Business lawyers advising the high-velocity mergers and acquisitions landscape of aesthetic medicine often find themselves peeling back the “retail” veneer of a target asset to expose the underlying medical reality. Medical spa (“medspa”) owners and investors are frequently lulled into a false sense of security by the industry’s luxury atmosphere, erroneously believing they operate in a regulatory gray area.
However, a Utah grand jury’s indictment of a licensed physician on April 1, 2026, demonstrates that this is a fiction that speaks to enforcement priorities and not legal differences. The jury indicted the physician for the alleged introduction of peptides that were not Food and Drug Administration (“FDA”) approved, including Semaglutide and Tirzepatide, Retatrutide, Cagrilintide, BPC-157, TB500, Ipamorelin, CJC-1295, GHK, GHK-Cu, and NAD+, into interstate commerce. The jury found probable cause that these products were sourced from China and sold to unwitting patients. This action, coupled with the referral of telehealth company Hims and Hers to the Department of Justice in February for potential violations of the Federal Food, Drug, and Cosmetic Act, signals a paradigm shift in how federal agencies view the medspa supply chain and the rising interest in unapproved peptides.
For counsel performing due diligence or providing corporate governance advice to medspas, understanding these four commonly overlooked areas of regulatory compliance is essential to mitigating client risk.
The Sterile Compounding Trap
Counsel advising along the medspa value chain, or conducting due diligence in this space, should actively review the “backroom” preparation of intravenous (“IV”) hydration therapies and peptides. Such preparations may inadvertently render the doctor’s office an unlicensed pharmacy.
Sterile Compounding Definition: Pharmacy boards in California, Ohio, and Kentucky have specifically called out that the mixing of IV bags constitutes “sterile compounding” and must adhere to appropriate sterility and stability practices. Such practices include strict pharmacy permits and adherence to USP Chapter <797> standards, including ISO-certified air environments.
Supply Chain Integrity: Facilities should source premixed products from authorized 503A pharmacies or 503B outsourcing facilities. This ensure the longer term sterile and stable products are not adulterated or misbranded, rather than mixing in-house outside of a sterile hood, which would have a higher risk of products being adulterated or misbranded.
Scope of Practice and the “Standing Order” Fallacy
Medspa owners may confuse their facilities to be the equivalent of luxury spas, where treatments may be chosen by the individual entering the facility from a menu of options. This is compounded by the fact that some prescribers have been known to leave “standing orders,” which allow for nonprescribers to simply dispense a drug consistent with said standard order without any additional oversight. Such standing orders bypass critical medical-legal requirements. To protect investments into medspas, it therefore benefits investors to confirm the following:
The Good Faith Exam: Every patient must receive a documented, individualized examination by an appropriately licensed prescriber (MD, DO, NP, or PA) before prescription drugs or fluids are administered.
Nursing Limitations: It is important that clinicians act within the scope of their practice. Accordingly, registered nurses must execute valid provider orders, cannot independently diagnose or prescribe, and cannot allow patients to self-diagnose. Boards in states such as Arizona and Mississippi are increasingly targeting “scope creep.”
“Sham” Directorships and Corporate Practice of Medicine
Consistent with state law, medications must be provided subject a prescription from an appropriately licensed prescriber. Some prescribers may take on a role as a “Medical Director” and then effectively “rent” their license by providing a “blanket” authorization to enable nonprescribers to dispense medication consistent with a standing order and without appropriate oversight. This makes the medical directors figureheads, and corporate counsel must look beyond the existence of a medical director agreement to evaluate its functional substance. As previously discussed, nursing boards have expressed a continuing concern around scope creep by nursing professionals who take on a prescribing function without the appropriate license.
Jurisdictions such as Oregon and Iowa pointedly call out such behavior and caution that physicians must provide active, documented supervision to a business entity. In the event of nonphysician investors, and consistent with state corporate practice of medicine regulations, states such as Washington caution that nonphysician owners are prohibited from overriding a clinician’s judgment.
Failure to follow these rules such that the physician has no actual role in clinical decision-making may render the facility, physician, and/or related management services agreement fraudulent vehicles for unauthorized practice.
Marketing Fraud
Aggressive marketing of compounded GLP-1 weight-loss drugs has cultivated a high-risk environment for consumer fraud litigation. Clinics selling such drugs by associating them with the brand names of approved GLP-1 drugs have already caught the attention of branded drug companies who are actively policing their trademarks. State attorneys general in Ohio and Connecticut are investigating medspas that falsely claim to provide “generic Ozempic” or imply that their products are FDA-approved.
Heightened Legal Scrutiny
While regulators in the past did not see this as a high enforcement priority, the FDA, FBI, and FTC are now unified in directing greater attention to the legal obligations of medspas and weight-loss clinics as medical practices.
This multi-agency heightened scrutiny coincides with a strategic pivot at the Department of Justice, emphasizing its treatment of compliance as a nonnegotiable seat at the M&A table.
In March 2026, the DOJ announced a department-wide Corporate Enforcement Policy. This policy, consistent with the DOJ’s “Evaluation of Corporate Compliance Programs” guidance, underscores the expectation that acquiring entities perform rigorous, proactive due diligence to identify and remediate misconduct within target assets. Acquiring entities that perform such due diligence may be offered a specific “Safe Harbor” if they voluntarily self-disclose criminal conduct discovered during the M&A process within six months of closing. This is a clear signal that the government expects “compliance-first” deal-making in the highly regulated healthcare and aesthetics sectors.
Business counsel must therefore integrate robust regulatory vetting into the deal cycle to avoid the full weight of a unified federal enforcement apparatus that now leverages interagency data analytics and a record-setting $6.8 billion False Claims Act recovery pipeline to root out fraud.
Conclusion
The recent federal indictment in Utah and the tightening grip of state boards should serve as a definitive market correction. Business lawyers advising medspas or potential acquirers must recognize that the perceived “regulatory gray area” inhabited by many medspas was always part of enforcement discretion and not a different regulatory mechanism. Failure to follow state and federal requirements, such as avoiding backroom IV mixing or nurse-led “menu” selections, carries risks of prosecution as felony misbranding and the unauthorized practice of medicine.
Over the span of a single week in June 2026, the Canadian government advanced significant new legislation to regulate online harms and modernize its national privacy regime. Coupled together, the changes brought forward by Bills C-34 and C-36 represent a significant modernization of Canada’s regulation of the internet and artificial intelligence (“AI”).
Neither Bill C-34 or Bill C-36 is law, yet. Each has cleared only the first reading in the House of Commons and must still move through the House and the Senate, and receive Royal Assent. For U.S. attorneys with clients that operate in Canada, collect data from Canadians, or otherwise run digital platforms that are accessible north of the border, the time to scope exposure is now.
Bill C-34: Regulating the Internet
Bill C-34 would enact two statutes: the Digital Safety Act (“DSA”) and the Digital Safety Commission of Canada Act (“DSCCA”). Together, they would create a framework of binding duties, new enforcement mechanisms, and significant financial penalties for noncompliance. The bill is a revamped version of Bill C-63, the Online Harms Act, which was introduced in 2024 but never became law.
The proposed Bill C-34 regime reaches well beyond conventional social media. The DSA would apply to three categories of regulated services accessible in Canada: social media services, AI chatbot services, and other online services. The third category is engaged only where the government is satisfied the service in question poses a significant risk of harm to children.
The DSA will primarily target seven types of harmful content, specifically the following:
intimate content communicated without consent (including deepfakes)
content that sexually victimizes a child or revictimizes a survivor
content that induces a child to harm themselves
content used to bully a child
content that foments hatred
content that incites violence
terrorism or violent extremism content
Further, the DSA imposes four primary duties. First, the DSA introduces the duty to protect children, which applies to every regulated service. Operators must implement design features for a safer minor experience, apply age verification or estimation to limit children’s exposure to pornographic content, and keep compliance records. Social media faces the most stringent version: a minimum account age of sixteen absent an exemption based on sufficient safeguards. Secondly, the DSA imposes a duty to act responsibly, which requires social media and AI chatbot operators to reduce users’ exposure to harmful content. Online platforms must label synthetically generated material, including AI audio or video that could be mistaken for real recordings, and give users tools to flag content and block other users. AI chatbots are additionally prohibited from four behaviors, including pretending to be human, impersonating licensed professionals, using manipulative techniques to foster unhealthy emotional dependencies, and encouraging self-harm or suicide. Thirdly, the DSA establishes a duty to make content inaccessible, which requires social media services to remove child sexual abuse material and nonconsensual intimate images (deepfakes included) within twenty-four hours. And finally, the DSA creates a duty of transparency, which requires every regulated service to publish a digital safety plan, a public-facing disclosure the regulator will assess.
Enforcement of the DSA under Bill C-34 will fall to the new DSCCA. The DSCCA is authorized to set standards and issue guidance, audit safety plans, hold hearings, compel testimony and documents, issue compliance orders enforceable as Canadian Federal Court judgements, and administer user complaints. The financial risk of noncompliance with the new DSA is substantial: maximum offense fines on conviction are the greater of $20 million or 5 percent of gross global revenue, and administrative monetary penalties levied by the DSCCA are the greater of $10 million or 3 percent of gross global revenue. Operational detail will follow in regulations, which are to be prepublished in the Canada Gazette with an opportunity for public commentary.
Bill C-36: The Privacy Reset
Bill C-36 seeks to enact the Protecting Privacy and Consumer Data Act (“PPCDA”), replacing key provisions of the existing federal Personal Information Protection and Electronic Documents Act (“PIPEDA”). The PPCDA is designed to strengthen protection of Canadians’ personal information in a data-driven economy shaped by AI and automated decision-making and follows two earlier failed efforts: Bill C-11 (2020) and Bill C-27 (2022). Bill C-27 (2022) was designed to replace PIPEDA with the new Consumer Privacy Protection Act (“CPPA”) and regulate AI—but died on the Order Paper when Canada’s Parliament was prorogued in January 2025.
Bill C-36 expressly recognizes privacy as a “fundamental right” and expands individual control over personal information, including rights of access, correction, deletion, and data mobility—each backed by a structured compliance process that organizations must follow when responding to a request. It imposes more rules-based governance obligations, requiring businesses to maintain mandatory privacy management programs with documented policies, safeguards, complaint processes, and assigned compliance responsibility. In short, it creates auditable structures capable of demonstrating compliance on demand.
Two features of Bill C-36 warrant particular attention. First, the proposed bill heightens transparency around automated decision-making such that organizations would have to disclose their use of such systems, provide individuals with explanations, and offer a means to challenge decisions. Secondly, Bill C-36 also designates children’s personal information as sensitive by default, triggering heightened safeguards and stricter limits on its collection, use, retention, and disclosure.
Notably, Bill C-36 departs from its predecessor Bill C-27 by dropping the proposed AI-specific framework and focusing exclusively on privacy modernization. Enforcement is consolidated in a new regulator, the DSCCA, armed with the binding order-making power and administrative penalties for noncompliance with either PPCDA or PIPEDA reaching the greater of $10 million or 3 percent of gross annual global revenue. The cumulative effect of the changes proposed by Bill C-36 is movement towards a rights-based framework backed by stronger enforcement, with particular attention to automated decision-making, cross-border data transfer, and children’s data.
Why U.S. Counsel Should Be Paying Attention (Now)
For U.S. practitioners, what matters most is not the mechanics of either bill but what the two signal together and how far their reach extends.
The penalties follow global revenue, not a Canadian footprint. Consistent with certain global trends, both Bills C-34 and C-36 size their maximum penalties against a percentage of gross global revenue. A company’s exposure is therefore not bounded by the scale of its Canadian operations. Even a small Canadian presence can expose a company to a penalty measured against its worldwide revenue. For any client with meaningful global revenue coupled with a limited Canadian nexus, that asymmetry is the central risk to flag to clients.
This is not exclusively a social media or “tech company” issue. Bill C-34 turns on whether a service is accessible in Canada. This is a threshold that can capture platforms with no Canadian establishment and no deliberate Canadian targeting. If a U.S. client operates an online service through which Canadians interact, share, or create content, it could fall within the scope of Bill C-34. In turn, Bill C-36 governs the handling of Canadians’ personal information across the data life cycle, with express attention to cross-border transfers. U.S.-based entities that may not be traditionally seen as “operating in Canada” may nonetheless be within scope.
The exposure clusters where clients are already concentrated. U.S. companies that own, host and operate AI chatbots should be on particular alert given this new prospective legislation. Canadian law has rarely regulated chatbots head-on, and the DSA would be among the first statutes to place binding safety duties directly on their operators. Automated decision-making draws new Bill C-36 duties to disclose its use and let individuals challenge the resulting decisions. Children’s data attracts heightened treatment under both bills, bringing Canada closer in line to other counties, including the United States and Australia, that have previously focused more on the protection of children. Organizations with AI-facing products, consumer platforms, or services used by minors run the risk of the most acute exposure.
Next steps. Internet businesses with any Canadian dimension—ranging from operations, users, data, or platforms accessible to Canadians—should assess their risk exposure under both bills in parallel, consider necessary compliance measures as recommended by Canadian legal counsel, and keep a watchful eye as Bill C-34 and Bill C-36 move through the legislative process. Canada’s digital rulebook is being rewritten, and attention by U.S. attorneys is critical to ensure ongoing success for U.S. business.
When your opposing counsel cites a fake case fabricated by a generative artificial intelligence tool in a court filing—a so-called “hallucination”—should you snitch? At least two courts sayyes.
As generative AI increasingly permeates our personal and professional lives, practitioners, courts, and creators face challenges such as hallucinated citations, privilege concerns, and regulatory uncertainty. Yet a single theme emerged during a well-attended Showcase Program at the Business Law Section’s Spring Meeting titled “AI in the Trenches and on the Bench: A Business Law Toolkit for In-House, Firm, and Courtroom”: When using AI, the human element remains indispensable.
The panel discussion, moderated by Paulette Rodríguez López of Crowell & Moring LLP, and featuring Jeffrey Huang of Pilot Company, Alina Lee of Aspire Law, Bradford Newman of Eversheds Sutherland, and the Honorable Richard Platkin of the Commercial Division of the Supreme Court of New York State, explored trends in and actionable guidance on AI’s evolving role in business law practice.
1. Of Humans: Context Matters
Human context and intent are the linchpins of proper AI use in legal practice. “Bad jury instructions, like bad prompt engineering, produce results that we don’t want,” said Judge Platkin.
Huang explained that context is central because generative AI outputs are products of iterative prediction and designed to be sycophantic; they are biased to appear helpful, even if the substance is inaccurate. Unlike human law clerks, Judge Platkin noted, AI models rarely respond “I don’t know,” nor do they systemically apply “learned legal doctrines or review of primary sources.”
Those design features of generative AI can result in hallucinations, including fake cases, inaccurate facts and quotes, and incorrect holdings. According to a 2024 study by researchers at Stanford discussed during the panel, even premium legal AI tools hallucinated between 17 and 33% of the time. Therefore, the panelists suggested that making the user’s goals, constraints, and contexts explicit in the prompts can help reduce hallucination risks and stressed that human-in-the-loop procedural design is essential.
2. By Humans: Building Scaffolding for AI Use
The panel’s discussion of the latest updates in AI jurisprudence offered concrete guideposts for incorporating AI tools in our professional work safely and ethically.
Know AI, Review AI, Disclose AI
Newman explained that lawyers do not need an entirely new ethical framework to begin governing AI use because existing professional responsibility rules already apply. ABA Model Rule of Professional Conduct 1.1 (competence) requires attorneys to understand how the AI tools they use function. Rules 5.1 and 5.3 (supervision) require attorneys to review generative AI outputs as competent attorneys would supervise and review the work of junior lawyers and paralegals. Rule 3.3 (duty of candor) obligates attorneys to disclose their use of AI tools when the applicable court rules require such disclosure and when the clients would reasonably expect to know about such use and the disclosure is necessary for the clients to provide informed consent.
Courts Are Split on Attorney-Client Privilege and Work Product (For Now)
Newman also discussed a court split on whether attorney-client privilege and work-product protections apply to communications involving AI tools. In U.S. v. Heppner, the U.S. District Court for the Southern District of New York reasoned that the AI outputs involved in the case were not protected attorney work products because the client had independently retrieved those outputs without the counsel’s direction, nor were the clients’ prompts privileged because they effectively amounted to disclosure to third parties. In contrast, the U.S. District Court for the Eastern District of Michigan in Warner v. Gilbarco, Inc. ruled that the AI outputs in the case qualified as protected attorney work products because the AI platforms used were better seen as mere tools. However, Newman predicted that this divergence will be short-lived, given that AI use by legal practitioners and pro se litigants is already widespread.
Toward a Federal AI Regulatory Framework?
The patchwork of state AI laws will likely be harmonized under a federalized AI regulatory framework with a federal regulator, Newman argued. Certain foreign jurisdictions such as the European Union, Canada, and Brazil have adopted more comprehensive frameworks. The state-by-state approach the U.S. has taken thus far, he warned, creates uncertainty and significant compliance burdens for businesses.
3. For Humans: More Capability, More Questions
The panel also discussed AI’s potential to expand an individual’s capability, whether a creator or pro se litigant, and novel questions that arise as a result.
Copyright: Human Creativity
“What AI produces on its own is not ownable and not copyrightable,” Lee explained, just as “monkey selfies” were not copyrightable. But while the U.S. Copyright Office concluded in a January 2025 report that current generative AI tools do not “allow humans to have sufficient control, the [Office] specifically [said] that this could change,” Lee said.
She offered illustrative examples of when work involving generative AI is and is not copyrightable.
Movies and comics with AI parts: The AI-created parts are not copyrightable, but the whole movie or arrangement of AI-created images is copyrightable.
AI-assisted brainstorming: The output is copyrightable because the human author still creates the output with the AI tool helping the author to generate ideas.
Visual art modified by AI: An artist who made a drawing and used AI to modify it was able to copyright the product by “specifically disclaiming what AI did” and submitting “the original input and the AI modification,” Lee said.
Prompts themselves: It may depend on “how creative [the applicant’s] prompt is. If [the applicant’s] prompt is very detailed and includes creativity rather than generic questions, it is more likely the prompt is also copyrightable,” Lee said.
Lee pointed out that despite the U.S. Copyright Office guidance, many questions related to generative AI and intellectual property remain. For example, as AI-assisted coding becomes a mainstay, how will it affect the valuation of codes in M&A?
AI and Pro Se Litigants: Tool or Trap?
Judge Platkin noted that as more pro se litigants submit AI-generated court filings without consulting an attorney, courts and the legal profession face novel challenges as a result. Courts must review mounting volumes of cases without the filter of trained counsel. While AI tools may give nonlawyers better chances to argue on the merits, the self-represented litigants also lack the legal training necessary to identify hallucinations or assess the merits of their argument. Though courts may be lenient toward pro se litigants who submit court filings with hallucinated claims and citations, more courts are imposing sanctions on vexatious pro se litigants, Judge Platkin said.
* * *
Judge Platkin’s statement toward the end of the session captured the spirit of the conversation: “I would not trust AI to make important decisions, but I would trust my decision more if I used AI,” he said. AI may reshape legal practice, but lawyers, judges, and clients will continue to bear responsibility for how AI tools are used. As adoption of AI accelerates across the profession, the discussion suggested that the future of AI in law will depend less on the technology itself than on the human judgment guiding it.
“Process is your friend”: A simple yet powerful reminder from panelist Mary A. Francis captured the central message of the ABA Business Law Section’s Spring Meeting CLE program “A Practical Toolkit for Board Governance.” As boards face heightened litigation risk, increased regulatory scrutiny, and rapidly evolving technological challenges, strong board governance is no longer just a best practice but has become a strategic necessity. The panel focused on practical, real-world guidance for lawyers and corporate leaders seeking to strengthen board oversight, protect privilege, and foster effective boardroom culture.
The panel was moderated by Paul T. Chryssikos (SVP and Chief Counsel, Lincoln Financial) and featured insights from Mary A. Francis (Corporate Secretary and Chief Governance Officer, Chevron Corporation), Tina V. John (VP, Deputy General Counsel, and Global Head of Corporate Law, Unisys Corporation), and Alex G. Romain (Partner, Jenner & Block LLP). Together, they categorized board governance into four key themes: (1) process discipline, (2) board effectiveness, (3) managing risk, and (4) boardroom culture.
Process Discipline (Begins with the Record)
Process discipline is foundational to effective governance and begins with the record: board minutes. Minute-taking is critical in evidencing proper board governance. Minutes serve as both the legal and evidentiary record of board deliberations and fiduciary oversight, and they often become central in litigation matters. Consistency in drafting is also a fundamental necessity. The minutes should use careful language that avoids ambiguity or confusion. For example, if a company uses the word “unanimous,” it should use that term consistently every meeting. Minutes should remain objective, avoid emotional language, and limit jargon or coded terms that could be misinterpreted. John emphasized that many motions to dismiss are granted solely due to the minutes properly reflecting informed board oversight. At the same time, minutes should not become transcripts. They must reflect that directors were informed and engaged and should avoid unnecessary detail about tense exchanges or distractions during meetings. When there is a dissenting opinion, identifying director(s) by name may be inappropriate, unless specifically requested. Romain reinforced that point from a litigator’s perspective, noting that while minutes are not intended to be transcripts, litigators often treat them as such and question whether something happened based on whether it is clearly described in the minutes.
Draft control is also critical. Access should be limited to only relevant stakeholders, and older versions should be deleted to reduce discoverability risk. Furthermore, the use of voice/video recording is strongly discouraged. The use of artificial intelligence tools for note-taking is deeply problematic due to the sensitive information being captured. AI tools should be completely avoided unless the tool is closed source and contains tight controls that delete the old records once the official minutes are produced.
Board Effectiveness (Requires Intentional Design)
Governance does not stop at documentation. Director orientation and onboarding are critical to foster good culture and overall board effectiveness. During orientation, directors should receive a broad overview of the business and all governance documents such as bylaws, policies, and organizational/structural charts. When possible, directors should also receive deeper exposure to the company’s operations and leadership team. “This is the first time leadership can really build their relationship with the board,” John said, emphasizing that onboarding also helps identify where directors may need additional education or support. The purpose of orientation and onboarding is simple—maximize a director’s ability to contribute and provide value.
Committee assignments and leadership positions also require a strategic approach. Each member should be evaluated based on their experience and subject matter expertise, which will help determine what committee(s) they are appointed to. Rotating committee chairs/members can also be valuable for development and accountability, although it may be unnecessary when effective leadership is already present.
The importance of manageable board materials cannot be overstated. In-house lawyers should constantly question the purpose of certain materials being presented to the board and ensure they are concise, consistent in style, and written in plain English. The consensus from the panel was clear: The board should not be overloaded with content. Doing so limits the ability of the board to focus on issues that are critical to the success of the company. This may also encourage less engagement and the use of external tools for synthesizing (e.g., AI), creating additional risk.
Managing Risk (Means Managing the Record)
Board risk management is most critical in areas such as conflicts of interest, privilege protection, and technology controls. Conflicts of interest can undermine the duty of loyalty, erode trust, and create significant litigation exposure. Companies should maintain comprehensive conflicts policies with clear disclosure protocols and should never assume directors intuitively understand where conflicts may arise. “Don’t assume that smart, sophisticated people know these things,” Romain said. When conflicts arise, directors should be immediately recused from discussions and denied access to relevant materials, and those actions should be documented in the minutes. It is imperative to uncover conflicts early to avoid significant problems in the future. When the issue is not clear cut, companies should err on the side of caution. As John explained, “The record is always examined in hindsight, and you will not receive the benefit of the doubt.”
Privilege protection is also an area of significant risk. There is a common misconception that labeling a document “attorney-client privileged” automatically protects it. However, privilege depends on the actual legal purpose of the communication. Legal advice should be clearly separated from business advice, and board minutes should never provide detailed summaries of privileged discussions. Third-party involvement further complicates issues and presents emerging challenges, particularly with AI tools. Most AI platforms function as third parties for privilege purposes, making careful platform selection essential to protecting the company’s privileged information.
Boardroom Culture (Shapes Governance Outcomes)
Even the best governance structures can fail without trust, professionalism, and decorum inside the boardroom. Directors should avoid scope creep into management roles, monopolizing conversations, or creating side discussions that distract from strategic board discussions. Board confidentiality is equally important because trust can quickly collapse if information leaks. Boards should also design meetings for meaningful discussion rather than management presentations. Presentations should consume no more than half of the meeting time, leaving ample time for directors to engage, challenge, and deliberate on strategic business decisions.
Board evolution and director turnover can also be healthy and effective, particularly as strategy changes. Directors should regularly assess whether they remain the right fit for the company’s future needs. Deeply entrenched boards that lack new skills can create stagnation and activism risk. Regular board evaluations help support board evolution, whether conducted internally or with outside assistance; evaluations help prevent complacency and improve overall board effectiveness. “If you don’t do it, an activist will,” Francis warned.
Conclusion
Across all four themes, the panel returned to one consistent principle: Governance succeeds when process is deliberate, disciplined, and aligned with purpose. From minutes and agendas to privilege protection and board culture, small procedural decisions often determine major legal outcomes. The strongest boards are not simply compliant, they are intentional. They create records that withstand scrutiny, cultivate directors who contribute meaningfully, and build cultures rooted in trust and accountability.
As governance challenges continue to evolve, particularly with the advent of AI and rising shareholder activism, one lesson remains clear: Process is not bureaucracy; process is protection (and your “friend”).
Previously, federal agencies treated disparate-impact liability as a legitimate tool by which to combat employment discrimination, allowing them to pursue claims where facially neutral practices produced statistically disproportionate outcomes for protected classes. That posture shifted abruptly in April 2025. President Trump’s executive order instituting a pullback on federal enforcement of disparate-impact claims has created a widespread impression that AI hiring risk is, for now, manageable.[1] That impression is wrong in two important ways, and the lawyers who help their clients understand both will be doing them a genuine service.
First, federal enforcement pullback does not touch private litigation. Second, executive order priorities reverse with administrations, even those of the same party. The conduct happening now generates liability that does not disappear when enforcement resumes. A new administration in 2029 will inherit accrued liability that it could suddenly decide to prioritize. This is a particularly large risk given the high level of public skepticism toward AI being used in the hiring process.
The Litigation Pipeline Is Already Building
The most prominent test case in this space is Mobley v. Workday, Inc., currently being litigated in the U.S. District Court for the Northern District of California.[2] The plaintiff, an African American man over forty, applied through Workday’s AI-powered screening platform to more than one hundred positions and was rejected from all of them, often within hours of applying. He sued Workday directly. The court has allowed the claims to proceed on an agent-liability theory, holding that drawing a legal distinction between human and software decision-makers would gut antidiscrimination law in the modern era. A nationwide collective action covering applicants over forty was conditionally certified in May 2025. In March 2026, the court rejected Workday’s argument that the Age Discrimination in Employment Act (“ADEA”) does not even cover job applicants. As of this writing, the case remains in discovery.
Mobley is not alone. In Baker v. CVS Health Corp., an applicant alleged that CVS’s AI video-interviewing platform violated Massachusetts law by functioning as a de facto lie detector test. That claim survived a motion to dismiss and later settled.[3] In March 2025, the American Civil Liberties Union filed a complaint against Hirevue and Intuit, alleging that an AI video-interview tool discriminated against a deaf Indigenous applicant by providing AI-generated feedback recommending that she “practice active listening.” The first AI hiring discrimination lawsuit brought by the Equal Employment Opportunity Commission (“EEOC”), against iTutorGroup, alleged that the company’s screening tool automatically rejected applicants based on age.[4]It settled.
The pattern across these cases is consistent. Plaintiffs’ firms have identified AI hiring discrimination as a viable basis on which to sue, courts have shown an increased willingness to let claims proceed past the pleading stage, and settlements are happening before verdicts. That last point matters. The cases that settle quietly do not produce the public precedent that would deter future filings. They produce the opposite: They serve as a signal to plaintiffs’ counsel that these cases have value.
The trend extends beyond employment law. On May 7, 2026, in American Council of Learned Societies v. National Endowment for the Humanities, Judge Colleen McMahon of the U.S. District Court for the Southern District of New York rejected the federal government’s argument that ChatGPT, rather than the government itself, was responsible for viewpoint-discriminatory grant terminations.[5] Judge McMahon pointedly compared the government’s defense to comedian Flip Wilson’s “the devil made me do it” catchphrase, often used to excuse his character’s wild behavior. While the ruling is a constitutional law case, not an employment law one, the rhetorical posture that employers will adopt at trial is the same and could easily meet the same fate.
The Jury Problem Nobody Is Talking About
For clients whose cases survive to trial, the liability picture looks worse than most employment lawyers have internalized. The reason is the jury pool.
AI hiring claims proceed on two tracks. Disparate-impact claims, the more common framing in cases like Mobley, turn on statistical showings and the business-necessity defense. This is territory where jury perception of AI matters less than expert testimony and the four-fifths rule. Disparate-treatment claims, by contrast, turn on whether the finder of fact believes the employer’s stated reason for the adverse action.
It is on this second track where the jury pool’s hostility to AI hiring tools creates the sharpest exposure, and where the doctrinal mechanics deserve closer attention. However, even on the disparate-impact track, juror skepticism affects how business necessity arguments rooted in AI’s claimed objectivity will land, illustrating the importance of understanding the public’s views of AI regardless of the legal theory being defended against.
Recent Pew Research Center data show that more than eight in ten American adults express concern about bias in AI-based decision-making in the hiring context, with over half describing themselves as very or extremely concerned about it. Roughly two-thirds of Americans say they would not want to apply for a job with an employer that uses AI to make hiring decisions. Most concerning for companies using AI in the hiring context is that these numbers are not driven by the demographics that typically skew concern about discrimination. They cut across partisan lines. They cut across income levels. And they cut across race and age in ways that should give defense counsel particular pause.
White non-Hispanic respondents express concern about AI bias at rates comparable to or exceeding those of minority respondents. Older Americans, those most likely to show up in a jury pool, are the most concerned of any age group, with concern among adults sixty-five and older running well above 90 percent. High-income, white-collar professionals, the jurors that defense counsel in discrimination cases typically count on to be skeptical of plaintiffs, are deeply worried about algorithmic bias in hiring.
This matters doctrinally, not just atmospherically. In disparate-treatment cases proceeding under the McDonnell Douglas burden-shifting framework,[6] once a plaintiff establishes a prima facie case, the employer must offer a legitimate, nondiscriminatory reason for the adverse action. The standard defense in AI hiring cases is some version of good-faith reliance. For example, employers can assert that they didn’t know the AI tool was biased and therefore had no reason to suspect a problem. However, under Reeves v. Sanderson Plumbing Products, Inc., a finder of fact who disbelieves the employer’s stated reason, combined with the prima facie case, may infer intentional discrimination without any additional evidence of discriminatory motive.[7]
Put the doctrinal picture together with the public opinion figures and it becomes clear why this is so dangerous for employers. A jury that overwhelmingly believes AI hiring tools are biased will be asked to evaluate the credibility of an employer’s claim that it had no reason to suspect bias in its AI systems. This illustrates the need for employers utilizing AI in the hiring process to take steps that will give them a more credible basis on which to assert nondiscriminatory intent.
Deferred Liability Is Still Liability
The Trump administration’s executive order directing federal agencies to deprioritize disparate-impact enforcement does not create a safe harbor. It simply removes one enforcement mechanism for a fixed period. Private rights of action under Title VII, the ADEA, and the Americans with Disabilities Act are unaffected. Meanwhile, multiple states, such as California, Colorado, Illinois, and Texas, are filling the enforcement gap.
What’s more, executive order priorities often reverse with changes in administrations. A new president taking office in January 2029 does not need new violations to pursue an aggressive AI hiring enforcement agenda. The next administration will inherit an actionable record of what employers are doing in the final months of the current administration.[8]
What to Do About It
The practical steps that follow can meaningfully mitigate the risk structure employers face when using AI in the hiring process.
Audit what is deployed. Clients should know, at minimum, which AI tools are being used at which stage of the hiring process and whether those tools have ever been independently tested for disparate impact. Tools that make or heavily influence accept/reject decisions carry the highest exposure.
Fix the vendor contracts. Indemnification clauses drafted before the agent-liability theory emerged in Mobley almost certainly do not address it. Representations about bias testing, audit rights, and data provisions should be standard negotiating points, not special asks. A vendor unwilling to provide any transparency into its testing methodology is itself a risk signal worth communicating to the client.
Build the documentation record now. The paper trail is the defense. Clients should be maintaining records of why each tool was selected, what due diligence was conducted, what the vendor represented about bias testing, and what any subsequent review found. If an internal concern about a tool was raised and not acted on, that document will surface in discovery. The time to address it is before litigation, not during.
The Window Is Narrower Than It Looks
The current enforcement environment is not a green light for employers to proceed without caution. It is a grace period with an uncertain expiration date. Meanwhile, private litigation is proceeding regardless, the jury pool is already unfavorable, and the liability being generated today will still be there when the next administration’s EEOC decides what to prioritize. The clients who will be best positioned when the next enforcement shift comes are the ones whose lawyers helped them understand the risk now—while there is still time to do something about it.
Exec. Order No. 14281, 90 Fed. Reg. 17,537 (Apr. 23, 2025) (directing federal agencies to deprioritize enforcement based on disparate-impact liability). ↑
Mobley v. Workday, Inc., 740 F. Supp. 3d 796 (N.D. Cal. 2024) (denying motion to dismiss on agent theory); Mobley, No. 23-cv-00770-RFL, 2025 WL 1424347 (N.D. Cal. May 16, 2025) (granting preliminary collective certification under ADEA); Mobley, No. 23-cv-00770-RFL, 2026 WL 636719 (N.D. Cal. Mar. 6, 2026) (denying motion to dismiss ADEA claims). ↑
Baker v. CVS Health Corp., 717 F. Supp. 3d 188 (D. Mass. 2024). ↑
Am. Council of Learned Soc’ys v. Nat’l Endowment for the Humans., Nos. 25-cv-3657 (CM), 25-cv-3923 (CM), slip op. (S.D.N.Y. May 7, 2026) (consolidated). ↑
McDonnell Douglas Corp. v. Green, 411 U.S. 792 (1973). ↑
Reeves v. Sanderson Plumbing Prods., Inc., 530 U.S. 133, 147 (2000). ↑
See 42 U.S.C. § 2000e-5(e)(1) (Title VII charges must be filed within 180 days, extended to 300 in deferral states); 29 U.S.C. § 626(d) (parallel ADEA filing requirement). ↑
This article is Part XII 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.
New York courts have a justifiable reputation for enforcing sophisticated commercial agreements in accordance with their terms. As stated clearly by the New York Court of Appeals in 2019: “In keeping with New York’s status as the preeminent commercial center in the United States, if not the world, our courts have long deemed the enforcement of commercial contracts according to the terms adopted by the parties to be a pillar of the common law.”[1] And as stated more recently by another New York court:
Freedom of contract, particularly between sophisticated commercial actors, dealing at arm’s length, is an important right, and, “[a]bsent some violation of law or transgression of a strong public policy, the parties to a [commercial] contract are basically free to make whatever agreement they wish, no matter how unwise it might appear to a third party.” . . . Where a contract was negotiated and relied upon by experienced, sophisticated business actors represented by counsel, the parties are entitled to the commercial certainty that flows from enforcing the plain meaning of their unambiguous agreement.[2]
New York has also long recognized, however, that “in every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.”[3]
But the implied covenant “is not without limits”; it operates solely “in aid and furtherance of other terms of the agreement,” and “it cannot be used to ‘imply obligations inconsistent with other terms of the contractual relationship.’”[4] Equally importantly, a breach of the implied covenant is simply a breach of the underlying contract, not an independent tort claim.[5]
Nevertheless, has a recent decision from the New York Court of Appeals (decided by a 4–3 majority), 111 West 57th Investment LLC v. 111 W57 Mezz Investor LLC,[6] “reimagined” the implied covenant and cast doubt on New York’s historically reliable contractarian bent?
A Crack in New York’s Contractarianism?
According to New York Court of Appeals Judge Garcia, in his dissent in 111 West 57th Investment, the answer is decidedly yes:
Prior to today’s decision, a party in plaintiff’s situation seeking to invoke the implied covenant of good faith and fair dealing had a high bar to clear, as New York courts interfered with the freedom of contract between well-represented parties in complex commercial transactions only in the most extraordinary circumstances. No longer. Instead, the majority, analogizing the parties to the junior mezzanine financing agreement at issue here to a city agency hiring a painting company and a student signing up to take a standardized test, holds that the covenant may be used to rewrite the specific terms of a multi-million-dollar construction loan agreement contract based on a court’s notion of fair play. . .
This majority’s reimagining of New York law will disrupt the expectations of contracting commercial parties, making uncertain the rights and liabilities in billions of dollars of outstanding loan agreements, and may well affect whether similarly situated parties will choose to subject themselves to New York law.[7]
Whoa! And two other judges joined in this dissent.
The majority opinion (written by Chief Judge Wilson and joined by three other judges) disagrees and suggests that its holding is in the mainstream of implied covenant jurisprudence when applied to discretionary acts—in this case, a lender’s decision to assign a portion of its outstanding loan to a third party, in circumstances alleged to have been in bad faith and designed to deprive one of the borrower’s major investors of its equity by inducing the borrower’s manager to acquiesce in a strict foreclosure. According to the majority, “[e]ven if [the lender] had the sole discretion to assign the junior mezzanine loan, doing so as part of an alleged backdoor deal to appropriate the value of plaintiff’s equity by conspiring with others to facilitate the scheme states a legally cognizable claim for breach of the implied covenant.”[8]
It is important to note, however, that the alleged scheme here was not an alleged civil conspiracy, which requires an underlying tort claim;[9] an alleged aiding and abetting of a breach of fiduciary duty (here, the applicable fiduciary duties appear to have been waived);[10] or a tortious interference with contract, which had been dismissed because both the assigning lender and the assignee “had ‘a right to protect [their] own legal and financial stake in the breaching party’s business’ and plaintiff failed to alleged that either [the lender or the assignee] took actions that ‘were motivated by malice, fraud, or illegal means.’”[11]
But let’s get into the alleged facts, or at least attempt to do so (the alleged facts in this matter are complex, have been the subject of several lawsuits against various defendants, and involve numerous claims).
Case Facts
Steinway Tower Ownership and Financing
The plaintiff in this case was 111 West 57th Investment LLC. The plaintiff was one of the principal equity investors in the development of 111 West 57th Street (also known as “Steinway Tower”), an ultra-luxury residential condominium in New York City (“Project”) and the skinniest skyscraper in the world. There were two other investors; one of the other investors (“Sponsor”) was “a special purpose vehicle by which the Project’s developers invested in and managed the Project.”[12] The three investors formed a Delaware limited liability company, 111 West 57th Partners LLC (which the court referred to as the “Joint Venture”), and entered into an LLC agreement (which the court referred to as the “JVA”).[13] Importantly, in the JVA, “Sponsor was designated the manager and was vested with ‘day-to-day authority to act for the Company,’ subject to certain ‘Major Decisions’ requiring plaintiff’s prior written consent, including ‘any financing or refinancing.’”[14] And, “[t]he JVA also contained an expansive ‘Waiver of Fiduciary Duties’ clause.”[15]
The Joint Venture borrowed $725 million to finance the Project, $325 million of which was provided as a nonrecourse junior mezzanine loan (“Mezz Loan”) by entities affiliated with Apollo (“Mezz Lenders”). The Mezz Loan was secured by a pledge of the equity interests in the entity owning the Project. The remaining $400 million was a traditional nonrecourse mortgage loan provided by a group of mortgage lenders (“Mortgage Lenders”) secured by the Project itself (“Mortgage Loan”).[16]
To have some appreciation of what happened next, it is important to understand the ownership structure: The Joint Venture wholly owned a subsidiary called 111 West 57th Mezz 1 LLC (“Junior Mezz Borrower”),[17] which in turn wholly owned 111 West 57th Holdings, LLC (“Senior Mezz Borrower”), which in turn wholly owned 111 West 57th Property Owner LLC (“Mortgage Borrower”). It appears that the Senior Mezz Borrower was the sole borrower on the original Mezz Loan, which was secured by a pledge of its equity in the Mortgage Borrower.
The Forbearance Agreement
As is common in construction projects, there were “budget overruns,” and the Mezz Loan apparently went into “technical default” by being “out of balance.”[18] To get back into balance required an additional infusion of capital. What happened next is a bit fuzzy and will ultimately be the subject of a trial.
At some point, given the ongoing default resulting from the failure to contribute the additional funds needed to bring the Mezz Loan back into balance, the Sponsor, apparently exercising its authority as manager of the Joint Venture, entered into a forbearance agreement with the Mezz Lenders.[19] Importantly, the default on the Mezz Loan was also a default under the Mortgage Loan—meaning the Mezz Lenders were at risk of the Mortgage Lenders foreclosing upon the Mortgage Loan, which, being senior to the Mezz Loan, could negatively affect the Mezz Lenders’ ultimate recovery on the Mezz Loan.[20] And the sole means for the Mezz Lenders to recover the loan proceeds appears to have been the equity in the Project.
At the same time the forbearance agreement was being entered into, the Mezz Lenders appear to have “exercised [their] contractual right under the operative loan agreement to ‘modify, split and/or sever any portion of the Loan,’” by requiring that the Mezz Loan be split into two pieces: a $300 senior mezzanine loan (“Senior Mezz Loan”) and a $25 million junior mezzanine loan (“Junior Mezz Loan”).[21]
The borrower of the Junior Mezz Loan then became the Junior Mezz Borrower, but the security for the Junior Mezz Loan now became a pledge of the Junior Mezz Borrower’s equity in the Senior Mezz Borrower (which, of course, structurally subordinated the Junior Mezz Loan to the Senior Mezz Loan). The borrower of the Senior Mezz Loan remained the Senior Mezz Borrower, and the Senior Mezz Loan continued to be secured by the Senior Mezz Borrower’s equity in the Mortgage Borrower.[22] The individual owners of the Sponsor also entered into a guaranty “under which they would become personally liable to repay the Junior Mezzanine Loan if any of them attempted ‘in bad faith . . . to materially delay any foreclosure against the Collateral, or any other exercise by Lender of its remedies under the Loan Document.’”[23]
Apparently, the Mortgage Loan and the intercreditor agreement between the Mortgage Lender and the Mezz Lenders were also amended in connection with the forbearance agreement. The amended intercreditor agreement restricted the Mezz Lenders’ ability to foreclose on their equity pledges unless they could “locate a new developer within sixty days of a foreclosure, and [] recommence construction under a new construction manager within thirty days of foreclosure.”[24]
The amended intercreditor agreement also required the Mortgage Lender’s approval of the identities of the developers and construction managers and provided a list of those likely acceptable to the Mortgage Lenders, but that list did not include the Sponsor or its individual owners.[25] But ultimately, the original developer did apparently come back into the deal.[26]
The Alleged “Backroom Deal”
The plaintiff alleged that “during the forbearance period,” the Mezz Lenders, the Mortgage Lender, and the Sponsor “negotiated a secretive ‘backroom deal’” to bring in additional equity investors and “extinguish [p]laintiff’s equity.”[27] The alleged plan was for new investors to invest in a new entity (“New Junior Mezz Lender”) that would acquire the Junior Mezz Loan from the Mezz Lenders (for its face amount of $25 million), which would then be strictly foreclosed upon and result in the New Junior Mezz Lender owning the Junior Mezz Borrower. As a result, all of the existing investors’ equity would be wiped out (which obviously included not only the plaintiff’s equity, but the Sponsor’s and all other existing investors’ equity as well), while the Senior Mezz Loan and the Mortgage Loan would remain in place.[28] Apparently, the new investors were then expected to invest some additional capital beyond the amount required to purchase the Junior Mezz Loan. And there were allegedly projections provided by the Mezz Lenders indicating that the return on the new investors’ capital infusion would be significant.[29] Presumably, these projections were based on a completed building and sales of the condominiums in that completed building, which apparently required additional capital to complete.
Shortly before the end of the forbearance period, the Mezz Lenders assigned the Junior Mezz Loan to the New Junior Mezz Lender, with the Mortgage Lender’s approval. Favorable amendments to the intercreditor agreement were also made. Within a short time after that, the New Junior Mezz Lender sent a notice of default and a strict foreclosure notice to the Junior Mezz Borrower pursuant to section 9-620 of New York’s Uniform Commercial Code.[30] The Sponsor apparently provided the plaintiff with a copy of the notice. And, “[p]ursuant to UCC 9-620, the Junior Mezz Borrower had twenty days to object to the strict foreclosure.”[31]
The plaintiff objected to the Sponsor acquiescing in the strict foreclosure as the manager of the Joint Venture, which was presumably the sole member of the Junior Mezz Borrower, and wanted the Sponsor to instead insist on a traditional foreclosure—the idea being that in a strict foreclosure, the New Junior Mezz Lender would receive the collateral in satisfaction of the Junior Mezz Loan, whereas in a traditional foreclosure, the New Junior Mezz Lender would conduct an actual foreclosure sale and any excess proceeds over the amount required to satisfy the Junior Mezz Loan might be paid to the Junior Mezz Borrower. The plaintiff claimed that this was a “Major Decision” requiring the plaintiff’s approval and, apparently, that the Sponsor was subject to an implied covenant not to acquiesce in the strict foreclosure in any event.[32]
The Sponsor refused to object to the proposed strict foreclosure on behalf of the Junior Mezz Borrower, and the plaintiff filed an action to prevent it. But the trial court ruled that the plaintiff lacked standing, and the strict foreclosure proceeded, resulting in the New Junior Mezz Lender acquiring, in satisfaction of the $25 million Junior Mezz Loan, all of the equity of the Senior Mezz Borrower, subject to the Senior Mezz Loan and the Mortgage Loan. And sometime thereafter, additional investments were made in the Joint Venture or its subsidiaries, resulting in the original developers who owned the Sponsor once again having an ownership stake in the Project.[33]
The Lawsuits
While the consummation of the strict foreclosure mooted the plaintiff’s effort to prevent it, the plaintiff amended its complaint to assert damage claims against the Sponsor, the Mezz Lenders, and the New Junior Mezz Lender. One of the plaintiff’s claims was that the Mezz Lenders and the New Junior Mezz Lender had tortiously interfered with the plaintiff’s rights under the JVA (by inducing the Sponsor not to object to the strict foreclosure). But the trial court dismissed that claim, apparently concluding that the decision not to object to the strict foreclosure was not a Major Decision and that, even if the Sponsor had an implied good faith obligation to object to the strict foreclosure, the Mezz Lenders and the New Junior Mezz Lender had “a right to protect [their] own legal and financial stake in the breaching party’s business” absent “a showing of either malice on the one hand, or fraudulent or illegal means on the other.”[34] According to the trial court, “malice, fraud or illegal means go beyond allegations of intentional bad faith acts.”[35]
Another of the plaintiff’s claims was that the Sponsor had breached its fiduciary duties to the plaintiff as the manager of the Joint Venture (and presumably that the Mezz Lenders or the New Junior Mezz Lender had participated in that breach). But that claim was dismissed because the JVA was a Delaware LLC, and Delaware law permits broad waivers of fiduciary duties in a limited liability agreement. Apparently, section 8.5 of the JVA did exactly that.[36]
The plaintiff also filed a derivative claim on behalf of the Joint Venture against the New Junior Mezz Lender, asserting that it violated the covenant of good faith and fair dealing under the pledge agreement when exercising its “discretion” to strictly foreclose—allegedly having induced the Sponsor “into giving away the company’s right to a sale by auction, which gutted the value received by the company.”[37] This claim is apparently still pending and was not involved in the Court of Appeals’ decision.[38]
But the plaintiff additionally filed a derivative claim on behalf of the Joint Venture against the Mezz Lenders, asserting that the Mezz Lenders’ exercise of their discretion to assign the Junior Mezz Loan to the New Junior Mezz Lender violated the implied covenant of good faith and fair dealing as applied to the pledge and loan agreement governing the Junior Mezz Loan. Although this claim survived a motion to dismiss at the trial court, the Appellate Division disagreed, holding:
[T]he Apollo Lenders had the right to assign the Junior Mezzanine Loan. The relevant loan agreement and pledge agreement, when read together, conferred considerable discretion to the Apollo Lenders. Because Apollo had the absolute right to assign the Pledge Agreement in its sole discretion under the loan documents, there can be no implied covenant claim against them.[39]
The Court of Appeals’ Approach to the Implied Covenant
The Appellate Division’s holding regarding the nonexistence of an implied covenant claim based on the exercise of the Mezz Lenders’ express contractual right to assign the Junior Mezz Loan was then appealed to the Court of Appeals, and this is where the fireworks occurred.
The majority opinion described the issue as follows:
[P]laintiff alleges that [the Mezz Lenders] violated the implied covenant under the Pledge Agreement by assigning the junior mezzanine loan to [the New Junior Mezz Lender] as a part of a “backroom deal” intended to push plaintiff out of the Project’s capital structure and benefit from the windfall of equity that would flow to [the New Junior Mezz Lender] (and others, including [the Mezz Lenders]) thereafter. Assuming without deciding that [the Mezz Lenders] had “sole discretion” to assign to the junior mezzanine loan under the terms of the Pledge Agreement and Loan Agreement, we disagree with the Appellate Division’s conclusion that such discretion exculpated [the Mezz Lenders] from the implied covenant. We instead hold that the second amended complaint sufficiently alleged a claim against [the Mezz Lenders] for breach of the implied covenant.[40]
Acknowledging that there was a split in authority among the various Appellate Division departments on the issue of whether there can be a breach of the implied covenant if the contract grants a party “sole discretion,” the majority of the Court of Appeals held that merely using the term sole discretion does not eliminate the implied covenant:
Accordingly, the implied covenant obligates the party with discretion [to] act in good faith, and “not [] arbitrarily or irrationally,” when “exercising that discretion.” A promisor’s discretion may not be used to violate a promise that “a reasonable person in the position of the promisee would be justified in understanding w[as] included.”[41]
The dissent did not disagree with the general principle that merely using the term sole discretion did not necessarily eliminate the possibility of an implied covenant constraining the unfettered exercise of that discretion. But Judge Garcia argued:
The relevant assignment clause permits [the Mezz Lenders], in [their] sole discretion, to assign the loan and reduce or eliminate risk, with certain bargained-for limits on that right. The parties negotiated two schedules of “prohibited transferees”; one effective prior to any default with a list of seven entities and one effective after any default that reduces that number to three.[42]
And those bargained-for limits on the persons to whom the loan can be assigned are the bargained-for constraints on the implied covenant’s operation within the discretion granted to the Mezz Lenders to assign the Junior Mezz Loan.[43] Thus, the Mezz Lenders’ “exercise of its discretion in assigning the loan to the [New Junior Mezz Lender], an entity not specifically prohibited from receiving the loan, did not deprive Borrower of the bargained-for limitations on transfer of the loan.”[44]
The majority countered:
It does not matter if the parties already negotiated certain restrictions with respect to a party’s sole discretion because the implied covenant’s very purpose is to cover that which is not anticipated and yet incompatible with the object of the contract when viewed as a whole, regardless of that sole discretion.[45] . . .
[T]he fact that the parties identified and agreed to certain entities to whom the loan could not be assigned does not suggest that the parties thereby authorized [the Mezz Lenders] to assign the loan to anyone else for a fraudulent purpose or in bad faith, which is what the plaintiff alleges.[46]
The majority also argued that their position on the implied covenant’s application to a discretionary right was consistent with Delaware law.[47]
New York Appears to Have a Broader Concept of the Implied Covenant Than Delaware
It is true that Delaware law similarly suggests that simply modifying the grant of discretionary authority with the word sole does not eliminate the implied covenant’s application to the exercise of that “sole discretion.”[48] Instead, something more is required.[49] “But ‘if the scope of discretion is specified, there is no gap in the contract as to the scope of the discretion, and there is no reason for the Court to look to the implied covenant to determine how discretion should be exercised.’”[50]
And even when the implied covenant applies to a discretionary right, it simply prevents the holder of the right from acting maliciously to destroy the fruits of the bargain for its counterparty without any “contractually grounded” justification.[51] “An obligation to act in the best interests of another party is a fiduciary duty, not a contractual one.”[52] A party can exercise a discretionary contractual right to protect its own contractual interests, even if doing so is detrimental to the other party. But it cannot exercise those discretionary rights solely to harm the other party.[53] In Delaware:
The implied covenant of good faith and fair dealing is the doctrine by which Delaware law cautiously supplies terms to fill gaps in the express provisions of a specific agreement. Despite the appearance in its name of the terms “good faith” and “fair dealing,” the covenant does not establish a free-floating requirement that a party act in some morally commendable sense. Nor does satisfying the implied covenant necessarily require that a party have acted in subjective good faith.[54]
In 111 West 57th Investment, the assignment provision limiting to whom the loan could be assigned was clearly for the borrower’s benefit and set the limits of that restriction. But the general provision stating that an assignment to anyone else was permitted in the lender’s sole discretion was for the lender’s benefit, not the borrower’s benefit. For the borrower, the fruits of the pledge agreement were forbearance from foreclosure for a specified period, subject to bargained-for restrictions on the persons to whom the loan could be assigned. For the lender, the fruits of the pledge agreement were security for the repayment of the Junior Mezz Loan, which, except for the guaranty provided by the Sponsor’s owners, was nonrecourse. That was the bargain.
This assignment provision was not a clause granting the Mezz Lenders discretion over the borrower’s right to assign its obligations to a purchaser of the Project, where the issue of exercising that discretion reasonably would normally arise. Obviously, the Mezz Loan had been split into a smaller Junior Mezz Loan to provide flexibility for the Mezz Lenders in realizing on its sole collateral—the equity interests in the chain of companies that ultimately owned the Mortgage Borrower. And in the absence of the bargained-for restriction in favor of the borrower, the loan would have been freely assignable by the lender in any event.[55] And even without the assignment, the Mezz Lenders had the right to initiate a strict foreclosure on the pledge securing the Junior Mezz Loan and to attempt to accomplish the objective that was in its best interest, given that the Mezz Lenders’ ability to recover on its loans was subject to the Mortgage Loan.
The sole issue on appeal was whether the plaintiff had stated a sufficient claim that the Mezz Lenders had breached the implied covenant in the pledge agreement securing the Junior Mezz Loan when the assignment was made to the New Junior Mezz Lender. It was not a question of whether the plaintiff had stated a sufficient claim against the Sponsor, alleging that the Sponsor had breached its implied covenant in the JVA by failing to object to the strict foreclosure. Nor whether the New Junior Mezz Lender had in fact induced the Sponsor to fail to object to the strict foreclosure in violation of the implied covenant applicable to the Sponsor’s discretionary powers as the manager of the JVA.[56] Nonetheless, the majority stated that “[e]ven leaving the assignment aside, the complaint’s remaining allegations sufficiently allege a scheme to induce the [borrower’s manager] to refuse to object to the strict foreclosure, and sufficiently allege [the Mezz Lenders’] involvement in that scheme.”[57]
But how can an alleged participation in an alleged scheme to induce a breach of an implied covenant (which is a contract claim, not a tort claim) be cognizable if such participation in such a scheme failed to qualify as tortious interference? After all, the majority “affirmed the dismissal of the tortious interference claims against both [the Mezz Lenders and the New Junior Mezz Lender] on the ground that they were insufficiently pleaded.”[58]
And isn’t the induced breach of the implied covenant, as thus described by the majority, an implied covenant in the borrower’s Delaware law–governed LLC agreement, not the pledge agreement? If so, is that not a claim for tortious interference by the Mezz Lenders with the borrower’s LLC agreement (which has apparently been dismissed)? If not, is the majority’s formulation of the plaintiff’s claim a way of invoking the implied covenant as a repackaged version of an aiding and abetting of a breach of fiduciary duty claim (which was effectively waived under Delaware law)? Under Delaware law, “[r]especting the elimination of fiduciary duties requires that courts not bend an alternative and less powerful tool [i.e., the implied covenant] into a fiduciary substitute.”[59]
The fact that New York’s LLC law is more limited in its statutory authority to permit parties to waive fiduciary duties in alternative entities[60] does not change the fact that Delaware, the law under which the Joint Venture was established, broadly permits such waivers, subject only to an ongoing obligation of good faith and fair dealing.[61] And the contours of that ongoing obligation of good faith and fair dealing respecting the “internal affairs” of a Delaware entity should be established based on Delaware’s approach to the implied covenant, not New York’s seemingly now-broader approach.[62]
There appears to be ongoing litigation of other claims against other defendants that do not invoke the implied covenant in the potentially troubling context of a lender’s decision to assign its loan in a manner that did not violate the express terms of the loan and equity pledge agreement.
Let’s Ask Captain Obvious
The majority opinion suggests that its approach to the implied covenant, as applied to the exercise of discretionary rights to assign a pledge agreement, is consistent with Delaware law.[63] But recent Delaware decisions have looked to English law and the “officious bystander test” as a convenient means of assessing whether the implied covenant should supply an implied term to fill a gap in the express terms of an agreement.[64] And that includes gaps created by grants of discretionary rights (to the extent that this particular right of the Mezz Lenders to assign to anyone to whom an assignment was not expressly prohibited can even be categorized as a discretionary right).
While English law has not conceptually embraced the implied covenant of good faith and fair dealing, it does, when necessary, cautiously imply terms in a manner not dissimilar to the limited gap-filling approach that the Delaware courts use in applying the implied covenant. As described by a recent Delaware Chancery Court decision:
[U]nder English law, “a term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed [to] it if it had been suggested to them.” The term must also “be so obvious as to go without saying or to be necessary for business efficacy.”[65]
And English law also supplies a convenient approach to determining when a term is “so obvious as to go without saying”—the “officious bystander test.”[66] That test asks whether “if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common ‘Oh, of course!’”[67]
This officious bystander is the English equivalent of our “Captain Obvious”—i.e., the person who makes those ridiculously obvious statements that prompt those who hear them to reply unanimously with “Thank you, Captain Obvious,” or sometimes with an even more colorful phrase that begins with the word “no,” followed by a scatological reference, and ending with the name “Sherlock.”
So, if an officious bystander had suggested to the parties negotiating the pledge agreement securing the Junior Mezz Loan that there be an express provision prohibiting the Mezz Lenders from assigning the Junior Mezz Loan to a third party “as part of a backdoor deal to appropriate the value of plaintiff’s equity by conspiring with others to facilitate that scheme,” would the parties have unanimously answered “Oh, of course”? I think not.
While the Junior Mezz Borrower, acting through the Sponsor, may have been indifferent, the Mezz Lenders might well have replied:
Wait a minute. What does that even mean? Does a foreclosure constitute a scheme? Isn’t the whole idea behind a foreclosure of an equity pledge to appropriate the value associated with the pledged equity to ensure repayment of our loan? We have even negotiated a personal guaranty to ensure that the Sponsor’s owners are at risk if they interfere with a foreclosure. We are entitled to foreclose right now. The borrower is in default; we are junior to the Mortgage Loan, and they have demanded that we find a new developer to get the Project back on track. We are offering the borrower a forbearance to provide time to get the Project back on track. And we are exercising our rights to split the loan to provide us flexibility in any foreclosure scenario, and we will undoubtedly assign the Junior Mezz Loan to another party as part of using that flexibility to foreclose on only a portion of the Mezz Loan and leave the remaining portion outstanding in our favor, all while fulfilling the obligations we have now had to undertake to the Mortgage Lender. So, “No, of course not!”
Or, as one Delaware Court of Chancery decision suggested would be the result of a similar question regarding an implied term that a plaintiff alleged was required by the implied covenant, there would have been no “Oh, of course” response by the parties. Instead, “[a]t best, further negotiation would have ensued. It is therefore not reasonably conceivable that the implied covenant can support the implicit [rights suggested by the plaintiff].”[68]
But the majority did not approach the implied covenant in this manner. Instead of asking what the parties to the pledge agreement (the Junior Mezz Borrower and the Mezz Lenders) would reasonably have understood the agreement might include by way of an implied term, the majority looked to what the plaintiff would have understood. The plaintiff, however, was not a party to the pledge agreement and would not have been there to hear the officious bystander offer the express term and be in a position to answer with the other negotiating parties, “Oh, of course.” Instead, looking to what a nonparty to the pledge agreement would have reasonably concluded, the majority held:
At bottom, accepting the second amended complaint’s allegations as true and making all reasonable inferences from those allegations in plaintiff’s favor, the pleading is sufficient to state a claim that Apollo breached the implied covenant in the Pledge Agreement. The purpose of the Pledge Agreement was to facilitate the forbearance of the original mezzanine loan from Apollo, such that the construction of the Project could continue and that the Joint Venture’s equity investment in the Project, including plaintiff’s $65 million investment, remained unimpaired. The Pledge Agreement and Loan Agreement were intertwined. As such, a reasonable party in plaintiff’s position would have understood that the Pledge Agreement included a promise by Apollo not to use its discretion under the Pledge Agreement to collude in a “backdoor deal” that stripped plaintiff of its position as an equity participant in the Project—the very equity the forbearance agreement was intended to protect. By implying such a promise, we recognize an obligation that was implicit in the Pledge Agreement. Allegations of this kind, which deprive parties of the benefits of the contract, are precisely what the implied covenant is intended to safeguard against.[69]
The facts in this case are so complex and difficult to pin down that it is perhaps understandable that the majority wanted those facts more fully developed at trial and the case not decided simply on the pleadings. But the only claim here, it seems, was the implied covenant claim arising under the pledge agreement against the Mezz Lenders by virtue of the assignment of the Junior Mezz Loan to the New Junior Mezz Lender—not the implied covenant claim that also exists pursuant to Delaware law under the JVA. And the normal purpose of a pledge agreement is to secure a loan made, not to ensure that the pledged equity interests “remain unimpaired.”[70]
Even if something untoward occurred here and the plaintiff suffered harm, it is important that a legally cognizable claim be used to address that harm.[71] It is not clear that the pledge agreement itself is the place to find the implied covenant to address that presumed harm. And the implied covenant cannot be the means of redressing every alleged injury arising out of a contractual relationship that is not addressed by the express terms. To allow the wrong legal theory to address a perceived harm can have “ramifying consequences, like the rippling of the waters, without end.”[72]
Concluding Thoughts
In a prior piece on the implied covenant,[73] I suggested that Texas may have overreacted by rejecting the implied covenant of good faith and fair dealing outright.[74] Specifically, I suggested that when the Texas Supreme Court declared that such a “novel concept . . . would . . . let each case be decided on what might seem ‘fair’ and in ‘good faith’ by each fact finder,”[75] it was describing and rejecting the utopian vision of the implied covenant, not the more practical gap-filling version that simply implies obvious terms necessary to give business effect to the other express terms of an agreement—in other words, the version of the implied covenant that is applied in Delaware and that I believe was also applied in New York. But the dissent in 111 West 57th Investment noted Texas’s position and suggested that Texas’s position had, in fact, been unfounded until the majority decision in this case because the implied covenant had been so cautiously applied.[76] But perhaps no more?[77]
There are legitimate transactions structured every day that adhere to the express terms of written agreements governed by New York law, and, in connection with them, consideration is given to the implied covenant in its limited (and rarely used) role of implying gap-filling terms consistent with those express terms. Does this case add a new dimension to that exercise?[78] And if so, are there discernible guidelines for navigating that new dimension?
Kirk La Shelle Co. v. Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933). ↑
Singh v. City of New York, 217 N.E.3d 1, 5 (N.Y. 2023) (citations omitted). ↑
See Zormati v. Citibank, N.A., 2026 N.Y. slip op. 01821, 2026 WL 849365, at *2 (N.Y. App. Div. 2d Dep’t Mar. 25, 2026); see also Smile Train, Inc. v. Ferris Consulting Corp., 986 N.Y.S.2d 473, 475 (N.Y. App. Div. 1st Dep’t 2014) (“[B]reach of the implied covenant of good faith and fair dealing is not a tort; rather, it ‘is a contract claim.’”); Randall’s Island Aquatic Leisure, LLC v. City of New York, 938 N.Y.S.2d 62, 63 (N.Y. App. Div. 1st Dep’t 2012) (“There can be no claim of breach of the implied covenant of good faith and fair dealing without a contract.”). ↑
111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, No. 41, 2026 N.Y. slip op. 03376, 2026 WL 1502410 (N.Y. May 28, 2026) (NYCA). ↑
Id. at *9 (Garcia, J., dissenting in part) (emphasis added). ↑
Id. The Joint Venture was an LLC formed under Delaware law, and Delaware law permits broad waivers of fiduciary duties but not waivers of the implied covenant. 6 Del. C. § 18-1101(c) (“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”). New York’s LLC statute is a more limited grant of authority to waive fiduciary duties. In New York, the waiver may not “eliminate or limit . . . the liability of any manager if a judgment or other final adjudication adverse to him or her establishes that his or her acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law or that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled. . . .”). N.Y. Ltd. Liab. Co. Law § 417(a)(1) (McKinney 2026). ↑
See 111 W. 57th Inv. LLC v. 111 W57 Mezz Investor LLC, 2022 N.Y. slip op. 34258(U), 2022 WL 17718682, at *2 (N.Y. Sup. Ct., N.Y. Cty. Dec. 15, 2022) (Trial Court). ↑
It is not clear whether the Junior Mezz Borrower was in the structure originally or only entered the structure as part of the subsequent forbearance agreement. ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *1. Apparently, the plaintiff alleged that the budget overruns exceeded the approved budget and that the plaintiff was not required to contribute its share of the shortfall and instead was entitled to trigger an equity put requiring that the Sponsor purchase the plaintiff’s equity. See Ambase Corp. v. Acrefi Mortg. Lending, LLC, 2019 N.Y. slip op. 33148(U), 2019 WL 5394498, at *1–3 (N.Y. Sup. Ct., N.Y. Cty. Oct. 22, 2019). The Sponsor disputed that and had apparently covered several capital contributions that the plaintiff had allegedly not funded. Moreover, the Sponsor had proposed a new financing to resolve the funding deficit, but the plaintiff had allegedly refused to approve the financing. See generally Ambase Corp. v. 111 W. 57th Sponsor LLC, 2018 N.Y. slip op. 30160(U), 2018 WL 587136, at *2–3 (N.Y. Sup. Ct., N.Y. Cty. Jan. 29, 2018); Iszo Cap. LLP v. Bianco, 2018 N.Y. slip op. 33384(U), 2018 WL 6809400, at *1 (N.Y. Sup. Ct., N.Y. Cty. Dec. 27, 2018). ↑
111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *2. ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *10 (Garcia, J., dissenting in part). ↑
See Calumet Cap. P’rs LLC v. Victory Park Cap. Advisors, LLC, 353 A.3d 88, 126 (Del. Ch. 2026). ↑
See Glenn D. West, Musings on the Exercise of “Sole Discretion,”Weil Glob. Priv. Equity Watch (Aug. 29, 2022) (discussing caselaw that suggests “sole discretion” by itself does not eliminate the implied covenant); Paul M. Altman & Srinivas M. Raju, Delaware Alternative Entities and the Implied Contractual Covenant of Good Faith and Fair Dealing Under Delaware Law, 60 Bus. Law. 1469, 1484 (2005) (suggesting means of limiting the implied covenant in grants of discretion with language in addition to sole discretion). ↑
McKenzie v. BDO USA, P.C., 2026 WL 191010, at *5 (Del. Ch. Jan. 26, 2026) (citations omitted). ↑
See Guilbeau v. Footprint Int’l Holdco, Inc., 2026 WL 1180159, at *22 (Del. Ch. Apr. 30, 2026). ↑
Allen v. El Paso Pipeline GP Co., 113 A.3d 167, 182–83 (Del. Ch. 2014), aff’d, 2015 WL 803053 (Del. Feb. 26, 2015). ↑
See generally 29 Williston on Contracts § 74.10 (4th ed. May 2026 Update) (“Generally, all contract rights may be assigned in the absence of clear language expressly prohibiting the assignment, and unless the assignment would materially change the duty of the obligor or materially increase the obligor’s burden or risk under the contract or the contract involves obligations of a personal nature.”). ↑
See 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 146 N.Y.S.3d 95, 99 (N.Y. App. Div. 1st Dep’t 2021) (“[T]he complaint states a derivative cause of action for breach of the duty of good faith and fair dealing by alleging that [the New Junior Mezz Lender], in which the pledge agreement vested discretion as to the exercise of UCC remedies, suborned insiders to allow it to exercise that discretion to plaintiff’s detriment.”). ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *10 n.10. ↑
SeeN.Y. Ltd. Liab. Co. Law § 417(a)(1) (McKinney 2026) ( a waiver of fiduciary duties in New York may not “eliminate or limit . . . the liability of any manager if a judgment or other final adjudication adverse to him or her establishes that his or her acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law or that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled”). ↑
6 Del. C. § 18-1101(c) (“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”). ↑
See generally Eccles v. Shamrock Cap. Advisors, LLC, 245 N.E.3d 1110, 1121 (N.Y. 2024) (quoting Hart v. Gen. Motors Corp., 129 A.D.2d 179, 184, 517 N.Y.S.2d 490 (N.Y. App. Div. 1st Dep’t 1987)) (noting that “the internal affairs doctrine . . . protects the interests and expectations of shareholders by giving effect to their choice as to what jurisdiction’s laws will govern the corporation’s affairs”). ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *5. ↑
See Guilbeau v. Footprint Int’l Holdco, Inc., 2026 WL 1180159, at *14 (Del. Ch. Apr. 30, 2026); Zync, Inc. v. Porshe Inv. Mgmt., S.A., 2026 WL 1507812, at *21 (Del. Ch. May 29, 2026). ↑
Footprint Int’l, 2026 WL 1180159, at *14 (quoting Marks & Spencer PLC v. BNP Paribas Sec. Servs. Tr. Co. (Jersey) Ltd., [2015] UKSC 72, [2016] A.C. 742 [21], [23]). ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *8 (emphasis added). ↑
Id. It is also not clear that the primary purpose of a forbearance agreement is to ensure that a borrower’s equity interests “remain unimpaired.” ↑
There is a legal maxim that is worth recalling—damnum absque injuria (a “harm without injury in the legal sense, that is, without such breach of duty as is redressable by an action”). Black’s Law Dictionary (5th ed. 1979). ↑
Tobin v. Grossman, 249 N.E.2d 419, 424 (N.Y. 1969). ↑
Texas does recognize the implied covenant in the context of contracts subject to the Uniform Commercial Code and certain “special relationships,” such as an insurance contract. See Tex. Bus. & Com. Code §§ 1.201(b)(20), 1.304, 2.306; see also Natividad v. Alexsis, Inc., 875 S.W.2d 695, 697–98 (Tex. 1994) (“The duty of good faith and fair dealing emanates from the special relationship between the parties and not from the terms of the contract, therefore its breach gives rise to tort damages and not simply to contractual liability. However, the ‘special relationship’ exists only because the insured and the insurer are parties to a contract that is the result of unequal bargaining power, and by its nature allows unscrupulous insurers to take advantage of their insureds. Without such a contract there would be no ‘special relationship’ and hence, no duty of good faith and fair dealing.”). ↑
English v. Fischer, 660 S.W.2d 521, 522 (Tex. 1983). ↑
111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *12 n.2 (Garcia, J., dissenting in part). ↑
Unlike either New York or Delaware, Texas LLC agreements can completely eliminate fiduciary duties without any ongoing implied covenant of good faith and fair dealing overlay. SeeTex. Bus. Orgs. Code § 101.401 (“The company agreement of a limited liability company may expand, restrict, or eliminate any duties, including fiduciary duties, and related liabilities that a member, manager, officer, or other person has to the company or to a member or manager of the company.”). ↑
As noted in my prior piece (West, supra note 66), I am working with coauthors on a more comprehensive law review article with the working title “Making Sense of the Implied Covenant of Good Faith and Fair Dealing.” This case has caused some rethinking, at least with respect to the “sense” of the doctrine in New York. ↑
In litigation, strategy, legal arguments, and effective evidence receive the bulk of the credit—win or lose. When cases are delayed, deadlines are not met, or a case is dismissed, however, the underlying issue often stems not from the legal strategy, but from deficiencies in execution and operational management.
Modern litigation relies on a series of coordinated and often mandated steps, each of which must be executed correctly and on time. When those steps break down, the entire case can lose momentum. Increasingly, the difference between a case that progresses efficiently and one that drags comes down to operational execution, not strategy.
What Actually Slows a Case: Depositions, Records, and Coordination
Two of the most important operational components in litigation are deposition coordination and records retrieval. Both are foundational, time-consuming, and highly sensitive to delays.
Depositions require close coordination among multiple participants, including attorneys, witnesses, court reporters, and litigation support teams, with remote technology frequently serving as the underlying infrastructure. This is particularly challenging as the ongoing shortage of court reporters and stenographers continues to affect deposition scheduling and availability nationwide. Success depends on proper resourcing, schedule alignment, availability confirmation, and reliable technical architecture. When any one of these components breaks down, momentum quickly slows, or worse: motions to compel, motions for sanctions, or even a risk of dismissal.
Litigation frequently relies on acquiring third-party records such as medical, employment, or education documents, each of which has its own rules for retrieval and varying lead times. With no standardized and universal retrieval system in place, delays are frequent. When a key record arrives late, it can shift deposition schedules, delay summaries and review, stall expert analysis, and lengthen the entire discovery process.
Small operational gaps rarely occur alone. They compound over time.
Cumulative Impact of Operational Issues
While a single operational issue may not drastically affect a case’s timeline, repeated or interconnected challenges resulting from inadequate operational management can steadily divert attention away from the areas where attorneys deliver the most value: developing strategy and overseeing legal process management. When these problems persist or build upon one another, the focus of the legal team shifts from strategic planning and legal analysis to troubleshooting operational setbacks. This shift ultimately undermines the attorney’s ability to drive the case forward with the strongest possible legal approach.
Common operational issues include fragmented communication across stakeholders, inconsistent workflows from case to case, resource management issues, and coordination gaps between service providers. These are not isolated problems; they are often the direct mechanisms behind the deposition and records delays described above. Fragmented communication drives deposition breakdowns when scheduling confirmations and availability updates move through disconnected channels, leaving little margin for error in an environment already strained by a nationwide stenographer shortage. Inconsistent workflows compound record retrieval delays, as ad hoc processes vary by case and by person, making problems difficult to detect until they have already affected the timeline. The symptoms are visible long before the structural causes are.
Hybrid Proceedings Have Changed the Operational Model
Litigation technology and supporting tools have dramatically changed over the last several years. Prior to the pandemic, nearly all depositions and proceedings were conducted in person. Today, a large portion are conducted virtually or in a hybrid format.
These developments have made some clear efficiency improvements. Attorneys no longer need to travel for every deposition, documents are accessible digitally, and scheduling is more flexible.
However, hybrid proceedings did not simplify litigation operations; they redistributed the complexity. Technology must work reliably, participants must be aligned across locations, and exhibits must be accessible and presented correctly in both remote and in-person settings.
What was once a simple in-person process now requires legal and technical readiness; if either is lacking, the proceeding stalls.
Technology Supports, but Doesn’t Replace, Execution
Technology is playing an increasing role in the entire litigation life cycle. Technology solutions that support scheduling, record retrieval, and transcription have improved efficiency and speed, but they are not without their own challenges.
In transcription, for example, automated speech-to-text outputs can reduce turnaround time for rough documents, but accuracy is not completely assured by automated services. Speech patterns, enunciation, use of technical terminology, or even a failed microphone, can all affect the quality of the output, which is critical when a single incorrect word can alter the meaning of testimony. For that reason, human review is still imperative. In many cases, transcripts go through multiple layers of review before they are finalized and ready to be submitted via evidentiary procedures. Currently, technology facilitates certain aspects of the workflow, but the process continues to rely on human oversight and management.
In effective legal operations management, coordination, quality control, and decision-making remain essential human responsibilities.
Execution Is a Competitive Advantage
As litigation becomes more complex, operational performance is becoming a differentiator. Law firms and legal departments are under pressure to move cases forward efficiently while managing costs. Consistent execution across every stage of the litigation life cycle is critical.
Trial readiness serves as a prime illustration of how operational execution plays an equally vital role alongside legal preparation. As litigation has grown more complex, with distributed teams, remote infrastructure, third-party dependencies, and tighter court schedules, trial readiness can no longer be assembled at the end of a case. It is the cumulative result of every operational decision made throughout discovery. When execution has been fragmented along the way, the gaps do not disappear at trial—they arrive with it.
Organizations that invest in structured workflows, reliable coordination, and integrated support are better positioned to maintain case momentum—not because they have better legal talent, but because their talent is not being diverted by operational breakdowns. Those that rely on informal or inconsistent processes will continue to find that execution problems compound into strategic challenges.
This is not a shift away from legal expertise. It is a recognition that expertise has always required infrastructure to deliver on its potential. In modern litigation, the firms that win consistently are not always the ones with the sharpest strategy—they are the ones whose strategy never gets undermined by the way the work is managed.
Section 106(a) of the Bankruptcy Code waives sovereign immunity for certain claims, including those under § 544. But does this waiver allow a trustee to bring a suit against a governmental unit under § 544(b)(1) based on state law? Until recently, courts were split. To resolve the issue, the U.S. solicitor general filed a petition for certiorari in United States v. Miller,[1] arguing that trustees cannot avoid tax payments to the Internal Revenue Service (“IRS”) under § 544(b)(1) if no actual creditor could have obtained relief against the government under the applicable state fraudulent transfer law outside of bankruptcy.
On June 24, 2024, the Supreme Court granted certiorari,[2] and on March 26, 2025, it ultimately ruled in United States v. Miller that § 106(a) does not authorize trustees to bring fraudulent transfer claims against the government under § 544(b) unless an actual creditor could do so under state law.[3] This decision narrows trustees’ avoidance powers and impacts cases beyond tax-related transfers.
Facts
The respondent was the bankruptcy trustee of a failed Utah-based business debtor whose shareholders misappropriated $145,000 in company funds to satisfy their personal federal tax liabilities prepetition. The debtor received nothing in return for paying off those debts.
The respondent brought a fraudulent transfer action against the United States seeking to claw back the misappropriated funds for the benefit of the bankruptcy estate. He filed the action pursuant to § 544(b), which allows a trustee to “avoid any transfer of an interest of the debtor . . . that is voidable under applicable law by a creditor holding an unsecured claim.”[4] To avoid dismissal due to the two-year “look-back” period under a § 548 fraudulent transfer claim, the respondent invoked Utah’s then-applicable fraudulent transfer statute—which gives creditors a cause of action to invalidate certain transfers by a debtor—as the “applicable law” underlying his § 544(b) claim.[5]
The United States argued that the respondent’s § 544(b) claim failed. The respondent could not identify an “actual creditor” that could have voided the fraudulent transfer because sovereign immunity would bar any such Utah cause of action against the United States. The bankruptcy court disagreed, concluding that the scope of sovereign immunity waiver under § 106(a) includes waiver of sovereign immunity with respect to the Utah cause of action nested within the § 544(b) claim. On appeal, the district court adopted the bankruptcy court’s decision. The Tenth Circuit affirmed.
The Circuit Split
Fourth, Ninth, and Tenth Circuits
According to the Fourth, Ninth, and Tenth Circuits, § 106 unequivocally abrogates sovereign immunity for claims under § 544(b), including fraudulent transfer claims brought under state law.[6]
Seventh Circuit
According to the Seventh Circuit, the waiver of sovereign immunity in § 106 does not extend to a derivative § 544(b) claim based on state law.[7]
The Decision
The Supreme Court (8–1, Justice Jackson writing) reversed the Tenth Circuit and held that the waiver of sovereign immunity under § 106(a) does not extend to § 544(b) suits brought by a trustee under state law standing in the shoes of an actual creditor. The Court reasoned that precedent and “statutory text, context, and structure” all demonstrate that waivers of sovereign immunity (whether under § 106(a) or otherwise) are prerequisites for jurisdiction.[8]
With respect to precedent, the Court previously held that waiver of sovereign immunity empowers courts to hear claims against the government. But that waiver does not create any new substantive rights against the government.[9]
Even the plain language of § 106(a)(5) provides that “[n]othing in this section shall create any substantive claim for relief or cause of action not otherwise existing under this title, the Federal Rules of Bankruptcy Procedure, or nonbankruptcy law.”[10] Likewise, the history of § 544(b) supports the same outcome. Section 544(b) was expressly “derived” from § 70e of the Bankruptcy Act of 1898, which gives trustees the same rights as creditors under state law.
When considering the lawsuit’s context, the Court acknowledged a critical undisputed fact in the record. The parties had agreed that, outside of the bankruptcy proceedings, the government could invoke the defense of sovereign immunity to bar any lawsuit against it seeking to invalidate a federal tax payment under a state’s fraudulent transfer law.
Applying this framework, the Court concluded that the waiver of sovereign immunity under § 106(a) does not create a new way for the government to be sued. In other words, the government is subject to claims brought by a trustee under § 544(b). Yet the government would enjoy immunity for the underlying state law claim in a hypothetical suit brought by an actual creditor of the estate.
The dissent argued that the Court “confus[es]” sovereign immunity doctrine with the requirement of stating a cause of action.[11] According to the dissent, no basis exists for treating state-law avoidance claims differently just because the defendant is the government. Congress, the dissent argued, merely chose to waive an affirmative defense to an otherwise valid claim in one setting, but not another. Can the government defeat a fraudulent transfer claim by raising sovereign immunity as an affirmative defense? Yes, when a private creditor pursues relief in a court other than bankruptcy court. No, when a trustee pursues relief in bankruptcy court. With this sort of analysis, according to the dissent, no substantive claim for relief is created, and no elements of any claim are modified.[12] Notably, the dissent’s analysis is based on the undisputed fact that “[n]o one disputes that a fraudulent transfer took place.”[13]
Implications of Miller
Ultimately, the Supreme Court in Miller held that the waiver of sovereign immunity under § 106(a) does not enable a trustee to file a derivative suit against a governmental unit under § 544(b)(1) of the Bankruptcy Code. Miller, along with the cases discussed therein, involved payment transfers to satisfy federal tax liabilities. Thus, arguably, the Miller ruling may narrow trustees’ avoidance powers in matters that concern other sorts of payments to governmental units, especially when those matters are premised on state law. Those payments could include payments of restitution, civil penalties, fines, and the like.
Also, the respondent argued that it could have secured a Utah-law judgment against the United States under “applicable law.”[14] That judgment could have confirmed that the transfers to the IRS were voidable without the trustee having to sue the government or otherwise implicate sovereign immunity. However, the Court declined to consider those arguments because the respondent failed to raise them below.
The United States also raised arguments based on preemption and the Appropriations Clause of the U.S. Constitution. Although those were arguments raised below, the Supreme Court ultimately did not reach them on appeal. Notwithstanding, those arguments could present additional bases to narrow trustees’ avoidance powers against the United States further.
Any opinions and views expressed herein are Ms. Momoh’s own and not of the United States Attorney’s Office for the District of Minnesota or the United States Department of Justice.
Petition for a Writ of Certiorari, United States v. Miller, No. 23-824, 2024 WL 382516 (Jan. 29, 2024). ↑
United States v. Miller, 144 S. Ct. 2678 (2024). ↑
Utah Code § 25-6-305(1) (as currently codified) (“A claim for relief regarding a transfer or obligation under this chapter is extinguished unless action is brought: . . . under Subsection 25-6-202(1)(a), no later than four years after the transfer was made or the obligation was incurred or, if later, no later than one year after the transfer or obligation was or could reasonably have been discovered by the claimant[.]”). ↑
See, e.g., Miller v. United States, 71 F.4th 1247 (10th Cir. 2023) (focusing on the wording of § 106 and holding Bankruptcy Code’s abrogation of sovereign immunity applied, not only to the section of the Code permitting Chapter 7 trustee to “step into the shoes” of an actual unsecured creditor to avoid transfers that were voidable outside of bankruptcy under applicable state law, but also to the underlying state-law fraudulent transfer cause of action relied upon by trustee to avoid the transfers), cert. granted, 144 S. Ct. 2678 (2024); Cook v. United States (In re Yahweh Ctr., Inc.), 27 F.4th 960, 966 (4th Cir. 2022) (holding that IRS does not have sovereign immunity to escape liability for an avoidable transfer claim (receipt of tax penalties) under § 544(b) and that by filing a proof of claim, the IRS waived sovereign immunity with respect to that claim); Zazzali v. United States (In re DBSI, Inc.), 869 F.3d 1004, 1013 (9th Cir. 2017) (“Congress unambiguously and unequivocally waived sovereign immunity for causes of action brought under § 544(b)(1). To construe the statutes in the manner in which the government proposes would be to ignore the plain text of § 106(a)(1), something we are not at liberty to due [sic].”). ↑
See In re Equip. Acquisition Res., Inc., 742 F.3d 743, 748 (7th Cir. 2014) (“Nothing in § 106(a)(1) gives the trustee greater rights to avoid transfers than the unsecured creditor would have under state law. By concluding that § 106(a)(1) did just that, the courts below erred.”). ↑
FDIC v. Meyer, 510 U.S. 471, 475 (1994); see also MOAC Mall Holdings LLC v. Transform Holdco LLC, 598 U.S. 288, 297 (2023) (Jackson, J.) (“An unmet jurisdictional precondition deprives courts of power to hear the case, thus requiring immediate dismissal.”). ↑
When pursuing a representations and warranties insurance (“RWI”) claim, an insured will sometimes be confronted with a contradictory policy provision or rule of law, or both. In such a situation, consideration of two doctrines may be of help: reasonable expectations of the insured, with respect to insurance law, and manifest disregard of the law, with respect to vacating an arbitration decision.[1]
The doctrine of reasonable expectations of the insured (“REI Doctrine”) is relevant to insurance policies generally, typically for liability insurance. When applicable, the doctrine looks to the objective reasonable expectations of an insured confronted with a policy provision that would otherwise block or cause a forfeiture of coverage. Case law regarding the doctrine is often predicated on the presence of certain factors that give rise to the insurer’s having greater bargaining power than the insured with respect to the terms and conditions of the policy. While the doctrine is usually applicable only in the case of an ambiguous policy provision, in some cases in some jurisdictions it has been held applicable even in the face of an unambiguous policy provision that adversely affects coverage availability.
The doctrine of manifest disregard of the law (“MDL Doctrine”) is relevant to arbitrations generally. The doctrine directs courts to give extreme deference to the decision of an arbitrator in evaluating evidence, interpreting an insurance policy or other contract, or otherwise applying the law relevant to the matter being arbitrated. The doctrine establishes an extremely high barrier to an arbitration party that is seeking judicial vacatur.
While there appears to be no case law in the U.S. that applies either doctrine to a claim under an RWI policy, each doctrine may present strategic or tactical advantages to an RWI insured, particularly one confronted with an otherwise contradictory policy provision or rule of law.
Reasonable Expectations of the Insured
In March 1970, Professor Robert E. Keeton of Harvard Law School published the first part of a two-installment article in the Harvard Law Review titled “Insurance Law Rights at Variance With Policy Provisions.”[2] In examining the landscape of published insurance law cases, Keeton was able to discern two primary principles that he believed explained favorable-to-policyholder court decisions that were seemingly contradicted by policy provisions: the principle of unconscionable advantage of the insurer and the principle of reasonable expectations of the insured.[3] The article proposed a formal recognition of the latter principle, which over time developed into the REI Doctrine.[4]
Subsequent to Keeton’s article, courts throughout the U.S. considered and many adopted some form of the REI Doctrine. Although there have been variations on each, two primary versions of the REI Doctrine developed: one in which courts used the REI Doctrine only in the interpretation of ambiguous insurance policy provisions (“Qualified Version”), and one in which courts used the REI Doctrine to overcome unambiguous insurance policy provisions otherwise contrary to the position being asserted by the insured (“Unqualified Version”).
Over time, enthusiasm for the REI Doctrine has waxed, with courts in a number (but fewer than a majority) of states adopting the Unqualified Version, and then waned, with many of those same courts retrenching to the Qualified Version and a few renouncing the REI Doctrine altogether. Throughout that period of wax and wane, a significant number of law professors, insurance attorneys, and other commentators weighed in on many aspects of the REI Doctrine.[5]
Courts often take into account the following factors (“REI Factors”) in determining whether or not the REI Doctrine (or, in addition or as an alternative, the contra proferentem interpretation principle, which results in ambiguities in an insurance policy generally being construed against the insurer and in favor of the insured)[6] might apply to an insurance claim dispute:
Whether the insurance policy in question could be considered to be a contract of adhesion, including whether:
the policy is a printed form
the insured is not encouraged or even permitted to negotiate changes to policy provisions
the insured did not make any changes to the policy provisions
the policy was presented to the insured on a “take it or leave it” basis
the insured received the policy after it went into effect
Whether the insurer or the insured drafted the policy or at least the policy provision in question
Whether the insurer has greater sophistication or bargaining power than the insured[7]
Under Delaware law, courts have applied a hybrid version of the REI Doctrine. The seminal case in Delaware with respect to the REI Doctrine is the 1974 Delaware Supreme Court case of State Farmv.Johnson,[8] in which the court determined that “an insurance contract should be read to accord with the reasonable expectations of the [insured] so far as its language will permit.”[9] However, in the 1982 Delaware Supreme Court case of Hallowellv.State Farm, the court limited the effect of Johnson by keying in on the phrase “so far as its language will permit” to hold that the REI Doctrine “is applicable in Delaware to a policy of insurance only if the terms thereof are ambiguous or conflicting, or if the policy contains a hidden trap or pitfall, or if the fine print purports to take away what is written in large print.”[10]
Under New York law, the REI Doctrine is effectively intertwined with the contract interpretation principle of contra proferentem. “For the most part, the reasonable expectations analysis is employed to determine if a contract is ambiguous in the first instance. Some courts also employ the doctrine to interpret an ambiguous provision.”[11]
As of 2024, it appears that the courts in only two U.S. states continue to apply the Unqualified Version of the REI Doctrine: Alaska and Hawaii. Moreover, a number of states that had adopted the Qualified Version of the REI Doctrine have retrenched by finding the Qualified Version to be no different effectively than the contra proferentem interpretation principle.[12] Notwithstanding that retrenchment, the REI Doctrine may still be of value to an insured in an RWI policy claim dispute, as discussed below in the section titled “The REI Doctrine, the MDL Doctrine, and RWI Claims.”
Manifest Disregard of the Law
In December 1953, the U.S. Supreme Court decided the case of Wilkov.Swan.[13] In connection with the Wilko Court’s holding that an agreement between a securities buyer and a securities broker to arbitrate future controversies constituted an invalid waiver of the buyer’s right to litigate under the Securities Act, the Court noted that one of the deficiencies of arbitration as opposed to litigation was that there was only an extremely limited right to “appeal” an arbitration decision, in the form of vacatur under the Federal Arbitration Act (f.k.a. “United States Arbitration Act”; “FAA”). Among other things, the Court noted that “the interpretations of the law by the arbitrators in contrast to manifest disregard are not subject, in the federal courts, to judicial review for error in interpretation.”[14] Subsequent to the Wilko decision, U.S. courts keyed in on that emphasized phrase in Wilko as support of a grounds for vacatur of an arbitration decision based on the arbitrator’s manifest disregard of the law.[15]
Among other things, courts found that manifest disregard of the law by the arbitrator constituted a common-law ground for vacatur, independent of and additional to the four statutory grounds for vacatur set forth in the FAA.[16] Those four statutory grounds are as follows:
(1) where the award was procured by corruption, fraud, or undue means;
(2) where there was evident partiality or corruption in the arbitrators, or either of them;
(3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or
(4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.[17]
However, in the March 2008 U.S. Supreme Court case of Hall Street Associates, L.L.C.v.Mattel, Inc.,[18] the Court determined that the only grounds for vacatur available under the FAA were those four statutory grounds. Nonetheless, while the Hall Street Court rejected manifest disregard of the law as an independent, common-law ground for vacatur, it left open the door for assertion of manifest disregard of the law either as a gloss on the four statutory grounds taken collectively or as shorthand for the statutory grounds “authorizing vacatur when the arbitrators were ‘guilty of misconduct’ or ‘exceeded their powers.’”[19]
A litigant seeking vacatur by reason of the arbitrator’s manifest disregard of the law faces an extremely high barrier to success.[20] In the U.S. Court of Appeals for the Second Circuit, for example, such a litigant “bears a heavy burden, as awards are vacated on grounds of manifest disregard only in those exceedingly rare instances where some egregious impropriety on the part of the arbitrator is apparent.”[21] The court “will uphold an arbitration award under this standard so long as the arbitrator has provided even a barely colorable justification for his or her interpretation of the contract,” and even if the court disagrees with the arbitrator’s decision.[22] “Vacatur is only warranted . . . when an arbitrator strays from interpretation and application of the agreement and effectively dispenses his own brand of industrial justice.”[23] Based on this high and exacting standard, some courts have determined that an arbitrator’s interpretation of a contract will be given full deference and that manifest disregard of evidence is not sufficient to constitute manifest disregard of the law.[24]
The test that courts in the Second Circuit, and in jurisdictions following the Second Circuit’s guidance, apply has three prongs:
“consider whether the law that was allegedly ignored was clear, and [was] in fact explicitly applicable to the matter before the arbitrators” (sometimes referred to as the “objective prong” or “objective component”);
“find that the law was in fact improperly applied, leading to an erroneous outcome” (i.e., if the outcome would have been the same from a proper application of the law, then this prong will not have been satisfied); and
“the arbitrator must have known of [the] existence [of the law], and its applicability to the problem before him,” with the court “infer[ring] knowledge and intentionality on the part of the arbitrator only if [it] find[s] an error that is so obvious that it would be instantly perceived as such by the average person qualified to serve as an arbitrator” (sometimes referred to as the “subjective prong” or “subjective component”).[25]
Under Delaware law, courts applying the MDL Doctrine utilize a three-prong test similar to the test utilized in the Second Circuit: “that the arbitrator (1) knew of the relevant legal principle, (2) appreciated that this principle controlled the outcome of the disputed issue, and (3) nonetheless willfully flouted the governing law by refusing to apply it.”[26]
The absence of a written reasoned decision of the arbitrator makes vacatur because of manifest disregard of the law even more difficult to obtain. Without a written reasoned decision, a court considering vacatur based on manifest disregard of the law would have to find clear and convincing evidence of manifest disregard of the law in the record of the arbitration—a nearly impossible task.[27]
Based on the foregoing, successful requests for vacatur of an arbitration award based on manifest disregard of the law have been exceedingly rare.[28]
The REI Doctrine, the MDL Doctrine, and RWI Claims
It appears that there have been no cases applying either the REI Doctrine or the MDL Doctrine in the context of RWI claims. On the flip side, it also appears that there have been no cases that have held that either the REI Doctrine or the MDL Doctrine is not applicable in the context of RWI claims.
With respect to the REI Doctrine, there are a number of arguments against applying it in the context of RWI claims, especially where there is an absence of one or more of the REI Factors. That said, however, particularly when the insured is up against an RWI policy provision that the insurer is using as the basis for a no-coverage position, assertion of the REI Doctrine may still be of value to the insured. Moreover, even when the context of an RWI claim does not support application of even the Qualified Version of the REI Doctrine, that does not mean that the reasonable expectations of the insured are irrelevant to resolution of the RWI claim.
There are a number of principles and doctrines in insurance law that have as one of their explicit or implicit underpinnings the reasonable expectations of the insured.[29] One is the interpretation principle of contra proferentem.
In the January 2021 New York Supreme Court case of WPP Group USA, Inc.v.RB/TDM Investors, LLC, one of the few reported RWI cases in the U.S., the court considered a number of RWI policy exclusions asserted by the insurer.[30] The court denied the insurer’s motion to dismiss with respect to one of those exclusions on the basis that the insurer’s interpretation of the exclusion “seemingly renders coverage for section 5 breaches illusory. . . . Ambiguities in exclusions must be strictly construed and are ordinarily resolved in favor of the insured.”[31] The WPP Group court did not explicitly couch the foregoing decision on the REI Doctrine or on the contra proferentem principle, but an argument can be made that the court implicitly gave weight to the insured’s reasonable expectations regarding the exclusion in reaching that decision.
With respect to the MDL Doctrine, application of the deference shown by the courts to the arbitrator’s treatment of the law in an RWI claim dispute arbitration seems inarguable. In addition to the public policy rationale in favor of arbitration reflected in the FAA, particularly with respect to the extremely limited grounds for judicial intervention to help ensure the finality of arbitration, it is also important to keep in mind that (i) an arbitrator’s sense of “equity” may come into play in appropriate circumstances, even though the applicable law might militate in favor of the arbitrator’s reaching a different decision;[32] and (ii) a person typically does not have to be a lawyer, former judge, or otherwise experienced in the law to serve as an arbitrator.[33]
As a recent example of the extreme deference to arbitration decisions shown by the courts faced with an arbitration party’s assertion of manifest disregard of the law, the February 2024 Delaware Chancery Court case of SM Buyer LLCv.RMP Seller Holdings, LLC stands out.[34] The SM Buyer court refused to vacate an arbitration decision in favor of a mergers and acquisitions (“M&A”) buyer, even though the court disagreed with the decision, which had resulted in a negative purchase price owed by the M&A seller (i.e., the arbitration decision required the seller to pay the buyer approximately $47 million and also return to the buyer approximately $40 million of closing purchase price based on a post-closing purchase price adjustment). The court noted that the “Delaware Supreme Court has explained that ‘review of an arbitration award is one of the narrowest standards of judicial review in all of American jurisprudence.’”[35]
Significantly, the SM Buyer court went on to state: “I would have ruled differently. . . . Here, I suspect the Seller viewed the Buyer’s adjustment as . . . outlandish.”[36] Nevertheless, the Vice Chancellor “reluctantly confirm[ed] the Award” in favor of the M&A buyer.[37] And, in November 2024, the Delaware Supreme Court reaffirmed the Delaware Chancery Court’s judgment, thus letting stand the arbitration award requiring the M&A seller to pay the M&A buyer for the “privilege” of the buyer’s acquisition of the target.[38]
So, putting all of the foregoing together, where are we?
First, if the insured has the choice under the RWI policy of arbitration versus litigation, and the choice of whether or not to have the arbitrator issue a reasoned decision, then the insured should evaluate and make those choices with respect to any given RWI claim dispute with an eye toward whether the policy and the law are more favorable to the insurer or the insured—favoring arbitration and no reasoned decision if the former and other issues are relatively equal.[39]
Second, if the RWI policy is unfavorable to the insured, particularly by virtue of an exclusion, then an assertion of the REI Doctrine, or at least the suggestion by the insured that it would not be reasonable for the insured to have expected an unfavorable result in favor of the insurer, may well enhance the likelihood of a relatively favorable settlement in favor of the insured.
Third, if applicable law is unfavorable to the insured, then the insured should select a party arbitrator and a third arbitrator more likely to be persuaded by equitable arguments in favor of coverage. The more “legalistic” the insurer’s arguments against coverage are, the more likely the arbitrator may be persuaded by equitable arguments, such as the simple “If not this claim, then what did I [the insured] pay the premium for?”[40]
Conclusion
Particularly when up against RWI policy provisions or rules of law unfavorable to coverage, two doctrines that an RWI policyholder should consider are the REI Doctrine and the MDL Doctrine. In the context of an arbitration of an RWI claim dispute, the former may be particularly useful, while the latter may make it more likely that the arbitration will result in a favorable final outcome for the insured.
In any event, the awareness of the insurer of the availability of these two doctrines may enhance the likelihood of a favorable settlement for the insured in such a situation. Notwithstanding policy provisions or rules of law that would otherwise encourage an insurer to deny coverage, the risk of an unfavorable outcome to the insurer as a result of these two doctrines may militate in favor of a mutually acceptable settlement of an RWI claim dispute.
Practice Tips for Attorneys for Insureds
Consider the following:
In the RWI policy arrangement and negotiation phase, try to obtain optionality for the insured with respect to whether any claim dispute will be arbitrated or litigated and whether or not an arbitrator will be required to issue a written reasoned decision.
If the insured does have such optionality, then be prepared to exercise it strategically when dealing with an RWI claim dispute, based on whether the policy and the law are unfavorable or favorable to the insured or the insurer (all other issues being relatively equal), including signaling to the insurer what such choices might be.
If the RWI policy or the law is unfavorable to the insured and a claim dispute does go to arbitration, consider the choice of a party arbitrator and a third arbitrator who are not lawyers and who are thus more likely to be persuaded by equitable considerations favoring coverage.
If the RWI policy is unfavorable to the insured, particularly with respect to an exclusion, consider whether the REI Doctrine may be available to the insured under applicable law. Even if the REI Doctrine is not available, consider how the reasonable expectations of the insured can still be used when presenting the insured’s case.
This article is the seventh in the RWI Practice Insights series by John T. Capetta.
This article focuses on U.S. buyer-side RWI policies and U.S. law (primarily Delaware and New York law). The term arbitrator is used in this article to refer to a single arbitrator or an arbitration panel. The doctrine of reasonable expectations of the insured is referred to in this article as the “REI Doctrine.” For a recent compendium of cases on the REI Doctrine generally, see 1 Jeffrey E. Thomas, New Appleman on Insurance Law Library Edition § 5.05 (“Reasonable Expectations Doctrine”) (LexisNexis 2024) [hereinafter Appleman]. See also Reasonable Expectations: Interpreting Insurance Policies in Common Law Jurisdictions (Lyndon F. Bittle, Timothy M. Thornton Jr. & Diane Bucci eds., Am. Bar Ass’n 2016) [hereinafter Reasonable Expectations]. The doctrine of manifest disregard of the law is referred to in this article as the “MDL Doctrine.” For a recent compendium of cases on the MDL Doctrine generally, see Domke on Commercial Arbitration § 38.23 (“Manifest disregard”) (3d ed., Clark Boardman Callaghan 2025) [hereinafter Domke]. SeealsoComm. on Int’l Commercial Disputes of the N.Y.C. Bar, The “Manifest Disregard of Law” Doctrine and International Arbitration in New York (Aug. 2012) [hereinafter NYCB Committee Report]. ↑
Robert E. Keeton, Insurance Law Rights at Variance With Policy Provisions: Part One, 83 Harv. L. Rev. 961 (1970). ↑
For a discussion of the difference between a principle and a doctrine, see Kenneth S. Abraham, The Expectations Principle as a Regulative Ideal, 5 Conn. Ins. L.J. 59 (1998–1999). As originally proposed by Keeton, REI was a principle; he later described it as a doctrine. ↑
For a discussion of the development of the REI Doctrine generally, see Appleman, supra note 1, § 5.05[1] (“Historical Development of the Doctrine”); Jeffrey W. Stempel, Unmet Expectations: Undue Restriction of the Reasonable Expectations Approach and the Misleading Mythology of Judicial Role, 5 Conn. Ins. L.J. 181 (1998–1999). For examples of commentary regarding the REI Doctrine, see the various scholarly articles set forth in the Symposium on the REI Doctrine, 5 Conn. Ins. L.J. 1 (1998–1999); Arthur J. Park, What to Reasonably Expect in the Coming Years from the Reasonable Expectations Doctrine, 49 Willamette L. Rev. 165 (2012). ↑
For a discussion of the contra proferentem principle generally, see Barry R. Ostrager & Thomas R. Newman, Handbook on Insurance Coverage Disputes § 1.05 (“The Contra-Insurer Rule”) (22d ed., Wolters Kluwer 2025). Many, if not most, RWI policies contain a provision purporting to nullify the contraproferentem principle, even though the principle often is not referenced by name. Whether such a provision is effective is beyond the scope of this article (although an argument can be made that the same reasons that would make the contra proferentem principle applicable to an insurance policy would also make such a nullification provision ineffective). In any event, it does not appear that such a provision would nullify the REI Doctrine, principles such as the narrow interpretation given to policy exclusions, or the burden of proof on the insurer with respect to policy exclusions. ↑
For a discussion of the REI Factors generally, see, e.g., Park, supra note 5, at 170–75, § III (“Justifications and Rationale in Support of the REI Doctrine”). Some courts have either called into question or disregarded the absence of certain of the REI Factors. See,e.g., with respect to disregard of the relative sophistication of the insurer and the insured REI Factor, Nat’l Union Fire Ins. Co. of Pittsburgh, Penn. v. Rhone-Poulenc Basic Chems. Co., No. 87C-SE-11, 1992 WL 22690, at *8 (Del. Super. Ct., Jan. 16, 1992); Reliance Ins. Co. v. Moessner, 121 F.3d 895, 904–05 (3d Cir. 1997); Alstrin v. St. Paul Mercury Ins. Co., 179 F. Supp. 2d 376, 390 (D. Del. 2002). Note, however, that this issue does not appear to have been addressed under New York law. SeeReasonable Expectations, supra note 1, at 253. ↑
State Farm Mut. Auto. Ins. Co. v. Johnson, 320 A.2d 345 (Del. 1974). ↑
Id. at 347 (internal quotation marks, citation, and footnote omitted). ↑
Hallowell v. State Farm Mut. Auto. Ins. Co., 443 A.2d 925, 928 (Del. 1982) (emphasis added). Neither Hallowell nor any subsequent case has explained how this limitation of the holding in Johnson to ambiguities, conflicts, hidden traps or pitfalls, or fine print takeaways permitted the Johnson court to imply an insurer prejudice requirement to the notice provision in the insurance policy in question. Perhaps the court considered the notice provision to be a hidden trap or pitfall. But if a timely notice of claim requirement in an insurance policy is considered a hidden trap or pitfall, what insurance policy requirement would not be a potential hidden trap or pitfall? ↑
Reasonable Expectations, supra note 1, at 252 (footnote omitted). ↑
9 U.S.C. § 10(a). The FAA applies to any “contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction. . . .” 9 U.S.C. § 2. The U.S. Supreme Court has affirmed the broad scope of the FAA by holding that “the term ‘involving commerce’ in the FAA [is] the functional equivalent of the more familiar term ‘affecting commerce’—words of art that ordinarily signal the broadest permissible exercise of Congress’ Commerce Clause power.” Citizens Bank v. Alafabco, Inc., 539 U.S. 52, 56 (2003). However, “the Act . . . [is] ‘something of an anomaly in the realm of federal court jurisdiction.’” It “bestow[s] no federal jurisdiction but rather requir[es] [for access to a federal forum] an independent jurisdictional basis” over the parties’ dispute. Hall Street Assocs., L.L.C. v. Mattel, Inc., 552 U.S. 576, 581–82 (2008) (quoting Moses H. Cone Mem’l Hosp., 460 U.S. 1, 25 n.32 (1983)); see also Vaden v. Discover Bank, 556 U.S. 49, 59 (2009). That independent jurisdictional basis for utilizing federal courts would be either subject matter jurisdiction (separate and apart from the FAA) or diversity jurisdiction.
Both Delaware and New York have “mini” state versions of the FAA applicable to the rare arbitrations not subject to the federal act, each of which sets forth statutory grounds for judicial vacatur. Del. Code tit. 10, ch. 57, § 5714 (2024); N.Y. C.P.L.R. ch. 8, art. 75, § 7511 (2024). Attempting to vacate an arbitration award under such mini FAAs for manifest disregard of the law generally presents an equivalent extremely high barrier to success. See,e.g., SPX Corp. v. Garda USA, Inc., 94 A.3d 745, 750 (Del. 2014). ↑
Hall St. Assocs., L.L.C. v. Mattel, Inc., 552 U.S. 576 (2008). ↑
Id. at 585. Subsequent to the Hall Street decision, certain U.S. circuit courts of appeal have decided that the MDL Doctrine is no longer applicable as grounds for vacatur, not even as a gloss on any or all of the statutory grounds as the Hall Street decision had left open. See Affymax, Inc. v. Ortho-McNeil-Janssen Pharms., Inc., 660 F.3d 281, 284–85 (7th Cir. 2011); Med. Shoppe Int’l, Inc. v. Turner Invs., Inc., 614 F.3d 485, 489 (8th Cir. 2010); Frazier v. CitiFin. Corp., LLC, 604 F.3d 1313, 1324 (11th Cir. 2010). Other U.S. circuit courts, such as the U.S. Court of Appeals for the Second Circuit, decided that the MDL Doctrine is still available post–Hall Street; while others, such as the U.S. Court of Appeals for the Third Circuit (covering the Delaware federal court), reached no decision on the issue. See,e.g., Sabre GLBL, Inc. v. Shan, 779 F. App’x 843, 849 (3d Cir. 2019). For a relatively recent compendium of the various U.S. circuit courts of appeals cases on this issue, see Joshua Daniel Jones & Elizabeth C. Wheeler, Manifest Disregard as Grounds for Vacatur After Hall Street, Am. Bar Ass’n (Mar. 28, 2025).
The U.S. Supreme Court has declined to resolve this split or provide clarity on how to interpret Hall Street regarding this issue, once in an opinion and also in a number of denials of certiorari subsequent to Hall Street. See Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., 559 U.S. 662, 672 n.3 (2010) (“We do not decide whether manifest disregard survives our decision in [Hall Street], as an independent grounds for review or as a judicial gloss on the enumerated grounds for vacatur set forth in the [FAA].” (internal quotation marks omitted)); Leslie A. Berkoff, Supreme Court Declines to Grant Certiorari on WhetherManifest Disregard Standard Is Proper Standard for Vacatur Under Federal Arbitration Act, inJanuary 2026 in Brief: Business Litigation & Dispute Resolution (Sara E. Brauerman & Armeen Mistry Shroff, eds.), A.B.A. Bus. L. Today (Jan. 2026) (regarding a case involving Mike (the “Pillow Guy”) Lindell). ↑
For a discussion of this standard generally, see Domke, supra note 1, at nns.22–27. ↑
Weiss v. Sallie Mae, Inc., 939 F.3d 105, 109 (2d Cir. 2019) (internal quotation marks and citations omitted). ↑
Id. (internal quotation marks and citations omitted). ↑
SeeDomke, supra note 1, at n.26. Butsee J.P. Duffy, Manifest Disregard of the Law—for Factual Errors? The Debate Continues, N.Y. L.J., Jan. 28, 2026. ↑
Duferco Int’l Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 389–90 (2d Cir. 2003); T.Co Metals, LLC v. Dempsey Pipe & Supply, Inc., 592 F.3d 329, 339 (2d Cir. 2010); EB Safe, LLC v. Hurley, 832 F. App’x 705, 707 (2d Cir. 2020); see Thomas R. Newman & Steven J. Ahmuty, Arbitration Awards—Manifest Disregard of Law, N.Y. L.J., Apr. 30, 2019; NYCB Committee Report, supra note 1, at 9–11. Other courts apply a two-prong test, essentially omitting the second prong of the three-prong test (although it presumably would still be applicable implicitly). SeeDomke, supra note 1, at n.13. Since the Hurley case in 2020, the Second Circuit and lower federal courts in the Second Circuit seem to have moved to a version of the two-prong test: “first, whether the governing law alleged to have been ignored by the arbitrators was well defined, explicit, and clearly applicable, and, second, whether the arbitrator [sic] knew about the existence of a clearly governing legal principle but decided to ignore it or pay no attention to it.” Spliethoff Transport B.V. v. Phyto-Charter Inc., No. 23-7308-cv, 2024 WL 5165511, at *1 (2d Cir. Dec. 19, 2024) (citation and interior quotation marks omitted). However, no official statement of the move seems to have been made, and some commentators still refer to the three-prong test. ↑
SPX Corp. v. Garda USA, Inc., 94 A.3d 745, 750 (Del. 2014) (internal quotation marks and footnote omitted). ↑
See,e.g., id. at nns.23–25. In addition to the rarity of arbitration awards being vacated based on the MDL Doctrine, an arbitration party desiring to challenge an adverse arbitration award also faces the potential imposition of sanctions if it does so without sufficient grounds. See, e.g., DigiTelCom, Ltd. v. Tele2 Sverige AB, No. 12 Civ. 3082 (RJS), 2012 WL 3065345, at *7 (S.D.N.Y. July 25, 2012) (arbitration party unsuccessfully seeking vacatur based, in part, on the MDL Doctrine hit with attorney fees sanction). ↑
See,e.g., Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 442 (Del. 2005) (covenant of good faith and fair dealing doctrine). ↑
WPP Grp. USA, Inc. v. RB/TDM Invs., LLC, N.Y. slip op. 30160(U), 2021 WL 143480, at *3 (N.Y. Sup. Jan. 15, 2021). ↑
Id. (citing Cragg v. Allstate Indem. Corp., 17 N.Y.3d 118, 122 (2011), a non-RWI case). ↑
See,e.g., Thomas A. Telesca, Elizabeth S. Sy & Briana Enck, Must Arbitrators Follow the Law?, 41 Franchise L.J. 347, 349–51 § B (“An Arbitrator’s Perspective May Impact the Outcome”) (Winter 2022). ↑
RMP Seller Holdings, LLC v. SM Buyer LLC, 329 A.3d 1044 (Del. 2024) (unpublished table decision). ↑
The REI Doctrine may also be of import when an RWI insurer’s denial of coverage is grounded in an interpretation of a provision of the acquisition agreement or M&A law rather than an interpretation of a provision of the RWI policy or insurance law. ↑
The first RWI claim that the author of this article worked on was already in arbitration when he was engaged by the insurer. The first, and perhaps the most effective, argument that the insured made at the arbitration hearing for that claim was along the lines of “If not this claim, then what does this insurance cover?” ↑
Artificial intelligence (“AI”) is rapidly transforming nonprofit business operations. AI provides great promise with respect to enhancing efficiency, optimizing workflows, analyzing data, and boosting productivity. At the same time, AI presents various legal, ethical, reputational, and other risks. A sound AI usage policy can enable a nonprofit organization to leverage the promise of AI without compromising work-product integrity; disclosing privileged, confidential, or proprietary information; eroding its mission; jeopardizing its reputation; or subjecting the nonprofit to undue legal exposure. Leaders in the nonprofit community should consider the following practical advice when developing and implementing an AI usage policy for their organizations.
1. Build out a process to monitor and correct inaccuracies.
While generative AI has shown a tremendous ability to quickly generate helpful outputs, generative AI also is notorious for sometimes generating inaccurate information. To guard against inaccuracies, require everyone who utilizes AI on behalf of the nonprofit organization to harbor the requisite expertise to generate the work product themselves so that they are able to evaluate and refine output and attest to the quality, accuracy, and integrity of the final work product.
2. Require human authorship.
Normally, nonprofit employees who generate work product in the ordinary course of business convey copyright to the nonprofit organization under the “work-made-for-hire” doctrine. Volunteers often assign or license copyright to nonprofit organizations for which they volunteer. The U.S. Copyright Office and U.S. courts have consistently taken the position that purely AI-generated material without meaningful human creative input is not copyrightable. What that means is that if a nonprofit employee or volunteer utilizes AI to generate a work product, the work product will not be subject to copyright protection unless there is more than a de minimis imprint of human authorship. As such, make clear through your policy that while AI can be leveraged as a suitable “consultant,” copyrightable work product ultimately requires human authorship.
3. Implement guardrails for privileged, confidential, and proprietary information.
Large language models crowdsource information to generate output. Such AI tools do not care about the source of the information. For that reason, nonprofits must carefully protect privileged, confidential, and proprietary information. Implement guardrails for when, if ever, such information can be inputted into an AI tool. With only very limited exceptions, board and committee meeting minutes; financial information; confidential employee, donor, or member information; privileged communications with counsel; and other proprietary or confidential information should never be inputted into an AI tool, especially a free AI tool. If you need to manipulate or otherwise leverage AI tools in connection with privileged, confidential, or proprietary information, consider purchasing rights to and approving employee use of specific closed AI tools so that you can leverage AI capabilities without risking unwanted disclosure. In all instances, implement guardrails around employees and volunteers utilizing free or unapproved AI tools to mitigate risks that accompany unwary acceptance of click-wrap agreements, which inevitably confer broad rights to AI platforms to utilize, learn from, and disseminate inputted content—all of which can put the nonprofit’s sensitive information at great risk.
4. Communicate policy expectations to employees and volunteers.
Employees and volunteers may have different levels of sophistication, comfort, and risk tolerance utilizing various AI tools on the market. Make sure to clearly communicate expectations so that all employees and volunteers understand the parameters of approved and prohibited AI use.
5. Do not allow AI to obscure mission, erode brand, or eclipse what makes the organization unique.
Generative AI privileges conformity by crowdsourcing large amounts of information. Imagine that you ask AI to generate a membership recruitment video based on your organization’s website. While the AI tool will almost certainly embed snippets of tailored content, it will inevitably preference conformity, perhaps by describing “a dynamic organization of industry professionals” with promised opportunities to “share knowledge and network with colleagues.” Catchy music (the kind you can imagine in your head right now) will play against the backdrop of a diverse group of business professionals smiling, shaking hands, and networking. Generic-feeling work product can feel empty to mission-driven organizations. Consistent with the expectation that AI work product must bear more than a de minimis imprint of human authorship, build expectations around mission alignment and brand management into your AI policy to make sure that your organization’s imprint is seen, heard, and felt.
6. Do not allow AI to stifle innovation.
Large language models generate output based on existing content. In some instances, that can be helpful. For example, if you would like to build an itinerary to explore famous museums in Florence, an AI trip-builder may be helpful as the famous museums are already in existence. In other instances—especially in the scholarly context—AI’s reliance on existing information can be problematic. Imagine, for example, an AI peer review tool that is evaluating a scholarly article on a novel theory. It may encourage the author to consult existing literature at odds with the novel theory, as opposed to critically and thoughtfully evaluating the new concept as a potentially valuable contribution to the scholarly cannon. Take care to evaluate how AI may be useful or detrimental in different contexts.
7. Review work product for discrimination, tort liability, and other areas of legal exposure.
AI does not evaluate content for discrimination, defamation, breaches of privacy, intellectual property misappropriation, federal False Claims Act compliance, or other torts, to name a few legal claims. Regrettably, because AI sources its output from such a large volume of unvetted information, it inevitably consults tortious, biased, and inaccurate content; images that embed protected copyrights and trademarks; and other problematic content. This can create exposure for a nonprofit organization that utilizes AI-generated resources. To mitigate exposure, make sure that human reviewers evaluate all AI-generated work product for discriminatory, defamatory, infringing, tortious, and other legally problematic content. When utilizing AI in higher-risk areas, such as when generating proposals or reports for federal grants or when utilizing personally identifiable information that is otherwise regulated under federal, state, or international data privacy laws, take special care to evaluate output against any legal obligations. Similarly, if it is determined that bias or discrimination has influenced a process, decision, or work product in any way—such as if AI is used as a screening and evaluative tool in the workplace-hiring process—take all necessary measures to remedy the bias or discrimination to ensure the integrity and lawfulness of the process, decision, or work product.
8. Embed a clause in third-party vendor, consulting, and other independent contractor agreements requiring compliance with the organization’s AI usage policy.
Independent contractors may or may not be bound by organizational policies. Include a provision in all agreements with independent contractors that requires contracting parties to abide by the organization’s AI usage policy when providing products and services to the organization. In so doing, transfer all risk to the vendor or consultant for any material breach of the provision, including through indemnification. Similarly, for unpaid speakers, authors, board and committee members, and other volunteer leaders, while indemnity would be atypical and heavy-handed in most situations, all agreements (including participation forms) with such individuals should require adherence to the organization’s AI usage policy.
9. Do not allow AI to substitute for human relationships.
AI cannot substitute for human relationships, which is of paramount importance for membership associations and other nonprofit organizations. Efficiency, automation, and other benefits of AI must be evaluated against the erosion of human interaction and its impact on the organization’s mission and community. For instance, an automated AI-generated email may be infuriating to a dedicated volunteer who craves the human touchpoints that association membership provides. Leverage AI sparingly when it is being implemented to supplant functions that previously functioned through human engagement.
10. Stay up to date on the evolving law.
The law surrounding AI and its usage is evolving rapidly. Ten years ago, we were barely talking about AI. Today, as of the date this article was written, thirty-eight states have enacted at least one law governing AI, and all fifty states have introduced various bills to regulate AI use. There also is intense pressure on federal policymakers in Washington, D.C., to regulate AI, which has not happened to date. Laws and regulations are being enacted at a time when we are still exploring AI’s full potential and confronting some of AI’s greatest risks. We are far from the final iteration of a comprehensive legal and regulatory scheme governing AI. With that in mind, any policy you adopt must be nimble enough to evolve with the law.
For more information, please contact the author at [email protected].
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