The Eastern District of Pennsylvania Bankruptcy Conference (“EDPABC”) is a nonprofit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.

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Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in late March/early April each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.

The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.

This hypothetical from a previous Forum, titled “The Greasy Spoon,” describes the fictional bankruptcy of a small restaurant chain in the wake of the COVID-19 pandemic. The hypothetical raises questions around the intersection of adversary proceedings in bankruptcy court and mandatory arbitration provisions, as well as the enforceability of prepetition guarantees in connection with postpetition liabilities.

The Greasy Spoon: Case Problem

The Greasy Spoon, LLC (“Company”) is a Pennsylvania limited liability company based in Montgomery County, Pennsylvania, that has two members, Bob and Brian Greasy, a father and his son. Through the Company, the Greasys owned and operated three restaurants in and around Norristown, Pennsylvania.

When the COVID-19 pandemic hit in March of 2020, the Company was initially able to weather the storm, obtaining Paycheck Protection Program (“PPP”) loans, dipping into savings, and hanging on through the initial wave of shutdowns. However, as the pandemic wore on, the Company found itself in an ever more precarious financial situation due to a decided lack of outdoor seating at its three locations as well as limited takeout operations. As the pandemic headed into its second year, the Company’s losses ballooned, and the Greasys wondered how much longer they could hang on. Finally, on June 15, 2021, a fire broke out in the East Norriton restaurant, the Company’s most popular location, severely damaging the kitchen and necessitating a closing so that repairs could be made. In addition, the Company found it increasingly difficult to retain and hire new staff because of COVID-related staffing shortages. As a result of the loss of revenues and staffing difficulties, the Company decided that it could no longer continue; and on July 7, 2021, the Company shuttered the two remaining locations and filed for protection under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Eastern District of Pennsylvania. As of the petition date, the Company had a number of long-standing contracts with vendors providing goods and/or services to their restaurants.

Problem #1

Several years earlier, in an effort to manage costs and ensure twenty-four-hour service coverage, the Company entered into an agreement (“Services Agreement”) with Hot Air HVAC Company, a Delaware limited liability company operating out of Laurel Hill, New Jersey. Pursuant to the Hot Air Services Agreement, the Company would pay a monthly subscription fee of $1,000. In exchange, Hot Air would manage all of the Company’s heating, ventilation, and air-conditioning (“HVAC”) needs, which included maintenance of the Company’s oven vents as well as its heating and air-conditioning systems. Whenever a maintenance issue would arise, the Company would contact Hot Air, which contracted with local HVAC repairmen and would send a repairman out to immediately assess and begin making any necessary repairs. The Services Agreement contained the following provision:

In the event of a dispute between the Company and the Customer (the “Parties”) that arises from this Agreement or the services provided hereunder including, but not limited to, a payment dispute, the Parties agree to submit their dispute to binding arbitration under the authority of the Federal Arbitration Act and in accordance with the Commercial Arbitration Rules of the American Arbitration Association.

In the year preceding the bankruptcy, the Company had fallen behind on any number of payables. Among other things, the Company failed to timely make its monthly service payments under the Services Agreement with Hot Air. As of June 2021, the Company was approximately four months in arrears. On June 12, the oven vent at the East Norriton location suddenly stopped working during the busy Saturday morning breakfast lunch. Frantic to keep its most profitable location operating on its busiest day, Brian called Hot Air with a service request—but Hot Air informed Brian that until the Company paid its past-due service fees, Hot Air would not send anyone out to the location. As a result, over the phone, Brian paid the $4,000 for the four months of past-due invoices. Within a couple of hours, Hot Air sent out one of its subcontractors, who inspected and repaired the oven vent in time to salvage the Saturday evening dinner rush.

After the Company filed for bankruptcy protection, it quickly filed a number of motions seeking to reject executory contracts that were no longer needed now that the restaurants had closed. Among others, the Company filed a motion to reject the Hot Air Services Agreement, which the bankruptcy court granted as unopposed.

A couple of months after filing for bankruptcy protection, the Company learned that the subcontractor sent out by Hot Air had failed to properly wire a replacement fan in the oven vent, which was the cause of the devastating fire that had occurred just several days later. After considering its options, the Company filed an adversary complaint in the bankruptcy court against Hot Air, asserting claims for negligence and breach of contract and damages in the amount of $20,000. In addition, the Company asserted a preference claim under section 547 of the Bankruptcy Code, seeking to recover the $4,000 paid to Hot Air on June 12.

Hot Air timely filed a motion to dismiss for failure to state a claim, which was denied. After the motion to dismiss was denied and approximately three months after the complaint was filed, Hot Air filed an answer with affirmative defenses; the parties then engaged in some initial discovery, serving interrogatories, requests for documents, and requests for admissions. Thereafter, Hot Air served initial responses to the Company’s discovery requests and filed a motion to compel discovery after the Company failed to serve any responses.

Two months after filing its answer and shortly after it served discovery responses and filed its motion to compel discovery, Hot Air filed a motion to compel arbitration and to stay the adversary proceeding based on the arbitration clause. Hot Air argued that there is a strong federal policy favoring the enforcement of arbitration clauses. It further noted that it had not filed a proof of claim in the bankruptcy.

The Company argued that the arbitration clause was no longer enforceable because the Company had rejected the Services Agreement and a party cannot pursue specific performance from a trustee or debtor in possession. Accordingly, the Company asserted, Hot Air could not compel arbitration. Further, the Company argued, the adversary complaint also included a preference claim against Hot Air that is a core matter under the Bankruptcy Code. Accordingly, the Company reasoned that the bankruptcy court clearly had jurisdiction over Hot Air with respect to the preference claim and that the dispute should not be bifurcated, with some claims subject to arbitration and others remaining before the bankruptcy court. Such bifurcation, the Company asserted, would be inefficient and unduly burdensome to the bankruptcy estate. The Company also argued that to the extent that the arbitration clause could still be invoked, Hot Air had waived arbitration by failing to object to the rejection of the Services Agreement, filing an answer that failed to raise arbitration as a defense, engaging in discovery, and not raising the arbitration issue at all for several months.

Hot Air countered that whether or not the preference claim was “core” was immaterial because the claim had its genesis in a payment made by the Company to Hot Air under the Services Agreement, and any payment disputes under the Services Agreement are subject to arbitration. Accordingly, Hot Air argued, the claims did not need to be bifurcated at all, and the bankruptcy court should order that they all be arbitrated.

Questions for Problem #1

1. Taking into account the parties’ arguments and relevant case law, should the bankruptcy court grant the motion to compel arbitration and order the parties to arbitration, notwithstanding the fact that the Company rejected the Services Agreement? Does it matter whether it is the debtor or the counterparty to a rejected contract that is seeking to compel arbitration?
2. Putting aside the rejection of the Services Agreement, did Hot Air waive its rights under the arbitration clause by answering the complaint, participating in discovery, and waiting several months to file the motion to compel arbitration?
3. Assume that Hot Air is also owed money for unpaid service charges and that, upon rejection of the Services Agreement, Hot Air filed a proof of claim for the service charges as well as liquidated rejection damages. Does Hot Air’s filing a proof of claim change the analysis on whether or not the court should compel arbitration?
4. If the court orders the parties to arbitration, should the arbitration be limited to the negligence and breach of contract claims, or should it include the preference claim? If the court bifurcates the claims, should it stay the preference action until conclusion of the arbitration?

Summary of Legal Authorities for Problem #1

Highland Capital Management, L.P. v. Dondero (In re Highland Capital Management, L.P.)^[1]

Background

The debtor, Highland Capital Management, L.P., commenced four separate adversary proceedings to collect tens of millions of dollars owed to it under certain promissory notes (collectively, “Note Adversary Proceedings”). Each note obligor was closely related to Highland’s former president, who himself was an obligor on three of the notes. The Note Adversary Proceedings were originally brought as breach of contract actions, but after the defendants raised certain affirmative defenses, the debtor amended its complaints to add claims for fraudulent transfers, declaratory judgments as to certain provisions of the debtor’s limited partnership agreement, breach of fiduciary duties, and aiding and abetting said breaches of fiduciary duties.

Thereafter, the former president, his wife, and a family trust that was one of the debtor’s largest partners (collectively, “Movants”) filed motions to compel arbitration relying on a mandatory arbitration provision in the limited partnership agreement, which also restricted the scope of discovery. They also sought to stay the litigation with respect to concededly nonarbitrable claims pending the completion of arbitration.

The debtor had previously rejected the limited partnership agreement under section 365 of the Bankruptcy Code. The debtor asserted, among other things, that (i) the rejection of the limited partnership agreement excused the debtor from mandatory arbitration, and (ii) the Movants had waived the right to arbitration by not invoking it earlier in the litigation. The debtor further argued that arbitration of some, but not all, of the debtor’s claims would be inefficient and a waste of resources.

Analysis

The court acknowledged the “wealth of federal case law dictating the strong federal policy undergirding the Federal Arbitration Act (“FAA”).”^[2] The court noted that “the FAA reflects a liberal federal policy favoring arbitration and requires arbitration agreements to be rigorously enforced according to their terms.”^[3] However, noting that other courts have wrestled with whether bankruptcy courts can treat arbitration provisions as “less mandatory” than other courts, the court observed that “bankruptcy cases are not like other lawsuits; they are multi-faceted, multi-party, and fast-moving.”^[4] The court also explained that one of the primary purposes of bankruptcy is to provide a centralized forum for a debtor and creditors to resolve their claims in an orderly fashion.

The court pointed out that some courts, in determining whether to enforce arbitration provisions, apply a “core versus noncore” analysis. Those courts, when presented with a noncore dispute, find that they generally must enforce mandatory arbitration provisions. In contrast, when presented with a core dispute, they employ a test derived from the U.S. Supreme Court’s decision in Shearson/American Express, Inc. v. McMahon.^[5] Under that test, a party seeking to avoid arbitration must show in enacting the relevant statute that Congress intended to preclude arbitration. Such a showing must be made based on (i) the statute’s text, (ii) its legislative history, or (iii) an inherent conflict and the underlying purpose of the statute.

However, the primary issue presented by the debtor was one that, according to the court, few other courts have addressed—namely, whether a contract counterparty can force a debtor to engage in arbitration where the underlying contract has been rejected. Relying primarily on a U.S. Court of Appeals for the Fifth Circuit decision involving a federal receivership, Janvey v. Alguire (discussed below),^[6] the court concluded that the debtor could not be compelled to engage in arbitration under the rejected limited partnership agreement. According to the Janvey court, an arbitration provision is a classic executory contract with performance due on both sides since neither party has performed an arbitration provision when one party seeks to enforce it. Looking to bankruptcy jurisprudence, the Janvey court determined that it could not order arbitration under a rejected contract because injured parties under a rejected contract cannot insist on specific performance by a trustee.

The court noted that although Janvey involved a federal receivership and not a bankruptcy case, the Fifth Circuit looked almost exclusively to bankruptcy law. The court found the Fifth Circuit’s analysis in Janvey persuasive and potentially binding. The court noted that under section 365, “if a bankruptcy trustee rejects an executory contract, the rejection, of course, constitutes a breach of the contract and subjects the estate to a claim for money damages on behalf of the injured party.”^[7] However, the court also concluded that the injured party cannot insist on specific performance by the trustee. “Instead, the injured party is treated as having a prepetition claim for damages arising as if the breach occurred immediately before the filing of the bankruptcy petition.”^[8]

The question then becomes whether such prepetition claim must be liquidated through arbitration. According to the court, most courts dealing with arbitration provisions do not analyze them as classic executory contracts even though, in the view of Professor Westbrook, that’s exactly what they are.^[9] Although arbitration provisions generally survive a contract, executory obligations may be avoided by a trustee under section 365; and, accordingly, because specific performance is not available against a trustee, arbitration provisions remain subject to rejection.

In following the Janvey court’s reasoning, the Highland Capital court rejected the reasoning of the bankruptcy court in In re Fleming Cos. (discussed below), which held that rejection does not prevent a party from enforcing an arbitration provision in the rejected contract.^[10] The court noted that in Fleming, it was the debtor demanding arbitration, which the court found to be a significant distinction.

With respect to the debtor’s argument that the Movants had waived arbitration, the court noted that the Note Adversary Proceedings were filed in January 2021 and that, thereafter, the Movants had engaged in the litigation for eight or nine months before moving to enforce the arbitration provisions. Among other things, they had filed answers with affirmative defenses, moved to withdraw the reference, and attended hearings—all without ever raising the issue of arbitration. Moreover, they had served significant discovery far outside the scope permitted by the arbitration provisions. The court concluded that although courts in the Fifth Circuit often impose a presumption against waiving the right to arbitration, under the circumstances, the Movants’ belated attempt to enforce arbitration was prejudicial to the debtor.

Madison Foods, Inc. v. Fleming Cos. (In re Fleming Cos.)^[11]

Background

The debtor filed a motion to compel arbitration and stay any related nonarbitrable claims. The debtor was a nationwide wholesale supplier of food and grocery products. The plaintiff had purchased a grocery store from the debtor prepetition. In connection with the sale, the plaintiff and the debtor entered into a facility standby agreement (“FSA”) containing an arbitration clause, as well as a number of related agreements and promissory notes. The debtor soon after filed a voluntary Chapter 11 petition and sought authority from the bankruptcy court to sell substantially all of its assets, including the notes, to a third-party buyer (“Buyer”). The debtor also rejected the FSA pursuant to section 365 of the Bankruptcy Code.

Thereafter, the plaintiff filed an adversary complaint against the debtor and the Buyer requesting various forms of relief, alleging that the notes were unenforceable due to fraud, breach of contract, and promissory estoppel. In response, the debtor moved to compel arbitration under the FSA, which provided that “[a]ll disputes . . . including any matter relating to this Agreement, shall be resolved by final binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association.”^[12] Both the Buyer and the plaintiff opposed arbitration.

The Buyer and the plaintiff asserted, among other things, that (1) the debtor waived arbitration by previously seeking a determination on an issue involving the FSA, and (2) the debtor breached the agreement by rejecting it pursuant to section 365.

Analysis

The court rejected the plaintiff and Buyer’s argument that arbitration had been waived. Although the debtor, in connection with the sale of its assets, had previously requested a determination of the enforceability of the consequential damages provision of the FSA, the court had refused to make such a determination, finding that the debtor was seeking an advisory opinion. Accordingly, the court determined that the plaintiff and the Buyer had failed to demonstrate any prejudice, which the U.S. Court of Appeals for the Third Circuit has established “is the touchstone for determining whether the right to arbitration has been waived.”^[13]

On the issue of whether rejection of the FSA barred any effort by the debtor to compel arbitration, the court found that it did not. The court distinguished a case relied upon by the plaintiff and the Buyer that held that a debtor who rejected a contract could not thereafter sue for breach of contract under the agreement but could maintain a suit in equity for the return of funds that had not been earned by the defendant. In contrast, the court concluded, the debtor in Fleming was not seeking to compel payment or any substantive performance under the FSA but was only seeking to compel arbitration under the terms of the FSA.

The court looked to other decisions holding that a party can compel arbitration despite a rejection or breach of the underlying agreement, including the decision in Southeastern Pennsylvania Transportation Authority v. AWS Remediation, Inc. (discussed below).^[14] The court found that rejection of a contract will not void an arbitration clause, in part because “[a]ny different conclusion would allow a party to avoid arbitration at will simply by breaching the contract.”^[15] In addition, the court rejected an argument that resolution of the issue should turn on whether it is the nonbreaching party who is seeking to compel arbitration, observing that “[b]oth parties agreed to the method of dispute resolution and both parties should be able to take advantage of it.”^[16] Accordingly, the court granted the debtor’s motion to compel arbitration and also stayed the nonarbitrable claims on grounds of judicial economy and to avoid inconsistent rulings.

Mintze v. American Financial Services, Inc. (In re Mintze)^[17]

Background

In a Chapter 13 case, after a lender filed a proof of claim, the debtor brought an adversary proceeding to enforce a purported prepetition rescission of a loan agreement. The underlying loan agreement contained an arbitration clause that covered all claims and disputes arising out of or related to the loan. The creditor moved to compel arbitration. The parties stipulated that the matter was a “core” proceeding, and the bankruptcy court had found that because it was a core matter, it had discretion to deny arbitration. The district court affirmed.

Analysis

On appeal, the Third Circuit reversed, holding that the core versus noncore distinction has no bearing on whether a bankruptcy court has discretion to deny enforcement of an arbitration agreement. Rather, under McMahon, regardless of whether a dispute is core or noncore, the party opposing enforcement of the arbitration agreement has the burden of demonstrating congressional intent to preclude arbitration for the statutory rights at issue through (1) the statute’s text, (2) the statute’s legislative history, or (3) an inherent conflict between arbitration and the statute’s underlying purposes. The Third Circuit noted the strong federal policy in favor of arbitration. The court observed that the McMahon test establishes a high burden for the party opposing arbitration.

The court rejected the debtor’s argument that its decision in Hays & Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc.^[18] stood for the proposition that a bankruptcy court lacks discretion to deny arbitration only in noncore matters. In Hays, the Third Circuit considered whether the Bankruptcy Code conflicts with the FAA “‘in such a way as to bestow upon a district court discretion to decline to enforce an arbitration agreement’ with respect to a trustee’s claims.”^[19] The Third Circuit in Mintze noted that it held in Hays that “where a party seeks to enforce a debtor-derivative pre-petition contract claim, a court does not have the discretion to deny enforcement of an otherwise applicable arbitration clause.”^[20] In Mintze, the Third Circuit clarified that the decision in Hays did not rest on the distinction between core and noncore proceedings, but rather “sought to distinguish between causes of action derived from the debtor and bankruptcy actions that the Bankruptcy Code created for the benefit of the creditors of the estate.”^[21] Accordingly, the standard adopted in Hays and derived from the McMahon decision does not turn on the core versus noncore distinction.

The Third Circuit then went on to consider whether the debtor had satisfied her burden of establishing congressional intent to preclude arbitration. Finding no such intent in the statutory text or legislative history of the Bankruptcy Code, the Third Circuit analyzed whether there was an inherent conflict between arbitration and the Bankruptcy Code. The bankruptcy court had found that resolution of the debtor’s contract rescission claim would have an effect on the rights of other creditors that was sufficient to create an inherent conflict, but the Third Circuit disagreed. The debtor’s claims did not arise under the Bankruptcy Code, and, accordingly, with no bankruptcy issue to be decided by the bankruptcy court, there could be no conflict between arbitration and the Bankruptcy Code. In sum, the Third Circuit concluded that the bankruptcy court lacked discretion to deny arbitration. “The FAA mandates enforcement of arbitration when applicable unless Congressional intent to the contrary is established.”^[22] Having failed to demonstrate such intent, the debtor’s attempt to avoid arbitration was denied.

Janvey v. Alguire^[23]

Background

The Janvey decision, relied upon heavily by the bankruptcy court in Highland Capital (summarized above), arose in the context of an SEC-imposed receivership over several related entities. As part of the receivership, the receiver initiated suits against certain former employees asserting claims for fraudulent transfer and unjust enrichment. The employees then filed motions to compel arbitration. The motions were litigated up to the Fifth Circuit twice on issues related to the arbitration agreements before again being remanded to the district court to determine “whether the Receiver is bound by the arbitration clauses.”^[24]

Analysis

Acknowledging the broad federal policy in favor of arbitration and the Supreme Court’s holding in McMahon, the court noted that there was little case law regarding the FAA and federal equity receiverships. The court examined the historical relationship between federal equity receiverships and bankruptcy law and determined that “because equity receivership law and bankruptcy law share similar roots regarding their successor rights, the Court will supplement the sparse equity receivership law by also examining relevant bankruptcy law.”^[25]

The court then determined that the receiver could be bound by the arbitration agreements and considered whether the receiver had the right to reject the arbitration agreements. Analogizing to bankruptcy law, the court adopted the Countryman material breach test for determining whether a contract is an executory contract that may be rejected. Under that test, a contract is executory if either party’s failure to complete performance would constitute a material breach. The court concluded that “arbitration agreements must be analyzed as separate executory contracts, based on the nature of the agreement as well as arbitration caselaw regarding severability.”^[26] The court, again relying on bankruptcy case law, found that upon rejection of an executory contract, the injured party cannot compel specific performance by a trustee. Finding that the receiver could and did reject the arbitration provisions, the court opined that forcing the receiver to adopt the arbitration provisions would be an unjust result, imposing a financial burden on the estate and valuing arbitration agreements above other contracts.

In light of the dearth of case law analyzing federal equity receiverships and arbitration agreements, the court looked to bankruptcy jurisprudence to determine whether arbitration of the receiver’s claims would conflict with the federal equity receivership statutory scheme. The court then discussed the Third Circuit’s analysis in Hays, noting that the Fifth Circuit had previously adopted the reasoning in Hays in determining that “where a core proceeding involves adjudication of federal bankruptcy rights wholly divorced from inherited contractual claims, the importance of the federal bankruptcy forum provided by the Code is at its zenith.”^[27] Thus, the Fifth Circuit held that where a cause of action is not derivative of prepetition legal rights possessed by a debtor, the bankruptcy courts have discretion to determine whether arbitration is inconsistent with the Bankruptcy Code.

After examining the statutory history of federal equity receiverships, the court explained that the objectives of the receivership were equivalent to the objectives of the Bankruptcy Code—that is, “to marshal assets, preserve value, equitably distribute to creditors, and, either reorganize, if possible, or orderly liquidate.”^[28] The court determined that “[f]or a bankruptcy court to be afforded discretion in refusing to enforce an arbitration clause, there must be a specific conflict with a central purpose of the Bankruptcy Code in arbitrating the particular claims at issue.”^[29] The court held that there was a conflict because, among other things, the fraudulent transfer claims (i) would allow the receiver to protect creditors, (ii) were brought pursuant to federal statutes that gave the receiver special jurisdictional authorization, and (iii) were likely not viable outside of the receivership. Thus, the court determined that it had significant discretion and denied arbitration as contrary to the purposes of the receivership.

Camac Fund, L.P. v. McPherson (In re McPherson)^[30]

Background

A creditor moved for stay relief to arbitrate claims against the Chapter 11 debtor pursuant to an arbitration clause in a prepetition funding agreement. Prepetition, the creditor had invoked the arbitration clause. The debtor filed a response disputing the enforceability of the arbitration clause before filing for Chapter 11 relief. The debtor then brought an adversary proceeding against the creditor, and the creditor requested that the bankruptcy court abstain from or stay the adversary proceeding in favor of the pending prepetition arbitration. The debtor asserted that all of the issues in the litigation overlapped with his reorganizational efforts such that the bankruptcy court should resolve the entire dispute between the parties. The creditor asserted that the arbitrator could resolve most, if not all, of the issues, and the bankruptcy court could then resolve the administration of any resulting claims.

Analysis

The court acknowledged that there was some merit to the debtor’s position that the Bankruptcy Code is intended “to facilitate a timely, cost-effective resolution of all claims asserted against a debtor,” which would be undermined by arbitration.^[31] Nevertheless, although the court noted that it might be a “suboptimal” outcome, the court held that applicable law required bifurcation of the claims between the bankruptcy case and the prepetition arbitration matter.^[32]

In considering the interplay between the FAA and the Bankruptcy Code, the court explained that “[t]he FAA and the Code both are grounded in important policy considerations concerning efficiency and fairness.”^[33] On the one hand, the FAA reflects a strong federal policy in favor of arbitration that “reflects the reality that, at least in contracts subject to negotiation, the arbitration clause may be a critical piece of the parties’ bargain and integral to their cost-benefit analysis of the contract itself.”^[34] On the other hand, the Bankruptcy Code “is not party- or contract-specific but seeks to balance the rights of many parties with many different contracts, rights, and interests involving a single debtor.”^[35]

The court then acknowledged the applicability of the McMahon analysis and noted that some courts start the analysis by first determining whether the dispute involves core or noncore claims. However, the court also recognized that the core/noncore distinction is “not mechanically dispositive” and that matters involving a mix of core and noncore issues require additional analysis.^[36] The court agreed with the line of cases holding that where a core claim is involved, bankruptcy courts have wider discretion to deny arbitration.

Finding that the dispute at hand involved both core and noncore claims, the court bifurcated the core and noncore claims, ordering the noncore claims to arbitration. Although the court expressed concerns that arbitration of the noncore claims carried the risk of interfering with the debtor’s reorganization efforts and could result in conflicting results, the court concluded that it was bound by U.S. Court of Appeals for the Fourth Circuit precedent strongly favoring arbitration. The court noted that had the bankruptcy been filed prior to the initiation of arbitration, the court might have come to a different conclusion.

Hoxworth v. Blinder, Robinson & Co.^[37]

Background

In Hoxworth, the Third Circuit articulated standards for determining when a party has waived arbitration. Among other things, the court considered whether the defendants had waived their right to compel arbitration by actively litigating the case for almost a year prior to filing their motion to compel arbitration. Citing Gavlik Construction Co. v. H.F. Campbell Co., the Third Circuit noted that “prejudice is the touchstone for determining whether the right to arbitrate has been waived.”^[38] The court observed that other courts have found that prejudice exists where a party substantially invokes “the litigation machinery” before pursuing arbitration.^[39] Relevant factors include the timeliness or lack thereof of a motion to arbitrate, the degree to which the party seeking arbitration has contested the merits of its opponents’ claims, whether that party has informed its adversary of its intention to seek arbitration, the extent of its nonmerits motion practice, its assent to the district court’s pretrial orders, and the extent to which both parties have engaged in discovery.

Analysis

In Hoxworth, the Third Circuit affirmed the district court’s denial of arbitration on waiver grounds where the defendants had participated in numerous pretrial proceedings over more than eleven months; moved to dismiss the complaint for failure to state a claim; filed a motion to disqualify the plaintiff’s counsel; took depositions of the plaintiffs that would not have been available in arbitration; inadequately answered discovery requests, prompting additional motion practice; objected to a motion for class certification; and only moved to compel arbitration after their motion to dismiss was denied and the plaintiff’s motion to compel discovery was granted.

Nova Hut A.S. v. Kaiser Group International Inc. (In re Kaiser Group International, Inc.)^[40]

Background

The appellant purchaser (“Nova”), who was sued by appellee debtors (collectively, “Kaiser”) in an adversary proceeding, appealed from the orders of the bankruptcy court denying its motions to stay the proceedings, to compel arbitration, and to dismiss the debtors’ third amended complaint. The bankruptcy court had denied arbitration on the basis that by filing a proof of claim in the bankruptcy case and pursuing litigation against a nondebtor affiliate in the Netherlands, Nova had waived arbitration. Nova filed a proof of claim but only invoked arbitration after the debtor objected to the proof of claim.

Analysis

The court reversed the bankruptcy court’s denial of arbitration, noting that “[t]he Third Circuit has recognized that prejudice is ‘the touchstone for determining whether the right to arbitrate has been waived.’”^[41] The court found that in denying the arbitration, the bankruptcy court had not addressed whether Kaiser had established prejudice. Here, although Nova filed a proof of claim and did not seek arbitration until Kaiser filed an adversary proceeding, Nova never answered the complaint and moved for arbitration each time Kaiser amended its complaint. In addition, Kaiser did not demonstrate that any delay in pursuing arbitration was unreasonable or resulted in prejudice. Similarly, although Nova had initiated litigation against a nondebtor affiliate in the Netherlands, Kaiser failed to make any showing of actual prejudice, and it appeared that there was no discovery or litigation advantage for Nova.

Southeastern Pennsylvania Transportation Authority v. AWS Remediation, Inc.^[42]

Background

On cross-motions for summary judgment, where the plaintiff had requested a declaratory judgment that a contract dispute between the parties was not subject to arbitration and the defendant sought to enforce a mandatory arbitration clause, the district court found in favor of the defendant and ordered arbitration.

Here, Amtrack and Southeastern Pennsylvania Transportation Authority (“Rail Companies”) had entered into a contract for environmental consulting with the debtor, a nonparty to the litigation, which subcontracted with the defendant to provide labor and materials. The defendant was not a party to the agreement, which contained a mandatory arbitration clause. In January 2002, the Rail Companies terminated the contract with the debtor, which then filed for bankruptcy relief. The bankruptcy court granted the debtor’s motion to reject the agreement. However, the bankruptcy court also approved the debtor’s sale of the accounts receivable owed to it by the Rail Companies under the contract to the defendant, which then filed a demand for arbitration in order to collect the receivables, leading to the filing of the adversary proceeding.

Analysis

After first determining that the debtor’s arbitration rights had been assigned to the defendant, the court turned to whether the Rail Companies’ prepetition termination of the agreement and the debtor’s postpetition rejection of the contract barred enforcement of the arbitration provisions. The court rejected the Rail Companies’ argument that an arbitration provision dies with the underlying contract. “While a rejection or termination of an agreement may affect the arbitrability of events that occur after the date of termination or rejection, it cannot change the remedial limitations applied to pre-rejection events.”^[43] The court concluded that allowing a party to avoid arbitration by terminating a contract would render mandatory arbitration provisions illusory and that the same rationale applies to a debtor’s rejection of a contract in bankruptcy. The court also noted that the Rail Companies had undermined their own arguments by previously seeking a modification of the asset purchase agreement to allow them to pursue set-asides arising under the agreement, finding that it would be unfair to allow the Rail Companies to pursue set-asides under the agreement but bar the defendant from invoking its arbitration provisions.

Problem #2

Since 2010, the Company had contracted with Cream of the Crop Dairy (“Cream of the Crop”) for the provision of all of the Company’s dairy needs, including both dairy products and various refrigerator units for storing the Company’s dairy inventory. In 2012, at Cream of the Crop’s request, Bob signed an “Unconditional and Continuing Guaranty,” which provided thus:

Guarantor, for and in consideration of [Cream of the Crop’s] extension of credit to [the Company], hereby personally guarantees prompt payment of any and all obligations of the Company to Seller whether now existing or hereinafter incurred. Guarantor expressly binds himself to pay on demand any sum that is due from the Company to Seller whenever Company fails timely to pay the same. Guarantor expressly acknowledges and agrees that this guaranty shall be an absolute, continuing and irrevocable guaranty for such indebtedness to the Company.

In 2017, Bob filed a no-asset Chapter 7 bankruptcy case in order to address significant outstanding credit card debt. Although Bob had some assets, including his interest in the Company, all of his assets were either exempt or represented collateral for debts. As a result, shortly after the Chapter 7 case was filed and Bob’s 341 meeting concluded, Bob received a discharge, the Chapter 7 trustee filed a report of no distribution, and the Chapter 7 case was closed. However, Bob never scheduled his guaranty obligation to Cream of the Crop, believing it was unnecessary because at the time there were no outstanding amounts due from the Company to Cream of the Crop. Accordingly, Cream of the Crop never received formal notice of the Chapter 7 case.

In the several months preceding the Company’s Chapter 11 filing, the Company had received several shipments of dairy products for which it had not tendered payment, as well as several sliding-door dairy refrigerators to replace aging units at each of its locations. As a result, when the Company filed the Chapter 11 case, the Company held outstanding invoices from Cream of the Crop reflecting approximately $26,000 due and owing to Cream of the Crop. It was only after the Company filed for Chapter 11 protection and Cream of the Crop received notice as a creditor of the Company that Cream of the Crop undertook its own investigation and discovered Bob’s Chapter 7 case from several years prior.

Realizing that it was unlikely that its unsecured claim would be paid in full in the Company’s Chapter 11 case, Cream of the Crop moved to reopen Bob’s Chapter 7 case and then filed an adversary complaint seeking (i) a declaration that the postpetition invoices for goods provided to the Company created fresh liabilities under the guaranty that were not discharged in Bob’s Chapter 7 case (“Count I”) and (ii) a judgment against Bob for the debts incurred by the Company (“Count II”). Cream of the Crop took the position that Bob’s Chapter 7 discharge did not extinguish his liability for the postpetition extensions because such liabilities arose postpetition.

Bob objected to Cream of the Crop’s attempt to impose liability, asserting that all debts arising under the guaranty, whether matured or contingent, were discharged in 2017. Bob also asserted that, notwithstanding his failure to schedule Cream of the Crop in his Chapter 7 schedules, at some point Cream of the Crop became aware of the bankruptcy: the Company’s general manager was aware and informed the Company’s vendors, and many of the vendors requested new payment terms after the Chapter 7 case concluded. Cream of the Crop insisted that it had no knowledge of the Chapter 7 case until 2021, after the Company filed the Chapter 11 case. It asserted that debt owing to Cream of the Crop was nondischargeable under section 523(a)(3) of the Bankruptcy Code and, therefore, was not discharged under section 727(b) of the Bankruptcy Code. Cream of the Crop moved for summary judgment.

Questions for Problem #2

1. Did Cream of the Crop’s claim against Bob arise prior to or after his Chapter 7 case?
2. Why is or is not the debt giving rise to Cream of the Crop’s claim against Bob nondischargeable pursuant to section 523(a)(3) of the Bankruptcy Code?
3. Was the debt discharged under section 727(b) of the Bankruptcy Code?
4. Assume the court finds that Cream of the Crop’s claims arose prior to the Chapter 7 case and thus were dischargeable. Given the dispute over whether Cream of the Crop had notice of the Chapter 7 case, can the court grant summary judgment in favor of either party?
5. Does the bankruptcy court have jurisdiction over Count II?

Summary of Legal Authorities for Problem #2

Jeld-Wen, Inc. v. Van Brunt (In re Grossman’s Inc.)^[44]

Background

The successor in interest to a reorganized Chapter 11 debtor brought an adversary proceeding to enjoin the prosecution of asbestos-related claims asserted against it as well as a determination that its liability for such claims had been discharged. In 1977, the appellee remodeled her home using products containing asbestos, which were purchased from a home improvement retailer called Grossman’s (“debtor”). In 1997, the debtor filed for protection under Chapter 11. The debtor provided notice of its claims bar date by publication, but there was no specific reference to potential future asbestos liability. The debtor’s Chapter 11 plan was confirmed in December 1997. The appellee did not file a proof of claim because she was unaware that she had any claim. It was not until she was diagnosed with mesothelioma in 2007 that she filed an action against the debtor’s successor. The successor moved to reopen the Chapter 11 case for a determination that its liability on the claims had been discharged.

Relying on Third Circuit precedent, the bankruptcy court held that the debtor’s confirmed Chapter 11 plan did not discharge the claims because they arose after the petition date. In Avellino & Bienes v. M. Frenville Co. (In re M. Frenville Co.),^[45] the Third Circuit had held that a “claim,” as defined by the Bankruptcy Code, arises when the underlying state law cause of action accrues. Because applicable New York law provides that an asbestos-related personal injury cause of action does not accrue until the injury manifests itself, the appellee’s claim did not accrue until after the debtor’s bankruptcy had been filed. The district court affirmed.

Analysis

On appeal in Grossman’s, the Third Circuit reexamined its decision in Frenville, which involved a litigation brought by four banks against the debtor’s former accountants, alleging that the accountants had recklessly prepared the debtor’s prepetition financial statements and seeking damages for the resulting losses. The accounting firm then filed an adversary complaint in the bankruptcy court seeking relief from the automatic stay to implead the debtor as a third-party defendant in order to seek indemnification. In Frenville, the bankruptcy court and the district court both found that the automatic stay barred the adversary proceeding, but the Third Circuit reversed on appeal. It held that the automatic stay, which applies only to prepetition claims, was inapplicable to the action because, under New York law, the accounting firm’s claim for indemnification did not arise until after the banks filed suit. In Frenville, the Third Circuit established the “accrual test” for determining when a “claim” arises under the Bankruptcy Code. Under the accrual test, the existence of a claim depends on (1) whether the claimant possesses a right to payment and (2) when that right arose, as determined by reference to applicable nonbankruptcy law.

In Grossman’s, the Third Circuit acknowledged that both the bankruptcy court and the district court had correctly applied the accrual test to determine that the appellee’s claims arose postpetition when she became ill, not prepetition when she purchased the offending products. However, the Third Circuit concluded that it should abandon the accrual test. The court noted that the other courts of appeal had uniformly declined to follow Frenville, which had been described as “one of the most criticized and least followed precedents decided under the current Bankruptcy Code.”^[46] Those courts criticized Frenville for its conflict with the Bankruptcy Code’s “expansive” treatment of the definition of claim, noting that both congressional reports and the U.S. Supreme Court have indicated that the term should be afforded the broadest possible scope.^[47] The Third Circuit agreed that “[t]he accrual test in Frenville does not account for the fact that a ‘claim’ can exist under the Code before a right to payment exists under state law.”^[48]

Considering the implications of when a claim arises under the Bankruptcy Code—including the effect that such a determination has on both the automatic stay and dischargeability of claims—and noting, in particular, the significant due process issues at play, the Third Circuit looked to the reasoning of other courts and explained that there are generally two lines of cases on the issue. The first line of cases applies the “conduct test,” under which a claim arises when the acts or conduct giving rise to the claim occur, not when the injury caused by the conduct manifests itself. The second line of cases applies the “prepetition relationship test,” under which a claim arises from a debtor’s prepetition conduct, but only where there is also some prepetition relationship. The prepetition relationship test is intended to allay due process concerns—namely, that under the conduct test, a claim could be discharged without the creditor ever receiving notice.

After examining the various approaches taken by courts on the issue, the Third Circuit noted that “there seems to be something approaching a consensus among the courts that a prerequisite for recognizing a ‘claim’ is that the claimant’s exposure to a product giving rise to the ‘claim’ occurred pre-petition.”^[49] The Third Circuit then held that “a ‘claim’ arises when an individual is exposed pre-petition to a product or other conduct giving rise to an injury, which underlies a ‘right to payment’ under the Bankruptcy Code.”^[50]

Reinhart FoodService L.L.C. v. Schlundt (In re Schlundt)^[51]

Background

In 2003, the debtor signed a personal guaranty in favor of Reinhart FoodService L.L.C. (“Reinhart”), guarantying his business’s debts under a supply agreement with Reinhart. The guaranty contained the following language:

I, David Schlundt, for and in consideration of your extending credit at my request to The Refuge, LLC personally guarantee prompt payment of any obligation of the Company to Reinhart FoodService, Inc. (“Seller”), whether now existing or hereinafter incurred, and I further agree to bind myself to pay on demand any sum which is due by the Company to Seller whenever the Company fails to pay same. It is understood that this guaranty shall be an absolute, continuing and irrevocable guaranty for such indebtedness of the Company.^[52]

In 2014, the debtor and his wife filed for protection under Chapter 7 of the Bankruptcy Code. The Chapter 7 case was a no-asset case, no bar date was ever set, and the debtor received a discharge. The debtor never scheduled Reinhart as a creditor. The debtor asserted that Reinhart must have learned of the bankruptcy while it was pending or shortly after. Reinhart asserted that it did not learn of the bankruptcy until 2018 and that had it known earlier it would have required new security.

In 2018, the debtor’s business obtained additional goods and services from Reinhart but shuttered its operations without ever paying its approximately $36,000 debt to Reinhart. Reinhart sought to reopen the debtor’s Chapter 7 case to obtain a declaratory judgment that the credit advances constituted a fresh liability under the guaranty such that the debtor’s liability was not discharged in the prior Chapter 7 case. Reinhart moved for summary judgment, and the debtor objected, asserting that all amounts due under the personal guaranty, whether matured or contingent, were discharged in 2014.

Reinhart initially sought a declaration that the debt was nondischargeable pursuant to section 523(a)(3) but thereafter adjusted its argument, relying solely on section 727(b). In sum, Reinhart asserted that the debtor’s liability for the 2018 invoices instead arose at the time Reinhart extended credit. The debtor argued that the 2014 discharge extinguished any and all personal liability to Reinhart and, in the alternative, that there were genuine issues of material fact regarding Reinhart’s lack of notice.

Analysis

The court noted that two views have developed on this issue regarding prepetition guaranties. The first view holds that a debtor’s discharge does not extinguish personal liability for postpetition credit extensions. The second view holds that all debts, including postpetition liabilities, arising under a prepetition guaranty are contingent claims that may be discharged in bankruptcy.

The court noted that the U.S. Court of Appeals for the Seventh Circuit has adopted the “conduct test” for determining whether a claim arose prepetition or postpetition.^[53] Under that test, the date that the claim arose is determined by looking to the conduct that gave rise to the claim. The court determined that under Seventh Circuit precedent, the conduct that gives rise to a claim under a contract is generally the signing of the contract; and, therefore, liability arises on the date that a contract is signed. The court found that this is most consistent with the Bankruptcy Code’s definitions of claim and debt and that, “under most circumstances, finding that a claim arose ‘at the earliest point possible’ will best serve the policy goals underlying the bankruptcy process.”^[54] Although some courts also require a prepetition relationship in order to address due process concerns, the Seventh Circuit has not determined whether such relationship is always required.

In this case, the court found that even under the relationship inquiry, Reinhart’s claim arose prepetition because he had a prepetition relationship with the debtor. In distinguishing cases relied upon by Reinhart, the court noted that in each of those cases the court relied primarily on state law and that, although not necessarily identified by name, those courts utilized the accrual theory instead of the conduct test. The court, “mindful that the bankruptcy discharge is meant to afford debtors a fresh start,” concluded that the earliest conduct between the debtor and Reinhart was the signing of the guaranty and, accordingly, the debt was dischargeable in 2014.^[55]

With respect to notice, the court determined that it did not need to make any factual determination. Reinhart could not state a claim for relief because under the plain language of section 523(a)(3), in a no-asset, no-bar-date bankruptcy case, “garden variety debts” do not fall within the scope of section 523(a)(3).^[56]

Russo v. HD Supply Electrical, Ltd. (In re Russo)^[57]

Background

In June 2011, the debtor’s company (“Company”) executed a credit application with the defendant (“HD Supply”), and the debtor executed a “Continuing Personal Guaranty.” In November 2011, the debtor filed for relief under Chapter 7 of the Bankruptcy Code. The debtor scheduled HD Supply as a general unsecured creditor, although he never formally revoked his guaranty and there was some dispute over whether HD Supply received notice of the bankruptcy. In March 2012, the debtor obtained his discharge. Thereafter, HD Supply delivered over $20,000 in products to the Company. After the Company failed to pay for the products, HD Supply sent a collection letter to the Company demanding payment and stating that the debtor was personally liable. The debtor filed an adversary complaint alleging that HD Supply violated the discharge injunction by sending the demand letters, and both parties moved for summary judgment. HD Supply argued that the continuing nature of the guaranty encompassed all future transactions and that because the debtor never revoked the guaranty in writing, he remained liable for post-discharge obligations incurred by the Company.

Analysis

The court noted that “[c]ourts have recognized that a personal guaranty is the classic example of a contingent liability because the guarantor’s liability is triggered only if the principal obligor has failed to satisfy its debt.”^[58] Accordingly, the court found that on the date that the debtor filed for bankruptcy, HD Supply held a contingent claim against the debtor for any future indebtedness that the Company might incur but fail to pay. Even though the future indebtedness had not been incurred at the time of the bankruptcy case, the claim itself existed by virtue of the debtor’s prepetition execution of the guaranty. The court observed that other courts have come to the same conclusion, including one that stated that courts “universally recognize that claims are contingent as to liability if the debt is one which the debtor will be called upon to pay only upon the occurrence or happening of a future event.”^[59] The future events that triggered the debtor’s liability were HD Supply’s postpetition extensions of credit and the Company’s failure to pay. Upon notice of the bankruptcy, HD Supply could have demanded a new personal guaranty. The court rejected any assertion that a debtor’s liability under a guaranty does not arise until the credit to the principal obligor is actually extended, finding that such an interpretation would “conflict[] with the broad definition of ‘claim’ [in the Bankruptcy Code] and is contrary to the very notion of a continuing guaranty.”^[60]

However, although the court granted summary judgment in favor of the debtor as to whether HD Supply’s claim was subject to discharge, the court denied summary judgment in favor of the debtor as to whether HD Supply had actual notice of the bankruptcy. The court concluded that HD Supply’s alleged lack of notice was relevant to the issue of whether the claim was actually discharged under 11 U.S.C. § 523(a)(3).

In re Lipa^[61]

Background

The debtor and his wife filed for Chapter 7 relief in December 2004 and received a discharge in March 2005. In 1997, the debtor had signed a personal guaranty with a building supply company pursuant to which he guaranteed the debts of his drywall company. Five years after the bankruptcy, the supplier filed suit against the debtor to enforce the guaranty. A couple of months later, the debtor moved to reopen the Chapter 7 case and sought damages for violation of the discharge injunction. The court granted the motion, and the supplier moved for reconsideration.

Analysis

The court noted that Congress gave the terms debt and claim “the broadest possible definitions so as to enable the debtor to deal with all legal obligations in a bankruptcy case.”^[62] Although “[t]he term ‘contingent’ is not defined in the Bankruptcy Code, . . . courts have concluded that contingent claims are those in which a debtor will be required to pay only upon the occurrence of a future event triggering the debtor’s liability.”^[63] Accordingly, because claim is defined to include “contingent” claims under the Bankruptcy Code, “a right to payment that is not yet enforceable under non-bankruptcy law at the time of the bankruptcy filing may still constitute a claim that is dischargeable in the bankruptcy case.”^[64]

Quoting In re Pennypacker,^[65] the court observed that “[g]enerally, ‘[t]he classic example of a contingent debt is a guaranty because the guarantor has no liability unless and until the principal defaults.’”^[66] Looking to other cases, the court explained that “a broad definition of claim allows a bankruptcy court to deal fairly and comprehensively with all creditors in the case and, without which, a debtor’s ability to reorganize would be seriously threatened by the survival of lingering remote claims and potential litigation rooted in the debtor’s prepetition conduct.”^[67]

Relying primarily on the broad definitions of debt and claim in the Bankruptcy Code, the court rejected other courts’ analysis to the contrary and held that the debtor’s liability under the guaranty, including for postpetition extensions of credit, had been discharged in the Chapter 7 case.

Republic Bank of California v. Getzoff (In re Getzoff)^[68]

Background

In November 1991, the accounting firm (“Firm”) owned by the debtor signed a promissory note and obtained a loan for $250,000 from the Republic Bank of California (“Bank”). On the same day, the debtor signed a continuing guaranty of the Firm’s obligations under the note. Under the guaranty, the debtor promised to pay any and all indebtedness owing from the Firm to the Bank, including

any and all advances, debts, obligations and liabilities of Borrowers or any one or more of them, heretofore, now, or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether direct or acquired by Bank, by assignment or succession, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined . . . .^[69]

In April 1992, the debtor and his wife filed for protection under Chapter 7 of the Bankruptcy Code. In May 1992, the Bank and the Firm entered into an agreement pursuant to which the indebtedness under the original note was reduced to $213,000 and the loan was extended. On the same date, the parties entered into a new note, and the debtor executed a new guaranty identical in form to the original guaranty. In December 1992, the Bank asked the debtor to execute a reaffirmation agreement, but the debtor did not comply. The Firm made payments on the new note until July 1993. In January 1994, the Firm and the Bank agreed to stipulate to a judgment allowing the Firm to extend the date for repayment until April 1998. However, after the documents were prepared, the debtor asserted that his personal guaranty had been discharged, so the Bank filed an adversary complaint seeking a declaration from the bankruptcy court that the second guaranty was a postpetition obligation that had not been discharged. Both parties filed motions for summary judgment.

The bankruptcy court granted summary judgment in favor of the debtor. The bankruptcy court concluded that the Bank had given additional consideration in exchange for the second guaranty. However, the court held that execution of the second guaranty was an improper attempt to reaffirm discharged debt without following the requirements of section 524(c) and (d) of the Bankruptcy Code.

Analysis

On appeal, the U.S. Court of Appeals for the Ninth Circuit Bankruptcy Appellate Panel (“BAP”) noted that a debtor may voluntarily repay a discharged debt and may also enter into an agreement with a creditor to reaffirm an otherwise dischargeable debt. However, in order for such agreement to be enforceable, it must be made in compliance with section 524(c) and (d) of the Bankruptcy Code, which encompasses five requirements:

1. the agreement must be made prior to discharge;
2. the agreement must advise the debtor that the reaffirmation may be rescinded up to sixty days after it is filed;
3. the agreement must be filed with the court;
4. the debtor cannot already have rescinded the agreement within the proper time frame; and
5. the agreement must be in the best interest of the debtor.^[70]

The purpose of these requirements is to protect debtors from creditor coercion, and reaffirmation agreements are not favored by the courts. Accordingly, any reaffirmation agreement that does not comply fully with section 524 is void and unenforceable.

Here, the Bank acknowledged that it had not complied with section 524. However, the Bank argued that the second guaranty was not a promise to repay a discharged debt. Instead, it was a new promise in consideration for the Bank’s promise to extend the terms of the loan to the debtor’s Firm. According to the Bank, since section 727 only discharges prepetition debt, the second guaranty was not discharged because it arose after the debtor’s bankruptcy was filed.

The BAP disagreed, noting not only the broadness of the definition of debt under the Bankruptcy Code but also the broadness of the scope of debts covered by the first guaranty itself. In other words, prepetition, the first guaranty made the debtor contingently liable for any obligation “now or hereafter made” to the Bank; and, accordingly, such debt was discharged.^[71] Further, the second note was merely a continuation of the first note; and by executing the second guaranty, the debtor effectively assumed the continuing guaranty obligation that had been discharged in his Chapter 7 case. Because he could not do so without following the requirements of section 524, the Bank could not recover that discharged debt.

Although the bankruptcy court here found that there was new consideration, the BAP found that under section 524(c), if the debtor’s consideration is based in whole or in part on a discharged debt, then a reaffirmation agreement must be filed with the court. The fact that the Bank gave new consideration was immaterial where the debtor’s new consideration was a promise to pay discharged debt.

Orlandi v. Leavitt Family Ltd. Partnership (In re Orlandi)^[72]

Background

The debtor owned an entity called Studio 26 Salon, Inc. (“Studio 26”), which in September 2005 entered into a commercial lease with the defendant (“Landlord”). The debtor also executed a personal guaranty of the lease. In July 2008, the debtor and his wife filed for protection under Chapter 7 of the Bankruptcy Code, and they received a discharge in November 2008. In March 2011, after exercising a five-year extension option under the lease, Studio 26 vacated the space prior to the expiration of the lease, and the Landlord sued the debtor in state court for almost $25,000 in unpaid rent. The debtor answered in state court, asserting his bankruptcy discharge as an affirmative defense. Thereafter, the debtor filed a motion to reopen his bankruptcy case, which was granted in November 2016, resulting in a stay of the state court litigation. In January 2017, the debtor filed an adversary complaint against the Landlord, asserting that his guaranty had been discharged and that the Landlord had violated the discharge injunction.

The Landlord filed a motion for summary judgment asserting that the lease extension renewed the personal guaranty and that the lease extension contained a survivability clause that superseded the bankruptcy filing and discharge. The bankruptcy court denied the motion for summary judgment and, following trial, entered judgment in favor of the debtor.

Analysis

On appeal, the U.S. Court of Appeals for the Sixth Circuit BAP agreed with the bankruptcy court. Like other courts considering the issue, the BAP stated that whether the personal guaranty was discharged turned on whether it constituted a prepetition debt under the Bankruptcy Code. The BAP also noted that there are two lines of cases on the issue, with some courts concluding that absent some affirmative action by a debtor to revoke a guaranty, a guaranty may be enforced as to obligations incurred postpetition, and with other courts concluding that a prepetition guaranty is a contingent claim that is discharged in bankruptcy. The BAP agreed with the latter line of cases, noting that the terms debt and claim, as defined in the Bankruptcy Code, are afforded the broadest interpretations available in order to ensure the promise of a fresh start.

One distinguishing feature of this case is that, unlike many other similar cases, there was no dispute that the debtor had scheduled the guaranty in his bankruptcy case and that the Landlord had notice of the bankruptcy. The BAP opined that when the lease extension was executed, the Landlord should have requested that the debtor reaffirm the guaranty or execute a new guaranty. The BAP did not address whether a newly executed guaranty would run afoul of section 524(c).

In re Shaffer^[73]

Background

David Osbourn and Michael Shaffer (together, “Debtors”) were part owners of St. James Electric, LLC (“St. James”). In 2011, St. James submitted a credit application to plaintiff Dulles Electric (“Dulles”) to obtain credit for future purchases. The Debtors each signed a personal guaranty pursuant to which they guaranteed the debts owed by St. James to Dulles. In November 2013, each of the Debtors filed a petition for relief under Chapter 7 of the Bankruptcy Code. They each obtained a discharge in February 2014. Neither expressly revoked their personal guaranties. Thereafter, St. James continued to operate, and Dulles continued to supply materials on credit. In March 2015, St. James filed a petition for relief under Chapter 7 of the Bankruptcy Code, scheduling a debt owed to Dulles in the amount of $20,000. No assets were available, and the case was closed in May 2015. Thereafter, Dulles reopened the Debtors’ Chapter 7 cases and filed adversary complaints against each of the Debtors, seeking declaratory judgments that their personal guaranties were not discharged.

Analysis

The bankruptcy court first noted that the Fourth Circuit follows the conduct test for determining when a debt arises—namely, that a debt arises when the conduct giving rise to the debt occurs. However, the court explained that “[a]lthough the existence of a claim is determined by the Bankruptcy Code, the timing of the creation of the liability is determined by nonbankruptcy law.”^[74]

The court discussed the distinction between a “restricted guaranty” and a “continuing guaranty” under Virginia law, noting that the distinction is important in bankruptcy cases.^[75] The court concluded that under a continuing guaranty, each transaction is considered a separate, unilateral contract; and, accordingly, the contingent liability arises when the loan is made, not when the guaranty is executed. “Logically, the conduct which gives rise to the contractual obligation can only occur if credit is extended and a default occurs.”^[76] Therefore, the signing of a guaranty by itself does not obligate a guarantor if credit is never extended. “Under a continuing guaranty, it is unknown what future extensions may be made and thus the liability as of the signing of the guaranty is not ascertainable.”^[77] Accordingly, the court held that the debts at issue did not arise until the credit was extended and therefore had not been discharged.

National Lumber Co. v. Reardon (In re Reardon)^[78]

Background

In December 2009, the debtors, James and Jeanine Reardon (together, “Debtors”) filed a joint petition for relief under Chapter 7 of the Bankruptcy Code. The Chapter 7 trustee filed a report of no distribution, and the case was closed in July 2010. In September 2015, the Debtors moved to reopen their case to amend their schedules to add previously omitted creditors—namely, National Lumber Company (“National”)—and the motion was granted. Thereafter, National filed an adversary complaint alleging that in 2007 the Debtors delivered two personal guaranties with respect to extensions of credit by National to Beechwood Village Realty Trust (“Trust”). The complaint further alleged that the Debtors had never revoked the guaranties, did not schedule National as a creditor, and did not provide notice to National of the bankruptcy; and that in reliance on the personal guaranties, National had extended postpetition credit to the Trust in the amount of $775,000, of which $56,000 remained outstanding.

In March 2007, the Trust, as borrower, had entered into a construction loan agreement with National, as lender, in the principal amount of $230,000, in order to complete a model home at a development owned by the Trust. The Debtors signed a guaranty for the loan. It was undisputed that the construction loan had been paid in full. It was also undisputed that following the filing of the Debtors’ bankruptcy, National had sold goods to the Trust for which there remained a balance of $56,000. National sought (i) a declaration that the Debtors’ liability for the postpetition advances was not discharged and (ii) a money judgment against the Debtors for the amount due.

The Debtors admitted to executing the guaranty. They further admitted that they did not schedule National as a creditor, asserting that the omission was inadvertent. The Debtors alleged that National nevertheless had notice of the bankruptcy and denied that National had relied on the guaranty in extending additional credit to Beechwood. The Debtors also asserted the affirmative defense that the bankruptcy discharged any liability that they had under the continuing guaranty.

Analysis

Following a trial, the bankruptcy court determined that it did not have jurisdiction over National’s request for a money judgment but found that it did have jurisdiction to determine whether the Debtors’ obligations under the guaranty were extinguished by their discharge. The court summarized the primary issue thus: “With respect to a debtor’s liability under a prepetition guaranty for a postpetition extension of credit, the question is whether the debt arose when the guaranty was executed or when credit was later extended to the principal obligor.”^[79] The court agreed with the reasoning of In re Jordan^[80] that the question of when a debt arises is one of federal law, but its determination is informed by state law. The court found that under Massachusetts law, a continuing guaranty is seen as “giving rise to a divisible series of individual transactions, with liability for each extension of credit arising at the time of its extension.”^[81] However, the court concluded that based on its terms, the guaranty at issue was actually a restricted guaranty that was limited to amounts due under the construction loan.

Weeks v. Isabella Bank Corp. (In re Weeks)^[82]

Background

The debtor filed an adversary complaint against Isabella Bank Corp. (“Bank”) alleging that the Bank violated his discharge injunction. The Bank moved for summary judgment. The debtor owned a family medical practice (“Practice”). The Practice had a lending relationship with the Bank going back to 2002, with the debtor guarantying all indebtedness owing from the Practice to the Bank. The debtor and his wife filed for relief under Chapter 7 in February 2005. At the time, the Practice’s indebtedness to the Bank consisted of a $50,000 term loan and a $100,000 line of credit. In June 2005, the Bank renewed the line of credit when it came due and required the debtor to execute a new guaranty, only days after he had received his discharge. The term loan would not come due until 2009.

Fifteen months after the renewal, the line of credit had expired, and the Practice was unable to pay it down. As a result, the Bank consolidated the line of credit and the term loan into a new term note with a maturity date of September 2011. At the same time, the Bank required the debtor to execute a new guaranty. A few weeks later, the Practice ceased operations; and, thereafter, the debtor made seventeen regular payments before advising the Bank that he would no longer make any more payments. The Bank then began demanding payment, which the debtor contended violated his discharge injunction.

Analysis

The court began by pointing out that although section 727(b) of the Bankruptcy Code generally discharges all prepetition debt, a debtor may nonetheless enter into an agreement to pay such debt provided such agreement satisfies the requirements of section 524(c) of the Bankruptcy Code. The debtor asserted that his discharge relieved him of any liability under his prepetition guaranties and that the two postpetition guaranties that he executed were unenforceable because they were reaffirmation agreements that failed to comply with the requirements of section 524(c). The Bank contended that the postpetition guaranties were not reaffirmation agreements because they did not and could not have complied with section 524(c); furthermore, the Bank contended that the postpetition guaranties were enforceable because the Bank had provided new consideration in the form of extending the terms of the loans.

The court noted that section 524(c) is “not artfully drafted” and, “[i]ndeed, it would appear that a comma and an ‘and’ are missing.”^[83] However, the court determined that section 524(c) nonetheless clearly prohibits connecting postpetition agreements with previously discharged debt other than as permitted therein. In other words, although a lender is free to enter into a lending relationship with a newly discharged debtor, section 524(c) strictly prohibits creditors from using a new loan to leverage payment of a previously discharged debt. The court observed that the parties had focused on whether the postpetition guaranties were subject to the requirements of section 524(c), but the court explained that it first needed to determine the implications of the prepetition guaranties because whether the postpetition guaranties were unenforceable reaffirmation agreements would be totally irrelevant if the discharge did not extinguish the debtor’s liability under the prepetition guaranties for the Bank’s alleged extension of postpetition credit.

The court rejected the reasoning of the Ninth Circuit BAP in Getzoff that the broad definition of claim in the Bankruptcy Code means that a debtor’s discharge extends to postpetition advances of credit under a prepetition guaranty. The court described such reasoning as “problematic” because it would permit the debtor to guaranty a hypothetical new equipment loan had he never previously guaranteed any obligations but render unenforceable any guaranty for such new equipment had the Bank had the “unfortunate foresight” to include future indebtedness under the prepetition guaranties.^[84] According to the court, since a reaffirmation agreement must be entered into prior to discharge, the Bank would have had to have realized during the relatively short time frame of the debtor’s bankruptcy that it would need a reaffirmation agreement if it ever intended to extend additional credit postpetition. From the court’s perspective, the more practical resolution would be to require a debtor to affirmatively revoke a continuing guaranty in order to escape liability for future advances. Thus, the debtor had a choice to make—postpetition, he simply could revoke the guaranty and risk the possibility that the Bank would not extend new credit to the Practice.

However, the court also concluded that the Bank never made a new loan with respect to the prepetition term loan but simply modified the loan when it consolidated the unmatured term loan with the extended line of credit. Since the debtor’s obligation on the term loan arose prepetition and had not been reaffirmed pursuant to section 524(c), the court denied summary judgment and allowed the debtor to proceed with his claims with respect to the term loan.

11 U.S.C. § 101(12)

The term “debt” means liability on a claim.

11 U.S.C. § 101(5)

The term “claim” means—

1. right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
2. right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.

11 U.S.C. § 523(a)(3)

A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

. . .

(3) neither listed nor scheduled under section 521(a)(1) of this title, with the name, if known to the debtor, of the creditor to whom such debt is owed, in time to permit—

1. if such debt is not of a kind specified in paragraph (2), (4), or (6) of this subsection, timely filing a proof of claim, unless such creditor had notice or actual knowledge of the case in time for such timely filing; or
2. if such debt is of a kind specified in paragraph (2), (4), or (6) of this subsection, timely filing of a proof of claim and timely request for a determination of dischargeability of such debt under one of such paragraphs, unless such creditor had notice or actual knowledge of the case in time for such timely filing and request[.]

11 U.S.C. § 727(b)

Except as provided in section 523 of this title, a discharge under subsection (a) of this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter, and any liability on a claim that is determined under section 502 of this title as if such claim had arisen before the commencement of the case, whether or not a proof of claim based on any such debt or liability is filed under section 501 of this title, and whether or not a claim based on any such debt or liability is allowed under section 502 of this title.

11 U.S.C. § 524(c) and (d)

(c) An agreement between a holder of a claim and the debtor, the consideration for which, in whole or in part, is based on a debt that is dischargeable in a case under this title is enforceable only to any extent enforceable under applicable nonbankruptcy law, whether or not discharge of such debt is waived, only if—

1. such agreement was made before the granting of the discharge under section 727, 1141, 1192, 1228, or 1328 of this title;
2. the debtor received the disclosures described in subsection (k) at or before the time at which the debtor signed the agreement;
3. such agreement has been filed with the court and, if applicable, accompanied by a declaration or an affidavit of the attorney that represented the debtor during the course of negotiating an agreement under this subsection, which states that—
   1. such agreement represents a fully informed and voluntary agreement by the debtor;
   2. such agreement does not impose an undue hardship on the debtor or a dependent of the debtor; and
   3. the attorney fully advised the debtor of the legal effect and consequences of—
      1. an agreement of the kind specified in this subsection; and
      2. any default under such an agreement;
4. the debtor has not rescinded such agreement at any time prior to discharge or within sixty days after such agreement is filed with the court, whichever occurs later, by giving notice of rescission to the holder of such claim;
5. the provisions of subsection (d) of this section have been complied with; and
6. 1. in a case concerning an individual who was not represented by an attorney during the course of negotiating an agreement under this subsection, the court approves such agreement as—
      1. not imposing an undue hardship on the debtor or a dependent of the debtor; and
      2. in the best interest of the debtor.
   2. Subparagraph (A) shall not apply to the extent that such debt is a consumer debt secured by real property.

(d) In a case concerning an individual, when the court has determined whether to grant or not to grant a discharge under section 727, 1141, 1192, 1228, or 1328 of this title, the court may hold a hearing at which the debtor shall appear in person. At any such hearing, the court shall inform the debtor that a discharge has been granted or the reason why a discharge has not been granted. If a discharge has been granted and if the debtor desires to make an agreement of the kind specified in subsection (c) of this section and was not represented by an attorney during the course of negotiating such agreement, then the court shall hold a hearing at which the debtor shall appear in person and at such hearing the court shall—

1. inform the debtor—
   1. that such an agreement is not required under this title, under nonbankruptcy law, or under any agreement not made in accordance with the provisions of subsection (c) of this section; and
   2. of the legal effect and consequences of—
      1. an agreement of the kind specified in subsection (c) of this section; and
      2. a default under such an agreement; and
2. determine whether the agreement that the debtor desires to make complies with the requirements of subsection (c)(6) of this section, if the consideration for such agreement is based in whole or in part on a consumer debt that is not secured by real property of the debtor.

1. No. 19-34054-sgj11, Adv. No. 21-03003-sgi, 2021 WL 5769320 (Bankr. N.D. Tex. Dec. 3, 2021) (memorandum opinion and order denying arbitration request and related relief). ↑

2. Id. at *4. ↑

3. Id. ↑

4. Id. ↑

5. 482 U.S. 220 (1987). ↑

6. 847 F.3d 231 (5th Cir. 2017). ↑

7. Highland Capital, Adv. No. 21-03003-sgi, at *8. ↑

8. Id. ↑

9. Jay Westbrook, The Coming Encounter: International Arbitration and Bankruptcy, 67 Univ. of Minn. Law School 595, 623 (1983). ↑

10. Fleming, 325 B.R. 687 (Bankr. D. Del. 2005). ↑

11. Id. ↑

12. Id. at 690. ↑

13. Id. at 691 (quoting Hoxworth v. Blinder, Robinson & Co., 980 F.2d 912, 925 (3d Cir. 1992)). ↑

14. No. 03-695, 2003 WL 21994811 (E.D. Pa. Aug. 18, 2003). ↑

15. Fleming, 325 B.R. at 694. ↑

16. Id. ↑

17. 434 F.3d 222 (3d Cir. 2006). ↑

18. 885 F.2d 1149 (3d Cir. 1989). ↑

19. Mintze, 434 F.3d at 230 (quoting Hays, 885 F.2d at 1150). ↑

20. Id. at 229 (citing Hays, 885 F.2d at 1161). ↑

21. Id. at 230. ↑

22. Id. at 233. ↑

23. No. 3:09-CV-0724-N, 2014 WL 12654910 (N.D. Tex. July 30, 2014). ↑

24. Id. at *2. ↑

25. Id. at *5. ↑

26. Id. at *9. ↑

27. Id. at *13 (quoting In re Nat’l Gypsum Co., 118 F.3d 1056, 1068 (5th Cir. 1997)). ↑

28. Id. at *17. ↑

29. Id. at *19. ↑

30. 630 B.R. 160 (Bankr. D. Md. 2021). ↑

31. Id. at 166. ↑

32. Id. ↑

33. Id. at 166–67. ↑

34. Id. at 167. ↑

35. Id. ↑

36. Id. at 168. ↑

37. 980 F.2d 912 (3d Cir. 1992). ↑

38. Id. at 925 (citing Gavlik Constr. Co. v. H.F. Campbell Co., 526 F.2d 777, 784 (3d Cir. 1975)). ↑

39. Id. at 926. ↑

40. 307 B.R. 449 (D. Del. 2004). ↑

41. Id. at 454 (quoting Hoxworth, 980 F.2d at 925). ↑

42. No. 03-695, 2003 WL 21994811 (E.D. Pa. Aug. 18, 2003). ↑

43. Id. at *3. ↑

44. 607 F.3d 114 (3d Cir. 2010). ↑

45. 744 F.2d 332 (3d Cir. 1984). ↑

46. Grossman’s, 607 F.3d at 120. ↑

47. Id. at 121. ↑

48. Id. ↑

49. Id. at 125. ↑

50. Id. ↑

51. No. 14-20454-beh, Adv. No. 20-02091, 2021 WL 3700401 (Bankr. E.D. Wis. Aug. 19, 2021). ↑

52. Id. at *1. ↑

53. Id. at *4. ↑

54. Id. ↑

55. Id. at *5. ↑

56. Id. ↑

57. 494 B.R. 562 (Bankr. M.D. Fla. 2013). ↑

58. Id. at 566. ↑

59. Id. at 567 (quoting In re Stillwell, 2012 WL 441193, at *3 (Bankr. D. Neb. Feb. 10, 2012)). ↑

60. Id. at 568. ↑

61. 433 B.R. 668 (Bankr. E.D. Mich. 2010). ↑

62. Id. at 669–70. ↑

63. Id. at 670. ↑

64. Id. ↑

65. 115 B.R. 504 (E.D. Pa. 1990). ↑

66. Lipa, 433 B.R. at 670 (quoting Pennypacker, 115 B.R. at 507). ↑

67. Id. (quoting In re Baldwin-United Corp., 55 B.R. 885, 898 (Bankr. S.D. Ohio 1985)). ↑

68. 180 B.R. 572 (9th Cir. BAP 1995). ↑

69. Id. at 573. ↑

70. Id. at 574. ↑

71. Id. ↑

72. 612 B.R. 372 (6th Cir. BAP 2020). ↑

73. 585 B.R. 224 (Bankr. W.D. Va. 2018). ↑

74. Id. at 227. ↑

75. Id. at 228. ↑

76. Id. at 229–30. ↑

77. Id. at 230. ↑

78. 566 B.R. 119 (Bankr. D. Mass. 2017). ↑

79. Id. at 127. ↑

80. 2006 WL 1999117 (Bankr. M.D. Ala. 2006). ↑

81. Reardon, 566 B.R. at 128. ↑

82. 400 B.R. 117 (Bankr. W.D. Mich. 2009). ↑

83. Id. at 122. ↑

84. Id. at 123–24. ↑

A rapid transformation in consumer finance is being brought about by open banking—a pivotal innovation that allows consumers to give third parties real-time access to their detailed financial data. Open banking has the potential to increase transparency, promote account portability, spur competition, and drive the next wave of innovation in consumer financial services.

Organic Market-Led Growth in the US

Over the last twenty years, open banking technology and use cases in the United States have developed organically, without significant federal or state regulatory intervention. The growth of open banking has been led by data aggregators—middlemen that use technology to extract data from a broad swath of financial institutions and provide it to third parties, which have predominantly been nonbank fintechs but increasingly include banks. Open banking creates opportunities for the companies leveraging this data to offer innovative products and features. But it simultaneously exposes consumers and financial institutions to significant risks, including data security vulnerabilities and unauthorized data use.

At the same time, governments around the world are granting consumers more rights to access their financial data and control how it is used and disclosed. The United Kingdom, the European Union, Singapore, and Australia, among others, have enacted open banking frameworks regulating consumer-permissioned sharing of financial data.

A Turning Point: New Rules Governing Consumers’ Personal Financial Data Rights

In October 2024, the Consumer Financial Protection Bureau (“CFPB”) issued final rules governing Personal Financial Data Rights under Section 1033 of the Dodd-Frank Act. After an eight-year rulemaking journey, the final rules codify consumers’ rights to

1. access their financial data electronically via “consumer interfaces,” such as a website or mobile app; and
2. delegate access to an “authorized third party” that can access data via a “developer interface,” such as an application developer interface (“API”).

The rules also require consumer disclosures and informed consent before a consumer may authorize a third party to access data, and they impose substantive limitations on how such third parties may access, use, and retain data. The rule also creates obligations for data accuracy and security.

While the rules don’t explicitly prohibit third parties from screen scraping—a controversial practice where a third party collects the consumer’s online banking credentials (username and password) to log in as the consumer and extract data from a bank’s website—they require data providers to offer more secure data sharing channels to mitigate risks and improve data sharing efficiency.

Transformative Potential of Open Banking Rails and Data

The transformative potential of open banking in consumer finance is just beginning to be understood. Take credit underwriting as a prominent example. By leveraging real-time, granular transaction data directly from a consumer’s deposit account, lenders can develop accurate assessments of financial health and ability to pay that move beyond the limitations of traditional credit reports, which can be stale and plagued with inaccuracies. Innovative use cases are also enabling better personal financial management and budgeting tools, faster identity verification, and smarter payments. This shift in capabilities has broad implications for expanding financial inclusion and enabling the next generation of personalized financial services. Like self-driving cars enabled by sensors that collect thousands of data points a second, and the powerful computers and systems that analyze and react to these data points to avoid collisions, open banking tools are providing the data points and signals that innovative financial services companies need to create an “autopilot” for the average consumer’s financial life.

Areas of Consensus and Controversy

There are areas of consensus in the final rules that should be celebrated, including requirements for clear and meaningful consumer disclosures and robust data security requirements for all parties handling sensitive financial data. However, controversies persist regarding many policy choices in the final rules. For example, the rules only subject certain financial products to disclosure, including credit cards and deposit accounts, while excluding a host of other financial products, including mortgages, auto loans, and investments. The rules also place significant restrictions on third parties receiving data by requiring that all use and retention be limited to what is “reasonably necessary” to deliver a consumer’s requested product or service—an amorphous standard that could be read to restrict innovative secondary uses. And while screen scraping is viewed critically as a risky and outdated practice, it remains permissible under the rules, placing the burden of managing its consequences on data providers. There are also strategic and technical decisions data providers and third parties must make, from API design to bilateral agreements that properly allocate liability for errors, fraud and data breaches, and risk management protocols. Banks may experience an influx of requests for data from authorized third parties, and their third-party risk management practices will need to adapt to assess the unique risks presented by these third parties.

The CFPB’s final rules also rely on “recognized standard setters” to develop “consensus standards” for data formats and access protocols, which are intended to promote interoperability, making it easy for a third party to obtain and digest similar data from multiple data providers. However, the coexistence of multiple data formatting standards (and proprietary formats from data aggregators) complicates this effort to achieve seamless interoperability.

Lastly, the integration of payment initiation data, such as bank account numbers and routing numbers used for ACH transactions, into open banking frameworks introduces opportunities for “pay by bank” services to challenge existing card networks. But these advancements also raise fraud concerns, requiring innovative solutions such as tokenized account numbers (“TANs”) to enhance security.

The Path Forward

Challenges lie ahead for the sound regulation of open banking in the US. A national banking trade association filed suit to stop the rule from taking effect the day it was finalized, and shifts in the CFPB’s leadership and regulatory priorities could cause the agency to amend the final rules in the near term. Notwithstanding these regulatory controversies and headwinds, the demand for consumer-authorized data sharing is expected to continue growing, driven by market forces and consumer expectations for greater control over their financial data.

Data providers will need to identify and document the “covered data” in their control or possession that is subject to disclosure, design compliant APIs, and establish robust third-party risk management protocols. Third parties accessing data, including fintechs and data aggregators, must evaluate their compliance strategies, consumer-facing experiences, and approaches to managing data use and retention. Questions around liability for errors, means of achieving accuracy and interoperability, and minimum contractual terms for third party access remain critical.

This is a transformative moment for open banking and the consumer financial services industry more broadly. Banks, fintechs, standard-setting organizations, and regulators are being pushed to work together in new ways. Now it is incumbent upon them to find common ground to support innovation, manage the operational and regulatory risks presented, and deliver real value to consumers.

Franchising, both domestically and abroad, represents a massive force driving economic growth. In 2023 alone, franchising output eclipsed $893 billion, with a rapidly growing trajectory that will likely see that number continue to grow in the coming years.^[1] As with many of the industries seeing continued growth and success, the franchising industry has become increasingly in demand, with companies seeking to expand their footprint through mergers and acquisitions (“M&A”).^[2] In particular, franchise systems have become sought-after targets for private equity companies.^[3] While acquiring franchise systems can provide lucrative growth opportunities, the industry presents challenges unique from those of other sectors.

Franchising is a highly regulated industry governed by a multitude of federal and state laws regarding the relationship between the franchisor and the franchisee.^[4] For eager investors and expanding companies, this complex legal framework can often be overlooked, overshadowed by the potential for massive financial gain achieved by either acquiring or merging with successful franchise systems. However, navigating this complex statutory and regulatory landscape is crucial for avoiding legal pitfalls that could significantly impact the success of the deal. New acquisitions are often followed by attempts to cut costs using a variety of strategies, one of which is terminating underperforming franchisees. In many states, investors are surprised to find that terminations are subject to a number of state-specific laws governing the relationship between franchisors and franchisees. Currently, twenty-three states have laws governing the relationship between franchisors and franchisees.^[5] Franchise relationships are also subject to the vast array of contractual obligations established in franchise agreements.

Beyond compliance with existing laws and applicable contractual provisions, prospective stakeholders must also carefully consider the relationship dynamics between the franchisor and franchisees. Unlike typical corporate acquisitions, where a company owns and controls its subsidiaries, franchise systems involve independent franchise owners who operate their businesses under the franchisor’s brand. While franchisees within a given system use a common set of trademarks and are subject to standardized system standards and requirements, each franchisee is ultimately responsible for the successful operation of their locations.^[6] Due to the more independent nature of franchisee operations, the success and satisfaction of these franchisees are essential for a successful franchise system. So, how can prospective investors maximize the success of a franchise system following an acquisition?

Strategies for Successful Franchise Acquisitions

Establish Clear Communication

One of the most important aspects of post-acquisition success is maintaining open, transparent lines of communication with franchisees. Franchisees, who are often independent business owners with significant investments, may feel uncertain or anxious about changes to the system. New ownership should immediately establish trust by holding open forums or meetings where franchisees can ask questions and voice concerns. Franchisee satisfaction is closely tied to franchisees’ perception of being heard by franchisors, which in turn affects overall performance and system growth. By being proactive in addressing concerns and outlining a clear vision for the future, new owners can mitigate potential disruptions and foster a positive transition. Trust is essential for franchisee buy-in, and clear communication builds that trust from the outset.

Engage in Collaborative Decision-Making

Allowing franchisees to have a seat at the table regarding important operational decisions can foster goodwill and system-wide buy-in.^[7] This could involve establishing a franchisee advisory council, which offers a structured way for franchisees to collaborate with the corporate team. Some franchise systems also have independent franchisee associations, which can serve as valuable allies for franchisors if sufficient effort is put into developing successful relationships.^[8] Research suggests that franchisee involvement and satisfaction lead to positive outcomes for the franchise system as a whole.^[9] Collaboration with experienced franchisees can also benefit franchisors. Franchisees often have extensive experience with the success and challenges faced by the system, providing practical insights into the success (or lack thereof) of different initiatives.

Think Beyond the Numbers

In the rush to maximize profits after an acquisition, some investors focus heavily on increasing EBITDA (earnings before interest, taxes, depreciation, and amortization). While EBITDA growth is important, it’s equally critical to take a long-term view of the franchise’s value, particularly regarding brand equity and sustainability. Short-term cost-cutting measures, such as reducing marketing spend or increasing franchise fees, may boost immediate profits but can erode the brand’s reputation and the satisfaction of franchisees. Instead, new ownership should focus on investments that build the brand’s reputation, customer loyalty, and franchisee success over time. 

A Tale of Two Acquisitions

The abovementioned points are showcased in two notable acquisitions within the franchise world. The first (Quiznos) serves as a cautionary tale, and the second (Popeyes), a playbook for success. These two acquisitions represent significantly different strategies for franchisee relations, resulting in two vastly different outcomes for each system. These cases also emphasize the importance of thorough due diligence prior to the acquisition of a franchise system. While financial statements and market trends provide necessary information for prospective investors, diligent investors and the lawyers who represent them can also learn invaluable information from those operating franchise systems at the ground level: the franchisees. As these case studies demonstrate, the success of a franchise system is inherently tied to the success of its individual franchisees.

Quiznos: The High Cost of Ignoring System Stability

In 2006, Quiznos became the target of a leveraged buyout (“LBO”) led by a private equity firm. At the time, Quiznos appeared to be a thriving franchise system with over 5,000 locations.^[10] However, the LBO saddled the company with significant debt, creating a financial environment where short-term profit extraction and aggressive cost-cutting took precedence over franchisee success. Over the next decade, Quiznos’s mismanagement of its franchisee relationships and systemic neglect led to lawsuits, closures, and a collapse that serves as a cautionary tale for the franchising industry. While Greg Brenneman’s tenure as chief executive officer (“CEO”) saw briefly improved relations due to his dedication to improved communication, Quiznos’s management ultimately failed to meaningfully work with franchisees long-term.

Lack of Meaningful Communication with Franchisees

Quiznos’s corporate leadership, under the financial pressures imposed by private equity ownership, operated with a one-sided approach that created significant discontent among franchisees. Quiznos largely failed to engage with its franchisees in meaningful dialogue. Complaints about high food costs, driven by mandatory purchasing agreements with corporate-approved suppliers at inflated prices, were ignored.^[11]

Over time, these unresolved issues fractured trust within the system, leading many franchisees to file lawsuits alleging fraud, breach of contract, and other claims. Transparent communication and a willingness to address franchisee concerns could have mitigated this crisis. Instead, the company’s silence and disregard for franchisee well-being amplified frustrations, destabilizing the system and tarnishing its reputation.

Failure to Involve Franchisees in Meaningful Decisions

Rather than fostering collaboration with franchisees, Quiznos imposed unilateral decisions that prioritized rapid revenue growth. The company pursued an aggressive expansion strategy, often saturating markets by placing new locations near existing ones.^[12] This policy forced franchisees into direct competition, diluting individual store profits and further straining relationships between franchisees and corporate leadership.

Quiznos also failed to meaningfully engage franchisees in the decision-making process surrounding food suppliers. While many fast-food franchisors negotiate with vendors who then supply locations directly (at a reduced cost since they’re buying in bulk), Quiznos corporate bought all of its supplies from vendors and then sold them to franchisees, resulting in substantially higher costs. While this decision may have been Quiznos’s contractual right, it ultimately cut into the margins of franchisees, reducing their earnings and making it difficult to earn any meaningful profit.^[13] Franchisees repeatedly requested a change in food sourcing to align with the industry standard preference for food co-ops, but Quiznos’s management held firm on its position.^[14]

Quiznos also took an adversarial approach to independently forming franchisee associations.^[15] Rather than seeing the associations as cooperative partners, the value of which has been seen in numerous franchise systems,^[16] management refused to meaningfully work with the formed associations.

Short-Term Thinking, Long-Term Consequences

The LBO also led to policies that emphasized short-term financial gains over the system’s long-term health. High franchise fees and royalties, combined with costly operational mandates, placed significant financial strain on franchisees. These revenue-generation strategies temporarily improved Quiznos’s EBITDA but undermined the profitability of its operators, forcing many into financial distress.

Additionally, Quiznos reduced investments in franchisee support, such as training, marketing, and operational resources. These cost-cutting measures saved money in the short term but left franchisees ill-equipped to navigate challenges, further exacerbating their struggles. As closures became rampant and legal disputes mounted, Quiznos’s reputation with franchisees, customers, and the market deteriorated. By 2014, Quiznos filed for bankruptcy, with its store count plummeting from over 5,000 locations to fewer than 400.

Lessons from the Decline

Quiznos’s collapse underscores the dangers of prioritizing short-term financial metrics over system stability and franchisee well-being. Where Popeyes (discussed below) thrived by embracing transparency, shared decision-making, and long-term investments, Quiznos crumbled under the weight of mistrust, overreach, and shortsightedness driven by private equity pressures.

The disconnect between corporate executives and franchisees also cost millions in litigation and settlements. In 2010, Quiznos settled a class action with disgruntled franchisees to the whopping tune of $206 million.^[17] Several other settlements have been reached with franchisees in the following years, resulting in the franchisor paying over $40 million in 2012 to a group of franchisees. Settlements have continued to be reached in franchise-related litigation as recently as 2020.^[18] These massive awards and countless years of litigation illustrate the importance of working collaboratively with franchisees early to ensure effective communication and collaboration.

For investors in franchising, this case highlights the risks of ignoring the operational foundations of the business. A franchise system is only as strong as the trust between franchisors and franchisees. When that trust is broken, no amount of aggressive growth or cost-cutting can compensate for the damage. Quiznos serves as a powerful reminder that success in franchising depends not just on financial engineering but on the strength of the relationships that sustain it.

Popeyes: A Recipe for Post-Acquisition Success

When Cheryl Bachelder stepped into her leadership role as CEO of Popeyes Louisiana Kitchen in 2007, the brand was struggling. Once a celebrated name in the quick-service industry, Popeyes had stagnated. Franchisees were disgruntled, profits were underwhelming, and the relationship between corporate and franchise owners was fractured. Yet, what could have been a cautionary tale in franchise mismanagement became a textbook example of post-acquisition success—rooted in the earlier strategies of clear communication, collaboration, and a steadfast focus on long-term growth.

Rebuilding Trust Through Transparent Communication

One of Bachelder’s first priorities was to bridge the chasm of mistrust between the corporate office and its franchisees. Years of one-sided, top-down decision-making had left franchisees feeling unheard and undervalued—sentiments that significantly stymie franchise systems.^[19] Bachelder turned the tide by establishing open forums, creating a space for franchisees to express their concerns and contribute ideas. This took multiple forms, one of which was conducting franchisee satisfaction surveys, something that the previous Popeyes ownership had declined to do.

Inviting Franchisees to the Table

Under Bachelder’s leadership, Popeyes took the bold step of embedding franchisee voices into the company’s decision-making process. By forming a franchisee advisory council, Bachelder ensured that operational strategies reflected the on-the-ground realities of franchise operations. Franchisees were invited to participate in high-level discussions about Popeyes’s strategy, particularly in discussions that directly impacted them, such as implementing a national advertising fund and increasing advertising contributions from franchisees.^[20] By involving franchisees in the strategy and discussions, Bachelder was able to more effectively convey the overall vision for corporate strategies. This strategy was successful, with the franchisees agreeing to increase their advertising contributions and transition to a more nationally focused advertising effort.

While many franchisors reserve the contractual right to unilaterally increase advertising fees (subject to some limitations), practically speaking, this move often results in significant pushback from franchisees. The decision by Popeyes’s leadership to include franchisees in discussions helped earn their buy-in to corporate initiatives.^[21] While franchisors oftentimes have the opportunity to make sweeping changes unilaterally under the language of their franchise agreements, the decision to include franchisees in the process results in greater collaboration, trust, and alignment between the franchisor and franchisees.

Shifting Focus from Quick Wins to Lasting Value

Rather than chasing short-term gains, Bachelder focused on fortifying Popeyes’s long-term value. She spearheaded initiatives that revitalized the brand, such as overhauling the menu, launching a Louisiana-themed marketing campaign, and introducing operational improvements. Perhaps most crucially, she restructured the financial relationship with franchisees, ensuring their profitability and encouraging reinvestment. These measures reflect a core principle explored in this paper: while immediate profitability may tempt new owners, sustainable growth demands thoughtful investments in the brand, franchisees, and customers alike.

Achieving Success Through Collaboration

The results of Bachelder’s strategy speak volumes. Over seven years, Popeyes experienced a dramatic resurgence in franchisee satisfaction, profitability, and market share. These more intangible improvements were reflected in the company’s financials as well. When Bachelder took over in 2007, Popeyes’s share prices were approximately $16.^[22] In 2017, when Popeyes was acquired by Restaurant Brands International, the share price had grown by a whopping 388 percent.^[23] Restaurant Brands International ultimately ended up paying $1.8 billion to acquire the franchise system.

A collaborative approach with franchisees also reduces the chances of burdensome litigation from displeased franchisees following an acquisition.^[24] For investors hoping to eventually profit off the sale of the franchise system later down the road, reducing the footprint of franchisee litigation within the system can lead to a more attractive valuation.

Bachelder’s journey at Popeyes underscores the lessons explored in this paper: post-acquisition success requires more than financial acumen—it requires building trust with franchisees, inviting collaboration at all levels of the franchise system, and balancing short-term financial demands with long-term aspirations for growth. For prospective investors in the franchising industry, Popeyes offers an invaluable case study on how to revitalize a system and secure enduring success in a competitive landscape. It proves that satisfying franchisee stakeholders and increasing company value aren’t mutually exclusive but rather deeply intertwined.

Conclusion

In the competitive and highly regulated franchising landscape, prospective investors must approach potential acquisitions of a franchised system with a nuanced understanding beyond mere financial metrics. The complexities of franchise laws and the intricate relationships between franchisors and franchisees demand a strategy that accounts for the vast array of franchising laws and regulations and strikes a sustainable balance between short-term financial success and long-term system growth. Successful integration of a franchise system hinges on more than just optimizing EBITDA; it requires fostering franchisee trust, ensuring collaborative decision-making, and making thoughtful investments that enhance brand equity and operational sustainability.

By recognizing the unique dynamics of the franchise model and addressing them with transparency and foresight, investors can position themselves to achieve sustained growth, brand loyalty, and enduring success in a rapidly expanding industry. Ultimately, those who recognize and prioritize franchisee engagement and success are not only going to be better positioned to comply with franchise laws and applicable contractual obligations, but they’re also more likely to realize more sustained financial growth within the system. A thriving franchise system is built on thriving franchisees—those who understand this simple truth are poised to turn their investments into enduring success stories.

1. Ashley Rogers, Jin Qi & Khadija Cochinwala, 2024 Franchising Economic Outlook (Int’l Franchise Ass’n & FRANdata Feb. 14, 2024). ↑

2. Alan R. Greenfield, Christina M. Noyes & Sherin Sakr, Presentation at the Am. Bar Ass’n 40th Annual Forum on Franchising: Mergers & Acquisitions: The Basics for Buying and Selling the System (Oct. 20, 2017). ↑

3. Id. ↑

4. Fundamentals of Franchising (Rupert Barkoff, Joseph Fittante Jr., Ronald Gardner Jr. & Andrew Selden eds., 4th ed. 2015). ↑

5. Id. ↑

6. Fundamentals of Franchising, supra note 4. ↑

7. Andrew Beilfuss, Ronald K. Gardner Jr., Eric H. Karp, Brenda B. Trickey & Kate B. Ward, Presentation at the Am. Bar Ass’n 47th Annual Forum on Franchising: Multiple Voices at the Table: Effective Franchisee Associations and Franchise Advisory Councils (Oct. 16, 2024). ↑

8. Greenfield et al., supra note 2. ↑

9. Fundamentals of Franchising, supra note 4. ↑

10. Katie Porter, What Happened to Quiznos? 4,000+ Closures—but There’s Still Hope, 1851 Franchise (updated Jan. 13, 2023). ↑

11. Jonathan Maze, A Brief History of Quiznos’ Collapse, Rest. Bus. (June 13, 2018). ↑

12. Keith Donovan, What Happened to Quiznos? (A Franchisee Hellscape), Startup Stumbles (Apr. 9, 2024). ↑

13. Jason Daley, Why These 3 Once Thriving Franchises Have Fallen on Hard Times, Entrepreneur (Aug. 6, 2014). ↑

14. Jonathan Maze, Has Quiznos Changed?, Franchise Times (updated Nov. 24, 2020). ↑

15. Id. ↑

16. Fundamentals of Franchising, supra note 4. ↑

17. Janet Sparks, Quiznos Settlement Finalized, Among Highest Penalties in Franchising, Marks & Klein LLP (Aug. 17, 2010). ↑

18. Beth Ewen, Leading Plaintiff Settles in Quiznos Lawsuits, Franchise Times (updated Oct. 12, 2020). ↑

19. Beilfuss et al., supra note 7. ↑

20. Cheryl A. Bachelder, The CEO of Popeyes on Treating Franchisees as the Most Important Customers, Harv. Bus. Rev. (Oct. 2016). ↑

21. Id. ↑

22. Popeyes Louisiana Kitchen, Inc. (PLKI) Stock Price History, Macrotrends (last visited Nov. 22, 2024). ↑

23. Id. ↑

24. Kirk Reilly, L. Seth Stadfeld & Phillip Leslie Wharton, Presentation at the Am. Bar Ass’n 29th Annual Forum on Franchising: Litigation After Acquisition of a Competing Franchise System (Oct. 11–13, 2006). ↑

Lateral partner hiring has become an essential component of law firms’ business development strategies, allowing firms to expand client relationships, strengthen practice groups, and enhance their competitive position in the legal market. However, while recruiting top talent is a significant investment, integration remains the determining factor in whether a lateral hire ultimately succeeds.

A failed lateral integration can have significant consequences, with an impact on not just the individual attorney but also firm morale, client retention, and overall profitability. Despite the high stakes, many firms lack a structured, accountable approach to ensuring a smooth transition.

Through conversations with law firm leaders who have managed the integration process or experienced it firsthand, this article highlights the essential components of a successful lateral partner transition and offers concrete strategies for law firms looking to maximize their investment in new talent.

1. Strategic Alignment: Identifying Success Before the Move

Before a lateral partner joins a new firm, both the firm and the partner must share a clear vision of what success looks like. Whether the goal is to expand into a new market, support existing client relationships, or strengthen a particular practice area, alignment on strategic priorities is critical.

Britt Schmidt, Chief Legal Talent and Inclusion Officer at Vorys, stresses the importance of setting expectations early. “In terms of successful integration, it all comes back to defining what success looks like,” she said. “We spend time up front discussing this with each lateral partner because success can mean different things depending on the reasons for the hire. It’s about aligning their goals with the firm’s strategic objectives.”

Similarly, David McClune, Chief Marketing & Business Development Officer at Davis Polk & Wardwell, highlights the risks of misalignment: “Lateral hiring is inherently risky, and there’s no one-size-fits-all solution. It’s crucial to have a clear understanding of what success looks like for both the firm and the lateral partner. This involves setting realistic goals and ensuring that the partner’s practice aligns with the firm’s strategic priorities.”

A key part of this alignment is integrating the lateral’s practice into the firm’s existing platform. A formal client cross-selling strategy should be developed as part of the lateral’s integration plan, with buy-in from all relevant stakeholders. This includes identifying how the lateral’s clients can benefit from the firm’s broader capabilities and determining where existing firm clients can leverage the lateral’s expertise.

This process requires coordination between the lateral partner, practice group leaders, business development teams, and key partners across the firm. Without this level of engagement, laterals may struggle to find their place within the firm’s business development ecosystem, limiting cross-selling opportunities and diminishing their long-term impact.

Lilit Asadourian, Partner at Barnes & Thornburg, points to that kind of engagement in describing how she assessed whether a firm was truly committed to her success. “I could tell right away that I was talking to a firm that was serious about me. It was clear because they were moving quickly, they were moving deliberately, and they had a defined vision of how I would fit into their strategic goals,” she said. “This alignment was crucial because it showed me that they valued my practice and were committed to supporting my growth.”

Firms that define success early, create a clear roadmap, and integrate laterals into the firm’s broader client strategy set the foundation for a smooth and effective transition.

2. Relationship Building: Proactively Facilitating Connections

Lateral integration is not just about business strategy; it is about people. The most successful laterals establish strong internal networks quickly, yet many firms take a passive approach, assuming that lateral partners will navigate the firm’s culture and relationships on their own.

Firms that take a hands-on approach to facilitating connections see better outcomes. At Vorys, for example, the firm ensures laterals are introduced to key stakeholders early. “We call them colleague connections,” Schmidt said. “We’ve already identified what they should see in a ninety-day plan and the key people they need to meet early on. We are putting those meetings on their calendar for them and act as matchmakers before they even get here.”

Sarah Kelly-Kilgore, Partner at Holland & Knight LLP, underscores the importance of internal visibility. “The more that you’re able to speak about your practice internally and connect with new colleagues to let them know you’re there and available, the better,” she said.

The scope of integration required of a successful transfer can be extensive. Joseph Welch, Partner at Blank Rome LLP, notes that he has opened over one hundred matters in the couple of years since he joined the firm. “This client demand has required me to integrate very quickly and get to know as many of my law partners and colleagues as possible. While great legal support is essential for growing and maintaining a sizable book of business, the firm’s business and marketing teams are equally important for continued success,” he said. “I enjoy regular (often weekly) meetings with our firm’s marketing and business support teams to make sure I’m reaching the right audiences and staying ahead of developing legal needs.”

Early introductions help new partners feel confident in their transition, Anna Maria Vitek, Executive Director of Lateral Partner Integration and Strategy at DLA Piper, explains. “We have dedicated support teams who can help them with a variety of different things on the logistical side. We have meetings scheduled as soon as they’re ready to join the firm where we introduce them to the administrative team that will support their onboarding and integration. This coordinated effort really helps our laterals feel supported and provides them with reassurance that they have made the right decision to join DLA Piper.”

Strong internal relationships accelerate integration, foster collaboration, and lay the foundation for long-term success.

3. Structured Oversight: Managing the Integration Process

Many lateral hires struggle not because they lack talent or business potential, but because their integration is left unstructured. A well-designed lateral integration program includes key milestones, regular check-ins, and clear performance metrics.

Patrick S. Tracey, Partner at Saul Ewing LLP, shares how a structured onboarding program made his transition seamless: “The firm’s onboarding program provided a comprehensive road map and introduction to the firm’s culture, policies, and initiatives. The guidance provided both nationally and locally from fellow partners, associates, and staff was critical to the transition.”

Taking ownership of the transition can accelerate success, says Licia Vaughn, Executive Director, Lateral Partner Integration, Strategy & Transitions at DLA Piper. “I had a corporate partner who joined from in-house and ramped up quickly because he approached the firm as his most valuable client. He was proactive and took everything seriously, including the plan we provided, which made his integration seamless,” she said.

McClune noted that rewarding leadership also helps drive successful integration efforts: “At a previous firm, we had a process where sponsoring partners were responsible for regularly checking in with laterals, especially in the first few months. This proactive management was incentivized and helped identify and address roadblocks early on.”

Firms that prioritize lateral success create incentives that reinforce the right behaviors. Recognizing a sponsoring partner’s role in a lateral’s success in compensation discussions encourages active engagement in the integration process. Aligning financial incentives with partner collaboration and client-sharing strengthens firmwide participation and fosters a culture where laterals are positioned to contribute more effectively. Individuals responsible for lateral integration, such as business development professionals or integration managers, are similarly more invested in outcomes when their compensation reflects measurable success. When integration is treated as a strategic function rather than an administrative task, firms maximize the impact of their lateral hires and strengthen long-term retention.

4. Measuring Success: Accountability in Lateral Integration

Without ongoing accountability and continuous refinement of the recruiting and onboarding approach, even a well-structured integration plan can fall short. Clearly defining responsibility for lateral success is critical. Firms often distribute ownership of integration across multiple departments—recruiting, business development, practice group leadership—without a single person or team ensuring that the process stays on track. When no one is specifically accountable, integration can become an afterthought, and the lateral’s long-term success is left to chance.

Firms that take a data-driven approach to lateral hiring and integration can refine their strategy over time. McClune underscores the importance of evaluating hiring decisions carefully and making adjustments based on real outcomes. “So much of the success of a lateral program comes down to the due diligence or recruiting process,” he said. “Firms can rush to make quick decisions to plug strategic gaps without taking the investment time to do proper due diligence.”

Firms that systematically track client retention, revenue growth, internal engagement, and business development activity can identify patterns in lateral success and failure. Metrics such as client follow-through on expected transitions, the depth of client relationships, and the lateral’s ability to generate new firmwide opportunities can reveal when an attorney overestimated their client loyalty or misunderstood client motivations. By analyzing these patterns—whether related to practice fit, integration effort, or individual approach—firms can refine their hiring strategy and provide targeted support to laterals at risk of underperformance.

Elevating Lateral Integration as a Competitive Advantage

Lateral hiring is not just about adding talent; it is about making strategic investments in people that strengthen a firm’s long-term trajectory. The firms that approach integration with the same rigor as recruitment position themselves not only to retain top laterals but to maximize their contributions in a way that enhances firmwide success.

Integration is most successful when there is a clear owner of the process—an individual or team dedicated to overseeing the integration journey. While collaboration among firm leadership, practice groups, business development professionals, and lateral partners is essential, having a designated point of accountability ensures that the integration is seamless and strategic. By establishing clear expectations, providing structured oversight, and aligning incentives to match desired behaviors, this process creates an environment where laterals can succeed quickly.

Capturing and analyzing data on client retention, integration success, and business development patterns can help firms refine their hiring approach, ensuring they are bringing in laterals whose practices and working styles align with the firm’s culture and long-term objectives.

Ultimately, lateral integration is not a one-time event but an ongoing strategy. The firms that excel in this domain understand that the true value of a lateral hire lies not in their initial arrival but in the enduring business, relationships, and leadership they cultivate over time. By elevating lateral integration to a strategic priority, with clear ownership of the process, firms can transform it into a powerful competitive advantage, securing their place at the forefront of the legal profession.

It’s no secret that the legal industry is stressful. Tight deadlines, substantial workloads, and difficult cases all combine to create a culture that is often detrimental to the mental well-being of attorneys and firm administrators. Recent lawyer suicides have brought even more light to this serious issue.

According to Reuters, which cites a 2023 Krill Strategies and University of Minnesota study, lawyers are twice as likely as the average adult to contemplate suicide, and attorneys who considered their jobs high-stress were twenty-two times more prone to considering suicide than those who called their jobs low-stress.^[1] Despite the increased research and heightened awareness, the mental health crisis in the legal industry hasn’t shown many signs of abating.

Association of Legal Administrators (“ALA”) members—and law firm leaders as a whole—have often been tasked with finding solutions to one of the industry’s more intractable issues. Here are five strategies firm leaders can use to help promote employee well-being and, as a result, increase retention, productivity, and profitability.

No. 1: Look at Billing Requirements

One of the main pressure points in the legal industry is meeting billable-hour requirements. Attorneys often work late, early, and on weekends or holidays to log their necessary hours. While many have accepted this as “the way things work,” leaders of the modern law firm should ask themselves whether this kind of overwork should still be inherent to the practice of law. Except in the most urgent cases, what work is accomplished at 10 p.m. that can’t wait until the next morning?

There is often the presumption that clients expect 24/7, 365-days-a-year service from their attorneys. However, as long as quality work is done during the day, clients tend to appreciate a firm’s commitment to the well-being of their employees. Of course, communication is key in this regard, as firms should be up-front about the expectations that clients should have when working with their attorneys.

A frequent counterargument to reducing billable hour requirements is that it would hurt firm profitability. In many cases, that may be true in the short term. But a longer-term view shows that decreased pressure to produce creates better-quality work, happier employees, and increased client satisfaction. Considering that word of mouth holds significant weight in the legal industry, lawyers who enjoy the firm at which they work are more likely to pitch their firm to high-value laterals or promising young associates.

Firm leaders may also want to consider changing their billing method entirely. Fixed fees and value-based pricing are two ways that firms can de-emphasize the billable hour while providing consistency for their clients and ensuring that the work done best serves the clients’ needs. This kind of change is not easy but can be a concrete way for a firm to demonstrate its commitment to reducing the stress of an already demanding job.

No. 2: Embrace Diversity and Inclusion

In any workplace, mental health can suffer when employees do not feel accepted or included by their employer or coworkers. The legal industry has historically been known as having a higher barrier to entry for women, people of color, and other minority groups. But in recent years, firms have put more effort into promoting diversity, equity, inclusion, and accessibility (“DEIA”)—to much positive acclaim.

What makes a DEIA program effective differs from firm to firm, but the most successful often include events centered around cultural celebrations (such as Pride Month and African American History Month); awareness campaigns surrounding microaggressions and other problematic behaviors; and employee resource groups that consist of like-minded attorneys and staff who can support, mentor, and advise each other on a regular basis.

The topic of DEIA is especially crucial today as many large organizations have begun to roll back their diversity initiatives amid the current political environment or for other reasons, such as a lack of buy-in or financial support from those in charge. However, many clients still want their firms to show progress on advancing diversity, so it behooves firms to continue making DEIA a priority in their strategic planning.

From a wellness perspective, a demonstrated commitment toward supporting employees no matter their backgrounds goes a long way in making them feel comfortable being their true selves at work.

No. 3: Utilize Employee Benefits

Today, many benefit programs offer mental health support, whether through insurance allowances for therapy and other mental health treatment, or through Employee Assistance Programs (“EAPs”). Hopefully, your firm is already making these options available to your employees. If not, now is the time to assess what you’ll want to include in your next benefit package.

EAPs can be a particularly crucial resource, as they allow employees and their families to seek help during different types of crises—including mental health—without encountering the (unfortunate) stigma that often accompanies such admissions in the workplace. It’s important for attorneys and staff to know to whom they can turn when struggling with their mental wellness.

No. 4: Explore New Technologies

While there has been much trepidation about the use of artificial intelligence (“AI”) in the legal industry—understandably so—there is one way in which it undoubtedly helps: efficiency. So much of the practice of law involves time-consuming tasks, such as extensive research and drafting myriad legal briefs. Though they must be used with caution, the AI tools available are cutting down the time it takes to complete those tasks, which in turn can help reduce burnout and job dissatisfaction.

No. 5: Engage the Legal Community

The issue of suicide hit close to home for ALA in 2023, when a member of our Middle Tennessee Chapter tragically took her own life. Those in the legal administration community wanted to make sure lessons were learned from such a devastating loss. Members from the chapter created a Mental Health Task Force to increase dialogue and bring awareness and education to help prevent a similar tragedy from happening in their community again. They also reached out to the Tennessee Lawyers Assistance Program, which supports lawyers and judges in need. While the program hasn’t extended to legal administrative professionals, the chapter is currently working to make that happen.

While resources may differ between states, the Middle Tennessee Chapter has offered a shining example of how the legal community can band together to make positive change when it comes to mental health awareness and support. Perhaps it starts within a firm or a town before extending to a group of firms or a larger locality.

Burnout and other overwhelming feelings of stress are real, and it is incumbent on all law firm leaders to address them before they turn into a crisis or, even worse, a suicide. The statistics are alarming, but the community’s response can alleviate this situation. With these strategies in hand, firms can be well prepared to ease some of the stress on attorneys and staff and make mental well-being a strong priority.

If you or someone you care about is struggling, confidential help is available for free by calling or texting 988 or going to the 988 Lifeline.^[2]

1. Jenna Greene, Stressed, Lonely, Overworked: What New Study Tells Us About Lawyer Suicide Risk, Reuters (Feb. 15, 2023). ↑

2. 988 Lifeline (last visited Jan. 25, 2025). ↑

Duke Law School was crowned “champion” of the MAC Cup II law student negotiation competition at the M&A Committee Meeting of the ABA Business Law Section in Laguna Beach, California, on January 31. Teams from Duke, Missouri Law School, Cardozo Law School, and Georgetown Law School achieved “Final Four” status after months of intense rounds of negotiations that began in October 2024 with sixty-four teams from forty-six law schools across the U.S. and Canada.

Jimmy Scoville and Kiran Singh of Duke Law School won the second MAC Cup hosted by the ABA BLS M&A Committee, triumphing over sixty-three other teams. Photo by Sarah Sebring.

“The M&A Committee started the MAC Cup to give law students opportunities to learn about and apply M&A negotiation skills,” said Rita-Anne O’Neill of Sullivan & Cromwell, chair of the M&A Committee. “The students get to advocate on behalf of a buyer or a seller while seeking a mutually agreeable deal.”

Students Jimmy Scoville and Kiran Singh from Duke Law School, who were self-coached, achieved first place; and students Liz Eastlund and Austin Siener from Missouri Law School, coached by Aaron Pawlitz (Lewis Rice) came in second. In the final negotiation round, Duke represented the seller’s counsel and Missouri represented the buyer’s counsel.

M&A Committee Chair Rita-Anne O’Neill welcomes attendees to the MAC Cup II championship awards presentation at the Committee’s Laguna Beach meeting. Photo by Sarah Sebring.

An Opportunity to Learn Negotiation Strategies

“The students’ performance was inspiring. Many judges noted the students’ ability to engage in constructive discussions on complex issues, and their evident preparation and thoughtfulness,” said Mike O’Bryan of Morrison Foerster, immediate past chair of the M&A Committee.

The MAC Cup is a mock M&A negotiation tournament; students are given a fact pattern and assigned to be buyer’s or seller’s counsel. They then prepare and negotiate with their counterpart counsel team the issues they deem most significant and a mark-up of a draft acquisition agreement.

According to O’Bryan, students learn about negotiating strategies and how to get to a deal, as well as substantive M&A issues. They receive access to professional M&A learning resources.

“Many teams have coaches from the M&A Committee, and others work with other practicing lawyers or professors. Students also get opportunities to network with M&A Committee members and other students interested in M&A issues,” said O’Bryan. “And, of course, the opportunity to be recognized for writing and negotiating skills and to compete for prizes including travel to Laguna and scholarships.”

Students Undaunted by Fierce Competition

“Beyond the basic research on sample provisions and legal issues, we spent a lot of time developing questions to guide each negotiation,” said Jimmy Scoville of Duke. “We would also prepare various ‘creative solutions’ that we could integrate or modify as we learned more about what our opponents cared about.”

According to Scoville, he and his colleagues found the competition helpful because of the exposure to so many different methods of negotiating.

“I appreciated all of the time the judges took to give individualized feedback and really enjoyed seeing myself progress in the competition as I applied their advice,’ said Scoville. “That was really satisfying. I also enjoyed getting to know our competitors in the semifinal and final rounds. All of the competitors were fantastic and incredibly smart people.”

And what qualities enabled Duke to come out on top?

“The Duke team showcased great poise in all of their matches and were one of the best teams that were able to not only present their arguments in a thoughtful fashion but also listen and adjust to their counterparties,” said Thaddeus Chase of McDermott Will & Emery. “They were collegial in all their matches and seemingly had a great mastery of the materials (even with the curveball for the Final).”

In addition to the MAC Cup trophy for the winning team, the winning and runner-up teams receive scholarship awards. 

Members and students celebrate the MAC Cup II winners. The winning and runner-up teams receive scholarship awards. Photo by Sarah Sebring.

The Path to MAC Cup III

The success of MAC Cup II has already created enthusiasm for next year’s competition among students, law schools, and the M&A Committee.

Wilson Chu of McDermott Will & Emery, who was chair of the M&A Committee from 2018 to 2021, was instrumental in building the competition from the ground up and has witnessed its enhanced reputation.

“We wanted to build a more robust pipeline of future business lawyers by flipping the law school experience to encourage students with a taste of real-world M&A,” said Chu. “MAC Cup II was more successful than planned with almost one hundred applicant teams from around fifty schools, with sixty-four teams competing in the main draw. Law schools are buzzing about MAC Cup III, especially the oversized, gaudy champions’ belt!”

The competition also benefits the M&A Committee’s leadership and members.

“The competition enables our members to give back to their alma maters and have a hand in guiding the next generation of M&A practitioners,” said Chase. “It also allows current members to see that young associates have the ability to grasp complex matters and actually negotiate.”

The recognition received by the student teams and the law schools also has strengthened the M&A Committee’s reputation as experts in negotiation who possess the practical knowledge required of M&A legal professionals.

“We’re already gearing up for MAC Cup III,” said O’Bryan. “Students can sign up for information at our MAC Cup website. With the resources and support that the MAC Cup offers, even students who haven’t taken an M&A course or worked for an M&A law firm can compete effectively.”

This is the second installment in the Year in Governance Series from the In-House Subcommittee of the ABA Business Law Section’s Corporate Governance Committee. Each month, the series will share key tips on a different corporate governance topic. To get involved in the Corporate Governance Committee, please visit the committee’s webpage.

A message from Kathy Jaffari: “As Chair of the Corporate Governance Committee, I would like to extend my sincere appreciation to the authors for this publication. The Corporate Governance Committee has ongoing opportunities for writing and volunteering with various projects, whether it’s an article you want to publish or a CLE that you want to present. Our Committee is dedicated to helping you promote informative resources for corporate governance practitioners. You may contact me at [email protected] to get involved.”

Director orientation and onboarding are two complementary but distinct processes that provide the foundation a newly appointed director needs for success. Orientation is a one-time event that introduces the director to the company, while onboarding, which typically lasts three to six months, helps the director dive deeper into critical topics and become more integrated into the business. Together, orientation and onboarding ensure new directors have a foundation for satisfying their fiduciary duties and the knowledge they need to become valuable contributors on the board.

1. Governance Requirements: Requirements for referencing director orientation in your organizational materials depend on stock exchange listing rules. The New York Stock Exchange requires director orientation to be included in the company’s corporate governance guidelines. Nasdaq does not. Regardless of requirements, it’s common for a company’s nominating committee to be responsible for ensuring adequate director orientation and onboarding as prescribed in the committee charter.
2. Responsibilities: Director orientation and onboarding processes are typically the responsibility of the Corporate Secretary’s office. The Corporate Secretary, while working with other internal leaders, is best positioned to build out orientation and onboarding materials while also serving as a liaison between the new director and the leadership team. Orientation and onboarding materials are often previewed with the CEO and/or the nominating committee, depending on governance requirements and leadership preference.
3. Orientation Timing: Director orientation should ideally be provided before a new director’s first board meeting and should be scheduled as soon as possible following appointment to the board. Providing materials and resources prior to the first board meeting helps ensure the director is well prepared and “oriented” to the company’s business and leadership.
4. Onboarding Timing: Director onboarding generally occurs over the course of the first few months following appointment to the board as the new director becomes more familiar with the company and its business. When developing an onboarding schedule, keep the board and committee calendar in mind to ensure that onboarding sessions complement upcoming topics on board and committee agendas.
5. Orientation Key Deliverables: Core orientation materials include a broad overview of the business, financial performance, forecasts and industry trends, and key governance and risk-related topics. New directors can benefit from a binder with foundational documents including charters, bylaws, board and committee schedules, corporate governance guidelines, company filings, organizational chart, code of conduct, and other important policies and governance documents.
6. Onboarding Key Deliverables: Core onboarding materials include meetings and presentations from key senior executives, materials related to committee assignments, tours of corporate headquarters or site visits, and meetings with individual directors. Encourage new directors to provide feedback on the areas of the business they are interested in learning more about to enhance planning and engagement.
7. Customization: A director’s experience varies; some are on multiple boards, and for some, this is their first board appointment. Understand the needs of your director and customize an orientation and onboarding program to fit their background. For example, providing an overview of director fiduciary duties will take less time for a well-seasoned director, while a first-time director would benefit from a robust presentation.
8. Relationship Building: Throughout both orientation and onboarding processes, plan introductions to the leadership team, key employees, and other board members. Provide insight into the current relationship dynamics between management and the board, as well as the dynamics of the board and each board committee. It’s helpful to set up meetings with each committee chair as well, even if the new director has not been appointed to a board committee.
9. Meetings with Outside Advisors: As part of onboarding, a new director will benefit from meeting with certain outside advisors. Depending on standard committee appointments, meetings with the company’s independent auditor or independent compensation consultant can be informative. If the board has specialized committees (e.g., sustainability, cybersecurity, risk), connect the new director with key external advisors to provide a deeper understanding of these areas.
10. Planning for Director Education: Request feedback during the orientation and onboarding process, and pay attention to a new director’s understanding and engagement. Recognizing what topics your new director was comfortable with, or not comfortable with, will help inform what topics they need more education on in the future.

The views expressed in this article are solely those of the authors and not their respective employers, firms or clients.

Despite legal and ethical concerns, many business leaders are still bullish on generative artificial intelligence (AI), and the industry is accelerating at a rapid pace. In fact, according to a UBS study, ChatGPT reached over 100 million monthly active users in the two months following its initial launch—making it the fastest-growing consumer application in history.

Unfortunately, as the use of generative AI surges, so too have the legal questions surrounding it. Copyright and trademark disputes regarding AI-generated material are on the rise—thrusting intellectual property (IP) law into uncharted territory. The cases being decided today, barely two years into the generative AI boom, may establish legal precedent that shapes the future of law for decades to come.

In the past several months, several high-profile legal cases have tested the boundaries of IP in the age of artificial intelligence, highlighting key issues.

Copyright Infringement When Using Content Created by AI

In Alcon Entertainment, LLC v. Tesla, Inc., Alcon Entertainment, the exclusive rights holder of the 2017 film Blade Runner 2049, has accused Tesla and Warner Bros. Discovery of using AI-generated imagery that closely mimics an iconic image from its film without prior permission. The image—depicting a man next to a futuristic-looking vehicle—was used at Elon Musk’s Cybercab launch event.

The suit claims that Tesla initially requested to use an actual image from the film. When Alcon Entertainment denied the request, the suit alleges Tesla and Musk used generative AI to create similar visuals, using Blade Runner images as a close reference.

Interestingly enough, whether a work is generated by AI or created by humans is irrelevant in this case. The question of fact will remain the same irrespective of how the image was created: Does this work infringe on Alcon Entertainment’s intellectual property?

But this case still provides attorneys with a valuable lesson. We will likely see these types of cases grow exponentially. AI tools can now produce images or written works in seconds, much more quickly than a human could. However, the images are not created from the “mind” of the AI; they are based on the information the AI has been exposed to already. Therefore, the “new” content the AI is creating is, most of the time, based on a human’s work.

Many day-to-day users of generative AI platforms are unaware of the potential risks associated with how these tools are trained. They may believe that the work they have asked generative AI to create is truly “original.” In many instances, individuals may not realize that their generated content mirrors copyrighted material until it’s too late.

For this reason, IP attorneys must continue to educate their clients about the risks involved in using generative AI and encourage them to rely on original, human-created content when possible. While AI can certainly aid the creative process, it should not be relied on as the primary source for public-facing materials. Of course, any AI-generated works should be reviewed by legal experts with scrutiny, as any prudent attorney would with work created by a human.

Copyright Infringement When Using Content to Train AI

The rapid adoption of generative AI has given rise to legal disputes not only about the output of these tools, but also concerning how these tools are trained.

For example, in Toronto Star Newspapers Ltd. v. OpenAI, Inc., more than five of Canada’s most prominent news outlets, including the Toronto Star newspaper, have filed a suit against OpenAI, alleging that OpenAI “scraped” content from their websites to train ChatGPT without their consent. The plaintiffs argue that this constitutes copyright infringement.

Similarly, in another landmark case filed this June, UMG Recordings, Inc. v. Uncharted Labs, Inc., several major record labels have teamed up to file a suit against Uncharted Labs for copyright infringement. The plaintiffs allege that the company’s AI model, Udio, illegally copies digital sound recordings to train its system. The tech then generates music that imitates the qualities of genuine, human-made recordings.

One potential outcome of both of these cases could be the establishment of licensing agreements. In the early days of music streaming platforms, similar legal battles ensued. The result? Licensing agreements that compensated artists for their music. Such license agreements laid the foundation for today’s major streaming platforms like Spotify, Apple Music, and Pandora. Today’s legal battles could similarly shape how generative AI companies acquire legal consent to use content generated by human artists in their training models.

For example, newspapers could provide AI companies with a license to scrape their news articles so long as the company pays a fee for the content and links back to the newspapers’ original article to credit the source of the answer or new material created. OpenAI has already announced licensing deals with The Associated Press and News Corp, among others.

Likewise, owners of music could potentially provide an AI platform with a license to train on their songs and create new music so long as a royalty is paid for using the music and users are notified that using any “new” music is subject to the copyright rights of the original owners.

When it comes to generative AI, Pandora’s box has been opened. Like it or not, this technology is here to stay. For this reason, attorneys should continue to closely monitor the ongoing cases surrounding generative AI to keep abreast of the rapidly evolving legal landscape. As the legal framework solidifies, those who stay informed will be best positioned to serve their clients.

This article provides a comparative analysis of two prominent business structures: the limited liability company (“LLC”) in the United States, with a focus on Florida and Delaware, and the Sociedad de Responsabilidad Limitada (“SRL”) in Bolivia. This analysis aims to delve into the fundamental similarities and distinctions that exist between two prominent legal systems: common law and civil, or continental, law. By examining these entities, we seek to uncover how they function within their respective frameworks and the implications of those differences. However, it is important to note that this exploration is not exhaustive,^[1] as the scope of this article is inherently limited. Thus, the aspects discussed here relate to the structural elements and characteristics of these types of business entities within their unique legal systems.

Legal Framework

The basis of the U.S. legal system is a combination of foundational principles and key legal documents. At its core is the U.S. Constitution, the supreme law that establishes the framework of the federal government, its relationship with the states, and the rights of its citizens. Rooted in English common law, it relies on judicial precedents to guide decisions. Statutes enacted by legislative bodies and regulations issued by administrative agencies provide specific rules across various domains. These laws are interpreted by courts, whose decisions contribute to case law, further shaping the legal landscape. Together, these elements create a comprehensive and dynamic legal system that governs the United States.

The Constitution does not directly govern LLCs in the United States but derives their existence and regulation from state laws, reflecting the decentralized nature of U.S. governance. The Tenth Amendment^[2] reserves to the states the power to regulate LLCs, resulting in diverse frameworks like the Delaware Limited Liability Company Act (“DLLCA”)^[3] and the Florida Revised Limited Liability Company Act (“FRLLCA”).^[4] However, federal constitutional principles indirectly shape LLC operations. The Commerce Clause^[5] allows Congress to regulate interstate business activities, affecting LLCs with cross-state operations. The Contracts Clause^[6] protects LLC operating agreements from retroactive state interference, while the Fourteenth Amendment^[7] ensures fair treatment under state laws. Additionally, LLCs benefit from First Amendment^[8] protections for commercial speech, such as advertising,^[9] though regulations must meet the criteria established in the U.S. Supreme Court’s Central Hudson Test.^[10] These constitutional influences underscore the balance between state-level autonomy and federal oversight in the regulation of LLCs.

Bolivia’s legal system is grounded in the civil law system, which draws its influence from the Roman Corpus Juris Civilis. Bolivia’s legal framework operates under the principles of civil law, which it inherited from Spanish and Napoleonic legal traditions. The civil law system emphasizes codified statutes, and legal decisions are often guided by applying these codes rather than judicial precedents.

Bolivia’s legal framework establishes a strong foundation for economic activity and business organization, emphasizing both individual and collective rights. The Bolivian Constitution^[11] ensures the right to engage in commerce, industry, or lawful economic activities, provided they do not harm the public good. It also guarantees freedom of business association, recognizing the legal status of such entities and supporting democratic business structures aligned with their statutes.^[12] Complementing this, the Commercial Code^[13] governs relationships arising from commercial activities, offering a broad definition that includes both the nature of activities and the individuals or entities conducting them.^[14]

Nature and Characteristics

In the United States, each state has its own laws governing the formation of LLCs. The first statute authorizing LLCs was adopted in Wyoming in 1977, and as late as 1988, only Florida had followed suit.^[15]

An LLC is a popular business structure in the United States that combines the liability protection of a corporation with the tax benefits and operational flexibility of a partnership or sole proprietorship.^[16] LLCs are hybrid business entities with a unique combination of favorable legal, business, and tax attributes that do not exist in any other single entity.^[17] In short, the LLC is an eclectic mixture of features drawn from several different traditional business forms that create an attractive package for many enterprises.^[18]

In Bolivia, the SRL is a relatively modern business entity, originating in nineteenth-century Germany with the Reich’s special law of 1892.^[19] From there, it spread to other jurisdictions, including Portugal in 1901, Austria in 1906, and England in 1907,^[20] eventually gaining global recognition.

The SRL occupies a hybrid position between capitalist and personalist corporate models. Like corporations, the SRL offers limited liability tied to members’ capital contributions but differs in not issuing freely transferable shares. Instead, it emphasizes the intuitu personae principle,^[21] prioritizing trust and personal relationships among members, as seen in the restricted transferability of quotas. This dual nature allows the SRL to combine the financial security of a corporation (Sociedad Anónima) with the personalized dynamics of a partnership (Sociedad Colectiva), making it a versatile and unique business entity.

Similarities

Limited Liability of Its Members

In the United States, one of the most appealing aspects of the LLC is the limited liability afforded to its owners and operators. For instance, in both Florida^[22] and Delaware,^[23] no member or manager is liable personally for any debt, obligation, or liability of an LLC solely by virtue of such party’s status as a member or manager. Furthermore, the individual assets of LLC members may not be used to satisfy the LLC’s debts and obligations; hence, a member’s risk of loss is limited to the amount of capital invested in the business.

In Bolivia, the SRL also provides limited liability to its members. According to Article 195 of the Commercial Code, members are liable only up to the amount of their contributions. This ensures that each partner’s personal assets remain protected, even if the company needs to cover debts or suffers losses during a given management period.^[24]

Separate Legal Entity

Under most LLC statutes, including under the DLLCA^[25] and the FRLLCA,^[26] an LLC is explicitly characterized as a separate legal entity whose identity is distinct from that of its members. As a separate “legal person,” an LLC can exercise rights and powers in its own name. Consequently, parties doing business with an LLC must look to the company, and not to the LLC’s members or managers, to satisfy any obligations owed to them.

Likewise, in Bolivia, SRLs are recognized as distinct legal entities from their members, meaning that they can enter into contracts, sue, and be sued independently from the individuals involved in ownership or management.

Flexible Management Structure

In the United States, LLCs can be member-managed or manager-managed, offering more flexibility for structuring control, especially for larger or multistate LLCs. The operating agreement typically sets the management terms​. Most LLC statutes default to a member-managed structure, such as under the DLLCA^[27] and the FRLLCA,^[28] where all members have management rights, similar to a general partnership.^[29] Some statutes, however, default to a manager-managed structure, where management is centralized in a smaller group of managers, akin to a corporation.^[30] Both member-managed and manager-managed structures can be elected, regardless of the jurisdiction’s default rule.^[31]

In Bolivia, the management of an SRL may consist of one or more managers, who can be either one or more of the members, similar to a member-managed LLC, or third parties who are nonmembers,^[32] similar to a manager-managed LLC. In any case, there must be a management structure, as it is the body that constitutes the “typical representation of that company.”^[33]

Differences

Perpetual Existence

LLCs often have perpetual existence and do not dissolve with member exit unless specified in the operating agreement.^[34] For instance, the DLLCA presumes a perpetual life.^[35] Likewise, under the FRLLCA,^[36] an LLC is presumed to have perpetual duration unless otherwise stated in its articles of organization or operating agreement.

In Bolivia, SRLs do not have an indefinite duration and are never presumed to have perpetual life; rather, its articles of formation must specify a lifespan in years. In practice, SRLs generally specify a ninety-nine-year duration, which may be renewed before its lifespan terminates.

Cap on Membership

In both Florida and Delaware, there are no minimum or maximum limits on the number of members an LLC can have. In both states, LLCs can have a single member or multiple members. There is no limit on the number of members in an LLC unless the LLC opts to be taxed as an S corporation, which has a maximum of one hundred members.

Membership limits are significantly different in Bolivia, where an SRL must have at least two members and no more than twenty-five members.^[37] This stems from the conception that defines a business entity (sociedad comercial) as a contractual agreement between two or more individuals to contribute resources toward a common goal. Consequently, it is inconceivable to have a business entity with only one member; thus, under Bolivian law, the legal minimum for forming such an entity is two members. On the other hand, the cap on the number of members of an SRL responds to its closely held nature, with both capitalist and personalist elements.

Operating Agreements

The governance of an LLC is outlined in a nonpublic document known as the “operating agreement” or “limited liability company agreement,” which, like a partnership agreement or corporate bylaws, is not filed with any state official.^[38] This document specifies the rights, duties, and obligations of members and managers and serves as the framework for the LLC’s operations. LLC members have considerable flexibility to tailor the operating agreement to their unique needs, often superseding default statutory provisions.^[39] Thus, the operating agreement controls relationships between members and between members and the company.^[40]

Contrary to the LLC, an SRL only requires one solemn document (testimonio de constitución) specifying the rights, duties, and obligations of members and managers and serving as the framework for the SRL’s operations, and it is made public through the Commercial Registry. Hence, an operating agreement is not required. However, on rare occasions, members of an SRL may choose to have a parasocial agreement (acuerdo parasocial),^[41] essentially a private contract among the members that provides specific terms and conditions governing the relationships between those members. A parasocial agreement differs from an operating agreement in that the former is very specific and limited to the laws and regulations that govern SRLs.

Taxation

By default, Florida^[42] and Delaware^[43] LLCs are taxed as pass-through entities, meaning that they do not pay income taxes themselves. Instead, their owners or members pay personal income tax on the LLC’s revenue after it passes through the business to members. This is advantageous because it avoids double taxation, which occurs when both the entity and the owners are taxed.

The tax regime in Bolivia is regulated by the Tax Code^[44] and Law No. 843.^[45] The SRL, which is governed by Bolivian tax law, does not support pass-through taxation for SRLs, so they are typically taxed as separate entities.

Conclusion

In comparing LLCs in Florida and Delaware with SRLs in Bolivia, several similarities and differences emerge, shaped by the distinct legal frameworks and business environments of these regions.

One of the key similarities between LLCs and SRLs is the concept of limited liability, which protects the personal assets of members or owners from the debts and obligations of the entity. Both business structures are also recognized as separate legal entities, capable of entering into contracts and engaging in litigation independently of their members. Additionally, both LLCs and SRLs offer flexibility in management structure, allowing for member-managed or manager-managed options, depending on the specific needs of the business.

However, notable differences exist between the two. LLCs in Florida and Delaware typically enjoy perpetual existence unless otherwise stated in their operating agreements, whereas SRLs in Bolivia must specify a finite duration in their formation documents. Another major difference is the membership structure: LLCs can have a single member or an unlimited number of members, while Bolivian SRLs are limited to a minimum of two and a maximum of twenty-five members. Furthermore, LLCs benefit from pass-through taxation, which avoids double taxation, while SRLs in Bolivia are taxed as separate entities, subject to different tax rules under Bolivian law.

The contrasting legal traditions in which these structures exist—common law in the United States and civil law in Bolivia—play a significant role in shaping these differences. While LLCs have a high degree of flexibility and autonomy, particularly in their internal governance through operating agreements, SRLs rely more on codified laws and public documentation, such as the testimonio de constitución. These structural and legal contrasts reflect the broader distinctions between the decentralized, case-law-driven approach of the United States and the codified, statute-based framework of Bolivia.

Thus, while LLCs and SRLs share common features like limited liability and separate legal status, the differences in membership, governance, duration, and taxation highlight how each entity is adapted to the legal and economic systems in which it operates. These distinctions can significantly influence the decision-making process for entrepreneurs and investors when choosing between these two business structures.

1. The author intentionally focuses on seven aspects to distinguish the similarities and differences between LLCs and SRLs: limited liability, separate entity status, management structure, perpetual existence, cap on members, operating agreements, and taxation. ↑

2. U.S. Const. amend. X. ↑

3. Del. Code Ann. tit. 6, §§ 18-101 to 18-1109. ↑

4. Fla. Stat. §§ 605.0101 to 605.1108. ↑

5. U.S. Const. art. I, § 8. ↑

6. Id. art. I, § 10. ↑

7. Id. amend. XIV, § 1. ↑

8. Id. amend. I. ↑

9. Jennifer L. Pomeranz, United States: Protecting Commercial Speech Under the First Amendment, 50 J.L. Med. & Ethics 265–75 (2022). ↑

10. The Supreme Court developed a four-part test, also known as “The Central Hudson Test,” in Central Hudson Gas & Electric Corp. v. Public Service Commission of New York to evaluate the constitutionality of regulations on commercial speech. 447 U.S. 557 (1980). ↑

11. Constitución Política del Estado (2009) (Bolivia). ↑

12. Article 47(I) states that all have the right to engage in commerce, industry, or any lawful economic activity, under conditions that do not harm the collective good. Id. art. 47(I). Likewise, Article 52(I) acknowledges and protects the right to freedom of business association. Id. art. 52(I). Additionally, Article 52(II) states that the State shall guarantee recognition of the legal personality of business associations, as well as democratic forms of business organizations, according to their own statutes. Id. art. 52(II). ↑

13. Código de Comercio (promulgado por Decreto Ley No. 14379 de 25 de Febrero de 1977) (Commercial Code (promulgated by Decree Law No. 14379 of Feb. 25, 1977)) (Bolivia) [hereinafter Code Com.]. ↑

14. Id. art. 1 (Scope of the Law). ↑

15. Jesse H. Choper, Jr. John C. Coffee & Ronald J. Gilson, Cases and Material on Corporations 810 (Wolters Kluwer, 7th ed. 2008). ↑

16. Chauncey Crail, What Is a Limited Liability Company (LLC)?: Definition, Pros & Cons, Forbes Advisor (updated June 5, 2024). ↑

17. Donald J. Scotto & Sharon Matthews, Limited Liability Company: The Growing Entity of Choice, Fairleigh Dickinson Univ. (last visited Dec. 7, 2024). ↑

18. Robert W. Hamilton & Richard A. Booth, Business Basics for Law Students: Essential Concepts and Applications 263 (Aspen L. & Bus., 3d ed. 2002). ↑

19. K. Wieland, La Sociedad de Responsabilidad Limitada, 19 Revista de Derecho Puertorriqueño 241 (1932). ↑

20. Raul Anibal Etcheverry, The Mercosur: Business Enterprise Organization and Joint Ventures, 39 St. Louis L.J. 979, 992 (1995). ↑

21. Intuitu personae refers to contracts or obligations that are entered into with specific consideration of the personal qualities, skills, or trustworthiness of the individual involved. ↑

22. Fla. Stat. § 605.0304. ↑

23. Del. Code Ann. tit. 6, § 18-303. ↑

24. Code Com. art. 195 (Characteristics). In SRLs, the partners are liable only up to the amount of their contributions. The common fund is divided into capital shares that, in no case, may be represented by stocks or securities. ↑

25. Del. Code Ann. tit. 6, § 18-201(b). ↑

26. Fla. Stat. § 605.0108. ↑

27. Del. Code Ann. tit. 6, § 18-402. ↑

28. Fla. Stat. § 605.0407(1). ↑

29. Jonathan R. Macey & Douglas K. Moll, The Law of Business Organizations: Cases, Materials, and Problems 925 (W. Acad. Publ’g, 14th ed. 2020). ↑

30. Id. ↑

31. Id. ↑

32. Code Com. art. 203 (Management of the Company). The management of the SRL shall be entrusted to one or more managers or administrators, whether they are partners or not, appointed for a fixed or indefinite term. ↑

33. Richard E. Hugo & Muiño O. Manuel, Derecho Societario 370 (Astrea, Buenos Aires, 2002). ↑

34. Lee Harris, Mastering Corporations and Other Business Entities 96 (Carolina Acad. Press 2009). ↑

35. Del. Code Ann. tit. 6, § 18-801(a)(1). ↑

36. Fla. Stat. § 605.0108(2). ↑

37. Code Com. art. 196 (Number of Members). An SRL may have no more than twenty-five partners. ↑

38. Macey & Moll, supra note 29, at 920. ↑

39. Id. at 920–21. ↑

40. Harris, supra note 34, at 82. ↑

41. This type of agreement is usually seen in corporations (shareholder agreements). ↑

42. 26 U.S.C. § 7701(a)(1); Treas. Reg. § 301.7701-3. ↑

43. 26 U.S.C. § 7701(a)(1); Treas. Reg. § 301.7701-3. ↑

44. Ley No. 2492, Agosto 2, 2003, Código Tributario Boliviano (Bolivia). ↑

45. Ley No. 843, Diciembre 20, 2004, Reforma Tributaria, Decreto Supremo No. 27947 (Bolivia). ↑

The Uniform Special Deposits Act (“USDA” or the “Act”) is a product of the Uniform Law Commission and was approved at its 2023 Annual Meeting. After consideration and deliberation by the Uniform Law Commission’s Special Deposits Committee, the Uniform Special Deposits Act was drafted to provide clarity on an area of law that has been subject to uncertainty for a number of years.

Special deposits, as the name suggests, are a “special” type of deposit that has different characteristics than other deposits, such as checking or savings deposits. Unlike deposits that are payable on a customer’s order, special deposits are established for a particular purpose, and a beneficiary becomes entitled to payment after a determination is made that a specified contingency has occurred. Special deposits play an important role in commerce and industry and ensure that funds deposited will be available to the person entitled to them in the future once their established purpose has been satisfied. They can serve a variety of parties in a range of contexts, but their use has been diminished by a small number of legal uncertainties, the collective significance of which is large. For example, in the past, case law has described special deposits or special accounts as akin to trust, bailment, or custody arrangements, but they are not used that way in practice.

The USDA establishes a framework under state laws for interested parties to utilize special deposits with a greater understanding of how such deposits will be treated under various circumstances. The Act was drafted utilizing a “minimalist” philosophy, and the drafters sought only to address specific uncertainties that exist under current law. As a result, the Act does not disrupt existing law but rather builds on it, and it leaves matters not addressed by the Act to be governed by general laws already governing deposits or contractual arrangements.

Importantly, the USDA is an “opt-in” statute, which means that parties intending to enter into a special deposit must specify in the agreement establishing the special deposit that they intend to be covered by the USDA as enacted in a particular state. This feature of the Act permits existing relationships to continue undisturbed, and permits parties to choose to utilize the protections provided by the USDA when they wish, so parties can choose to utilize the protections for certain deposit products and not others. Parties are also permitted to amend existing agreements to be covered by the USDA after enactment if they satisfy the criteria to establish a special deposit under the Act.

There are four key legal uncertainties that the USDA is designed to remedy by establishing rules to eliminate those uncertainties without interfering with other aspects of laws governing deposits.

First, the “opt-in” characteristic performs a kind of double duty in the USDA. As described above, it enables freedom of contract—the parties establishing the special deposit decide whether the arrangement will be governed by contract law or by the USDA. In addition, the “opt-in” is the mechanism identifying the deposit as “special” and subject to the select set of rules set out in the USDA. A deposit designated as “special” and subject to the USDA must satisfy the objective criteria in Section 5 of the Act, which include that it be (i) designated as “special” in an account agreement governing the deposit at a bank, (ii) for the benefit of at least two beneficiaries (one or more of which may be a depositor, which also has a specific definition in the Act that could include a person who establishes the special deposit even without funding it), (iii) denominated in money (defined in the Act as “a medium of exchange that is currently authorized or adopted by a domestic or foreign government,” which is borrowed from the Uniform Commercial Code), (iv) for a permissible purpose identified in the account agreement, and (v) subject to a contingency specified in the account agreement that is not certain to occur, but if it does occur, creates the bank’s obligation to pay a beneficiary.

The permissible purpose requirement is an important feature of the USDA that prevents the special deposit from being used inappropriately for fraudulent or abusive purposes—for example, to defraud creditors. A permissible purpose is defined in Section 2 as “a governmental, regulatory, commercial, charitable, or testamentary objective of the parties stated in the account agreement.” A special deposit must serve a permissible purpose from creation until termination. In addition, a deposit or transfer that is fraudulent would not be for a permissible purpose, and the voidability of the deposit under other law would not be affected by the USDA.

Second, the USDA provides clarity on the treatment of a special deposit in the event of the bankruptcy of a depositor. Under current law, there may be uncertainty as to whether funds deposited into a special deposit could be “swept” into the bankruptcy estate of the person who deposited them. A special deposit under the USDA is “bankruptcy remote” because Section 8 provides that neither a depositor nor a beneficiary has a property interest in a special deposit. The only property interest that may arise with respect to a special deposit is in the right to receive payment from the bank after the occurrence of a contingency. The USDA protects the special deposit, but not the accrued “payable” to a beneficiary after the contingency is determined.

Third, the Act provides clarity on the applicability of creditor process to a special deposit. Currently, the uncertainty as to whether a creditor can “freeze” a special deposit pending an adjudication by a court undermines the utility of the special deposit, because it could interfere with the purpose that the special deposit is designed to achieve. At the time the special deposit is established, the identity of the ultimate beneficiary has not yet been determined because the contingency has not yet occurred. Section 9 of the USDA provides that creditor process is not enforceable against the bank holding the special deposit, except in limited circumstances. Instead, creditor process may be enforceable against the bank holding a special deposit with respect to any amount that it must pay after the determination of a contingency, but not on the special deposit itself. Section 10 provides a similar limitation on using an injunction or temporary restraining order to achieve the same or a similar outcome. Like the provisions dealing with bankruptcy, the provisions dealing with creditor process protect the special deposit, but not an accrued payable to a beneficiary after the contingency is determined.

Fourth, the USDA provides clarity on the legality of the bank exercising a set off or right of recoupment against a special deposit that is unrelated to any payment to a beneficiary or the special deposit itself. Section 11 prohibits set off or recoupment except in limited circumstances. And, as with the provisions dealing with bankruptcy and creditor process, the provisions dealing with setoff protect the special deposit but not an accrued payable to a beneficiary after the contingency is determined.

The USDA creates a mechanism for parties to a commercial transaction to obtain a low-cost and safe return of earnest money and provides protection to parties seeking to deposit funds for particular purpose to be determined at a future point in time. The USDA also provides clarity to other aspects of a special deposit relationship that have been muddled in the case law, for example, by expressly providing that the relationship between the bank and a beneficiary is a debtor-creditor relationship and that a bank does not have a fiduciary duty to any person in connection with a special deposit. Section 12 of the Act includes additional clarifications on the scope of a bank’s duties and liabilities, and to provide incentives such that banks will offer a special deposit product.

The four uncertainties described here require statutory solutions because they relate to third parties’ interactions with a special deposit and cannot easily or effectively be addressed by contractual agreements between the parties. The USDA is narrowly tailored to cure these four mischiefs and eliminate uncertainty so that parties can utilize special deposits with greater confidence that their expectations will be met. In addition, creating clear rules should reduce litigation risks and expenses for the parties and banks.

The Act is intended to provide needed benefits to depositors, beneficiaries, and banks, and also to be fair to other creditors of the participants in the arrangement. The drafters considered a wide range of potential arrangements where a special deposit governed by the Act may be useful, and the statute was drafted to allow flexibility for the parties to create an account agreement reflecting the circumstances of their particular transaction. The USDA includes a list of sample permissible purposes that highlights some of the use cases for special deposits, and for the avoidance of doubt as to the permissibility of those use cases. But it is not an exclusive list, and in the time since the USDA was approved by the Uniform Law Commission, additional potential uses have been raised as well.

This article is related to a CLE program that took place during the ABA Business Law Section’s 2023 Fall Meeting. To learn more about this topic, listen to a recording of the program, free for members.

The views expressed in this article are the authors’ personal views and do not necessarily represent the views of the CFTC or the federal government.