In the ongoing war against cyber fraud, a whistleblower is one of the most valuable soldiers. With insider access and detailed knowledge about a contractor’s operations, whistleblowers are uniquely poised to reveal cyber fraud in the intricate landscape of government contracts. The U.S. Department of Justice’s Civil Cyber-Fraud Initiative (“Initiative”), launched in 2021, further empowers these individuals, arming them with the formidable False Claims Act (“FCA”).
This piece, the second in a two-part series about the Initiative, is designed to enlighten potential whistleblowers on their journey to unveiling cyber fraud. It offers an in-depth look at the FCA, essential cybersecurity standards integral to potential claims, and strategic advice for whistleblowers.
The False Claims Act: Arming Whistleblowers in the Battle Against Fraud
The FCA provides the government with a potent weapon to counteract fraud, helping recover billions of stolen taxpayer dollars annually. The FCA covers all government programs. Examples of FCA actions include those brought against healthcare providers who defraud Medicare and Medicaid by overbilling, contractors who charge federal agencies for goods and services not delivered, and individuals who defraud federal agencies by using misrepresentations to obtain grants or loans. The FCA provides for recovery of triple the damages incurred by the United States, plus a penalty for each violation.
In qui tam actions, individuals or entities with inside information about fraudulent conduct file suits on behalf of the United States. The government then investigates the allegations. If a case is successful, whistleblowers can receive a percentage of the government’s recovery. If the government intervenes or takes over the lawsuit, the relator is typically entitled to between 15 and 25 percent of the recovery. The exact percentage within this range often depends on the extent of the relator’s contribution to the prosecution of the action. If the government decides not to intervene, the relator can proceed with the lawsuit independently. In this case, the relator can receive a higher recovery percentage, typically between 25 and 30 percent. The rate could be more or less depending on factors detailed in the FCA.
Cybersecurity Standards: The Core Battlefront for FCA Claims
In cases involving allegations of cyber fraud, noncompliance with cybersecurity standards and contractual requirements—by neglecting to meet mandated data protection measures, utilizing components from restricted foreign countries, or allowing unauthorized access to systems, for example—can be the basis for an FCA claim. Whistleblowers and their counsel should be familiar with these requirements, including the following.
Federal Information Security Modernization Act (“FISMA”)
FISMA requires federal agencies and contractors to develop, document, and implement an agency-wide program to provide information security for their information systems and data.
National Institute of Standards and Technology (“NIST”) Guidelines
NIST provides a framework for improving critical infrastructure cybersecurity. It comprises a set of standards, guidelines, and practices to manage cybersecurity risk, including detailed technical recommendations for securing information systems.
Defense Federal Acquisition Regulation Supplement (“DFARS”)
For contractors working with the Department of Defense (“DoD”), compliance with DFARS’s cybersecurity requirements is mandatory. These requirements include implementing NIST standards and reporting cyber incidents to the DoD within a prescribed time frame.
Agency-Specific and Contractual Cybersecurity Requirements
Various government agencies may introduce additional, specific cybersecurity requirements in their contracts. For example, the Department of Health and Human Services has its own Health Insurance Portability and Accountability Act (HIPAA) Security Rule for protecting sensitive patient health information. Additionally, individual contracts often dictate specific cybersecurity measures tailored to the project, such as implementing particular security software, limiting data access, or mandating regular security audits.
Suiting Up for Battle: Key Steps in Preparing a Whistleblower Claim
To maximize recovery under the FCA, a whistleblower must carefully prepare and plan. Below are a few essential steps to consider.
Keep Detailed Records
Document any suspected violations meticulously. Include dates, locations, individuals involved, and actions taken. It is crucial to respect laws and company policies while collecting this information.
Know Your Rights
The FCA protects against employer retaliation, including provisions for reinstatement, double back pay, and compensation for any costs or damages. Familiarize yourself with these provisions.
Seek Legal Guidance
Navigating an FCA claim is a complex process. Retain an attorney experienced in FCA litigation and cybersecurity issues to guide you through the process. An attorney can assist in investigating a potential FCA violation, filing the claim, prosecuting the case, and negotiating your share in the recovery.
Maneuvering the Minefield: Tips for a Successful Whistleblower Campaign
While the path of a whistleblower is long and arduous, careful navigation can avoid potential landmines. Below are some tips to steer clear of common pitfalls.
Don’t Delay
The FCA operates on a “first-to-file” rule, precluding later suits based on the same facts. For this reason, promptly filing your claim is wise once you’ve amassed sufficient evidence of a violation.
Maintain Operational Secrecy
Keep the details of your suit confidential until the government decides whether to intervene. Prematurely disclosing allegations may jeopardize your eligibility to share in any recovery.
Avoid Public Intelligence Leaks
Publicly disclosing allegations can potentially bar your claim under the FCA’s public disclosure rule. A whistleblower should avoid divulging information to the media, social media, or other public forums before bringing a complaint.
Secure Personal Boundaries
While collecting evidence to support your claim, remain within the confines of the law and your employment agreement. Illegally obtained evidence could discredit your claim and expose you to legal liability.
Brace for Repercussions
The whistleblower journey can often be challenging, personally and professionally. Understand that you may face pushback or ostracism at your workplace. Prepare for these challenges mentally and emotionally, and seek support where needed, such as from legal professionals or support networks for whistleblowers.
Remain Committed
Throughout the process, keep sight of the importance of your role. Whistleblowing is crucial to uncovering cyber fraud, contributing significantly to a safer digital landscape. This sense of purpose can give you the resilience to navigate the challenges.
Conclusion
The FCA and the Initiative empower whistleblowers to combat cyber fraud within government contracts. Whistleblowers stand as critical defenders on the front line of cybersecurity enforcement. An intimate understanding of cybersecurity standards and careful documentation of suspected infringements are essential for strong FCA claims. The FCA’s protections against retaliation further equip these brave individuals for the task.
A whistleblower’s journey may be fraught with challenges. Still, the potential financial and psychological rewards—the gratification of being a crucial ally in the fight against cyber fraud—are compelling. Through their courage and commitment, whistleblowers contribute significantly to maintaining the integrity of government contracts, ensuring a safer and more reliable digital landscape for all. By sounding the alarm, they help fortify our nation’s cybersecurity defenses and drive us toward a more secure digital future.
The famous hoary aphorism holds that the law is a seamless web. Seamless it may be, but with each passing day the web weavers expand its size and use it to cover spaces that in earlier times did not even exist. And as these new fields of endeavor grow, disputes about them inevitably find their way to the country’s courts.
Like others, litigators cannot fail to have noticed the rapid advance of technology into all corners of modern life. This advance has radically transformed the practice of law and the businesses of clients. Ongoing innovations in law practice, client relationships, and relationships with the bench have added to the ferment. So it is no surprise that any treatise that describes business litigation would need to be updated on a regular basis. That is the case with Business and Commercial Litigation in Federal Courts (Robert L. Haig, ed.), a multivolume work published by the ABA’s Litigation Section. Previous editions were published in 1998, 2005, 2011, and 2016. The fifth edition was published in December 2021.
The fifth edition in its hardcopy form stretches over sixteen volumes. It includes 180 chapters, of which twenty-six are on entirely new topics. Hundreds of attorneys and judges contributed to the fifth edition as authors, including some of the most prominent names in their fields.
The treatise is not limited to describing legal and strategic issues or recent developments in specified areas of business law. Each chapter also ends with a checklist and, where appropriate, customizable forms. Depending on the topic, the checklists vary from lists of tasks to accomplish to lists of issues an attorney should consider. The overall result is a work that provides an effective overview of business litigation in numerous substantive areas, as well as detailed coverage of procedural topics, together with practical pointers and reminders.
Comparisons with other court systems
Although the title of the treatise posits a focus on federal litigation, the fifth edition has added several chapters comparing business litigation in US federal courts with business litigation in US state courts generally, and with New York and Delaware courts in particular—New York and Delaware being the states whose courts most commonly encounter business litigation, both domestic and cross-border. The new edition also adds chapters comparing business litigation in US federal courts with similar litigation in Canada and Mexico. With these additions the treatise can serve as a valuable jumping-off point for litigators who find themselves in need of guidance either when deciding which court system they prefer or in counseling clients at the outset of litigation about what issues they need to be concerned about. These new chapters are not, and cannot be, comprehensive analyses of procedure in these jurisdictions—each one has treatises of its own dedicated to just that—but they do provide a useful starting point.
The chapter on state courts generally is necessarily a broad overview; after all, a deep dive into fifty different court systems would likely have been impractical. But as a place to begin, it provides useful analysis of how to think about the differences between federal and state court litigation, as well as issues to consider in the decision about which state court to sue in. For example, litigators selecting a forum should look at such matters as quality of procedures, perceived quality of judges, whether the state system has a specialized business court, how the state handles discovery issues, what the privilege rules are, how difficult it is to get interim relief, and how long the trial backlog is. The checklist at the end of the chapter sets forth the issues litigators should consider in forum selection.
New York and Delaware are two of the premier American locations for business litigation. Let’s look at the chapter on New York as an example of how the new edition approaches the comparison between federal and other courts. The chapter begins with strategic considerations in choosing between federal and New York courts. One feature that is unique to New York is the availability of interlocutory appeals. Almost alone among states, New York practice permits most orders to be appealed, rather than requiring the parties to wait until the end of the case. This can affect cost, settlement prospects, and many of the decisions counsel must make during the course of the case.
Actual litigation procedures are more alike than different, though there are variations in timing and nuance. For example, summary judgment motions in New York may be made only after an answer is filed. A jury may be requested until discovery closes, with the filing of a “note of issue.” Unlike in federal court, a plaintiff in New York state court who advances both legal and equitable claims in the same case is deemed to have waived a jury on the legal claims.
Even where the normal New York rules differ noticeably from the federal rules, the Commercial Division of the New York Supreme Court has adopted many rules that adjust normal New York state procedures to bring them more into line with the federal rules, particularly with respect to discovery and some aspects of motion practice. So the differences tend to be more in the details than in the broad strokes. But some differences do remain.
The chapters comparing business litigation in Delaware, Canada, and Mexico with federal litigation likewise provide useful guideposts to the most salient differences. These chapters are accompanied by useful checklists of issues and strategic decision points.
Given the constraints of the space and the breadth of the subject matter, these chapters are a valuable addition to the treatise that will serve users in good stead—not as exhaustive surveys but as useful bird’s-eye views of the various considerations to take into account. One may perhaps quibble with the omission of a chapter comparing US federal courts with the proverbial 800-pound gorilla, California, which has its own unique procedures and a much more statute-oriented legal system than many other states. California generates an enormous volume of litigation, and its courts’ decisions are influential in a number of other states. Perhaps it will be included in the next edition.
New Chapters on Law Practice
Other new chapters look at emerging issues in law practice. Among these are “Budgeting and Controlling Costs,” “Coordinating Counsel,” “Fee Arrangements,” “Third-Party Litigation Funding,” and “Use of Jury Consultants.”
Let’s take as an example a subject most practicing attorneys care about deeply (for obvious reasons): fee arrangements. Litigators no doubt are familiar with various alternative fee arrangements and have taken note of increased use of billing methods other than straight hourly billing, such as contingencies or flat fees. But how to choose which arrangement works best? What incentive structures does each create for the attorney and the client? How can the downsides of each structure be minimized? Are there feasible ways to combine features of various structures into a mutually acceptable arrangement? What ethical issues can come into play in each structure?
The new chapter tackles these issues in systematic fashion. It gives pointers regarding how to think about what kind of fee arrangement to use. For example: as a practical matter, what kind of fee arrangement is feasible in any particular case? How do the incentives line up for the client and for the lawyer? What sort of arrangement is most likely to permit the client to achieve its goals?
The chapter describes each of the usual kinds of fee arrangements, together with hypothetical examples of how they work. The risks of a mistaken expectation should be considered when structuring the fee arrangement. Some ways of dealing with this risk include combinations or variations of different kinds of structures, such as by caps, escalators, partial contingencies, guaranteed minimums, collars, or using a monthly floor or ceiling to control expectations.
The checklist at the end of the chapter goes step by step through the analysis that is needed at each stage of the process for either hourly or flat fee arrangements or for conventional contingent fee setups. It does not include checklists for other possible structures, but one may infer that is because the universe of possibilities is so large that no checklist can account for every conceivable variation. The forms supply model paragraphs for inclusion in an engagement letter in a number of different types of fee agreements.
Another new chapter discusses third-party litigation funding. This subject has been in the news lately, with some high-profile cases going ahead with the backing of litigation funders. But many practitioners are unfamiliar with the nuts and bolts of how litigation funding works and don’t have a good idea of what the pitfalls might be. The new chapter lays out the basics: when is funding feasible or sensible? How is it set up? How does an attorney or client locate and vet a funder? What terms are typical? What does a funder expect from an attorney or from the client? What kind of vetting should the attorney and client expect from the funder? How does the process work once a funder is in place, in terms of periodic reports and control of litigation? How much input does the funder have on settlement decisions?
Perhaps most interesting are the sections on ethical issues. The presence of a funder can affect the scope of work product and privilege, and care must be taken to avoid waivers. Here the chapter provides some specific recommendations. Another ethical consideration is how to structure the funding agreement to ensure it does not run afoul of the fee-splitting rules. Interestingly, some of the recent case law highlights the need to avoid running afoul of champerty statutes; these statutes may be antiquated, but certain states still enforce them and will refuse to uphold funding arrangements that run afoul of them.
It remains to be seen how much development there will be in this area, whether on the business side or the case law side. But for now, this chapter is an effective overview of the issues that an attorney can comfortably consult at the beginning of his or her analysis of the subject.
Other chapters likewise build on new developments in both law and technology. For example, the chapter “Budgeting and Controlling Costs” contains extensive discussion of electronically stored information (ESI) discovery and the rules governing it, as well as discussion of using technology at trial. But it also covers ways to think about, plan for, and budget for other time-tested features of American litigation such as pleadings, motions, conferences, and appeals.
New Areas of Substantive Law
Several of the new chapters address areas of substantive law that either did not exist in developed form at the time of the fourth edition or, for whatever reason, were not included in earlier editions. Some of the new substantive law chapters include “Art Law,” “Fraudulent Transfer,” “Monitorships,” “Political Law,” “Shareholder Activism,” “Trade Associations,” and Virtual Currencies.
One obvious new area of law is artificial intelligence. It is likely that the chapter is already in need of updating, what with the advent just this year of ChatGPT, BingAI, Bard, and other new AI interfaces. The availability of these tools has raised a host of new issues that are being discussed in the legal press and in the profession generally. The issues include serious questions about how professional responsibility meshes with the use of AI as a tool for lawyers.
Although the chapter obviously does not address new questions that arose after publication, the chapter is illuminating for its focus on the basics of what AI is, how it works, what assumptions may be built into the algorithms, and how it can be used in law practice consistent with applicable ethical rules. It starts with the basics: what is AI and how does it work? Conceptually, it is not hard to demystify: AI is simply software that uses algorithms to find patterns in large volumes of data and incorporates what it “learns” into its continuing operation. But each of those steps contains pitfalls: are there biases in the algorithm? Is the algorithm selecting appropriate features from the data? Is it weighting the inputs properly? For this reason, use of AI in business decisions may lead to tussles over discovering the algorithm if the decisions lead to litigation. The degree to which it is discoverable is not yet established—case law is still developing. And attorneys’ need to analyze algorithms will undoubtedly lead to an increase in demand for both consulting and testifying experts.
AI has already made its way into discovery. The most familiar manifestation is predictive coding, which is actually just an application of AI to identify patterns in the contents of documents that indicate whether documents are responsive to document requests or otherwise relevant. The availability of this AI tool may affect a litigant’s ability to argue a request is burdensome if that litigant declines to use predictive coding or other technology-assisted search techniques. AI may also provide new ways for assessing probabilities of outcomes at various steps in a litigation as well as the ultimate outcome of a case.
All this raises issues of professional responsibility, which the chapter addresses forthrightly. Consider: does the availability of AI imply that lawyers must become familiar with it as part of the normal standard of care? Must the attorney consult with the client about whether and to what extent to use AI? Is the AI constructed in a manner that will adequately preserve confidentiality, and are technology vendors blocked from seeing the contents of what is provided to them? Can “outsourcing” some work to AI skate close to facilitating the unauthorized practice of law?
The chapter concludes with a checklist that addresses the issues a practitioner should account for in a protective order when a case involves use of AI, and a sample request for production of AI-related documents pertaining to such items as the underlying algorithm, weighting, or validity studies. Of course this area is developing so quickly that new issues arise seemingly by the week. Undoubtedly pocket part/updates will be on the way.
Another new chapter addresses an area that existed before but has been transformed by technology: art law. Digital creation and consumption of art has massively increased the volume of art business and, consequently, of art-related litigation. The nature of art—such as its highly subjective appeal, its lack of readily ascertainable market value, and the uniqueness of each piece—creates issues of its own. For example, consider: how is the work to be valued for purposes of deciding whether an underlying dispute meets the $75,000 threshold for diversity jurisdiction?
Even traditional art raises unique issues of provenance and authenticity that other business endeavors may not. Certainly this field has wide scope for use of experts. And the chapter deals with longstanding issues concerning art: stolen artwork, contracts for art, dealing with auction houses, licensing, copyright, fair use—the list goes on and on. The chapter also addresses statutes (both federal and state) that affect art, artists, and others.
Updated and Revised Chapters
The bulk of the fifth edition updates the fourth edition. To get an idea of how thorough the update is, consider the chapters in two areas that have experienced a great deal of case law development. First, “Class Actions.” This chapter could be a book in itself, weighing in at more than 400 pages. The table of contents for this one chapter alone spreads over six pages.
It is no secret that class action jurisprudence has developed extensively in the past six or seven years. The sheer number of issues relating to class action litigation and the pace of development in this area are reflected in the size of the chapter on the subject.
The chapter begins by discussing the basic theory of having a class action rather than multiple individual actions. It goes on to cover the basics of what is needed to be able to proceed under Rule 23, followed by class certification and the mechanics of how to sue as a class, including: notice to absent class members, how to set up issue classes and subclasses, settlement, appeals, and appointment and compensation of class counsel. There are also sections on defendant classes and preclusive effect of a class action judgment. The chapter is quite thorough: it also covers subject matter jurisdiction, standing, statute of limitations issues, class action waivers and arbitration, choice of law, and certain ethical issues. Subchapters examine specific types of class actions: antitrust, securities, consumer fraud, intellectual property, employment, ERISA, and privacy/cybersecurity.
There has been ferment in certain areas. For example, after the Supreme Court’s 2017 decision in Bristol-Myers Squibb Co. v Superior Court, 137 S. Ct. 1773 (2017) (no pendent jurisdiction in mass actions), courts have been faced with the issue of whether personal jurisdiction over absent members of the plaintiff class must be demonstrated. Most courts have said no: the named plaintiff is the relevant actor for jurisdictional purposes, and the interests of absent class members are protected through the procedural safeguards of Rule 23.
Especially in securities fraud class actions, which typically are brought under Rule 23(b)(3), an important question is which issues are legitimately addressed at the class certification stage, as opposed to being left for the merits. To certify a Rule 23(b)(3) class, the plaintiff has to show that common questions of law and fact predominate. In 1988, in Basic v. Levinson, 485 U.S. 224 (1988), the Supreme Court adopted the “fraud on the market” theory, under which reliance normally is presumed at the class certification stage because the entire market is deemed to have been affected by the claimed misrepresentations—unless the defendant can rebut the presumption. (If the defendant rebuts the presumption, then each plaintiff would need to show reliance individually, and the class could not be certified.) Can the defendant rebut the presumption of reliance by showing the price of the relevant stock was not affected by the claimed misstatements? Or is that a merits issue that should not be addressed at the certification stage? The Supreme Court’s 2021 decision in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, 141 S. Ct. 1951 (2021) holds that a district court should consider all evidence relevant to class certification, even if it overlaps substantially with the merits.
Consumer class actions have become common in recent years, especially under federal statutes such as the Fair Debt Collection Practices Act, the Telephone Consumer Protection Act, and the Fair Credit Reporting Act. Some recent case law has questioned whether there is Article III standing under certain of these statutes because of the lack of a concrete injury—in other words, just because Congress provides for statutory damages does not mean there is a redressable injury that qualifies a dispute as an Article III “case or controversy.” Circuits have come to different conclusions about different claims. The Supreme Court held in TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021) that a bare statutory violation without an actual injury does not confer standing to sue. As the treatise notes, it is likely that Ramirez will lead to extensive further litigation about what is and is not a “concrete injury” that can confer standing on a named plaintiff and absent class members.
The checklists at the end of the class action chapter focus on the issues any class counsel must think about. For the most part these are pitched at a reasonably high level of generality. It may be that more granular checklists simply aren’t feasible, given the large variety of possible class actions and the wide spectrum of possible claims. The forms likewise are pitched at a fairly high level of generality. Again, this is probably unavoidable.
Another subject matter chapter that has seen a great deal of activity and thus necessarily has been thoroughly updated is “Derivative Actions by Stockholders.” This chapter is also large, more than 120 pages. Various aspects of derivative litigation have seen significant development in recent years, and the treatise provides a useful overview of the new case law developments in the context of an overall approach to derivative litigation.
One such issue is defining when a derivative plaintiff may proceed without first making a demand on the board of directors. Ordinarily, because the board is vested with the responsibility for overseeing the company’s activities, it is for the board to decide whether to sue on behalf of the corporation (often, this decision is referred by the board to a special litigation committee). As a corollary to that principle, a shareholder cannot sue on behalf of the corporation without first bringing the matter to the body legally entrusted to act for the company, namely, the board of directors, and demanding that the board act. Demand is excused if it would be futile, but how to establish futility has been an ongoing issue for courts. Different states’ standards may vary in their details. The premier state for corporation law, Delaware, offers the Aronson[1] and Rales[2] standards for measuring whether demand is futile for a challenge to a corporate decision or corporate inaction, respectively. As the treatise points out, both these tests essentially ask whether the directors were disinterested and whether their decisions reflect a business judgment protectable under the business judgment rule. This issue is heavily litigated, and recent case law highlights the obligations of directors to educate themselves and make reasoned, good faith decisions. Several recent litigations, set forth in the chapter, saw denials of motions to dismiss based on allegations of director lassitude or perfunctoriness.
It is worth noting that other states (including New York) apply somewhat tighter tests to evaluate demand futility (meaning that futility may be established less often). Counsel should heed the treatise’s caution to apply carefully the precise legal formulation in the relevant state, and to analyze in advance of suit what the standard might be. In the event more than one possible venue is possible, the divergent standards (and choice-of-law rules) should be taken into account.
Even deciding which claims are derivative has seen recent ferment. The Delaware Supreme Court reformulated its test for distinguishing individual from derivative claims in 2004,[3] clarified it in 2016, and revisited it again in 2021.[4] It makes a huge difference which side of the line a claim falls on: derivative claims are subject to demand on the board; may be handled through a special litigation subcommittee; and may be subject to bonding requirements to secure the corporation’s expenses. And, as the Court of Chancery observed in 2020, derivative claims are extinguished when the underlying corporation ceases to exist. None of these are true of individual claims.
Given the exacting procedural and analytical hurdles that confront both sides in a derivative suit scenario, the checklists are of especial importance and utility. The steps for making a demand are listed. So are the steps for appointing a special litigation committee. The chapter also has a checklist of factors to consider in formulating a settlement. Because of the complexity of the analysis at each stage of the litigation, perhaps an issues checklist would have been useful: what questions should a prospective plaintiff think about? What questions should a defendant company and board think about? It may well be that state-by-state variations, subtle though they may be, make any such issues list close to impossible. But perhaps a checklist focusing on the Delaware issues would have been helpful because of Delaware’s outsized influence, even for disputes relating to companies organized elsewhere.
Class actions and derivative litigation are but two of the dozens of subject matter areas the treatise has covered in the past and has now updated in this new edition. Merely listing some of them will convey a sense of the broad range of topics the treatise encompasses: subject matter jurisdiction; provisional remedies; privileges; settlements; cross-examination; punitive damages; arbitration; judgments; enforcement of judgments; social media; antitrust; securities; mergers and acquisitions; professional liability; banking; trademarks; licensing; ERISA; employment discrimination; products liability; negotiable instruments; advertising; fraud; civil rights; energy—plus dozens and dozens more.
Closing Thoughts
The treatise represents a monumental effort by, literally, hundreds of attorney authors to share their wisdom in providing an overview of scores of areas of law. By its nature, business litigation is far too diverse and sprawling to be summarized exhaustively even in a multivolume treatise like this one. But despite this, as a first stop for litigators encountering issues for the first time—or even not for the first time—the treatise provides a useful guide to point them in the right direction and to highlight the salient points that must be considered in an array of legal fields.
This spotlight has occasionally quibbled with the choices the authors or editors made, but those quibbles are just that—quibbles. They do not detract from the overwhelmingly positive contribution this treatise has made to the practice of business litigation. The authors and editors have provided a true service to the profession.
Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (2000). ↑
If you live or do business in California, state taxes can be a significant part of the overall taxes you pay, even if your bill to the IRS is bigger.[1] Even if you don’t call California home, the state does an aggressive job of drawing people into its tax net of high individual (13.3 percent) and high business (8.84 percent) tax rates. If you once lived in California but move away, you might end up in a tax fight over whether you really left, and when.
Even if you never set foot in California, you can be taxed. Suppose you just do some consulting for a California-based company or law firm, from your home or office out of state. California can’t possibly tax you, right? Think again. The Golden State usually takes the position that you delivered the benefit of your services inside California when you sent in your work product, or just talked to the California client over the phone.
And since you might never have filed a California tax return to report that California source income, there is no statute of limitations. For all these reasons, it pays to know something about how and when to fight back when California sends off a volley of tax due or audit notices. When you add the state’s notoriously aggressive enforcement and collection activities, it’s even more important to know your rights.
California’s tax system is complex. Rather than adopt federal tax law wholesale, California’s legislators pick and choose, adopting some rules and not others. Often, if a federal rule favors taxpayers, California will not conform. Conversely, if a federal rule favors the IRS, California is more likely to agree and to say “me too.”
Statute of Limitations
How long you are at audit risk might surprise you. You may be used to clocking the IRS three-year statute of limitations. For completeness, it’s important to mention the six-year IRS statute of limitations, too. The IRS gets six years to audit if you omit over 25% of your income, or in certain other cases. Still, the main IRS statute of limitations is three years, and that is the one the IRS tracks carefully.
In contrast, the California Franchise Tax Board (FTB) always gets an extra year, so it has four years, not three, to launch an audit. That can invite some planning. Say that you are involved in an IRS audit, but the IRS has not yet issued a Notice of Deficiency. You may want to drag your feet and hope that your federal tax dispute will put you outside California’s four-year reach.
Maybe you’re thinking that you can slow-walk your IRS audit so that an IRS Notice of Deficiency is not issued until after California’s four-year statute has run. It would seem logical that if California hasn’t audited within the four years the statute provides, it would be too late for California to try to piggyback on the IRS audit. However, there is another California statute of limitations that applies any time there is an IRS adjustment, even if the IRS adjustment doesn’t occur until years after the four-year California statute of limitations has expired.
If an IRS audit changes your tax liability, you lose your IRS case. or you agree with the IRS that you owe a few more dollars to it, you are obligated to notify the California FTB within six months. Under Cal. Rev. & Tax. Code section 19060, if you fail to notify the FTB of the IRS change to your tax liability, the California statute of limitations never runs. California usually will bill you promptly, but you might get a tax bill ten years later—with lots of additional interest. So, if you settle up with the IRS, you should settle up with the FTB too.
When California Audits First
What if the “me too” runs the other way? Given California’s aggressive tax enforcement, the FTB often audits first, when the IRS is not involved. Suppose that you have a California tax audit first, and by the time it is resolved, the federal statute of limitations has run. What happens then? Happily, with the IRS statute of limitations closed, the answer should be nothing. Frequently, California tax advisers count on this result.
Because the California statute of limitations is four years, not three, it is possible that California may initiate its audit after the federal statute is already closed. More likely, if the California audit is initiated one to two years after a return filing, there will be a year or two left on the three-year federal statute. Even without trying to cause a delay, the California audit and ensuing administrative appeals may not be resolved until after the three-year federal statute (or even the six-year federal statute) has run. In that event, it may be too late for the IRS to say, “me too.”
Disputing a Notice
A notice from the FTB is rarely welcome news. Sure, it might just tell you that you are getting a refund. But more often than not, an FTB notice says you owe additional taxes. Or even before that, it may start simply with a letter that says you were selected for audit. Since representing yourself is usually a mistake, a tax lawyer or accountant should handle it. Which professional you select to interface with the FTB depends on your issues, the type of return, and the sensitivity of the audit.
But once you sign a power of attorney on the required Franchise Tax Board form, you should not need to deal directly with the FTB. Having a lawyer or accountant out front gives you more protection. Although field audits are possible, most audits are done by correspondence, with lots of back and forth in what the FTB calls Information Document Requests (IDRs).
This process operates similarly to the IRS, which also uses IDRs to solicit and collect information. These IDRs serve to gather the facts and documents necessary to understand and verify the items you reported on your tax return. The IDRs and your responses provide a record of communication between you and the FTB that will be important later.
Audit Issue Presentation Sheet (AIPS)
As the FTB gathers information, they will prepare an Audit Issue Presentation Sheet (AIPS) that details adjustments the FTB proposes to make to your tax return. An AIPS includes a discussion of the facts, the relevant law, and the proposed adjustment. Some auditors prepare one big AIPS about your return, while others prepare several AIPS for different tax issues. You can respond in writing, laying out the facts and arguments based on the tax case law, regulations, etc. Since the FTB usually follows federal tax law when there is no conflicting California law, it is okay to cite to federal tax authorities when you respond to the FTB.
Notice of Proposed Assessment (NPA)
Eventually, the FTB will write up its findings and send a Notice of Proposed Assessment (NPA) that proposes additional taxes based on the audit results. If you receive a Notice of Proposed Assessment and agree with the proposed change to your tax liability, there are various payment options available.
Interest Is Running: Should You Pay to Stop It?
If the FTB proposed additional tax in a Notice of Proposed Assessment, there will be interest too, and possibly penalties. Interest accrues on the tax from the original due date of the tax return for that tax year. Applicable interest will also accrue on certain penalties if they are assessed. If you pay the balance due as reflected on the notice within fifteen days of the notice, no additional interest will be assessed.
As with other tax debts, interest can add up fast. Filing a protest or appeal alone does not stop the accrual of interest. It may take months or years to resolve your protest or appeal, and the accrual of interest will not stop during this period. However, to limit the accrual of interest, you may make payments in connection with a protest and/or appeal, which would be held in suspense pending the outcome of the protest or appeal.
Of course, if you win your tax dispute and do not owe any additional taxes, you win the interest point too. But if you are risk averse, you may want to make a deposit to stop the running of interest. This is done in many California tax disputes, and is often worth exploring. Notably, you do not lose your right to protest the proposed audit adjustments if you make a payment.
You can designate the payment as a deposit without prejudicing your position in the FTB dispute. And if you prevail, you can even get interest back from the state. That is, if the FTB withdraws or reduces the amounts on its NPA following protest or appeal, the FTB will pay interest on the tax deposit or on any overpaid amount.
Protest
If you do not agree with the proposed adjustments, you can file a protest by the due date shown on the front of the Notice of Proposed Assessment. If you do not timely protest, the assessment becomes final, and the FTB will start billing you for the amount due, including penalties and interest. A protest is a formal document. Apart from a variety of identifying information, a protest must include the amounts and years you are protesting, a statement of facts, an explanation of why you believe the FTB is wrong, and evidence and documentation to substantiate your position.
You have the right to request an oral hearing on your protest. If you want to have an oral hearing, you must include the request in your protest. Hearings can be conducted at an FTB field office, or by phone or video conference. The hearing officer is independent from the FTB auditor who wrote the NPA, but the hearing officer still works for the FTB. This means some California taxpayers worry that the hearing officer may rubber-stamp what the auditor did.
In any case, the hearing officer makes a determination of what the FTB believes is the correct amount of tax based on the facts and the law. Can you split the difference with the auditor or the hearing officer? That would be nice, but the auditor and the hearing officer do not have the ability to compromise cases. Instead, there is a separate process for settlement proposals discussed below.
Notice of Action (NOA)
After the FTB considers your protest and makes a final decision, they will send you a Notice of Action (NOA) that documents the FTB’s findings. It may affirm, revise, or withdraw the proposed assessment. If you agree with the amount shown on the NOA, there are various payment options available. If you disagree, you can appeal to the Office of Tax Appeals (OTA) within thirty days of the date of the NOA.
Office of Tax Appeals (OTA)
The Office of Tax Appeals is a separate agency that is independent of the FTB. Up until 2017, tax appeals were heard by the California State Board of Equalization (BOE). The BOE was a five-member elected administrative body, the only elected tax board in the country. However, the BOE became very controversial, and in 2017, then-Governor Brown signed a bill that slashed the agency’s employees from 4,800 to just 400.
As a result, the elected, five-member Board of Equalization no longer hears tax appeals, which are now handled by the Office of Tax Appeals. The OTA functions like a state tax court. When you file a timely appeal with the OTA, you are given an opportunity to provide additional supporting information.
There is a briefing process in which the taxpayer and the FTB submit briefs to the OTA. OTA cases are normally decided by a panel of three administrative law judges, although in some small cases, there may be a single judge. You may also request an oral hearing before OTA so that you can present witnesses and testimony.
Following the OTA’s consideration of the law and facts in your appeal, it will issue a decision in writing. Both sides, the taxpayer and the FTB, have the right to petition for a rehearing within thirty days of the decision. If no petition for rehearing is filed, the OTA’s decision becomes final after thirty days.
If you do not file an appeal with the OTA within the prescribed time the taxes, penalties, and interest become due and payable. However, you may pay the balance due and file a claim for refund, which must generally be filed within one year from the date of payment.
Superior Court
Not many tax disputes go beyond the OTA. However, if you have waged a contest with the FTB and before the OTA and you still want to fight, in some cases, you can go to court. However, once you exhaust your remedies at the OTA, subject to a few exceptions, you generally must first pay any tax amounts owed before bringing an action against the state.
Thus, you can pay the tax liability and file a claim for refund. If you appealed the FTB’s denial of your claim for refund and do not agree with the OTA’s decision, you may generally file an action against FTB in California Superior Court within ninety days. But not all the rules are consistent. For example, a suit for refund on a residency case must be filed within sixty days. After the California Superior Court makes a decision, either you or FTB may file an appeal of the decision to the California Court of Appeal.
Compromises
Many disputes of all sorts settle. That is true with taxes too, and both the IRS and the California FTB will entertain settlement proposals at the appropriate levels. In general, it is easier to settle a case with the IRS than it is with the FTB. For one thing, in IRS Appeals, the IRS Appeals Officer can compromise cases.
In contrast, the FTB appeal process is more rigid. Indeed, the main place that FTB settlements can be explored is with a separate unit of the FTB. The FTB Legal Division has a separate Settlement Bureau that is responsible for settling tax, penalties, and interest when you enter the Settlement Program. One can divert a case into the FTB Settlement Program at several stages, even when the case is already being considered by the OTA.
Residency Audits
One common type of audit concerns whether you are a California resident. There are all sorts of California tax disputes, but the alluring nature of a move before a sale and the presence of residency audits makes them appropriate for a couple of comments. It can be tempting for a California taxpayer who expects a large income event to pull up stakes and move before the income hits. It might be the settlement of a large legal dispute, the sale of a block of stock or hoard of cryptocurrency, or the sale of a company.
What type of income or gain is involved will influence whether a move before the sale can help. But whatever the income or gain may be, timing is always relevant. A move right before a sale understandably attracts attention from the FTB. One reason is the tax return itself. A taxpayer who moves and sells in the same year will need to show the entire tax year on their part-year California return. Showing a modest amount of income in the first (California) part of the year followed by vast sales proceeds in the latter (non-California) part of the year may prompt an audit.
The larger the time buffer between a move and sale, the better. And the cleaner the facts, the better. Keeping a spouse or children in California can make it difficult or impossible to prevail. Having moved back into California by the time of an audit can also be hard to explain, unless some unusual and unexpected event has transpired that made the permanent move out of California short-lived—a death in the family, divorce, new dream job in California, etc. might help to explain. However, the FTB may see a move out of state followed by a move back (no matter what the reason) as a temporary relocation, and as insufficient to change the tax bill on the sale.
In some residency audits, the state is arguing that the domicile of the taxpayer did not change, period. However, much of the time, the dispute is about timing. That is, by the time of the audit, it may be clear that the taxpayer is no longer a California resident. But the FTB may say that the move was not effective until after the sale. In some cases, the FTB may say that the transaction was far enough along (fully negotiated, a signed letter of intent, etc.), that even though the closing happened when the taxpayer was no longer a California resident, California can tax it.
A move generally involves a continuum of dates, so the FTB may try to move the needle by whatever number of days is needed to collect the tax. There is also an increasing body of California tax law about California sourcing, so that even if a sale is made by a person who is unquestionably a non-resident, the asset sold may have acquired a California situs. In short, California’s tax net is expanding rather than contracting.
Other Notices
Residency audits are not the only common variety. Disputes over non-residents earning California source income are extremely common. A Form 1099 from a California company can draw a non-California independent contractor into California’s net. A sale by out-of-state persons of an LLC or partnership interest can trigger a notice too.
For years, many non-California taxpayers have preferred selling an interest in an entity that holds California real property or business assets, rather than having the entity sell the real property and distribute the proceeds to the owners. The idea is that the former is a sale of an intangible, sourced to the residence of the seller of the intangible. The latter, of course, is a sale of California property, so it is California source income.
In Legal Ruling 2022-02,[2] however, the FTB held that if a portion of the owner’s gain from the sale of a partnership interest is characterized as ordinary income under section 751(a), that gain is sourced as if the partnership had actually sold the relevant portion of its assets. Whatever portion of the gain would have been “business income” apportionable to California under the Uniform Division of Income for Tax Purposes Act (UDITPA) will be treated as California source income even though the owner sold a partnership interest.
The FTB has also successfully argued that the California sourcing of an S corporation’s sale gain passed through to its out-of-state shareholders despite the fact that the property (goodwill) was an intangible.[3] On this principle, one could expect that gain realized by one pass-through entity (Holdco) from the sale of an interest in a second pass-through (Subco) will retain its character as California source income despite the fact that Holdco’s interest in Subco is an intangible. Given how common LLC holding company structures have become, a lot of out-of-state taxpayers may find themselves on the wrong end up an FTB notice following the sale of an operating company conducting business in California.
Conclusion
Tax audits and disputes in California are common, but they don’t have to be overwhelming. If you have one, consider the state’s unique system and procedures, and you will improve your odds of a good result.
Robert W. Wood practices law with Wood LLP (www.WoodLLP.com) and is the author of Taxation of Damage Awards and Settlement Payments (5th ed. 2021) available at www.TaxInstitute.com. This discussion is not intended as legal advice. ↑
This is a summary of the Hotshot course “No-Shops: Termination and Forcing the Vote,” covering termination of a deal for a superior proposal, break-up fees, and a look at what it means to “force the vote.” View the course here.
Termination
If the target company’s board changes its recommendation, the buyer has the right to terminate the merger agreement.
If the board determines that a competing bid actually is a Superior Proposal (not just one that could be) and changes its recommendation, then the target often has the right to terminate the agreement too.
Force the Vote
Sometimes, instead of letting the target terminate the deal to take a Superior Proposal, the buyer may negotiate for a “force the vote” provision.
This requires that the target board put the original transaction in front of its shareholders, so they can decide whether to take it despite the board’s changed recommendation.
The principal impact is that it grants a timing and tactical advantage over the competing bid.
Break-up Fees
If either the target or the buyer does terminate the deal, then the target must pay the buyer a break-up fee.
Fees aren’t very high, usually ranging around 2% to 4% of the deal value.
That’s because of case law developed over the years to ensure that fees don’t preclude competing bids.
This course also includes interview footage with Jenny Hochenberg from Freshfields Bruckhaus Deringer and Igor Kirman from Wachtell, Lipton, Rosen & Katz.
This is a summary of the Hotshot course “No-Shops: Changing Board Recommendations and Matching Rights,” a look at when a target board can change its recommendation for a superior proposal or an intervening event that also includes a discussion of matching rights. View the course here.
No-Shops: Board Recommendations and Matching Rights
Public M&A agreements require that the target’s board recommend that its shareholders vote in favor of the deal.
The board’s fiduciary duties also require that it maintain the ability to change its recommendation until the shareholders approve the transaction.
That’s why the deal-protection framework contains fiduciary-out exceptions. Under these exceptions:
The target board can change its recommendation; and
Terminate the existing deal to take a topping bid any time before the shareholders approve the existing deal.
Change in Board Recommendation
Usually, for the target board to change its recommendation, it must:
Determine, in good faith, after consulting with its outside legal and financial advisors, that continuing to recommend the transaction would be inconsistent with its fiduciary duties.
Most deals also require that the board conclude that the new deal is a Superior Proposal (and not one that could or would be).
The reason for this higher standard is that, at this stage:
The new bidder should have had an opportunity to review the diligence, negotiate with the target, and make a binding bid.
This lets the target board make a more definitive assessment than during the earlier stages of the deal.
The typical Superior Proposal formulation requires that the new proposal be:
For a minimum amount of the target’s stock or assets (usually at least 50%);
More favorable to the target’s stockholders from a financial point of view than the existing deal (when taking into account all relevant considerations, including timing, regulatory conditions, and deal certainty); and
Occasionally, there is an absolute, rather than a comparative, requirement.
For example, that the new deal be reasonably likely to be completed or that it has financing (if it’s a cash deal).
Matching Rights
Before a board can change its recommendation for a Superior Proposal, the initial buyer generally has 3 to 5 business days after the board’s determination to match the new terms.
If the competing bidder amends its proposal, the initial buyer has subsequent, shorter match periods. In other words:
Before a target board can take action that might destroy the original deal, it agrees to give the original bidder a chance to propose a revised (and better) deal; and
The Superior Proposal determination must include any such revised terms.
Intervening Events
In some deals, the parties also set out the target’s right to change the board recommendation based on an Intervening Event.
Intervening Event is often defined as something significant that occurs after the signing of the deal that wasn’t known or, sometimes, also wasn’t reasonably foreseeable, at the time of signing.
The idea is that a target board can change its recommendation but shouldn’t be able to simply change its mind about what it already knew at signing.
A common example is “discovering gold under the target’s headquarters.”
It’s more likely that some other positive development for the target makes the original deal no longer justifiable—such as FDA approval for a biotech company.
The parties will also often negotiate exceptions to the definition of Intervening Event.
These exceptions clarify instances when the target board does not have the right to change its recommendations. For example:
They might exclude adverse developments at the buyer in a stock-for- stock deal.
The theory is that other provisions protect the target for those events, like the “no Material Adverse Effect” condition.
This course also includes interview footage with Jenny Hochenberg from Freshfields Bruckhaus Deringer and Igor Kirman from Wachtell, Lipton, Rosen & Katz.
This is a summary of the Hotshot course “No-Shops,” a discussion on protective provisions in public M&A agreements, with a close look at the No-Shop provision and its main exceptions, Window-Shops and Go-Shops. View the course here.
Protecting Against the Interloper Risk
When a buyer wants to acquire a public company target one of its main concerns is that between signing and closing, a competing bidder “jumps” the deal with a better offer, and the buyer loses the deal.
This is the so-called interloper risk.
Public company merger agreements protect against this risk through various deal-protection provisions. These provisions create a framework that covers:
If, how, and when the target can engage with a competing bidder.
This includes the no solicitation provision itself (often called the “No-Shop” clause), which restricts the target from soliciting competing bids and engaging with competing bidders.
It also includes the exceptions to these restrictions—Window-Shops and Go-Shops.
The target board’s recommendation to its shareholders and when it can change that recommendation.
This includes the definitions of Superior Proposals and so-called Intervening Events.
When the target or buyer can terminate the merger agreement and the related consequences.
This includes matching rights, forcing the vote, and termination and termination fee provisions.
Deal-protection provisions can also apply to the buyer when buyer-shareholder approval is required (this is less common).
No-Shops, Window-Shops, and Go-Shops
The No-Shop clause is the heart of the deal-protection framework.
It prohibits the target from:
Soliciting competing bids;
Engaging in discussions or negotiations with a competing bidder; and
Providing diligence access to a competing bidder.
These prohibitions apply to:
The target;
Its officers;
Directors; and
Advisors—like its investment bankers.
No-Shops are not usually flat prohibitions.
They often have one or two fiduciary-out exceptions:
A Window-Shop; and
Sometimes a Go-Shop.
Window-Shops
Window-Shop exceptions let the target engage with a competing bidder that makes an unsolicited proposal, but only if:
After good-faith consultation with its outside legal and financial advisors, the target board thinks that the bid could (or would) reasonably lead to a Superior Proposal.
At this stage of the process, the target board doesn’t have to conclude that the new bid is a Superior Proposal—only that it could (or would) reasonably lead to one.
Under a Window-Shop, the target can also grant diligence access.
But it must enter into a confidentiality agreement with the competing bidder that meets certain parameters, like that:
It’s generally at least as favorable to the target as the original buyer’s confidentiality agreement.
If the deal has a two-step structure, the Window-Shop period lasts until:
The tender offer expires; and
The buyer accepts the tendered shares for payment.
In a single-step merger, the Window-Shop period lasts until the target shareholder vote.
This means that even if the deal remains pending for several months (e.g., because of a long regulatory delay), the target’s ability to engage with a competing bidder still ends at the time of the shareholder vote.
Go-Shops
In a minority of cases, the parties also include a Go-Shop provision.
Go-Shops allow the target to actively solicit new bidders for an agreed period after signing.
They’re mostly used in situations when a target board hasn’t run a pre-signing market check, such as a formal or informal auction.
Usually, as long as the No-Shop includes common fiduciary outs, the target board can get comfortable that it’s securing an attractive deal, while preserving the ability to consider unsolicited topping bids.
Sometimes, especially in private equity deals, the target goes one step further with a Go-Shop clause.
A typical Go-Shop clause provides two benefits to the target:
First, it gives the target a limited Go-Shop period (usually 30-60 days postsigning) to actively seek better deals instead of just being open to unsolicited ones.
Second, if the target abandons the deal with the initial buyer and accepts a topping bid that originated during this Go-Shop period, then it doesn’t have to pay the full termination fee.
Often, it only pays half the amount that would’ve been owed outside the Go-Shop period.
Notification Obligations
Before a target can even consider terminating a deal for another bid, it has to first notify the initial buyer—usually within 24–48 hours of receiving the proposal.
The target has to disclose the proposal’s material terms and conditions.
This means that the initial buyer is kept appraised of the competing bid and the terms needed to match the overbidder.
This course also includes interview footage with Jenny Hochenberg from Freshfields Bruckhaus Deringer and Igor Kirman from Wachtell, Lipton, Rosen & Katz.
In our transformative digital age, opportunities abound—but challenges loom large. The constant threats of hacking and data breaches in our interconnected world underscore the critical importance of robust cybersecurity. Cybercrime is expected to cost the world $8 trillion in 2023 and $10.5 trillion by 2025, according to Cybersecurity Ventures.[1]
For government contractors, the stakes are exceptionally high. Government contracts often incorporate exacting cybersecurity requirements, with severe consequences for noncompliance. The U.S. Department of Justice’s Civil Cyber-Fraud Initiative (“Initiative”) has added a new dimension to this landscape, wielding the formidable False Claims Act (“FCA”) to combat cybersecurity deficiencies among government contractors.
This article, the first in a two-part series, provides an in-depth look at the Initiative and the DOJ’s significant enforcement actions since the Initiative’s launch in 2021. Additionally, it offers proactive strategies for government contractors to remain ahead of the curve in this high-stakes, rapidly evolving digital environment.
The DOJ’s Civil Cyber-Fraud Initiative
Launched in October 2021, the Initiative was a landmark step toward clamping down on contractors that fail to comply with federal cybersecurity standards.[2] The Initiative aims to identify, pursue, and prosecute cybersecurity-related fraud against the government. It primarily targets three categories of misconduct:
Noncompliance with cybersecurity standards. The FCA can be used to pursue instances where government contractors knowingly fail to comply with the cybersecurity standards in their contracts with the government. These standards might include specific measures to protect government data, restrictions on non-U.S.-citizen employees accessing systems, or prohibitions on using components from certain foreign countries. Failure to meet these standards deprives the government of what it has contracted for.
Misrepresentation of security controls and practices. FCA liability can arise when a company knowingly misrepresents its security controls and practices during the contracting process or contract performance. Misrepresentations could influence the government’s contractor selection or contract structuring process, violating the FCA. For example, a contractor might misreport details about system security plans, monitoring practices for system breaches, or password and access requirements.
Failure to timely report suspected breaches. A company may violate the FCA if it knowingly fails to report suspected cyber incidents promptly. Government contracts often require prompt reporting of such incidents, which is imperative for the agencies to respond, remediate vulnerabilities, and limit harm.
The False Claims Act: A Key Legal Weapon
The FCA, first enacted during the Civil War to combat fraudulent suppliers, is the government’s primary tool for punishing the known misuse of taxpayer funds. It permits the government and private citizens (acting as whistleblowers or “relators”) to sue those who defraud governmental programs. The Initiative utilizes the FCA to hold contractors accountable for misrepresentations or breaches related to their cybersecurity practices. Penalties can be severe—treble damages and substantial fines per false claim, rendering the FCA a potent deterrent.
Recent Case Developments: The Initiative in Action
Implementing the Initiative has already led to some significant case developments, detailed below, that underline the Initiative’s enforcement capabilities. These cases demonstrate the potential fallout for businesses with government contracts if they provide substandard cybersecurity services, overstate their cybersecurity capabilities, or delay reporting cybercrime. It’s a stark reminder that contractors can be held accountable for fraudulent practices. With the government’s emphasis on cybersecurity enforcement and the increasing pervasiveness of cybercrime, these first few enforcement actions under the Civil Cyber-Fraud Initiative represent only the tip of the iceberg.
Comprehensive Health Services
In March 2022, the DOJ announced its first FCA resolution involving cyber fraud since the Initiative’s inception.[3] Comprehensive Health Services (“Comprehensive”), a medical service provider with contracts and subcontracts with the State Department and Air Force to operate medical facilities in Iraq and Afghanistan, settled FCA claims by agreeing to pay $930,000.
The United States alleged that Comprehensive submitted false claims for reimbursement under its contract and failed to disclose that it had not complied with contract terms requiring it to securely store patients’ medical records.[4] Comprehensive allegedly left medical records in an unprotected network drive, easily accessible to nonclinical staff, a violation it had not reported.
The relators and their counsel collectively received a total recovery of $498,741, consisting of individual shares for the relators, attorney fees, and expenses.
Aerojet
July 2022 saw a significant settlement where defense contractor Aerojet agreed to pay $9 million.[5] This settled allegations of Aerojet misrepresenting its compliance with cybersecurity standards and fraudulently entering into contracts with the Department of Defense and the National Aeronautics and Space Administration despite knowing it did not meet the minimum cybersecurity requirements.
The relator, a former senior director of cybersecurity at Aerojet, initiated the qui tam lawsuit in 2015. The government declined to intervene in the action. Following years of discovery and summary judgment briefing, a jury trial commenced on the relator’s promissory fraud claim. The relator asserted that Aerojet was liable for damages amounting to $19 billion. That figure represented three times the total value of each invoice paid under each agreement allegedly secured through false statements or fraud. If the jury found Aerojet to have violated the FCA, Aerojet also faced the possibility of civil penalties, debarment, and suspension.
The parties settled on the second day of trial, with the whistleblower receiving $2.61 million as his share of the $9 million that Aerojet agreed to pay the government to settle the cyber-fraud allegations.
Jelly Bean Communications Design
In March 2023, another government contractor, Jelly Bean Communications Design (“Jelly Bean”), and its manager agreed to pay $293,771 to resolve FCA allegations.[6]
The United States alleged that Jelly Bean, under its contracts with the Florida Healthy Kids Corporation (“FHKC”), submitted false claims for federal funds.[7] Jelly Bean failed to provide secure hosting and maintain proper software systems for the website HealthyKids.org, which collected and transmitted applicants’ personal information for Medicaid coverage. As a result, more than 500,000 applications were hacked, compromising sensitive data such as names, addresses, Social Security numbers, financial information, family relationships, and secondary insurance details. In response to the data breach and cybersecurity failures, FHKC shut down the application portal in December 2020.
Achieving Cybersecurity Excellence: Key Strategies for Government Contractors
As the digital landscape grows more complex and the threats more sophisticated, government contractors must approach cybersecurity compliance with an assertive and agile mindset. Below are some essential strategies.
Understand Cybersecurity Standards
Familiarize yourself with applicable cybersecurity requirements, including Federal Information Security Modernization Act (“FISMA”) requirements, National Institute of Standards and Technology (“NIST”) guidelines, and specific agency-level standards. Ensure strict adherence to these contractual obligations, and be careful in making assurances to the government when entering into government contracts to avoid any potential FCA violations.
Invest in Robust Security Infrastructure
Ensure that departments tasked with cybersecurity have sufficient resources for risk evaluation, threat mitigation, and adherence to governmental regulations. Allocate resources to develop cutting-edge cybersecurity technology and train skilled personnel. Regularly update and patch all systems to eliminate potential vulnerabilities and secure applications and systems.
Formulate an Incident Response Plan
Develop a comprehensive incident response plan outlining immediate steps in the event of a cybersecurity breach. The company’s plan should encompass notification procedures, evidence-preservation methods, remediation strategies, and a communication plan.
Respond to Internal Complaints
React to internal warnings appropriately. Allocate sufficient resources for investigating claims that surface through internal reporting channels. Importantly, ensure the protection of whistleblowers by not taking adverse actions against those raising internal warnings. Ignoring this advice could lead to additional liability for unlawful retaliation.
Comply with Reporting Timelines and Mandates
Understand and comply with the reporting timelines stipulated in government contracts. Failure to do so could lead to severe violations and potentially trigger FCA liability.
In addition, it is crucial to carefully structure and record any disclosures made to, or waivers from, the government. In the Aerojet case, for example, the government contractor had disclosed its noncompliance to the government. Still, the relator and government maintained that the contractor’s admissions did not reveal the full scope of the noncompliance.
Promote Cybersecurity Awareness
Conduct regular training sessions and awareness programs to help employees appropriately identify and respond to potential threats. Reinforce the importance of their role in maintaining cybersecurity and the possible consequences of noncompliance.
Proactively Engage with Legal Counsel
Independent legal advice is essential in deciphering a company’s legal obligations and mitigating claims of cybersecurity fraud. Good counsel becomes particularly vital in the face of potential whistleblower complaints—and even more so when contemplating any adverse action against the individual raising these concerns. Engaging counsel upholds privilege claims over the investigation and introduces specialized knowledge and experience in dealing with complex issues. By proactively seeking professional legal guidance, your company can maintain its compliance edge, fulfilling its obligations and adeptly resolving whistleblower claims.
Conclusion
The inception of the DOJ’s Civil Cyber-Fraud Initiative signals a heightened era of scrutiny, underscoring the importance of robust cybersecurity compliance for government contractors. Armed with the potent False Claims Act, authorities are poised to enforce stringent compliance. A company’s cybersecurity deficiencies, knowing misrepresentations, or failure to timely report breaches could lead to significant penalties. Engaging legal counsel seasoned in the intricacies of cybersecurity and FCA matters may prove indispensable in successfully navigating these obligations, potentially mitigating grave financial repercussions and safeguarding the future of the business.
The legal profession is on the cusp of a transformation as artificial intelligence (AI) technologies like ChatGPT are becoming increasingly sophisticated. These tools promise to make the generation of written content faster and more efficient than ever before. This flood of content will present a challenge for legal professionals who will need to find ways to differentiate their expertise in an era of information abundance.
How can forward-thinking legal professionals preemptively adapt to the imminent changes brought about by AI technologies like ChatGPT, and effectively position themselves to stand out in a market that will be more crowded than ever?
By proactively developing well-informed opinions and perspectives, honing public speaking skills, and having a clear focus in their practice, legal professionals can establish a distinct presence in their respective areas of practice, and stay ahead of the curve.
The Anticipated Impact of ChatGPT on Legal Marketing
ChatGPT, with its ability to analyze extensive text data, is poised to revolutionize content generation in the legal profession. As more lawyers and legal marketing departments embrace this technology, there will be an influx of written content that happens nearly instantaneously. Client alerts, articles, blog posts, social media campaigns, and even books can all be produced and disseminated faster and more efficiently than ever before. Legal professionals must anticipate this shift and think creatively about how to make their written marketing materials and lawyer thought leadership stand out. Innovating and demonstrating specialized expertise will be crucial.
Differentiating through Opinion and Perspective
In the wave of information that AI technologies are set to generate, it is essential for lawyers who want to stand out to have a unique perspective. An attorney with well-formed opinions can be a guiding force for clients. Savvy lawyers with focused practices are more likely to have opinions on recurring issues in their specific area of expertise. These opinions are not about being right or wrong but are based on what works for them, cultivated through repeated experience.
Opinions in the legal profession are dynamic in nature and evolve as lawyers gain new experiences and insights. A lawyer with well-formed specific views is often perceived as more credible and decisive. Clients typically prefer representation that is proactive, confident, and based on informed judgment. Such lawyers are not just seen as legal representatives, but as counselors and trusted advisors, providing emotional intelligence, strategic decision-making, and advocacy skills that cannot be replicated by AI.
One of the crucial aspects of differentiating oneself as a lawyer through written communication is the ability to distill complex legislative changes into digestible and actionable insights for clients and their businesses. In a landscape soon to be awash with an abundance of AI-generated content that may lack uniqueness, lawyers need to craft well-structured, concise, and personalized written material to stand out from the crowd. This writing should break down legal jargon, incorporate real-world examples for relatability, and, most importantly, offer clear recommendations that set them apart from the redundant information circulating in the market. This human element—the ability to clearly articulate and guide based on informed opinions—is what will differentiate legal professionals in the fast-approaching deluge of written information.
The Power and Benefits of Public Speaking for Lawyers
“Public speaking is one of the most underdeveloped yet essential skills for lawyers,” says Jordyn Benattar, a lawyer and the founder of public speaking coaching firm Speakwell.
As the amount of information available swells, clients will turn to trusted advisors who can skillfully sift through this information and render it into clear and actionable insights. Public speaking emerges as an invaluable asset and clear differentiator in this context. Through engaging and articulate presentations, lawyers can foster trust, a cornerstone in the lawyer-client relationship. By speaking at conferences and live events, or through webinars and published videos, lawyers can gain visibility, establish their authority in their practice area, and build a reputation as experts in their field.
Additionally, public speaking provides a platform for lawyers to showcase their personality and communication style, something written materials often lack and an essential factor for clients when choosing legal representation. It gives potential clients and collaborators a glimpse into what it’s like to work with lawyers, how they approach problems, and how they communicate solutions.
This enhanced reputation not only aids in business development but also plays a significant role in attracting top talent. When a law firm’s attorneys are recognized for their public speaking prowess, it adds an allure to the firm, increasing the chances skilled and talented professionals will want to work there. On a personal level, public speaking fosters the development of communication skills and bolsters confidence. Lastly, public speaking engagements can present networking opportunities with other speakers and attendees, allowing lawyers to establish meaningful connections among recognized experts in their chosen area of interest.
Developing Public Speaking Skills
“At any stage of your legal career, developing the learnable and indispensable skill of public speaking can very well become your greatest competitive advantage,” says Benattar. To excel as a public speaker, especially in the legal realm, a multi-faceted approach to skill development is essential.
Understanding the audience is crucial. Legal professionals must recognize that their audience might not possess legal expertise, and it’s imperative to tailor the content to the audience’s knowledge level. This involves avoiding legal jargon when unnecessary and focusing on the key messages that resonate with the audience’s interests and concerns.
Refining body language is another key aspect. A lawyer’s posture, gestures, and facial expressions can significantly impact how the audience perceives the message. Maintaining eye contact, for instance, can create a connection with the audience and convey confidence. Similarly, using gestures effectively can emphasize points and keep the audience engaged.
Voice modulation is equally important. A monotone delivery can make even the most intriguing content seem dull. Varied pitch, appropriate pacing, and strategic pauses can make the content more engaging and help in emphasizing key points.
Speak on enjoyable topics that have been researched thoroughly. Being well-prepared not only boosts confidence but also ensures that the speaker can handle questions and engage effectively with the audience. It’s important to structure the content logically and have a clear understanding of the key takeaways that the audience should leave with.
Regular practice is required. This could take the form of rehearsing in front of a mirror, recording oneself, or practicing in front of a trusted colleague or friend who can provide constructive feedback that can be acted upon.
In addition to practice, attorneys should consider investing in resources such as coaching, courses, and books that focus on public speaking. These resources can offer insights into advanced techniques and provide a structured approach to developing public speaking skills.
Conclusion
Legal professionals that employ human, engaging, and succinct thought leadership will cut through the AI-enabled clutter. As clients and prospects are often too time-strapped to navigate through an abundance of written material, by embracing the role of trusted advisor and utilizing the art of public speaking, attorneys can provide those they serve clarity, relevance, and a personal touch. This combination of attributes is invaluable in getting noticed and being remembered by the people who matter most to the trajectory of your career. A focus on being forward-thinking and proactive, coupled with the ability to communicate insights effectively, will define the successful legal professionals of the future.
Steeped in tradition, governed by highly detailed rules of play, and with a culture that values sportsmanship and civility, professional golf had seemed for many years impervious to change. That state of quietude abruptly ended last year.
What follows is an overview of the game-changing events that have recently occurred, the questions that remain unanswered, and anticipated next steps that will shape the final form that the business of golf will take. Since this saga is ever-evolving, this overview can only reflect the state of play at the time it goes to press.
The oldest principal player in this drama is the PGA Tour, a nonprofit organization based in Florida that runs most golf tournaments. The Tour holds lucrative contracts with the major TV networks that televise such events. Five players sit on its eleven-person governance committee. To be clear, the PGA Tour oversees only a discrete segment of professional golf. It does not run the four “majors”: the Masters, the U.S. Open, the Open (the British Open), or even the PGA Championship (which is run by the PGA of America, an association of club professionals that also has responsibility over the Ryder Cup). However, it does operate a number of other tours, including one that features up-and-coming players who aspire to qualify for and join the PGA Tour.
PGA Tour events involve players competing by playing eighteen holes each day for four days (for a total of seventy-two holes). After the first two rounds of a tournament, the half of the field who have the worst scores fail to “make the cut”; they are sent home without earning a single dollar. (This has been a sore point for non-elite golfers.) At the end of four days, the player with the lowest aggregate score wins. In the event of a tie, a playoff ensues.
The first shock wave to impact the business of golf came in 2022 when LIV Golf was launched, with Australian golfer Greg Norman as its CEO and the Public Investment Fund (PIF), the sovereign wealth fund of Saudi Arabia, serving as its financial backer. LIV enticed several well-known PGA Tour professionals to join its tour with multimillion-dollar signing bonuses and the prospect of earning more money with fewer events. LIV’s format features fifty-four holes over three days of competition, and it involves team as well as individual competition. What’s more, no golfer is cut from a LIV tournament; all participants earn money. The attraction of LIV for professional golfers was simple: make more money for less work.
LIV’s exposure to the viewing public has been limited by the fact that it has not been able to reach agreements with the major television networks. LIV also does not operate a player development circuit; it has just raided the PGA Tour ranks for players.
Corporate ownership of sports leagues is not unknown; in motorsports; NASCAR and Formula One are examples. What makes LIV different is the involvement of the Saudi sovereign wealth fund. Critics of LIV have accused the Saudi government of sportswashing, using its investment in golf to distract from its human rights record, the murder of Washington Post columnist Jamal Khashoggi, and speculation about its being involved in 9/11 (though allegations of connections have been investigated, no direct link has been established). Jay Monahan, Commissioner of the PGA Tour, commented in 2022 that no golfer ever had to apologize for being a member of the PGA Tour. His criticism of LIV and PIF at the time earned him the support of 9/11 Families United, a group of family members of those who died and survivors of the attacks. In the context of sportswashing accusations, it’s worth noting that LIV is not PIF’s only foray into the world of sports: PIF led a consortium that acquired U.K. soccer club Newcastle United in 2021 and has also made significant multi-year investments in Formula One and WWE.
Following the first LIV event in London in June 2022, the PGA Tour made good on its threat of sanctioning players who joined the LIV Tour by barring them from participating in PGA Tour events. Unkind words between the golfers of the rival tours ensued, as did litigation. A number of LIV players—followed by LIV Golf itself—sued the PGA Tour in federal court in California. alleging antitrust violations. The Tour countersued for interference with contractual relations. The Tour also hired lobbyists to seek support from Congress to help fend off its new rival—all to no avail. In order to prevent further defections of its players to LIV, the PGA Tour raised purses, which put financial stress on the organization. At one point Monahan, in a telling comment, observed: “If this is an arms race and if the only weapons are dollar bills, the PGA Tour can’t compete.”
The vitriol between the two tours and their respective players made the second shock wave particularly upsetting to loyal PGA golfers and their fans. On June 6, PGA Tour Commissioner Monahan and PIF Governor Yasir al-Rumayyan announced that following secret negotiations (from which players as well as LIV Golf CEO Norman were excluded), they had entered into a framework agreement to form a new and yet-to-be-named legal entity that would combine their respective commercial and business assets (including LIV) as well as those of the DP World Tour (formerly known as the European Tour). The PGA Tour would remain a nonprofit organization and retain full control over how its tournaments were played. The PGA Tour’s board would appoint the majority of the board of the new entity and hold a majority voting interest in the new entity. Monahan of the PGA Tour would be the CEO, and al-Rumayyan would chair the board of the new entity. PIF would also hold a right of first refusal with respect to any required further cash investments.
The press release announcing the deal also indicated that the parties would “work cooperatively and in good faith to establish a fair and objective process for any [LIV] players who desire to re-apply for membership with the PGA Tour or the DPA World Tour.” The press release also indicated that they would cease all litigation between the parties. Good to their word, the parties soon thereafter filed a joint motion in federal court in California to dismiss the pending lawsuits with prejudice.
Monahan admitted that a subsequent meeting with the PGA Tour players was “intense” and “heated.” One player was quoted as saying that the players who remained loyal to the PGA Tour and had not followed the money felt betrayed. 9/11 Families United was also highly critical of the deal.
How much remains to be negotiated became evident when the New York Times on June 26 broke a story based on its having obtained a copy of the framework agreement. The newspaper reported that the agreement was a scant five pages long (slim even for a typical M&A letter of intent). Apart from the mutual agreement to dismiss the pending litigation, the only other firm commitments found in the agreement involved mutual confidentiality and non-disparagement covenants, a ban on recruiting players to rival tours, and a deadline of December 31 of this year for entering into a final, binding agreement (unless mutually extended). That final agreement will ultimately require the approval of the PGA Tour board. In short, the “merger” is far from being a done deal.
Where things go from here is as difficult to predict as picking the winner of the next PGA or LIV tournament.
Within days of the deal becoming public, the PGA Tour announced that Tour Commissioner Monahan had experienced “a medical situation” and would be stepping away from his day-to-day duties until further notice. Fortunately, during Monahan’s medical leave the PGA Tour had the benefit of having on its board two veteran dealmakers: Board Chairman Edward D. Herlihy, a corporate partner at Wachtel, Lipton, Rosen & Katz, and investment banker James J. Dunne III. Both men were involved in the earlier rounds of negotiations and presumably were well positioned to keep things moving forward. Even more fortunate, Monahan, more quickly than expected, sent a memo to the PGA Tour policy board on July 8 announcing that his still-undisclosed health condition had “improved dramatically,” allowing him to return to his CEO role on July 17. What Monahan’s health episode demonstrates is that any point in any deal, whether during negotiations or during post-closing integration, the sudden and unexpected unavailability of a key player, decision-maker, or champion of the deal can be very unsettling and potentially derail the transaction.
On his return, Monahan and the PGA Tour Board will face a variety of substantive questions, including:
Who should replace independent board member and former AT&T CEO Randall Stephenson, who abruptly resigned shortly following Monahan’s announcement of his planned return? (In his resignation letter, Stephenson wrote that he had “serious concerns with how this framework agreement came to fruition without board oversight” and that “the construct currently being negotiated by management is not one I can objectively evaluate or in good conscience support, particularly in light of the U.S. intelligence report concerning Jamal Khashoggi in 2018.”)
What value should be placed on the business assets that each party will be contributing to the new entity?
Will there continue to be a LIV Tour, separate and apart from the PGA Tour?
Will the PGA Tour adopt certain attributes of the LIV Tour?
Under what terms will the LIV players be able to play in the PGA Tour events?
Should PGA Players who did not migrate to LIV be compensated for their loyalty? If so, who decides what each of them should receive?
Other open questions involving third parties include:
How will television networks and other media outlets cover professional golf events on a going-forward basis? Will new contracts need to be negotiated?
Similar questions can be raised regarding sponsors of the two tours and individual players; how will they react? Will those agreements also require renegotiation?
Will a significant number of disaffected fans simply tune out professional golf?
As for coming attractions, the U.S. Department of Justice has indicated that it is investigating the PGA/PIF/LIV deal for possible antitrust violations. It was recently reported that the parties agreed to drop the anti-poaching provision from the framework agreement, presumably in order to reduce their antitrust risk profile.
Further congressional inquiry or even proposed legislation may follow the three-hour hearing of the Senate Permanent Subcommittee on Investigations at which PGA Tour board member Dunne and Chief Operating Officer Ron Price appeared on July 11.
Next to be served up: professional tennis? The head of the Association of Tennis Professionals (ATP) Tour recently confirmed that “positive” talks had taken place with PIF and other parties regarding investment in the men’s professional tennis tour.
Even occasional viewers of televised golf will acknowledge that during the final round of a tournament, they cannot forecast who will win in advance. To learn the final outcome, they must stay tuned until the very end. So too with this current golf-related business drama. We may have seen the first two acts, but it is far from clear how many more there will be, and what professional golf will look like when the final curtain comes down.
On June 22, 2023, a federal court in New York (“Court”) issued sanctions against two lawyers and a law firm for submitting “non-existent judicial opinions with fake quotes and citations created by the [generative] artificial intelligence tool ChatGPT.”[1] The lawyers and their firm were jointly fined $5,000 and ordered to mail individual letters to each judge wrongly identified as the author of the non-existent opinions. While the sanctions order has been publicized as a cautionary tale against premature reliance on artificial intelligence (AI) tools,[2] a closer read shows that sanctions were not directed at faulty use of new technology but rather at disregard for well-established principles of professional conduct inherent to the Rule of Law.
Two of the opening sentences of the Court’s opinion capture its essence: “Technological advances are commonplace and there is nothing inherently improper about using a reliable artificial intelligence tool for assistance. But existing rules impose a gatekeeping role on attorneys to ensure the accuracy of their filings.”[3]
While acknowledging that the submission of fake, AI-generated opinions is unprecedented, the Court identified the essential harm committed by the sanctioned lawyers as “abuse of the adversary system” that flowed from the submission of fake opinions.[4] Essentially, the Court sanctioned the involved lawyers and their firm for “abandon[ing] their responsibilities when they submitted non-existent judicial opinions with fake quotes and citations” created by ChatGPT, and, equally for continuing “to stand by the fake opinions after judicial orders called their existence into question.”[5]
Emphasizing long-standing and well-tested principles of the Rule of Law, the decision is an invitation for lawyers to use reliable new technologies—while keeping in mind their professional obligations to safeguard the adversary legal system and honor and uphold principles of the Rule of Law. This article breaks down the Court’s opinion and offers a summary of some of the key principles of the Rule of Law that it invokes.
The Long Road from Reliance on ChatGPT to Rule 11 Sanctions
In February 2022, Steven Schwartz of the Levidow Firm filed suit in the Supreme Court of the State of New York on behalf of a personal injury claimant. This case was removed to the United States District Court for the Southern District of New York. Since Schwartz was not admitted to practice in that district, another attorney from the same firm, Peter LoDuca, filed notice of appearance in the case. Schwartz continued to perform all the substantive legal work for the federal case, with LoDuca merely signing and filing documents authored by Schwartz.
In the course of litigation, Schwartz prepared and LoDuca signed and filed a response to the defendant’s motion to dismiss. This responsive filing, a so-called “Affirmation in Opposition,” was wrongly filed in accordance with New York state and not federal court requirements. [6] It cited and quoted from purported judicial decisions that were said to be published in the Federal Reporter, the Federal Supplement Reporter, and Westlaw. Although LoDuca signed and filed the affirmation, he made no effort to verify the form of the filing or any case law cited therein.
Two weeks later, on March 15, 2023, the defendant filed a response, “impliedly assert[ing]” that cases cited in the plaintiff’s affirmation did not exist and stating that the few cases which the defendant was able to locate did not stand for the propositions for which they were cited.[7] The Court conducted its own search for the cited materials but was unable to locate multiple authorities cited. Neither LoDuca, Schwartz, nor the firm they worked for sought to withdraw the filing or provide any explanation.
In April 2023, the Court ordered plaintiffs to file an affidavit that annexed copies of the cited decisions that raised concerns.[8] Eventually, LoDuca filed an affidavit authored by Schwartz that annexed ChatGPT-generated excerpts of all but one of the fake opinions, which was described as an unpublished opinion. The affidavit was vague about the source of the excerpted materials, stating that the purported opinions represented only what was made available by online database, without identifying any “online database” by name or admitting reliance on ChatGPT.
The Court’s review found that while the fake opinions had some traits that were superficially consistent with actual judicial decisions, (e.g., citing to plausible panels of federal judges, credible docket numbers, and purported citations to case law), blatant stylistic and reasoning flaws on the face of the excerpts made it clear that they could not have issued from a US appeals court. One fake opinion, for example, started off discussing wrongful death claims related to the death of “George Scaria Varghese” only to abruptly shift to discussing claims of “Anish Varghese” who was denied boarding on a flight. The excerpts additionally conflated facts and jurisdictions, contained erroneous citations, and advanced procedural history “border[ing] on nonsensical.” [9]
Thus, the Court’s sanctions opinion sharply focused on the importance of protecting the adversarial process from fake submissions. The Court plainly stated that “if the matter had ended with [the lawyers] coming clean about their actions shortly after they received the defendant’s March 15 brief questioning the existence of the cases, or after they reviewed the Court’s Orders of April 11 and 12 requiring production of the cases, the record now would look quite different.”[10]
Appreciation for the Rule of Law as a Safeguard during Uncertain Times
The sanctions opinion shows that even in cases of clear and obvious failing of technical competence, the Court’s interest remains focused on ensuring the Rule of Law. Rule of Law is defined as the restriction of the arbitrary exercise of power by subordinating it to well-defined and established laws.[11] Traditional principles of the Rule of Law relevant to the Court’s opinion include: the principles of stare decisis, legal certainty, and legal predictability. The Court’s decision connects these principles to legal practice by citing to rules of professional conduct.
“The Anglo-American common-law tradition is built on the doctrine of stare decisis (‘stand by decided matters’), which directs a court to look to past decisions for guidance on how to decide a case before it. This means that the legal rules applied to a prior case with facts similar to those of the case now before a court should be applied to resolve the legal dispute.”[12]Stare decisis is one of the main reasons why lawyers cite to other cases in their briefs and writings, because judges are required to align their decisions with relevant and authoritative precedents. Stare decisis relies entirely on the existence of authentic precedent authored by judges. When stare decisis is undermined, legal certainty is undermined as well. Legal certainty is the principle that requires that the law be clear, precise, and unambiguous, and its legal implications foreseeable. Fake cases disrupt clear laws, provoke ambiguity, and prevent assessment of foreseeable legal implications. Legal certainty implies legal predictability—that adjudication must be predictable. This means that laws must be clear, stable, and intelligible so that those concerned can with relative accuracy calculate the legal consequences of their actions as well as the outcome of legal proceedings.
Justice John Marshall Harlan considered the importance of giving the public a “clear guide,” the value of helping individuals “to plan their affairs,” the benefits of “expeditious adjudication,” and “the necessity of maintaining public faith in the judiciary as a source of impersonal and reasoned judgements” as providing strong indication that courts should respect their own precedents.[13] Perhaps echoing Justice Harlan’s approach, the Court here provides useful illustration of the contemporary impacts:
Many harms flow from the submission of fake opinions. The opposing party wastes time and money in exposing the deception. The Court’s time is taken from other important endeavors. The client may be deprived of arguments based on authentic judicial precedents. There is potential harm to the reputation of judges and courts whose names are falsely invoked as authors of the bogus opinions and to the reputation of a party attributed with fictional conduct. It promotes cynicism about the legal profession and the American judicial system. And a future litigant may be tempted to defy a judicial ruling by disingenuously claiming doubt about its authenticity.[14]
Highlighting the connection between harmful systemic impacts and relevant procedural and ethical legal practice rules, citing Rule 11 of the Federal Rules of Civil Procedure, the Court found that filing papers “without taking the necessary care in their preparation” was an “abuse of the judicial system” subject to Rule 11 sanction.[15] Further, the Court cited Rule 3.3(a)(1) of the New York Rules of Professional Conduct, 22 N.Y.C.R.R. § 1200.0 (NYRPC), which states, “A lawyer shall not knowingly make a false statement of fact or law to a tribunal or fail to correct a false statement of material fact or law previously made to the tribunal by the lawyer.” In highlighting the appropriateness of reliance on other lawyers, databases, and technology, the Court implicitly points to Rule 5.1 NYRPC that imposes obligations on lawyers, particularly firms and direct supervisors, to make reasonable efforts to ensure conformity with these and other rules. The Court even went to the extent of discussing potential violations of criminal law, noting that knowingly passing off false documents as authentic ones issued by the courts of the United States implicates the federal criminal statute prohibiting such conduct. The Court ultimately found that since no fake signatures or seals were submitted, the criminal statute was not invoked, despite noting the strong resonance between the crimes the statute seeks to prevent and the circumstances of the case.[16]
Lawyers in the United States, regardless of where they are barred, have an obligation to uphold principles of Rule of Law. This means while lawyers have an obligation to zealously represent their clients, they are required to fulfill this obligation in a manner that upholds the integrity and fair functioning of the legal system. When it comes to citing precedents, this means that lawyers have an obligation to advance arguments grounded in authentic legal precedent. This includes the obligation to check citations and to locate and review full decisions. This principle extends to all actors in the legal system, whether they are judges, attorneys, or pro se litigants. The adversarial system depends on transparent and open development of the law by judges through an adversarial process. Reliance on fake decisions not only undermines the potential for a fair fight between the parties, but it also undermines the value, certainty, and predictability of a decision.
Generative AI is a type of AI system “capable of generating text, images, or other media in response to prompts. Generative AI models learn the patterns and structure of their input training data, and then generate new data that has similar characteristics.”[17] Consumer-grade generative AI tools, now in the hands of millions of people across the globe, are transforming the way people work, create, and interact with one another.
The law frequently lags behind technological, political, social, and economic developments. This is because creating laws and regulations specific to the new context and challenges takes time, diverse inputs, and planning. When technological change provokes political, social, and economic uncertainty, it also provokes tremendous legal uncertainty—as the nature of legal problems that people face are also transformed. As technology triggers rapid changes, the gap between the law and newly evolving legal problems becomes exponentially bigger.
This lag between technology and the law can often create anxiety around technological change and development. The Court’s sanctions order and opinion shows how a sound appreciation for the principles of Rule of Law can act as a safeguard or safe harbor during times of uncertainty provoked by technological change. In the context of technological change and lagging legal change, new laws, regulations, policies, and guidelines are reliably derived from existing laws, regulations, policies, and guidelines and, therefore, will unwaveringly uphold basic principles of the Rule of Law. Knowledge of and appreciation for what is existing (here the rules of professional responsibility) can help lawyers better navigate uncertainty, avoid sanction, and achieve more favorable results for their clients.
If you are interested in learning more about the Rule of Law and business, please sign up to take the ABA Business Law Section Rule of Law Working Group’s CLE webinar, available online free for ABA members.
This article is part of a series on intersections between business law and the rule of law, and their importance for business lawyers, created by the American Bar Association Business Law Section’s Rule of Law Working Group. Read more articles in the series.
Mata v. Avianca, Inc., No. 54, 22-cv-1461 (PKC), at 1 (S.D.N.Y. June 22, 2023). ↑
Id. at FN 2 (noting that the document Schwartz filed was “a creature of New York state practice” that did not satisfy federal court requirements for opposing a motion to dismiss). ↑
Id. at 7. The Court requested the following cases, stating that failure to comply would result in dismissal of Plaintiff’s case: Varghese v. China Southern Airlines Co., Ltd., 925 F.3d 1339 (11th Cir. 2019); Shaboon v. Egyptair, 2013 IL App (1st) 111279-U (Ill. App. Ct. 2013); Peterson v. Iran Air, 905 F. Supp. 2d 121 (D.D.C. 2012); Martinez v. Delta Airlines, Inc., 2019 WL 4639462 (Tex. App. Sept. 25, 2019); Estate of Durden v. KLM Royal Dutch Airlines, 2017 WL 2418825 (Ga. Ct. App. June 5, 2017); Ehrlich v. American Airlines, Inc., 360 N.J. Super. 360 (App. Div. 2003); Miller v. United Airlines, Inc., 174 F.3d 366, 371-72 (2d Cir. 1999); In re Air Crash Disaster Near New Orleans, LA, 821 F.2d 1147, 1165 (5th Cir. 1987); and Zicherman v. Korean Air Lines Co., Ltd., 516 F.3d 1237, 1254 (11th Cir. 2008). ↑
Id. at 23-4. This portion of the Court’s opinion should be of particular interest to counsel advising on development of generative AI projects, as it suggests that any AI hallucinations that fabricate court judgments to include court signature and seal might potentially lead to criminal charges. See also Dredeir Roberts, How General Counsels Battle the Weaknesses in the United States Rule of Law, Business Law Today (Aug. 12, 2022). ↑
