Hunter Boots Limited’s UK secured creditors in the administration. It is not clear whether the assets of Hunter Boot USA were pledged to secure Hunter Boots Limited’s UK debt, nor how much was actually paid for the limited assets being purchased from Hunter Boot USA. The bulk of the value appears to have been in the brand itself, which was separately purchased directly from Hunter Boots Limited. The court appears to acknowledge that fair value was paid to Hunter Boot USA for its assets, but whether there was a claim that could have been filed to avoid the transfer of the consideration for Hunter Boot USA’s assets to Hunter Boots Limited’s creditors on some fraudulent transfer basis is unclear. Regardless, a fraudulent transfer does not necessarily create successor liability—it typically only creates an opportunity for the transferor’s creditor (here, the landlord) to claw back the transfer. ↑
Alan R. Bromberg, Byron F. Egan, Dan L. Nicewander & Daniel S. Trotti, The Role of the Business Law Section and the Texas Business Law Foundation in the Development of Texas Business Law, 41 Tex. J. Bus. L. 41, 63 (2005). The Texas Business Law Foundation is also responsible for legislation that severely limits the alter ego theory in contract-based cases (Tex. Bus. Orgs. Code § 21.223), the recent establishment of the Texas Business Courts, and several business-friendly revisions to Texas corporate law. ↑
Avamer 57 Fee LLC v. Hunter Boot USA LLC, 241 N.Y.S.3d 181, 185 (N.Y. App. Div. 1st Dep’t 2025). ↑
Much attention is paid by plan sponsors of tax-qualified retirement plans to their plan’s administrative practices and procedures. However, plan sponsors should also consider a few corollary administrative practices and procedures for health and welfare plans at the beginning of the year by considering the following three “new year” resolutions:
Resolution #1: Make sure health and welfare plan documentation and delegation is current, accurate, and understood.
Plan sponsors should review the documentation that describes who has authority to administer the plan and what decisions are delegated to vendors versus retained by the sponsor. Start with the plan document(s) (including any wrap plan document), insurance contracts or administrative services only (“ASO”) agreements, summary plan description(s) (“SPD”), and any administrative services agreements. Sponsors should confirm that these documents align with actual operations, especially where claims, appeals, eligibility, enrollment, and COBRA are handled by third parties.
Plan sponsors should also confirm that the documents clearly address and are consistent on key governance points, including:
who is the ERISA “plan administrator” and who is the named fiduciary (if applicable);
who has authority to interpret the plan, make discretionary decisions, and decide claims and appeals (and whether discretion is intended);
delegations to internal teams (e.g., HR/benefits, payroll) and to vendors (third-party administrator (“TPA”), carrier, pharmacy benefit manager (“PBM”), COBRA administrator), including any limits and escalation protocols;
the scope of authority to amend the plan, approve benefit changes, or approve deviations from standard terms (and who can approve exceptions); and
document hierarchy and conflict resolution (plan document vs. SPD vs. policies vs. vendor communications).
Many plan sponsors find that a formal health and welfare plan committee can provide meaningful advantages over a purely “position-based” delegation model (e.g., delegating administration entirely through one or two roles), particularly for larger employers, employers with complex benefit offerings, or employers navigating increased scrutiny around claims, vendor performance, privacy, and fiduciary governance.
A formal committee helps bring structure and consistency to decisions that can create significant legal and operational risk, such as claims appeals, plan interpretation, discretionary determinations, and vendor oversight. A formal committee can help demonstrate that fiduciary decisions are consistent and actively managed through a structured process. The formal minutes or decision records of a committee can demonstrate procedural prudence, provide clear vendor instructions, and provide better audit trails for amendments and communications if issues later arise or decisions are challenged. A delegated committee can also provide better continuity beyond any single role-holder, providing oversight over cost management and trend analysis, population health strategy, vendor rationalization, and risk management.
Once the appropriate parties or committee members are identified, they should receive both ERISA fiduciary training and confidentiality training if privy to any protected health information or individual claims data. This training should be provided upon appointment/delegation and at least once a year thereafter. Training should reinforce the “dos and don’ts” that commonly create risk in the welfare space, such as making off-script coverage promises, issuing informal eligibility overrides, deviating from claims/appeals timelines, and Health Insurance Portability and Accountability Act (“HIPAA”) and data protection obligations.
Resolution #2: Set a proactive annual calendar for welfare plan governance and vendor oversight.
Unlike retirement plans, welfare plan issues such as enrollment changes, eligibility disputes, claims escalations, leave/COBRA coordination, and vendor issues tend to arise intermittently rather than at prescheduled times throughout the year. A strong annual cadence helps the sponsor stay ahead of both compliance and operational risk before issues become urgent or inconsistent practices develop.
At the beginning of the year, sponsors should set a welfare plan governance calendar that includes, as applicable:
open enrollment planning, communications, and proofing timelines;
carrier/TPA/PBM governance meetings (quarterly is often a good baseline), including performance metrics and recurring problem categories;
claims and appeals governance touchpoints, including review of escalations, exceptions, and any “pattern” denials;
reviews of required participant notices (e.g., COBRA, HIPAA special enrollment, Children’s Health Insurance Program Reauthorization Act (“CHIPRA”), Women’s Health and Cancer Rights Act (“WHCRA”), Medicare Part D, etc.) and confirmation that vendor workflows match plan terms; and
a benefits-change and plan-amendment workstream (especially when cost-sharing, network changes, or eligibility rules shift midyear).
Meeting agendas and materials should be distributed in advance, and internal stakeholders should be reminded to review materials ahead of time so that decisions are made deliberately and consistently, not reactively in email threads.
Resolution #3: Keep detailed records of welfare plan decisions, especially exceptions, claims escalations, and vendor direction.
Welfare plan disputes often come down to documentation: what the plan says, what the sponsor communicated, what the vendor did, and why an exception was (or wasn’t) made. Plan sponsors should maintain dated, retrievable records of key decisions and instructions, including:
minutes or written summaries of governance meetings (even if informal), documenting what was reviewed, what was decided, and why;
written records of any direction to vendors—particularly where the sponsor escalates a claim, requests reprocessing, approves an accommodation, or interprets ambiguous plan language;
documentation of plan amendments and the approvals supporting them, and confirmation that the SPD and participant communications were updated accordingly; and
a controlled process for handling exceptions (eligibility overrides, late elections, premium recoupment, coverage reinstatements), including who can approve, what criteria apply, and how exceptions are documented to avoid inconsistent administration.
As a best practice, circulate decision summaries or draft minutes in advance of the next meeting and approve them as the first agenda item. Where the sponsor has authority to amend the plan or approve material vendor changes, maintain signed evidence of approval (minutes, written consents, or signature packets) and retain supporting backup materials. Over time, these governance habits can meaningfully reduce risk, improve vendor accountability, and help ensure the plan is administered in a way that is both defensible and aligned with the sponsor’s overall benefits strategy.
To prove insider trading, the government must establish that a defendant traded securities “on the basis” of material nonpublic information (“MNPI”) in violation of a duty of trust. In many insider trading investigations, those under the microscope will try to show the government that they traded for a reason other than on the basis of MNPI. The success of such a defense depends in part on the interpretation of the language “on the basis of.” Since the 1990s, there has been a circuit split, still unresolved by the U.S. Supreme Court, on how to interpret these four words. Some courts follow the “knowing possession” standard, under which the government need only prove that a defendant traded while knowingly possessing MNPI. Other courts follow the “use” standard, requiring the government to prove that the defendant traded because of the nonpublic information.
Like everything else, artificial intelligence (“AI”) may soon change the way those suspected of insider trading defend themselves. AI, which investors and analysts increasingly rely on to trade stocks and analyze data, could make it easier for an individual investor to create a defense to insider trading. Imagine that an individual gets inside information about a publicly traded company. However, before trading, that person queries AI about the stock and obtains a comprehensive bespoke analysis supporting buying the company’s stock. AI makes it possible, if not easy, for someone possessing MNPI to create a ready-made defense should the government pursue charges for insider trading—and it may be enough to create reasonable doubt.
The Rise in AI-Assisted Trading
Investors and analysts are increasingly using AI in stock trading to analyze data, generate stock picks, and automate trading decisions. And for obvious reasons: AI offers advanced algorithms that can process large volumes of real-time data in a fraction of the time it would take even a seasoned analyst to do the same. AI can also analyze complex patterns in stock prices, financial statements, economic indicators, and even news articles to make predictions with higher accuracy than traditional methods—and all without human intervention.
New trading firms like XTX Markets and Tiger Brokers purportedly use AI to execute millions of trades daily, and there are AI-driven funds like Pictet that leverage AI to try to improve returns. Beyond the professionals, AI trading tools are also becoming available to retail investors. Experts are predicting that this could create a “seismic transformation” in the entire stock market.[1]
Overview of Insider Trading Law
Insider trading is commonly understood as buying or selling securities on the basis of MNPI in breach of a duty. Importantly, there is no federal statute that explicitly bans insider trading. Rather, the law of insider trading has evolved through common-law concepts of fraud and deceit.
The “classical theory” of insider trading refers to a case of a corporate insider who owes a fiduciary duty to the company or its shareholders and breaches that duty by trading on the basis of MNPI.[2] The “misappropriation theory” expands liability by assigning fiduciary duties to certain corporate outsiders.[3]United States v. O’Hagan held that although the defendant was not a corporate insider of the acquirer, he owed a duty to his firm’s client, the source of the information, not to trade on MNPI.[4] Liability for insider trading can attach both to a person that trades on MNPI and an individual that provides a tip in breach of a duty for the personal benefit of the tipper.[5]
The Debate over “Use” Versus “Knowing Possession”
Under both the classical and misappropriation theories of insider trading, a defendant must purchase or sell securities in reliance on, or “on the basis of,” MNPI.[6] Courts have struggled to unify behind a common interpretation of what “on the basis of” means, and two standards have emerged: the “use” standard and the “knowing possession” standard. In other words, does the government have to prove that an insider actually used MNPI to trade, or is it sufficient that the defendant knowingly possessed MNPI at the time of the trade?
A series of appellate decisions in the 1990s created a circuit split on this question. First, in United States v. Teicher, the defendant appealed his insider trading conviction, arguing that he had traded on the basis of public information that led him to become interested in the stocks at issue rather than the inside tips he had received.[7] Teicher argued that the jury instructions wrongly permitted a conviction “[b]ased upon the mere possession of fraudulently obtained material nonpublic information without regard to whether this information was the actual cause of the sale or purchase of securities.”[8] The U.S. Court of Appeals for the Second Circuit rejected the argument and held that the government solely need to prove “knowing possession” of MNPI to obtain a conviction for insider trading.
Six years later, the U.S. Court of Appeals for the Eleventh Circuit reached the opposite conclusion in SEC v. Adler.[9] In that case, the court there held that to prove a defendant engaged in insider trading, the U.S. Securities and Exchange Commission (“SEC”) needed to show that the defendant “used” the nonpublic information to trade because a broader “knowing possession” standard would capture cases that did not actually involve fraud. To address the concern that a “use” standard would impede the government’s prosecution of insider trading, the court created a “burden-shifting” framework:
[W]hen an insider trades while in possession of material nonpublic information, a strong inference arises that such information was used by the insider in trading. The insider can attempt to rebut the inference by adducing evidence that there was no casual connection between the information and the trade—i.e., that the information was not used.[10]
Shortly after Adler, the U.S. Court of Appeals for the Ninth Circuit applied the “use” standard in a criminal case. In United States v. Smith, the court found that “use” rather than “knowing possession” was more consistent with the scienter requirement of § 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5.[11] The Ninth Circuit also declined to apply the “strong inference” that the Adler court introduced because criminal cases prohibit presumptions of fact.[12]
SEC Rule 10b5-1
The SEC attempted to resolve this debate through rulemaking and proposed Rule 10b5-1 in December 1999, which was enacted in August 2000. It effectively adopted the “knowing possession” standard, providing as follows: “[A] purchase or sale of a security of an issuer is on the basis of material nonpublic information [about that security or issuer] if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale.”[13]
Despite the SEC’s rulemaking, courts have inconsistently adopted the Rule 10b5-1 standard. For example, the Eleventh Circuit in Fried v. Stiefel Laboratories, Inc. ignored Rule 10b5-1 and cited Adler to conclude that a finding of liability required proof that the defendant had actually used MNPI to trade.[14] The U.S. Court of Appeals for the Eighth Circuit similarly concluded that the government must prove that the defendant “actually used the information,” without citing Rule 10b5-1.[15] Lower courts have also differed on the deference afforded to the SEC’s definition.
Critically, the Supreme Court has not weighed in, and there has not been much development in this law since the late 1990s.
AI-Assisted Trading as a Potential Defense in Insider Trading Prosecutions
A key defense to insider trading is that the defendant did not trade “on the basis of” MNPI. The defendant might claim that the trading decision was based on a factor independent of MNPI, and AI tools could provide that independent factor. For example, the defendant could establish that the trades were part of a routine investment strategy or diversification effort and were motivated by publicly available information aggregated by AI.
Relatedly, the use of AI could be part of a mosaic defense to insider trading. The “mosaic theory”[16] is the view that a trader who gathers information from multiple public and nonpublic sources, analyzes the data, and makes an independent decision cannot be liable for insider trading if no one piece of information qualifies as MNPI. The defendant could argue that even if he had tidbits of nonpublic information, he used AI to supplement his knowledge and create a “mosaic” of information, and the entire picture provided the reason for his trades.
An investor who gets inside information about a stock could query AI about the stock before trading and then point to AI’s analysis as the reason for its trades. Of course, ten years ago a defendant could accomplish the same goal by running Google searches for a stock before trading. But the sophistication of AI’s capabilities and the rise in AI-assisted trading make it so much easier to have a cogent investment thesis.
The ability to successfully use AI-assisted trading as a defense to an insider trading prosecution will depend on how a court interprets “on the basis of.” Under a “use” standard, an investor could show that it used AI, not the MNPI, as the basis for the trade. Under a “knowing possession” standard, AI-assisted trading would do little to support a defense if the government was able to show knowing possession of MNPI.
A key development in this area might be the Supreme Court’s rejection of Chevron deference last year. In a post-Chevron world, courts may be more inclined to independently interpret § 10(b) without deference to Rule 10b5-1, and to conclude that the “use” standard is more consistent with the statute’s proscription of deception and manipulation. Indeed, the government might have a harder time convincing a court that the “knowing possession” standard embraced by Rule 10b5-1 comports with Rule 10(b).
Conclusion
In sum, AI-assisted trading might present an obstacle to the government’s prosecution of insider trading. At a minimum, assuming AI-assisted trading continues to expand, the government may have to consider how defendants could use this information when it assesses whether to bring an insider trading case.
United States v. Anderson, 533 F.3d 623, 631 (8th Cir. 2008). ↑
In Dirks v. SEC, the Supreme Court appeared to recognize the legality of the mosaic theory of securities analysis, in which analysts obtain fragments of information from company insiders and then use those fragments to create a mosaic of information to value the company. 463 U.S. 646 (1983). “It is commonplace for analysts to ferret out and analyze information,” the Court said, “and this often is done by meeting with and questioning corporate officers and others who are insiders.” Id. at 658. However, since Dirks, a number of high-profile defendants, including Raj Rajaratnam, Rajat Gupta, and Doug Whitman, were unsuccessful in arguing the mosaic defense to insider trading. ↑
Enacted in 1907, California’s Cartwright Act stands, in terms of anticompetitive collusion, as one of the most consequential statewide antitrust statutes in the country.[1] Recognized by California’s Superior Court as “broader in range and deeper in reach than the Sherman Act,” the Cartwright Act allows California businesses and consumers to pursue antitrust claims ineligible under federal law.[2] Differences between California and federal regulatory frameworks—with specific regard to indirect purchaser standing, anticompetitive tying standards, third-party criminal liability, and relaxed pleading requirements—have opened pathways to substantial recoveries for California plaintiffs. This article discusses these differences and explains how they bolster protection for California consumers.
The Illinois Brick Doctrine and Indirect Purchasers
Precedent established by the 1977 United States Supreme Court Case Illinois Brick Co. v. Illinois dictates that indirect purchasers of goods or services along a supply chain cannot seek damages for antitrust violations committed by the manufacturer of the product.[3] According to the ruling, a direct purchaser is the party that buys the relevant product directly from the manufacturer, while an indirect purchaser acquires the product through an intermediary—such as through a wholesaler or retailer. The Court reasoned that allowing indirect purchasers to sue would create two principal issues: first, the risk of duplicative recoveries (where both direct and indirect purchasers recover for the same overcharge, leading to excessive liability for defendants), and second, the complexity of tracing and apportioning damages through multiple levels of distribution. This standard, allowing only direct purchasers to seek damages from anticompetitive practices, is known as the Illinois Brick doctrine.
California responded swiftly to the Illinois Brick ruling, enacting a 1978 amendment to the Cartwright Act that granted standing to “any person who is injured” by unlawful activity “regardless of whether such injured person dealt directly or indirectly with the defendant.”
In California v. ARC America Corp. (1989), the Supreme Court definitively held that Illinois Brick did not preempt California’s broader standing provision.[4] The Court reasoned that Illinois Brick was a rule of federal statutory interpretation under the Clayton Act, not a broader federal policy requiring uniformity among states. Principles of federalism permitted California to prioritize compensation for all injured parties and robust private enforcement over the administrative concerns that motivated the federal restriction. By allowing indirect purchasers to sue for damages passed through the supply chain, California courts balance robust enforcement and deterrence against concerns about duplicative recovery and apportionment complexity. This landmark decision has enabled injured parties at any level of the supply chain to seek recovery for anticompetitive conduct in California and numerous other states.
This concept is further exemplified in Union Carbide v. Superior Court (1984), a Supreme Court of California case that addressed the question of whether indirect purchasers could sue for damages under the Cartwright Act.[5] The case involved a class of indirect purchasers of industrial gas who alleged that Union Carbide and other manufacturers conspired to fix prices, causing them to pay artificially inflated rates to the distributors. Defendants argued that federal law, as interpreted in the Illinois Brick decision, barred such suits to prevent complex damages apportionment and the risk of multiple liability. The court determined that the 1978 amendment to the Cartwright Act demonstrated clear legislative intent to diverge from the federal standard set by Illinois Brick. The court ultimately denied Union Carbide’s petition to dismiss the case, reinforcing the independence of California antitrust law and expanding the legal standing for consumers and other indirect purchasers within the state who seek recovery for price-fixing schemes.
Tying Arrangements
Another separation between federal and California antitrust law concerns tying arrangements: agreements in which a seller conditions the sale of one product (the “tying” product) to the purchase of a second product pertaining to a different relevant market or market segment (the “tied” product). California’s antitrust protections may facilitate consumer action against such practices by softening the evidentiary threshold needed to expose anticompetitive tying arrangements.
Federal law has gradually moved from uniform per se illegality for tying arrangements, viewing tying as inherently anticompetitive, to a more nuanced per se rule.[6] Contemporary federal law states that tying arrangements are per se violations only when they meet all of the following prongs: (1) the forced purchase of one product is needed to obtain a separate desired product; (2) the seller has appreciable market power with respect to the tying product; and (3) the tie affects a substantial amount of commerce in the market for the tied product. The concern is that the perpetrator is using its market power in a related market as leverage to artificially enhance its market power up or down the supply chain.
California, however, does not require the fulfillment of all those conditions to constitute a violation. Under the court’s interpretation of section 16727 of the California Business & Professions Code, in addition to an agreement tying the sale of two products together, plaintiffs must demonstrate either that the defendant held sufficient market power in the tying product or that the tie foreclosed a substantial volume of commerce in the tied product market.
Morrison v. Viacom (1998) illustrates this difference well. In this case, the California state court applied sections 16720 and 16727 of the Cartwright Act to determine whether television services illegally compelled cable subscribers to purchase bundled broadcast channels despite their disinterest.[7] The court did not find that a “substantial amount of sale was affected in the tied product for local broadcast television,” yet ruled that California’s antitrust law was not preempted by federal cable law.[8]
Importantly, while tying arrangements may be challenged under either section 16720 or section 16727 of the Cartwright Act, the latter section is limited to commodities. The primary ramification of this distinction is that standing precedent under section 16720 requires all three prongs be satisfied to establish a per se violation, whereas only two prongs (with either substantial market power or substantial market impact) need to be fulfilled in analyses under section 16727. The necessity of just two prongs broadens the possibility for future claims examined under section 16727.
Third-Party Criminal Liability
Another distinct feature of California antitrust law is its breadth of criminal liability that extends to third parties. The Cartwright Act expressly criminalizes not only participation in a trust or cartel, but also “any person who engages in any such conspiracy or takes part therein, or aids or advises in its commission, or who as principal, manager, director, agent, servant or employee, or in any other capacity, knowingly carries out any of the stipulations, purposes, prices, rates, or furnishes any information to assist in carrying out those purposes, or orders thereunder or in pursuance thereof, is punishable.”[9] This sweeping language indicates that even a third party who is not an actual competitor in the affected market—for example, a consultant or data provider—could face criminal punishment if they assisted in the implementation of the anticompetitive agreement. Extending punishment even to tangential parties in a conspiratorial scheme can strengthen deterrence.
While this broad approach prioritizes deterrence, it may produce unintended consequences for market participants. Professional service providers may adopt overly cautious practices when working with California clients, potentially limiting legitimate competitive intelligence services and increasing transaction costs. The risk of criminal liability could also create a chilling effect on pro-competitive collaboration through trade associations, standard-setting bodies, and joint ventures. Balancing robust enforcement against these practical considerations remains an ongoing challenge for California policymakers.
Relaxed Pleading Standards
Under federal procedural law, as established by Bell Atlantic Corp. v. Twombly (2007) and Ashcroft v. Iqbal (2009), a complaint must provide sufficient facts to state a claim to relief that is plausible on its face.[10] In antitrust cases, simply pleading that competitors behaved similarly (e.g., through parallel pricing) is not enough—the complaint must contain further factual enhancement suggesting an actual interparty agreement. In practice, federal courts often demand that an antitrust plaintiff allege “plus factors” or circumstances that make plausible the occurrence of collusion, as opposed to mere coincidence. At the pleading stage, this is a relatively stringent threshold, resulting in the dismissal of numerous antitrust suits pre-discovery.
In October 2025, California enacted Assembly Bill 325 to lower the pleading standard for Cartwright Act cases. Under the modified regulations, complaints can survive a motion to dismiss by pleading a plausible conspiracy. Plaintiffs will not be expected to allege facts that tend to exclude the possibility of independent action in order to survive dismissal. In a direct deviation from federal precedent established in Twombly and Iqbal, if the complaint articulates a coherent theory of a conspiracy, the case should survive dismissal because alternative explanations for conspiratorial behavior need not be addressed at the early stages of the suit.
This divergence is particularly salient following the rise of complex, data-driven collusion allegations such as claims that firms use price-fixing algorithms to tacitly coordinate prices. For example, if a plaintiff alleges that a group of competitors adopted the same pricing algorithm and prices consequently adjusted in lockstep, the parallel conduct plus the context might be deemed plausible enough for the continuation of the case.
Conclusion
California’s robust network of antitrust regulations ensures that the most vulnerable parties can seek remediation. The Cartwright Act enhances deterrence beyond federal protections by entitling parties across the distribution chain to raise complaints, heightening the standards and consequences for companies engaging in tying, and broadening the processing ability for antitrust claims. Aggrieved consumers can access a web of protections against anticompetitive corporations—past what relief the federal government provides. California’s regulatory framework presents an exciting case study into whether stricter antitrust legislation can offer heightened protection to consumers without deterring business operations.
Please note that the Cartwright Act does not include provisions that could be considered analogous to Section 2 of the Sherman Act (anticompetitive unilateral conduct) or Section 7 of the Clayton Act (anticompetitive merger control). ↑
See N. Pac. Ry. Co. v. United States, 356 U.S. 1, 8 (1958); Jefferson Par. Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 11–12 (1984); United States v. Microsoft Corp., 253 F.3d 34, 95 (D.C. Cir. 2001). ↑
Morrison v. Viacom, 66 Cal. App. 4th 534, 546 (1998); Cal. Bus. & Prof. Code §§ 16720, 16727 (2026). ↑
In complex Chapter 11 cases, general unsecured creditors frequently find themselves buried under layers of secured debt and alternative financing arrangements. Equitable subrogation allows the estate, upon satisfaction of a secured debt, to preserve the associated lien and step into the secured creditor’s position, rather than having the security discharged to confer a windfall on the party whose debt was paid or its junior creditors. Used strategically, equitable subrogation can allow an estate and its unsecured creditors to reach value that would otherwise remain locked beneath stacks of secured debt. This article examines equitable subrogation as it can be applied in Chapter 11 cases, focusing on debtor-guarantor relationships and plan design considerations, and uses a recent retail Chapter 11 case to illustrate those principles.
Equitable Subrogation: Core Principles
Equitable subrogation is a long-standing doctrine grounded in principles of fairness rather than contract. “Subrogation” is another word for “substitution.” Equitable subrogation permits a party who pays a debt for which another is primarily liable to step into the shoes of the satisfied creditor when equity requires.[1] It is an “equitable assignment.”[2]
If a guarantor meets the requirements for equitable subrogation, it obtains the rights of the creditor, including the creditor’s rights in collateral.[3] Where payment of a debt typically discharges a security interest, equitable subrogation permits the security interest to survive in favor of the subrogee.[4] The doctrine does not create new rights or reorder priorities;[5] instead, it operates as a form of equitable assignment, preserving existing rights that would otherwise be lost through payment.
Courts often emphasize that equitable subrogation turns on substance rather than form.[6] The inquiry focuses on whether the payor satisfied an obligation for which another was primarily liable and whether, in equity, the burden of that obligation should be without prejudice to the payor. In this sense, subrogation is less concerned with the mechanics of payment than with the consequences of allowing a lien to be extinguished by payment when doing so would distort the parties’ preexisting priorities. By treating subrogation as an equitable assignment, courts preserve the economic reality of the transaction and prevent inequitable results.
Courts have applied equitable subrogation in a wide variety of contexts, including insurance, suretyship, and real estate.[7] In bankruptcy, the doctrine may arise where a party pays a secured obligation to protect its own legal or economic interests. When applicable, subrogation prevents junior lienholders or unsecured claimants from benefiting from the extinguishment of senior secured debt without having satisfied that debt themselves.
Guarantors, Nonvoluntary Payment in Full Satisfaction, and Priority Preservation
For subrogation to apply, the debtor must not be the primary obligor, must not voluntarily pay the debt, and must satisfy the debt. Courts have held that subrogation is not available to a party who voluntarily pays another’s debt “for the purpose of gaining the security interest.”[8]
Courts generally reject a rigid application of the so-called volunteer rule where payment is made pursuant to a preexisting legal obligation or to protect the payor’s own interests.[9] Guarantors who satisfy the debt of a primary obligor typically do not act voluntarily; rather, their payment is compelled by the guaranty itself.
Equitable subrogation also requires that the guarantor satisfy the obligation in full. It is not available to a guarantor who settles with the creditor without obtaining a release of the creditor’s lien or the primary obligor.[10] In bankruptcy, untriggered debtor guaranties are contingent and subject to estimation under 11 U.S.C. § 502(c), which could result in significant payment of the obligation without the requisite satisfaction of it.[11]
Equally important is the distinction between a guarantor and a primary obligor. A party that is primarily responsible for a debt cannot invoke equitable subrogation, as there is no inequity in requiring that party to bear the burden of payment.[12] By contrast, a guarantor who satisfies a secured obligation may be equitably subrogated to the creditor’s lien rights, provided that subrogation does not unfairly prejudice third parties.[13]
These requirements underscore that equitable subrogation is not a device for manufacturing priority. Courts will deny subrogation where payment is truly voluntary, where the payor is the primary obligor rather than a guarantor, where the guarantor does not fully satisfy the obligation, or where the application of the doctrine would disrupt settled expectations that equity seeks to protect.
Although the Bankruptcy Code expressly addresses creditor subrogation under § 509,[14] it does not displace state-law equitable subrogation rights available to debtors.[15] Where state law permits subrogation, and where guaranty agreements do not expressly waive that right, equitable subrogation may arise independently of the Bankruptcy Code. Because equitable subrogation is, as the name suggests, an equitable remedy, courts will not infer its availability where the parties have expressly agreed to waive or limit subrogation rights, particularly in guaranty agreements drafted to alter common-law suretyship principles.
This distinction between Bankruptcy Code subrogation rights and state-law equitable subrogation rights is particularly important in debtor-guarantor scenarios. Section 509 addresses the rights of co-debtors and guarantors who pay claims against the debtor, but it does not speak to the inverse situation in which a debtor satisfies an obligation it guaranteed for a nondebtor affiliate. In those circumstances, courts look to applicable state law to determine whether equitable subrogation arises and whether the resulting rights become property of the estate.[16]
Recognizing this distinction avoids conflating statutory subrogation with equitable subrogation and underscores that equitable subrogation remains available, where appropriate, to preserve estate value even in the absence of explicit Bankruptcy Code authorization.
Structuring Plans to Preserve Subrogation Rights
The manner in which a secured obligation is satisfied can determine whether subrogation rights are preserved or lost. Because payment of a secured debt ordinarily extinguishes the associated lien, practitioners must take care to structure transactions so that equity preserves the lien for the benefit of the subrogee.
Chapter 11 plans offer a powerful vehicle for effectuating equitable subrogation. A plan may expressly acknowledge guaranty relationships, identify the purpose of the payment, and provide for the equitable assignment of loan documents and collateral rights to the estate or a post-confirmation trust. Plan confirmation provides finality and reduces the need for post-confirmation litigation over lien priority and ownership.
In practice, this requires careful attention to how the transaction is characterized and documented. Plans that rely on equitable subrogation should clearly identify the debtor’s guaranty obligation, the source and purpose of the payment, and the parties’ intent that the lien securing the satisfied debt be preserved for the benefit of the estate. Ambiguity on these points increases the risk that payment will be characterized as a voluntary discharge rather than a subrogable transaction.
Incorporating these concepts directly into the plan also promotes transparency. Creditors are afforded notice of the intended treatment of liens and collateral, and confirmation binds parties who might otherwise seek to challenge the preservation of the secured position after the fact. In this way, plan-based equitable subrogation can reduce litigation risk while providing a predictable framework for distributing value.
Where payment and assignment are integrated into a confirmed plan, the resulting subrogation rights become property of the estate under § 541(a)(7),[17] thereby preserving value for distribution in accordance with the plan’s priority scheme. An assignment agreement further evidencing the equitable assignment/subrogation is a best practice.
Addressing these issues directly in the plan reduces the risk that equitable subrogation will later be challenged as inequitable, waived, or prejudicial to third parties.
Illustrative Application: A Retail Chapter 11 Case
These principles were recently illustrated in a retail Chapter 11 case involving a debtor that had guaranteed secured loans made to affiliated real estate entities. The affiliates owned income-producing commercial properties that secured the senior lender’s claims through first-priority mortgages. The debtor, while not the primary obligor on those loans, was liable under broad guaranties and had also pledged its own assets as additional collateral.
As is common in retail restructurings, the debtor’s capital structure included multiple layers of asserted claims. In addition to the senior secured lender, various junior and disputed lien claimants asserted interests in the debtor’s cash proceeds, including claims styled as secured under nontraditional financing arrangements, such as merchant cash advance agreements. Absent payment of this debt by the debtor, equitable subrogation would not have been an option. And, absent a mechanism to preserve the senior lender’s lien position following payment, the satisfaction of the guaranteed debt would have extinguished the mortgages and related liens, allowing other parties to improve their relative position simply by virtue of that payment.
The Chapter 11 plan required the debtor to pay the secured guaranty debt and addressed this collateral extinguishment risk directly. Rather than treating payment of the guaranteed debt as a transaction that discharged the associated mortgages, assignments of rents, and security interests, the plan expressly acknowledged the debtor’s status as a guarantor, the purpose of the payment, and the parties’ intent that the estate succeed to (i.e., step into the shoes of) the lender’s rights following payment. The plan provided for the satisfaction of the secured obligation, the equitable assignment of the secured lender’s liens, and the assignment of the loan documents and mortgage interests to a post-confirmation trust to further evidence the equitable assignment under principles of equitable subrogation.
Through this structure, the estate stepped into the shoes of the satisfied secured creditor and retained the benefit of the existing lien position and collateral, rather than allowing those rights to be lost upon payment. As a result, the collateral continued to support a secured claim held for the benefit of the estate, altering the priority and distribution analysis under the confirmed plan. Absent payment of this debt by the debtor and the equitable assignment of the secured creditors’ loan documents, unsecured creditors would have been completely out of the money.
The application of equitable subrogation in this context did not create new rights or elevate unsecured creditors beyond the position previously occupied by the senior lender. Instead, it preserved existing priority rights that would otherwise have been extinguished and prevented a windfall to the affiliated real estate entities whose debt was paid and to other parties whose claims depended on the discharge of the senior security interests. The case illustrates how equitable subrogation, when addressed deliberately through plan design, can play a meaningful role in preserving estate value in cases involving guaranties and affiliated collateral.
Conclusion
Equitable subrogation remains an underutilized tool in Chapter 11 practice. Properly applied and incorporated into a plan, it can preserve secured rights that would otherwise be extinguished by payment—providing a potential lifeline for unsecured creditors.
See JPMorgan Chase Bank v. Cook, 318 F. Supp. 2d 159, 165 (S.D.N.Y. 2004). ↑
Barnes v. Cady, 232 F. 318, 324 (6th Cir. 1916). ↑
Boyd v. Superior Bank FSB (In re Lewis), 270 B.R. 215 (Bankr. W.D. Mich. 2001). ↑
Barnes v. Cady, 232 F. at 324 (“Under some circumstances the payment of a mortgage does not satisfy it or destroy its lien, because equity regards the person making the payment as the owner thereof for certain definite purposes and keeps it alive and preserves its lien for his benefit and security.”). ↑
“[I]t is well-established that the subrogee acquires no greater rights than those possessed by the subrogor. . . .” Boyd v. Superior Bank FSB, 270 B.R. at 217. ↑
In re Minn. Kicks, Inc., 48 B.R. 93, 104 (Bankr. D. Minn. 1985) (“[P]recluding the assertion of subrogation rights to issuers of standby letters of credit while allowing guarantors to assert them would be no more than an exercise in honoring form over substance.”). ↑
Fireman’s Fund Ins. Co. v. TD Banknorth Ins. Agency, Inc., 72 A.3d 36, 40 (Conn. 2013) (“The common-law doctrine of legal or equitable subrogation therefore enables an insurance company that has made a payment to its insured to substitute itself for the insured and to proceed against the responsible third party.”); United Prairie Bank v. Molnau Trucking LLC, 23 N.W.3d 535, 543 (Minn. 2025) (“In the suretyship context, a surety that performs its obligations under a bond it has issued [has] the right of equitable subrogation.”); Kim v. Lee, 31 P.3d 665, 670 (Wash. 2001) (“[I]n the real estate context, equitable subrogation has been traditionally invoked only to prevent unjust enrichment.”). ↑
Bednarowski & Michaels Dev., LLC v. Wallace, 293 F. Supp. 2d 728, 730–731 (E.D. Mich. 2003) (explaining that a “key requirement” is that the party seeking subrogation must be “compelled” to pay the debt of another). ↑
In re Chalk Line Mfg., Inc. 181 B.R. 605, 610 (Bankr. N.D. Ala. 1995) (permitting equitable subrogation where subrogee paid obligation to “protect its contract interest” but not “under compulsion.”). ↑
Pa. Nat’l Mut. Cas. Ins. Co. v. City of Pine Bluff, 354 F.3d 945, 951 (8th Cir. 2004) (“A prerequisite to equitable subrogation is the surety’s full satisfaction of any underlying debt or obligation.”). ↑
In re Fox, 64 B.R. 148, 153 (Bankr. N.D. Ohio 1986). ↑
Mich. Hosp. Serv. v. Sharpe, 339 Mich. 357, 373–74, 63 N.W.2d 638 (1954) (a party who is primarily obligated cannot use equitable subrogation to recover from other parties). ↑
Nationstar Mortg., LLC v. Williams (In re Williams), 643 B.R. 369, 377 n.10 (Bankr. M.D. Ga. 2022) (the prejudice analysis includes “whether the superior or equal rights of others would be prejudiced by the application of equitable subrogation to the lien”). ↑
11 U.S.C. § 509(a) (“Except as provided in subsection (b) or (c) of this section, an entity that is liable with the debtor on, or that has secured, a claim of a creditor against the debtor, and that pays such claim, is subrogated to the rights of such creditor to the extent of such payment.”). ↑
“State law subrogation, although deriving from similar considerations, is distinguishable from statutory subrogation under § 509(a) of the Bankruptcy Code, which grants the right of subrogation to a co-debtor or guarantor of the debtor who has paid the creditor’s claim.” Boyd v. Superior Bank FSB (In re Lewis), 270 B.R. 215, 217 n.1 (Bankr. W.D. Mich. 2001). ↑
Dwyer v. Ins. Co. (In re Pihl, Inc.), 560 B.R. 1, 8 n.37 (Bankr. D. Mass. 2016) (“Many courts have noted that the requirements of § 509 are distinguishable from those of equitable subrogation, but have held or implied that either theory may provide a basis for subrogation in a bankruptcy case.”). ↑
Property of the estate includes “[a]ny interest in property that the estate acquires after the commencement of the case”); see also 5 Collier on Bankruptcy ¶ 541.16 (16th ed. 2024) (“An example of the application of section 541(a)(7) would be if the trustee entered into a contract after commencement of the case. The estate’s interest in such a contract would, pursuant to section 541(a)(7), be property of the estate.”). ↑
The Eastern District of Pennsylvania Bankruptcy Conference (“EDPABC”) is a nonprofit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the U.S. District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of bankruptcy and creditors’ rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.
Materials Preview
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in late March / early April each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous forum, titled “Green Thumb Lighting,” describes the fictional bankruptcy of a heat lamp manufacturer after its production facility was destroyed by a fire, further complicated by the use of some of its products to grow medical marijuana.
The hypothetical raises questions around federal bankruptcy law and marijuana. Although marijuana use has been legalized by forty states and the District of Columbia for either recreational or medical use, it remains illegal under federal law. This hypothetical addresses various issues that arise when a business related to the marijuana industry faces insolvency. Among other things, the hypothetical addresses whether and under what circumstances a company with marijuana-related income or operations is permitted to seek protection under the Bankruptcy Code. In addition, the hypothetical address related issues surrounding the treatment of marijuana-related creditor claims and the ability of companies in the marijuana space to access traditional banking relationships. Finally, the hypothetical addresses the extent of a debtor’s property interests in existing government grants, the scope of a debtor’s directors’ and officers’ fiduciary obligations, and the ability of a debtor’s professionals to recoup fees under an indemnification provision in their engagement letter.
Green Thumb Lighting: Case Problem
In 2010, a group of successful Pennsylvania farmers decided to use their knowledge of mass cultivation to develop a new LED lighting technology for indoor farming. The technology, which the group ultimately integrated into large light bulbs, offered a unique combination of spectrum ratio (color) and heat intensity while consuming relatively little power. The group first shared the technology with industry friends and colleagues, but after realizing it was a hit, the group decided to incorporate. Each of the group members served as an officer of Green Thumb Lighting, Inc., with friends and other investors as shareholders.
Until 2015, Green Thumb experienced great success and became known as the premier indoor heat lamp manufacturer. During that time, Green Thumb successfully brought on several of the industries’ largest farmers as clients. Indeed, one particular client, Queen Ranch in California, accounted for approximately 25 percent of Green Thumb’s yearly revenue. As a result, Green Thumb grew quickly to employ over 500 employees, with its headquarters and a large manufacturing facility in Reading, Pennsylvania. The company also leased several small offices throughout the state to offer its salespeople convenient and flexible work locations and off-site inventory storage units for faster regional deliveries—both typically leased from the company’s customers.
Unfortunately, in early 2015, widespread wildfires destroyed a large portion of Queen Ranch. As a result, Queen Ranch reached out to many of its suppliers, including Green Thumb, to cancel outstanding, as well as future, purchase orders until Queen Ranch could redevelop its land. Unless it replaced the Queen Ranch revenue, Green Thumb would experience substantial losses. Desperate for new clients, Green Thumb began an expansive marketing program.
During this time, the Pennsylvania legislature began contemplating the adoption of a medical marijuana program for qualifying citizens. News of this possibility quickly spread as it was covered by every major and local news outlet in Pennsylvania. Shortly thereafter, the Pennsylvania legislature passed the Medical Marijuana Act, which, among other things, created a limited number of licenses for winning applicants to grow cannabis. The application process was public and involved an evaluation of many different factors, including the applicant’s likelihood of success. The committee responsible for this evaluation was statutorily obligated to announce the winners by June 2016.
While the applications were pending, Green Thumb was able to secure enough clients to make up for the Queen Ranch lost revenues. Most of these new clients, however, were only willing to enter into agreements that would become effective in July 2016. With no other choice, Green Thumb took the purchase orders to its state-chartered bank, Sulton Bank, which handled all of its deposit accounts, seeking a line of credit to cover expenses until the agreements kicked in. Sulton Bank agreed to provide a revolving loan secured by all of Green Thumb’s account receivables.
Though certain counterparties failed to satisfy their obligations, Green Thumb began to cash in on most of the agreements in July 2016 and established its integrated relationships with such customers, leasing off-site sales and inventory storage spaces. Things were good. Green Thumb was profitable and running like a well-oiled machine. With money to spend, the CEO of Green Thumb decided to purchase an expensive commercial liability insurance policy that covered almost every loss imaginable. The policy provided that disputes “will be governed by the law of the state in which the suit is brought.”
Unfortunately, later in 2017, the Green Thumb production facility experienced a fire of its own. Apparently, a glitch in the company’s custom bulb manufacturing software triggered a series of equipment malfunctions, which resulted in an electrical fire that destroyed virtually all of the Green Thumb facility. Production stopped, but the company continued to bear overhead costs.
Right after the fire, Green Thumb provided its insurance provider with notice of the damage and subsequently filed a claim under its fire coverage. The insurance provider confirmed receipt of the claim but because of the circumstances surrounding the fire, it notified Green Thumb that processing would require additional diligence. Between the damage to its assets and the lost revenue attributable to a lack of production, Green Thumb simply could not afford the delay. Worse yet, creditors began to circle as Green Thumb’s loan maturity approached.
Faced with limited options, Green Thumb sought the advice of a prominent law firm, Harper Marsh & Luzardo LLP (“HML”). HML first pressed the insurance company for answers, but the provider just gave them the runaround. Meanwhile, after several months, Sulton Bank began threatening to enforce its security interests against all of Green Thumb’s account receivables. Various other unsecured creditors, including customers who had funds on deposit with Green Thumb, also began to threaten action. Customers paid these deposits to lock in the price of the bulbs that they would purchase at a later date.
With the walls closing in, Green Thumb initiated negotiations with Sulton Bank to file for Chapter 11 bankruptcy relief and then pursue a claim against the insurance provider. Part of those discussions involved a $1 million cash collateral agreement provided by Sulton Bank, which would remain Green Thumb’s depository bank, and premised on the anticipated post-petition receipt of outstanding account receivables from Green Thumb’s newly acquired customers arising from pre-petition sales and post-petition sales of remaining off-site inventory. The proceeds of the cash collateral agreement would be used to pay key employee salaries and the lease payments for Green Thumb’s off-site locations and fund continued operations to service such customers, among other things.
On February 12, 2018 (“Petition Date”), Green Thumb, with help from HML, filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the Eastern District of Pennsylvania. At the same time, Green Thumb filed several first-day motions, including approval of the Sulton Bank cash collateral agreement. With no objections, the bankruptcy court approved the cash collateral agreement. The bankruptcy case was off to a good start.
HML began preparing a complaint against Green Thumb’s insurance provider alleging several claims, all of which ultimately sought coverage of the fire damage. Shortly after the Petition Date, HML filed and properly served the complaint on the provider.
One day before the deadline to answer the complaint, the insurance provider reached out to Green Thumb to explain how it intended to respond. According to the provider, its investigation revealed that some bulbs manufactured by Green Thumb were being used by medical marijuana cultivators. It was the insurance provider’s position that funding a new facility would thus violate the federal Controlled Substances Act despite the Pennsylvania medical marijuana program. The insurance provider filed its response the next day.
Unsurprisingly, Sulton Bank was not pleased with the insurance provider’s discovery and response. The case now appeared more complicated (and expensive) than originally anticipated. With pressure mounting, Sulton Bank moved to convert the case to a Chapter 7 and appoint a trustee who would liquidate the remaining assets and litigate the claim against the insurance provider. The bankruptcy court agreed and entered an order converting the case and appointing a trustee.
Questions
(1) After conversion, the Chapter 7 trustee filed a motion to dismiss the bankruptcy case because the debtor had been technically receiving “illegal” proceeds under federal law. What grounds / code provision(s) is the motion based on, and will the bankruptcy court grant the motion? Can the bankruptcy case be saved by bifurcating Green Thumb’s business going forward, i.e., abandoning cannabis-related assets? If the motion is granted, what are Green Thumb’s state law remedies, if any?
(2) Assuming the case is permitted to proceed, can the cannabis-producing customers that paid deposits for the bulbs file claims against the estate?
(3) May the Chapter 7 trustee continue to deposit the debtor’s cash in the state-chartered Sulton Bank?
(4) Is the insurance company obligated to provide coverage of the assets notwithstanding their use to grow state-sanctioned cannabis? Does the Chapter 7 trustee have a good objection to the secured claim of Sulton Bank on the basis that the loan agreement is unenforceable? Though the cash collateral agreement purports to bind the Chapter 7 trustee, does it?
(5) In 2015, Green Thumb applied for and was awarded grant funds from the Pennsylvania State Department of Agriculture (“Department”) to purchase certain equipment used to manufacture the bulbs. Among other things, the statute governing the grant program spells out very specific requirements regarding how grant funds are to be expended. The statute also mandates certain invoicing, payment, and reporting procedures.
To receive these funds, the Department required Green Thumb to execute a grant agreement. This agreement included a provision that restricted the sale of the assets funded by the grant proceeds for a period of five years:
For a period of 5 years from the date of this Agreement, Green Thumb will not lease, sell, transfer, or assign any and all property, whether real or personal, that is purchased in whole or in part with funds provided by the Department under this Agreement. Green Thumb agrees to obtain the prior written approval of the Department prior to leasing, selling, transferring, or assigning such property, in whole or in part.
Remarkably, these particular assets survived the fire; and after making a few calls, the Chapter 7 trustee found a suitable buyer for the equipment.
In due course, the Chapter 7 trustee filed a § 363 motion asking the bankruptcy court for authorization to consummate the sale. Enforcing the pre-petition grant agreement, however, the Department then filed an objection arguing that the equipment purchased with grant proceeds was not property of the debtor’s estate. How should the bankruptcy court rule?
(6) Having lost almost all of their investments, the shareholders, as well as other creditors of Green Thumb, retained an attorney to pursue any and all claims against the directors and officers (“D&Os”) of Green Thumb. The shareholders asked the attorney whether the D&Os have breached any of their fiduciary duties. How should the attorney respond? What are the D&Os’ best defenses?
(7) Struggling to sell the remaining assets, the Chapter 7 trustee found an investment bank, GreenView LLC, to market and sell the business, and filed an employment application under § 328 on its behalf. The engagement letter included a provision that stated:
Indemnification. The Company agrees to indemnify and hold harmless GreenView from and against all claims, direct damages, losses, and actual out-of-pocket reasonable expenses, including court costs and reasonable attorneys’ fees.
Skeptical of the need for an investment bank’s assistance, however, Sulton Bank objected, seeking § 330 review of any fees and reimbursement of costs sought by GreenView. After several rounds of negotiations with Sulton Bank, GreenView agreed to incorporate the following language in the retention order:
a. The Trustee is authorized to retain GreenView to act as her investment banker under 11 U.S.C. §§ 327(a) and 328(a).
b. Notwithstanding the preceding paragraph of this Order and any provision to the contrary in the Application or the Engagement Letter, the U.S. Trustee and Sulton Bank shall have the right to object to GreenView’s request(s) for interim and final compensation and reimbursement based on the reasonableness standard provided in § 330 of the Bankruptcy Code consistent with other investment banking fees earned during an expedited § 363 marketing process.
After the business was sold, GreenView filed a fee application seeking compensation in the amount of $1.5 million. Outraged at GreenView’s request, Sulton Bank objected to the fee application, arguing that GreenView did not contribute to the sale because it never solicited the purchaser. Following a hearing, the bankruptcy court reduced GreenView’s fees by $200,000. Now, under the indemnification provision in the engagement letter, GreenView seeks reimbursement of $20,000 in legal fees for defending its fee application. Is GreenView entitled to reimbursement for these fee-defense fees?
Summary of Legal Authorities for Questions #1 and #2
U.S.C. Authorities
11 U.S.C. § 707
The court may dismiss a case under this chapter only after notice and a hearing and only for cause, including—
(1) unreasonable delay by the debtor that is prejudicial to creditors;
(2) nonpayment of any fees or charges required under chapter 123 of title 28; and
(3) failure of the debtor in a voluntary case to file, within fifteen days or such additional time as the court may allow after the filing of the petition commencing such case, the information required by paragraph (1) of section 521(a), but only on a motion by the United States trustee. . . .
11 U.S.C. § 721
The court may authorize the trustee to operate the business of the debtor for a limited period, if such operation is in the best interest of the estate and consistent with the orderly liquidation of the estate.
11 U.S.C. § 363(c)(1)
(c)(1) If the business of the debtor is authorized to be operated under section 721, 1108, 1203, 1204, or 1304 of this title and unless the court orders otherwise, the trustee may enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice or a hearing.
21 U.S.C § 841
(a) Unlawful acts
Except as authorized by this subchapter, it shall be unlawful for any person knowingly or intentionally—
(1) to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance; or
(2) to create, distribute, or dispense, or possess with intent to distribute or dispense, a counterfeit substance.
21 U.S.C. § 846
Any person who attempts or conspires to commit any offense defined in this subchapter shall be subject to the same penalties as those prescribed for the offense, the commission of which was the object of the attempt or conspiracy.
21 U.S.C. § 856
(a) Unlawful acts
Except as authorized by this subchapter, it shall be unlawful to—
(1) knowingly open, lease, rent, use, or maintain any place, whether permanently or temporarily, for the purpose of manufacturing, distributing, or using any controlled substance;
(2) manage or control any place, whether permanently or temporarily, either as an owner, lessee, agent, employee, occupant, or mortgagee, and knowingly and intentionally rent, lease, profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance. . . .
Case Authorities
In re Olson, No. NV-17-1168-LTiF, 2018 WL 989263 (B.A.P. 9th Cir. Feb. 5, 2018)
Overview
“The Debtor [was] 92 years old, legally blind, and [lived] in an assisted living facility.” Among other reasons,
[s]he sought [C]hapter 13[] relief to stop foreclosure of her commercial real property. One of the tenants at that property operated a marijuana dispensary on the premises and continued to pay rent to Debtor postpetition. Debtor’s plan called for her to sell the commercial real property to pay off all creditors. At the hearing on the motion to sell and reject the lease with the tenant, the bankruptcy court dismissed the case sua sponte on the ground that Debtor’s postpetition acceptance of rents from the dispensary business was an ongoing criminal violation that disqualified her from bankruptcy relief.
On appeal, the U.S. Court of Appeals for the Ninth Circuit vacated the decision and remanded. The Ninth Circuit held that the bankruptcy court failed to make adequate findings to discern the standard under which it ordered dismissal.
Facts
Prepetition, Debtor Patricia G. Olson was the general partner of Olson Bijou Center, L.P., a California limited partnership (“OBC”). OBC owned a shopping center on Lake Tahoe Boulevard in South Lake Tahoe, California . . . (the “Shopping Center Property”).
Beginning in January 2013, Appellee Cody Bass began leasing space in the Shopping Center Property from OBC. . . . The lease expressly authorized Mr. Bass to operate a “dispensary.”[] Pursuant to that authority, Mr. Bass operated at the leased premises Tahoe Wellness Cooperative (“TWC”), a marijuana dispensary authorized under California law.
“The Shopping Center Property was encumbered by a deed of trust in favor of U.S. Bank, N.A.” After the Shopping Center Property missed payments, U.S. Bank recorded a notice of default and later recorded a notice of sale. The foreclosure sale was set. In response, the debtor filed a Chapter 13 petition, which stayed the foreclosure proceeding.
. . . That same day, she filed a quitclaim deed transferring OBC’s interest in the Shopping Center Property to herself individually. Mr. Bass continued to pay rent postpetition to Debtor or her counsel.
About a month after the bankruptcy filing, the bankruptcy court approved a stipulation between Debtor and U.S. Bank for the use of cash collateral for Debtor’s ordinary operating expenses and maintenance of the Shopping Center Property as well as assisted living expenses and health insurance. . . . In exchange, Debtor granted U.S. Bank a postpetition replacement lien on all rents generated from the Shopping Center Property and agreed to make adequate protection payments of $4,000 per month. According to the stipulation, at that time expected rental income was $16,220 per month, including TWC’s monthly rental payment of $10,200. In early May 2017, the court approved another cash collateral stipulation extending the agreement to use cash collateral . . . and modifying the budget to exclude the rent from TWC. There [was] no evidence in the record to indicate whether the postpetition rents paid by Mr. Bass were used to make payments pursuant to the initial cash collateral stipulation. . . .
. . . Debtor filed a motion to sell free and clear under § 363(f) the Shopping Center Property and the adjacent property, which she also owned, for $3 million [to pay all creditors]. . . . Debtor also filed a motion to reject the lease and the option agreement with Mr. Bass.[] In her declaration in support of the motion to reject, Debtor stated that she had entered into the lease with Mr. Bass in January 2013 and that Mr. Bass “currently operates a medical marijuana dispensary at 3443 Lake Tahoe Blvd[.]” . . .
Mr. Bass opposed both motions. In his declaration in support of his opposition to the motion to sell, Mr. Bass confirmed that he had been operating a marijuana dispensary on the premises pursuant to the terms of his lease with OBC and that he had paid rent to the Debtor postpetition.
The bankruptcy court sua sponte dismissed the debtor’s case after learning about the dispensary.
The bankruptcy court
concluded, “based on its interpretation of relevant case law,” that because Debtor had continued to receive rent postpetition, the case had to be dismissed:
I think it’s a crime for Ms. Olson to be accepting rents from an illegal operation, so I am dismissing this case. . . . My finding is this debtor is leasing property for an unlawful purpose under federal law, although lawful under state law . . . and has continued to accept rents during the course of her bankruptcy.
. . . In response to a request for clarification from Debtor’s counsel, the [bankruptcy] court explained:
[I]f the debtor has committed a crime during the course of the bankruptcy and continued for several months to commit a crime during the course of the bankruptcy, I think that is a basis for not providing relief to the debtor. Had the debtor, prior to filing bankruptcy or not during the bankruptcy had not committed the crime of taking money from a marijuana operation, I would feel differently. But that’s not what happened here. Because you don’t, in my opinion, get to go through five or six months of a bankruptcy knowingly receiving illegal proceeds and then say, oh, I’m not going to take those anymore, I want to sell the property now, so I get to play here. I don’t think that’s correct.
Court Analysis
The Ninth Circuit began its analysis with the basic proposition that a bankruptcy court grants or denies relief based on a specific provision of the Bankruptcy Code. In this case, the Ninth Circuit offered two possible provisions: (1) bad faith under § 1307(c) and (2) the bankruptcy court’s inherent authority under § 105. According to the Ninth Circuit, the former requires a bankruptcy court to engage in a totality of circumstances analysis. The latter, on the other hand, can only be invoked “within the confines of the Bankruptcy Code,” particularly when a statute “adequately addresses the conduct at issue,” such as § 1307(c).
Turning to § 1307, the Ninth Circuit noted that dismissal is a two-step analysis:
First, it must be determined that there is “cause” to act. Second, once a determination of “cause” has been made, a choice must be made between conversion and dismissal based on the “best interests of the creditors and the estate.” . . .
Although not listed, bad faith is cause for dismissal. . . . [To] determin[e] bad faith, the bankruptcy court [should] apply a totality of the circumstances analysis, considering (1) whether the debtor misrepresented facts in her petition or plan, unfairly manipulated the Bankruptcy Code, or otherwise filed her [C[hapter 13 petition or plan in an inequitable manner; (2) the debtor’s history of filings and dismissals; (3) whether the debtor only intended to defeat state court litigation; and (4) whether egregious behavior is present.
Conclusion
According to the Ninth Circuit, “[t]he bankruptcy court stated that it had ‘looked at the cases,’ but did not articulate any rules drawn from those cases that applied to the facts before it.” The Ninth Circuit noted that “[s]ome courts have held that, to the extent estate assets are used for or generated by the operation of a federally prohibited marijuana business, a trustee or debtor in possession may not administer those assets without violating federal law.” Further,
[s]ome courts have held that a bankruptcy filing or a plan of reorganization proposed by a debtor who is involved in an illegal enterprise is not in good faith, even where the debtor does not have a subjective bad motive, is in legitimate need of bankruptcy relief, and there is otherwise no indicia of an attempt to abuse the bankruptcy process.
Finally, “some courts have concluded that a debtor engaged in an illegal business who seeks bankruptcy relief comes into court with unclean hands and is not eligible for relief.”
The Ninth Circuit ultimately held that the bankruptcy court “made no finding of bad faith or unclean hands.” Further, the bankruptcy court improperly “concluded that it was a crime for Debtor to be accepting rents from Mr. Bass’ business without making any findings showing that all the elements of a CSA [Controlled Substances Act] violation had been established.” Accordingly, on remand, the Ninth Circuit directed the bankruptcy court to “articulate the findings that led it to determine that Debtor was violating the CSA and what legal standard it relied upon in dismissing the case.”
In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015)
Overview
The United States Trustee (“UST”) moved to dismiss the Chapter 7 case filed by a Colorado marijuana grower and his wife, while the debtors simultaneously moved to convert the case to one under Chapter 13. The U.S. Bankruptcy Court for the District of Colorado ruled that “cause” existed to dismiss the case based on the UST’s inability to lawfully administer the debtors’ assets, and the debtors could not convert the case to one under Chapter 13.
The U.S. Court of Appeals for the Tenth Circuit affirmed and held that
neither a Chapter 7 nor 13 trustee c[ould] administer the most valuable assets in [the debtors’] estate. Without those assets or the marijuana based income, the debtors [could not] fund a plan without breaking the law, and [were] therefore ineligible for relief under Chapter 13. . . .
[Further,] [a]dministering the debtors’ Chapter 7 estate would require the Trustee to either violate federal law by possessing and selling the marijuana assets or abandon them. If he did the former, the Trustee would be at risk of prosecution; if he did the latter, the creditors would receive nothing while the debtors would retain all of their assets and receive a discharge as well.
According to the Tenth Circuit, that “amount[ed] to prejudicial delay that [was] sufficient to demonstrate cause to dismiss their Chapter 7 case under § 707(a).”
Facts
The debtors jointly owned a commercial building in Denver that consist[ed] of two units (the “Property”). Mr. Arenas gr[ew] and wholesale[d] marijuana in one unit.[] He and [Mrs.] Arenas lease[d] the other unit to Denver Patients Group, LLC (“DPG”), a marijuana dispensary. . . .
The debtors filed their Chapter 7 bankruptcy petition after they brought an eviction action against DPG in state court that resulted in a $40,000 attorney’s fees award against them. . . . Lacking the resources to pay the $40,000 judgment . . . , the debtors filed a Chapter 7 petition. . . . According to [the debtors’] schedules, Mrs. Arenas [was] disabled and receive[d] monthly pension benefits and social security totaling $2,977.[] The family’s remaining monthly income of $4,265 stem[med] from rental income and Mr. Arenas’ marijuana business.[] Their monthly expenses [were] approximately $7,235, making their monthly net income $7. Their nonexempt assets [were] 25 marijuana plants (valued at $6,250)[] and the Property[] (collectively the “Assets”). . . .
The UST filed a motion to dismiss for cause under § 707(a). The UST alleged that it would be impossible for a Chapter 7 trustee to administer the Assets without violating federal law. In response, the [debtors] moved to convert their case to Chapter 13 [under § 706] and objected to the motion to dismiss. After an evidentiary hearing on both motions, the bankruptcy court issued a written order denying the debtors’ motion to convert and granting the UST’s motion to dismiss.
Court Analysis
With respect to converting the Chapter 7 case to a Chapter 13 case under § 706, the Tenth Circuit analyzed the debtors’ good faith by examining the totality of the circumstances.
First, the debtors’ “monthly income from sources other than marijuana was not enough to fund their plan.” The debtors conceded “that the only way they can fund a plan is with the rental income from the marijuana dispensary. Without the rental income, their monthly expenses of $7,000 exceed[ed] their non-marijuana income by $4,000 a month. Even with the rental income, the plan [was] barely feasible because their Schedule I reflect[ed] a surplus of less than $8 a month, yielding at best, a nominal dividend.[] [Mrs.] Arenas [was] disabled and unable to work. That, combined with [Mr.] Arenas’ age and employment history, amply support[ed] a finding that the debtors’ income [was] unlikely to increase during the plan term. The court considered the debtors’ “ability to earn and likelihood of future increases in income” and concluded that their plan [was] not likely confirmable because it [was] not feasible.
Conversion was therefore inappropriate.
Second, short of exposing him to physical harm, nothing could be more burdensome to the Trustee’s administration than requiring him to take possession, sell and distribute marijuana Assets in violation of federal criminal law. There is no way the Trustee could administer the plan without committing one or more federal crimes.[]
Finally, as for the debtors’ “motivation and sincerity,” the bankruptcy court found the debtors to be sincere and credible and took pains to emphasize that their motives in seeking bankruptcy relief were not improper.[] That said, the court also recognized that lack of good faith carries an objective rather than a subjective meaning. If the debtors [were] incapable of proposing a confirmable plan, it [was] objectively unreasonable for them to seek Chapter 13 relief whether their intentions [were] kindly or not. . . .
With respect to dismissal under § 707(a), the Tenth Circuit held that “[t]he impossibility of lawfully administering the estate constituted cause for dismissal. . . .” Moreover, “[i]f the Trustee abandoned the Assets, the debtors would retain their business after exposing the Trustee to grave risk, provide the creditors with little or no recovery, and receive a discharge, protected all the while from their creditors’ collection efforts by the automatic stay and then the discharge injunction.” This, according to the Tenth Circuit, was “the epitome of prejudicial delay” and therefore cause for dismissal.
a licensed “caregiver” and marijuana grower under the Michigan Medical Marijuana Act[,][] filed for relief under [C]hapter 13 after falling behind on his house payments, his utility payments, and at least one payment on his truck. . . .
The United States Trustee filed a motion to dismiss . . . , arguing that “the debtor appears to be engaged in the marijuana industry and the Court should not enforce the protections of the Bankruptcy Code to aid violations of the federal Controlled Substances Act.” . . .
The bankruptcy court recognized that debtors generally “cannot conduct an enterprise that admittedly violates federal criminal law while enjoying the federal benefits” of the Bankruptcy Code. However, the court also recognized that “the Debtor filed his case in good faith, and it is quite obvious from his credible testimony that he is in dire need of bankruptcy relief and the court’s assistance.” Thus, the court held that the debtor was entitled to bankruptcy relief—provided, however, that the debtor discontinue the medical marijuana business.
Court Analysis
The court began by recognizing the tension between state and federal law, and expressly stated that “the Debtor’s post-petition medical marijuana business violates federal law and renders the Debtor ineligible for relief under the Bankruptcy Code.” According to the bankruptcy court, however, “the conclusion that dismissal is required does not necessarily follow”:
The Debtor’s business is patently incompatible with a bankruptcy proceeding, but his financial circumstances are not. In other words, if the Debtor were not engaged in post-petition criminal activity, there would likely be no controversy about his eligibility for relief under [C]hapter 13.[] The problem, of course, is that he derives nearly half of his income from activity that Congress forbids as criminal. The Debtor, it seems, must choose between conducting his medical marijuana business and pursuing relief under the Bankruptcy Code. The court has ample authority to require him to make that choice, and given his obvious financial distress, the court concludes that this approach is preferable to dismissal.
Such authority was found in §§ 1304 and 363 of the Bankruptcy Code. Under those provisions, a bankruptcy court is given discretion to limit the use of estate property in certain circumstances. Because the debtor’s use of the marijuana property violates the CSA, the court found that those provisions gave the court authority to mitigate the risk of forfeiture by ordering the debtor to cease operations.
Conclusion
First, the court ordered that the marijuana plants—and any products or inventory derived from the marijuana plants—be abandoned. Second, the court ordered the debtor “to destroy the marijuana plants and any product or inventory derived” from the marijuana plants. “Eliminating the contraband from the estate by way of immediate abandonment, and ordering its destruction as a condition of the Debtor’s eligibility to proceed further, will remove the shadow that the contraband casts on this proceeding.”
In other words,
to balance the court’s (and the Debtor’s) obligations under federal law, including federal criminal law, the Debtor’s legitimate need for relief under [C]hapter 13, and Michigan’s policy choices reflected in the MMMA, the court will refrain from dismissing the Debtor’s case at this time, but will enjoin him from conducting his medical marijuana business (and violating the CSA), while his case is pending.
The debtor’s business involved leasing warehouse space to tenants who were engaged in the business of growing marijuana. In fact, “[a]pproximately 25% of the Debtor’s income [was] produced from leasing space in the Debtor’s Warehouse to tenants who use[d] that space for the cultivation of marijuana.” A secured creditor, VFC Partners 14 LLC (“VFC”), sought dismissal of the case under the “clean hands doctrine” and argued that the debtor’s activities “made it unworthy of the equitable protection of the bankruptcy court. In addition, VFC argue[d] that the Debtor’s case was filed in bad faith and should be dismissed on that basis.”
Court Analysis and Conclusion
The court applied § 1112 of the Bankruptcy Code, which provides a list of factors to be considered when determining whether “cause” exists to convert or dismiss a Chapter 11 case. Because that list is nonexclusive, the court also considered VFC’s clean-hands argument in the context of determining “cause.”
The court first found “gross mismanagement of the estate”:
The Debtor has freely acknowledged that it engages in conduct that exposes the Debtor to criminal liability and that exposes its primary asset to forfeiture. It acknowledges that its criminal behavior has continued post-petition. The fact that it engaged in this conduct and entered into the leases with its tenants pre-petition does not constitute mismanagement of the estate because the estate is a post-petition entity. However, the Debtor entered its bankruptcy case with the offending leases in place and has maintained those leases during the pendency of its [C]hapter 11 bankruptcy case. It is that post-petition presence of activity on the Debtor’s property—pursuant to leases that it knowingly entered into—that violates the CSA; exposes the Debtor to criminal liability; and exposes both the Debtor and its mortgage creditor to forfeiture of the Warehouse that constitutes gross mismanagement of the estate and requires the Court to either convert this case to a case under [C]hapter 7 or to dismiss it.
Second, the court found that the debtor lacked clean hands:
Title 11 U.S.C. § 1129(a)(3) provides that a plan may only be confirmed if it is “proposed in good faith and not by any means forbidden by law.” Because a significant portion of the Debtor’s income[] is derived from an illegal activity, § 1129(a)(3) forecloses any possibility of this Debtor obtaining confirmation of a plan that relies in any part on income derived from a criminal activity. This Debtor has no reasonable prospect of getting its plan confirmed. Even if § 1129 contained no such good faith requirement, under no circumstance can the Court place itself in the position of condoning the Debtor’s criminal activity by allowing it to utilize the shelter of the Bankruptcy Code while continuing its unlawful practice of leasing space to those who are engaged in the business of cultivating a Schedule I controlled substance.
Finally, the court ordered a subsequent hearing to determine whether conversion or dismissal was proper.
In response to state laws permitting certain marijuana-related activity, FinCEN issued guidance to clarify Bank Secrecy Act expectations for financial institutions seeking to provide services to marijuana-related businesses (“FinCEN Guidance”).
The FinCEN Guidance began with an overview of the memorandum issued by then–Deputy Attorney General James M. Cole, which provided guidance to federal prosecutors concerning marijuana enforcement under the CSA (“Cole Memo”). Among other things, the Cole Memo established a set of priorities that prosecutors should consider when deciding whether to enforce the CSA:
Preventing the distribution of marijuana to minors;
Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
Preventing marijuana possession or use on federal property.
The FinCEN Guidance then established that “the decision to open, close, or refuse any particular account or relationship should be . . . based on a number of factors specific to th[e] institution.” According to the FinCEN Guidance, “[t]hese factors may include [the institution’s] business objectives, an evaluation of the risks associated with offering a particular product or service, and its capacity to manage those risks effectively.”
“In assessing the risk or providing services to a marijuana-related business,” the FinCEN Guidance also established the standard of due diligence that the institution should perform. Importantly, when dealing with information regarding state licensure obtained in connection with customer due diligence, “a financial institution may reasonably rely on the accuracy of information provided by state licensing authorities.”
Finally, the FinCEN Guidance expressly stated that “[t]he obligation to file a SAR [suspicious activity report] is unaffected by any state law that legalizes marijuana-related activity.” In doing so, the FinCEN Guidance established three levels of SAR reporting, and provided a list of “red flags” to help assist institutions identify activity that implicates one of the Cole Memo priorities. Notably, FinCEN has made clear that its guidance remains in place despite former attorney general Session’s rescission of the Cole Memo.
Plaintiff’s Complaint allege[d] that Defendant breached the parties’ insurance coverage contract by failing to pay Plaintiff’s insurance claims for stolen property. Plaintiff, who own[ed] and [lived] at a property in the Puna District of the State and County of Hawai`i, purchased a homeowners insurance policy from the Defendant (the “Policy”).
Among other things, the Policy provided “coverage for loss to ‘trees, shrubs, and other plants.’”
[T]welve plants were stolen from Plaintiff’s property. Nine of the twelve plants were fully matured . . . marijuana plants. The remaining three plants were less mature plants. . . . Plaintiff [alleged] that she “lawfully possessed, grew, nurtured and cultivated the plants consistent with the laws of the State of Hawaii . . . permitt[ing] individuals to possess and grow marijuana for medical purposes[.]”
Court Analysis and Conclusion
The district court began with the fundamental proposition that an illegal contract, or one that is in violation of public policy, is unenforceable. Despite marijuana’s legal status under state law, the court held that the contract must also be lawful under federal law to be enforced. In Tracy, the court refused to enforce the contract because “Plaintiff’s possession and cultivation of marijuana, even for State-authorized medical use, clearly violates federal law. To require Defendant to pay insurance proceeds for the replacement of medical marijuana plants would be contrary to federal law and public policy, as reflected in the CSA.”
Mann v. Gullickson, No. 15-cv-03630, 2016 WL 6473215 (N.D. Cal. Nov. 2, 2016)
Overview and Facts
In Mann v. Gullickson, the plaintiff sold two businesses to the defendant: (1) Dispensary Permits.com (“DP”), “a consulting business for state-regulated marijuana dispensary or cultivation licenses”; and (2) weGrow Enterprises, Inc. (“weGrow”), “a franchise hydroponic retail operation.” In exchange, the defendant forgave a $10,000 loan to the plaintiff and executed a promissory note agreeing to pay the plaintiff another $400,000.
After the defendant defaulted on the promissory note, the plaintiff sued the defendant for breach of contract. The defendant then moved for summary judgment contending that the parties’ agreement was void for illegality because it related to medical marijuana—a prohibited substance under the CSA. To support this argument, the defendant proposed a bright-line rule: “California law includes federal law and thus, a violation of federal law is a violation of law for purposes of determining whether or not a contract is unenforceable . . . .” The plaintiff advocated for a more nuanced approach that focused on the legality of the remedy, not the legality of the subject matter.
Court Analysis and Conclusion
Indeed, the court sided with the plaintiff and denied the defendant’s motion. Although the district court recognized the “continued erosion of any clear and consistent federal public policy in this area,” the court ultimately couched its opinion on the nature of the businesses and held that requiring the defendant to satisfy the note’s obligation did not force the defendant to “possess, cultivate, or distribute marijuana, or to in any other way require her to violate the CSA.” The court emphasized that “[t]here is no indication in the record the Companies directly grew or sold marijuana.” Thus, the note was not void for illegality.
In Green Earth Wellness Center, a cannabis company sued its insurance carrier for failing to pay on claims, unreasonable delay, and bad faith.
Green Earth operated a medical marijuana dispensary and commercial grow facility near Colorado Springs. Green Earth made two claims to its carrier, Atain. For its first claim, Green Earth claimed that “smoke and ash from [a nearby wildfire] overwhelmed [Green Earth’s] ventilation system, eventually intruding into the growing operation and causing damage to Green Earth’s marijuana plants.” For its second claim, Green Earth claimed that burglars broke into Green Earth’s facility causing damage to the roof and stealing marijuana plants. Atain denied both claims.
Atain argued that the policy excluded coverage for “[c]ontraband, or property in the course of illegal transportation or trade.” Atain further argued that “public policy requires that coverage be denied, even if the [insurance] Policy would otherwise provide it.”
Court Analysis and Conclusion
The court determined that Colorado law applied as the insurance contract mandated that disputes “will be governed by the law of the state in which the suit is brought.”
Applying Colorado state law meant that the district court could disregard Atain’s “illegality under federal law” argument. The court further held that (1) Atain’s policy failed to define contraband; (2) Atain failed to prove Green Earth violated Colorado’s marijuana laws; and (3) there were mixed messages regarding enforcement at the federal level. Consequently, the court found that Atain’s “contraband” exclusion was ambiguous.
The appeal to the U.S. Court of Appeals for the Third Circuit arose out of an adversary action brought by the Chapter 11 trustee of
debtor Life Service Systems, Inc. (LSS) against defendant Westmoreland Human Opportunities, Inc. (WHO), charging the latter with a breach of its fiduciary duty to LSS’s Unsecured Creditors Committee (Committee). Both LSS and WHO [were] non-profit organizations which provide[d] community services to residents of Westmoreland County in western Pennsylvania.
In 1995, LSS was selected by the Department of Housing and Urban Development (HUD) to receive grant moneys under the federal Supportive Housing Program; LSS and HUD executed a Supportive Housing Grant Agreement (Grant Agreement) as part of this grantor/grantee arrangement. Shortly thereafter, LSS experienced significant financial difficulties, ultimately filing a Chapter 11 bankruptcy petition.
Facts
“Because WHO was one of LSS’s largest creditors, it accepted an invitation to join the Unsecured Creditors Committee.”
“During its tenure on the Committee, WHO, without notifying either its fellow Committee members or the Bankruptcy Court, assumed LSS’s position as recipient of Supportive Housing Program funds, executing a[n] . . . Amendment” to the Grant Agreement. LSS’s Chapter 11 trustee “alleged that WHO, by assuming LSS’s interest in the grant relationship in this manner, breached its fiduciary duty to Committee constituents. WHO defended arguing “that LSS’s interest in the Supportive Housing Program grant relationship was not property of LSS’s bankruptcy estate and thus did not trigger a fiduciary duty owed” by WHO.
“The Bankruptcy Court rejected WHO’s defense, holding that LSS’s interest in the grant relationship constituted part of LSS’s bankruptcy estate and that WHO had therefore violated its fiduciary obligations. It entered judgment against WHO in the sum of $135,653.” The district court affirmed.
Court Analysis
On appeal, the Third Circuit disagreed with the bankruptcy and district courts and held that
LSS’s interest in the grant relationship with HUD is excluded from the definition of “property of the estate” set forth in § 541 of the Bankruptcy Code. Despite § 541’s considerable breadth, HUD’s singular supervisory interest in ensuring the effective administration of the Supportive Housing Program, evidenced by the pervasive, strict, and minute oversight over the grant relationship imposed by the Program’s relevant statutory and regulatory provisions, suffices to exclude LSS’s interest in the Supportive Housing Program grant relationship from § 541’s property definition.
Conclusion
The Third Circuit concluded that had the bankruptcy court “given proper weight to HUD’s strong interest, LSS’s interest in the grant relationship would have been excluded from LSS’s estate for bankruptcy purposes.” In addition, the Third Circuit “note[d] that considerations of bankruptcy policy militate[d] in favor of excluding LSS’s interest from § 541’s property definition,” distinguishing the “LSS’s Trustee’s attempts to rely on case law holding that government-issued licenses, in general, qualify as property of the estate under the Bankruptcy Code.”
In re Joliet–Will County Community Action Agency, 847 F.2d 430 (7th Cir. 1988)
Overview and Facts
The Joliet–Will County Community Action Agency (“Joliet–Will”) was “a private nonprofit community service organization financed exclusively by federal and state grants. The organization’s charter authorize[d] it to raise funds from foundations and other private donors,” although it had never done so.
ACTION, the federal agency that has succeeded the Office of Economic Opportunity, awarded Joliet–Will two grants for a “foster grandparents” program. Other federal agencies granted money for child care, family planning, insulation for homes of low-income people, legal assistance to the poor, and other community service activities to various Illinois state agencies that in turn passed on the money to Joliet–Will (sometimes with matching state grants as well) in accordance with the terms of the federal grants. Joliet–Will was mismanaged, and ultimately went broke and filed a petition for bankruptcy under Chapter 7 of the Bankruptcy Code. A trustee was appointed. Her inventory of the assets in the possession of Joliet–Will turned up cash plus furniture, office equipment, vehicles, aluminum siding, insulation materials, and other personal property. . . .
The federal and state agencies . . . claim[ed] that all of Joliet–Will’s assets belong[ed] to them because all th[e] assets [were] either federal or state grant money or personal property bought with such grant money, and [were] therefore . . . not available for distribution to the creditors. The bankruptcy . . . and the district court . . . disagreed, ruling that Joliet–Will’s assets should be distributed to the trade creditors pro rata, minus the usual costs of administration.
Court Analysis and Conclusion
On appeal, the U.S. Court of Appeals for the Seventh Circuit carefully reviewed the terms under which the grants were made, and reversed. The Seventh Circuit decision in favor of the federal and state agencies was based on the following factors:
“The grants imposed minute controls on the use of the funds, such that the recipient has very little discretion.”
“The statutes creating the grant programs . . . d[id] not authorize the federal government or any state government to allow appropriated funds to be used to pay creditors of a private institution unless the creditor incurred an expense specifically authorized by the grants and applicable regulations.”
A number of cases reviewed by the court held “that federal funds in the hands of a grantee remain the property of the federal government unless and until expended in accordance with the terms of the grant.”
“[T]he treatment of such grants in other areas of law, notably criminal law, [is that] thefts of federal grant money (or personal property bought with such money) are treated as thefts from the federal government.”
In re Premier Airways, Inc., 303 B.R. 295 (Bankr. W.D.N.Y. 2003)
Overview and Facts
Prior to its Chapter 7 filing,
Premier Airways, Inc. (“Premier”) operated a small airport in the Town of Angola, New York. This facility occupied 177.73 acres of land consisting of seven parcels. Four of these parcels constituted an original airfield that the debtor acquired in 1990. Then in 1993, the debtor obtained an AIP [Airport Improvement Program] grant [from the Federal Aviation Administration (“FAA”)] to purchase three contiguous parcels for airport expansion. As a condition for the grant, Premier agreed to follow comprehensive regulations regarding the structure and operation of the expanded facility. Physically, these regulations required that the airport provide space to the FAA for air traffic control and air navigation activities. Premier also agreed to reduce obstructions in its air space; to open its facility to general public use; to serve as a “reliever airport” in the event that no other commercial airport was available; to avoid closings for non-aeronautical reasons without the permission of the FAA; and to maintain accounts that [were consistent] with FAA guidelines. The regulations mandated compliance with environmental, labor and anti-discrimination laws. Most importantly, Premier promised never to sell, mortgage or encumber the facility. In the event that the newly acquired parcels were no longer used as an airport, Premier was obliged to return a proportionate part of the proceeds of sale to the FAA. . . .
. . . Eventually, however, Premier encountered financial problems and filed a [Chapter 7] petition. . . . With due diligence, the [C]hapter 7 trustee proceeded to liquidate the estate’s assets. Meanwhile, the FAA filed a proof of claim for an equitable lien. . . .
The FAA essentially contend[ed] that the expansion parcels were not property of the bankruptcy estate, and that therefor, the United States retain[ed] a superior interest in that portion of the sale proceeds . . . attributable to those parcels.
Court Analysis and Conclusion
Although it acknowledge[d] that section 541 of the Bankruptcy Code gives broad definition to property of the estate, the FAA assert[ed] that from this definition, courts have excluded property acquired through the use of federal grants, where the federal interest suffices to deem that property an asset of the federal government[,] [specifically relying on Judge Posner’s holding in Joliet –Will County].
Unlike with personal property, however, the bankruptcy court held that
[p]ursuant to 11 U.S.C. § 544(a)(3), the trustee enjoyed the rights of a bona fide purchaser of the expansion properties. Thus, proceeds from their sale [were] property of the bankruptcy estate, free of any secured claim or equitable lien of the FAA. Accordingly, the FAA [held] only the status of a general unsecured creditor.
Summary of Legal Authorities for Question #6
Case Authorities
Miller v. American Telephone & Telegraph Co., 507 F.2d 759 (3d Cir. 1974)
Overview and Facts
Plaintiffs, stockholders in American Telephone and Telegraph Company (“AT&T”), brought a stockholders’ derivative action . . . against AT&T and all but one of its directors. The suit centered upon the failure of AT&T to collect an outstanding debt of some $1.5 million owed to the company by the Democratic National Committee (“DNC”) for communications services provided by AT&T during the 1968 Democratic national convention. . . .
Plaintiffs’ complaint alleged that “neither the officers or directors of AT&T have taken any action to recover the amount owed” from on or about August 20, 1968, when the debt was incurred, until May 31, 1972, the date plaintiffs’ amended complaint was filed. The failure to collect was alleged to have involved a breach of the defendant directors’ duty to exercise diligence in handling the affairs of the corporation[] [because of] a preference to the DNC in collection procedures in violation of § 202(a) of the Communications Act of 1934 . . . , [which] amounted to AT&T’s making a “contribution” to the DNC in violation of a federal prohibition on corporate campaign spending.
On a motion to dismiss filed by the defendants, the district court dismissed the complaint on the theory that collection efforts are within the business judgment purview of the directors unless it could be proved that the directors’ action was “plainly illegal, unreasonable, or in breach of a fiduciary duty.”
Court Analysis and Conclusion
In reviewing New York law, the applicable law due to the AT&T’s place of incorporation, the court held that
[t]he plaintiffs’ complaint in the instant case alleges a similar “waste” of $1.5 million through an illegal campaign contribution. . . . The alleged violation of the federal prohibition against corporate political contributions not only involves the corporation in criminal activity but similarly contravenes a policy of Congress clearly enunciated in 18 U.S.C. § 610.[] That statute and its predecessor reflect congressional efforts: (1) to destroy the influence of corporations over elections through financial contributions and (2) to check the practice of using corporate funds to benefit political parties without the consent of the stockholders.
Accordingly, the Third Circuit held that the complaint alleged actual damages to the corporation, and stated a cause of action for which relief could be granted.
In re Beyries, No. 10-13482, 2011 WL 5975445 (Bankr. N.D. Cal. Nov. 29, 2011)
“Plaintiff Northbay Wellness Group (“NWG”) [was] a corporation set up to sell medical marijuana. It operated during 2005 and 2006 and generated several million dollars in sales. Plaintiff Dona Frank was its chief executive officer as well as a director,” and
defendant [and Chapter 7 debtor] Michael Beyries was the attorney for NWG [who] counseled them on how to conduct their business. . . . NWG and Frank [sought] to establish that they ha[d] nondischargeable claims against Beyries. . . .
During the time Beyries was representing [NWG], Frank gave him many thousands of dollars from the sale of marijuana in cash stuffed into envelopes. The funds were not counted, no records were kept, and Beyries gave no receipt. Frank testified that she gave “at least” $25,000.00 to Beyries in this fashion. The evidence established that these funds were not for current legal expenses but were rather intended as a defense fund in case anyone associated with NWG was prosecuted by state or federal officials. Since the money was not for legal services being performed at the time and there was no fee agreement designating the money as prepaid fees, the conclusion [was] that the funds belonged in Beyries’ trust account. His failure to properly account for this money was therefore nondischargeable pursuant to § 523(a)(4) of the Bankruptcy Code.
However, the court held that it could not “enter a judgment for plaintiffs because they were engaged in unlawful activity.” That is, “[w]hile the sale of marijuana may be legal under state law, it is a . . . federal crime which cannot be legalized by a state.” The bankruptcy court therefore dismissed the adversary proceeding because the plaintiffs had “unclean hands.”
On appeal, however, the holding was reversed, and the Ninth Circuit directed the bankruptcy court to apply a balancing test, rather than a per se test, that weights the substance of the right asserted by the plaintiff against the misconduct giving rise to the plaintiff’s “unclean hands.” See Northbay Wellness Group, Inc. v. Beyries, 789 F.3d 956 (9th Cir. 2015).
In re Pingrey, No. 12-10158, 2012 WL 1833928 (Bankr. N.D. Cal. May 18, 2012)
“Claimant Charles Arnold was grievously and permanently injured while an employee on the ranch of Chapter 13 debtor Dale Pingrey. Prior to the bankruptcy, Arnold was prosecuting a personal injury action against Pingrey in state court. Arnold . . . filed a proof of claim in the bankruptcy proceedings” and asked the bankruptcy court “to abstain from adjudicating his claim in favor of the state court.”
Pingrey was transparent about his intentions for filing Chapter 13—“[h]is business was growing marijuana, which may be legal under California law but not federal law,” and “Pingrey believe[d] that if he litigate[d] in federal court, he c[ould] show that Arnold’s claim [was] barred by the doctrine of unclean hands.” The bankruptcy court noted that it “cannot imagine any court applying this equitable doctrine to bar Arnold from recompense for his severe injuries. Pingrey’s reliance on an earlier decision of this court is misplaced; the equities are different.” Accordingly, due to the fact that the litigation was already pending in state court and the fact that litigation in Chapter 13 cases is rarely carried out in bankruptcy court, the bankruptcy court abstained from proceeding with the litigation.
This Article explores the conflict between state and federal marijuana laws from a business entity law perspective. For example, managers owe a fiduciary duty of good faith to their businesses and equity holders. One of the ways in which managers can violate this duty is by causing their business to intentionally violate the law. This is a problem for the marijuana industry because its managers constantly and intentionally violate federal law and therefore violate their fiduciary duties by growing and selling marijuana. This Article concludes that the industry’s ability to attract professional stakeholders is harmed by marijuana business stakeholders’ inability to take advantage of key business law protections, such as limited liability. This Article [thus] proposes a state law exception that allows marijuana businesses to operate normally under state business entity law, with normal business entity law protections, despite their continuing violation of federal law. . . .
. . . In form, the exception would hold that a violation of another jurisdiction’s laws, which directly contradicts laws passed within Colorado, w[ould] not act as a violation of the law for purposes of establishing good faith and clean hands in a Colorado court with regard to a business operating entirely within Colorado’s borders. The court c[ould] apply this exception when it finds that state public policy outweighs the value of enforcing the foreign jurisdiction’s law. . . .
The exception could originate either from a court ruling or legislative action. A court could find that for purposes of a state’s business entity laws, the violation of the CSA by a domestic marijuana business is not a violation of the law, or a state legislature could pass a law giving courts this guidance. Whichever body created the exception, the function would be the same—state courts would allow marijuana businesses to take advantage of normal business entity law protections and regulations.
The article goes on to conclude that if new laws were passed,
equity holders would not lose limited liability protection simply because they funded a marijuana business. If the marijuana business becomes insolvent and is unable to pay its debts, the equity holders would not be liable to the business’s creditors automatically and simply because they funded an illegal business. This, of course, would not mean that they could not lose their limited liability in other ways, such as under a normal application of the alter ego test. The effect of this would be to promote high net worth investors coming into the industry. These investors would bring with them demands for professional management of their businesses. Likewise, marijuana business managers would not be in continuous violation of their duty of good faith simply because they are operating in violation of the CSA. Again, this would not mean that managers could not violate their duty of good faith by breaking other laws, such as state marijuana regulations. But because managers would not be in continuous violation of the law, now they would have an incentive to operate the business within all non-CSA laws so as to avoid personal liability. This should have the effect of giving comfort to investors in marijuana businesses that the business they invested in will be operated professionally.
Summary of Legal Authorities for Question #7
U.S.C. Authorities
11 U.S.C. § 328
(a) The trustee, or a committee appointed under section 1102 of this title, with the court’s approval, may employ or authorize the employment of a professional person under section 327 or 1103 of this title, as the case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or percentage fee basis, or on a contingent fee basis. Notwithstanding such terms and conditions, the court may allow compensation different from the compensation provided under such terms and conditions after the conclusion of such employment, if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions. . . .
11 U.S.C. § 330
(a)(1) After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103—
(A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and
(B) reimbursement for actual, necessary expenses. . . .
(3) In determining the amount of reasonable compensation to be awarded to an examiner, trustee under chapter 11, or professional person, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including—
(A) the time spent on such services;
(B) the rates charged for such services;
(C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;
(D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;
(E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and
(F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.
The U.S. Supreme Court held that the Bankruptcy Code does not permit bankruptcy courts to award attorney fees to counsel employed by the bankruptcy estate for work performed in defending a fee application.
Respondent ASARCO LLC hired petitioner law firms pursuant to § 327(a) of the Bankruptcy Code to assist it in carrying out its duties as a Chapter 11 debtor in possession. . . . When ASARCO emerged from bankruptcy, the law firms filed fee applications requesting fees under § 330(a)(1), which permits bankruptcy courts to “award . . . reasonable compensation for actual, necessary services rendered by” § 327(a) professionals. ASARCO challenged the applications, but the Bankruptcy Court rejected ASARCO’s objections and awarded the law firms fees for time spent defending the applications. ASARCO appealed to the district court, which held that the law firms could be awarded fees for defending their fee applications. The Fifth Circuit reversed, holding that § 330(a)(1) did not authorize fee awards for defending fee applications.
Court Analysis and Conclusion
First, the Supreme Court analyzed the American Rule regarding fees, whereby “each litigant pays his own attorney fees, win or lose,” absent explicit statutory or contractual authority. It then reviewed the statutory authority of §§ 327(a) and 330(a) and held that the Bankruptcy Code does not permit bankruptcy courts to award attorney fees to counsel or other professionals employed by the bankruptcy estate for work performed in defending a fee application in court. That is, the statutory text authorizing “reasonable compensation for actual, necessary services rendered by” such professionals neither explicitly nor implicitly “authorizes courts to shift the costs of adversarial litigation from one side to the other,” and so cannot displace the American Rule with respect to fee-defense litigation.
Second, and crucial to the Supreme Court’s decision, was the statutory language of § 330(a)(1): compensation is available “only for ‘actual, necessary services rendered.’” The Supreme Court went on to explain: “Time spent litigating a fee application against the administrator of a bankruptcy estate cannot be fairly described as labor performed for—let alone disinterested service to—that administrator.” And § 330(a)(1) allows only compensation for work performed in service of the bankruptcy estate.
“[T]he Debtor and its affiliates filed [C]hapter 11 petitions,” and “[t]he UST appointed [a] Committee, which thereafter retained counsel.” Committee counsel each sought § 328(a) approval
of a provision in their retention applications entitling them to compensation from the Debtors’ estates (subject to approval by the Court pursuant to sections 330 and 331) for any fees, costs or expenses, arising from the successful defense of their fees.
The UST objected to the inclusion of the fee defense provisions in the retention applications,[] [arguing] that the provision is precluded by the recent Supreme Court holding in ASARCO. . . . The UST also argue[d] that the fee defense provisions should not be approved because such fees are outside the scope of employment and are unreasonable. . . .
The UST argued that all terms of employment must actually relate to the services to be rendered by the professionals, i.e., the representation of the committee and its interests. It argued that defending one’s own fees is not a service performed by committee counsel for the committee but instead are services performed only for themselves. Last, the committee argued that “[c]ourts generally hold that exculpation and indemnification clauses are permissible in retention agreements if the clauses are reasonable in accordance with 11 U.S.C. § 328(a).”
Court Analysis and Conclusion
The bankruptcy court addressed two questions in arriving at its conclusion that the fee-defense provisions in the retention applications could not be approved.
First, it addressed whether the retention agreements were contracts and held that they are. According to the court, “[h]owever, it is not a bi-lateral one; rather, it is subject to objection by other parties and is ultimately subject to approval (and modification) by the Court.”
Second, the court addressed whether the retention agreement contract was a contractual exception to the American Rule. The court held it was not, noting that
there is not a contract between two parties providing that each will be responsible for the other’s legal fees if it loses a dispute between them. Rather, here there is a contract between two parties (the Committee and Committee Counsel) that in the event Committee Counsel win a challenge to their fees, a third party (the estate) will pay their defense costs even if the estate is not the party who objected. As the UST notes, this is not the typical contract modifying the American Rule.
The court further noted that the retention agreement could not bind the estate as the estate was not a party to it. The court also noted that even if the retention agreement was a contractual exception, the contract was still one that must be reviewed and approved as permissible by the bankruptcy court.
Finally, the bankruptcy court reviewed examples of cases where such indemnification clauses were held permissible in a non-bankruptcy context and found none of them persuasive because the examples either predated ASARCO or were allowed as bald orders without any reasoning. Accordingly, the bankruptcy court “conclude[d] that ASARCO prevent[ed] the Court from concluding that section 328 permits defense fees even if they were routinely allowed by the market in bankruptcy or non-bankruptcy contexts prior to that ruling.”
After the commercial failure of the former Intercontinental Hotel at O’Hare Airport, River Road Hotel Partners, LLC, and its affiliates (“Debtors”) filed for Chapter 11 bankruptcy. The Debtors retained FBR Capital Markets & Co. (“FBR”) as their financial adviser to oversee a planned restructuring. In addition to a restructuring fee, a provision in the retention agreement provided that FBR would be reimbursed for legal fees and expenses “in connection with” its services or for expenses incurred “related to or result[ing] from [] performance . . . of the services contemplated by . . . this agreement.” The bankruptcy court approved the retention agreement with the qualification that “the reimbursement of all FBR’s out-of-pocket expenses shall be subject to further review and approval by the Court pursuant to section 330 of the Bankruptcy Code.” FBR sought $1.8 million, mostly attributable to the attorney fees it paid in defense of its request for its restructuring fee.
Court Analysis and Conclusion
First, the district court held that ASARCO was “directly on point” despite FBR’s attempt to distinguish ASARCO given that the case involved a nonlegal professional, as opposed to the lawyers in ASARCO. The district court found this distinction to be irrelevant: “Sections 327(a) and 330(a) apply to all professionals, and ASARCO’s discussion is cast in broad language to include all professionals, not just attorneys.” The district court also rejected FBR’s argument that ASARCO was not applicable because FBR was seeking “reimbursement” rather than a direct payment for services: “FBR still seeks compensation for funds expended in fee-related litigation, which brings the matter directly under ASARCO’s ruling. FBR’s attempt to differentiate meaningfully Section 330(a)(1)(A) from 330(a)(1)(B) fails also, because ASARCO explicitly cited both of those subparts and held, ‘This text cannot displace the American Rule with respect to fee-defense litigation.’”
Second, the district court found that the retention agreement did not act as a stand-alone contract, thus entitling FBR to reimbursement, because the retention agreement had to be read together with the retention order. “By making out-of-pocket expenses subject to Section 330 review, the Retention Order bound the Bankruptcy Court to abide by the statute.” In other words, the two documents did not qualify as a contract exception to the American Rule given the language of the retention order.
In the Nortel Networks case, an indenture trustee asserted a claim against the bankruptcy estate, including an $8.1 million claim for attorney fees. The indenture trustee also asserted the right to be paid for the fees incurred defending the $8.1 million fee request. The indenture, which was a contract between the debtor and, inter alia, the indenture trustee, contained a provision allowing the trustee to be reimbursed for such fees. The Nortel Networks court, after reviewing ASARCO and Boomerang Tube, concluded that the indenture came within the contract exception of the American Rule.
The debtor’s counsel filed a retention application seeking approval under § 328(a) of language specifically providing for payment of any fees incurred in defending its requests for payment of fees. The paragraph for which it sought approval provided:
The Client agrees to pay all reasonable legal fees incurred in obtaining Court approval of all employment and fee applications including dealing with any objections to any of the applications is [sic] also compensable to [the Gorman firm]. The Client agrees to pay all reasonable legal fees including dealing with any objections to court approval . . . The Client agrees that all reasonable fees and expenses incurred by [the Gorman firm] in collecting and/or obtaining approval of its fees and costs by bankruptcy or any other court shall be added to the total fees and costs due from the Client. All such fees and costs if disputed shall be resolved by the Court.
The creditors’ committee objected to the provision requiring payment of the debtor’s counsel’s fees for defending its fee application. The committee argued that the fee-defense provision was not allowed under the ASARCO holding.
The court reviewed the rationale for the holdings in the ASARCO and Boomerang Tube cases and the respective courts’ disallowance of those fee-defense provisions. The court then reviewed the Nortel Networks case and the reasoning for the court’s allowance of the fees incurred by the indenture trustee in defending its fee request. The court noted that “Nortel’s relevance [was] limited by the fact that the court did not have to decide whether the fee defense provision was a reasonable term under § 328(a), because counsel for the indenture trustee was not employed by the bankruptcy estate.”
The Hungry Horse court found that ASARCO’s holding was limited to § 330(a) of the Bankruptcy Code and held:
ASARCO does not hold that a fee-defense provision can never be a “reasonable term” under § 328(a). Nothing in the Code says that an employment term must benefit the estate to be reasonable. A typical employment agreement between a lawyer and client has many terms; some benefit the client, while others benefit the lawyer. Considered together, they may be reasonable.
It then went on to provide an example of a fee-defense provision that might be “reasonable”:
Fee Defense. The Client agrees to pay all reasonable legal fees and expenses incurred by the Firm, and also by any counsel retained by the unsecured creditors’ committee (if one is formed in the Client’s bankruptcy case) for successfully defending their respective fee applications. The bankruptcy court must approve all of such fees as reasonable. The Client will have no obligation to pay for any fees or expenses the Firm incurs defending fees that are not allowed.
People looking for legal help today have more ways to find an attorney than ever before: search engines, AI chatbots, social media, online directories, and word-of-mouth referrals that inevitably lead to an online search. At the center of it all sits a law firm’s website, serving as the hub where all of these paths converge.
Based on over twenty-five years of experience working with solo attorneys and small law firms on thousands of law firm website projects, I am here to share what makes a law firm website as effective as possible.
Why Do I Need a Law Firm Website?
Law firm websites traditionally had three primary functions: establishing credibility for the firm and its attorneys, generating new business from various marketing channels, and providing a tech-forward client experience. Recently, a fourth function has emerged: building artificial intelligence (“AI”) visibility.
Let’s explore each of these a bit more.
Establishing Credibility for Attorneys and Law Firms
A law firm’s website often has the job of making the first impression. The website needs to quickly and effectively convey what the firm does and why it stands out from the competition. Prospective clients, potential employees, opposing counsel, and professional peers should easily find it when they search for the firm or its attorneys by name.
The main objective is to seamlessly blend the firm’s offline reputation with its online presence so that the website feels like a natural extension of the services and expertise the firm provides.
Generating New Business from Marketing Efforts
For many firms, their website is the primary tool to help them generate new business. Think of the website as the hub for all online and offline marketing efforts. Whether they learn of a firm through a referral or the firm’s marketing efforts, most people will visit a law firm’s website before contacting it for legal services.
To convert those visitors into contacts, the website must be easy to navigate, have audience-focused content, represent the brand well, and make it simple to reach the firm in a variety of ways.
Extending Great Client Service with Online Functionalities
A website can serve as an extension of a law firm’s client experience. Integrating online payment, client portals, and electronic intake forms can simplify day-to-day tasks and make communication with clients feel easy.
Using your website as a resource hub can take that experience to the next level. Not only do educational materials help build authority online, they can help law firm clients understand their case and navigate challenges better when they arise. These resources can be blog articles, white papers, video libraries, newsletters, and so on.
Building Authority and AI Visibility
Generative AI is changing user behavior at a rapid pace. As products like ChatGPT, Gemini, and Claude increase in sophistication, they are becoming popular tools for people looking for law firm recommendations.
These tools increasingly recommend attorneys directly to users, who may contact a law firm without ever visiting the firm’s website. A common example of this is the use of AI Overviews and AI Mode in Google. These create a zero-click experience because the user gets the answer they’re seeking without clicking anywhere else.
Establishing AI visibility means helping systems like ChatGPT and Gemini understand what your law firm does and when to recommend it to users. This is where the firm’s website becomes less a destination for the human user and more a source that AI draws on to learn about the firm and inform its summaries and recommendations.
What Content to Include in Your Law Firm Website
With a website playing a role in so many aspects of a firm’s business, things can quickly feel overwhelming. But websites can be built in stages. Starting with just the basics, here are the core elements all law firm websites should have.
Homepage
This is the page that really makes the first impression. It should clearly communicate the firm’s brand and services, and it should draw users in with a variety of visuals and ways to quickly discover available content. Within seconds and without scrolling, a visitor should have a relatively clear picture of what the firm is about.
A homepage should include a thorough amount of content because search engines value it more heavily than any other page. The homepage will commonly introduce the firm and then highlight and preview content from other sections of the website, such as client reviews, case results, practice areas, firm news, blog posts, and attorney introductions.
Attorney Profiles
Aside from the homepage, attorney profile pages are the most frequently visited part of law firm websites. They should include recent professional headshots, a medium-length profile that speaks to the attorney’s experience, contact information, and bulleted lists of other professional accomplishments.
Attorney profiles should be engaging, spark interest, and confirm important details about the attorney’s background and how it relates to services the firm provides. It should not be a full-length CV, though that can be linked to separately if appropriate for the practice and clientele.
Practice Areas and Services
A page listing the practice areas or services a law firm provides starts to get into the meat of what the firm does and what uniquely separates it from other firms that do the same thing. For a validation-oriented website in a referral-driven practice, a list of services may be enough. But firms that want traction with online marketing or AI visibility should publish a thorough page for each service or practice area.
About Us
This page or section serves as a catchall to cover aspects of the firm’s founding, purpose, history, core values, and community involvement that weren’t covered by the homepage. For smaller practices, this content especially helps to establish the firm as its own entity. It can also be a great area to honor and reference older or founding attorneys who have retired from the firm but still have name recognition in the community or industry.
Published Reviews
Outside of the homepage and attorney profiles, reviews are the next most popular type of content on law firm websites. Reviews, especially those showcasing published reviews from third-party party sites like Google Business and Avvo, show potential clients that other people in similar situations have had success with the firm. Individual reviews come across as authentic endorsements and, when paired with a client photo and star graphics, can make a very strong impression.
Contact Information
At the end of the day, the website is there to facilitate connection with the law firm. Contact information should be visible on all pages. A contact form should be made available for people contacting the firm after hours or who aren’t available for a phone call at that moment. The firm may also add additional contact methods, such as live chat or SMS texting. People have all sorts of ways they prefer to communicate with a business; just look at how many ways you can order pizza! It is important that your law firm meets clients where they’re at to encourage them to connect with you in the most convenient way for them.
Disclaimers and Privacy Policy
Law firms need to be especially careful to have disclaimers and privacy policies that maintain compliance with various state, national, and international requirements. Firms need to be explicit about what does and does not create an attorney-client relationship. They also need to disclose how personally identifiable information (“PII”) is used and shared with third parties, such as advertising platforms. New in recent years is 10DLC compliance for firms that want to communicate and market to their clients via SMS text messaging.
How Do Law Firm Websites Need to Adapt with AI?
Since many people are turning to generative AI to research and synthesize information and using its answers to form their opinions, AI visibility is important to position your firm more broadly in the marketplace. This means understanding how to facilitate your law firm’s presence in generative AI outputs.
Before getting into the weeds with technical recommendations to improve law firm website performance with generative AI, it’s important to recognize the ultimate goal of these tools: AI chatbots are competing to be the fastest, most reliable source of information that saves the user time and helps them make better decisions.
Deliver a Strong Opening
Generative AI processes content in a much more resource-intensive way than traditional search engines. To manage their resources, generative AI systems use retrieval processes to decide which content is worth pulling into their responses. By adding tables of contents, TL;DR summaries, and statements like “this article contains” to the opening of a page, you can increase the odds the AI tool will commit resources to processing your content.
Get to the Point
Generative AI tools prioritize content that gets to the point and doesn’t bury an answer deep within a story. Clear, direct statements are more likely to be quoted and cited by generative AI (and humans) than ones heavily hedged with words like “probably,” “often,” and “frequently.” If something is true, it’s best to state it clearly and then follow up with nuance or exceptions.
Use Proper Content Structure
Clearly organizing page content with descriptive headings and a logical progression to a conclusion helps generative AI systems process information more efficiently. For instance, a page can define a problem, then explain solutions, discuss practical application, and finally note exceptions to be aware of.
Break a Problem Down
Generative AI systems often give answers that explain why something works. When your law firm is cited in answers like these, it builds trust and shows experience. In your articles and substantive content, use first-principles thinking to break problems and issues down into the essential elements, challenge assumptions, and demonstrate why your solutions and explanations are superior.
Maximize Website Speed
When a generative AI goes outside of its internal knowledge and searches the web for an answer, the clock is ticking. While users understand that the AI tool is processing, they still expect an answer within seconds. This means that an AI needs to browse and process dozens of pages in that time. Websites need to respond quickly to these requests, or the tool may move on to websites that respond faster.
Generally a generative AI system will be looking to have a page respond within half a second and completely load within 2.5 to 5 seconds. Google publishes a page speed evaluation tool, and website developers have many tools at their disposal to increase website speed, including caching utilities and content delivery networks.
Build a Broadly Positive Online Reputation
Generative AI systems understand that when a person is looking for legal help, they’re
looking for a recommendation to a law firm or a lawyer, not just a website. To that end, AIs will use information available online, beyond a law firm’s website, to influence its recommendations. This includes professional peer review websites like Martindale-Hubbell and Best Lawyers, client review websites like Google, Yelp, and Avvo, social media sites like LinkedIn, and state bar records for disciplinary checks. They can also bring in information news and legal publications and other online sources such as Reddit. An exercise every law firm and lawyer should try is to ask their AI tool of choice what it thinks about them and their firm.
A Word of Caution
Just as search engines gave rise to an entire industry of people promoting shady tricks and quick ways to top results, so too is generative AI. Your BS detector needs to be better than ever. And while some trickery may result in short-term gains, over the long run, meaningfully building your firm’s online reputation in a way that resonates with humans (client reviews, quality publishing, speaking, engagement in the community, being helpful) will also resonate with generative AI.
Other Tips to Keep in Mind for Your Law Firm Website
So far, we have covered the basics of what a law firm website needs and how it functions in the age of generative AI. What follows here are four additional things to consider during the creation and continued evolution of your firm’s site.
Prioritize and Commit
Exciting as websites are, trying to tackle everything a law firm may want (i.e., new design, podcast, blog, social presence, and digital advertising campaign) all at once may quickly overwhelm a firm’s staff and resources. Spend time up front to discover what matters most to the firm, and tackle that first. Then expand the scope of content and resources after the website launches. This builds in flexibility for marketing and operations to take shape as the practice evolves.
Use SEO
Having a website show up on search, and in generative AI chatbots, requires search engine optimization (“SEO”). Effective SEO includes attention to technical functionality, on-page keyword implementation, authoritative content writing, and linking strategies. All of this jargon is to say: your law firm website needs to be fast, informative, and regularly updated.
Although SEO efforts can be started during the initial website creation process, law firms that want to generate new business from their online presence need to make SEO part of their long-term marketing strategy. Additionally, if your firm is planning to update your current website design, it’s important to have SEO-focused professionals help with the transition to ensure design and content decisions do not negatively affect any online visibility the firm has earned.
Prioritize Digital Accessibility
All websites, especially those representing businesses, need to comply with Americans with Disabilities Act (“ADA”) requirements and be accessible to individuals with disabilities. This means that the website is fully functional for people with visual, auditory, and physical disabilities, among others.
Users with visual disabilities such as blindness or vision loss will typically use assistive technology, such as a screen reader, or configure the display settings on their device (e.g., contrast, font size,) to make things readable to them. The website needs to let these users navigate, read content, and complete actions without interference. It should not override or block, in any way, the configurations or technologies the visitor is using.
To accommodate users with auditory disabilities, one important step is to ensure that video and audio content has captions or transcripts available. Most video services and podcast services now automatically add captions using AI. Often, the firm simply needs to enable these options and double-check the accuracy.
ADA compliance should be baked into a website’s code and design decisions from the beginning. This will not only ensure the best experience for the visitor, it improves how the website performs for AI agents and search engines.
Focus on Quality Written Content
Producing new website marketing content or migrating existing content to a new website platform is one of the most time-consuming parts of website development. Attorneys will often take on the task of content writing but quickly lose steam due to client obligations and the reality that it takes several hours, even with generative AI assistance, to write a decent page of website content. It also doesn’t help that writing marketing copy, especially about yourself, is surprisingly difficult compared to the legal writing they’ve trained to do. Engaging with a professional writer, or a website agency that has writers on staff, can save significant time and frustration all around.
When it comes to migrating existing content, firms are often surprised by how much work it takes to properly move content to a new website configuration. It’s not uncommon for an established law firm to have a body of content that has grown to hundreds or even thousands of pages and media files. This all needs to be migrated with great care to avoid any business or marketing disruptions.
Start Designing Your Law Firm’s Website Today
Having a professional website that aligns with a firm’s business and marketing goals is one of the best investments a law firm can make. Well-crafted websites pay for themselves over and over in time saved and business earned. Further, firms that work to nail down the foundations of their web presence now will be better able to adapt to the rapidly evolving generative AI landscape.
Today, law firms have more options than ever for developing a website. However, between do-it-yourself website builders, online gig boards, specialized law firm marketing agencies, and in-house teams, it can be a real challenge to decide what’s best for your firm. You can, of course, search online and find many capable solutions and providers. Websites frequently contain design credits at the bottom, so you can also search for law firms that are similar to yours, either in your market or outside of it, to discover who is performing well and see how they got it done. And don’t forget good old-fashioned conversations with your peers, especially those who have similar business ambitions and websites you admire.
Once you’ve compiled a short list of options, be sure to research thoroughly so that you can weigh the pros and cons of each, compare proposals and costs, and make a confident decision.
This is an updated version of an article that originally appeared in Business Law Today on January 27, 2023. The previous version was authored by Grace Lau.
The dominant narrative surrounding in-house legal departments emphasizes risk control. Legal is expected to prevent disputes, ensure regulatory compliance, and protect the enterprise from downside exposure. In boardrooms and budget discussions, legal value is often articulated in negative terms: losses avoided, fines reduced, or claims successfully defended.
This narrative, while accurate, is incomplete.
Some of the most valuable work performed by in-house legal teams does not merely internalize risk for the company; it enables customers by quietly reducing friction, clarifying legal boundaries, and building trust. This value is real and consequential, yet unrecognized because it arises as a by-product of Legal’s everyday work rather than as a discrete, customer-facing initiative.
Intellectual Property Practice as Customer Enablement
Intellectual property (“IP”) practice provides a clear illustration of how internal legal work benefits customers. The routine work of in-house IP counsel often includes identifying, challenging, and invalidating patents that pose undue risk to the company’s freedom to operate. While the intended beneficiary of this work is the employer, its effects extend well beyond the firm.
By removing weak or overbroad patents from the landscape, in-house IP counsel reduces uncertainty not only for the company but also for customers who rely on its products and technologies. Customers benefit from clearer operating boundaries, reduced exposure to downstream infringement claims, and greater confidence in adopting and integrating the company’s products.
This knock-on effect of customer enablement is rarely acknowledged as a form of legal value, despite being a predictable outcome of Legal’s ordinary responsibilities.
Legal Risk Clearance as Customer Enablement
The IP example is not unique. It reflects the secondary value of a broader category of in-house legal activity—namely, legal risk clearance.
Across legal disciplines, in-house teams routinely identify, assess, and resolve legal uncertainty to protect the enterprise. When this risk clearance occurs early and effectively, it also stabilizes the environment in which customers interact with the company’s products and services. Legal risk clearance, therefore, functions as a form of customer enablement.
Customers may not see risk clearance, but they notice the results: fewer disputes, clearer rules, safer products, and greater confidence.
Parallel Examples Across Legal Functions
Contracting offers another example. As part of contractual risk clearance, in-house legal teams develop standardized agreements, define fallback positions, and resolve recurring points of contention to manage risk and improve efficiency.
The customer-facing effects are substantial. Standardized contractual frameworks reduce negotiation time, lower transaction costs, and decrease post-execution disputes. Customers benefit from faster onboarding, clearer expectations, more predictable commercial relationships, and, when customers use outside counsel, reduced bills.
In regulated industries, in-house legal teams spend significant time interpreting regulatory requirements and engaging with regulators to align internal practices with evolving standards. This work is undertaken to reduce the company’s enforcement risk.
Early regulatory risk clearance benefits customers by enabling faster approvals, fewer disruptions, and reliable access to compliant products. Customers directly experience these outcomes even if the work is behind the scenes.
Why This Value Is Often Overlooked
This form of value creation is frequently underappreciated because it is indirect, preventive, and embedded in routine legal work. When friction is successfully removed, problems never materialize, and the value remains invisible.
As a result, legal departments are often evaluated based on activity volume or cost control rather than on the conditions they improve for customers and markets.
Why Customer Value Must Be Part of the Legal Value Story
The prevailing approaches to assessing in-house legal performance are incomplete because they focus almost entirely on the enterprise. Legal value is typically described in terms of cost containment and risk avoidance, without considering the external effects of Legal’s work.
Yet much of the everyday work performed by in-house legal teams produces tangible benefits for customers. Through legal risk clearance across areas such as IP, contracting, regulatory compliance, and product safety, Legal reduces uncertainty, removes friction, and builds trust, all of which directly affect customers.
For this reason, any serious account of in-house legal value must consider customer impact. Excluding the customer perspective systematically understates Legal’s contribution and obscures one of its most strategically important roles: enabling others to operate with confidence.
Recognizing customer enablement does not dilute Legal’s traditional mission. It strengthens it. By accounting for the external effects of Legal’s internal work, organizations can more accurately capture the full value of their in-house legal teams, and more deliberately deploy them where that value matters most.
For decades, immigration compliance in corporate transactions was often relegated to a post-closing human resources task, secondary to intellectual property, environmental, and other operational diligence. That approach is no longer defensible. Intensified federal enforcement, expanded use of the successor liability doctrine, proliferating state law compliance obligations, and the growing dependence of U.S. businesses on foreign national labor all mean that immigration compliance must be central to any informed due diligence strategy and reflected in negotiated deal terms to effectively mitigate potential post-closing risk and protect investment value.
Recent enforcement actions signal a renewed and unprecedented focus on worksite compliance, Form I-9 audits, and joint-employer liability, including aggressive scrutiny of subcontractor workforces. At the same time, long-standing but often misunderstood immigration liabilities embedded in mergers and acquisitions (“M&A”) transactions—particularly those involving workforce continuity—have become increasingly visible to regulators, deal teams, lenders, investors, insurers, and other parties central to the dealmaking process.
Immigration due diligence is essential to evaluating deal value, ensuring continuity of operations, and assessing post-closing enforcement exposure, as well as allocating risk through negotiated deal terms. Parties that fail to engage at the right depth and stage of the transaction do so at their own operational and legal peril. This article briefly describes the diligence that every transactional attorney should be prepared to conduct—or outsource—on behalf of their client.
Red-Hot Immigration Enforcement Risk
The intensity of immigration enforcement has historically ebbed and flowed with presidential administrations, but the intensity exhibited by the current administration is unprecedented. Civil Form I-9 audits can result in millions of dollars in fines even when no unauthorized employment is found. If unauthorized employment is found, exposure escalates, and the penalties can be catastrophic: significant monetary fines, debarment from government contracting, business license impact, reputational harm, operational disruption, increased labor costs, and EBITDA compression are the best-case scenario. Indictments and criminal convictions—for both the organization and individual employees—are all on the table.
Immigration and Customs Enforcement (“ICE”) is no longer focusing on low-hanging fruit; instead, they are embracing complex investigations and prosecutions premised on joint-employer liability, successor liability, and subcontractor compliance. Exposure arising from a subcontractor’s violations is no longer hypothetical. Companies can no longer hide behind shell corporations or staffing agencies to circumvent Form I-9 requirements, and, absent a robust and well-negotiated subcontractor agreement with appropriate compliance and indemnification provisions, companies may find themselves on the hook for a third party’s compliance failures.
Deal Structure and Immigration Consequences
The form of an M&A transaction—asset purchase versus stock purchase—has profound immigration implications. A stock deal preserves the employing entity and often supports continuity of immigration sponsorship under successor-in-interest principles, but it also carries forward all historical immigration liabilities to the buyer. By contrast, an asset purchase may limit inherited liability but frequently disrupts visa sponsorship, requiring employers to refile or amend petitions, reverify employment authorization, enroll or re-enroll in E-Verify as required, and, in some cases, terminate employees who cannot promptly transfer or maintain status. These disruptions can undermine deal value by causing loss of critical talent and increasing transition costs.
Another important factor is how employees are treated at closing—for example, as new hires versus continuous employees. Organizations need to be able to defend this choice when the audit arrives, supported by clear, contemporaneous, nonprivileged documentation explaining the rationale and operational steps taken. As part of diligence, buyers should, at minimum, obtain and conduct a privileged review of a risk-based sample of Forms I-9 (and, where applicable, review E-Verify compliance), with escalation to broader review where red flags appear. Sellers should be prepared to facilitate that review, remediate curable defects before closing, and align on transition plans to preserve lawful status and work authorization for key employees. Identified Form I-9 issues may justify purchase price reductions, indemnities, or escrow holdbacks, as well as additional negotiated deal terms (including representations, warranties, covenants, and conditions), and they may potentially implicate required disclosures on corresponding schedules. Additionally, such issues may result in potential exclusions from any representation and warranty insurance (“RWI”) policy.
Hidden Form I-9 Liability in Corporate Transactions
Form I-9 compliance represents one of the most frequently overlooked risks in M&A transactions. When a buyer acquires a workforce through a merger or acquisition, it must either adopt existing Forms I-9 or treat employees as new hires.
Adopting legacy Forms I-9 means inheriting all defects—substantive and technical—associated with those forms. Errors in Forms I-9 are common and can result in fines assessed on a per-form basis. In large transactions, this liability can quickly become material. The risk, however, is not cabined to monetary penalties. The larger risk is that the buyer entity may inherit a partially or wholly unauthorized workforce, thus creating compliance and legal exposure as well as workforce continuity risk. This risk can also drive increased labor costs, particularly in sectors or geographies where labor availability is limited or otherwise commands a premium.
Treating employees as new hires can reduce historical exposure but must be handled carefully. If this avenue is chosen, all new Forms I-9 must be completed no later than three business days from the closing effective date. While some transactions include a pre-closing announcement that provides additional runway to complete the new Forms I-9, many sellers resist pre-closing disclosure to the workforce because of confidentiality obligations, the risk of employee flight, union requirements, customer or vendor instability, or competitive harm if the deal does not close. As a result, buyers often have little to no advance access to the workforce, making it necessary to stand up a rapid, post-closing onboarding process. Attempting to reverify an entire workforce within the first three days after close is a difficult, but not impossible task.
Whatever the buyer’s approach to Forms I-9, E-Verify participation must also be addressed early in transaction planning. If the buyer adopts legacy Forms I-9, it generally cannot create E-Verify cases for existing employees. If employees are treated as new hires, the buyer entity must create E-Verify cases within three business days of the closing effective date and be prepared to manage tentative nonconfirmations (which indicate Form I-9 data entered does not match the records that E-Verify checks against, but do not necessarily mean the employees are not authorized to work in the United States) without taking premature adverse action.
These Form I-9 considerations add risk to the already complex landscape of E-Verify for dealmakers. The decision to implement or terminate E-Verify participation can affect workforce onboarding, employee relations, and potential labor availability, and E-Verify noncompliance creates standalone risk. If acquired employees are assigned to qualifying federal contracts, they may become subject to E-Verify, even if not treated as a new hire for Form I-9 purposes. Moreover, in addition to federal law, a growing number of states and municipalities mandate E-Verify participation for certain employers. The failure to comply can result in business license impact, debarment, or monetary fines. Conversely, other states limit how employers may use E-Verify and have expanded antidiscrimination protections related to citizenship and immigration status, creating additional exposure if onboarding practices are applied inconsistently across locations. In certain sectors or geographies, client contracts may require E-Verify enrollment even if not required by applicable law. The failure to comply with contractual E-Verify requirements may jeopardize existing or prospective contracts or, at best, may result in reputational damage and loss of trust with clients. Thorough review of not only federal and state-level obligations, but also all material customer contracts, during diligence is critical to preventing these consequences.
At the end of the day, Form I-9 compliance is not merely an HR task to be parked on a post-closing checklist. It is a critical window into workforce integrity and the overall compliance culture, as well as a mechanism for identifying, quantifying, and mitigating risks to deal value, including exposure to fines, operational disruption, and EBITDA pressure. Buyers should conduct diligence that assesses not only financial risk, but also reputational, operational, and continuity risks embedded in the target’s workforce and verification practices. While many Form I-9 defects are a problem money can solve, risks such as reputational damage or loss of key labor can have far-reaching consequences that materially erode deal economics and undermine integration plans.
Subcontractors and Joint Employer Risk
Immigration enforcement increasingly targets subcontractor arrangements, particularly where buyers attempt to insulate themselves from liability. While employers cannot directly verify subcontractor employees’ work authorization, robust pre-closing diligence and strong contractual controls are necessary to mitigate joint employer findings. Diligence should extend beyond the target’s direct payroll to high-risk relationships—subcontractors, staffing agencies, and other sources of temporary workers—and include a review of subcontractor agreements for applicable immigration compliance, indemnification provisions, audit rights, and notice covenants for government inquiries or audits.
A Transaction’s Impact on Foreign National Employees
Foreign national employees are often central to a target company’s operations. Visa categories such as H-1B, L-1, E-1, E-2, O-1, and TN are highly sensitive to changes in corporate structure. Transactions that fail to account for these dependencies risk immediate work authorization gaps, costly refilings, or forced departures.
In addition, pending green card sponsorship creates long-term exposure. Labor certifications under the PERM regulations, immigrant petitions, and adjustment applications can be invalidated by changes in legal entity, geographic location, or job duties—resetting years of progress and harming employee retention.
Immigration Due Diligence as a Deal Standard
Immigration law is complex and nuanced. At a minimum, practitioners should review the following when conducting immigration due diligence for a transaction:
Forms I-9:
Ensure that a Form I-9 exists for each employee.
Determine error rate on existing Forms I-9.
Review electronic system (if used).
Review I-9 retention practices, including purging.
Determine any prior audits (state or federal) and their outcomes.
E-Verify:
Determine if target is an E-Verify participant and enrolled hiring sites.
Determine if participation is mandatory or required by client contract.
Determine level of compliance.
Determine any prior audits (state or federal) and their outcomes.
Subcontractors:
Assess which workers are employed by subcontractors or staffing agencies.
Assess if any temporary workers in operationally critical roles.
Review subcontractor agreements.
Assess if subcontractors used to circumvent E-Verify obligations or actual or constructive knowledge.
Work with employment specialists to assess potential misclassification risk.
Conclusion
Immigration compliance is no longer a peripheral issue: It is a core transactional risk with direct financial, operational, and reputational consequences. As enforcement intensifies and global mobility becomes increasingly regulated, immigration due diligence has emerged as a required discipline in corporate transactions. Addressing these issues early in the transaction positions buyers to identify potential risks and adjust valuation, negotiate targeted indemnities or holdbacks, structure deal terms around identified risks, and sequence post-closing remediation to protect deal economics and continuity of operations.
For dealmakers and counsel, the question is no longer whether to conduct immigration due diligence, but how early and how deeply it is integrated into the transaction process—from preliminary risk screens and data requests at the letter of intent (“LOI”) stage, to targeted sampling and remediation planning during confirmatory diligence, through to integration playbooks and post-closing monitoring to protect the continuity of operations and minimize EBITDA pressure. The choice is simple: integrate immigration diligence into the deal, or potentially pay for it later.
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