Jennings, Strouss & Salmon, PLC: Publications

Eight Things a Debtor Should Never (or Almost Never) Do

The Great Recession and its aftermath have been a difficult time for investors and business owners who borrowed or guaranteed debt to finance their businesses and investments. After years of helping such borrowers (debtors) with their debt restructuring options, I have compiled a list of eight things they should never (or, except in certain cases, almost never) do:

8. Don't just proceed with "business as usual." Some debtors expect to continue operating the same business that has been losing money. Before doing so, they need to determine whether adjustments (e.g., reducing overhead or other costs) can be made so that the business can operate profitably on a go-forward basis. If it cannot, then the business likely is not worth saving. Remember - when you find yourself in a hole, the first thing to do is to stop digging.

7. Don't try to improve your company's cash flow by nonpayment of payroll taxes. Directors and officers of corporations, members or managers of limited liability companies, and certain financial employees of both may be personally liable as "responsible persons" (persons with a duty to collect and pay over withholding taxes) for failing to collect and pay over "trust fund" taxes - the portion of income, social security, and Medicare taxes required to be withheld from employees' paychecks. Tax authorities regard these monies as theirs and can be very aggressive in trying to collect them from those who directed or released their payment for other purposes. Responsible persons thus may incur personal liability where none previously existed if such taxes are not paid.

6. Don't withdraw money from your retirement plan. Funds in ERISA-qualified retirement plans typically are exempt from creditors' claims under Arizona law. There is no limit on the amount of the exemption, and it therefore is a valuable protection. Retirement funds are exempt for a reason - they are needed for your retirement. Early withdrawal also can result in stiff penalties. These funds should be considered "off limits" to any restructuring efforts and used only as a last resort.

5. Don't wait until you have exhausted your resources. It doesn't pay to use your last available funds to make one more installment payment if you still will have other unresolved debts and obligations. Instead, conserve your remaining resources and use them towards a comprehensive solution to resolve all of your debts.

4. Don't try to narrow down your debts to the largest one. While having one remaining creditor might sound simpler than having many, it actually can make debt restructuring more difficult. It is better to have multiple creditors, some of whom hopefully will support your restructuring proposal. That is particularly so if you decide to restructure in bankruptcy, where leaving one large creditor could give that creditor veto power over your restructuring plan.

3. Don't transfer valuable assets to Aunt Sally. You might think that if Aunt Sally has your valuable assets, your creditors can't get them. Wrong! Very broad laws apply to protect your creditors whenever you dispose of assets while insolvent without receiving "reasonably equivalent value" in return. Such transfers can subject you and Aunt Sally to liability and preclude you from protecting those assets (or their value) through better methods. And don't assume that no one will find out about such transfers. Your creditors might ask about them, and you likely will have to disclose them if you file for bankruptcy protection. Such transfers can taint you in the eyes of your creditors and the court, causing them to question otherwise legitimate conduct.

2. Don't lie about or fail to disclose assets or transfers. If you do so outside of bankruptcy, you could be engaging in fraud. If you do so in connection with a bankruptcy case, you could be committing a bankruptcy crime or risking your right to a bankruptcy discharge of your debts. It simply isn't worth the risk. Remember, honesty is not only the best policy - it will help you avoid more serious trouble.

1. Don't wait until the last minute to get professional help. Just as a good coach prepares a game plan, good counsel can help you evaluate your situation, determine your objectives, and devise the best plan to achieve them. And the more time you and your counsel have to do so, the better are your chances of a successful outcome.

Bureau of Reclamation Supplemental Report Identifies Conduits with Hydropower Potential

The U.S. Department of the Interior’s Bureau of Reclamation (“Reclamation”) has recently added 373 existing Reclamation conduits and canals, with the combined potential of generating an additional 365,219 megawatt-hours of hydropower annually, to its prior year’s Report that had identified 191 existing Reclamation dam and reservoir sites with a potential of 1.2 million MWh of power annually. Both reports may be viewed at www.usbr.gov/power.

The March 2012 report (released April 12, 2012), entitled “Site Inventory and Hydropower Energy Assessment of Reclamation Owned Conduits,” finds that while sites were identified in 13 of the 17 western states, approximately 70% of the capacity and energy potential on Reclamation owned conduits is located in Colorado, Wyoming and Oregon. In Arizona, twenty-six canal sites were identified with a potential installed capacity of approximately 5 MW and potential annual energy production of 28,464,753 kWh.

Organized by region and by state, the report identifies for each canal site: the structure type, potential installed capacity, potential annual energy, design head, maximum turbine flow, plant factor, months of potential generation, distance to closest distribution or transmission line, and available flow data period. A minimum head for a technically feasible micro-hydropower project was determined to be 5 feet; and only sites with at least 4 months of annual operation that could produce 50kW of capacity based on gross head and the design flow of the canal were included in the Report.

While this latest Report may assist irrigation districts, cities, municipalities, and cooperatives in determining whether to study the feasibility of developing the hydropower potential of the identified sites, it is also designed to assist private developers interested in hydropower development utilizing these resources. To that end, the authors have alerted potential developers to the jurisdictional split between Reclamation and the Federal Energy Regulatory Commission (“FERC”) over hydropower development at Reclamation facilities. Following a basket of cases in the 1980’s challenging FERC’s jurisdiction over private development at Reclamation facilities, procedures for handling such cases were resolved through a Memorandum of Understanding between Reclamation (Lease of Power Privilege Process) and FERC (Licensing and Exemption procedures) in the late 1990’s. Jennings Strouss attorneys represented entities involved in certain of those cases. In the event of a conflict, those procedures will be instrumental in determining the appropriate agency’s jurisdiction, with the outcome dependent on the authorizing legislation for the particular project.

EEOC Issues Update to Enforcement Guide Regarding Arrests and Convictions Screenings

On April 25, 2012, the EEOC issued an update to its Enforcement Guide warning that it will carefully scrutinize employers who use arrest or conviction records as part of their pre-employment screening. The new Guidance, “Consideration of Arrest and Conviction Records in Employment Decisions Under Title VII of the Civil Rights Act of 1964,” provides an indication of the EEOC’s position when examining employer’s pre-employment screening.

not ask about convictions on the job application and use the screening only after the candidate has advanced in the interview process;
limit the inquiry to convictions narrowly tailored to identify criminal conduct “with a demonstrably tight nexus to the position in question”;
limit the time within which the conviction occurred;
have an articulable business necessity for the exclusion; and,
provide the affected candidate the opportunity to explain the conviction to determine whether the policy as applied is job related and consistent with business necessity.

The Guidance also states employers must show that their policy “operates to effectively link specific criminal conduct, and its dangers, with the risks inherent in the duties of a particular position.” A policy that excludes all candidates with any criminal convictions from all employment opportunities will not withstand EEOC scrutiny.

This is an area fraught with pitfalls for employers. If you have, or are planning to implement, a pre-employment screening regimen that includes restrictions for criminal convictions, you should consult experienced labor counsel.

Recent Decision by Arizona Court of Appeals Impacts Anti-Deficiency Statute

Arizona's anti-deficiency statute provides that, for certain types of qualifying residential loans, a borrower's liability - and a lender's corresponding claim - is limited to the value of the real property that secures the loan. The breadth and scope of the statute, which was enacted in 1971, have been the subject of many judicial decisions. The Arizona Court of Appeals recently decided three important issues under the anti-deficiency statute. In Helvetica Servicing, Inc. v. Pasquan, the court held that (i) a borrower who refinances a purchase money loan that is afforded anti-deficiency protection does not lose that protection to the extent that the refinance proceeds are paid to satisfy the original purchase money obligation, regardless of whether the refinancing involves a different lender and a different deed of trust than did the original loan; (ii) a borrower who uses loan proceeds to construct a qualifying residence may receive anti-deficiency protection under certain circumstances; and (iii) a lender who disburses sums in a loan transaction for non-purchase money purposes may trace, segregate, and recover these sums in a deficiency action.

Background

In Helvetica Servicing, the borrower obtained a $600,000 loan, secured by a deed of trust, to purchase real property. The borrower thereafter received from a different lender a refinance loan and a construction loan to build a residence for a combined $2.1 million; these loans were secured by new deeds of trust on the same property. Approximately three years later, the borrower obtained the loan that eventually became the subject of the litigation. The proceeds of that third loan were disbursed as follows: (i) $2.2 million paid off the loans secured by the existing first and second deeds of trust; (ii) $398,000 repaid unsecured loans and credit cards that were purportedly used to finance construction of the residence; (iii) $491,000 paid off alleged "closing costs," "points/interest," and "interest/reserves;" and (iv) $358,000 was paid directly to the borrower. After the borrower defaulted on this third loan, the lender commenced a judicial foreclosure action, in which the lender eventually acquired the property for a credit bid. The court later concluded that the fair market value of the property was $2.3 million. The lender then argued that it was entitled to a deficiency judgment based on full amount of the loan, which was approximately $3.7 million. The borrower disagreed, contending that the entire loan was subject to anti-deficiency protection. The trial court sided with the lender. The borrower appealed.

Refinance Loans

The borrower argued that the third loan remained a purchase money obligation. The lender maintained that by refinancing a purchase money loan in the manner that the borrower did, the borrower "destroy[ed] the purchase money status, and forfeit[ed] anti-deficiency protection." The lender's principal argument was that the loan was no longer entitled to anti-deficiency protection because the original deed of trust had been replaced by new deeds of trust and the subsequent lenders were different than the lender for the original loan used to purchase the property.

The Court of Appeals agreed with the borrower, holding that the anti-deficiency statute was intended by the legislature to "place the risk of inadequate security on the lenders rather than borrowers" and "to 'protect consumers from financial ruin' and 'eliminate ... hardships resulting to consumers who, when purchasing a home, fail to realize the extent to which they are subjecting assets besides the home to the legal process." Invoking this intent and relying on a 1997 case that held that anti-deficiency protection is not lost when the borrower enters a refinancing with the same lender under the same deed of trust, Helvitica held that the character of a purchase money obligation is not changed simply because it is refinanced by a new lender with a new deed of trust.

Therefore, to the extent that refinance loan proceeds are used to satisfy a purchase money loan that qualifies for protection under Arizona's anti-deficiency statute, those proceeds will be afforded the same anti-deficiency protection.

Construction Loans

Helvitica noted that "[n]o Arizona appellate decision had addressed whether ... 'construction loans' used to build a residence are purchase money obligations entitled to anti-deficiency protection." The court looked to California case law for guidance, and observed that the terms "purchase" and "purchaser" in the California anti-deficiency statute have been interpreted broadly to include borrowers who obtain a construction loan to construct a residence. Helvitica found the California "analysis and conclusion equally applicable to and consistent with Arizona's legislative scheme."

Accordingly, a construction loan qualifies as a purchase money obligation if: (i) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (ii) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in the anti-deficiency statute.

Non-Purchase Money Funds

The last issue that Helvitica addressedis what happens when a purchase money transaction includes non-purchase money loan funds. The court identified three possible answers to the question, ranging from the two extremes (making the entire loan a recourse obligation vs. affording anti-deficiency protection to the entire amount) to the middle ground of permitting non-purchase money sums to be traced, segregated, and included in a deficiency. Helvitica adopted the middle ground, and holds that allowing a lender to obtain a deficiency judgment for non-purchase money loan funds that can be segregated and traced as such is most consistent with the underlying goals of Arizona's anti-deficiency legislation.

Thus, to the extent that a borrower's liability includes both purchase money and non-purchase money sums, a lender may pursue a deficiency judgment for the latter amounts, to the extent that they can be segregated and traced.

* * * * * * * * * * *

Helvitica touched on but does not specifically address a number of related issues, including whether loan funds used to remodel a residence or add on to it qualify for anti-deficiency protection for the same reasons that construction loans do.

Finally, it should be kept in mind that the lender in Helvitica brought a judicial foreclosure action. If the lender had instead non-judicially foreclosed, it would not have been entitled to recover a deficiency regardless of whether the loan was purchase money, if all of the other anti-deficiency requirements were met (as they were in Helvitica). Thus, although Helvitica does not expressly make this point, it bears reminding that if a creditor believes its loan consists wholly or in part of non-purchase money funds and that all of the other anti-deficiency requirements do or may exist, then the safer course to recover such funds is to bring a judicial foreclosure action, rather than foreclosing non-judicially and subsequently bringing a deficiency action.

Do Directors and Officers Owe Fiduciary Duties to Creditors?

It is generally understood that a company's directors and officers owe fiduciary duties to its shareholders. In Arizona, they also owe them to creditors - at least once the company becomes insolvent.

Arizona follows the "Trust Fund Doctrine." It was first recognized here in A.R. Teeters & Assocs. v. Eastman Kodak Co., 172 Ariz. 324, 836 P.2d 1034. (App. 1992), in which the Arizona Court of Appeals explained:

"The theory of the trust fund doctrine is that all of the assets of a corporation, immediately on its becoming insolvent, exist for the benefit of all of its creditors and that thereafter no liens nor rights can be created either voluntarily or by operation of law whereby one creditor is given an advantage over others."

Teeters, 836 P.2d at 1041 (citation omitted). In Teeters, the court held that an officer, director, and stockholder who loaned money to the company breached a fiduciary duty owed to the company's other creditors where (i) he caused the transfer of corporate assets to himself (ii) the transfer occurred while the corporation was insolvent; and (iii) the transfer had the effect of preferring him to the disadvantage of other creditors of the same priority.

A few points worth noting:

The Trust Fund Doctrine is similar to, but in some ways broader than, the concept of a "preference" under the Bankruptcy Code.[1] Liability arises under state law and exists regardless of whether (i) the transfer occurs within certain proximity of a bankruptcy filing or (ii) a bankruptcy case is ever filed. There must be a showing, however, that the company was insolvent at the time of the transfer. E.g., In re Weinberg, 410 B.R. 19, 28-19 (9^th Cir. BAP 2009). There is no fiduciary duty to, or trust fund for, creditors until then.
Teeters' language appears to make the Trust Fund Doctrine applicable whenever, as a result of the transfer, "one creditor is given an advantage over others." Thus far, it has been applied in Arizona only when the transferee is, or is related to, a director, officer, or stockholder. No reported Arizona case has been found applying it to transfers to non-insider, arms-length creditors.
The source of recovery is a breach of fiduciary claim against the officer or director that caused the company to make the transfer. Liability, if established, is limited to the value of the assets received by the transferee.
Query whether the doctrine will be applied and/or fiduciary duties extended where the transfer occurs within the "vicinity" or "zone of insolvency" or where it causes the company to become insolvent. This issue has been addressed in other jurisdictions.[2] For now, Teeters' language suggests that in Arizona, the trust fund does not arise until the company becomes insolvent.

No Arizona cases could be found applying the Trust Fund Doctrine in the context of an Arizona limited liability company. It would seem logical, however, to do so.

The bottom line is that officers, directors, and others in control of a company's affairs need to be careful about transfers made while the company is insolvent. Such transfers could result in liability to them where none previously existed.

-------------------------------------

[1] The doctrine is similar to the concept of a preferential transfer under the Bankruptcy Code. Under the Bankruptcy Code, a transfer made to a creditor on account of a debt is considered preferential, and therefore recoverable, if (among other things) it was made within a certain time frame -- one year for insider creditors and ninety days for all other creditors -- prior to the bankruptcy filing and enables the creditor to receive more than it would otherwise receive in a bankruptcy liquidation. 11 U.S.C. §547. The doctrine also presumably applies to transfers made for less than reasonably equivalent value, which also may be recoverable under state fraudulent transfer law. See A.R.S. §44-1001 et seq.

[2] See, e.g., Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. 1991)(unpublished opinion by the Delaware Court of Chancery suggesting that the expansion of duties to creditors can occur in the "vicinity of insolvency"); but see RSL Communications PLC v. Bildrici, 649 F. Supp 184, 206 (S.D.N.Y. 2009)(applying New York law and rejecting a "zone of insolvency" theory); North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A. 2d 92, 101 (Del. 2006)(applying Delaware law, the Delaware Supreme Court held that no direct claim for breach of fiduciary duty may be asserted by the creditors of a solvent corporation that is operating in the zone of insolvency).

Conflicting District Court Decisions Regarding NLRB Posters

On Friday, April 13, 2012, the United States District Court for the District of South Carolina, Charleston Division, issued an order holding the National Labor Relations Board (NLRB) may not require employers to post a notice advising employees of their rights under the National Labor Relations Act.

This ruling conflicts with last month’s ruling by the United States District Court for the District of Columbia upholding the NLRB’s authority to require posting of the notice.

Unless and until an Arizona federal judge, the Ninth Circuit Court of Appeals or the United States Supreme Court rules the NLRB has no authority to require the poster, the rule will apply to Arizona employers, which currently have until April 30, 2012 to comply.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact the author, Keith Overholt, or the Chair of our Labor and Employment Department, John Egbert.

The Jobs Act Eases Rules on Capital Formation

The new Jumpstart our Business Startups Act of 2012 ("JOBS Act"), signed into law on April 5, 2012, implements significant changes to the federal securities laws, in an effort to assist small and mid-sized businesses seeking to raise capital. This Client Alert, which focuses on "Crowdfunding," is the first in a series addressing some of those key changes.

Part One: CROWDFUNDING IS AUTHORIZED AT THE FEDERAL LEVEL - Caution Regarding State Law Compliance

The Crowdfunding title of the JOBS Act will allow a private company to raise funds from a larger pool of investors who are not "accredited" so long as the amounts raised from those investors is limited and the offering complies with additional requirements.

Companies using these provisions can raise up to $1 million from the "crowdfunding investors" in a rolling 12-month period. A company using crowdfunding must sell its securities either through a registered broker or through a funding portal registered with the Securities and Exchange Commission ("SEC") and a self-regulatory organization.

Investors whose annual income or net worth is less than $100,000 will be able to invest up to the greater of $2,000 or 5% of their annual income or net worth in the company. Investors whose annual income or net worth is at least $100,000 will be able to invest 10% of their annual income or net worth up to a maximum of $100,000.The JOBS Act mandates that a company using the crowdfunding provisions must disclose information regarding its officers, directors and shareholders with more than a 20% stake in the company, and background checks on those individuals must be performed. In addition, these companies must make financial disclosures, which will vary, based on size of the offering.

The JOBS Act imposes various other required disclosures and conditions, including disclosure of risk factors, establishing a minimum threshold for the offerings and allowing investors to cancel their investment commitments as set forth in new SEC rules to be adopted. The SEC is required to adopt conforming rules within 270 days after enactment.

Companies making securities offerings under the crowdfunding provisions will be subject to tiered financial disclosure. The level of disclosure will be based on the aggregated total value of securities offered within the prior 12 months, including the offering for which the company will make the disclosure. The law directs the SEC to adjust the following amounts for inflation at least every five years.

For offerings of $100,000 or less:

o Income tax returns for most recent year; and

o Financial statements certified by principal executive officer

For offerings greater than $100,000 up to $500,000:

o Financial statements reviewed by an independent public accountant using SEC approved standards and procedures

For offerings greater than $500,000 up to $1 million:

o Audited financial statements

Important Notes: Although the JOBS Act implements certain changes at the federal level, securities offerings must continue to comply with applicable state securities laws. While the JOBS Act limits the reach of some state laws, others continue to apply to the offerings, and those laws do not yet contain similar exemptions. In addition, the JOBS Act contains numerous technical provisions regarding eligibility and compliance requirements. The SEC is required to publish rules designed to more fully clarify many of these new requirements. Accordingly, readers are urged to consult with counsel when contemplating any securities transactions, including those using the new JOBS Act exemptions.

National Labor Relations Board Mandates Employers Post Notice Advising Employees of Rights by April 30

Although litigation continues to determine whether the National Labor Relations Board may require virtually all employers to post a notice of certain rights afforded under the National Labor Relations Act regardless of whether its employees are organized, April 30, 2012 is the date on which employers must comply. As of April 30, all employers must post the notice in a conspicuous place, typically where other government mandated notices concerning wage and hour laws and other employee rights are located. A coalition of employer groups sued the NLRB in federal court in Washington, D.C. seeking to have the court hold that the requirement was beyond the Board’s authority. The court upheld the NLRB’s authority to require the poster but ruled the NLRB may not deem the failure to post the notice as an unfair labor practice by itself or to suspend the statute of limitations on employees’ unfair labor practice charges. The court’s ruling does permit the NLRB to find the failure to post the notice to be evidence of union animus in unfair labor practice proceedings on a case by case basis. We expect the NLRB to take that position in virtually all cases, the significance of which will vary according to the specific circumstances of each employer.

Unless and until the District of Columbia Court of Appeals orders otherwise, employers desiring to comply with NLRB’s mandate must post the notice by April 30, 2012. A copy of the notice may be found at www.nlrb.gov/poster.

Recent Arizona Court of Appeals Decision Impacts Arizona's Anti-Deficiency Statute

Arizona’s anti-deficiency statute provides that, for certain types of qualifying residential loans, a borrower’s liability - and a lender’s corresponding claim - is limited to the value of the real property that secures the loan. The breadth and scope of the statute, which was enacted in 1971, have been the subject of many judicial decisions. On March 20, 2012, the Arizona Court of Appeals decided three important issues under the anti-deficiency statute. In Helvetica Servicing, Inc. v. Pasquan, the court held that (i) a borrower who refinances a purchase money loan that is afforded anti-deficiency protection does not lose that protection to the extent that the refinance proceeds are paid to satisfy the original purchase money obligation, regardless of whether the refinancing involves a different lender and a different deed of trust than did the original loan; (ii) a borrower who uses loan proceeds to construct a qualifying residence may receive anti-deficiency protection under certain circumstances; and (iii) a lender who disburses sums in a loan transaction for non-purchase money purposes may trace, segregate, and recover these sums in a deficiency action.

Background

Helvetica Servicing, the borrower obtained a $600,000 loan, secured by a deed of trust, to purchase real property. The borrower thereafter received from a different lender a refinance loan and a construction loan to build a residence for a combined $2.1 million; these loans were secured by new deeds of trust on the same property. Approximately three years later, the borrower obtained the loan that eventually became the subject of the litigation. The proceeds of that third loan were disbursed as follows: (i) $2.2 million paid off the loans secured by the existing first and second deeds of trust; (ii) $398,000 repaid unsecured loans and credit cards that were purportedly used to finance construction of the residence; (iii) $491,000 paid off alleged “closing costs,” “points/interest,” and “interest/reserves;” and (iv) $358,000 was paid directly to the borrower. After the borrower defaulted on this third loan, the lender commenced a judicial foreclosure action, in which the lender eventually acquired the property for a credit bid. The court later concluded that the fair market value of the property was $2.3 million. The lender then argued that it was entitled to a deficiency judgment based on full amount of the loan, which was approximately $3.7 million. The borrower disagreed, contending that the entire loan was subject to anti-deficiency protection. The trial court sided with the lender. The borrower appealed.

Refinance Loans

Helvitica held that the character of a purchase money obligation is not changed simply because it is refinanced by a new lender with a new deed of trust.

Therefore, to the extent that refinance loan proceeds are used to satisfy a purchase money loan that qualifies for protection under Arizona’s anti-deficiency statute, those proceeds will be afforded the same anti-deficiency protection.

Construction Loans

Helvitica noted that “[n]o Arizona appellate decision had addressed whether … ‘construction loans’ used to build a residence are purchase money obligations entitled to anti-deficiency protection.” The court looked to California case law for guidance, and observed that the terms “purchase” and “purchaser” in the California anti-deficiency statute have been interpreted broadly to include borrowers who obtain a construction loan to construct a residence. Helvitica found the California “analysis and conclusion equally applicable to and consistent with Arizona’s legislative scheme.”

Non-Purchase Money Funds

Helvitica addressed is what happens when a purchase money transaction includes non-purchase money loan funds. The court identified three possible answers to the question, ranging from the two extremes (making the entire loan a recourse obligation vs. affording anti-deficiency protection to the entire amount) to the middle ground of permitting non-purchase money sums to be traced, segregated, and included in a deficiency. Helvitica adopted the middle ground, and holds that allowing a lender to obtain a deficiency judgment for non-purchase money loan funds that can be segregated and traced as such is most consistent with the underlying goals of Arizona’s anti-deficiency legislation.

Thus, to the extent that a borrower’s liability includes both purchase money and non-purchase money sums, a lender may pursue a deficiency judgment for the latter amounts, to the extent that they can be segregated and traced.

* * * * * * * * * * *

Helvitica touched on but does not specifically address a number of related issues, including whether loan funds used to remodel a residence or add on to it qualify for anti-deficiency protection for the same reasons that construction loans do.

What You Need to Know About the "Protecting Tenants at Foreclosure Act"

On May 20, 2009, President Obama signed the Protecting Tenants at Foreclosure Act of 2009[1] ("PTFA" or "Act"), which was amended on July 21, 2010 ("2010 Amendment").[2] The PTFA was enacted to protect residential tenants from being promptly evicted following foreclosures. In many cases, historically, the foreclosing creditor's lien is senior to the tenant's right to possession under the lease, and tenants were evicted because they held junior interests subject to foreclosure. The PTFA subjects any "successor in interest" to existing "bona-fide" leases and provides a 90-day notice requirement before eviction actions can be commenced. As originally enacted, the PTFA was scheduled to expire in 2012, but the sunset date was extended to 2014 by the 2010 Amendment.

The law generally applies to all residential leases. Section 702 of the Act applies to any "federally-related mortgage loan," and additionally to "any dwelling or residential real property."

In Arizona, in the case of non-judicial foreclosures, the law applies to residential leases entered into before a trustee's sale has been concluded. Although the original act applied to leases entered into before "notice of foreclosure," the 2010 Amendment clarified the cut-off date to be "the date on which complete title to the property is transferred to a successor entity or as a result of an order of court or pursuant to the provision in the mortgage, deed of trust, or security deed."

The "successor in interest" must provide a 90-day notice to any "bona fide tenant," which includes month-to-month leases and tenancies at will. Section 702(a)(2)(B). The "successor in interest" often has difficulty determining the nature of the lease relationship between the borrower and the tenant. Foreclosing creditors or purchasers at trustee's sales may not have the benefit of copies of leases.

If it is determined that there is no lease, or that the lease is terminable at will, a 90-day notice to vacate can be issued after the trustee's sale has been conducted. If there is a "bona-fide" oral or written lease, it must be honored for the term of the lease. An exception to that rule is when the "successor in interest" intends to utilize the property as the owner's primary residence. In that event, the owner can send out a 90-day notice to vacate after the trustee's sale has been concluded and need not honor the lease beyond the 90 days.

For the lease to be "bona fide," the tenant cannot be the mortgagor or the child, spouse, or parent of the mortgagor. Additionally, the lease or tenancy must be the result of an arm's length transaction, and rent must not be substantially less than fair market value for the property, except if rent is reduced due to a federal, state or local subsidy. Section 702(b). In a clear case when a "successor in interest" has determined that the lease is not "bona fide," the new owner can proceed without providing the 90-day notice. Otherwise, it would bode well to send out the 90-day notice.

A practice used by lenders is to request that the recipient of the notice provide the "successor in interest" with information about any lease and information about whether the lease is "bona fide," within a certain set time frame (i.e. inquiring if the recipient is the mortgagor, child, spouse or parent of the mortgagor). The notice may also indicate that if the information is not provided by the recipient within a set time frame, the "successor in interest" will presume that there is no "bona fide" lease. Often times, the notice will advise the recipient that rent must continue to be paid, where it is to be paid and that eviction proceedings will commence if rent is not timely paid.

The PTFA does not specify the required mode of service of the notice. It would be beneficial to have the notice hand-delivered, and to secure an acknowledgement of receipt or declaration of the party serving the notice attesting to the hand-delivery. If there is a written lease with a notice provision, notice served in accordance with the notice provision should be acceptable. Mailing or posting notice may be sufficient when expressly provided for by law, such as when a summons and complaint is served in a special detainer action. See A.R.S. § 33-1377(B) and Rule 18(h), Arizona Rules of Procedure for Eviction Actions. However, the PTFA has no provision for mailing or posting of notices.

The PTFA does not have a specific remedy provision. If the "successor in interest" commences an eviction proceeding without sending out a 90-day notice or during the 90-day time frame after sending out the notice, tenants may appear and affirmatively defend based upon a violation of the PTFA.

In Bank of New York Mellon v. De Meo, 227 Ariz. 192, 254 P.3d 1138 (App. 2011), the Arizona Court of Appeals reversed the trial court and dismissed an eviction proceeding commenced by the Bank, which acquired title at a trustee's sale. The Bank sent out a traditional five-day demand for possession following the trustee's sale, but did not provide the 90-day notice required by PTFA. The Bank argued that it provided the 90-day notice orally to the tenant before commencing the eviction action. The Court refused to find that the oral 90-day notice was effective. Id. at 195, ¶ 15, n. 4, 254 P.2d at 1141. The Bank also argued that it should be deemed to have complied with PTFA, because it waited 97 days after sending out the five-day demand for possession before filing a forcible entry and detainer action. Id. at 193, ¶ 5, 254 P.2d at 1139. The Court refused to accept that logic and dismissed the action, holding that the required 90-day notice must be sent. Id. at 195, ¶ 15, 254 P.2d at 1141.

The PTFA does not reach the issue of whether the "successor in interest" must wait until the end of the 90-day time frame to commence an eviction proceeding, if the tenant fails to pay rent. Presumably, tenants who are not paying rent also are not taking the time to defend eviction actions. In some cases, tenants may have difficulty determining to whom the rent should be paid, if there has been a resale of the property following the trustee's sale. Consideration of special circumstances may be appropriate before proceeding with an eviction action during the 90-day time frame, if the tenant has failed to pay rent.

[1] Title VII, Section 701-704 of the Helping Families Save Their Homes Act of 2009.

[2] Section 1484 of the Dodd-Frank Wall Street and Consumer Protection Act.

FERC Clarifies Treatment of Pipeline’s Discount-Type Adjustments for Negotiated Rates

In an order on rehearing issued March 15, 2012 in Texas Gas Transmission, LLC, 138 FERC ¶ 61,175, the Federal Energy Regulatory Commission (“FERC”) took the opportunity to reiterate, and in light of overly broad precedent, clarify the conditions a pipeline must satisfy in order to obtain a discount-type adjustment for negotiated rate transactions in a Natural Gas Act section 4 rate case. Recognizing that its policy on this issue has evolved over the fifteen years since the negotiated rate program was established in the Alternative Rate Policy Statement[1], the Commission reiterated its intent that “customers electing the recourse rates will be no worse off as a result of the use of negotiated rates.” But because the Commission’s statements in individual cases concerning how to accomplish that goal have varied, the following clarifications were provided in this order:

There is no per se prohibition of discount adjustments for negotiated rates;
Such an adjustment might be permitted if the pipeline has a tariff provision protecting recourse rate shippers from inappropriate cost shifting;
The pipeline will have the burden to show that its proposed discount adjustment takes into account any above-maximum rate revenues, and that it has included an appropriate corresponding reduction in its proposed discount adjustment;
If a pipeline has tariff language permitting it to seek a discount-type adjustment for negotiated rate transactions, parties may raise the issue whether costs should be allocated to the negotiated rate transactions based on the full revenues received in those transactions during the test period; and
Discount-type adjustments in fuel tracking mechanisms are not permitted, as pipelines are required to be at risk for discounts given between rate cases.

In response to the argument that by giving pipelines the choice of whether to implement a tariff provision permitting a discount adjustment for negotiated rates, the Commission is opening the door for abuse (since the pipeline will either add or delete the provision depending on whether it will work to its advantage in the next rate case), the Commission stated that it may consider allegations of such abuse in individual cases, such as where a pipeline with such a provision proposes to delete it.

Key FERC orders referenced:

Columbia Gulf Transmission Co., 133 FERC ¶ 61,078 (2010)
Wyoming Interstate Co., Ltd., 117 FERC ¶ 61,150 (2006) (WIC II)
Southern Natural Gas Co., 94 FERC ¶ 61,063 (2001); Southern Natural Gas Co., 95 FERC ¶ 61,038, order on reh’g, 95 FERC ¶ 61,364 (2001)
Enbridge Pipelines (KPC), 103 FERC ¶ 61,305 (2003)
El Paso Natural Gas Co., 114 FERC ¶ 61,305 (2006)
Nornew Energy Supply, Inc., 116 FERC ¶ 61,192 (2006)
Tennessee Gas Pipeline Co., 135 FERC ¶ 61,208 (2011)

[1] Alternatives to Traditional Cost-of-Service Ratemaking for Natural Gas Pipelines, 74 FERC ¶ 61,076, order granting clarification, 74 FERC ¶ 61,194, reh’g denied, 75 FERC ¶ 61,024 (1996) (“Alternative Rate Policy Statement”).

Changes in NERC Reliability Standards FAC-008/FAC-009 will take Effect on January 1, 2013

Entities that are included on the NERC Compliance Registry as either a Generator Owner (GO) or Transmission Owner (TO) should be preparing for changes in the NERC Reliability standards FAC-008 and FAC-009. The changes will require at least some modifications to the registered entity's FAC-008 (Facility Ratings Methodology) documents.

Effective as of January 1, 2013, the present FAC-008-1 and FAC-009-1 Standards will be replaced by a much more detailed FAC-008-3 Standard. The new FAC-008-3 Standard will also include the requirement to share ratings with other interconnected or affected parties. All registered GOs and TOs will need to revise their facility ratings documents to comply with FAC-008-3 by January 1, 2013. To the extent a registered entity's equipment rating procedures are not compliant with the revised FAC-008-3 Standard, those procedures will need to be revised and new equipment ratings derived and communicated to other entities prior to January 1, 2013.

The changes were driven by at least three factors:

(1) A recognition that the FAC-008-1 Standard and the FAC-009-1 Standard could result in two separate but similar compliance documents;

(2) The need to allow for separate rating methodology requirements for generator facilities and for transmission facilities; and

(3) A desire to have more detail in the standard to make compliance requirements more clear.

Highlights from the new FAC-008-3 include:

There are now separate requirements for Generator equipment and for Transmission equipment, as well as some requirements that explicitly apply to both Generator and Transmission equipment.

Generators and Associated Interconnect Equipment:

The Standard contains criteria for documenting how generator ratings are determined. Documentation must include:

Assumptions used in determining the rating (ambient conditions, run time, any corrections, etc.)

Any design, construction or operating factors that are considered in or affect the rating determination

A general rule that the generator rating can't exceed the rating of the most limiting piece of equipment for the generator and its interconnection

The Standard also contains criteria for the rating methodology for generator interconnect equipment (breakers, meters, PTs and CTs, buswork, etc.)

Transmission Equipment

The Standard contains separate criteria for the rating methodology used for transmission equipment. These criteria require the following items be included in the methodology:

Discussion of whether ratings are based on manufacturer data, industry standards (IEEE, etc), or operating performance restrictions

Explanation of the assumptions, design criteria, and/or methods used to identify equipment ratings.

A general rule that the rating of any assemblage or grouping of equipment can't exceed the rating of the most limiting piece of equipment in the assemblage or grouping.

A discussion of the process used to determine the normal, short term emergency, long term emergency, and drastic action limits for the equipment.

Communicating Ratings

The new FAC-008-3 contains a broad requirement to share equipment ratings with affected or interconnected parties, replacing the FAC-009 Standard.

The Standard includes a new requirement that effectively gives affected entities, such as the Reliability Coordinator, connected Transmission Operator (TOp) or Generator Operator (GOp), Planning Authority or Transmission Planner the ability to comment on (question) any equipment rating provided by a GO or TO. Any such comment must be answered by proposing a new rating or explaining why the original rating is valid.

The new Standard also allows affected entities to request information on the most limiting element affecting a rating as well as the second and third most limiting elements. In practice, requests for information on the second and third most limiting elements should be rare except for extremely critical elements or elements that are central to serious SOLs or IROLs.

Finally, all registered TOs and TOps should be aware there are a number of other changes relating to the TO and TOp functions that will go into effect later this year (PER-003-1) or in 2013 (PER-005-1, EOP-001-1, EOP-005-2, EOP-006-2, and EOP-008-1). Some of these changes are significant. Any entity that is listed on the NERC Compliance Registry as a TO or TOp should become familiar with the revised Standards and take active measures to ensure the entity is compliant within the deadline specified for each respective revised Standard.

Is That Personal Guaranty Enforceable?

For creditors, a personal guaranty can provide an important third-party source of payment. For guarantors, its enforceability can mean the difference between solvency and insolvency.

At first glance, a guaranty's language can seem ironclad. Uncompensated guarantorsare often said to be "favorites of the law," however, and the courts will strictly construe the guarantor's undertaking. Moreover, various defenses to the enforcement of personal guaranties have evolved. Three of them are discussed below.

Failure to Properly Bind the Marital Community. In order to bind a marital community under Arizona law, both spouses must join in the guaranty transaction. Additionally, there is a strong presumption under Arizona law that all property acquired during the marriage is community property. Accordingly, a creditor's failure to have both spouses sign the guaranty may, as a practical matter, render the guaranty uncollectible.

Modification of the Obligation Without the Guarantor's Consent. Where, without the guarantor's consent, the principal and the creditor modify their contract, the guarantor is discharged unless the modification is of a sort that can only be beneficial to the guarantor. Thus, creditors will want to get the guarantor's written consent to any modification, regardless of to whom it may be viewed as being favorable.

Breach of Duty of Disclosure. A creditor owes a guarantor a duty of good faith and fair dealing. That includes the duty to disclose facts which increase the guarantor's risk. Before this duty arises, the creditor must (i) have reason to believe that there are facts which materially increase the risk beyond that which the guarantor intends to assume and (ii) have reason to believe that those facts are unknown to the guarantor. The duty of disclosure continues throughout the parties' relationship. Thus, a creditor who makes multiple extensions of credit, learns of the debtor's insolvency, and has reason to believe the guarantor is unaware of it, has a duty to disclose the insolvency to the guarantor before making further advances. Its failure to do so can relieve the guarantor of liability on all further extensions of credit.

Conclusion. Creditors and guarantors can tend to overemphasize a guaranty's formidable-sounding language. Thorough examination and review of the surrounding facts and circumstances, however, can lead to the discovery of one or more defenses and to the conclusion that liability is hardly certain.

FERC Seeks Comments on Coordination Between Natural Gas & Electricity Markets

FERC Commissioner Moeller has issued a request for comments on the need for coordination between the natural gas and electricity markets. FERC and other industry participants have viewed this issue with increasing interest over the past few years. Many predict a dramatic increase in the reliance on natural gas as a fuel source for electricity due to factors such as climate change regulation and a surge in the development of shale gas.

The increased reliance on natural gas as a fuel source underscores the interdependency of the electric and natural gas industries, as well as key differences that could adversely affect reliability and operations within both industries. Organizations such as the North American Electric Reliability Corporation (NERC) and the North American Energy Standards Board (NAESB) have established committees to examine the need for industry coordination. RTOs are analyzing the issue through their stakeholder processes as well. Commissioner Moeller’s request for comments marks FERC’s first attempt to address these coordination issues in a comprehensive manner.

Commissioner Moeller emphasizes the need for national and regional policies to address these concerns. He has posed a number of broad questions geared towards laying the foundation for future regulation in this arena, including:

What role FERC should have in overseeing coordination and what duties should be delegated to other entities (NERC, NAESB, etc.);
Whether and how FERC should take into account regional differences, such as the differences between regions with organized electricity markets and those operating on a bilateral basis;
Whether, with an increase in gas-fired generation, FERC needs to address the effect of electric generators on natural gas transportation and the flows on natural gas pipelines;
Whether there is a need to address operational differences between the two industries and harmonize standard business practices.

LLC Payment Classifications: Member Distributions vs. Compensation: Beware of Unintended Consequences

Those who do business through a closely-held limited liability company (LLC) often receive their share of business profits in the form of member distributions instead of guaranteed payments (compensation). [1] They may be advised, for example, that there are tax advantages to doing so.[2] What they may not realize, however, is that paying LLC members in the form of distributions instead of compensation may impair the limited liability protection otherwise afforded to LLC members and expose them to creditors' claims, at least where the LLC engages in activities with a high risk of liability and/or becomes insolvent.

While there may be reasons for choosing to give members distributions instead of compensation, there are potential risks to the LLC's members from a creditor standpoint. A.R.S. § 29-706 provides that a limited liability company "shall not make a distribution to its members to the extent that at the time of the distribution, after giving effect to the distribution, all liabilities of the limited liability company would exceed the fair value of the assets of the limited liability company...." Liability is imposed on each member who receives such distributions for the amount of such distributions.[3]

Take, for example, a medical practice that conducts its business as a professional limited liability company[4] and for which there has been a large malpractice claim. If the medical practice thereafter continues to pay its doctor members in the form of distributions instead of compensation, each member potentially can be personally liable for distributions received at any point after the company's liabilities exceed its assets.

Other legal doctrines[5] can lead to the same result; and similar rules can apply in the context of corporations[6] and limited partnerships.[7] Thus, while there may be good reasons for classifying payments to members as distributions instead of compensation, beware the unintended consequences of doing so: it may adversely affect the limited liability protection otherwise afforded an LLC's members.

[1] Pursuant to IRS regulations, compensatory payments to LLC members are to be treated as guaranteed payments (similar to payments to an independent contractor) rather than salary.

[2] Whether or not there are actual tax advantages is beyond the scope of this discussion. For example, LLC members may still be liable for self-employment taxes at the personal level, whether they receive distributions or guaranteed payments or neither.

[3] Subsection D provides: "If a member receives a distribution with respect to his interest in a limited liability company in violation of this chapter or an operating agreement, he is liable to the limited liability company for a period of six years thereafter for the amount of the wrongful distribution."

[4] A.R.S. § 29-706 is made applicable to professional limited liability companies through A.R.S. § 29-843

[5] In Hullet v. Cousin , 32 P.3d 44 (Div. 1 2001), for example, the Arizona Court of Appeals applied fraudulent transfer law. There, after a limited partnership sold its only asset (an apartment complex), it distributed the net proceeds to its partners. A creditor later sued the limited partnership for claims related to the apartment complex. The creditor obtained a default judgment against the partnership, but the judgment was uncollectible because there were no assets remaining in the partnership. The creditor then sued the limited partners, arguing that the limited partnership's transfer of assets to them was voidable as fraudulent pursuant to Arizona Revised Statutes "A.R.S." sections 44-1004 and 44-1005. The Arizona Court of Appeals directed that judgment be entered in favor of the creditor on his fraudulent transfer claim against the limited partners. In so holding, the Court (citing to the functional equivalent of A.R.S. §29-706 as respects limited partnerships) recognized that a "limited partner is not entitled to distribution from a limited partnership to the extent that it would cause the liabilities of the limited partnership, other than those to partners on account of their partnership interests, to exceed the fair value of the limited partnership's assets. A.R.S. § 29-337 (1998)."

[6] A.R.S. §10-640(C).

[7] A.R.S. § 29-337.

Arizona's Minimum Wage Increases January 1, 2012

On January 1, 2012, Arizona’s minimum wage will increase by 30 cents to $7.65 per hour. Arizona’s minimum wage is higher than the federal minimum wage, which is currently $7.25 per hour.

In 2006, Arizona voters enacted a voter initiative, known originally as the “Raise the Minimum Wage for Working Arizonans Act” (the “Arizona Minimum Wage Act”). The Arizona Minimum Wage Act, which became effective January 1, 2007, established an Arizona minimum wage and also provided that the minimum wage was subject to an annual increase based on the increase in the cost of living. The cost of living is measured by the federal Consumer Price Index for All Urban Consumers, U.S. City Average, for all items during the 12 months ending each August 31. Pursuant to the authority granted by this law, the Industrial Commission reviewed the cost of living information and determined that Arizona’s minimum wage would be increased for calendar year 2011. In October 2011, the Industrial Commission of Arizona determined that the state’s hourly wage should increase based on a 3.8 percent increase in the federal Consumer Price Index this year.

Under federal law, a state may require a minimum wage that exceeds the federal wage. If there is a difference between the laws, the employer must follow the requirement that is the most beneficial to the employee. Thus, an Arizona employer that is subject to both the federal and state laws must pay the Arizona minimum wage rate. Further, Arizona employers must make sure they are in compliance with both the federal and the state laws. Our labor and employment attorneys can answer questions regarding the laws and regulations, and advise you on compliance issues. As you review your individual compliance, some further information regarding the Arizona Minimum Wage Act and regulations may be helpful.

Exceptions

The Arizona Minimum Wage Act provides only a few exceptions from its coverage. One exception is for small businesses that generate less than $500,000 in gross annual revenue, if that small business is not covered by the federal Fair Labor Standards Act (FLSA). From a practical standpoint, most employers are subject to the FLSA. Another exception applies to the state of Arizona and the U.S. government. Additionally, the Arizona Minimum Wage Act does not apply to any person who is employed by a parent or a sibling, or who is employed performing babysitting services in the employer’s home on a casual basis.

EEOC Releases Opinion Letter Regarding Pre-Employment Inquiries into Arrests & Convictions

The EEOC has released a letter outlining its general position with respect to employers using arrest and conviction records in pre-employment screening. Generally, the EEOC admonishes employers to distinguish between arrest and conviction records warning that arrest records are susceptible to errors and do not reflect whether the person was convicted of a crime. It also warned employers to tailor the use of conviction records to the position to be filled. Finally, if the use of conviction records results in a disparate impact on minorities, the employer should not use them. For more information on pre-employment inquiries regarding arrests and convictions from the EEOC, click here.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contactthe author, Keith Overholt, or the Chairof our Labor and Employment Department, John Egbert.

FASB Has Reissued its Accounting Standards Update

We previously advised our friends and clients about the Financial Accounting Standards Board (FASB) decision to withdraw the requirement that an employer contributing to a multi-employer pension plan must include the employer's share of the plan's unfunded liability on its financial statement. FASB has now reissued its Accounting Standards Update (No. 2011-09). Although employers will not have to include a calculation of their share of a plan's unfunded liability, they will have to include funding information about multi-employer pension plans to which they are obligated to contribute. Employers should work with their counsel to determine how to obtain that information from the plans. The new rule applies to all nongovernmental employers contributing to multi-employer pension plans. It is effective for fiscal years ending after December 15, 2011 for publicly held employers, and for fiscal years ending after December 15, 2012 for non-publicly held employers. The Accounting Standards Update can be found here.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contactthe author, Keith Overholt, or the Chair of our Labor and Employment Department, John Egbert.

NRLB Requires Employers to Post Notice Regarding Employee's Rights to Join a Union

Effective November 14, 2011 virtually all employers which are not in the agricultural, railway or airline business will be required to post a notice advising their employees of their right to be represented by a labor union. If 20% or more of the employees speak a foreign language, the notice must be in the foreign language. It will be an unfair labor practice to fail to post the notice. Although the National Association of Manufacturers has filed a lawsuit in federal court in the District of Columbia to contest the NLRB's authority to require the notice, the regulation currently remains in effect. The notice can be obtained here and can be posted as one 11x7 notice or two 8x11 pages.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contactthe author, Keith Overholt, or the Chair of our Labor and Employment Department, John Egbert.

Employers' Use of Independent Contractor Agreements Are Being Targeted

On September 19, 2011, the U.S.Department of Labor (DOL) announced that it has entered into a memorandum of understanding with the IRS which permits these two agencies to share information about employers' use of independent contractors. The DOL's press release is available here.

Some individual states have entered into similar arrangements with the DOL. It is becoming very clear that the issue of whether a worker is properly classified as an independent contractor is a high regulatory priority. Employers should exercise caution when classifying its workers as independent contractors. A determination that certain workers are really employees, and not independent contractors, can have very significant financial consequences for the employer. The list of factors the IRS uses to determine whether a worker should be classified as an employee or independent contractor is available here.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact the author, John Egbert, or another member of our Labor & Employment Department .

Department of Labor Announced it Will Re-Propose its Rule on the Definition of Fiduciary

The Department of Labor announced today that it would "re-propose" its rule on the definition of a fiduciary with respect to providing investment advice to pension plan participants.The Department received 260 comments on its first proposed rule causing it to re-examine its effort to amend the existing 1975 regulation.The Department expects to issue its new proposed rule in early 2012.The announcement can be found here.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

National Labor Relations Board Limits Undocumented Workers' Remedies

On August 9, 2011, the National Labor Relations Board (NLRB) issued a decision holding that undocumented workers are not entitled to back pay or reinstatement, even if their claims are meritorious.

In Mezonos Maven Bakery, Inc., 357 NLRB No. 47 (2011), a group of undocumented workers were terminated following complaints about the treatment they were receiving from a supervisor.The employees then filed unfair labor practice charges.The employer opposed reinstating and reimbursing the employees because their undocumented status precluded back pay, even though it was the employer, and not the employees, who violated the Immigration Reform and Control Act (IRCA).

The Board analyzed the Supreme Court's decision in Hoffman Plastic Compounds and concluded that regardless of which party violated the IRCA, the Board could not award back pay."The holding is categorically worded: back pay may not be awarded to undocumented aliens.It suggests no distinction based on the identity of the IRCA violator."Thus, whether the employer knowingly hired undocumented workers, or was given false documentation by the employee, "undocumented immigrants working in the United States are party to an employment relationship the Court deems criminal."

The Arizona legislature has expressly eliminated discretionary benefit payouts to undocumented workers in many Arizona statutes such as those involving unemployment compensation, the Arizona Health Care Cost Containment System (AHCCCS), and welfare. As a result, there has not been a need for Arizona courts to weigh in as of late. However, although the Arizona Court of Appeals upheld a denial of workers compensation benefits to an undocumented furniture worker in 2006 because the denial was "not unfounded," one of the judges opined that because the legislature did not expressly provide that undocumented workers were "employees" under the Workers Compensation Act, they should not be entitled to benefits under that Act. Gamez v. Indus. Comm'n of Arizona, 213 Ariz. 314, 325, 141 P.3d 794, 805 (App. 2006)(Barker, J., concurring).

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Legal Watch Series: Topic 9 - Employees' Privacy Rights When Using Company Computers

Introduction: This is the ninth article in a continuing series of short informational pieces relating to one of the hottest topics in litigation, e-discovery. The purpose of these articles is to provide your business with some guidelines on how to most efficiently prepare for e-discovery. If you are new to our distribution, or if you would like to view previous articles in this series, please visit our website.

Employers who provide computers to employees for company business should not assume that they have unlimited rights to inspect or conduct wholesale discovery of an employee's personal data on company computers, even if they have a policy that states employees should not use the company computer for personal use.

City of Ontario, CA v. Quon, 130 S. Ct. 2619 (2010) involved a City of Ontario SWAT team member who used his employer-issued PDA for personal communications. The City's policy did not prohibit the personal use of the communications device, but did indicate that such use could be monitored; however, there was an unwritten practice that such use would not be monitored as long as the employee paid for excess charges. When Quon's supervisor asked to see the text messages on Quon's PDA, he refused and sued under various federal statutory and United States constitutional privacy theories. The Ninth Circuit Court of Appeals held that the employee had a "reasonable expectation of privacy" as defined in the Fourth Amendment of the Constitution, and that the supervisor's request to search the PDA was unreasonable.

The Supreme Court disagreed. Its opinion was narrowly based on Quon's reasonable expectation of privacy. The Supreme Court avoided the Fourth Amendment constitutional issue due to its concern that the implications of the emerging technology were still developing.

In Sprenger v. Rector and Board of Visitors of Va. Tech., -- F. Supp. 2d ---, 2008 WL 2465236 (WD Va. 2008), Sprenger, a state employee, sued her employer, Virginia Polytechnic Institute and State University (Virginia Tech), claiming violations of the Americans with Disabilities Act (ADA) and Family Medical Leave Act (FMLA). During discovery, the University subpoenaed the "electronically stored information" on the computer used by Sprenger's husband. The defense was specifically interested in obtaining e-mails concerning the lawsuit and those sent between Sprenger and her husband. Sprenger was successful in quashing the subpoena, asserting that the information on her husband's computer was protected by marital privilege, even though the University had a computer policy that stated no user should have any expectation of privacy in any e-mail sent or received, and that all e-mails were subject to monitoring. The Court found that Virginia Tech failed to present evidence that the policy was regularly enforced and that the Sprengers had received notice of the policy.

This was not the case in United States v. Etkin, 2008 WL 482281 (S.D.N.Y. 2008), where the United States District Court for the Southern District of New York held that the defendant did not have a reasonable expectation of privacy in e-mails sent from his office computer because each time he logged on, a "flash screen warning" appeared stating that the employer may monitor or inspect the computers at any time; therefore, an expectation of privacy was "entirely unreasonable."

Other notable cases include, Curto v. Med. World Communications, Inc., 2006 WL 1318387 (E.D.N.Y. 2006)(plaintiff could not claim an expectation of privacy, although e-mails with her attorney from a company computer were privileged); Leventhal v. Knapek, 266 F.3d 64(2^nd Cir 2001) (investigatory searches on a state-owned computer did not violate an employee's fourth amendment rights, since the employer had reasonable grounds to believe that the searches would uncover evidence of the misconduct); United States v. Slanina, 283 F.3d 670 (5^thCir. 2002) (absence of a city policy placing the defendant on notice that his company computer usage was monitored, and the lack of any indication that other employees had routine access to his computer, provided the defendant with a reasonable expectation of privacy); Long v. Marubeni Am. Corp., 2006 WL 2998671 (S.D.N.Y. 2006) (plaintiff waived the attorney-client privilege even though he, in communicating with his counsel, used a personal, password-protected email account).

In Stengart v. Loving Care Agency, Inc., 990 A. 2d 650 (NJ 2010), Marina Stengart filed suit against her former employer, after her employer performed a forensic image of the hard drive from the laptop that she had returned, discovering privileged, password-protected correspondence between Stengart and her attorney made through her web-based e-mail account.

The employer argued that the e-mail messages were not protected because its written policy stated that the company may access "all matters on the company's media systems and services at any time." The trial court found in favor of the employer; but was reversed on appeal because of ambiguities in the employer's electronic communications policy that supported a reasonable expectation of privacy. In addition, the court concluded that the defense had violated professional conduct rules by failing to alert plaintiff's counsel that it had discovered the messages prior to reading them. The decision was affirmed by the New Jersey Supreme Court, but it should also be noted that, unlike most states, New Jersey's constitution recognizes a right to "informational privacy."

A similar issue was raised in a California case, Holmes v. Petrovich Development Co., 119 Cal. Rptr. 878 (App. 2011), which involved employment discrimination as defined by California law. Contrary to the New Jersey decision, the California Court of Appeals held that e-mails between an employee and her personal attorney, sent from a company-owned computer using a private, password-protected account, were not "confidential," thus, no reasonable expectation of privacy existed and the communications were not protected by the attorney-client privilege. The court's decision was influenced by the fact that the messages were in violation of the company policy prohibiting personal use of company computers, stating that the computers are for business purposes only and subject to monitoring. The employer also had procedures in place to support the fact that employees are made aware of such policies. The court commented that using the computer under the circumstances was "akin to consulting her attorney in one of [the employer's] conference rooms, in a loud voice, with the door open, yet unreasonably expecting that the conversation overheard by [the employer] would be privileged." California does not have a constitutional right to "informational privacy."

In conclusion, unless a state has a unique constitutional provision, employers must implement and reasonably enforce comprehensive policies concerning company computer usage, and ensure procedures are in place to document that employees are aware of such policies in order to access and/or use an employee's personal data.

If your company needs assistance in formulating a company computer usage policy, or would like to further discuss issues related to e-discovery in the work place, please contact Michael Palumbo, 602-262-5931 or Valerie Walker, 602-262-5844.

______________________________________________

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Department of Labor Proposes Changes to Persuader Reporting Requirements

The Department of Labor has proposed changes to, and seeks public comment regarding its interpretation of, the persuader reporting requirements set forth in Section 203 of the Labor-Management Reporting and Disclosure Act (LMRDA). Section 203 currently requires employers to disclose arrangements with any third-party to directly or indirectly persuade their employees as to their collective bargaining rights,or to obtain information about the activities of a labor organization involved in a labor dispute with the employer.

There has always been an exception to this reporting requirement for any "advice" given to the employer. In the past, this exception has excluded arrangements where the third-party does not have any direct contact with employees, such as drafting or reviewing documents, letters, or speeches presented to employees during an organizing drive or in anticipation of an NLRB election. These activities were deemed "advice," therefore, there was no need to disclose.

Should the Department of Labor's proposal become effective, the term "advice" will be limited to "oral or written recommendations regarding a decision or course of conduct," outside of representing the employer in a court, administrative, or arbitration proceeding. The term "persuader activity" would include training or directing supervisors and other management representatives to engage in persuader activity; establishing antiunion committees composed of employees; planning employee meetings; deciding which employees to target for persuader activity or discipline; creating employer policies and practices designed to prevent organizing; and determining the timing and sequencing of persuader tactics and strategies. In these instances, the Department of Labor believes the third-party has gone beyond mere recommendation and has engaged in actions, conduct, or communications with the object to persuade employees, either directly or indirectly, about the employees' protected, concerted activity. As such, the duty to report will be triggered.

The full text of the proposed interpretation can be found in the Federal Register. Electronic comments may be submitted here. Comments must be received by August 22, 2011.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Department of Homeland Security Embarks on a Major Compliance Effort

The Department of Homeland Security (DHS) is embarking on a major compliance effort to audit I-9 and related records of thousands of employers. Employers throughout Arizona and other southwestern states are receiving notices that they must produce I-9 and related information, such as unemployment insurance tax returns, payroll registers and 1099 forms for contract laborers. Employers are required to provide the requested information within three days of receiving the notice.

The DHS is entitled under the law to request that you relinquish your original Form I-9s along with copies of the other requested records. If you receive such a notice, the first thing you should do is seek legal counsel. Next, contact the local DHS office in your area to verify the identity of the auditor making the request to ensure that he or she is, in fact, a DHS employee. Once this is done, you should be prepared to comply with the auditor's request for information. By law, you are required to maintain, and the auditor will ask to see, a Form I-9 for all current employees, as well as those who have left employment within the prior 12 months. It is advised that you retain copies of all records you provide to the auditor along with a signed, itemized receipt. In addition to the I-9 records, the DHS will request copies of your company's key ownership information, business licenses and organizational documents. Remember, when the auditor arrives at your place of business, be sure to carefully review credentials to confirm he or she is the authorized auditor before you produce any information.

Below is the contact information for the Arizona Department of Homeland Security:
1700 W. Washington St.
Phoenix, AZ 85007
602-542-7030
http://www.azdohs.gov/

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

NLRB Proposed Procedural Changes to Representation Cases

The National Labor Relations Board has issued a Notice of Proposed Rule making, proposing amendments to several existing procedures in representation cases. In issuing this proposal, the Board has stated that it hopes to reduce unnecessary litigation, streamline pre- and post-election procedures, and facilitate the use of electronic communications and document filing. However, this will result in a shorter time between the filing of a petition for an election, which may affect employers' campaigns.A public hearing will be conducted on July 18, 2011. Comments must be received by August 22, 2011.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

New Guidelines for Applying for Functional Affirmative Action Program Agreements

The U.S. Department of Labor's Office of Federal Contract Compliance Programs has released an update to the process by which federal supply and service contractors can apply for Functional Affirmative Action Program agreements. Full details of new directive can be viewed here.

Section 503 of Executive Order 11246 provides that government contractors with 50 or more employees and a federal contract of $50,000 or more are required to develop a written affirmative action program for each of its establishments. Significant changes were made by OFCCP, including requiring written approval by the agency's director before contractors can begin developing FAAP agreements eliminatingthe provision for automatic approval if OFCCP failed to act upon the request within 120 days; changing the expiration date for each agreement from three to five years, at which point a renewal must be approved; and adding the possibility of a compliance evaluation by OFCCP should contractors fail to submit the required annual updates to their agreements.

All contractors with current FAAP approved agreements will be required to renew them in line with the new guidance.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

U.S. Supreme Court Provides Employers with Protection from Class Actions

On Monday of this week, the United States Supreme Court issued a decision which is a major win for employers. The Court substantially restricted when employees can join together in a "class action" against their employers to assert claims of discrimination, retaliation and related claims. This landmark decision gives significant protections from class actions, especially large, multi-state employers. To access the entire decision, click here.

Each case a business or individual may face is unique and may require legal advice. If youhave any questions about this ruling or how it might affect you, please contact John Egbert or another member of our Labor and Employment Department.

Legal Watch Series: Topic 8 - Social Media and the Workplace

Introduction: This is the eighth article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

Facebook, My Space, LinkedIn, Plaxo, Twitter, Skype, YouTube, Blogs, etc...you name it; almost everyone is doing it. Social Networking that is.

A social networking site has been defined as a "web-based service...that allow[s] individuals to (1) construct a public or semi-public profile within a bounded system, (2) articulate a list of other users with whom they share a connection, and (3) view and traverse their list of connections and those made by others within the system." Boyd and Ellison, "Social Network Sites: Definition, History, and Scholarship," Journal of Computer Mediated Communication (2007).

POTENTIAL PROBLEMS

Social networks can be a Pandora's box for an employer. Significant risks are presented by the very nature of social networking sites.

Following are some situations where social networking has caused embarrassment to an employer, drawn regulatory attention, or led to negative litigation consequences:

In 2010 and 2011, the National Labor Relations Board (NLRB) brought several complaints against businesses that disciplined employees for posting comments about the company on social networks (See discussion below);
In April 2009, a Wall Street Journal article reported that the SEC is monitoring corporate communications made via Twitter to ensure trading rules are not violated;
In April 2009, a Domino's Pizza employee posted an allegedly humorous video about how pizzas are made. The video included unhygienic and rude behavior, as well as employees mocking customers.
In October 2008, Virgin Airlines flight attendants posted disparaging remarks about the company's airplanes and customers.

A major concern to employers is the admissibility of information posted on social media sites being presented as evidence during litigation proceedings. The discoverability of this information does not require a technology savvy attorney; it is simply out there for the taking.

On the other hand, an employer may benefit from discovery of information posted to social networks, as exemplified in the Indiana Federal District Court case, EEOC v. Simply Storage Management, Inc., (S.D. Ind. May 11, 2010) involving a claim for emotional injury by an employee. The court allowed Simply Storage Management to obtain discovery from the plaintiff's Facebook and MySpace accounts, noting "it is reasonable to expect severe emotional or mental injury to manifest itself in some [social networking] content."

Another possible risk regarding social media is being caught in untruths. Last year, a Canadian who had taken a leave of absence from her job to battle depression, announced that her insurance provider, Manulife, had revoked her health benefits after discovering photos on her Facebook page depicting her attending a Chippendales show, celebrating a birthday and enjoying a day at the beach.

An example of this from the legal world is the situation where a lawyer was found to have committed an ethical violation and to have incurred the wrath of a judge by making a false statement about the supposed death of her father in order to obtain a continuance of a deadline. The tech savvy judge logged on to her Facebook page and determined that she was out and about socially instead of participating in funeral related activities. This can just as easily happen in your business. Surely, employers want to minimize these types of problems, but, the question is how to effectively do that.

Policy Considerations

As noted above, there has been a rash of cases involving the limits of an employer's ability to control employee interaction on social networks. Although many companies have implemented social-media policies prohibiting employees from posting disparaging comments or sharing confidential company information on the Internet, policies that totally prohibit such postings have been called into question.

One of the complaints filed by the NLRB was against a Connecticut ambulance service company that terminated an employee for violating its social-media policy that stated "Employees are prohibited from making disparaging, discriminatory, or defamatory comments when discussing the Company or the employee's superiors, co-workers and/or competitors." Specifically, the employee posted a negative comment about her supervisor (she called him a "17", a term for a psychiatric patient, and a "scumbag" among other things ) on her personal Facebook page and co-workers thereafter posted similar comments. The Company suspended, and eventually terminated, the employee because the postings violated the Company's Internet policies. The NLRB Complaint alleged that the Company implemented and enforced an overly broad policy concerning blogging and Internet posting because it prohibited employees from making disparaging remarks when discussing the company or supervisors, and prohibited employees from depicting the company in any way over the Internet without company permission. The NLRB contended that the policy was too broad in that it interfered with the recognized employee right to discuss the terms and conditions of employment with co-workers and others. There was a settlement of this matter in January 2011, resulting in the employer's modification of its social networking policy specifically relating to personal internet communications regarding work-related issues.

As similar situation arose in May of this year (2011) when the NLRB filed a complaint against a Chicago BMW dealership that allegedly unlawfully fired a sales person for Facebook comments critical of the employer. The salesperson posted photos and commentary critical that only hot dogs and bottled water were offered to customers at a promotional event. The Complaint was based on the same rationale as the Connecticut case, discussed above. This matter has not been resolved one way or the other.

On the other hand, in a matter arising out of Tucson, Arizona, an Arizona Daily Star reporter was terminated for inappropriate and unprofessional tweets. The newspaper did not have a social networking policy and, in fact, urged its reporters to use social media on the job. The reporter in question was terminated for purportedly unprofessional, sexually inappropriate and pro-violence tweets, including one where he referred to TV station reporter as "stupid." The reporter filed an unfair labor practice charge with the NLRB; however, the NLRB dismissed the charge. It concluded that, since the comments did not relate to the conditions of employment, the termination was lawful.

Policy Suggestions

More and more business are learning that social networking, used properly, can be an effective business tool. Businesses are also learning that imposing significant restrictions on the use of social media are, not only possibly illegal, but often counterproductive to a dynamic work place. Nevertheless, employers still need to exert some control over the use of social networks, especially where employees are presenting themselves as representatives of the company or are discussing company related affairs. What follows are some suggestions that have been offered by commentators in this field:

The policy should include a statement that the company believes social networking is an important form of communication.
The policy should make it clear that social networking activities are not to interfere with the employee's primary job responsibilities.
The policy should contain a non-exclusive list of social networking risks posed to the company. Specifically, since most social network sites contain identifying information, including work information, the policy should emphasize that postings are likely to reflect on the company and its image. The policy should impress upon the employee that they need to take responsibility for representing the company in a professional manner.
The policy should describe what activities are and are not permitted, and what type of permission is necessary. Specifically, the policy should prohibit social networking communications relating to confidential, sensitive or legal matters.
The policy should state who is covered by the policy's mandates.
The policy should walk the fine line between protecting the company and respecting the rights of employees to freedom of speech.
The policy should include a reminder of existing policies, particularly those related to harassment, discrimination, confidentiality, privacy and disclosure, and should discuss training and dissemination of policy information.
The policy should emphasize the use of good judgment and mandates the use of a "personal opinion only" disclaimer.
The policy should reference the company's code of ethics (i.e., do not disrespect employees, competitors, business partners, etc.).

If your company needs assistance in formulating a social networking policy, or would like to further discuss issues related to a social networking issues in the work place, please contact Valerie Walker, 602-262-5844.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will be discussing the issue of an employee's expectation of privacy when using a company-issued computer, cell phone and/or pda.

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Protecting Assets at Risk: Bankruptcy Options for Individual Investors and Other Business People

The Great Recession has taken a toll on many individual investors and business owners. Declining real estate and other asset values, combined with weak business revenues, have eroded wealth and financial stability, forcing the cancellation or postponement of projects no longer feasible in the current economic landscape. That is especially so for those who borrowed or guaranteed debt to finance their businesses and investments. As a result, many borrowers ("debtors"), who previously stood on solid ground financially, have found themselves burdened with debt they can no longer afford to service.

For debtors in this situation, there are various avenues of recourse. For example, rather than waiting for creditors to initiate collection actions, debtors can be proactive by contacting their creditors to negotiate arrangements to resolve their troubled debt. Such agreements may include requesting that the creditor discount the debt, extend the term for repayment, or reduce the interest rate. Before considering such requests, creditors will likely insist that the debtor provide updated financial information on which any concessions will be based. These negotiations are sometimes referred to as "workouts" or "out-of-court restructurings."

Such workout discussions may or may not be successful. Negotiations can stagnate, for example, where (i) a creditor is asking for more than the debtor believes is appropriate or can reasonably pay; (ii) the debtor has multiple creditors or troubled loans and is unable to reach an agreement with respect to all of them; or (iii) the debtor has better options under the Bankruptcy Code (the "Code").

Diplomatically presented, the possibility of bankruptcy protection often can provide debtors valuable leverage in workout discussions; and pragmatic creditors may prefer a non-bankruptcy resolution; however, coercive threats of bankruptcy also may doom such discussions and end them. Creditors consider themselves justly owed the debt and may quickly, and sometimes irrevocably, dig in their heels at what they perceive as heavy-handed threats of bankruptcy in order to avoid payment.

Creditors know that bankruptcy can prevent them from proceeding with collection activities, likely will involve additional out-of-pocket costs and expenses to them, and can enable debtors to reduce, stretch out, or otherwise limit the recovery on their claims. Thus, pragmatic creditors may prefer a non-bankruptcy resolution.

It is paramount at the workout stage for debtors to fully consider and understand their options under Chapters 7, 11, and 13 of the Code, including the advantages, costs and risks associated with each. Only then can they assess the type of relief most likely to accomplish desired objectives, and how much they may want to offer their creditors in order to avoid bankruptcy altogether.

Chapter 7

In 2005, Congress, urged by the credit industry, passed changes to bankruptcy law making it more difficult for individuals to file for liquidation under Chapter 7, channeling them instead toward debt repayment plans pursuant to Chapters 11 or 13. Those changes included a "means test" for determining a debtor's financial ability to repay a greater portion of his or her debts over time.

Interestingly, the means test applies to those with "primarily" consumer debt. The courts have interpreted "primarily" to mean more than half in aggregate dollar amount of all debts. (1) The means test does not apply to those with primarily business or investment-related debt. Such persons may still file for Chapter 7 relief, regardless of their current income levels.

Debtors who file for Chapter 7 relief do so primarily to become discharged from personal liability on their debts. They are required to disclose their assets and debts, and it is then up to a bankruptcy trustee to determine whether there are any assets that can be liquidated to generate a distribution to creditors. That, in turn, requires (i) an estimate of asset values and (ii) a careful analysis of whether, and to what extent, certain assets are "exempt," or protected from creditors' claims under applicable law. In this article, the non-exempt, unencumbered portion of the assets is referred to as "Assets at Risk."

Chapter 7 debtors may still need to service debt secured by assets abandoned by the trustee that the debtor wishes to retain, such as the mortgage on the family home or a car loan. Otherwise, Chapter 7 debtors generally are able to shed their debts and are not obligated to make future payments to the unsecured creditors to whom they were indebted prior to filing for Chapter 7 relief.

Assuming a debtor has primarily business or investment-related debt, why, then, would he or she voluntarily choose to file under Chapter 11 or 13?

Chapters 11 and 13

Perhaps the most common reason for debtors to choose Chapters 11 or 13 over Chapter 7 is to retain Assets at Risk - assets that would be sold by the bankruptcy trustee or otherwise lost in Chapter 7 liquidation. The Assets at Risk may be a business interest or asset essential to the debtor's livelihood, or a real estate investment that generates income or has strong potential for appreciation. Chapter 11 or 13 debtors can propose a plan calling for the retention of those or other assets; however, what must they do to keep them?

In exchange for retaining assets, the debtor's plan must, at a minimum, provide (i) restructured debt payments to secured creditors on the secured portion of their claims and (ii) payment to unsecured creditors of at least as much as they would receive in a Chapter 7 liquidation. The former calls for a valuation of the secured creditor's collateral, whereas the latter calls for an analysis of the liquidation value of the Assets at Risk. The higher the liquidation value, the more that must be paid to unsecured creditors under the plan.

Another reason some debtors may prefer Chapters 11 or 13 over Chapter 7 is to restructure the repayment terms of secured debt. There are restrictions on doing so, however, over the creditor's objection where the debt is secured by the debtor's primary residence. (2) Even so, Chapter 11 or 13 debtors still may strip off a junior lien on a primary residence that has a value less than the senior liens.(3) This cannot be done in Chapter 7 and, absent a non-bankruptcy workout, can only be done through a Chapter 11 or 13 plan.

While a decision to restructure under Chapters 11 or 13 may be the best way for a debtor to retain Assets at Risk and restructure secured debt, it should not be made lightly. Restructuring can involve significant risk and expense, legal and otherwise. It also imposes and requires the debtor to perform special duties, including those of reporting and disclosure, (4) and transactions outside the debtor's ordinary course of business will require advance bankruptcy court approval.

A bankruptcy filing also will put the debtor and the debtor's past dealings in what one of our bankruptcy judges has termed "a fishbowl." It will provide creditors a forum in which to conduct discovery and otherwise obtain information from the debtor, question financial arrangements with insiders and affiliates, question and possibly attack the propriety of pre-bankruptcy transactions (including those involving family members and other insiders), seek adequate protection of any interests in collateral, seek relief from the bankruptcy stay to foreclose liens, and seek the appointment of an examiner to investigate and oversee or a trustee to operate the debtor's affairs. A bankruptcy filing also may result in the debtor's loss of credit, including credit cards; impair the debtor's ability to borrow; and increase the cost of credit. It also could adversely affect the amount a prospective buyer is willing to pay for the debtor's assets. Finally, the legal fees for Chapter 13, and especially Chapter 11, bankruptcies can be significant; and one or more aggressive creditors can greatly increase them.

With proper lead time and preparation, experienced counsel can help debtors appreciate these risks, evaluate Assets at Risk and available exemptions, avoid potential hazards, and increase the chances of successfully confirming a plan. Further, just as a good coach prepares a game plan before the competition begins, good counsel can help debtors, whenever possible, compose their plans before they file. Debtors who do so are more likely to successfully confirm a plan of their liking - in less time and at a lower expense - than if they had waited until the eleventh hour.

Creditor Involvement in the Plan Confirmation Process

In both Chapters 11 and 13, a number of requirements must be met before a plan can be confirmed; and creditors can object to confirmation of the plan if those requirements are not met. Two of the most significant confirmation requirements for individuals are that (i) unsecured creditors receive at least as much as they would in a Chapter 7 liquidation; and, if an unsecured creditor objects) that (ii) the debtors distribute an amount not less than their projected disposable income for a specified term (discussed further below).

Unlike Chapter 13, Chapter 11 is a semi-democratic process in which creditors have the right to vote on the plan. Thus, while some creditors and "creditor classes" (voting groups of creditors) may vote against the plan, Chapter 11 requires that at least one non-insider creditor class (the rights of which have been impaired or altered by the plan) vote in favor of it before it can be confirmed. (5) This encourages deal-making as part of the plan confirmation process. For example, a creditor that initially opposes the plan might be persuaded to support it if changes are made to improve that creditor's treatment. Any such improved treatment must, however, apply as well to all other creditors of the same class and cannot unfairly discriminate against creditors in other classes. The creditor voting requirement can complicate and add to the cost of an individual Chapter 11 case.

Choosing Between Chapters 11 and 13

Given that Chapter 11 cases can involve more reporting, creditor involvement and legal fees, why, then, would a debtor choose Chapter 11 over 13?

Reasons may include:

Eligibility. Some debtors are not eligible for Chapter 13 relief, which requires the debtor to have "regular income" and that the debtor's debt fall below certain levels (currently, unsecured debts must total less than $360,475 and secured debts must total less than $1,081,400). (6) If either (i) the debtor does not have "regular income" or (ii) either debt level is exceeded, Chapter 13 relief is not available.
Restructuring secured debt beyond five years. Debtors who seek to restructure a secured debt (including stripping off the undersecured portion of a partially secured claim) for repayment over more than five years must do so in Chapter 11. Chapter 13 does not allow such restructurings beyond five years. Instead, a Chapter 13 plan must provide for distribution of an amount not less than the secured portion of the claim in the form of equal monthly payments over the life of the plan. (7) If the secured portion of the claim is substantial, it may not be feasible to fully repay it within five years. In such situations, Chapter 13 is not a viable option.
Pace. Chapter 13 requires that the debtor file a plan at the beginning of the case and has a prescribed pace. For example, Chapter 13 debtors typically must file their plans when they file their case or within fourteen days thereafter. (8) Chapter 11 debtors, by comparison, have more flexibility regarding the pace. They generally have the exclusive right to file a plan at any time within the first four months of the case (the "exclusivity period"). That period might be extended for cause; and even after it expires, a plan can still be proposed, although others can then propose one as well or seek to dismiss the case. (9) Debtors desiring more flexibility thus might prefer Chapter 11.

Although Chapter 11 debtors have more flexibility to "take their time" - a practice prevalent for years in the District of Arizona - that may no longer be a good strategy for individual debtors. First, various requirements have been added to guard against delay. Additionally, for debtors who are short on resources or otherwise concerned about costs, longer cases translate into more expensive cases. Moreover, a slower pace might give the debtor's adversaries more time to get up to speed and mount a stronger opposition to the plan. Finally, all other things being equal, bankruptcy judges tend to view debtors more favorably if they move promptly towards reorganization than if they do not. Therefore, absent special circumstances justifying a more deliberate approach, individual debtors often will be better served if they move swiftly to confirm a restructuring plan.

Trustee and Trustee Fees. In Chapter 13, a trustee is automatically appointed. The Chapter 13 trustee reviews the plan and makes recommendations to the court as to whether or not it should be confirmed or modified. The Chapter 13 trustee also receives the payments under a confirmed plan and distributes them to creditors. For these efforts, the Chapter 13 trustee receives a fee that can be as much as "10% of the payments made under the plan." (10)

In Chapter 11, a trustee is not automatically appointed (11) and no such percentage-based fee is collected. Instead, the debtor typically continues "in possession." Chapter 11 debtors, however, must pay quarterly fees to the U.S. Trustee from the petition date through substantial consummation of the plan and entry of a final decree. The fees are based on the level of disbursements and currently are, for example, $325 per quarter in which quarterly disbursements total less than $15,000; and $650 per quarter in which they total $15,000-$75,000.

In summary, the types of trustee fees charged in Chapter 11 and 13 cases are different; and total fees in either case will depend upon various factors, such as the total amount of plan payments and the length of the case. Debtors who intend to propose lower plan payments might have lower trustee fees under Chapter 13, while trustee fees might be a neutral factor for debtors who expect to process a Chapter 11 case quickly and make higher total plan payments.
Projected Disposable Income Requirement. If an unsecured creditor objects to the plan (and assuming that the plan does not call for its claim to be fully paid), Chapter 11 and 13 debtors each must meet different requirements with respect to their projected disposable income (PDI). Chapter 13 debtors must propose to pay all of their PDI received during the "applicable commitment period" - five years for those with above-median income - to their unsecured creditors. (12) Chapter 11 debtors, by comparison, must show that the value of all of their plan distributions is at least equal to their PDI for the longer of five years or the life of the plan. (13) Thus, Chapter 11 debtors may be able to satisfy this requirement if all of their plan payments - to both secured and unsecured creditors - equals or exceeds their PDI.

PDI also is determined differently under Chapters 11 and 13. "Disposable income" is defined under both as the debtor's current monthly income (CMI) less amounts "reasonably necessary to be expended" for maintenance or support of the debtor and dependents, for domestic support obligations, for qualifying charitable contributions, and for business expenses. (14) CMI, in turn, is calculated by averaging the monthly income received by the debtor received from all sources (without regard to its taxability) during the six-month period preceding the commencement of the case. While this calculation presumptively determines CMI, it can be rebutted by evidence of a substantial change in the debtor's income at the time of plan confirmation. (15)

In Chapter 13, however, the expense limitations of the "means test" standards (which are derived from expense guidelines of the Internal Revenue Service and may be much lower than the actual living expenses of many potential Chapter 11 debtors) apply in determining what expenses are "reasonably necessary" for debtors with above-median incomes. Although there is a split of authority on this issue, there is support for the proposition that Chapter 11 debtors are not limited by the IRS expense guidelines and that the reasonableness of their expenses instead must be judicially determined. (16) Arguably, then, there is more flexibility in determining PDI in Chapter 11 cases; and debtors with higher expenses might fare better in Chapter 11.

Concluding Comments

Bankruptcy, particularly reorganization, can be an expensive, time consuming process. It should not be undertaken lightly. Before filing for bankruptcy relief, debtors should define and prioritize objectives, such as whether to retain Assets at Risk, shed burdensome debt, reduce future debt service obligations, or obtain a fresh start. Debtors also should work closely with legal counsel to develop those objectives and evaluate the best options for accomplishing them, including the possibility of staying out of bankruptcy altogether by negotiating a non-bankruptcy workout.

Careful evaluation, preparation, and planning increase the chances for achieving the desired results in the most expeditious and least expensive manner, whether that means avoiding bankruptcy altogether or filing for the type of bankruptcy relief and seeking confirmation of the type of plan that best accomplishes it. That can only occur with ample lead time, which permits the gathering, assimilation, analysis and discussion of information, objectives and alternatives.

(1) E.g., In re Kelly, 841 F. 2d 908 (9th Cir. 1988); In re Mohr, 425 B.R. 457 (Bankr. S.D. Ohio 2010; In re Shelley, 231 B.R. 317 (Bankr. D. Neb. 1999); Waites v. Braley, 110 B.R. 211 (Bankr. E.D. Va. 1990).
(2) See Code §1322(b)(2) and §1123(b)(5).
(3) E.g., In re Zimmer, 313 F. 2d 1220 (9th Cir. 2002).
(4) That is particularly so for Chapter 11 debtors. For example, Chapter 11 debtors must file monthly operating reports listing their monthly receipts and disbursements (Bankruptcy Rule 2015.3); periodic entity reports disclosing information about entities in which they have a substantial or controlling interest (Bankruptcy Rule 2015.3); and disclosure statements containing adequate information from which creditors can make an informed judgment about the plan. (Code §1122).
(5) The precise manner in which creditors may be classified and ballots are tallied is outside the scope of this article.
(6) Code §109(e).
(7) Code §1325(a)(5)(B). Additionally, see, e.g., In re Barnes, 32 F.3d 405 (9th Cir. 1994)(holding that plan, which called for restructuring of the secured claim over nineteen years and only proposed to repay sixty percent of it over the five-year plan period, did not comply with Code §1325(a)(5)(B)(ii).
(8) Bankruptcy Rule 3015(b).
(9) Code §1121. By waiting beyond the exclusivity period, however, they risk the chance that a creditor or other party in interest might file a competing plan. Code §1121(c).
(10) 28 U.S.C. §586(e)(1)(B).
(11) In Chapter 11, a trustee may be appointed for cause, however, including fraud, dishonesty, incompetence, gross mismanagement or where such appointment is in the interest of creditors.
(12) Code §1325(b)(1).
(13) Code §1129(a)(15)(A).
(14) Code §1325(b)(2) and §1129(a)(15)(A).
(15) In re Lanning, 560 U.S. __ (2010).
(16) See In re Roedemeier, 374 B.R. 264 (Bankr. D. Kan. 2007); and Section D.2. of 2005 Committee Note to Official Bankruptcy Forms 22A, 22B, and 22C, reprinted in Norton Bankruptcy Law and Practice 2d, Bankruptcy Rules, at 1146 (Thomson/West 2006-2007 ed.) See also 7 Colliers on Bankruptcy ¶ 1129.03[15][a] (describing such a reading of Code § 1129(a)(15)(B) as "flawed." As stated by the Roedemeier court, "in calculating an individual Chapter 11 debtor's projected disposable income, §1129(a)(15)(B) must be read to allow a judicial determination of the expenses that are reasonably necessary for the support of the debtor and his or her dependents." In re Roedemeier, 374 B.R. at 272-73.

Brian N. Spector
Member
T: 602.262.5977
F: 602.495.2654
bspector@jsslaw.com

Mr. Spector's practice focuses on debt resolution, bankruptcy, and collection matters, including receiverships, foreclosures, fraudulent transfer litigation, provisional remedies, guaranty claims, and other actions involving the collection of secured and unsecured debt. In the bankruptcy context, Mr. Spector has represented secured creditors, individual and business debtors, asset purchasers, landlords, and franchisors. He also has served as a Chapter 11 trustee and lead counsel for numerous unsecured creditors committees. Mr. Spector is a past Chair of the State Bar Bankruptcy Section and the Jennings Strouss Business Restructuring and Reorganization Section. He has served as a Judge Pro Tem for the Maricopa County Superior Court since 2005. Mr. Spector earned a J.D. from the University of Arizona College of Law and a B.A. from Stanford University. Since 2005, he has been included in The Best Lawyers in America© in the category of Bankruptcy and Creditor-Debtor Rights Law. Mr. Spector has also been listed, since 2007, in Southwest Super Lawyers Magazine for Bankruptcy & Creditor/Debtor Rights.

U.S. Supreme Court Upholds Legal Arizona Workers Act

The United States Supreme Court has upheld the Legal Arizona Workers Act (Arizona Law). Under the Arizona Law, passed in 2007, the license(s) of an Arizona employer may be, and in certain circumstances must be, suspended or revoked, if the employer knowingly or intentionally employs an unauthorized alien. The Arizona Law also requires Arizona employers to use E-Verify (an internet based federal electronic verification system) to confirm the work authorization status of employees. Thus, if not already doing so, Arizona employers should register for, and be using, E-Verify to confirm work authorization.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information or have questions about the Legal Arizona Workers Act, please contact a member of our Labor and Employment Department.

Arizona's Anti-Deficiency Laws

This summary of the Arizona Anti-Deficiency Laws relating to obligations that are secured by liens on residential properties is not intended to be a definitive or exhaustive treatment of such laws, but, rather, will serve as a brief introduction to and discussion of certain issues in such legal area.

Arizona's anti-deficiency statutes were enacted in 1971. The purpose of the anti-deficiency statutes is to bar a homeowner's personal liability after losing a residential property to foreclosure under certain circumstances. The statutes prohibit execution against and attachment of a borrower's assets when the property foreclosed upon either judicially or through a trustee sale is (i) a qualified property and (ii) the debt is a qualified loan. See A.R.S. § 33-729 (applicable to mortgages and deeds of trust that are judicially foreclosed as mortgages) and A.R.S. § 33-814 (applicable to deeds of trusts that are enforced though a trustee sale).

(i) Qualified Property. A.R.S. § 33-814(G) states that if trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to a trustee's power of sale, no action may be maintained to recover any difference between the amount obtained for sale and the amount of the indebtedness and any interest, costs and expenses (the "Deficiency").

The Arizona Courts have broadly defined this requirement that the property be "utilized" as a dwelling. In Northern Arizona Properties v. Pinetop Properties Group, 151 Ariz. 9, 725 P.2d 501 (Ct. App. 1986), the Court of Appeals held that an investment condominium, which was occasionally occupied by the owners and third party renters, fell within the statutory definition. In deciding that the condominium was utilized as a dwelling, the Court employed the definition of a "dwelling" in Webster's Dictionary. In Mid Kansas Federal Savings and Loan Association of Wichita v. Dynamic Development Corporation, 167 Ariz. 122, 804 P.2d 1310 (1991), the Arizona Supreme Court held that commercial residential properties being constructed and for their eventual resale as dwellings are not "utilized" as dwellings when they are unfinished and have never been lived in. Thus, if the dwelling has at least occasionally been occupied by the owners or by third parties, then it most likely will qualify as having been utilized as a dwelling.

In the context of a mortgage, the applicable statutory provision, A.R.S. § 33-729 (A) applies and defines the qualified property in the same manner as the deed of trust statute cited above.

Qualified Property may include ownership in residential property held in a condominium unit or though stock in a housing cooperative, as well as outright fee interests.

(ii) Qualified Loan. This element requires that (except as otherwise discussed below) the mortgage or deed of trust must be a purchase money mortgage ("PMM"). A PMM is a mortgage or deed of trust given concurrently with the conveyance of the subject real property between a buyer and seller and given to secure the loan, the proceeds of which are used to purchase the real property.

In addition, a refinance of a PMM has also been held to be a PMM for purposes of the anti-deficiency statutes. The Court of Appeals in Bank One, Arizona, N.A. v. Edward R. Beauvais, 188 Ariz. 245, 934 P.2d 809 (Ct. App. 1997) held that a note that was an extension, renewal or refinancing by the same lender of an original PMM note retained its character as a purchase money note. A lien securing debt, the proceeds of which are used for improvements on the residential property, will most likely not be treated as a PMM.

It is noteworthy is that the court in Beauvais did not resolve the issue of whether a borrower who refinances a PMM note and borrows funds in addition to the unpaid balance of the original loan amount receives protection under the anti-deficiency statutes for the total amount of the new loan, or whether the amount can be bifurcated to determine which amount is a PMM and which amount is non PMM. In Beauvais, the borrower borrowed $75,000 from the bank to pay off an earlier loan which was wrapped into the new loan amount of $240,000 to purchase the new home for a total new consolidated loan of $315,000, and a new promissory note in this amount was executed by the borrower. The note was secured in part by a second lien deed of trust on the new home. Three years later, a new note (the "Workout Note") in the amount of $190,000 (the remaining balance due on the consolidated loan) was executed which was characterized by the bank as "renewal" of the $315,00 note and an extension of the earlier $75,000 loan. The Court of Appeals held that even though that bifurcation issue was raised in the trial court, the bank made no such argument on appeal concerning the bifurcation of the Workout Note, and, thus, the Court of Appeals did not consider this issue. While it is likely that this issue will be resolved in subsequent cases, it has not been resolved as of this writing.

As stated above, if the property is a qualified property and the loan is a qualified loan, the anti-deficiency statutes will prohibit a lender who forecloses judicially or non-judicially through a power of sale provision, to bring an action against the borrower for any deficiency resulting upon the sale of the property. It is also clear under Arizona law that if the mortgage or deed of trust is a PMM, the lender may not waive the lien and sue on the note. See Baker v. Gardner, 160 Ariz. 98, 770 P.2d 766 (1988).

Finally, a PMM that is assumed by a buyer in connection with the buyer's acquisition of the subject property does not retain its character as a PMM as to that buyer. Southwest Savings and Loan Association v. Ludi, 122 Ariz. 226, 594 P.2d 92 (1979). See also Cely v. DeConcini, McDonald, Brammer, Yetwin & Lacy, P.C., 166 Ariz. 500, 803 P.2d 911 (Ct. App. 1990).

(iii) Protections where a Non-PMM Is Foreclosed Non-Judicially. Generally, if the debt or loan secured by a deed of trust is not a PMM, the anti-deficiency statute will apply and prohibit an action against the borrower for any deficiency if the qualified property is sold through the power of sale provision at a trustee sale. See Mid Kansas, 167 Ariz. at 124, 804 P.2d at 1313. However, a lender can obtain a deficiency judgment on a non-PMM if the lender elects to sue the borrower on the note and forecloses judicially; or, except as discussed above in the case of a PMM, the lender may elect to waive the lien and sue on the note. Thus, the holder of a non-PMM secured by a junior lien can sue on the note where the senior lienholder forecloses non-judicially pursuant to a power of sale provision and the second lien is eliminated by the trustee sale.

Corporate Governance Lessons from the 2008 Financial Crisis: Assessing the Effectiveness of Corporate Governance Through a Look at Troubled Companies

I. Introduction

Everyone loves a scapegoat. The financial crisis of 2008 is no exception. When share values plunged around the world, companies closed and millions lost their jobs, homes and savings. Shareholders, the public and politicians pointed fingers everywhere. Directors of troubled companies found themselves directly in the line of fire, regardless of whether their companies were the "cause" of the problem, or were simply caught in the general economic decline.

Criticism leveled at Boards of Directors (Boards) included allegations that they were too complacent in:

allowing their executives to engage in risky behavior;
adopting compensation programs (prepared by management) that encouraged risky behavior;
succumbing to pressure from shareholders to exceed prior results, which led to cost-cutting measures and other risky behavior; and
failing to assure that they had the necessary expertise and information needed to monitor the business and assess its risk profile.

Query, however, whether it is appropriate to blame directors for failing to predict and prevent these troubles. Directors serve on their Boards as a part-time endeavor. They necessarily rely on professional advice from consultants and independent auditors in addition to information provided by management. Is it fair to assume that they could have predicted the most severe economic downturn since the Great Depression of the 1930s, let alone directed their companies to take steps to ameliorate its effects?

Commentators have split on these issues. Grant Kirkpatrick, for example, believes that corporate governance failed in significant respects in preventing the latest financial crisis. (1) In contrast, Professor Brian Cheffins believes that corporate governance mechanisms performed their intended functions in important respects during the most recent financial downturn, so there is not a significant need for reforming corporate governance. Professor Cheffins studied the thirty seven companies that were removed from the S&P 500 index during 2008. (2)

While commentators may debate the extent to which corporate governance was to blame for the latest financial crisis, it is helpful to review common governance mechanisms and to assess how these mechanisms performed during these troubled times. This analysis is anecdotal only, due to the difficulty of obtaining detailed information about the existing governance mechanisms in place and due to the confidentiality of Board proceedings. Nevertheless, important lessons can be gleaned from this assessment, as discussed more fully below.

While companies can always improve their corporate governance, it appears that the existing structures should suffice to protect most companies, provided that Boards and their management actively perform those functions in a meaningful way.

The importance of this proviso, however, cannot be overstated. In many of the major failures over the past decade, Boards may have had appropriate mechanisms in place that should have recognized and prevented the troubles, yet they failed to exercise independent judgment and oversight. Accordingly, the problems that arose could fairly be blamed to a large extent on implementation, rather than the need for additional governance regulation.

Similarly, in assessing the need for additional reforms, it is important to remember that directors do not have a duty to be omniscient, but rather should exercise their sound judgment after careful analysis of the information available to them. Blame for the general economic decline resulting from the latest financial crisis should be limited to the few firms that aggressively engaged in unduly risky behavior without adequate analysis and mitigation of risk.

This article reviews some of the more common methods of addressing corporate governance. Some of the procedures are mandatory in various jurisdictions due to government regulation or stock exchange listing requirements. Others are adopted on a voluntary basis. Each company should consider which of these procedures are best suited to its particular circumstances. Recommendations for Boards to consider appear at the end of this analysis.

In reviewing these governance mechanisms, keep in mind that, in recent decades, a large part of the emphasis in corporate governance has been designed to align the interests of the Board and executives with that of the equity owners. While that goal is generally laudable, it is important to remember that seeking current returns and profitability should be balanced with also preserving those equity interests. Executives often feel pressured to produce short-term profitability, which may result in a liquidity crisis that could jeopardize the entire long-term ownership interests of the shareholders. Notable failures, like Enron, The FINOVA Group, Inc., and Lehman Brothers serve to remind us of those dangers.

II. Existing Corporate Governance Procedures

A. Introduction

Following the financial crisis of 2000, Congress enacted the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). (3) Sarbanes-Oxley required important new governance mechanisms, including increased:

audit committee membership

and responsibilities; (4)

financial expert requirements; (5)
certifications of public reports by CEOs and CF0s; (6)
performance of a risk analysis; (7) and
tightening the standards for auditing requirements/independence. (8)

These reforms, among others, became mandatory for public companies, with certain exceptions. Other existing governance mechanisms that are commonly used or may impact the Sarbanes-Oxley requirements include:

splitting the Chairman and CEO functions;
enhancing director qualifications (through selection and training);
Board independence and replacement of executives;
presence of independent advisors for the Board (e.g., as to legal, risk, compensation, business,

and/or financial);

legal liability;
institutional shareholder activism;
shareholder rights (elections and meetings); and
regulatory authority.

The foregoing mechanisms have received varying levels of criticism following the latest financial crisis. After reviewing the reports of Kirkpatrick and Cheffins, (9) and reflecting my own experience and observations, this article offers an assessment of these governance methods.

B. Audit Committees and Financial Experts

The presence of independent members of the audit committees, especially financial experts, has helped to strengthen the performance of those committees. Those directors, however, need to rely to a large extent on the advice of financial professionals, including the company's auditors, to advise them on sophisticated financial matters. Even the audit committee financial experts cannot be expected to fully understand the nuances of the financial statements or to uncover potentially risky behavior or inappropriate activity that is not discovered by those with more exposure to the operations (e.g., internal and external auditors).

While companies with independent audit committees and financial experts did not always discover fraud or self-dealing (e.g., in Enron and Worldcom) the relative absence of fraud in the latest financial crisis, as compared to 2000, (10) reveals that the independent audit committee functions appear to be fulfilling their purpose. Companies, however, could benefit from a more robust risk assessment process, including challenging assumptions regarding liquidity and other critical areas. If the audit committees are to perform those functions, then they should consider methods in which they can help assure their companies undertake that analysis. (Alternatively, companies may seek to have that function supervised by a separate risk committee.)

C. CEO and CFO Certifications

Again, the reduction of fraud in the latest crisis as compared to 2000 could largely be attributable to the requirement that the CEOs and CFOs certify the company financial statements, as mandated by Sarbanes-Oxley. Most executives probably continue to exercise the same degree of oversight over the financial statements as they did prior to the adoption of this requirement. They will continue to rely on advice from professional advisors as to whether company financial statements are proper. Sarbanes-Oxley, however, helps to focus their attention on items within their knowledge, including the identification of risk factors.

D. Risk Analysis and Chief Risk Officers

This area of the law perhaps deserves the most criticism, although it also has probably been the most maligned. Since the adoption of Sarbanes-Oxley, companies have undertaken to better assess their risks, although the quality of that analysis necessarily varies among companies. Even the best risk analysis, however, would not have predicted the severity of the 2008 economic decline for most companies, at least for those outside of the financial services and real estate arenas. Nevertheless, Boards can help fulfill an important function by challenging their executives to perform a robust risk analysis and to develop strategies for minimizing the impact if foreseeable risks occur. Those risks can include crises relating to liquidity, key customers, key employees, litigation, governmental investigations, product or service failures and other potential risks that could severely impact the company.

Risks like these can occur at any time. For example, long before the Deepwater Horizon oil spill of 2010, BP suffered a refinery explosion in Texas. (11) The risks apparently were known at lower levels in the company. (12) Siemens and Boeing have had to deal with issues of bribery of foreign officials and breaching public tender rules, respectively. (13) And Citibank lost its private bank license in Japan due to money laundering charges. (14) Boards would benefit from adequate crisis management training in a broad range of potential issues.

Some companies may have performed risk analyses without undertaking a true "stress test" based on severe assumptions. Although the severity of the 2008 financial crisis was unprecedented in recent times, the occurrence of economic cycles in various industries, particularly financial and real estate, are not unprecedented. (15) As a result, directors of all companies can help to preserve shareholder values by assuring that their executives undertake a risk assessment and help to develop methods of addressing the potential problems.

Enron is a prime example of a company that implemented procedures to address a known risk, but the procedures were not implemented in an independent and thoughtful manner. I understand that Enron required Board committee approval of conflict of interest transactions involving senior executives and the company, but those transactions were routinely approved without modification. Moreover, there were no apparent mechanisms in place to monitor the performance of those transactions or assess the aggregate impact of those cumulative approvals.

Similarly, Lehman Brothers had a risk committee, but that committee only met twice in 2006 and 2007, and Bear Stearns only established its committee shortly before it failed. (16) Obviously, those committees were not successful in preventing their subsequent downfalls. To be most effective, a risk committee should be implemented long before the crisis has developed. Otherwise, the committee will necessarily serve in a reactive rather than a proactive manner, and its available courses of action will be more limited once the troubles have surfaced.

Of course, the operation of any business involves risk, and an appropriate level of risk should be accepted. Some Boards, however, may have inappropriately accepted undue risk, presumably to enhance profitability rather than to protect liquidity. For example, Northern Rock's Board apparently consciously decided not to hedge its liquidity with back-up lines of credit. (17)

Companies could enhance their risk assessments by including those assessments in their planning process. Some companies are enhancing this process through the creation of a Chief Risk Officer (CRO). An independent CRO who reports to the Board, rather than the CEO, and whose compensation is established by the Board and not the CEO, might be an appropriate method of assuring independence of and attention to this critical function. Without these features, the CRO's independence will depend on the officer's ability to exercise those functions while being subordinate to an executive focused on things other than risk analysis and mitigation. Of course, there are other methods to address this issue, including incorporating risk analysis and avoidance into compensation programs for all executives. Each Board should decide on the best method for addressing these issues based on its own risk profile and management structure.

Engagement of an executive focused primarily on analysis and mitigation of risks could help to identify problems that the Board and auditors might not otherwise catch. For example, many financial institutions jeopardized their liquidity position by supporting the capital of their financing conduits with lines of credit maturing in 364 days, because credit lines with a maturity of a year or longer had to be supported by the bank's capital. (18) The aggregate impact of those lines severely impacted many of those institutions.

In France and the UK, risk management has been introduced into corporate governance principles. (19) The Basel II capital accord requires Boards to review and guide corporate strategy, major plans of action and risk policy. (20)

The risk assessments should evaluate the impact that compensation programs have on the company' s risk profile. The latest financial crisis has emphasized the imbalance of those programs in financial services firms and how those programs helped lead to risky behavior that was not adequately protected. Granted, firms often thought that the presence of credit ratings, insurance and other provisions would help to insulate them from significant loss, but those protections were apparently insufficient to prevent or mitigate the losses at many companies.

Companies like UBS and JP Morgan have begun to tie compensation to long-term results, requiring deferral of bonuses, mandating share ownership, and factoring in risk-weighting into their compensation formulas. Seventy percent of the companies listed on the FTSE defer some part of their annual bonuses. (21) Boards should be careful to understand the consequences of the incentives created by the performance objectives.

E. Auditor Independence and Requirements

Since the enactment of Sarbanes-Oxley, auditors have been more vigilant about assessing risk exposure. The collapse of Arthur Anderson has served as an example of what can happen if they fail to do so. Again, the absence of significant fraud demonstrates that, in most companies, this governance mechanism is functioning reasonably well. It is important, however, to remember that auditors are not guarantors of company activity, regardless of their independent function. Ultimately, the company needs to manage and control itself, rather than to rely on inappropriate activity being discovered by the auditors.

F. Splitting the Chairman and CEO Roles

Having a separate Chairman from the CEO can provide an independent person to help guide the Board's oversight of the company and reduce the ability of the CEO to control the Board's agenda. It would also provide a person to whom the CFO, CRO, general counsel and others who are to exercise independent judgment from the CEO could discuss concerns. In the absence of an independent chairman, the audit or risk committee Chairs also could fulfill that function. In the UK, companies listed on the London Stock Exchange must have an independent Chairman separate from management or explain why they do not do so. (22) However, given that the British banking sector failed to perform any better than its U.S. counterparts, it is questionable whether the presence of an independent chairman would have made a difference in most cases. (23) Again, each Board should decide these issues for itself.

G. Enhancing Director Qualifications

As Carl Ichan has said: "[M]any board members were demonstrably unqualified, abjectly remiss or simply too cozy with management." (24) Many Board members are appointed due to their friendship with the executives or other Board members. Some are appointed to help fulfill perceived needs to add diversity to the Board along gender or racial lines. While those goals are laudable, they should not be at the expense of assuring that the Board is capable of exercising its oversight duties and is sufficiently skilled to understand and exercise independence over the company's direction. A sophisticated company probably needs more experienced and dedicated directors, who can understand the complexity of the matters before them.

Examples of Boards that lacked Board expertise in the company' s business or independence include Bear Stearns and Dillards. (25) At eight major U.S. financial institutions, two thirds of their Board members lacked any banking experience. (26)

Director qualifications can be enhanced through appropriate "onboarding" and periodic training to help assure that the directors understand the company, their duties and the technical aspect of their committee duties, whether it be related to compensation, financial risk or otherwise. Boards help to monitor the qualifications and contributions of their members through evaluations and feedback from shareholders.

H. Director Independence and Management Changes

As Mr. Ichan noted, (27) many directors at troubled companies failed to exercise independence. UCLA professor Avanidhar Subrahmanym found that as the degree of social interaction increased between directors and the executives, their effectiveness as independent directors decreased. While it is important for directors to interact with management, including those who need access to the Board (CFO, CRO, general counsel), the relationship should not interfere with their respective duties to the company and its equity owners, creditors and others, as appropriate.

It takes courage to emphasize risk analysis and prevention measures when shareholders demand increased performance. Warren Buffett had the courage to do so throughout the 1990s when he resisted investing in the "dot com" and telecom bubbles, publicly stating that the valuations in those industries could not be justified, let alone sustained. Ultimately, his judgment proved correct following the market tumbles of the early 2000s. Few directors had the courage to follow suit in subsequent years, but those companies that have withstood the recent turmoil have perhaps been cognizant of their risk profiles and have taken appropriate protective measures.

Directors exercised independent judgment during the latest financial crisis. For example, at the thirty-seven companies removed from the S&P 500 in 2008, Boards replaced CEOs and other executives much more frequently than general trends would predict. They replaced thirteen CEOs and twelve other executives at those companies. (28) This forty percent rate of dismissal for CEOs exceeded the 2.1 percent ten-year average ending in 2007 for the largest 2,500 companies. (29)

While directors appear to have exercised independence in dismissing executives when problems surfaced, it is questionable whether they exercised appropriate independence in approving management proposals for operations and compensation that led to those troubles in later years. Perhaps directors would better serve their constituents by exercising that independence from the start, through a robust risk analysis and planning process, rather than reacting to a crisis when it arises.

In addition, while executives were dismissed, in many instances the departing executives were entitled to severance arrangements that did not provide the Board with an adequate means of withholding those payments, at least without the likelihood of an expensive and distracting litigation. Similarly, when Boards are seeking to hire replacements for the departed executives, they may be pressured to again adopt similar assured severance arrangements. In approving executive agreements, Boards might consider the impact that this insulation from financial results might have on the company's risk profile.

I. Independent Board

Advisors Boards would be well advised to have access to independent advisors when they deem it appropriate. Sarbanes-Oxley requires that the Board have the freedom to engage counsel and other advisors when it desires it, but Boards appear to exercise that prerogative infrequently. Boards might consider engagement of independent professionals to independently guide the Board on issues, particularly those involving Board independence, duties, risk management and liability. Those professionals could be the same as those supporting the company's risk analysis. If the company appointed a Chief Risk Officer, that officer could independently report to the Board and use the same professionals. Ultimately, this is merely one aspect of the overall risk assessment process.

J. Legal Liability

While an expensive and destructive method of helping to assure corporate governance, the legal system serves an important role in helping to assure that companies and their managers fulfill their duties. Because the defense of legal action is enormously expensive, however, companies would be well served to rely on other corporate governance mechanisms to properly manage the company.

Because suits are often commenced when share prices fall, regardless of causation, essentially in an attempt at legal extortion, it is not possible to assess the impact of this method of enforcing corporate governance. Similarly, government investigations often follow financial turmoil, in part due to pressure from the agencies to demonstrate that they have addressed the issue, as well as to address actual violations.

K. Institutional

Shareholder Activism Major shareholders frequently flex their muscles to contact management and attempt to influence the company's direction. While institutional investors may not have been unusually active in this regard after the latest crisis, (30) they helped obtain important changes at a number of troubled companies. In addition, those institutions most likely had a larger impact through informal discussions that were never reported. Of course, shareholders owning a sufficient number of shares to implement change can collectively cause the company to do so, whether through cooperative measures or proxy contests.

While discussions between shareholders, the Board, and management can be a healthy method of obtaining input on the market's reaction to current operations and results, Boards should independently evaluate those inputs to be sure that the interests of some equity holders do not unduly influence the company's overall direction to the detriment of others, especially if those equity owners are seeking short-term results at the expense of capital preservation.

L. Shareholder Rights

Shareholders often seek to elect directors annually and to reserve the right to call a special meeting with a small number of shares. In practice, it would appear that most shareholders routinely approve management proposals and Board slates, so this mechanism is not an effective method of governing the company, with notable exceptions. Troubled companies often bow to pressure to install new directors, or adopt shareholder proposals to avoid a proxy fight. Most shareholders, however, do not engage in this kind of activism. Instead, they tend to sell their shares or simply voice their displeasure to management. In the UK, shareholders owning five percent of a company can call a meeting to dismiss a director, although this power is rarely used. (31) It is too early to determine whether the SEC' s new "proxy access" rules, (32) which allow shareholders to nominate directors, will impact corporate governance.

M. Regulatory Supervision

While shareholders and the public expect that regulatory authorities will help protect them from harm, those agencies are habitually unable to adequately monitor the activities of the myriad companies under their jurisdiction. They tend to investigate following complaints or after the troubles have already occurred. Following cyclical economic downturns, there has been a tendency to add additional regulations designed to address the perceived shortcomings with the existing rules. Some of that is a direct result of the political process, where the legislatures and administrators want to show how they have taken action to prevent a recurrence in the future. The Basel II capital accord enables bank regulators to impose capital charges for incentive structures that encourage risky behavior. (33)

Yet, the same problems continue to surface. The answer may well be in better enforcement of existing regulations, rather than the hurried creation of widespread reforms. Legislatures would be better served by enacting narrowly-tailored reforms to address only the actual deficiencies in corporate governance, rather than rushing to enact broad changes in response to public pressure to "do something."

III. Conclusion: Thoughts for Board Consideration

After reviewing the consequences of the most recent financial downturn, Boards should review their corporate governance procedures to assess their efficacy in light of their particular circumstances. Areas they may wish to evaluate could include:

undertaking a more robust risk analysis, with challenging assumptions and an evaluation of anticipated crises relating to:
- liquidity;
- loss of customers;
- loss of key employees;
- litigation/governmental investigations;
- product/service failures; and
- other anticipated risks;
- appointment of a Risk Committee of the Board, if those functions are not exercised by the Audit Committee;
- appointment of a Chief Risk Officer, and determining the reporting and compensation arrangements for that person;
- strengthening the Board selection, training and evaluation programs to assure that directors are competent and willing to exercise their duties in light of the company's business and regulatory environment.
- periodically evaluating Board independence;
- determining whether the Chairman and the CEO should be separate persons; and
- evaluating compensation programs in light of the risk analysis, including a review of severance arrangements.

While overall, corporate governance performed fairly well at most companies, Boards (along with almost everyone else) underestimated the scope of the recent economic downturn. Accordingly, while widespread reform is not clearly necessary, all Boards could benefit from an honest assessment of their risks, strengths and weaknesses in determining the course of their company' s future endeavors.

1 . Grant Kirkpatrick, The Corporate Governance Lessons from the Financial Crisis, 96 Fin. Market Trends 51 (July 2009).
2. See Brian R. Cheffins, Did Corporate Governance "Fail" During the 2008 Stock Market Meltdown? The Case of the S&P 500, 65 Bus. Law. 1 (2009). Cheffin is the S.J. Berwin Professor of Law, University of Cambridge.
3. Pub. Law 107-204, 116 Stat. 745 (July 30, 2002) (codified at 15 U.S.C. § 7201 [Sarbanes-Oxley].
4. Sarbanes-Oxley, supra note 3, at § 301.
5. Id. at § 407.
6. Id. at § 906.
7. Id. a t § 404.
8. Id. at §§ 201-206.
9. See supra notes 1 and 2.
10. See Cheffins, supra note 2, at 28-29.
11. See, e.g., Kirkpatrick, supra note 1, at 18.
12. Id.
13. Id.
14. Id.
15. See, e.g., S. Henke, The Great 18-Year Real Estate Cycle, Globe Asia (Feb. 2010), available at www.cato.org.
16. Kirkpatrick, supra note 1, at 19.
17. Id., at 28.
18. See, e.g., Kirkpatrick, supra note 1, at 11.
19. Id. at 24.
20. Id. at 17. See also Jacqui Hatfield & Gil Cohen, Banking Industry Regulatory Update, 64 Consumer Fin. L.Q. Rep. 134 (2010).
21. Kirkpatrick, supra note 1, at 28.
22. See Cheffins, supra note 2, at 55.
23. Id.
24. Id. at 54, quoting Carl Ichan, Corporate Boards that Do Their Job, Wash. Post, Feb. 16, 2009 at A15.
25. Cheffins, supra note 2, at 35
26. Kirkpatrick, supra note 1, at 22.
27. See supra note 24.
28. See Cheffins, supra note 2, at 37.
29. Id. at 40.
30. See id. at 45-50.
31. Id. at 59-60.
32. See SEC Rule 149-11
33. See, e.g., Kirkpatrick, supra note.1, at 16; Hatfield & Cohen,Banking Industry Regulatory Update, supra note 20.

Social Security "No-Match" Letters Are Back

The Social Security Administration (SSA) has resumed sending no-match letters to employers if an employee's name and/or social security number does not match the SSA records. For years, the SSA sent no-match letters (referred to by the SSA as "Decentralized Correspondence" or "DECOR" notices) to employers. The SSA stopped sending the no-match letters a few years ago after litigation was filed challenging a controversial proposed rule issued by the U.S. Department of Homeland Security relating to no-match letters. The proposed rule was eventually rescinded and the resumption of SSA no-match letters became effective as of March 22, 2011.

Unfortunately, the resumption of no-match letters creates questions for employers regarding how to respond to the letters. No-match letters normally provide that the employer does not have to respond to the letter. However, employers should not ignore the letters. Doing so may have serious repercussions.

The SSA has stated that a no-match letter is not a basis, in and of itself, for an employer to take any adverse action against an employee, such as laying off, suspending, firing or discriminating against an individual. In fact, there are a number of reasons why information reported to the SSA may not correspond with SSA records including, but not limited to, typographical errors, incomplete employer records, unreported name changes or even an error in the SSA records. Therefore, employers should not jump to conclusions about the reasons behind a letter.

Employers should develop a company-wide policy for uniformly handling all no-match letters and carefully follow the instructions set forth in the letters. The policy should ensure that all no-match letters are received, and/or forwarded to, one department for processing. According to the SSA, employers should take reasonable steps to resolve the mismatch and apply those reasonable steps uniformly to all employees.

Each case a business or individual may face is unique and may require legal advice. If you have questions about developing or updating your procedures for addressing "no-match" issues, or would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Avoiding Discrimination Claims under the Genetic Information Nondiscrimination Act (GINA)

The Genetic Information Nondiscrimination Act of 2008 (GINA) prohibits employers and other entities covered by GINA Title II from requesting or requiring genetic information of an individual or family member of the individual. However, there are some occasions when an employer must request health information, such as to support a request for medical leave or a reasonable accommodation, when it may obtain genetic information in response.

In order to avoid this, the new GINA regulations suggest providing the following warning to employees or health care providers when making such a request:

The Genetic Information Nondiscrimination Act of 2008 (GINA) prohibits employers and other entities covered by GINA Title II from requesting or requiring genetic information of an individual or family member of the individual, except as specifically allowed by this law. To comply with this law, we are asking that you not provide any genetic information when responding to this request for medical information. "Genetic information," as defined by GINA, includes an individual's family medical history, the results of an individual's or family member's genetic tests, the fact that an individual or an individual's family member sought or received genetic services, and genetic information of a fetus carried by an individual or an individual's family member or an embryo lawfully held by an individual or family member receiving assistive reproductive services.

If this warning is provided, any resulting acquisition of genetic information will be considered inadvertent, and therefore not in violation of GINA. Employers should consider adding this warning to any forms that may request medical information, including leave forms, pre-employment forms, or reasonable accommodations request forms.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Arizona Legislature Provides Guidance to Employers in Dealing with the Arizona Medical Marijuana Act

Governor Brewer has just signed legislation that will provide assistance to employers in their implementation of the Arizona Medical Marijuana Act ("AMMA") in the workplace. The new law amends existing drug testing statutes (A.R.S. § 23-493 et seq.) to make it easier for employers to discipline employees who use marijuana, even when they are cardholders under the AMMA. The new law also allows employers to use the electronic registry to verify an employee's cardholder status.

The AMMA allows limited use of marijuana for medicinal purposes without threat of criminal or civil penalty under Arizona law. It does not, however, alter marijuana's status as an illegal drug under federal law. The AMMA contains a very broad anti-discrimination provision that might prove challenging for many employers. Specifically, it prohibits employers from discriminating against a prospective or current employee who is a registered cardholder because of (1) the person's status as a cardholder, or (2) as a result of a registered qualifying patient's testing positive for marijuana through a drug screening. Although the AMMA created an exception to this anti-discrimination provision for employees who used, possessed or were impaired at the workplace or during the hours of employment, the AMMA did not define "impairment" or "under the influence."

Arizona's existing drug testing statutes already provided employers with some protection against lawsuits, but the new law expands that protection to account for the AMMA. The new law adds two new provisions that may help protect employers from litigation. First, it protects employers who take disciplinary action based on a good faith belief that an employee had an impairment while working on the employer's premises or during hours of employment. The law very favorably defines "impairment" to include symptoms that a prospective employee or employee may be under the influence of drugs or alcohol that may decrease or lessen the employee's performance, including the person's speech, appearance, odor and unusual behavior. The new law also defines "current use of any drug," and expands the definition of "good faith." These definitions will provide guidance and assistance to employers dealing with issues under the AMMA and drug testing.

The second new provision protects employers who take action to exclude an employee from performing a safety-sensitive position based on the employer's good faith belief that an employee is engaged in the current use of any drug if the drug could cause an impairment or otherwise decrease or lessen the employee's job performance or ability to perform the employee's job duties. The new law defines "safety- sensitive position" to include a job that includes duties that could affect the safety or health of the employee or others (such as operating a motor vehicle, equipment or machinery or power tools; performing duties at a customer's location;preparing or handling food or medicine; and working in certain occupations regulated by the professions section of Arizona law), as well as a job the employer designates as a safety-sensitive position.

Employers who have, or adopt, a drug testing policy and program that meet the requirements of Arizona's drug-testing statute will qualify for these new protections. Therefore, Arizona employers should review their drug-testing policies. If you have questions about this new law or the AMMA and their impact on your workplace, or if you would like assistance with reviewing and revising your policies, our labor and employment attorneys are available to assist you.

Client Alert: Department of Labor Seeks to Broaden Definition of Fiduciary Under ERISA

On March 1 and 2,2011 the Department of Labor held public comment hearings on its new proposed regulations defining a fiduciary for purposes of employee benefit plans. It is likely the new regulations will cause many who provide financial services to employee benefit plans to be a fiduciary with respect to the plan. The new regulations will result in fiduciary status for those who do any of the following:

1. Provide advice, appraisals or fairness opinions as to the value of investments, make recommendations as to buying, selling or holding assets, or recommendations as to the management of securities or other property.

2. Acknowledge fiduciary status for purposes of providing advice regardless of whether the person meets other requirements of the regulation.

3. Is an investment advisor under Section 202(a)(11) of the Investment Advisors Act of 1940.

4. Provide advice or make recommendations pursuant to an agreement, arrangement or understanding, written or otherwise, with the plan, a plan fiduciary or a plan participant or beneficiary, where the advice may be considered in making investment or management decisions with respect to plan assets, and the advice will be individualized to the needs of the plan, a plan fiduciary or a participant or beneficiary.

The proposed regulations may be found at the Federal Register.

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Client Alert: ADAAA Regulations Released

The Equal Employment Opportunity Commission (EEOC) issued its final revised Americans with Disabilities Act (ADA) regulations and accompanying interpretive guidance in order to implement the ADA Amendments Act of 2008 (ADAAA), which prohibits employment discrimination on the basis of disability.

In keeping with the ADAAA, the new regulations are to be construed broadly, and will dramatically change an employer's focus from whether someone is disabled, to what accommodations should be made.

These new regulations will be effective May 24, 2011, and are available in the Federal Register. Employers with 15 or more employees are encouraged to revise policies and train supervisors to comply with these new rules. [For assistance with either of these, please contact Jennings, Strouss & Salmon]

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article, please contact a member of our Labor and Employment Department.

Hefty Fines Issued for HIPAA Violations

Within a couple of days apart, the U.S. Department of Health and Human Services (HHS) Office for Civil Rights (OCR) issued civil money penalties (CMPs) to two covered entities for failure to comply with the Health Insurance Portability and Accountability Act's (HIPAA) privacy rule.

On February 22, 2011, OCR fined Cignet Health of George's County, Md. (Cignet) $4.3 million for failure to provide patients access to medical records within the allotted time frame required by HIPAA. This first-ever imposed penalty was a result of what the OCR claims was Cignet's "willful neglect" to provide 41 patients access to their medical records within 30 to 60 days of the submitted requests. These violations occurred between September 2008 and October 2009.

OCR Director Georgina Verdugo stated in a news release, "Covered entities and business associates must uphold their responsibility to provide patients with access to their medical records, and adhere closely to all of HIPAA's requirements." Verdugo also indicated that the HHS will continue to investigate and take action against organizations that knowingly disregard their obligations under the HIPAA privacy rules.

In addition to the direct violations of HIPAA privacy rules, the OCR claimed that Cignet failed to cooperate with its investigations into the violation claims and provide records in response to the OCR's subpoena. HIPAA covered entities are required to cooperate with HHS investigations; however, Cignet only produced the medical records after the OCR filed a petition to enforce its subpoena in U.S. District Court and obtained a default judgment.

Two days after the Cignet fines were issued, the OCR executed a $1 million resolution agreement with The General Hospital Corporation and Massachusetts General Physicians Organization Inc. (Mass General). After an investigation, the OCR determined that Mass General was liable for the privacy rule violation made by an employee who left documents containing protected health information (PHI) related to 192 patients on a subway train.

The HIPAA privacy rule requires that covered entities protect the privacy of patient information through administrative, physical and technical safeguards at all time. Director Verdugo indicated that the OCR investigation revealed that Mass General failed to establish reasonable and appropriate safeguards to protect the privacy of sensitive information when it was removed from the hospital's premises.

As part of the resolution agreement, Mass General entered into a Corrective Action Plan, which includes the development and implementation of a comprehensive set of policies and procedures that ensure patient information is protected when removed from the hospital; training of staff members on these policies and procedures; and designating the director of internal audit services of Partners Healthcare System Inc., the hospital's parent company, to serve as an internal monitor to assess the hospital's compliance with the corrective action plan and submit semi-annual reports to HHS for three years.

"To avoid enforcement penalties, covered entities must ensure they are always in compliance with the HIPAA Privacy and Security Rules," said Verdugo. "A robust compliance program includes employee training, vigilant implementation of policies and procedures, regular internal audits, and a prompt action plan to respond to incidents."

Each case a business or individual may face is unique and may require legal advice. If you would like additional information regarding the content of this article or the variety of services Jennings Strouss provides to our health care clients, please contact Fred Cummings.

Richard C. Smith is a member of the Tax, Estate Planning & Probate Departmentsand represents clients in all aspects of tax, corporate and business planning. His practice has a particular emphasis in the employee benefits area including the design, implementation and other aspects of pension, profit sharing and other qualified plans. He also advises clients in estate planning matters, including estate plans, wills, trust and family partnership agreements. He represents many physicians' practices and handles health care matters for them. Contact Mr. Smith at rsmith@jsslaw.com or 602.262.5972.

Bradley V. Martorana is an Associate attorney focusing his practice on corporate, healthcare,tax and securities law. His practice includes counseling corporations, limited liability companies and partnerships as to the tax and non-tax consequences of formation, operation, compensation and other commercial transactions. He also advises buyers and sellers in mergers, acquisitions, reorganizations and other restructurings and represents issuers and investors in private placements of equity and debt securities. Mr. Martorana also advises on a variety of other business and real estate matters. Contact Mr. Martorana at bmartorana@jsslaw.com or 602-262-5958.

Client Alert: FASB May Expand Disclosure Requirements

The Financial Accounting Standards Board (FASB) is currently discussing an expanded disclosure requirement for those participating in a multiemployer pension or other post-retirement benefit plans.

The proposed change, expected to be released later this year, will require employers to disclose any unfunded pension liability on its financial statements, and could dramatically affect a company's ability to obtain financing, particularly if the plan's funding status deteriorated during the financial crisis of 2008, when plan asset values dropped significantly. For more information, visit the FASB website.

Each case a business or individual may face is unique and may require legal advice. If you are an employer participating in a multiemployer pension or other post-retirement benefit plan and would like additional information regarding the content of this article, please contact a member of our
Labor and Employment Department.

What’s Happening with NERC Reliability Standards?

Reliability has always been an issue for electric utilities. Municipal utilities, with their local connections and close relationships with their customers, have generally prided themselves on their reliable operations. So the new reliability standards shouldn't be a big deal, right? Unfortunately, the answer is the standards are a big deal, even for utilities with strong reliability records.

Reliability standards have been around for a while. The North American Electric Reliability Corporation, or "NERC", was started in 1968 in response to a major blackout. There was a recognition that the increasing level of transmission interconnections created a very real possibility an outage on one utility's system could "cascade", pulling other utility systems down. NERC was created as a voluntary organization that helped utilities (mainly the larger investor owned ones) create voluntary standards to increase reliability of the interconnected Bulk Electric System (the "BES"). NERC operated on this voluntary basis for a number of years.

However, the evolution of the electric industry changed things. The increase in transmission interconnections, power being shipped from one area to another, and the appearance of independent power producers caused an increased risk of cascading outages affecting large areas. The risk was greatly enhanced by the paradigm shift that occurred in the industry. Instead of (mainly) large utilities with discrete control areas and an "obligation to serve", the electric industry began to transition to NERC's Functional Model that broke the electric utility industry down into an alphabet soup of theoretically independent functional entities. The functional entities, ranging from Distribution Providers to the Electric Reliability Organization, created a potential vacuum concerning who was responsible for maintaining system stability to "keep the lights on". NERC's response to the potential responsibility vacuum was to make everyone responsible through an expanded and reworked set of reliability standards.

The question of the effectiveness of reliability standards came to a head following the August 2003 blackout of a sizable portion of the central and eastern United States and Canada. NERC was reformulated from what was effectively a voluntary trade group to a self-funding quasi-governmental organization operating under delegated authority from the Federal Energy Regulatory Commission ("FERC"). The most significant change resulting from the re-invention of NERC was that the reliability standards to protect the BES changed from being voluntary to being mandatory and enforceable. NERC's new ability to enforce the standards included the ability to levy serious financial penalties of up to $1,000,000 per occurrence per day.

In practice, the mandatory reliability standards have a significant impact on many utilities, including municipal utilities. Compliance activities can require new procedures, increased documentation, and possibly changes in labor agreements. Utilities are also subject to periodic audits of their compliance. The audit is a formal process that contains a combination data requests, interviews, spot checks and detailed reviews of utility procedures and documentation. The actual audit is performed by teams of knowledgeable utility and regional reliability organization employees that are convened by a Regional Reliability Entity ("RE"), such as ReliabilityFirst, to visit and review the utility being audited. The different functional areas are audited on different schedules. For example, utilities that are registered as Generation Owners or Generation Operators are audited more frequently than utilities that are registered as Distribution Providers or Load Serving Entities. NERC's mandatory standards have been in place long enough that even the functions with the longest time between audits - Distribution Providers and Load Serving Entities - are now coming up for audits.

Audits can and have resulted in identification of potential reliability standards violations. The potential alleged violations can lead to a requirement for a mitigation plan and possibly a monetary penalty. In some cases, the audit team has also recommended the utility being audited should be registered under additional reliability functions. The results of the individual audits vary. There have been some common themes, though. A lack of documentation adequate to prove compliance has been a frequent problem for initial audits for all reliability functions. Inadequate or insufficiently documented Vegetation Management Plans have been an issue for Transmission Owners. A failure to document or follow a time-specific testing plan for protective devices has been a problem for many Generation Owners and Transmission Owners. Cyber-security concerns have expanded as more attention is focused on the area. Notably, an asymmetry in the viewpoint of the audit participants also affects audit outcomes. The auditors, NERC and the RE's have a huge exposure if there are significant blackouts, but don't bear the cost of compliance. Utilities support reliability, but are sensitive to the cost/benefit tradeoff of compliance activities. Such differences in viewpoints can and do lead to differences in interpretation.

So what can a prudent utility manager do in regards to reliability compliance? Joint Registration Organizations, such as Michigan Public Power Agency operates, can reduce burdens and concerns for smaller utilities with little or no generation. Utilities with generators that are 20 MVA or larger or plants that are 75 MVA or larger, as well as utilities that own transmission that operates at 100 kV or higher may want to staff in-house expertise, make use of consultants, or both.

Any utility that is individually registered for reliability functions should document its processes and procedures for reliability compliance in its registered area. The utility should follow the documented procedures. However, documented procedures shouldn't be defined too tightly. It is much better to have a testing procedure that says you test relays every five years with the testing being performed in a 60 day window around the anniversary date than to say you will test the relay every 1,826 days.

Finally, if you find your utility has violated a standard, react promptly. Consider outside counsel. Recognize you will almost certainly be better off to self-report the violation than to wait until it comes out in an audit. Then undertake corrective action, including negotiation of a mitigation plan with the RE if necessary.

And remember - we are all just trying to keep the lights on.

Dan Cooper is a Consulting Engineer with the law firm of Jennings, Strouss & Salmon.

Client Alert: The Arizona Medical Marijuana Act Presents Issues for Employers

On November 2, 2010, Arizona voters approved, by a very narrow margin, Proposition 203, the Arizona Medical Marijuana Act, legalizing marijuana for medicinal purposes. Arizona is the 15th state to pass medical marijuana legislation.

The Arizona Medical Marijuana Act (the "Act") permits a "qualifying patient" with a "debilitating medical condition" to obtain marijuana from a registered non-profit medical marijuana dispensary and to use the marijuana to treat or alleviate the medical condition. A "qualifying patient" is a person who has been diagnosed by, and received written certification from, a physician as having a debilitating medical condition and would likely benefit from the medical use of marijuana to treat or alleviate the medical condition. This client alert highlights some of the major implications for employers.

The Act prohibits employers from discriminating against a prospective or current employee who is a registered "cardholder" because of (1) the person's status as a cardholder or (2) as a result of the registered qualifying patient's testing positive for marijuana through a drug screening. While only a qualifying patient may use medical marijuana, other individuals may also be "cardholders" subject to some of the protection from discrimination. Under the Act, a registered "cardholder" may be (1) a qualifying patient, (2) a designated caregiver, or (3) a nonprofit medical marijuana dispensary agent who has been issued and possesses a valid registry identification card by the Arizona Department of Health Services or its successor agency.

The Act does create two limited exceptions to this anti-discrimination provision. First, there is an exception for employers who would "lose a monetary or licensing related benefit under federal law or regulations." Second, an employer is not required to hire or continue to employ a registered qualifying patient who tests positive for marijuana components or metabolites, if the patient used, possessed or was impaired by marijuana on the premises of the place of employment or during the hours of employment.

The Act does not allow employees to use marijuana at the workplace. The Act specifically provides that it does not authorize any person to undertake any task under the influence of marijuana that would constitute negligence or professional malpractice. Further, the Act does not authorize any person to operate, navigate or be in actual physical control of any motor vehicle, aircraft or motorboat while under the influence of marijuana, although, under the Act, a registered qualifying patient shall not be considered to be under the influence solely because of the presence of metabolites or components of marijuana that appear in insufficient concentration to cause impairment. Thus, employers may still take action against employees who use marijuana in the workplace or who work while impaired by marijuana.

By April 2011, the Arizona Department of Health Services is required to begin accepting applications for marijuana registry identification cards. Thus, Arizona employers should review the Act and then review and revise their policies to address the provisions of the Act. Employers should also consider conducting updated training of managers, supervisors, and safety and HR personnel.

If you have any questions about the Act's impact on employers, or would like assistance with evaluating and revising policies, our labor and employment attorneys are available to assist you.

Each case an employer may face is unique and may require legal advice. If you need further information regarding the Arizona Medical Marijuana Act, please contact the author, Jan Hutchison, or one of the other attorneys in our Labor and Employment Department.

Janet Hutchison is a commercial transactional attorney and litigator whose practice focuses on the areas of labor and employment, real estate and general business matters. Ms. Hutchison has extensive experience in employment matters, including discrimination, wrongful discharge and wage and hour matters. She frequently advises clients on employment policies and procedures and represents employers in federal and state court litigation, as well as before the various administrative agencies. Read more... Contact Ms. Hutchison at jhutchison@jsslaw.com or 602.262.5945.

The ABCs of RECs

Editor's Note: "From a Legal Perspective" appears in each edition of District Energy magazine to address legal issues of current importance to the district energy industry. It is intended for educational purposes only and does not constitute legal advice.

Getting credit for the production or purchase of renewable energy is becoming increasingly important as states develop and refine their renewable portfolio standards, as private markets emerge to commodify the benefits of renewable resources, and as our national energy policy moves toward a more organized approach to address greenhouse gas emissions.

For that reason, contracts governing the output of renewable energy resources now commonly address the ‘green' rights associated with the renewable project that either currently, or in the future, may hold some value - be it in the private marketplace or under a regulatory scheme. These rights are typically referred to as "environmental attributes" or "renewable energy credits" (RECs), though they are also known as "green tags," "green energy certificates" or "tradable renewable certificates." Whatever their name, environmental attributes generally include the right to be regarded as the owner or holder of the legal and market rights associated with the green aspects of the facility. They represent the technology and environmental attributes of electricity generated from renewable resources. (See www.epa.gov/greenpower/buygp/types.htm#rec.)

A still-nascent but developing market exists for the trading of environmental attributes, or RECs. In order to facilitate such markets, a number of REC tracking organizations operate in different regions of the country. The owner of the RECs can, and in some states must, register its RECs on a tracking registry. To do so, the REC holder must be able to establish that it is the party legally entitled to claim such RECs. Even in regions where such markets are not operating, it is still important to define the legal ownership of environmental attributes due to the uncertainty and still-evolving nature of the laws and policy surrounding greenhouse gas emissions.

Specific contractual provisions dealing with environmental attributes are necessary because the capacity and energy available from a renewable resource are often sold separately from the environmental attributes associated with that same project. The buyer of electric capacity and energy from a renewable resource may be different from the buyer of the environmental attributes of the project.

CALLOUT: Specific contractual provisions dealing with RECs are necessary because a project's capacity and energy are often sold separately from the RECs.

Because the sale of a project's electric capabilities is frequently separated from the sale of its environmental attributes, the contract governing the sale of electric capacity and energy from a renewable resource must make clear whether the buyer is or is not also receiving the environmental attributes. If the electric buyer is not also the REC buyer, then the contract needs only to clearly provide that the sale of capacity and energy does not include the RECs, which the seller will sell or transfer separately.

Defining Environmental Attributes

The first provision that requires attention is the definition of environmental attributes, RECs or whatever term is being employed. State laws requiring or encouraging a renewable resource portfolio will each have a statutory definition. These definitions vary from state to state; thus care must be taken not only to reflect the law of the state that governs the agreement but also to consider the need to satisfy the laws in other states as well. While moving in the direction of uniformity, the five major tracking systems (see sidebar) do not yet use identical definitions either. The definition should also make clear how RECs or environmental attributes are being measured, so that the agreement is clear regarding the amount of credit the buyer is actually receiving. [Typically one REC is created for every 1,000 kWh (1 MWh) generated.]

SIDEBAR
Major REC Tracking Systems in the United States

Electric Reliability Council of Texas (ERCOT)
New England Power Pool/Generation Information System (NEPOOL/GIS)
PJM Generation Attribute Tracking System (GATS)
Western Renewable Energy Generation Information System (WREGIS)
Midwest Renewable Energy Tracking System (M-RETS)

Typically, the wisest course of action is to use a broad definition of environmental attributes, at least where the parties' intent is for the seller to transfer and the buyer to receive all of the environmental benefits, in whatever form they may be recognized and by whatever name or other criteria. Not only does current usage vary from state to state and tracking system to tracking system, but one must remain mindful that new laws and policies continue to emerge.

What Are Environmental Attributes Worth?

If the electric buyer is also the REC buyer, then the contract must also make the pricing clear. Sometimes the parties will agree that the price being paid by the buyer for the electric output also covers the buyer's purchase of the RECs. In other cases, the buyer will pay an agreed rate for the electric output and a separate and additional rate for the RECs.

Beyond the provision clearly establishing the initial rate, attention must be given to other provisions in the contract that affect rates, because the parties may or may not intend to treat the electric rates differently from the rates for RECs. For example, if there is an annual rate adjustment provision, does that provision apply to the electric rate, the REC rate or both? Do the parties want and intend for the same rate adjustment mechanism to apply to both the electric rate and the REC rate? If not, separate rate adjusters must be included, with clear delineation of which adjuster applies to which rate.

As a further example, consider the common provision that allows the seller to discontinue deliveries if the buyer is in default and fails to cure that default within the time designated in the contract. In such an event, the seller typically has the right to suspend deliveries of electric capacity and energy while the buyer remains in default. Not only must the parties consider whether the same provisions should apply to effect a suspension of the REC buyer's rights to the RECs, but they must also consider whether the same provisions can apply as a practical matter. Consider a buyer that remains in an uncured default for all of three days. A seller can easily suspend deliveries of electric power and energy at any time, making it very practical to be able to suspend deliveries and then recommence them three days later. A three-day ‘suspension' of RECs, in contrast, may mean absolutely nothing. If registered, they likely would not be ‘de-registered' within three days, much less reregistered on the fourth.

The contract governing the sale of environmental attributes should also commit the seller to provide the buyer with whatever backup the buyer may need from time to time to verify its entitlement to the attributes. The seller should be obligated to provide information confirming that the RECs have not been sold to any other entity except the buyer, and to provide on request whatever technical information the buyer may need. Such technical information might include information to confirm that the generator qualifies as a renewable resource, or the amount of energy it is producing.

Conclusion

The renewable resource industry and the state and federal laws pertaining to it are largely new and still emerging. Renewable portfolio standards are neither universal nor fully standardized. It is thus important when contracting for environmental attributes that the provisions be sufficiently specific to address existing law while sufficiently broad to capture new terminology or rights that may evolve through future laws.

Alan Robbins is a member of Jennings Strouss & Salmon PLC. Based in the firm's Washington, D.C., office, he is engaged in the firm's energy and regulatory practice. He has extensive experience representing clients before the Federal Energy Regulatory Commission and other federal and state agencies and commissions. He may be reached by email at arobbins@jsslaw.com.

Client Alert: The New Estate and Gift Tax Law

Washington has, at last, acted to interject some certainty, albeit temporary, to the area of estate and gift tax planning. Under the recently enacted "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010," the federal estate tax, which disappeared for 2010, springs back to life in 2011 and is imposed at the top rate of 35% of the estate's value after the first $5 million. Following is a brief overview of the new law.

The New Law

The new law brings back the estate tax, and for 2011 and 2012, the top rate will be 35%. For 2011, the exemption amount (the Unified Estate Tax Credit equivalent) will be $5 million per individual (indexed for inflation after 2011). At those levels, the vast majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subject to any federal estate tax.

The new law also gives estates of decedents who died in 2010 certain choices as to which tax rules to apply. Certain elections and filings must be timely made to claim the benefits of such provisions. If you experienced a death in your family in 2010, you should consult with us as to your course of action.

Under the new law, the estate and gift tax exemptions will be reunified starting in 2011, which means that the $5 million estate tax exemption will also be available for lifetime gifts at the same level. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but the lifetime exemption for gifts was only $1 million for years prior to 2011. The gift tax rate, starting in 2011, is 35%. The exemption from the generation-skipping tax (GST) - the additional tax on gifts and bequests to grandchildren or lower generations when their parents are still alive - will also rise to $5 million from the $1 million it would have been without the new law. The GST rate for transfers made in 2011 and 2012 will be 35%.

From a planning standpoint, a convenient feature of the new law effectuates the transfer of the unused portion of the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from estate taxes. In the language of tax professionals, the estate tax exemption will be "portable."

We are revisiting a number of the estate planning techniques with our wealthier clients, including, to name but a few, transfers to grantor retained interest trusts, installment sales of assets to irrevocable grantor trusts, gifting or other transfers to multi-generational trusts, the creation and funding of family limited partnerships and family limited liability companies, and outright gifts of substantial values of assets to younger generations. Washington will likely act again in the next 24 months, which is the duration of these temporary estate and gift tax laws under the new Act. There can be no assurance that the efficacy of these planning techniques will survive any further changes in these laws.

If Washington fails to act before 2013, then the unified credit amount for gift and estate taxes will revert back to $1 million per individual, the GST exemption will return to $1.3 million per individual, and the maximum marginal rate of 55% will apply to such transfers.

Estate Plan Tune-Up

Many clients have been delaying the periodic review and tune-up of their estate planning documents pending the new legislation. Regardless of whether you are impacted by provisions of the new Act, now may be the appropriate time to contact us to initiate a comprehensive review of your related documents, such as wills, trusts, medical powers of attorney, living wills, and general or limited powers of attorney.

If you would like more details about the estate or gift tax or any other aspect of the new law, please do not hesitate to call any of Jennings, Strouss & Salmon's estate and gift tax professionals identified below.

John R. Christian 602.262.5805
William A. Clarke 602.262.5886
Stephen E. Lee 602.262.5824
Nancy C. Pohl 602.262.5927
Jack N. Rudel 602.262.5951
Richard C. Smith 602.262.5972
Wayne A. Smith 602.262.5953

Labor & Employment Client Alert: Arizona's Minimum Wage Increases

On January 1, 2011, Arizona's minimum wage increased to $7.35 per hour. This increase made Arizona's minimum wage higher than the federal minimum wage, which is currently $7.25 per hour.

Arizona voters enacted a voter initiative, known originally as the "Raise the Minimum Wage for Working Arizonans Act," in 2006 (the "Arizona Minimum Wage Act"). The Arizona Minimum Wage Act, which became effective January 1, 2007, established an Arizona minimum wage and also provided that the minimum wage was subject to annual increase based on the increase in the cost of living. The cost of living is measured by the federal Consumer Price Index for All Urban Consumers, U.S. City Average, for all items during the 12 months ending each August 31. Pursuant to the authority granted by this law, the Industrial Commission reviewed the cost of living information and determined that Arizona's minimum wage would be increased for calendar year 2011.

Under federal law, a state may require a minimum wage that exceeds the federal wage. If there is a difference between the laws, the employer must follow the requirement that is the most beneficial to the employee. Thus, an Arizona employer that is subject to both the federal and state laws must pay the Arizona minimum wage rate. Further, Arizona employers must make sure they are in compliance with both the federal and the state laws. Our labor and employment attorneys can answer questions regarding the laws and regulations, and advise you on compliance issues. As you review your individual compliance, some further information regarding the Act and regulations may be helpful.

Exceptions

The Arizona Minimum Wage Act provides only a few exceptions from its coverage. One exception is for small businesses that generate less than $500,000 in gross annual revenue, if that small business is not covered by the federal Fair Labor Standards Act (FLSA). From a practical standpoint, most employers are subject to the FLSA. Another exception applies to the state of Arizona and the U.S. government. Additionally, the Arizona Minimum Wage Act does not apply to any person who is employed by a parent or a sibling, or who is employed performing babysitting services in the employer's home on a casual basis.

Tipped Employees

"Tipped Employees" have special rules under the Arizona Minimum Wage Act and the regulations relating to the Act. With regard to an employee who customarily and regularly receives tips or gratuities from patrons or others, an employer may pay a wage up to $3.00 per hour less than the minimum wage if the employer can establish by its records that for each week, when adding tips received to wages paid, the employee received not less than the minimum wage for all hours worked. If an employee's tips combined with the employer's direct wages do not equal the Arizona minimum hourly wage, then the employer must make up the difference.

For purposes of the Arizona Minimum Wage Act, it is the employer's responsibility to maintain a record of the tips considered for purposes of asserting a tip credit. Further, if an employer elects to use the tip credit provisions, then the amount per hour that the employer takes as a tip credit must be reported to the employee in writing each workweek. Employees who customarily and regularly receive tips may pool, share or split tips between them, and the amount each employee actually retains is considered the tip of the employee who retains it. Employees may also pool, share or split tips with employees who do not customarily and regularly receive tips in the occupation in which the employee is engaged, including management or food preparers, however, such tips may not be credited toward that employee's minimum wage. Further, a tip credit is available only for the hours spent in the tipped occupation. If a tipped employee is routinely assigned to duties associated with a non-tipped occupation, no tip credit may be taken for the time spent in such duties.

Employers should carefully review the laws and regulations for determining who is a "tipped" employee, the application of tip credit rules and regulations and record-keeping requirements, and consult counsel with any questions.

Each case an employer may face is unique and may require legal advice. If you need further information regarding the Arizona Minimum Wage Act, please contact the author, Jan Hutchison, or one of the other attorneys in our Labor & Employment Department.

Janet Hutchison is a commercial transactional attorney and litigator whose practice focuses on the areas of labor and employment, real estate and general business matters. Ms. Hutchison has extensive experience in employment matters, including discrimination, wrongful discharge and wage and hour matters. She frequently advises clients on employment policies and procedures and represents employers in federal and state court litigation, as well as before the various administrative agencies. Read more... Contact Ms. Hutchison at jhutchison@jsslaw.com or 602.262.5945.

2010 Year End Income Tax Planning Strategies

As the end of the year approaches, we often suggest methods that can help lower your tax bill this year and possibly next. The process is very challenging this year. As we all are too well aware, the Bush tax cuts that were enacted in 2001 and 2003 are scheduled to expire in 2011. Such expiration would result in increased tax rates next year for virtually all taxpayers. Accordingly, the standard planning practice of deferring all taxable revenues and accelerating all deductions and credits may serve to actually increase the total income tax liabilities for the years in question.

Until as recently as the first week in December 2010, it appeared that Congress was not going to extend the Bush tax cuts prior to this year end, thus prolonging the suspense associated with the current year end tax planning. If such Bush tax cuts were not extended for a taxpayer, then the reverse of the customary tax strategies would be appropriate. We would be recommending that taxpayers accelerate taxable income and defer deductions and credits through a variety of available techniques.

Last week, however, the White House and certain Congressional leaders announced a compromise bill entitled, "Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010," which among other things, would extend for a two-year period the Bush tax cuts for all taxpayers. The compromise bill was met with considerable opposition by certain Congresspersons, but, as we go to press with this missive, most commentators believe that the compromise bill will be enacted in substantially the proposed form. Consequently, it appears that we can proceed with year end income tax planning utilizing many of the conventional tactics that have been implemented in past years. If the compromise bill is derailed, however, these issues must be revisited.

We have compiled a checklist of actions that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. Our tax attorneys can narrow down the specific actions that you can take when we meet with you to tailor your particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:

Increase the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year.
If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2010.
Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
Subject to the foregoing caveats, postpone income until 2011 and accelerate deductions into 2010 to lower your 2010 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2010 that for future years may be phased out over varying levels of adjusted gross income (AGI). These include IRA and Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2010. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year, or if the tax rates for next year are increased, as discussed above.
If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into Roth IRA's if eligible to do so. For 2010, even taxpayers with higher income are eligible for the Roth conversion. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2010. Remember also to take your required minimum distributions from your IRA, 401(k) Plan, or other qualified plan.
It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2011.
If you own an interest in a partnership or S corporation, you may need to increase your basis in the entity so that you can deduct a loss from it for this year.
Consider using a credit card to prepay expenses that can generate deductions for this year.
If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2010.
Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding prior to year-end.
Estimate the effect of any year-end planning moves on the AMT for 2010, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
Businesses should consider making expenditures that qualify for the business property expensing option (under IRC §179) for assets bought and placed in service this year, assuming the compromise bill is enacted.
You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
If you are self-employed and have not done so yet, set up a self-employed retirement plan.
If you are thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities, the latter may yield a bigger deduction for you.
If you are age 70½ or older, own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings.
Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2010 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
Depending on your particular situation, you may also want to consider triggering a debt-cancellation event in 2010, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.
If you have losses from businesses that might otherwise be suspended under the passive loss rules, consider increasing the time that you devote to such business to satisfy the minimum hourly requirements for classification as an active business, thus freeing up such loss deductions.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

Demand Response: Getting Credit for Contributions to a Smarter Grid

Editor's Note: "From a Legal Perspective" appears in each edition of District Energy magazine to address legal issues of current importance to the district energy industry. It is intended for educational purposes only and does not constitute legal advice.

Large Scale District Cooling Systems - Optimizing a Smarter Grid" was the topic featured at a plenary panel discussion at IDEA's 101st Annual Conference in Indianapolis. IDEA members from around the globe touted the support that district cooling systems lend to grid operations by offsetting peak demand and flattening electric load profiles. Throughout the discussions, IDEA President Rob Thornton, serving as moderator for the panel, asked a simple yet important question: are customers getting the credit they deserve for these contributions?

Legislators and regulators have echoed this question on a national level by examining the role of demand response in our nation's energy policies. Though not a new concept, demand response has received increasing attention in recent years as policymakers focus on independence from fossil fuels. The theory is simple. End-use customers, reacting either to price signals or instructions from grid operators, reduce their electricity demand when transmission systems are constrained in order to increase reliability and ultimately lower energy prices. In practice, the full potential of demand response has not been maximized.

This year, the Federal Energy Regulatory Commission (FERC) took two steps toward solving this problem. First, FERC issued a National Action Plan on Demand Response, which provides the roadmap for implementing initiatives originally prescribed by the Energy Independence and Security Act of 2007 (EISA). Second, FERC proposed changes to its regulations that would standardize, and possibly increase, payments to demand response providers in organized wholesale markets. This column will examine these recent developments and discuss their implications for district energy.

National Action Plan on Demand Response

Congress, in the EISA, directed FERC to develop a National Action Plan on Demand Response that addresses three objectives: (1) providing technical assistance to states to maximize demand response opportunities; (2) establishing a national communications program to foster "broad-based customer education and support"; and (3) developing tools and support materials for use by customers, utilities, regulators and demand response providers. The National Action Plan, which was issued in June 2010, provides a road map for the implementation of these initiatives.

The Plan recognizes that demand response programs are in various stages of development and usage at the local, state and regional levels. A key aspect of the Plan is the formation of an umbrella Coalition, comprised of governing officials, utilities, independent grid operators, industrial and commercial customers, industry associations, consumer advocates and other stakeholders, all of whom would play a part in developing future demand response strategies and activities. The Coalition will act as a clearinghouse for information and a resource for research and development. It will aid in the development of standards and protocols, taking into account regional differences and tapping into the experience of existing programs.

For IDEA members, the Plan's focus on communications, tools and support materials will likely be most useful. The Plan recognizes the importance of large commercial and industrial customers in maximizing demand response successes. The Plan notes that, as compared to residential consumers, industrial and commercial customers are more sophisticated and may already have in place the infrastructure and institutional knowledge necessary to implement demand response programs, producing more immediate results. Demand response incentives, products and technologies must be tested on those who can more readily take advantage of them. The Plan therefore calls for the Coalition to target large-scale customers with educational tools and materials aimed at increasing the availability of demand response opportunities.

It is important to note that the communication and educational opportunities can flow both ways. The Coalition could also serve as a platform for IDEA members to inform lawmakers

and other stakeholders of the benefits that district energy can provide. Participation

in the Coalition could lead to demand response programs that are better tailored to the unique operational aspects of district energy systems.

Demand Response Compensation in Organized Wholesale Energy Markets

In March 2010, FERC proposed a new regulation that would standardize the compensation paid to customers for reductions of electricity consumption that are bid into organized wholesale markets. This proposal grew out of FERC's concern that existing compensation structures may hinder the development and use of demand response resources.

FERC's proposal would require ISOs and RTOs to pay demand response resources bidding into the day-ahead and real-time energy markets the full market price for energy, calculated as the Locational Marginal Price (LMP), in all hours of the day. FERC recognizes this approach has met with some resistance in past cases. However, FERC believes current compensation levels are not creating the incentives to utilize and further invest in demand response. By treating demand response resources on par with generating resources, FERC aims to encourage competition and maintain just and reasonable energy prices.

FERC received comments on this proposal from all sectors of the industry with views ranging from complete support to total opposition. In response to these comments, FERC is holding a technical conference in late summer or early fall of 2010 to further examine its proposed regulation changes. Specifically, although FERC originally proposed that payments would be made in all hours of the day, it now asks whether such an approach is desirable. Some commenters proposed a "net benefits test" to evaluate when demand response should receive compensation at the full market price. The technical conference will examine whether such a test is necessary and, if so, what the parameters should be.

FERC will also look at how demand response compensation should be funded. Some commenters argued about who should bear the burden of these costs. Others complained that IS0s/RTOs will need to revisit the methodologies used to establish LMPs because they presently contain cost allocations that do not reflect the compensation levels contemplated by FERC's proposal. FERC recognized that compensation and cost allocation issues are inextricably intertwined and will use the Technical Conference to further determine whether it should mandate a single allocation approach for all organized markets.

We will not know what this new regulation will ultimately look like until FERC issues its Final Rule on this proposal in the coming months. To the extent IDEA members can reach the markets with measurable load reductions, this new regulation, as currently written, could mean greater financial recognition of those benefits.

What Is in Store for the Future?

At first blush, FERC's proposal on demand response compensation provides a more attractive payment structure to those able to bid demand response resources into the market. This proposal might get whittled down in the rulemaking process. But, at a minimum, FERC recognizes the need for additional financial incentives to increase demand response participation. This new regulation could result in higher payments for those IDEA members with access to wholesale energy markets and the ability to vary electric demand to support grid operations.

On a larger scale, as the Coalition gains momentum and begins implementation of the National Action Plan, we can look for a better flow of information, and an opportunity to influence the development of standards and best practices. The Coalition could serve not only as a source of information, but also as a platform to educate government officials and other industry participants about the benefits that district energy systems can provide in this arena.

Elizabeth Teuwen is an energy lawyer with Jennings Strouss & Salmon PLC in Washington, D.C. Her practice focuses on the electric and natural gas sectors of the energy industry. She represents municipal utilities, rural cooperatives and end users before the Federal Energy Regulatory Commission and advises clients on electric industry restructuring, renewable energy development, power supply arrangements and transmission issues. Teuwen can be reached at eteuwen@jsslaw.com.

Labor & Employment Client Alert: Hiring Incentives

Businesses that hire formerly unemployed workers between February 3, 2010 and December 31, 2010 could be eligible for a tax break under the Hiring Incentives to Restore Employment (HIRE) Act passed earlier this year.

If the new hire was unemployed for at least 60 days prior to being hired, including recent college graduate and rehires, a business can be exempt from its share of the Old Age, Survivors and Disability Insurance tax (OASDI), currently 6.2% of wages up to $106,800. The employee cannot have been hired to replace another employee, unless that other employee left voluntarily or for cause.

An additional tax credit is also available for retaining these employees for one year.

Each case an employer may face is unique and may require legal advice. If you need further information ensuring that your business maximizes its benefits under the HIRE Act, or any other legislation, please contact the author, Valerie Walker, our L&E Department Chair, John Egbert, or one of the other attorneys in our Labor & Employment, Tax or Estate Planning and Probate Departments.

About the Author
Valerie J. Walker is an Associate attorney focusing her practice on litigation, and labor and employment law. Ms. Walker represents clients before state courts and state and federal agencies in discrimination, wrongful discharge and wage litigation cases as well as breach of contract cases. She has previously worked as a law clerk for the National Labor Relations Board in New York City. Contact Ms. Walker at vwalker@jsslaw.com or 602.262.5844.

Legal Watch Series: Topic 7 - Shifting Costs Incurred in Producing Electronic Information

Introduction: This is the seventh article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

I) Overview: The Explosion of ESI - The Server has replaced the Banker's Box

We have all read about it. We discuss it all the time. Over the past decade or more, there has been an explosion of electronic information. And, Electronically Stored Information (ESI) continues to grow at an astounding pace. A standard compact disc contains 650 megabytes of data and translates to 325,000 typewritten pages or about 153 banker's boxes of paper. One gigabyte is the equivalent of 500,000 typewritten pages. (See Source 1, p.77)

Businesses that once thought in terms of gigabytes, now use terms such as terabytes (1,000 gigabytes), petabytes (1,000 terabytes) and exabytes (1,000 petabytes - 10 with 18 zeros.) According to a 2003 study conducted by the School of Information Management and Sciences (SIMS) at the University of California at Berkeley, five exabytes of new data was produced in the single year of 2002. (See Source 2)

"Even a small backup tape, such as a four-millimeter digital audio tape (DAT), can hold between 20 and 40 gigabytes of information. If you printed out even 120 gigabytes of textual documents on paper, it would be as tall as the Sears Tower...you can literally wipe-out a building of paper in 15 minutes," Thom Wisniski, Chief Knowledge Officer, Haynes and Boone, Dallas. (See Source 3)

North American businesses create in excess of 3.25 trillion emails per year and create more than 90% of their information in digital form. (See Source 4)

As a result, computerized data has become commonplace in litigation. The sheer volume of such data, when compared with conventional paper documentation, can be staggering. Large corporate computer networks create backup data measured in terabytes, or 1,000,000 megabytes; each terabyte represents the equivalent of 500 billion typewritten pages of plain text. Digital or electronic information can be stored in any of the following: mainframe computers, network servers, personal computers, hand-held devices, automobiles, or household appliances; or it can be accessible via the Internet, from private networks, or from third parties. Any discovery plan must address issues relating to such information, including the search for it and its location, retrieval, form of production, inspection, preservation and use at trial. (See Source 1)

Emails have replaced other forms of communication aside from just paper-based communication. Many informal messages that were previously relayed by telephone or at the water cooler are now sent via email. Additionally, computers have the ability to capture several copies of (or drafts) of the same email, thus multiplying the volume of documents. All of these emails must be scanned for both relevance and privilege. Also, unlike most paper-based discovery, archived emails typically lack a coherent filing system. Moreover, dated archival systems commonly store information on magnetic tapes which have become obsolete. Thus, parties incur additional costs in translating the data from the tapes into useable form. (See Source 5)

All of these facts underlie the current reality that litigation involving electronic discovery is incredibly costly. Who is to bear the huge costs associated with electronic discovery?

II) The Party Producing Discovery Pays its Own Costs Unless....

The traditional rule is that the party producing discovery at the request of another party pays its own costs associated with the discovery. This general rule will usually be applied in the ESI context: "Normal and reasonable translation of electronic data into form usable by discovering party should be ordinary and foreseeable burden of respondent." (See Source 6)

ESI is often less burdensome to produce than paper documents because ESI can be searched more easily and can be downloaded to appropriate media, thus avoiding the cost of paper reproduction. However, there are circumstances where the searching and reproduction of certain types of ESI are quite a bit more costly and burdensome; and, in these situations the courts may modify the traditional rule by shifting costs. For example, courts are often willing to modify the rule and make the requesting party pay when ESI is contained in that are most reasonably accessible, such as backup tapes. Refer to earlier ESI Alert #6 re Accessibility

And, the general rule is most often inapplicable where a non-party is served with a subpoena seeking ESI. In that situation, courts are even more likely to compensate the subpoenaed party for the costs of production, especially if the subpoena requires an extensive response or the use of information technology professionals. (See Source 7)

Sedona Principle #13 acknowledges these principles: "Absent a specific objection, party agreement or court order, the reasonable costs of retrieving and reviewing electronically stored information should be borne by the responding party, unless the information sought is not reasonably available to the responding party in the ordinary course of business. If the information sought is not reasonably available to the responding party in the ordinary course of business, then, absent special circumstances, the costs of retrieving and reviewing such electronic information may be shared by or shifted to the requesting party."

California and Texas have statutes or court rules that impose some of the costs of discovering ESI on the requesting party. (See Source 8)

The party responding to the request for ESI has the burden of proving that cost shifting is warranted. (See Source 9). Because the cost-shifting analysis is so fact-intensive, it is necessary to determine what ESI may be found on the inaccessible media. This raises a point that we have made in other contexts: in determining whether cost shifting may be appropriate, it is necessary for the court (and, therefore, the lawyers) to thoroughly understand the party's computer system, both with respect to active and stored data.

III) Zubulake Opinions and Other Cases

Judge Shira A. Scheindlin of the United States District Court for the Southern District of New York has issued a series of opinions relating to cost shifting that are recognized by the legal community (both judges and lawyers) as establishing the principles by which all are governed. These are known as the Zubulake opinions; there are five of them, three of which will be discussed here.

Zubulake I - Zubulake v.UBS Warburg LLC, 217 F.R.D. 309 (S.D.N.Y. 2003)

Plaintiff sued UBS for employment discrimination. Plaintiff alleged damages in the range of $15-19 million. UBS contested liability, but admitted damages could be as high as $1.3 million. Plaintiff sought, among other things, emails relating to her that were sent to or from 5 UBS employees. The emails were stored on some 74 backup tapes. The Court's opinion discusses the "reasonably accessible ESI" concept as the key stone in any cost shifting analysis. The Court concluded that on line, near line and off line data are reasonably accessible and, therefore, not eligible for cost shifting. However, legacy data such as disaster recovery back-up tapes or fragmented or damaged data are not reasonably accessible and, thus, may be eligible for cost shifting. The Court summarized the inquiry by stating that the real question is "...how important is the sought-after evidence in comparison to the cost of production." (217 F.R.D. at 322-23)

To answer that question the Court devised a 7-factor test cost-shifting analysis:

The extent to which the request is specifically tailored to discover relevant information (the most significant factor);
The availability of such information from other sources;
The total cost of production, compared to the amount in controversy;
The total cost of production, compared to the resources available to each party;
The relative ability of each party to control costs and its incentive to do so;
The importance of the ESI to the issues at stake in the litigation; and
The relative benefits to the parties of obtaining the information.

(Note: The Federal Court Civil Discovery Standards, August 2004, § 29 (b) (iv), pp 59-61 lists 16 factors to be applied to the allocation of cost analysis.)

Zubulake II - Zubulake v. UBS Warburg, LLC, 216 F.R.D. 280 (S.D.N.Y. 2003)

To assist is in applying the seven factor test set out in Zubulake I ordered a "test run" ("sampling") to determine the likelihood of discovering relevant information in the inaccessible back-up tapes. Plaintiff was allowed to select 5 tapes to be restored. The restoration of these tapes provided the Court with actual results regarding the existence of relevant information in the requested ESI, so that the analysis was not theoretical or speculative.

UBS hired an outside forensic ESI firm, Pinkerton, to perform the restoration. Pinkerton extracted some 6200 emails from 1 of the 5 employees' servers, then ran word searches for Plaintiff's name, initials, etc. This yielded 1075 original emails. UBS's legal counsel reviewed these, and deemed approximately 600 to be responsive. The total cost of this process was $19,000. Pinkerton charged $11,500, and UBS's counsel charged $7,500. Extrapolating this cost to all 74 requested tapes would amount to $274,000 - $166,000 in restoration/search costs and $108,000 in attorney and paralegal review costs. UBS asked that all future costs (i.e., the estimated $274,000) be shifted to Plaintiff.

Zubulake III - Zubulake v. UBS Warburg LLC, 216 F.R.D. 280 (S.D.N.Y. 2003)

The Court held that the responding party should always bear the cost of reviewing and producing the electronic data after it has been retrieved. Thus, Plaintiff would not bear any of UBS's attorney/paralegal review costs. But, the Court held that Plaintiff would bear 25% of restoration/search costs.

Peskoff v. Faber, 251 F.R.D. 59 (D. DC 2008) is another case where the Court discussed the concept of reasonable accessibility and shifting of costs. The opinion was drafted by Magistrate Judge John M. Facciola of the DC District, one of the most respected jurists in the field of e-discovery.

Initially, the Court ordered bids for forensic testing of computers and servers to determine whether cost was justified in light of the amount at issue in the litigation, damages allegedly exceeded a million dollars. The lowest bid for the forensic testing was $33,000. The Court concluded that "anticipated cost of doing forensic search will [not] dwarf the final recovery."

The Court refused to depart from the traditional approach that the producing party will bear the costs of the search, noting the following factors:

Cost shifting is appropriate only where electronic discovery imposes an undue burden or expense.
There was no undue burden or expense because the responding party was responsible for need to do forensic examination. He failed to take his obligations seriously. "A party should not be entitled to shift the costs of restoring and searching data that it converted into an inaccessible format when it should have anticipated litigation."

Another case where the Court declined to shift costs is Omnicare, Inc., v. Mariner Healthcare Management Company, 2009 WL 1515609 (Del Ch. 5/29/09). This case involved a suit by a large nursing home operator against a large pharmaceutical supplier relating to the pricing of products and services. Given the nature of the entities and the operations, the amount of information sought in discovery was "complex and voluminous". A discovery dispute arose out of the plaintiff's request for various types of ESI, including backup tapes. It was estimated that the cost of restoring the backup tapes was between $22,000 and $40,000, and the defendant refused to bear that burden.

The Delaware Chancery Court, departing from the approach used in many courts, held that the fact that ESI may be in backup tapes instead of active storage does not necessarily render it not reasonably accessible, especially in light of other considerations. The Court was influenced by the fact that the estimated cost of restoring the backup tapes was minimal in light of the amount in controversy- tens of millions of dollars.

An example of a case where the court agreed to shift the costs to the requesting party is OpenTV v. Liberate Technologies, 219 F.R.D. 474 (N.D. Cal. 2003). The Court ruled that cost shifting was warranted where digital data in the form of source code was stored in an inaccessible format for purposes of discovery, where process of extracting search code from its database took between 1.25 and 1.5 hours per source code, amounting to between 125-150 hours of work to complete extraction process for the approximately 100 versions of source code requested by the requesting party.

Similarly, in Genworth Financial Wealth Management, Inc. v. McMullan, 2010 U.S. Dist. LEXIS 57870 (D. Conn. June 10, 2010), the Court ordered that defendant former employees who left the plaintiff to start up a competing company must, pursuant to Plaintiff's discovery request, allow forensic imaging of their computers' hard drives by a neutral expert. The Court further ordered cost shifting that required the Defendants, the responding parties, to pay 80% of the cost of the hard drive examination, meaning that the Court shifted 20% of the cost to the requesting party. The Court would have likely shifted more of the costs to the requesting Plaintiff but for some egregious conduct by the Defendants relating to electronic discovery issues.

Lessons

Discovery of ESI can be very costly. However, with a thorough knowledge of discovery rules and cases interpreting them, costs can be made more manageable. Make sure you consult with your lawyer on these ESI issues.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will be discussing issues relating to employee's personal use of company computers and social networking

Resources Used for This Legal Watch

Manual for Complex Litigation § 11.446, Discovery of Computerized Data, (4^th Ed. 2004)
See http://www2.sims.berkeley.edu/research/projects/how-much-info-2003/
Electronic Evidence, - a special report from Corporate Legal times, August 2003
Bradford S. Babbitt and Kori E. Termine, The New Reasonable Accessibility Standard- What's so Reasonable about it? E-Discovery, ABA Section of Litigation, 2007
The "Sheer Volume" of discovery of ESI: Byers v. Illinois State Police, 2002 WL 1264004 (N.D. Ill. June 3,2002)
Daewoo Electronics Co., Ltd. v. U.S., 650 F. Supp 1003, 1006 (----1986)
Federal Rule of Civil Procedure 45 (c) (1) and 45 (c) (2) (B); In re Automotive Refinishing Paint, 229 F.R.D. 482 (E.D. Pa. 2005)
Cal. Code Civ. P. § 20031 (g) (1) and Texas R. Civ. P. 196.4
Mikron Industries, Inc. v. Hurd Windows & Doors, Inc., 2008 WL 1805727 (W.D. Wash. 2008)

Cornell’s PURPA Victory NYSEG Still Obligated to Purchase Excess Output from Cornell’s Cogeneration Facility

IDEA member Cornell University recently rebuffed an attempt by its host utility to terminate the obligation to purchase excess energy from Cornell's cogeneration facility. In a March 2010 decision, the Federal Energy Regulatory Commission (FERC) ruled that New York State Electric and Gas Corporation (NYSEG) is still subject to the mandatory purchase obligation under the Public Utility Regulatory Policies Act of 1978 (PUPRA), at least with respect to Cornell. [1] This column will discuss recent changes to PURPA that spawned this FERC proceeding, analyze the FERC decision preserving the requirement that NYSEG purchase the output of Cornell's cogeneration facility, and provide guidance to IDEA members facing a possible elimination of the mandatory purchase requirement.

EPAct 2005 Modifies PURPA's Mandatory Purchase Requirement
PURPA was initially passed in 1978 to promote the growth of cogeneration and small power production. The Act established a class of qualifying facilities (QFs) that received exemptions from various federal and state laws and enjoyed other benefits related to power production. One of these benefits was a requirement that utilities purchase all the available output from QFs in their service territories.

Through the years, utilities have opposed the mandatory purchase requirements which, they claim, force them to buy energy that they do not need or cannot use. Further, they have argued that developments in the industry, such as standardized interconnection procedures, open access transmission tariffs and established energy markets, have removed the obstacles that PURPA was originally designed to eradicate.

Congress responded to these complaints in the Energy Policy Act of 2005 (EPAct 2005). While PURPA still remains in effect today, EPAct 2005 added a new PURPA Section 210(m), which allows utilities to terminate their obligation to purchase energy from any QF over 20 MW that has nondiscriminatory access to certain wholesale energy markets. Section 210(m) applies only to new contracts or obligations, leaving existing contracts intact.

In 2006, FERC issued a Final Rule (Order No. 688) establishing the process by which utilities could apply for termination approval. FERC found that the six existing Regional Transmission Organizations (RTOs) and the Electric Reliability Council of Texas provide the necessary access to wholesale energy markets described in Section 210(m). In their applications to FERC, utilities located in those designated regions can rely on a rebuttable presumption that QFs greater than 20 MW have nondiscriminatory access to wholesale markets.

FERC gave QFs the opportunity to rebut this presumption and illustrated the kind of evidence needed to make this showing. For example, a QF could present evidence that its highly variable thermal or electric demand prevents it from effectively participating in the market. Alternatively, the QF may lack access to the scheduling mechanisms necessary to make advanced energy sales on a consistent basis. Or, transmission constraints may prevent the QF from being able to deliver energy to market. FERC determines on a case-by-case basis whether the QF presented sufficient evidence to demonstrate a lack of market access.

Cornell Protests NYSEG's Termination Application
Cornell certified its 40 MW facility as a QF in late 2009. Shortly thereafter, NYSEG applied to FERC to terminate its purchase obligation under PURPA, relying on the rebuttable presumption that its membership in the New York ISO (NYISO) provides QFs with adequate access to a wholesale energy market. If NYSEG's application were granted, Cornell would need to make alternate, and possibly less beneficial, arrangements for the excess output from its QF. Cornell therefore protested the application [2] - it was the only QF to do so.

Cornell presented evidence that the operating characteristics of its facility prevent it from participating in NYISO's day-ahead and real-time energy markets. Because Cornell's facility serves steam load, which is highly sensitive to the variable weather conditions in central New York State, the amount of electricity available for sales to the market is both variable and unpredictable, leaving Cornell vulnerable to penalties imposed by NYISO for over- or under-generation. To demonstrate that it does not have nondiscriminatory access to NYISO markets, Cornell highlighted the fact that the NYISO penalties are waived for other intermittent resources.

NYSEG answered Cornell's protest. Although it recognized the variable nature of the QF's operations, NYSEG argued that Cornell failed to quantify that variability. NYSEG also refuted the unique operating conditions of Cornell's facility, arguing that Cornell's steam generation did not necessarily dictate its available electric output.

In the end, FERC sided with Cornell. FERC noted that a mere showing that electric output was dependent on variable weather conditions would not have sufficed. Rather, in upholding NYSEG's obligation to purchase from Cornell, FERC focused on the highly variable demands of Cornell's steam load and the resulting unpredictable electric output available for sale into NYISO markets. That fact, coupled with the discriminatory nature of the NYISO penalties for under-generation, satisfied FERC that Cornell lacked nondiscriminatory access to the NYISO markets.

What This Decision Means for IDEA Members
This case is significant because it shows FERC's willingness to consider the variable nature of steam load in the context of PURPA purchase obligations. The key in these cases is being able to show how a particular wholesale market operates in a manner that does not accommodate district energy systems.

Cornell's successful challenge provides a road map for other IDEA members that may be facing similar termination threats. That said, it is not always easy to predict how a regulatory agency like FERC is going to rule. Only two years ago, FERC denied a QF challenge that was similarly based on the variable nature of a QF's available output due to the needs of its thermal host. [3] In that case, FERC cited a lack of detail and actual data of past experiences - information that it did not seem to require from Cornell. This shows the fact-specific nature of these cases. FERC examines QF challenges on a case-by-case basis. Nevertheless, by examining both past victories and failures, IDEA members can increase their chance of success in challenging a utility's termination request.

Utilities are required to notify all QFs in their region when they file a termination application. If you receive such notification and believe the continuation of a mandatory purchase requirement is beneficial, the Cornell case offers the following lessons in preparing a challenge:

Show up. Cornell's efforts demonstrate that it is possible to ward off termination of PURPA's mandatory purchase obligation. But that can only happen if you participate in the process. Cornell was the only QF to file a protest against NYSEG's application, and it is the only QF from which NYSEG is still required to purchase energy. FERC granted NYSEG's termination request for all other QFs in the NYSEG service territory.
Know your market. These challenges turn on whether the QF has nondiscriminatory access to wholesale markets. Whether due to transmission constraints, scheduling issues or your own operational limitations, your challenge to a termination application must identify the specific obstacles that prevent you from reaching the market. This means explaining your own operations in the context of your particular RTO's market rules and identifying the impact of any market failures.
Give FERC all the details. These proceedings are highly fact specific. Merely stating you do not have access to energy markets is not enough. You must demonstrate with specificity the operating characteristics of your facility or other factors that prevent you from effectively participating in the wholesale market.

1. New York State Electric & Gas Corporation and Rochester Gas and Electric Corporation, 130 FERC ¶ 61,216 (2010).

2. The protest was prepared by Leonard Singer from the law firm of Couch White.

3. Virginia Electric and Power Company, 124 FERC ¶ 61,045 (2008).

Legal Watch Series: Topic 6 - Accessibility - what ESI must be produced

This is the sixth article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

As noted in one of our earlier ESI Alerts, a party can be compelled to produce ESI (electronically stored information) in several different contexts: as a party to litigation, as a subject of a governmental investigation, or in response to a third-party subpoena. Under Rule 26 (b) (2) (B) of the Federal Rules of Civil Procedure, only ESI that is "reasonably accessible" must be produced. ESI that is not reasonably accessible because of "undue burden and cost" normally does not have to be produced. The burden of proving that ESI is not reasonably accessible is on the party objecting to the production request.

Unfortunately, the Rules do not define what is "reasonably accessible" or the key phrase "undue burden and cost". The Comments to the Rule discuss the issue in terms of volume of information and ability to search for it. And, The Sedona Conference, one of the major think tanks in the area of e-discovery, has noted that the definition might lie in whether the primary source of the requested ESI is active data and information or whether it is back-up tapes or legacy data from old, obsolete systems that requires forensic analysis to find, with the former being reasonably accessible and the latter not. (See Sedona Principle #8.)

In W.E. Aubuchon Co., Inc. v. BeneFirst, LLC, 245 F.R.D. 38 (D. Mass. 2007), the federal district court characterized sources of ESI from most accessible to least accessible: (1) active online data (e.g. hard drives), (2) near-line data (typically robotic storage devices such as optical disks) and offline storage/archives (removable optical disks or magnetic tape media that can be labeled and stored on a shelf or rack), (3) backup tapes, and (4) erased, fragmented or damaged data, which can be only be accessed after significant forensic processing.

In determining whether ESI is reasonable accessible, the Rules envision a balancing test and list factors that courts should weigh in determining whether ESI is inaccessible due to cost and undue burden. Those factors include:

The specificity of the discovery request
The quantity of information available from other more easily accessible sources
The failure to produce relevant information that seems likely to have existed but is no longer available
The likelihood of finding relevant, responsive information that cannot be obtained from other more easily accessed sources
Predictions as the to the importance and usefulness of the information sought
The importance of the issues at stake in the litigation
The respective resources of the parties.

An analysis of this type must be done on a case-by-case basis, resulting in little, if any, specific guidance.

In dealing with accessibility issues, e-discovery commentators encourage litigants to use a two-tiered process that focuses on early negotiation. Often, more easily accessible sources will provide a party with sufficient information necessary to process or defend a claim. Thus, it is important for counsel and clients to attempt to agree on protocols at the outset. For this reason, Rule 26 (f) of the Federal Rules imposes an obligation on parties and counsel to conduct an "early meeting" to discuss issues such as accessibility. In those situations, an early agreed upon discovery plan could mean that there will be no need to deal with the more difficult sources of information later. Of course, this approach demands a level of cooperation that is often absent in litigation. However, given the likely very significant costs of e-discovery, clients will be best served to insist on a more cooperative approach. (See, The Sedona Conference Cooperation Proclamation.)

As noted above, ESI that is not reasonably accessible because of cost and undue burden does not normally have to be produced. Clearly, there are exceptions to the usual rule. Federal Rule of Civil Procedure 26 (b) (2) (C) deals with the exceptional circumstance. To obtain ESI that is not reasonably accessible, the requesting party must obtain a court order compelling production under the criteria set out in the Rule. The showing that must be made by the requesting party is fairly stringent. One of the devices often used by the courts in this situation is to have the parties engage in forensic testing, i.e. sampling, to see if a full scale search is justified. For example, in Zubulake v. UBS Warburg LLC, 217 F.R.D. 309 (S.D.N.Y. 2003), Judge Sarah Scheindlin, a recognized e-discovery guru, ordered that five backup tapes be restored and sampled before deciding whether to require further restoration.

Intimately related to the accessibility issue is the issue of cost of production. It is standard operating procedure in discovery (electronic and paper) for the producing party to bear the cost of compiling the requested information. But, often that is not the case when the sought-after material is electronic and there are accessibility issues. In other words, where the ESI is on the harder end of the accessibility scale, courts show a much greater willingness to make the requesting party pay some or all of the production costs.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will explore "cost shifting".

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Selling in a Down Market? It May Still be the Right Move

Many business owners have deferred consideration of whether to sell their businesses due to the distressed world markets and the impact on their recent financial performance. They believe that offering prices will necessarily fall below what they otherwise might achieve. They may also fear the perception that attempts to sell now are a sign of desperation, resulting in depressed offering prices.

Those owners may be missing an excellent opportunity to achieve their business goals, and sales prices may surpass their expectations. In addition, myriad reasons exist to consider selling in any kind of market, regardless of the health of their business. There are also ways to structure transactions that can help bridge the valuation gap. As a result, owners ought to consult with professional advisors who can help them evaluate when to market their business for sale and how best to seek potential bidders.

Why Consider Selling Now

Many buyers have been absent from the market, perhaps waiting for valuations to bottom out. Others lack equity or debt capital needed to finance the transactions. There are many potential buyers, however, that are capable of consummating a transaction at any time. Many are facing increasing pressure to put their capital to use, so sellers can expect an increase in potential bidders. Sellers of quality companies who market their companies at this time may face reduced competition for the buyers' attention, since many other potential sellers are still absent from the market. These factors should increase the chances of consummating a transaction for the seller.

Some bidders will seek distressed companies that are forced to consider a sale at this time. Others are searching to purchase at a discounted price a company with proven revenues or with desired characteristics, like new products, markets or access to a desirable client base. Regardless of their circumstances, sellers may find current values attractive, especially when factoring in the time value of money, potential increases in tax rates, and the continued risk of operating their company.

With appropriate support, sellers and their financial advisors may be able to largely ameliorate the impact the economic downturn may have had on sales and revenue trends, especially if the most recent trends are again starting to improve.

Methods of Bridging the Valuation Gap

Sellers who are seeking a larger valuation than their bidders have offered might consider transaction structures that can help both parties achieve their ultimate goals.

Many transactions contain deferred payments, sometimes based on achievement of certain target performance. These "earn outs" allow sellers to achieve the full value of their companies if performance warrants those payments, while giving buyers some assurance that they are not overpaying for prospective results. Earn-outs should be carefully structured and drafted to help reduce the chances of a dispute concerning the achievement of the targeted performance and the amount of the payments.

Alternatives to an earn-out exist. For example, owners can obtain assured payments to themselves or their heirs through the use of annuities or fully-paid life insurance to fund a portion of the purchase price. To illustrate, consider a single-owner business in the United States in which the owner wishes to sell at a specified amount, to enable him to live for retirement and to pass on wealth to his children. If the owner sold the company for cash paid at the closing, the owner would have to pay tax on the proceeds (either at capital gains or ordinary income tax rates). With the estate tax in flux in the United States, it is not clear what would be the tax impact on the owner's estate when he passes the remainder of his estate to his children, but it is foreseeable that there could be an additional tax to the children when the estate passes to them.

In contrast, the owner may be able to directly pass a substantial portion of the sales price of the company to his children through the company's purchase of life insurance or an annuity, which may provide a larger net return to the children and may avoid tax when distributed. Moreover, the cost of the annuity will be less than the ultimate payout, especially when there is sufficient time for the annuity to grow. Ultimately, sellers and buyers will need to obtain specific tax advice at the time of a transaction to determine the then-current tax impact of the proposed transactions.

Access to Capital

Many business owners may seek to sell all or a portion of their companies at this time because they need capital to support liquidity, future growth or current operations. Due to the tightening of the capital markets, owners should consider available financing options that present acceptable terms, even if that option includes sale of some or all of the company's ownership, through direct sales of equity or the grant of options or warrants. Many companies mistakenly seek to protect profits over liquidity, and later rue the day when they lack capital to withstand an unexpected crisis or to seize on an opportunity presented to them.

Companies lacking access to capital could be forced into bankruptcy if they become insolvent. Bankruptcy could result in the elimination of the existing equity positions in a company. To help avoid those situations, business owners should consider methods of boosting liquidity when performance is reasonably strong. Among the methods to evaluate could include a potential sale of all or a portion of their company. While other options may be preferable to the owner, it could be prudent to pursue multiple alternatives simultaneously, as it is difficult to know which approach will ultimately become successful.

Joining forces with additional investors could not only provide the needed capital for the company, it could help in attracting further rounds of additional debt or equity, and enhance the company's ability to acquire other businesses. The new investors could also bring connections, talent, and other synergies to the company, which could enhance returns for all equity owners.

Financial Diversification

Many business owners are considering a sale of their companies now, because the recent economic upheaval has highlighted their financial dependence on the success or failure of their business. For many owners, their investment in the business comprises their largest single investment. Its failure could have a catastrophic impact on their personal financial circumstances. Selling all or part of their business enables them to diversify their portfolio. Often, the buyers hire the sellers and the existing employees to continue operating their company. Those owners often get the "best of both worlds", in that they can often realise immediate proceeds for their business, but have some assured future income (with an appropriate employment agreement with severance provisions), as well as to assure that their workers remain employed.

Business owners can achieve many of their objectives, even in this difficult economic environment, through a sale of some or all of their company. If properly structured, a sale can result in a strengthening of the business, while allowing the business owner to monetise at least a portion of the business, and perhaps even to help provide for his or her estate planning needs. Moreover, businesses generally benefit from additional capital regardless of their position in the business cycle. Potential sales can help provide access to that capital. As a result, business owners should consider a sale of all or part of their business at any time, even in challenging economic conditions.

Tax Update: Status of the Federal Estate Tax

As you have probably heard, Congress failed to enact estate tax legislation in 2009. This failure to act has caused legislation passed in 2001 to culminate into a repeal of the estate and generation-skipping transfer taxes in 2010. The repeal is followed by a reinstatement of the estate and generation-skipping transfer taxes in 2011, with a reversion to the transfer tax rules in effect in 2001. We had hoped that Congress would act quickly this year to reform the estate tax so that we would be able to provide a clearer picture of the status of the estate tax at this time.

As of now, and until Congress passes estate tax legislation, the estate, generation-skipping transfer and gift tax rates and exemptions for 2010 and 2011 are as follows:

There is no estate tax or generation-skipping transfer tax imposed on decedents dying in 2010. These taxes will return on January 1, 2011 with a rate of 55% (up from 45% in 2009), and an exemption of $1 million (indexed for inflation in the case of generation-skipping transfer taxes; this exemption amount is decreased from $3.5 million in 2009).
For decedents dying in 2010, the income tax basis of assets will not be "stepped-up" to their fair market value at date of death. Rather, the decedent's income tax basis will "carry over" to the persons who inherit the assets, subject to a $1.3 million step-up for heirs generally and a $3 million step-up for property left to a surviving spouse. On January 1, 2011, the stepped-up basis rules will return.
The gift tax continues to exist in 2010, but the tax rate is 35% (down from 45% in 2009). The gift tax rate will increase to 55% in 2011. The lifetime exemption for gift tax is $1 million for 2010 and 2011, and the gift tax annual exclusion amount continues to be $13,000 per donee in 2010.

If Congress enacts estate tax legislation this year, this legislation could be made retroactive to January 1, 2010.

The inaction by Congress leaves taxpayers and their counsel with a great deal of uncertainty. Additionally, it could cause unintended results for the estate plan of someone who dies in 2010 if Congress does not enact estate tax legislation that is retroactive to January 1, 2010. Most revocable trusts use terminology from transfer tax rules, such as "unified credit amount" and "maximum marital deduction." If there is no estate tax, the provisions of the trust may read differently than what was originally intended. Additionally, special language may need to be added to utilize the special basis adjustments described above for the estate of someone dying in 2010.

If you would like to discuss how these changes impact your estate plan, please contact one of the attorneys in our Tax or Estate Planning & Probate departments.

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice within this client alert is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in a client alert.

Legal Watch Series: Topic 5 - More on Litigation Holds and Document Preservation

Introduction: This is the fourth article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

In our last ESI Alert, we discussed the obligation of an organization to put a "hold" on its document destruction practices even before litigation commences, when litigation is reasonably anticipated. This is called the litigation hold.

As noted in the last ESI Alert, we were going to discuss the principle of accessibility of electronic documents in this Alert. However, in the meantime, two very significant United States District Court opinions dealing with litigation holds were published. Thus, it seems appropriate to discuss them now.

The new opinions were issued out of the Southern District of New York and the Southern District of Texas. The New York opinion, The Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, 2010 WL 184312 (S.D.N.Y. 1/15/10), was authored by Judge Shira Scheindlin, author of the famous Zubulake opinions that are generally regarded as the leading cases on electronic discovery. The Texas opinion, Rimkus v. Cammarata, 2010 WL 645253 (S.D. Tex. 2/19/2010), was written by Judge Lee H. Rosenthal, the current chair of the Federal Judicial Conference Advisory Committee for Federal Rules of Civil Procedure.

The Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities

The Pension Committee case analyzes the duty to properly preserve relevant information, including ESI, from the perspective of the plaintiff. In this case plaintiffs failed to institute a written litigation hold in a timely manner and, when they did institute the litigation hold, they failed to properly preserve the relevant ESI, resulting in lost material evidence. Losing material evidence is called "spoliation", which can result in significant sanctions, ranging from an assessment of costs and fees to dismissal or default.

Judge Scheindlin started her discussion of the duty to institute litigation holds and preserve documents with the statement" "[B]y now it should be abundantly clear that the duty to preserve means exactly what it says and that a failure to preserve records - paper or electronic- and to search in the right places for those records will inevitably result in the spoliation of evidence."

Judge Scheindlin developed a four-pronged analysis to be used in the determination of possible sanctions for spoliation of evidence. The most important element of the analysis, for our purposes, is the level of culpability of the party with the duty to preserve, whether the conduct was acceptable, negligent, grossly negligent or willful. These levels of culpability are part of a continuum. Negligent conduct is that which is unreasonable and that creates a risk of losing relevant evidence, while willful conduct involves intentional or reckless conduct that makes loss of relevant evidence highly likely. The degree of sanctions will depend on where the conduct falls on the continuum.

Judge Scheindlin provided examples of conduct to help those with a duty to preserve understand the analytical framework:

Failure to issue a written litigation hold warning is gross negligence;
Failure to collect information from key players can be gross negligence or willful conduct;
Failure to preserve email or back-up tapes after the duty to preserve has arisen can be gross negligence or willfulness;
Failure to obtain records from all employees, some of whom may have had only a passing involvement in the events, as opposed to key players, will be negligence;
Failure to take all appropriate measures to preserve ESI is negligence at a minimum;
Failure to collect information from files of ex-employees where the employer has control over the information is gross negligence; and,
Failure to monitor the continuing collection of evidence will be negligence.

In Pension Committee, Judge Scheindlin determined that the spoliating party's actions in failing to timely institute written litigation holds, failing to execute a comprehensive search for documents and/or failing to sufficiently monitor their employee's document collection were grossly negligent. As a result, Judge Scheindlin instructed the jury that the plaintiffs were grossly negligent in failing to preserve evidence after the duty to preserve arose, and informed it that they could presume that such lost evidence was relevant and would have been favorable to the party.

One commentator concludes that the impact of the Pension Committee Case is that the "honor system" of allowing employee self-collecting or "preservation in place" has been called into serious question. "[T]otal reliance on any employees to search and select won't cut it in Judge Scheindlin's court." Rather, the older practice of preemptive collection for preservation with data reduction later will gain re-ascendency.

Rimkus v. Cammarata

To summarize the Rimkus v. Cammarata case, a group of employees left and filed a suit against their former employer, Rimkus Consulting, to release them from their non-compete agreements. In a countersuit, Rimkus alleged that the former employees violated their non-competes and additionally made off with trade secrets and proprietary information.

Judge Rosenthal's opinion in Rimkus expands on the "culpability continuum" of Pension Committee and introduces the concept of "preservation proportionality". Unlike Pension Committee, which involved negligent actions, Rimkus involved the intentional destruction of emails and other ESI when they were known to be relevant to anticipated or pending litigation. Further, the "spoliators" concealed and delayed providing information that would have revealed their spoliation.

Much of what was deleted was no longer available from alternative sources; however, despite the deletions of emails subject to the duty to preserve, the adverse party had evidence available to prosecute its claims and respond to defenses. Because the Court found that there was sufficient evidence for the other side to prove its case, it declined to impose the most drastic sanction (judgment for the other party) and instead decided that the appropriate sanction was to inform the jury about what had been done and to give the jury the option of applying an adverse inference instruction, i.e. that the evidence that should have been preserved and if produced would have been unfavorable to the spoliating party.

Judge Rosenthal emphasized the need to consider both the spoliating party's culpability and the level of prejudice to the party seeking discovery. Even though there was willful destruction of evidence, a significant amount of the incriminating evidence was recovered by the plaintiff, meaning that the prejudice to the other party was not so great. In light of those facts, the Court was unwilling to issue the harshest sanctions.

Judge Rosenthal stated in her opinion:

Spoliation is the destruction or the significant and meaningful alteration of evidence. ...Electronically stored information is routinely deleted or altered and affirmative steps are often required to preserve it. Such deletions, alterations and losses cannot be spoliation unless there is a duty to preserve the information, a culpable breach of that duty and resulting prejudice.

These general rules [of spoliation] are not controversial. But applying them to determine when a duty to preserve arises in a particular case and the extent of that duty requires careful analysis of the specific facts and circumstances. It can be difficult to draw bright-line distinctions between acceptable and unacceptable conduct in preserving information and in conducting discovery, either prospectively or with the benefit (and distortion) of hindsight. Whether preservation or discovery conduct is acceptable in a case depends on what is reasonable, and that in turn depends on whether what was done-or not done-was proportional to that case and consistent with clearly established applicable standards. (My emphasis)

Quoting from The Sedona Principles for Electronic Document Production, Judge Rosenthal noted: "Electronic discovery burdens should be proportional to the amount in controversy and the nature of the case. Otherwise, transaction costs due to electronic discovery will overwhelm the ability to resolve disputes fairly in litigation." She then goes on to state: "For example, the reasonableness of discovery burdens in a $550 million case arising out of the liquidation of hedge funds, as in Pension Committee, will be different than the reasonableness of discovery burdens in a suit to enforce noncompetition agreements and related issues, as in the present case."

Judge Rosenthal concluded:

Applying a categorical approach to sanctions issues is also difficult, for similar reasons. Determining whether sanctions are warranted and, if so, what they should include, requires a court to consider both the spoliating party's culpability and the level of prejudice to the party seeking discovery. Culpability can range along a continuum from destruction intended to make evidence unavailable in litigation to inadvertent loss of information for reasons unrelated to the litigation. Prejudice can range along a continuum from an inability to prove claims or defenses to little or no impact on the presentation of proof. A court's response to the loss of evidence depends on both the degree of culpability and the extent of prejudice. Even if there is intentional destruction of potentially relevant evidence, if there is no prejudice to the opposing party that influences the sanctions consequence. And even if there is an inadvertent loss of evidence but severe prejudice to the opposing party, that too will influence the appropriate response, recognizing that sanctions (as opposed to other remedial steps) require some degree of culpability.

Lessons

The best way to avoid such risks and consequences? Have an effective litigation hold process in place which includes the following:

Issue a legal hold that is written and that clearly articulates the preservation process. A written notification serves as a foundation for a defensible fact trail that will make it less likely for opposing counsel to bring spoliation into play.
Sending a written hold is not sufficient. You must take proactive steps to ensure understanding and compliance on behalf of the custodians. As in the Rimkus case, such action is a critical step toward isolating any "bad actors" that seek to inadvertently (or overtly) destroy evidence.
Ensure a means to effectively defend your actions and preservation process. In the case of spoliation motions, a well-understood and consistently applied process will always support the litigant faced with defending their actions as being reasonable and in good faith.

The real takeaway here is that preservation and the use of litigation holds continue to be a hot issue in the courts. With this level of notoriety, the courts are unquestionably becoming less tolerant of improper hold implementations. Take appropriate steps now, including contacting your outside litigation counsel, before you too become an example what not to do when it comes to legal holds.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will cover the concept of accessibility of ESI.

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Resources Used for This Legal Watch

1. The Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, 2010 WL 184312 (S.D.N.Y. 1/15/10)

2. Rimkus v. Cammarata, 2010 WL 645253 (S.D. Tex. 2/19/2010)

3. The Sedona Conference Commentary on Legal Holds: The Trigger & The Process

Regulators Are People Too: Approach them like that

Know your audience. That applies to your favorite regulatory agency, too. To know your audience, you need to try to understand what is driving them. What are their policy objectives? How do those policy objectives apply to your company or your particular regulatory proceeding? How can you make their jobs easier and enable them to declare success, while at the same time achieving an acceptable outcome for you? What are the specific roles, responsibilities and biases of the individuals you are dealing with?

You undoubtedly address these and other similar questions when developing a new marketing plan, a new advertising campaign or new promotional materials. You should approach the promotion of your regulatory objectives in a similar manner.

Know what you want, and why - Identify your objective clearly. Do so before you start or become involved in the regulatory process. Understand whether your primary interest is in a dollar outcome or instead in the setting of policy or precedent. If your interest is a matter of dollars, then you presumably have flexibility in how you achieve or package that result. But, if your objective is grounded in policy or principle, then you must decide the extent to which you need to remain true to that philosophy.

Know how what you want fits or conflicts with known regulatory policy or regulatory objectives - Understand the mindset of your regulators. Their policies and policy objectives will color the glasses through which they examine your proposal. When possible, present your position as one that is consistent with their policies or that furthers their policy objectives. Even when what you want is at odds with their policy, it is often more effective to say "I really want to get on board with your policy, but I can't unless you change [X] because otherwise I will suffer this terrible consequence, which surely is not what your policy is intended to cause," than it is to say "I object to your policy because it's bad policy."

Remember, even if you don't like their policy or it doesn't work for your company, the regulators likely helped formulate that policy. They therefore are not likely to think and will not admit that it is bad policy. Telling them that you think it is bad policy will only cause them to become defensive, not receptive. Just as would not tell parents that you think their child is ugly, but might ask if they ever considered having the child sport a different hair style, so too should you suggest some tweaking of policy rather directly deride the policy.

Explaining pertinent differences between district energy and other regulated utilities to which the policy applies will likely provide you the springboard for this approach. Explain why you are different and why that means some change to the policy is necessary when applied to you. Most regulators recognize that one size does not always fit all, but sometimes you have to first make clear that not everyone is the same size.

Establish and maintain credibility - Credibility is essential. Do not come into a regulatory proceeding ill-prepared. Know your objective, know your issues and know the basis for each. Know where your position is supported by existing practice or policy and where it departs from it. Be able to explain why. Be able to explain what the significance is to both you and to the public. Have a clear, understandable and not overly detailed explanation of your position, but also be ready to back it up with as much detail and support as is available.

The regulators' job is to balance the interests of the regulated company and the interests of the consumers or the public at large. Help them do that. Address not only your needs and interests, but the consumers' and public's interests as well.

Don't be afraid, but be respectful - Regardless of what you think of the individuals involved, approach them politely, respectfully and as professionals. Speaking pedantically, or otherwise causing them to take offense, will only cause them to become defensive and determined to not agree with your position. Your mission is to achieve your regulatory objective, not to give the individuals a personal reason to be belligerent towards you or your position.

Conduct prefiling educational meetings - When possible, and assuming that the rules governing your particular regulatory agency allow, meet with them before your file your case. In most cases, the "ex parte" rules prohibit you from unilaterally discussing your case with decision-making individuals at the regulatory agency outside the presence of other parties. But such rules often do not apply until you have filed your case. Discussing a draft of your proposed application in advance of filing is often permitted. If so, such discussions not only afford you an opportunity to 'heads up' and educate the regulators, but also to get some initial feedback. Getting such feedback can be invaluable. It can prompt you to modify your filing before you make it, so that you fashion it a manner that is more likely to address the regulators' concerns.

Garner customer support - The more widely supported your position, the easier it is for the regulators to approve it. Do what you reasonably can to obtain the support, or at least non-objection, from your customers. You will have to deal with your customers' views once you make your filing, so why not try to do so before you file, thereby smoothing out some of the bumps in the regulatory path that you are likely to confront later on?

Always keep in mind that 'the regulators' are, like you, people with a job to do. Understand the job of the agency, and understand the jobs and the roles of the individuals with whom you are dealing. Most people appreciate being treated respectfully even if they disagree with your opinion or position. Be respectful by being prepared, professional and aware of their views and responsibilities.

Change on the Horizon

In July 2009, the Arizona Supreme Court created the Attorney Discipline Task Force for the purpose of preparing a motion to amend the rules that govern the regulation of Arizona lawyers. The Court directed the Task Force to review and adopt the best practices from the lawyer regulation system in Colorado.

In December 2009, the Task Force filed a rule-change petition that reflects the results of its work. The petition proposed sweeping changes to the current Arizona system. The proposed changes are intended to achieve several objectives, including:

Better public involvement. Under the proposed system, members of the public will be involved much earlier in the decision-making process.
Attorney Regulation Committee. Currently, there is no official public involvement in a lawyer discipline case until the appellate phase before the Disciplinary Commission of the Arizona Supreme Court. The Disciplinary Commission currently consists of six lawyers and three non-lawyers, but the Commission does not weigh in on a case until after months of investigations and, often, a hearing on the merits of a case. Under the proposed changes, the Disciplinary Commission will be supplanted by a new body, known as the Attorney Regulation Committee ("ARC"), which also will consist of six lawyers and three non-lawyers. However, the new committee's involvement in a case will occur much earlier than the current Disciplinary Commission's involvement. The role of the ARC will be to decide whether there is probable cause to file a formal complaint against a lawyer; thus, the ARC will be involved at the start of a case instead of near the end. Depending on the ARC's work load, it can make probable cause decisions as a full panel of nine, or in smaller panels of three, but there must always be at least one public member serving on the smaller panels.
Communications with the ARC. The complainant in a discipline case often is a member of the public. Under the proposed new system, the complainant will have the right to submit a written statement directly to the ARC. (The respondent lawyer will have the same right.) Under the current system, bar counsel present the positions of both the complainant and the respondent to a probable cause officer. That practice will be replaced with an opportunity for direct, written communication.
Involvement in settlements. The State Bar will be required, under the new system, to advise a complainant in writing of any settlements reached with respondent lawyers. If the complainant wishes to comment on the settlement, he or she will be given an opportunity to do so at a hearing on the settlement.
Hearing Panels. The public will now also be involved in evidentiary hearings on lawyer discipline cases. Hearings will occur before a panel of three: the Presiding Disciplinary Judge (discussed below), a volunteer lawyer, and a member of the public.
Communications with Complainants. The proposed rules contemplate that the State Bar will engage in more thorough communications with complainants to explain the rationale for the Bar's decisions.
Appeal of Dismissals. Complainants will also be given an opportunity to appeal a dismissal by the Bar to the ARC. That option currently exists but not to a body that contains at least one member of the public.
Faster Final Results. The new process is intended to result in a substantially decreased elapsed time from the initial complaint to final outcome, without sacrificing the attorney's due process, as described below. Many cases are anticipated to be resolved through agreements that occur either prior to formal proceedings or in the early stages of formal proceedings. The formal process will be sped up substantially because decisions of the Presiding Disciplinary Judge and/or Hearing Panel final absent an appeal to the Supreme Court. Currently, any case that could result in discipline is required to go both to the Disciplinary Commission and the Court before it becomes final.
Preservation of Due Process for Lawyers and Appropriate Treatment of "Low Level" Violations. Arizona lawyers often complain of an imbalance in the current system that results in discipline for isolated and/or well-intentioned errors, while more serious misconduct is not prosecuted. Whether or not statistics support this impression, the impression nevertheless exists and has undermined many lawyers' trust in the integrity of the system. The proposed rules are also intended to address and correct this situation:
More than Just a Probable Cause Finding. Under the current system, a single probable cause panelist (who is a member of the State Bar Board of Governors) decides whether there is probable cause to conclude that an ethical violation has occurred. By rule, if there is probable cause, the case proceeds to a formal complaint. Nothing in the current rules directly addresses whether the degree of misconduct justifies a potential public sanction and/or the use of State Bar resources to pursue the case through formal proceedings. Under the new system, once the ARC decides there is probable cause, the ARC then proceeds to a second level of inquiry, which includes such matters as whether the evidence is sufficient to prove the misconduct at a hearing, whether the conduct warrants discipline, actual or potential injury, and prior discipline. The ARC's authority is not limited to authorizing the State Bar to file a complaint. It may also dismiss a case, order additional investigation, refer a matter to diversion, and order lower-level discipline.
Increased Frequency of Diversion. The rules do not require the State Bar to offer diversion more frequently to lawyers, but the intent of the rules (and the experience in Colorado) is clearly to encourage this practice. Cases of isolated misconduct or misconduct that does not show a callous disregard for a lawyer's responsibilities or where there was little risk of prejudice should be handled by a diversion contract that gives a lawyer a chance to learn from and correct errors without the public stigma of formal discipline.
Right to Refuse Informal Discipline. As with the current system, a respondent is not required to accept informal discipline or diversion but may decline and demand formal proceedings.
Communications of Charges and Opportunity to Respond. The new process will not affect the current system of affording respondent lawyers an opportunity to respond to allegations before the case proceeds to the ARC or to a resolution before going to ARC. The new process will, however, formalize contempt authority for the Presiding Disciplinary Judge for handling those lawyers who fail or refuse to cooperate with the State Bar's investigation.
Direct Appeal to the Supreme Court. The current Disciplinary Commission will no longer as an intermediary appellate body under the new system. The current discretionary review by the Supreme Court, however, will be replaced with a right of direct appeal.
Consistency and Availability of Interim Decisions. Under the current system, there are several hearing officers. Under the new system, there will be a Presiding Disciplinary Judge ("PDJ"). Depending on the volume of cases, the PDJ can appoint additional disciplinary judges. However, the establishment of a PDJ position is intended to keep the process moving and also to assure consistency among the treatment of cases.
Separation of the State Bar Board of Governors from State Bar Lawyer Regulation. Currently, the Probable Cause Panelist is a member of the State Bar Board of Governors, the body that controls the budget of the State Bar's Lawyer Regulation Division. Many Arizona attorneys have been concerned that the close relationship between the elected Board of Governors and the prosecutors directly or indirectly could influence decisions on particular cases. The new rules would address this concern by replacing the Probable Cause Panelist with the ARC, which will be under the administrative supervision of the Arizona Supreme Court, and also be establishment of the PDJ position, who will have adjudicatory authority over all formal cases and, therefore, can monitor (and if necessary correct) any pre-hearing conduct that appears to favor unfairly either the respondent or the complainant.

There are many other aspects of the proposed rule changes. Lawyers and members of the public have a chance to review the entire rule change petition and submit written comments by April 1, 2010. The Task Force will meet again in April to review the comments and determine whether any changes to the current proposal are appropriate

Legal Watch Series: Topic 4 - Litigation Holds - When Destruction is Prohibited

Introduction: This is the fourth article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

"Aside perhaps from perjury, no act serves to threaten the integrity of the judicial process more than the spoliation of evidence. Our adversarial process is designed to tolerate human failings - erring judges can be reversed, uncooperative counsel can be sheparded, and recalcitrant witnesses compelled to testify. But, when critical documents go missing, judges and litigants alike descend into a world of ad hocery and half measures and our civil justice system suffers." United Medical Supply Co. v. United States, 77 Fed. Cl. 257, 258-59 (Fed. Cl. 2007).

The key concept in understanding litigation holds is "reasonable anticipation." Organizations have the duty to preserve traditional and electronic documents when litigation or investigation is reasonably anticipated, which is often before the service of a lawsuit or a subpoena. An organization's duty to preserve such documents for litigation or investigation supersedes its data retention policy. Once the duty to preserve arises, the destruction of the information raises a presumption that disclosure of materials would be damaging.

Courts have significantly different ideas of when litigation should be reasonably anticipated thus triggering the litigation hold duty. For example:

Duty to preserve can arise based on oral threats. In re Napster, Inc. Litigation, 462 F. Supp. 2d 1060, 1068 (N.D. Cal. 2006)
Defendant should have reasonably anticipated the employee's discrimination claim when employee filed EEOC complaint, at the very latest. However, the court found that the defendant should have reasonably anticipated litigation five months before the filing of the EEOC action based on emails from several employees revealing that they knew that the plaintiff intended to sue. Zubulake v. UBS Warburg, 220 FRD 216-17 (SDNY 2003) (Zubulake IV)
Adversary parties exchanged correspondence over a dispute to see if they could resolve the problem amicably over a two year period. Duty to preserve did not arise until a lawsuit was filed two years later. The court held that "back and forth equivocal letters about a dispute" were not sufficient to raise the reasonable anticipation of litigation: "A demand letter alone may be sufficient to trigger an obligation to preserve evidence and support a subsequent motion for spoliation sanctions. However, such a letter must be more explicit and less equivocal than [the correspondence at issue]. Given the dynamic nature of electronically stored information, prudent counsel would be wise to ensure that a demand letter sent to a putative party also addresses any contemporaneous preservation obligations." Cache La Poudre Feeds, LLC v. Land of Lakes, Inc., 244 F.R.D. 614, 623 (D. Colo. 2007)

As noted in earlier ESI Alerts, every organization should adopt a formal, written preservation plan as part of its records management program. The program must include an adequate litigation hold provision. An organization must retain all relevant documents (but not multiple identical copies) in existence at the time the duty to preserve attaches and any relevant documents created thereafter. The duty to preserve extends to those employees likely to have relevant information, otherwise known as the "key players." The number of key players can be extensive. For example, in In re NTL, Inc. Securities Litigation, 244 F.R.D. 179 (S.D.N.Y. 2007), sanctions were imposed for destruction of evidence including emails of approximately 44 of the defendants' key players.

Given the potential sanctions for failure to preserve (discussed below), a conservative approach is warranted; the organization should be more inclusive than exclusive when preparing a list of sources to be examined and possibly preserved. It is also very important for the organization to document all steps it takes in connection with the litigation hold, i.e. "tracking" the litigation hold. If there is ever a question regarding the rationale of the company's actions, the ability to prove to the court what steps were taken is often the difference in a finding of good faith, thereby invoking the "safe harbor" provisions of Rule 37, Federal Rules of Civil Procedure (See ESI Alert # 3) and sanctions.

A litigation hold can take many forms, from evidentiary copies prepared by a forensic professional, to simply taking custody of a laptop or backup tapes. It is important to preserve the integrity of the contents of electronically stored information (ESI). This includes the formatting of a document, its metadata and, where applicable, its revision history. Preservation should focus on preserving media, e.g. hard drives, floppy disks, CDs, backup tapes and mobile devices rather than particular files, folders or other forms of data. Preserving media, as opposed to preserving just the ESI, preserves not only data that appears to be initially relevant, but also data that could become relevant. Preserving media also preserves other information such as metadata, deleted material that could later become important. All relevant backup media should be pulled out of service and stored in a safe place, preferably in the custody of someone who can later establish a chain of custody for authentication purposes.

All persons who have potentially relevant documents or information (key players) must be notified of the litigation hold. Notices must be sent as soon as possible after litigation or a subpoena is anticipated, and the date and time of the Notice must be noted. The Notice should include information regarding the general nature of the litigation or investigation and the scope of preservation (i.e. subjects and time frames of potential relevance to the litigation or investigation). The Notice must be explicit that potentially relevant ESI must not be destroyed. The Notice must note specific steps to ensure that ESI is preserved and the identity of person in charge of monitoring preservation activities (check lists are recommended). The Notice should include procedures for collecting information. The Notice should require a confirmation from involved employees that they have received it and will comply. (See, Stio and Quigley, Getting a Grip on the Litigation Hold, e-discovery, ABA Section on Litigation, 2007, p.20) Here is a sample litigation hold notice.

Not all relevant ESI will be on the organization's systems. Responsive ESI may be in the possession of third parties, such as vendors, consultants, former employees, outside directors, etc. If the organization has control over this information, these sources of potentially relevant ESI must be considered when distributing litigation hold notices.

Courts impose significant sanctions for failing to preserve evidence, i.e. spoliation. Such sanctions can range from a monetary award to the party seeking information that has been lost, to adverse jury instructions, to entering default against the offending party. Some examples of these situations follow:

Lack of litigation hold can constitute gross negligence and can justify monetary sanctions. Phoenix Four, Inc. v. Strategic Resources corp., 2006 WL 1409413 (SDNY 2006)
Defendant's failure to suspend its destruction of electronic documents at any time after receiving notification of litigation did not satisfy good faith requirement of Rule 37 (f) and was at least grossly negligent, if not reckless, justifying adverse inference and costs. Doe v. Norwalk Community College, 248 FRD 372 (D.Conn 2007)
Court grants adverse inference instruction and deeming certain facts established as sanctions for failure to establishing litigation hold, resulting in loss of emails. 3M Innovative Properties Co. v. Tomar Electronics, 2006 WL 2670038 (D. Minn. 2006)
Appropriate spoliation sanctions where government over a five year period repeatedly failed to maintain relevant records and repeatedly misstated steps being taken to prevent spoliation included prohibition of cross-examination of opposing expert and costs and fees. United Medical Supply Co. v. United States, 77 Fed. Cl. 257, 258-59 (Fed.Cl. 2007)
Party's failure to preserve relevant documents, including email, were inadequate and resulted in a $1 million sanction. In re Prudential Ins. Co. of Am. Sales Practices Litigation, 169 FRD 598, (D. NJ 1997)
Attorney's fees and costs awarded for destruction of computer hardware during discovery. Lauren Corp. v. Century Geophysical Corp., 953 P.2d 200 (Colo. App. 1998)
Attorney's fees and costs awarded to plaintiff after opposing party untruthfully claimed its computer system was unable to produce requested data. GTFM, Inc. v. Wal-Mart Stores, Inc., 2000 U.S. Dist. LEXIS 3804 (S.D.N.Y. 2000)
Destruction of word processing files by employee of defendant company warranted sanctions of ten percent of plaintiff company's total attorney fees and costs. Gates Rubber Co. v. Bando Chemical Industries, Ltd. 167 F.R.D. 90 (D.Colo.,1996)
Plaintiff produced an email in response to a discovery request, and subsequent inspection of the hard drive revealed that the produced email was altered from its original wording, so the court dismissed plaintiff's claim and awarded defendant its attorney's fees and costs. Munshani v. Signal Lake Venture Fund, 2001 Mass Super. LEXIS 496, 3-4 (Oct. 9, 2001)

Because of the potentially serious implications for the failure to properly administer the litigation hold, the organization should involve its counsel to evaluate the extent to which retention policies must be suspended because of impending litigation.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will cover the concept of accessibility of ESI.

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Resources Used for This Legal Watch

1. Arkfeld, Electronic Discovery and Evidence, Chapter 5, Law Partner Publishing (2003)

2. Grenig, Marean and Poteet, Electronic Discovery and Records Management Guide: Rules, Checklists and Forms, Chapter 7, Thomson West, 2009

3. Cohen and Lender, Electronic Discovery- Law and Practice, Chapter 4, Aspen Publishers (2009)

4. The Sedona Conference Commentary on Legal Holds: The Trigger & The Process

5. Zubulake v. UBS Warburg, 229 F.R.D. 422 (S.D.N.Y. 2004) (Zubulake V)

The Jury Is Out: Legal Community Continues to Argue the Benefits and Detriments of Legal Process Outsourcing

The outsourcing of legal work is quickly becoming more and more commonplace and it's easy to understand why. Companies that outsource can save hundreds of dollars, every hour, on legal tasks that otherwise would be performed by U.S.-based attorneys charging up to $400 an hour or more. It's a very attractive option and markets are starting to see more and more businesses that specialize in legal process outsourcing (LPO). However, it pays off to fully understand what LPO companies do, how they operate, and how they can save you money before deciding whether this is a viable route or another case of "getting what you pay for."

Consider, LPOs routinely charge between $30 and $60 per hour. Compared to what you're paying now, that probably sounds like a bargain. But know that many of these companies are based in other countries with cheap labor pools such as India and the Philippines. They seek to persuade American law firms and in-house attorneys to outsource some of the more labor-intensive and costly tasks associated with legal matters.

According to one blog, Legally Yours, which follows the emergence and progress of LPO, worldwide firms such as Clifford Chance, Allen & Overy, and Linklaters have recently turned to legal outsourcing to reduce costs. Moreover, a leader in international mining, Rio Tinto, recently decided to outsource a large amount of its legal work to an Indian LPO company. As such, it appears that the initial apprehension regarding LPO is waning. At the same time, the scope of work that law firms are willing to outsource continues to grow, as do their profits. For instance, Legal Outsource Advisors, based in Ohio and founded by a former U.S. trial lawyer, enumerates twenty-six categories of tasks that it can perform, from fairly routine tasks like deposition summaries, document review, and basic legal research, to more complex projects such as document management, electronic discovery, and contract drafting. In addition, Pangea3, another LPO outfit based in New York, advertises on its Web site that "Pangea3 helps companies and law firms improve their efficiency, minimize business and legal risks, stay ahead of the competition and reduce their legal costs by delivering world-class quality legal process outsourcing services using attorneys, engineers and technologists in India." Pangea3 also claims to have "a carefully structured business model that ensures that its clients receive the highest quality work, total peace of mind and dramatic cost savings."

Criticism of legal outsourcing remains, although by most accounts significant improvements have been made to alleviate the most common problems associated with outsourcing. Companies involved in LPO continue to seek the appropriate balance between quality and cost, with considerable success. Nevertheless, some still dispute that legal outsourcing requires a sacrifice in quality. David Perla, co-founder of Pangea3, revealed to Anthony Lin of New York Law Journal that clients outsourcing legal work have held what he calls "bake offs" to determine whether U.S.-based attorneys produced higher quality of work than their India-based counterparts. According to Perla, the Indians "soundly trounced the Americans."

Moreover, concerns over confidentiality and ethical issues remain a key factor for many firms choosing against legal outsourcing. The often-sensitive nature of the outsourced material mandates that LPO companies train employees and implement security systems to protect confidential and proprietary information. The LPO industry, however, maintains that those concerns are outdated, and asserts that appropriate protocols have now been implemented to avoid breaches of confidentiality and ethical requirements.

Despite these concerns, LPO continues to grow. According to About.com Guide to Legal Careers, LPO is predicted to generate revenues of $640 million by the end of 2010 and experts estimate that 79,000 U.S. legal jobs will be moved offshore by 2015. Nevertheless, the long-term impact on the American legal landscape remains unclear; in this already tight job market for students graduating from law school this year, outsourcing will likely have an adverse affect on the number of available jobs. Further, first and second-year associates, who often build their confidence and gain valuable experience by tackling the often labor-intensive, but legally robust tasks of analyzing boxes of documents, summarizing deposition transcripts, researching legal issues, and writing briefs, may no longer have those tasks on which to "cut their teeth." In an age where trials are almost approaching extinction as a means to resolve disputes, LPO companies could extinguish the few remaining sources of experience for young lawyers. Paralegals, long relied upon by firms for their document management skills and less-expensive rates, may also find the number of available opportunities is shrinking as more document and file management projects are sent overseas.

All things considered, LPO provides a cost-effective way to manage the increasing expense of legal representation. The impact, however, of such outsourcing on those who work as attorneys and paralegals is uncertain. It is possible that as law firms and clients continue to save money by outsourcing, ultimately jobs could be lost and the legal field as a whole may begin to constrict. Outsourcing, coupled with the ongoing economic recession, may in fact reshape the American legal landscape in a profound way. For now, however, the jury is still out.

Legal Watch Series: Topic 3 - Destruction is Not an Evil Term

Introduction: This is the third article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently organize to deal with electronic discovery. The articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

Common sense tells us that an organization should not be required to keep all of its records (paper or electronic) forever. Fewer records kept means less overall cost and greater efficiency in searching and retrieving records. However, cost and efficiency are not the only relevant considerations in deciding what to keep and for how long, and there are often tensions between the various considerations. This article will discuss some of the relevant legal and business considerations for keeping or destroying records.

According to ISO (International Organization for Standardization) 15489, a "record" is defined as information created, received and maintained as evidence by an organization or person in the transaction of business or in the pursuance of legal obligations, regardless of media. A record includes information holding operational, legal, fiscal, vital or historical value. (See Resource #1)

Information and records are valuable strategic assets, storing information representing a wealth of institutional knowledge. Any document retention program should reflect the businesses' judgment of the value of its information and records. See Pub. Citizen v. John Carlin, 184 F. 3d 900, 910-11 (D.C. Cir. 1999) (Finding it appropriate under federal statute to allow agencies to maintain record-keeping systems in the form most appropriate to the business or the agency, reflecting the administrative, legal, research and other values.)

Common sense should also tell us that there is no generic information and records management policy appropriate for every entity. The value of information will vary greatly from organization to organization, and even within an organization. The retention of records in various divisions of the business might be different. There is no one size fits all policy and procedure. To be effective, the retention procedure must accommodate the different needs of the affected group.

A reasonable records retention policy takes industry practices and business judgment into consideration. It should never be forgotten that an organization's information records primarily exist to permit the organization to do business. The organization's need for information should be a significant factor in structuring its retention program. While some documents contain information which is deemed irreplaceable and must be indefinitely retained (archived), information and records that do not have such continuing value to the organization can be destroyed when the organization, in its business judgment, determines it is no longer needed. (See Resource #2)

Courts recognize that records destruction is a necessary, every day event. Federal Rule of Civil Procedure Rule 37 (f) provides a "safe harbor" for businesses that implement and utilize good faith policies and procedures for destruction of documents. Good faith usually exists where the policy and procedure is conducted in the regular course of business and where the policy and procedure is based on rational considerations of cost and benefit, whether the plan was applied consistently and whether there is a provision for the suspension of the plan when necessary.

In deciding what records to retain, the business should keep in mind who might be seeking the production of documents and in what situations. The more common requests for production of documents are by the government as part of its regulatory function or via civil or criminal investigation, an adversary in the litigation context, a third party subpoena, or (less likely) a Freedom of Information Act (FOIA) request.

In developing its record retention practies, the business should conduct thorough research into laws, rules and regulations that set out document retention requirements. Different categories of documents will have different retention periods; but, the default retention period for public records is permanent. Such research is best done by a lawyer, who is familiar with the industry and the specific business. However, there are a number of "off-the-shelf software packages" that, when combined with regular updates, can identify relevant retention statutes and regulations. Once the legal requirements have been ascertained, it is important that they be applied consistently. Inconsistency in the application of the procedures may create the impression of ulterior motive and imply improper conduct. (See Resource #3)

It is very important that the organization maintain its records relating to the development of the records retention program. This documentation should include copies of the training material and resources, as well as any documents reflecting changes to the policy or implementation of its provisions. Without such evidence, it may be difficult to establish that the policy is anything more than an ad hoc reaction to a particular situation, in which case the protections afforded good faith policies would be lost.

Most businesses have routine legal record keeping requirements that exist as a matter of course and that are not dictated by unique situations, such as litigation. Illustrative examples of these types of requirements are listed below. Of course, the illustrations are by no means complete. (A Google search of the term "records retention" resulted in 5.8 million hits.) As noted earlier, companies need to do or have their lawyer do an exhaustive search of legal sources to determine what requirements apply to them. For purposes of this article, some of these example requirements include:

Accounting Needs/Audits/Taxation

Sections 802 and 1102 of the Sarbanes-Oxley Act of 2002 (criminal penalties for destroying or concealing documents)
The Securities and Exchange Commission has issued rules relating to the Retention of Records Relevant to Audits and Reviews, 17 CFR Part 21

State and Federal Regulatory Needs

HIPPA - Health Insurance Portability and Accountability Act of 1996
The investment industry is under a requirement to maintain for a specified period (3 or 6 years depending on the circumstances) all communications with certain investment customers.

State and Federal Statutory Needs

The USA Patriot Act contains numerous document retention requirements.
Every state has some form of document retention regime, driven in varying measure by the state's corporation, tax, employment, environmental and other laws and regulations.

Personnel Records

Instead of requiring the retention of records, The Federal Fair and Accurate Credit Transaction Act requires a business to destroy personal information of former employees and consumers before it is discarded.
Personnel records normally should not be stored on company computers because of privacy concerns.

International Companies

Companies that do business in foreign countries have even more unique needs, for example, The Charter of Fundamental Rights of the European Union.

The Opinion of the United States Supreme Court in the Andersen Consulting case, Arthur Andersen v. United States, 544 U.S. 696, 704, 708 (2005), makes it clear that document destruction in the normal course of business is acceptable. The Court noted that document retention policies, which are created in part to keep certain information from getting into the hands of others, including the Government, are common in business. The Court also noted that it is not wrongful for a manager to instruct his employees to comply with a valid document retention policy under ordinary circumstances. "A knowingly corrupt persuader cannot be someone who persuades others to shred documents under a document retention policy when he does not have in contemplation any particular official proceeding in which those documents might be material." 544 U.S. at 708.

Thus, if a document destruction policy and procedure was developed in good faith and not for the purpose of destroying evidence relevant to litigation or investigation, it will be upheld. If a business has reason to anticipate that a claim might be made by a third party or an investigation might be conducted, it is obligated to suspend its document retention procedures, at least to the extent that it impacts the claims, i.e. it needs to make sure that relevant documents are not destroyed. This is called a "litigation hold", a topic that will be explored in our next discussion.

Even in situations where an organization is required to put a "litigation hold" on documents related to a specific case or specific issues, it is allowed to continue to implement its good faith document retention policy, i.e. document destruction, with respect to documents outside the litigation hold.

In conclusion, document destruction is not evil. Destruction is an acceptable stage in the information life cycle. An organization may destroy information when there is no continuing value or need to retain it. When a business adheres to a rational document retention policy in good faith and destroys documents without knowledge of the reasonable possibility of a claim, there will be no sanctions for following the policy. The development of a document retention policy often requires the services of legal counsel. (See Resource #4)

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will explore the important topic of litigation holds. Stay tuned!

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Resources Used for This Legal Watch

Grenig, et. al, Electronic Discovery and Records Management Guide, §5: 2, p. 146, 2009 edition
Grenig, et. al, Electronic Discovery and Records Management Guide, §4: 1, p. 101, 2009 edition
Carlucci v. Piper Aircraft Corp., 102 F.R.D. 472, 485 (S.D. Fla. 1984)
Federal Rule of Civil Procedure 37 (f) - "safe harbor" provision

How Secure is Your Intellectual Property? Maintaining Your Ownership Rights

On a daily basis, IDEA members enlist talented employees and third-party contractors to contribute their experience and expertise to projects that enhance the district energy industry. These employees and contractors may be charged with innovating technology and implementing or improving valuable business practices. Often, by performing these tasks, these employees and contractors create or improve valuable intellectual property. This intellectual property - whether manifesting in a patent, copyright, trademark or trade secret - likely translates into economic value that contributes to an IDEA member's company or other business entity (Organization). Organizations are well-served to closely monitor the creation of intellectual property by employees and contractors within the Organization and take affirmative steps to best maintain ownership rights to efficiently preserve the economic value of their intellectual property.

Forms of Intellectual Property
Intellectual property that an employee or contractor may create for an Organization could manifest in different forms. For example, an employee or contractor may create intellectual property by developing copyrightable content, conceiving patentable inventions, expanding valuable trade secret information or creating source-identifying trademarks.

A patent offers protection for a new and useful "invention," such as processes or methods, machines, articles of manufacture, compositions of matter, or new or useful improvements of the same. To be eligible for a patent, the invention must fit into the above patentable subject matter, and must also be useful, novel and non-obvious in relation to existing inventions. A patent, which can only be issued in the United States by the U.S. Patent and Trademark Office, grants the inventor the right to exclude others from making, using, offering for sale or selling the invention. Patent-protected inventions are valuable corporate assets because they protect an Organization's core technology.

A copyright offers protection for various types of "works," including literary works, software programs, pictorial and graphic works, audio visual works, architectural works and works of compilation. In the United States, a copyright protects an "original work of authorship fixed in a tangible medium of expression." A copyright holder enjoys the exclusive right to control (among other rights) the copying, reproduction, distribution and publication of the work and the creation of derivative works. It's important to remember that a copyright protects only the exact expression in the work - not the general idea or concept of the work. Copyright-protected works are also valuable corporate assets because they may be used to protect an Organization's core technology, such as software applications, as well as an Organization's creative works, for instance, advertising and promotional materials.

A trademark is a word, name, symbol, sound or phrase used on goods or in association with services to indicate the source or origin of those goods or services. A registered trademark prevents others from using the same or confusingly similar marks for similar goods or services, allowing an Organization to control the quality and reputation associated with its products and services in the marketplace. Organizations are well-served to select distinctive trademarks to better identify their goods or services and also to file applications for federal registration of these marks.

Trade secrets are confidential information, techniques, practices or know-how that are proprietary to an Organization or of commercial value to it, because they are generally not known or available to the public. An Organization must take reasonable steps to maintain and protect the confidential nature of its trade secrets. Otherwise, they may fall into the public domain and lose their competitive value.

Update: Extension and Expansion of Rules for NOL Carrybacks

As we reported in our September tax client alert, under the American Recovery and Reinvestment Act (ARRA) enacted in February, many small businesses that had expenses exceeding their income for 2008 could choose to carry the resulting loss back for up to five years, instead of the usual two. Under the ARRA, this option was available for an eligible small business (ESB) that had no more than an average of $15 million in gross receipts over a three-year period ending with the tax year of the net operating loss (NOL). Pursuant to the Worker, Homeownership, and Business Assistance Act of 2009 (WHBAA) enacted last month, this carryback option is no longer limited to ESBs. Additionally, the WHBAA extended the carryback option to include NOLs that arise in tax years beginning in 2009. Thus, businesses averaging gross receipts in excess of $15 million can now take advantage of these carryback rules and will have an option of carrying back losses for any one tax year beginning before January 1, 2010 and ending after December 31, 2007.

As under the ARRA, the election to carryback NOLs can generally only be made for one tax year. Thus, for a calendar year taxpayer, the business can elect to carryback 2008 or 2009 losses, but not both. However, an ESB that made or makes an election under the rules of the ARRA may make the election for two tax years instead of one. An ESB that has losses in both 2008 and 2009 could potentially carryback the 2008 losses under the ARRA rules and the 2009 losses under the WHBAA rules.

The WHBAA does limit the amount of the NOL that can be carried back to the 5th tax year before the loss year to 50% of the business's taxable income for that year. This limitation is not applicable to a 2008 NOL of an ESB that makes an election under the ARRA. Additionally, the WHBAA includes a separate, similar set of NOL carryback rules for life insurance companies.

Businesses that have large losses in 2008 and/or 2009 should consult with their tax advisors regarding these carryback rules as they may be able to offset income earned in up to five prior tax years and be eligible for a refund.

Each case a business or individual may face is unique and may require legal advice. If these changes apply to you, or you have other tax related questions, please contact either Nancy C. Pohl or Richard C. Smith

About the Authors
Nancy C. Pohl is an Associate attorney practicing in the Estate Planning and Probate, Tax and Corporate Securities and Finance Departments. Her practice focuses on corporate and partnership tax planning, estate planning, tax-exempt organizations, general business planning and federal and state tax litigation. She also regularly advises clients on estate planning and probate matters. Contact Ms. Pohl at npohl@jsslaw.com or 602.262.5927.

Richard C. Smith is a Member of the Tax, Estate Planning & Probate Departments and represents clients in all aspects of tax, corporate and business planning. His practice has a particular emphasis in the employee benefits area including the design, implementation and other aspects of pension, profit sharing and other qualified plans. He also advises clients in estate planning matters, including estate plans, wills, trust and family partnership agreements. Contact Mr. Smith at rsmith@jsslaw.com or 602.262.5972.

Upcoming Changes Regarding Roth IRA Rollovers/Conversions

After 2009, you will be able to roll over amounts from qualified employer sponsored retirement plans, such as 401(k)s and profit sharing plans, and regular IRAs, into Roth IRAs, regardless of your adjusted gross income (AGI). Currently, individuals with more than $100,000 of adjusted gross income as specially modified are barred from making such rollovers.

What's so attractive about a Roth IRA? In summary:

Earnings within the account are tax-sheltered (as they are with a regular qualified employer plan or IRA).
Unlike a regular qualified employer plan or IRA, withdrawals from a Roth IRA are not taxed if some relatively liberal conditions are satisfied.
A Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) after he or she reaches age 70 1/2 as is generally the case with regular qualified employer plans or IRAs. (For 2009, there's a moratorium on RMDs.)
Beneficiaries of Roth IRAs also enjoy tax-sheltered earnings (as with a regular qualified employer plan or IRA) and tax-free withdrawals (unlike with a regular qualified employer plan or IRA). They do, however, have to commence regular withdrawals from a Roth IRA after the account owner dies.

The cost is that the rollover will be fully taxed, assuming the rollover is being made with pre-tax dollars (money that was deductible when contributed to an IRA, or money that was not taxed to an employee when contributed to the qualified employer sponsored retirement plan) and the earnings on those pre-tax dollars. For example, if you are in the 28% federal tax bracket and roll over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth IRA, you'll owe $28,000 of federal tax. So you'll be paying tax now for the future privilege of tax-free withdrawals, and freedom from the RMD rules.

Should you consider making the rollover to a Roth IRA? The answer may be "yes" if:

You can pay the tax hit on the rollover with non-retirement-plan funds. Keep in mind that if you use retirement plan funds to pay the tax on the rollover, you'll have less money building up tax-free within the account.
You anticipate paying taxes at a higher tax rate in the future than you are paying now. Many observers believe that tax rates for upper middle income and high income individuals will trend higher in future years.
You have a number of years to go before you might have to tap into the Roth IRA. This will give you a chance to recoup (via tax-deferred earnings and tax-deferred payouts) the tax hit you absorb on the rollover.
You intend to convert an existing IRA account in which you have assets with substantially reduced values that you expect to substantially increase in the future.
You are willing to pay a tax price now for the opportunity to pass on a source of tax-free income to your beneficiaries.

You also should know that Roth rollovers made in 2010 represent a novel tax deferral opportunity and a novel choice. If you make a rollover to a Roth IRA in 2010, the tax that you will owe as a result of the rollover will be payable half in 2011 and half in 2012, unless you elect to pay the entire tax bill in 2010.

Why would you choose to pay a tax bill in 2010 instead of deferring it to 2011 and 2012. Absent Congressional action, after 2010 the tax brackets above the 15% bracket will revert to the higher pre-2001 levels. That means the top four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current top four brackets of 35%, 33%, 28%, and 25%. The Administration has proposed to increase taxes only for those making $250,000, but it is difficult to predict who will be hit by higher rates. In addition, there are health reform proposals before Congress right now that would help finance healthcare reform with a surtax on higher-income individuals. So if you believe there's a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover in 2010.

Here are some ways individuals can prepare now for next year's rollover opportunity.

Non-high-income individuals who are able to make deductible IRA contributions this year should do so. They'll reduce their 2009 tax bill and, if they make the conversion to Roth IRA next year, they won't have to pay back the tax savings until 2011 and 2012.
Individuals who have never opened a traditional IRA because they weren't able to make deductible contributions (and who never rolled over pre-tax dollars to a regular IRA) should consider opening such an IRA this year and making the biggest allowable nondeductible contribution they can afford. If they convert the traditional IRA to a Roth IRA next year they will have to include in gross income only that part of the amount converted that is attributable to income earned after the IRA was opened, presumably a small amount. In 2010 and later years, they could continue to make nondeductible contributions to a traditional IRA and then roll the contributed amount over into a Roth IRA. However, note that if an individual previously made deductible IRA contributions, or rolled over qualified plan funds to an IRA, complex rules determine the taxable amount.
Some high-income individuals may plan to make large conversions in 2010 but to opt out of the deferral of tax until 2011 and 2012 because they fear they will be in a higher tax bracket in those years than in 2010. These individuals should avoid the standard year-end-planning wisdom of accelerating deductions and deferring income but should do the reverse in an effort to avoid being pushed into the highest brackets by a large IRA-to-Roth-IRA conversion in 2010. These individuals should be considering ways to defer deductions to 2010, and accelerate income from next year into 2009.

Each case a business or individual may face is unique and may require legal advice. If these changes apply to you, or you have other tax related questions, please contact Richard C. Smith.

Richard C. Smith is a Member of the Tax, Estate Planning & Probate Departments and represents clients in all aspects of tax, corporate and business planning. His practice has a particular emphasis in the employee benefits area including the design, implementation and other aspects of pension, profit sharing and other qualified plans. He also advises clients in estate planning matters, including estate plans, wills, trust and family partnership agreements. Contact Mr. Smith at rsmith@jsslaw.com or 602.262.5972.

Legal Watch Series: Topic 2 - Preparing for E-Discovery

Introduction: This is the second article in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of this series is to provide your business entity with some guidelines on how to most efficiently organize itself to deal with electronic discovery. These articles will continue to be emailed regularly over the next few months. If you are new to our distribution, or if you would like to view previous articles in this series relating to ESI, visit our website.

As noted in our first article of this series, we assume that you have already developed good faith policies and procedures for the preservation/retention/destruction of documents and Electronically Stored Information (ESI) in the regular course of business. This is largely a function of whether the policy is based on rational considerations of cost and benefit, whether the plan was applied consistently and whether there is a provision for the suspension of the plan when necessary. If you have done so, you will benefit from the "Safe Harbor" provisions of the Federal Rules of Civil Procedure, see Federal Rule 37(f) (no sanctions for destruction of ESI in good faith).

Having previously developed a document retention policy, and in anticipation of that day when your company almost assuredly will face a request for documents from the government, an adversary or a third-party, your ESI discovery team must focus on the following issues and plan for them.

What documents do we have?
Identify the scope, breadth, and depth of ESI that may be sought during discovery, taking potential claims and defenses into consideration.

What should be retained?
Reducing the amount of ESI that is retained will save cost of e-discovery. Limit the volume of information; save only important business records, documents required by law, regulatory records, and documents relevant to potential litigation. Personal records and communications should not be stored on company computers.

Where is it?
After determining the scope of ESI there must be an analysis of where the content resides in the organization's system. If organizations are not certain where ESI resides, the litigation hold will be too expansive resulting in extra disruption and costs. If you know where it is, you can find it more easily. This is often referred to as an "ESI Map."

How do we preserve it?
First, take control of the key players' media used in creating or keeping ESI, eg. phones, PDA's, laptops, etc. These "key players" are the ones who control the records. Second, suspend the document destruction procedures. This second step is also known as a litigation hold - the duty to preserve documents when litigation is reasonably anticipated, usually before the service of a lawsuit. We will be addressing litigation holds in a separate, upcoming article.

How do we find it and gather it?
Determine the best document collection strategy for your business. Are you going to gather the information in-house or use an outside vendor? Will you use software programs or perform manual searches? If you use software, will you use off-the-shelf programs or custom software?

After we find it, what form should we save it in?
The best way to preserve ESI is to first collect, then copy the media. There are numerous methods available to copy media, as referenced in the section above. Consult with your IT advisors to determine what software is best for your operation.

How do we review it?
Processing includes reviewing and analyzing the ESI. Tasks associated with processing include determination of duplicate information, relevance and privilege review and evaluation of ESI for more efficient use. This is often the most expensive part of electronic discovery. It can be helpful to convert ESI to a form that allows a more effective and efficient review. There are software programs that are designed to assist the process, but they are often very expensive.

How do we produce it?
Determine the best format for producing the ESI. Following are the four formats most commonly used:

Native format: the format in which the file was created
Quasi-native format: for example extracting part of a data base and loading it into another data base to produce a final format
Quasi-paper: converting ESI into TIFF or PDF format
Paper

The need for pre-planning between counsel and client.
In order to fulfill legal obligations to ensure that all sources of potentially relevant client information are identified and preserved, counsel must become fully familiar with the client's document retention policies, as well as the client's data retention architecture.

Ultimately counsel, whether in-house or outside, must respond to the courts regarding the adequacy of ESI discovery. If counsel is not properly informed, or if inventories and records policies have not been properly prepared, counsel will be limited in their effectiveness. This involves risk both for the lawyer and the business client. Thus, a business litigant cannot avoid legal counsel involvement. The critical variable is timing - when should legal counsel be brought in to the discussion? Hopefully, the answer is obvious - sooner rather than later.

______________________________________________

In the next Legal Watch Series: Preparing for E-Discovery newsletter, we will explore and discuss the parameters of accessibility. Accessibility is a key concept in the e-discovery landscape because ESI that in inaccessible due to burden and cost is presumed not to be discoverable. Stay tuned!

About the Author
For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo.

Michael R. Palumbo focuses his practice on commercial and real estate litigation. Particular areas of experience include banking (UCC Articles 3 & 4) litigation; title insurance, escrow agent and Deed of Trust litigation; and quiet title, adverse possession, homeowners' associations and real estate agent disputes. He has participated in more than 50 trials in the Superior Courts of Arizona and District Court of Arizona, in most of which he was lead counsel. Mr. Palumbo can be reached at 602.262.5931 or mpalumbo@jsslaw.com.

Resources Used for This Legal Watch

Stio and Quigley, Getting a Grip on the Litigation Hold, e-discovery, ABA Section on Litigation, 2007, p.20
Zublake v. UBS Warburg, 229 F.R.D. 422 (S.D.N.Y.)(Zublake V)

Employment Client Alert: Changes to the Genetic Information Nondiscrimination Act

Summary: This Client Alert will provide an overview of the Genetic Information Nondiscrimination Act of 2008 (GINA), including examples of what is considered genetic information, and what changes were recently put into effect. Employers will learn how these changes affect their business and what actions they should to take to ensure that they are complying with the recent changes. Employees will learn how their genetic information is protected by GINA.

The most notable new anti-discrimination law in twenty years, the Genetic Information Nondiscrimination Act of 2008 (GINA), went into effect for health insurers in May of this year, and for employers on November 21, 2009. GINA protects Americans from being treated unfairly by health insurers and employers because of differences in their DNA that may affect their health.

GINA prohibits employers and health insurers, with some exceptions, from asking employees to provide their family medical histories. Also, insurers cannot require such testing or use genetic information to deny coverage or set premiums or deductibles. These recent changes also prohibit any employment decisions being made based on an employee's genetics. Health plans will also be prohibited from rewarding their members for giving family medical histories when completing health risk questionnaires.

What is Genetic Information?
Genetic information does not include information about a person's current health status. However, genetic information does include:

A person's genetic tests;
Genetic tests of family members;
The manifestation of a disease or disorder in a family member;
Participation of a person or family member in research that includes genetic testing, counseling or education.

What Will GINA Do?
GINA was enacted to enable individuals to take advantage of genetic testing that may reduce the chance of contracting certain disorders, without suffering any adverse employment or insurance related consequences. Some of these developments include tests for breast or colon cancer mutations, classifications of genetic properties of existing tumors to help determine a course of treatment, tests for Huntington's disease, as well as carrier screenings for fragile X syndrome, spinal muscular atrophy, and cystic fibrosis. GINA's purpose is to ensure that anyone who requests a genetic test for cancer will not be charged a higher rate for health insurance due to the presence of a positive genetic predictor for cancer, nor will their employment status be adversely affected by this type of health decision. The law also enables people to take part in research studies without fear that their DNA information might be used against them in health insurance or the workplace.

The bill may have only a small effect on what we do today, but its impact may grow with advances in biotechnology. It is comprehensive, requiring amendments to portions of the Title VII of the Civil Rights Act, the Employee Retirement Income Security Act (ERISA), the Health Insurance Portability and Accountability Act (HIPAA), the Internal Revenue Code, the Public Health Service Act and Title XVIII of the Social Security Act (Medicare). It is intended to be a federal baseline for discrimination, and does not preempt stricter state laws that may already be in effect.

What Won't GINA Do?
Although fairly broad in reach, GINA does not:

Prohibit the use of genetic information to make payment determinations, such as reimbursement for additional testing covered for those participants at a higher risk of a disease or disorder;
Prohibit health care providers from recommending genetic tests to their patients;
Mandate coverage for particular tests or treatments;
Affect underwriting based on current health status;
Prohibit certain types of research by insurers or employers.

What Actions Should Employers Take?
Employers should immediately post the mandatory "EEO is the Law" poster supplement next to their current version of the "EEO Is the Law" poster. A copy of the poster supplement may be obtained at the EEOC website.

We also recommend employers update their policies, handbooks and training to reflect these new changes. We are available to assist you with these updates and can provide additional counsel on the effects these rules may have on your business practices.

About the Authors
Valerie J. Walker is an Associate attorney focusing her practice on litigation, and labor and employment. She has previously worked as a law clerk for both the Cook County Public Defender and the National Labor Relations Board in New York City. For more detailed information regarding these changes, please contact Valerie Walker at vwalker@jsslaw.com or 602.262.5844.

John J. Egbert is Chair of the firm's Labor & Employment Department. Mr. Egbert's practice focuses in the areas of discrimination, wrongful discharge, and wage and hour litigation. He represents both private and public clients in federal and state court litigation, as well as before the various administrative agencies. He frequently advises clients on employment policies and procedures and represents employers in labor arbitration. Mr. Egbert also practices extensively before the state and federal appellate courts. Contact John Egbert at jegbert@jsslaw.com or 602.262.5994.

Legal Watch Series: Topic 1 - The Need for and Preparation of Your E-Discovery Team

Introduction: This is the first in a series of short informational pieces relating to one of the hottest topics in litigation over the past five years - electronic discovery. The purpose of these articles is to provide your business entity with some guidelines on how to most efficiently deal with electronic discovery. The articles will be emailed regularly over the next few months.

The Need for an ESI-Discovery Team

Records management programs are fundamental tools in addressing the creation, retention and disposition of records, including Electronically Stored Information (ESI). This article assumes that your business has adopted such a program. If it has not done so, a program should be implemented immediately.

Computerized data have become commonplace in litigation. The sheer volume of such data, when compared with conventional paper documentation, can be staggering. Large corporate computer networks create backup data measured in terabytes, or 1,000,000 megabytes; each terabyte represents the equivalent of 500 billion typewritten pages of plain text. Digital or electronic information can be stored in any of the following: mainframe computers, network servers, personal computers, hand-held devices, automobiles, or household appliances; or it can be accessible via the Internet, from private networks, or from third parties. Any litigation discovery plan must address issues relating to such information, including its location, preservation, retrieval, inspection, form of production and use at trial.

There is a very strong chance that your business will be called on to respond to a request for production of ESI. Such production requests can emanate from governmental investigations, litigation in which the company is a party or subpoenas from third-party litigation. Before ESI can be produced, it must be found (hopefully cost effectively).

Preparation is the key to an effective and efficient response to ESI discovery and organization is the key to preparation. If your business takes the initiative to form an ESI discovery response team before you are faced with a subpoena or a request for production of documents, you will reap significant benefits in reduced costs and reduced disruptions to your operations.

Who Should Be Part of the Team? Manager and Coaches

Developing and implementing an effective ESI response program is a task that requires a team of professionals who fully understand the organization and the types of records created by the organization. ESI discovery involves aspects of administration, legal, technological (IT) and records retention procedures and policies. Thus, any complete ESI discovery team must include people from each of these areas in order to make sure there is an informed understanding of the intersection between corporate information systems and the prevailing legal requirements. Some businesses have found it preferable to use outside consultants to develop an ESI Response Program rather than to develop it in-house. Although there are e-discovery services designed to help companies with electronic record keeping, any such program should include consultation with outside litigation counsel.

Senior Management/Operations - This person will represent the business side of the discussion. For example, someone must address the budget considerations and cost analysis of whatever program is established. Another important consideration will be the impact on operations and productivity of the ESI discovery plan. There are many other business concerns that would be clear to this person, but not necessarily to others.

Representative of the General Counsel's Office or Outside Counsel - This person will bring knowledge of the legal considerations to the group. Things such as "litigation holds," spoliation of evidence, and privilege issues must be understood and addressed when formulating the plan. This cannot be properly done without a lawyer.

Representative of the Information Technology Department - It should be obvious that a person who is familiar with the types of ESI the organization creates and receives, knows where the ESI is stored and how to locate it, and understands the technological capabilities of the organization, needs to be part of the team that develops an ESI Response Program.

Representative of the Records Department - This person implements and monitors the policies and procedures, trains employees and assists in complying with document preservation and destruction. All of these functions are implicated in records discovery. This person's knowledge will be particularly important in adopting and carrying out "litigation holds", i.e. suspension of the destruction of records that are relevant to potential litigation.

Electronic Discovery Director - Some very large corporations, such as Pfizer, have established the position of Electronic Discovery Director; however, it is only in the biggest businesses that are continuously involved in litigation where such a person would be cost effective.

Perhaps the most important consideration in forming the team is the determination of the leader of the group - the "spokesperson." In all likelihood, the "spokesperson" will be called on to explain the company's ESI-Discovery policies and procedures in some forum - either in a litigation discovery deposition or in a court hearing - relating to the adequacy of the company's actions. Since it is never a good idea to have a company lawyer be a witness in any legal proceeding, the person should come from one of the other departments. Obviously, the person selected should possess the qualities of a good witness: well-spoken, composed, professional, presentable, etc.

______________________________________________

In the next Legal Watch: Preparing for E-Discovery newsletter, we will walk you through developing your ESI Response Program, highlighting what questions need to be asked.

Resource Used for This Legal Watch
- Manual for Complex Litigation § 11.446, Discover of Computerized Data, (4th Ed. 2004)

For more information or questions regarding E-Discovery and the Rules for Electronically Stored Information Management, contact Michael R. Palumbo at 602.262.5931 or mpalumbo@jsslaw.com.

Tax Incentives: How Public Institutions Can Reap Benefits

Managing greenhouse gas emissions is an inescapable reality in today's world. Whether mandated by law or voluntarily committed, many public institutions served by district energy systems are looking for ways to reduce their carbon footprint. For example, a number of IDEA's university members, have signed onto the American Colleges & University Presidents' Climate Commitment, requiring them to take immediate steps towards becoming carbon-neutral. On a regional level, hospitals, local governments and other non-profit entities are making similar commitments.

Unfortunately, the recent economic downturn has meant budget cuts and limited financing opportunities, making it harder to meet these capital-intensive, climate change goals. Tax incentives have been used since the 1960's to promote energy conservation and encourage investment in alternative energy resources. Recent legislation has expanded the application of these tax incentives to combined heat and power systems and a number of renewable energy technologies. For many businesses, these tax credits make investments in green projects possible. But what about tax-exempt organizations? Local governments, universities, hospitals and other non-profit organizations may not have the tax liabilities against which to claim these credits.

The ability to monetize these tax incentives through partnership with private developers may provide IDEA members an alternative means of funding investments in energy efficiency and renewable energy projects. This column will provide a brief overview of the tax incentives available and business structures that have been used to pass those incentives on to tax-exempt organizations.

Energy Investment Tax Credits
Investment tax credits are available for business investment in "energy property," which includes combined heat and power systems and equipment that uses solar energy to generate electricity, to heat or cool buildings, or provide heat for industrial processes. These credits also apply to geothermal, wind, fuel cell and other renewable technologies. Under the American Recovery and Reinvestment Act of 2009 (ARRA), Congress increased the credit to 30% of the equipment cost (up from 10%) for projects installed before January 1, 2017. The credit vests at a rate of 20% per year; if a taxpayer disposes of the property within 5 years of utilizing the credit, the IRS will recapture the unvested portion of the credit.

The ARRA also provides grants in lieu of the tax credit described above. Instead of the tax credit, businesses receive an upfront cash payment from the U.S. Treasury. However, any entity partnering with a local government or tax-exempt organization is not eligible to receive this grant. Additionally, as with the investment tax credit, the grant is subject to recapture if the property is sold within 5 years of the grant.

Another tax benefit applicable to certain renewable energy projects is the ability to accelerate depreciation. Combined heat and power facilities and some renewable technologies are deemed to be 5-year properties, meaning the applicable recovery period for depreciation purposes is only 5 years.

Energy Efficiency Tax Deductions
Building owners are also able to claim a federal tax deduction of $1.80 per square foot for reducing a commercial building's energy consumption by 50% or more. The deduction is available for modifications to heating, cooling, ventilation, and hot water systems, as well as other improvements to the building envelop and interior lighting. For publically-owned buildings, these tax deductions can be passed on to the person "primarily responsible for designing the property."

State Incentives
A number of individual states have also enacted tax incentives for both renewable energy projects and energy efficiency initiatives. The Database of State Incentives for Renewables and Efficiency contains a comprehensive list of the tax incentives available in each state. See http://www.dsireusa.org.

Monetizing Tax Credits
Over the years, private developers have utilized an assortment of business models to entice capital investment in renewable energy projects by monetizing tax incentives. For example, under the sale-leaseback model, the developer sells the project to investors, and the investors in turn lease the equipment back to the developer to operate and maintain the system. As the owner of the project, the investors are allocated the tax credits.

In a "partnership flip," the developer and investor form a partnership to own the project, and a majority of the income and loss of the project, along with the tax credits, are allocated to the investor. At some point in the future (generally at least 5 years after the property is placed in service so that there are no recapture issues for investment tax credits), the interests are "flipped," causing the partners' interests in the allocation of profits and losses of the partnership to shift.

While tax-exempt entities might take advantage of these models, there are some limitations. For instance, sale-lease back transactions generally cannot involve tax-exempt property. Likewise, state law may limit participation in partnership flips, and risks could include a revocation of tax-exempt status.

The Third-Party Alternative
Another structure gaining in popularity is the third-party ownership and management of renewable and efficiency projects through the use of power purchase agreements or performance contracts. This model may be easier to implement than those described above.

The Power Purchase Agreement (PPA) model has typically been used for solar panel systems, although it could apply to other renewable technologies. A developer installs the system on the customer's property, owns and operates the facilities, and is responsible for all maintenance. The developer then sells the energy produced by the system to the customer under the power purchase agreement, and the tax benefits are realized through a reduced price for the energy.

Similar to the PPA, the Performance Contract model is often used to implement energy efficiency projects. Here, the customer contracts with a private energy service company (referred to as an "ESCO") for retrofits and other energy-saving equipment. This might include adjusting HVAC systems, installing energy management control systems, or modifying boilers and chillers. The customer pays the ESCO to design, install and maintain the equipment. The ESCO is responsible for financing the project, and usually guarantees a level of energy savings over the term of the contract. Again, the tax credits available to the private ESCO could be reflected in the price paid for services under the performance contract.

These third-party contracting models have both benefits and potential drawbacks. On the plus side, there is no up-front cost to the customer. The developer owns the equipment, and is responsible for its operation and maintenance. However, there are still transactional and operational costs involved in these projects. There is also some risk in allowing a third party access to the premises and to on-site facilities.

No Silver Bullet
Business structures do exist to allow public institutions to realize the benefit of tax incentives though partnership with private entities. However, there is no silver bullet - any deal will have its benefits and potential downsides.

Third-party contracting arrangements are probably the easiest to implement. There are a number of issues to consider when negotiating these deals. What happens to the equipment at the end of the contract term? How do you manage the risk of providing the contractors access to your facilities? What, if any, coordination with the local utility is necessary? How do the savings compare to the cost of financing and constructing the project on your own? These, and other factors, may influence the ultimate viability of these third-party options.

2009 Year-End Tax Planning for the Medical Professional

As the end of the year approaches, healthcare providers should undertake tax planning designed to reduce their income tax liabilities for year 2009 and future years. Certain tax-saving tactics are suggested below. Most of these strategies are premised upon the time-honored principle of deferral of income into future years, and acceleration of deductions into the current year.

High income earners should, however, take into account that many observers expect the top federal tax rates will increase in future years, thus making the deferral of taxable income less appealing. Even long-term capital gains rates may jump. Accordingly, it may be beneficial to recognize profits or gains this year at the comparatively lesser rates.

A non-exhaustive checklist of tax-saving moves that may be available to healthcare professionals for year 2009 follows:

Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding then buy back the same securities at least 31 days later.
Postpone income until 2010 and accelerate deductions into 2009 to lower your 2009 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2009 that are phased out over varying levels of adjusted gross income ("AGI"). These include IRA and Roth IRS contributions, conversions of regular IRA's to Roth IRA's, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2009. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year, or if the tax rates for next year are increased.
If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into Roth IRAs if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2009. On a related note, effective January 1, 2010, even taxpayers with higher income are eligible for establishing of, or conversion to, Roth IRA's. This may be a significant tax planning opportunity for those who have IRAs or qualified plan assets with significantly depressed values.
If you own an interest in a limited partnership, a limited liability company, or an S corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year. Businesses should consider making expenditures that qualify for the up to $250,000 business property expensing option (under IRC §179) for assets bought and placed in service this year; the maximum expensing amount will drop to $25,000 for assets bought and placed in service next year (higher expensing amounts apply to certain specialized assets), and the expensing option is phased out if property placed in service during the year exceeds a ceiling which is $800,000 for 2009. Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus write-off generally will not be available next year (some exceptions apply, such as for businesses affected by Presidentially declared disasters).
You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
If you have not done so yet, set up a retirement plan.
Depending upon your particular situation, you may also want to consider triggering a debt-cancellation event in 2009, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.
If you have losses from a business that might otherwise be suspended under the passive loss rules, consider increasing the time that you devote to such business to satisfy the minimum hourly requirements for classification as an active business, thus freeing up such loss deductions.
You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $13,000 in 2009 to an unlimited number of individuals but you cannot carry over unused exclusions from one year to the next.
Consider using a credit card to prepay expenses that can generate deductions for this year.
If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to increase the deduction for those taxes in 2009.
Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding prior to year-end.
You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
Estimate the effect of any year-end planning moves on alternate minimum tax for 2009, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2009 miscellaneous itemized deductions subject to the 2%-of-AGI floor.

To view the article in its original format, please visit: healthcarewealthcare.com

U.S.-Mexico Cross Border M&A Transactions

Overview
As the economic relationship between the United States and Mexico has continued to grow and mature, our two countries' economies have become increasingly integrated. Nowhere is this more evident than in the number of companies operating on both sides of the border and in the increased economic cooperation between U.S. and Mexican companies and entrepreneurs. This cooperation may take many forms, from simply investing in previously existing companies, to forming new joint ventures, to merging with or acquiring a target company on the other side of the border. While many of the economic and legal fundamentals inherent in such transactions remain the same whether the transaction is domestic or international in nature, there are nonetheless unique issues and concerns that must be addressed in cross border transactions.

Transactions with Mexican Partners:

Setting Up the Deal
A successful business venture involving parties from both sides of the border requires serious forethought on both the legal and business fronts. The parties must consider the assets each brings to the table, the best way to optimize those assets and the best way to limit or mitigate any risk factors. In a merger or joint venture, the partners must decide such basics as who will have day-to-day management or decision-making authority to bind the company; which decisions require unanimous or super-majority consent due to their importance; under what circumstances a party may exit the joint venture, selling their interest to a third party; under what circumstances a party may be forced out of the business through a buy-out provision; what happens when the parties become deadlocked on decisions of vital importance to the business; what happens when the business requires additional capital and one party is not willing or able to make a new capital contribution, etc.

Going through the exercise of asking these questions and working out agreeable solutions will ultimately result in a document to memorialize the relationship of the parties. In the United States, this would typically take the form of a shareholders or similar agreement. However, it is important to note that the use of such documents in the Mexican context should be approached with caution, as certain typical provisions may run afoul of Mexican law and be unenforceable. For this reason, it is vital that the parties avoid the wholesale transfer of U.S. style documents to the Mexican arena. While U.S. parties may feel more comfortable with their standard documents and legal structure, these must be reviewed by attorneys licensed to practice Mexican law in order to ensure their enforceability. Many of the goals set out under U.S.-style documents must be structured differently in the Mexican system in order to ensure enforceability. For example, due to a general prohibition under Mexican law, shareholders are not permitted to agree beforehand how they will vote their shares. This would undermine the enforceability of many provisions under the typical U.S shareholders' agreement. However, in Mexico, if properly structured as part of the articles of incorporation and bylaws, many of the same goals and objectives may be achieved.

Acquisition of Shares or Assets
In the case of an acquisition, whether it be of shares or assets, the necessary due diligence will be much the same as with a domestic transaction. There will, however, be certain key differences to be aware of. First and foremost will be the legal and regulatory framework within which the business operates and within which the assets are held. Mexico has unique rules regarding the participation of foreign ownership in certain industries. Notable examples include: the petroleum and electricity generating industries, which are generally limited to government participation; land passenger transportation services and radio and television transmission (except cable television), which are reserved for Mexicans; the domestic airline industry, which allows a maximum 25% foreign participation; and the insurance industry, which allows a maximum 49% foreign participation, just to name a few. In addition, foreign participation may require government notification and, in certain circumstances, approval.

Other differences to be aware of include the threshold and approval process for certain transactions that are subject to anti-trust scrutiny, as well as restrictions involving foreign ownership of real property located in the coastal and border regions. In addition, many other practices vary. Notable examples include: i) regulatory oversight and environmental controls and restrictions, which vary significantly from their U.S. counterparts; ii) the role of the notary public in Mexico's civil law system. The Mexican notary public is a lawyer empowered by the state to vest the documents he or she "notarizes" with presumed authenticity, truth and enforceability. He is also charged with the correct calculation and payment of taxes generated by these transactions; iii) the role, duty and standards of professionals such lawyers, accountants and brokers, which are not regulated to the same extent as their U.S. counterparts; iv) the use of escrow arrangements for facilitating transaction closing and post-closing matters, which is not commonly used in Mexico; and iv) the extent and use of insurance, such as title insurance, which is not as extensively used in Mexico as in the United States.

Specific Business Considerations
There are a number of situations peculiar to doing business in Mexico. Following is a brief description of some of the most relevant:

Restrictions on Foreign Investment
Briefly discussed above, depending upon the type of business to be engaged in, there may be restrictions either limiting the amount of foreign capital permitted to participate in a certain venture, or barring foreign capital altogether.

Labor
The low wages prevalent in Mexico have been a motivating factor in much foreign direct investment. Nonetheless, investors should be aware that Mexico's labor law system is much more employee oriented than its U.S. counterpart. Employment in Mexico is not generally considered "at will." This means that employees may only be fired for those causes specifically enumerated in the federal labor law statute, or by payment of a statutorily calculated severance payment. In addition, there are a number of other differences from the U.S. system, including mandatory profit sharing, annual holiday and seniority bonuses, minimum vacation and rest days, and more. There are, however, mechanisms commonly used to manage the risk inherent in some of these items. For example, exposure to profit sharing is commonly mitigated through the use of "service companies" that provide the employees to the income-generating entity. These must be carefully structured, however, in order to be deemed sufficiently independent and therefore legitimate. Similarly, "friendly" unions are often employed to provide a buffer against assaults by more aggressive unions.

Form of Entity
Mexican law provides for a number of types of entities, some of which match up better than others with particular U.S. investors' needs. The most common type of Mexican business entity is the sociedad anónima de capital variable or S.A. de C.V. This is most similar to the U.S. corporate form. Another type of entity often preferred by U.S. investors is the sociedad de responsabilidad limitada de capital variable or S. de R.L. de C.V., which is most comparable to a U.S. limited liability company, or LLC and is given "flow through" tax treatment for U.S. income tax purposes. In addition, Mexican law provides for a number of other types of entities, most of which are used only rarely.

Taxes
The most important taxes in Mexico include the federal income tax (impuesto sobre la renta), the value added tax (impuesto al valor agregado), the single rate business tax (impuesto empresarial a tasa única), and state taxes including the real estate tax (predial) and the real property transfer tax (impuesto sobre adquisición de bienes inmuebles). While the overall tax burden is comparable to that generally prevailing in the United States, U.S. investors doing business in Mexico will require expert tax advice from the outset in order to choose the most appropriate type of Mexican business entity for their particular U.S. tax situation, and make adequate use of the provisions of the U.S.-Mexico tax treaty in order to avoid being subjected to "double taxation."

Conclusion
Cross border mergers and acquisitions transactions between the United States and Mexico now occur on a regular basis. Given the differences that exist between the legal systems and business customs between the two countries it is essential that U.S. parties to such transactions avoid the temptation to transfer wholesale the documents and structures they may have become used to in the domestic arena. It is highly advisable to rely on counsel licensed to practice in Mexico to advise on the proper Mexican documents and structures necessary to achieve the parties' objectives.

Mr. Herrera is a member (partner) with the law firm of Jennings, Strouss & Salmon where he practices corporate law with an emphasis on Mexico-related mergers, acquisitions, joint ventures and resort development. Mr. Herrera is licensed in both Mexico and the U.S.

2009 Year End Tax Planning Strategies

As the end of the year approaches, it is a good time to think of methods that can help lower your tax bill this year and possibly next. Factors that compound the challenge include the stock market's swoon (and partial recovery), the difficult economic climate we are in right now, and the strong possibility that there will be tax changes in the works over the next few years.

The indisputably good news we are certain of is that Congress has once again acted to "patch" the alternative minimum tax ("AMT") problem for 2009; has provided other AMT relief, has reinstated and/or expanded a number of tax breaks (such as the tax deduction for state sales and excise taxes paid on the purchase of new cars, including light trucks, SUV's, motorcycles and motor homes; an enhanced tax credit for higher education expenses; and a 65% subsidy for COBRA premiums for up to nine months. For 2009, businesses continue to enjoy tax breaks such as a beefed-up expensing option under Code Sec. 179; a 50% bonus first-year depreciation writeoff for most new machinery, equipment and software placed into service this year; deferral on debt discharge income from reacquisitions of debt; reduced capital gains for holders of qualified small business stock; and shortened S corporation built-in gains holding period. Certain favorable employee benefit changes were also enacted in the current year legislation known as the American Recovery and Reinvestment Act of 2009 ("ARRA").

We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:

Increase the amount you set aside for next year in your employer's health flexible spending account ("FSA") if you set aside too little for this year. Do not forget you can set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.
If you become eligible to make health savings account ("HSA") contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2009.
Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
Postpone income until 2010 and accelerate deductions into 2009 to lower your 2009 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2009 that are phased out over varying levels of adjusted gross income ("AGI"). These include IRA and Roth IRS contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2009. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year, or if the tax rates for next year are increased.
Many observers expect that the top tax rates for high income taxpayers will increase in 2010 and beyond. You may wish to consider accelerating income (particularly long term capital gains that have been reported on the installment sale method) into 2009 in order to take advantage of the current rates.
If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into Roth IRA's if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2009. On a related note, effective January 1, 2010, even taxpayers with higher income are eligible for establishing of, or conversion to, Roth IRAs.
It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2010.
If you own an interest in a partnership or S corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year.
Consider using a credit card to prepay expenses that can generate deductions for this year.
If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2009.
Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding prior to year-end.
You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
Estimate the effect of any year-end planning moves on the AMT for 2009, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
If you are thinking of making energy saving improvements to your home, such as putting in extra insulation or installing energy saving windows, a credit of up to $500 may be available for such improvements if made this year.
Substantial tax credits are available for installing energy generating equipment (such as solar electric panels or solar hot water heaters) to your home. The credit will be larger this year than last for expenses over $6,667.
If you are thinking of buying a hybrid vehicle eligible for a tax credit, check to see if it is eligible for the credit, and, if so, purchase it before year-end.
You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
Businesses should consider making expenditures that qualify for the up to $250,000 business property expensing option (under IRC §179) for assets bought and placed in service this year; the maximum expensing amount will drop to $25,000 for assets bought and placed in service next year (higher expensing amounts apply to certain specialized assets), and the expensing option is phased out if property placed in service during the year exceeds a ceiling which is $800,000 for 2009. Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus writeoff generally will not be available next year (some exceptions apply, such as for businesses affected by Presidentially declared disasters).
You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
If you are self-employed and have not done so yet, set up a self-employed retirement plan.
You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $13,000 in 2009 to an unlimited number of individuals but you cannot carry over unused exclusions from one year to the next.
If you are thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
If you are age 70½ or older, own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings.
If you are receiving Social Security benefits, there are a number of steps you can take to reduce or eliminate tax on your benefits.
Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2009 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
Depending on your particular situation, you may also want to consider triggering a debt-cancellation event in 2009, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.
If you have losses from businesses that might otherwise be suspended under the passive loss rules, consider increasing the time that you devote to such business to satisfy the minimum hourly requirements for classification as an active business, thus freeing up such loss deductions.
Consider taking advantage (or assisting a younger generation family member in taking advantage) of the first time homeowners tax credit, in the amount of 10% of purchase price of the residence, not to exceed $8,000 if purchased prior to December 1, 2009.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

2009 Year-End Tax Planning: Tax-Saving Strategies for the Real Estate Professional

As the end of the year approaches, real estate professionals should undertake tax planning designed to reduce their income tax liabilities for year 2009 and future years. Below is a non-exhaustive checklist of tax-saving moves that may be available. Most of the strategies are premised upon the time-honored principles of deferral of income into future years and acceleration of deductions into the current year.

High-income earners, however, should take into account that many observers expect the top federal tax rates will increase in future years, thus making the deferral of taxable income less appealing. Even long-term capital gains rates may jump up. Accordingly, it may be beneficial to recognize profits or gains this year at the comparatively lesser rates.

Maximize deductions. Consider extending your subscriptions to professional journals, paying professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2009 miscellaneous itemized deductions subject to the 2%-of-AGI floor. Consider using a credit card to prepay expenses that can generate deductions for this year.

You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year. You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
Postpone income until 2010 and accelerate deductions into 2009 to lower your 2009 tax bill. This strategy may enable you to claim larger deductions, credits and other tax breaks for 2009 that are phased out over varying levels of adjusted gross income ("AGI"). These include IRA and Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher-education tax credits, the above-the-line deduction for higher-education expenses and deductions for student loan interest.

Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2009. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year, or if the tax rates for next year are increased. This strategy may backfire, however, as previously discussed.
Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. Meet with a tax advisor to discuss year-end trades you should consider making.
Plan for your future. If you are self-employed and have not done so yet, set up a self-employed retirement plan.
Consider converting a traditional IRA to a Roth IRA. If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into Roth IRAs, if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2009. On a related note, effective January 1, 2010, even taxpayers with higher income are eligible for establishment of, or conversion to, Roth IRAs.
Evaluate increasing your tax withholdings. If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2009. Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding prior to year-end.
Estimate the effect of any year-end planning moves on the Alternative Minimum Tax (AMT) for 2009. Keep in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
Think green. If you are thinking of making energy saving improvements to your home, such as putting in extra insulation or installing energy saving windows, a credit of up to $500 may be available for such improvements if made this year. In addition, substantial tax credits are available for installing energy-generating equipment (such as solar electric panels or solar hot water heaters) to your home. The credit will be larger this year than last for expenses over $6,667. If you are thinking of buying a hybrid vehicle eligible for a tax credit, check to see if it is eligible for the credit, and, if so, purchase it before year-end.
Manage business losses. If you have losses from businesses that might otherwise be suspended under the passive loss rules, consider increasing the time that you devote to such business to satisfy the minimum hourly requirements for classification as an active business, thus freeing up such loss deductions. If you own an interest in a partnership, a limited liability company or an S corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year.
Businesses should consider making expenditures that qualify for the up to $250,000 business property expensing option (under IRC §179) for assets bought and placed in service this year. The maximum expensing amount will drop to $25,000 for assets bought and placed in service next year (higher expensing amounts apply to certain specialized assets), and the expensing option is phased out if property placed in service during the year exceeds a ceiling which is $800,000 for 2009. Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus writeoff generally will not be available next year (some exceptions apply, such as for businesses affected by Presidentially declared disasters).
Give wisely. You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $13,000 in 2009 to an unlimited number of individuals, but you cannot carry over unused exclusions from one year to the next. If you are thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
First-time homebuyer tax credit. Consider taking advantage (or assisting a younger generation family member in taking advantage) of the tax credit, in the amount of 10% of purchase price of the residence, not to exceed $8,000 if purchased prior to December 1, 2009.
Take advantage of health flexible spending accounts (FSA) or health savings accounts (HSA) if you have access to them. Increase the amount you set aside for next year in an employer's FSA if you set aside too little for this year. Do not forget you can set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids. If you become eligible to make HSA contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2009.

Substantial tax savings may result by implication of the identified strategies to the extent applicable to particular circumstances of the real estate professional. Consultation with tax advisors is, of course, an imperative aspect of the planning process.

Bankruptcy As The New Beginning

The economic downturn is taking its toll on businesses of every size. The very thought of bankruptcy is viewed by business owners and management as somewhat of a defeat. There is bound to be a national restructuring, where previously viable industries and business models will vanish and be replaced by new ideas and new structures. That is where bankruptcy enters the picture. It offers the opportunity for resurgence. Businesses can use bankruptcy as a means to an end; a business tool to capitalize on a new beginning.

Overview
Filing a bankruptcy proceeding often invokes a fear of the unknown. Having a working knowledge of bankruptcy concepts is key to preserving remnants of an old business or providing a fresh start for a new one. Bankruptcy can be a way a business which is not necessarily in financial distress can purchase assets, effectuate a merger or obtain financing if it is available. In the case of small businesses, owners may be tied to the obligations of the business through personal guarantees or the use of personal credit. Having a comprehensive bankruptcy plan is the essence of emerging with personal finances in tact.

There are essentially two types of bankruptcies available for a business: Chapter 7 and Chapter 11. Chapter 7 is a straight liquidation. A trustee is immediately appointed randomly from a panel of individuals who have met the Bankruptcy Code qualifications to serve in that capacity. The trustee takes control of the debtor's assets, sells them and distributes the proceeds to creditors. The trustee can operate the debtor's business during the liquidation process. Trustees have full access to the debtor's books and records. The benefit to a Chapter 7 is that there is an immediate finality.

Chapter 11 is typically a reorganization case. As in a Chapter 7, all assets become property of the "Estate," but in a Chapter 11, there is no trustee and the debtor remains in possession of the assets. In fact, the debtor is referred to as the "debtor-in-possession" or "DIP." Businesses typically continue to operate in a Chapter 11 with the goal of restructure debt or otherwise re-order their financial or corporate structure. Although generally referred to as a reorganization, a DIP can liquidate its assets in a Chapter 11 proceeding and may want to do so believing that the DIP can achieve a higher value than could a Chapter 7 trustee. This process may ultimately benefit an owner who also has personal obligations for the business debt.

Bankruptcy as an Ally-Why Be a Debtor
The most common use of the Chapter 11 bankruptcy process is one designed to restructure the company's balance sheet. A company that wants to extend or refinance onerous debt, eliminate burdensome contracts or leases, and/or bring in new capital can generally accomplish these goals by a Chapter 11 filing which provides these opportunities and a temporary safe haven.

But, Chapter 11 is not just for severely financially distressed entities. There are a myriad of other business reasons for filing a bankruptcy. Bankruptcy may be a good alternative for a business that owns some troubled properties and other healthy ones. Structuring a "roll up" and then using the bankruptcy process to propose a long-term solution can provide the necessary and ultimate protection for the distressed properties. Other common business transactions such as sales, mergers and acquisitions may be accomplished in a more beneficial fashion for all parties under the protective umbrella of Chapter 11.

For example, with Bankruptcy Court approval, the Chapter 11 debtor can sell its assets during the course of the bankruptcy or through a plan of reorganization. The debtor only has to show that the sale is an exercise of its best business judgment and will benefit creditors. More importantly, the sale can occur "free and clear of liens and other interests." The liens attach to the proceeds, which the debtor disburses appropriately. That may permit a purchaser to acquire the assets without having to delve into disputes with creditors and with little or no risk of successor liability. Plus, a final sale order from the Bankruptcy Court is virtually impossible to overturn. All bankruptcy sales are subject to higher and better bids. However, the initial bidder which is outbid may be able to obtain reimbursement for amounts spent in due diligence, a so-called a "break-up fee."

Similarly, investments of capital, post-bankruptcy extensions of credit, and mergers can be accomplished free of many of the risks attendant with these transactions outside of bankruptcy. Because the bankruptcy process involves extensive noticing procedures and disclosure, some federal and state restrictions applicable outside of bankruptcy may not be imposed in bankruptcy.

Many lenders dealing with financially troubled companies insist on a bankruptcy filing before they will refinance. The bankruptcy gives the lender the opportunity to solidify its lien position or possibly even improve it. A lender is not obligated to continue funding a loan post-petition and thus, a debtor may want to obtain financing. This financing may be on an unsecured or secured basis but it requires Bankruptcy Court approval.

Bankruptcy Realities
Cases change. Parties change. But, there seems to be a certain set of realities which exists in every bankruptcy case. Bankruptcy is fluid. Unlike usual commercial dealings or litigation in which the facts are established, a bankruptcy proceeding is constantly changing. One day the debtor may be seeking to reorganize and the next trying to liquidate a number of its assets.

The Bankruptcy Court is a court with broad jurisdiction. The Court can and will exercise jurisdiction over just about any entity and any matter that relates to the debtor in any fashion.

The Bankruptcy Court is a court of equity. That matters to a business person because it means the results are unpredictable. The Bankruptcy Code is designed to strike a balance between debtor and creditor interests. Nevertheless, as a court of equity, the Bankruptcy Court can wield enormous power in fashioning relief as it sees fit. And, every judge has his or her own unique theory for dealing with the numerous debtor/creditor issues that arise. The caveat is to keep expectations within reason and be prepared to change position or strategy on a moment's notice.

Bankruptcy events (e.g., sales and motions) are always an emergency. Not every issue that arises in a bankruptcy proceeding is presented as an emergency, but almost. In a typical Chapter 11, while the debtor may have had weeks to prepare an issue, it will file a motion to be heard on an expedited basis and creditors may be given literally hours to respond.

Debtors will almost always be given one bite of the apple. Most judges will follow the unwritten rule that debtors should have at least one opportunity to restructure. But, a debtor that abuses the system will be in trouble. It behooves a debtor to get it right the first time; it behooves a creditor to be patient. Cash is king. From either side of the aisle, cash wins at the end of the day. From a debtor's perspective, available cash is critical to get through the administrative expenses associated with the Chapter 11, and to weather the period of time when cash may not be available from a pre- or post-petition lending source. From a creditor' s perspective, a quick resolution of its claim is usually advisable inasmuch as cash is available early on in the case and everyone is optimistic that the debtor will survive. That may not be the situation down the road.

What Bankruptcy Cannot Do

Save money initially. Chapter 11 is an expensive process in terms of professional fees, disbursements to the United States Trustee's Office, and uncompensated time for management to spend on bankruptcy matters.
Allow the debtor to hide out. Chapter 11 is often referred to as a fish bowl. The financial reporting requirements are extensive and creditors are given carte blanche ability to explore the debtor's books and records.
Restructure a company that has no business. Bankruptcy cannot substitute for the lack of viability. There needs to be a core business to reorganize.
Force creditors or customers to continue doing business with the company. Trade vendors, which supply on an open account, can require COD payments and are not required to extend credit terms. Customers without a contractual obligation to purchase from the debtor can simply quit the relationship.

What Bankruptcy Can Do

Provide at least a short respite from paying creditors. The automatic stay brings all collection efforts and lawsuits to an immediate halt.
Provide an opportunity to alter debt repayment terms.
End troublesome contracts or leases. The debtor has a relatively unfettered ability to reject contracts or leases which it no longer believes are in its best interest.
Allow a business owner to work with creditors for an overall solution and to preserve personal finances.

No one can predict when the economy will improve or how different businesses will be impacted during the recovery. Phoenix has been through multiple cycles and it always seems to weather the storm. Clearly, bankruptcy can be a useful tool from the perspective of an owner, investor or purchaser. Bankruptcy no longer represents financial disaster--the once-feared "B" word really stands for a positive part of business.

The Right Path? Understanding Technology Consortia and Their Importance to Your Business

Consider the following scenario: Late one afternoon you receive a frantic call from one of your company's engineers. He or she wants to join a new technology consortium to allow your company to align its R&D efforts with what appears to be an emerging industry standard. The problem is the engineer needs your approval "right away" to allow the company to become a member of the consortium because it's having a critical technology meeting tomorrow.

The engineer e-mails you a copy of the consortium's membership agreement, which looks fairly straightforward, so you authorize your company's participation as a new member. Unknowingly, you may have just compromised some of your company's most lucrative proprietary technology.

Defining Consortia
Technology consortia are generally defined as collaborative efforts among companies and other key players (such as research institutions) in a particular industry that collectively try to address and solve key technology or research challenges.

Some technology consortia, for example, are formed to create "standards" that facilitate greater compatibility among the various technologies in that space, so that the industry can collectively develop increasingly innovative products. Other consortia may be formed to address research roadblocks, which are challenging an entire industry sector. In many of these situations, the consortium members-who are often fierce competitors-are voluntarily coming together to collaboratively solve significant obstacles that are holding back the next generation of research and development. Many sectors of the technology industry have seen a rapid growth in the number of technology consortia, including the hardware, software, semiconductor, wireless, and life sciences industries.

How a particular consortium functions and the specifics of its membership can have a profound effect on your company's business and your intellectual property rights. So, before you join any consortium, you should always take a closer look at the business and legal ramifications of your participation.

Benefits of Participation
Though technology consortia are often promoted by major technology companies, membership can benefit small to midsize companies and even research institutions because such participation can give you a "voice" in the R&D that might impact your industry for years to come. However, every company needs to evaluate the specific pros and cons of participating-or not participating-in any particular consortium.

Some potential benefits of participating in a consortium include increased market acceptance of your technology, the ability to help create new technologies that would not exist absent broad industry collaboration, and the ability to spread substantial research and development costs across multiple consortium members.

There are, however, potential pitfalls to joining a particular consortium-or the wrong consortium-which could prove to be detrimental to your business. Generally, these pitfalls fall into two categories: business and legal risks.

Business Risks
If your company joins a consortium that promotes a "losing" technology or standard, there is a possibility that your company's market share will decline, perhaps precipitously. Trying to play "catch up" with your own R&D (if catching up is even possible) could be prohibitively expensive. Eventually, your existing technology or products could approach obsolescence as competing technologies or standards evolve in a different technological direction.

To avoid the negative implications of not joining the "right" consortium, it is critical to evaluate competing consortia and then analyze which collaborative initiative has the potential of winning the broadest industry acceptance. It's also imperative that you make sure that a particular consortium's purpose aligns with your company's overall business plans and direction.

Moreover, it is important to examine the organizational structure of each consortium. These factors could determine the extent and nature of your company's participation in the consortium's governance and the obligations imposed on you as a member.

Legal Risks
One of the most significant legal risks posed by joining a consortium is your company could inadvertently relinquish some of its most crucial intellectual-property rights. Membership agreements increasingly require each consortium member to comply with all of the consortium's "policies and procedures." This commitment, when fully evaluated, could mean your company is obligated to: disclose confidential patents and other intellectual property to the other members of the consortium (at a minimum); license certain company patents and other intellectual property, sometimes royalty-free, to other consortium members; and share, or even transfer, ownership of your company's technology if you contributed it to the collaborative efforts of the consortium. Thus, it is essential for a company to carefully review all consortium agreements and policies to fully evaluate how membership might impact your company's valuable intellectual property rights.

Maneuver Carefully
Technology consortia are already an essential part of R&D in many companies. Companies that are often competitors increasingly are turning to consortia to collaboratively address technology and research challenges impacting that industry sector. While consortia membership could catapult your company toward greater industry- wide success, the decision to join a consortium is fraught with complexity and should not be undertaken lightly. Evaluation of each consortium should be part of your larger business plan. As with every other piece of your company's business roadmap, maneuver the path with caution and make sure you fully understanding every avenue you pursue.

We've Got Trouble: Financial Trouble in Construction City

The national business media has turned its attention to what is characterized as the "second wave" of delinquencies occurring in the commercial sector - a term meant to include retail, office, industrial and other commercial projects. The condition is so severe that the analysts have characterized failing commercial mortgages as capable of "wiping out" what is left of the financial sector. That is a very serious prediction.

They note that more than $2 trillion in commercial mortgages will mature before the end of 2013, and the market forces that battered the housing market will do the same to commercial properties. Furthermore, it's noted that a substantial number of commercial loans are in default. The riskiest component of the equation is construction loans.

According to some commentators, construction loans are held disproportionately by smaller banks and most vulnerable to failure. With proformas that justified the loans evaporating (no real tenants), the lender is faced with adding to its inventories of homes, empty shells of completed commercial buildings and skeletons of buildings under construction. Some commentators state that the downward spiral will continue till it comes full circle to when the federal government stepped in with TARP and other rescue programs, to counteract the housing crisis. These commentaries are braced with huge numbers to support the scenario, but like all the figures floating out there - they are too large to put in perspective, let alone comprehend.

The question this poses is obvious: What do these predictions mean for Phoenix? At this point, a good bet is that as bad as the commercial market is in Phoenix, it's unlikely that it will drag financial institutions into collapse. There's no doubt that there are too many vacant houses, too few jobs and flat personal income, with an inevitable effect on commercial properties - particularly retail and office. Vacant homes and stressed consumers simply mean no business - and no business means no occupancy - and the dominoes all fall, with the financial institutions left as the last ones to topple.

But Phoenix is a large market, with pockets of some - if not strong - activity. It's also resilient and a target for cash investors waiting on the sidelines. In fact, there appears to be enough cash that, if freed, could salvage enough of the market to keep it alive - perhaps on resuscitation, but not dead. There's evidence of this already moving into the Valley.

There's no doubt that lenders are beginning to realistically assess their inventory of loans - those that are salvageable and those are not. Many lenders are concurrently following two tracks, with the hope that the negotiations will succeed:

working out negotiations
aggressively pursuing foreclosure

Another phenomenon that may account for some measure of optimism is that the risk appears to be distributed among a large number of banks, both in and out-of-state. The failure of one project here does not signify a collapse of an institution.

In short, there are those who predict a doomsday brought on by the collapse of commercial loans dragging the lenders down with it, and include some impressive numbers to support their viewpoint. However, for those executives that may not like what they see - it should not send them ducking under the desk. An optimist at heart would see there is still water in the glass - regardless of whether it is half full or empty - and share some measure of confidence that we will still be around when the commercial market turns.

Mortgages Ltd.: Bankruptcy's Perfect Storm

"Perfect Storm"n. 1. a critical or disastrous situation created by a powerful concurrence of factor (Merriam-Webster Dictionary) 2. the simultaneous occurrence of weather events which, taken individually, would be far less powerful than the storm resulting of their chance combination (Wikipedia).

In late 2007 and early 2008, the country was suffering from a credit crisis and a severe downturn in the real estate market. As a result, Phoenix lender Mortgages Ltd. ("ML") might not have made the front page amidst the myriad of foreclosures, bank closings, and bankruptcies. ML had been in the "hard money" lending business for over 45 years and had typically provided its investors with high rates of return, even in economic down times. The company had weathered many Phoenix real estate declines. But, this time there was a remarkable confluence of events. On June 2, 2008, Scott Coles, ML's principal committed suicide. Because of Coles' years-long authoritarian management style, the company was left completely rudderless. It soon became apparent that ML had lent millions of dollars on some of the most speculative real estate projects in metro-Phoenix, which in good times might have survived, but in bad times were doomed. The real estate crash was going to be worse than anyone anticipated. Home foreclosures were at an all time high, Fannie Mae and Freddie Mac were in financial chaos, and investor capital was non-existent. As matters unraveled, it became clear that frightened investors had stopped investing in ML and ML had stopped funding loans to which it had committed. Borrowers seized on the situation and stopped paying, sued ML on all sorts of lender liability theories, and for the most part, the payments to 2800 investors who had funded all of the ML loans literally evaporated. A real estate crash, hard money, a company without leadership-indeed the perfect storm.

The Bankruptcy Case
On June 23, 2008 one of the largest ML borrowers ($120 million) who was in default filed an involuntary petition against ML. Another defaulted large borrower ($109 million) had already filed suit against ML claiming its loan had been underfunded. Even though ML believed these were litigation tactics to deflect collection actions, the entire ML financial condition seemed to justify consent to relief. What followed was a tsunami. In the one year from commencement of the case to the effective date of the confirmed plan of reorganization, 6 related Chapter 11 and 17 state court cases were filed. Historically speaking, it was one of the largest Chapter 11 bankruptcies filed in the State of Arizona, involving a $1 billion loan portfolio, 2,800 investors, 61 borrowers, 3 Court-appointed committees, one unofficial committee of large investors, and approximately 91 mechanic lien holders on multiple different properties. The related Chapter 11 cases and state court cases involved over $500 million in assets. And, to add to the complexity, administrative proceedings involving three regulatory governmental agencies were initiated or maintained, and the probate of the Coles estate was commenced.

ML's Business
The business structure for ML worked essentially as follows. ML made short term loans secured by real estate, including multifamily residential projects, office building and undeveloped mixed-use projects in Arizona. The loans were evidenced by a promissory note and deed of trust on the real estate. Money for the loans was raised mainly from investors who received a fractional interest in the note and deed of trust. The deeds of trust had as many as 90 beneficiaries. Through various agency agreements, investors granted ML the authority to act on their behalf with respect to the loans. ML was paid a servicing fee in addition to receiving what was known as the "spread," the difference between the interest paid by the borrower and the interest paid to the investor. The structure became a driving issue in the case. As borrowers stopped paying and consequently, there was no money to pay investors, investors began to challenge the agency agreements, ML's authority to deal with the troubled loans and its ability to retain any servicing or spread monies. In addition, it became troubling as to how the investor's interests should be treated. Since they owned the notes and deeds of trust, which would mean the notes and deeds of trust were not property of the estate, did the investors really have a claim against the estate?

The Cast of Characters
ML was anything but the usual Chapter 11 with standard "first day" motions, cash collateral and dip financing issues. By the second week of the case, motions to appoint a trustee had been filed and scheduled for trial, post-Coles management had been fired, and ML's counsel Greenberg Traurig as well as financial advisors MCA Financial had been ousted. For the next month, the company was literally "weaving and bobbing" until new counsel could be hired, dip financing could be obtained, a CEO could be put in place and the trustee motions could be quieted. In the meantime, borrowers continued to capitalize on the events and only 6 of the 66 loans were paying.

The Official Committee of Investors (the "OIC")
Immediately after the case was filed, a group of investors formed an unofficial committee to protect their interests. They hired counsel who began participating in the case and subsequently convinced the United States Trustee to make the committee official. This was an unusual committee in that it had inherent conflicts. Unlike unsecured creditors whose interests are generally aligned, the investors had interests in different notes. Treatment of one borrower and set of investors under one note was not always advantageous to other investors. Nevertheless, the authority was never challenged and the OIC eventually confirmed a plan calling for investors to be invited to transfer their interests to individual limited liability companies governing each note.

Radical Bunny, LLC
During ML's heyday, a company run by ML's accountant, Radical Bunny, LLC, raised investor money at resort seminars and then made a series of loans to ML. Each of the loans was evidenced by a separate promissory note and purportedly secured by all of ML's assets, consisting of its note and deed of trust interests and certain real estate obtained through previous foreclosures. At the time of the bankruptcy filing, Radical Bunny was owed about $200 million. Numerous issues arose as to this claim. First, there was a question as to Radical Bunny's security interest in that, despite the enormity of the debt, there was no security agreement, it appeared ML's name was improperly identified on the UCC-1, and it failed to obtain deeds of trust on the real property. Radical Bunny argued that its security interest was based on a letter to Coles stating its notes were secured by ML's assets even though no collateral was specifically identified. It also argued that its secured interest in the REO was through a UCC filing on proceeds, i.e. the real estate foreclosed on was proceeds of the notes and deeds of trust on which it had a lien. The issue was never resolved and ultimately, Radical Bunny was granted a secured interest as part of the OIC Plan.

Whether secured or unsecured, Radical Bunny was the largest creditor and a driving force in the proceedings. To complicate matters, however, Radical Bunny was thrust into its own bankruptcy by an involuntary petition filed by its investors and eventually consented to relief under Chapter 11. Shortly thereafter, a trustee was appointed. The members of Radical Bunny have been sued by the Securities and Exchange Commission for various securities law violations relating to their fund-raising activities.

The Coles Contingency and the Multiple Conflicts
ML's sole shareholder was the S.M Coles Revocable Trust which also owned S.M. Coles, LLC, an entity apparently used by Coles for his private investment activities. The beneficiaries of the Trust were Coles' first and second wives. The creditors in the case claimed the wives had received benefit from Coles alleged wrong-doing. After Coles' death, a new trustee was appointed for the Coles Trust and he also served as the personal representative for Coles' probate estate. Then, a few months after ML's bankruptcy, Coles LLC filed a Chapter 11 bankruptcy to stop foreclosure on its real estate interests.

Undeniably, everything was intertwined. ML's funds could be traced as having been used by Coles LLC and in fact, ML filed a proof of claim in the Coles LLC bankruptcy for over $30 million. Coles LLC was ML's landlord and despite the fact that the Trust owned both entities, Coles LLC filed for and was awarded an administrative rent claim and an order for eviction.

Board governance became an issue. After management was ousted in the early days of the case, the Trust appointed two ML employees to serve as board members. Neither had board-related experience and because of Coles authoritarian management style, they had no experience in supervising the entire business. Significantly, both were also investors and one was the trustee for the company's 401(k) plan--also a significant investor.

The Other Committees
An Unsecured Creditor Committee was appointed, but that raised the problem of defining its constituency. The unsecured trade debt was relatively small, about $5 million. But, there was a question as to whether all of the investors should be treated as unsecured creditors. First, although investors had received a fractionalized interest in the borrower notes and deeds of trust, there was a dispute as to the validity of the assignments. The consequence with this determination would be that the notes and deeds of trust were property of the estate and hence, the investors were mere unsecured creditors. The second question was whether investors had an unsecured claim based on allegations that they were defrauded. Ultimately, they were granted an unsecured claim based on the amount of their deficiency in recovering on their notes.

Another committee was appointed representing certain a group known as the Value to Loan investors ("VTL's"). One of the ML investment vehicles was known as the MP Funds which were limited liability companies set up to purchase fractionalized interests in various borrower notes. ML investors could purchase an interest in an MP Fund and would have a more diversified investment. In order to fund the MP Funds, ML borrowed money from the VTL's, about $7 million. Thus, the VTL's were not creditors of ML but rather of the MP Funds which never filed bankruptcy. Nevertheless, yet another committee was established to protect their interest.

The Borrowers
Since ML was a hard money lender, it stood to reason that its borrowers could not qualify for conventional financing. Perhaps, that factor was irrelevant in the days of the company in which loans where by and large made on a 50 percent loan to value ratio. But, Coles had abandoned that model and began lending aggressively, including 100 percent construction loans on high-rise condominiums. The list of borrowers included several long-time Phoenix developers, rumored to have reputations for un-collectability and for hiding assets. The bankruptcy made it easy to flaunt non- payment and that much easier for other borrowers to follow suit. And, to make matters more difficult, the OIC decided to insert itself in dealing with borrowers even though that task was clearly within the purview of the company. To say the least, the borrowers seized on the confusion and what might have been ordinary lender "work-outs" became litigation fiascoes. Four borrowers filed bankruptcies, one representing about $120 million of the portfolio. Several borrowers filed lawsuits against the investors on theories of lender liability since the investors were the actual owners of the notes and deeds of trust.

One of the daunting issues in the case was the question of foreclosure. Since the notes and deeds of trust for each borrower property were held by multiple investors, foreclosure would mean taking title in the names of multiple beneficiaries. Then, how would title be conveyed without the consent of each of those beneficiaries. This problem will undoubtedly persist post-confirmation.

The Small Investor Group
The MP Funds had a number of smaller investors apparently so their investments would be diversified. One particular group known as the Mahakian Group hired counsel and was quite vocal in the case particularly in challenging ML's authority to modify the borrower loans. Eventually, however, the Mahakian Group became a co-proponent of ML's plan.

The Big Investor Group
Another significant investor group was known as the RevOps. These investors had invested in the individual borrower notes but then had received from the company a guarantee of payment. The RevOps represented a significant dollar amount of the investors, about $125 million. Some individual investments were as much as $40 million.

The Dynamics
Greed versus greed. In the first meeting with the company and the OIC, one committee member stated that he expected investors would receive 100 cents on the dollar. This position was voiced in July 2008 when people in every other kind of investment had lost at least two thirds of their investments and in light of the fact ML investors had 1) received double-digit interest rates when most people were receiving half as much and 2) signed multiple documents acknowledging the enormity of the risk of their investments. On the other hand, Coles had abandoned any notion of conservatism and was plunging the company into high-risk ventures with high-risk borrowers. And, he was apparently maneuvering investors in and out of loans, some on demand of the investors themselves, but all in a juggle to survive the company motto of "no investor has ever lost a dime with ML." Add in the Radical Bunny situation where the principal had solicited $200 million mainly from "moms and pops" on the strength of the return from ML. These dynamics created an extremely vitriolic atmosphere and made a consensual plan difficult.

The Plan of Reorganization

The Plan Alternatives
Prior to the bankruptcy, the company made the decision to suspend any solicitation of new funds from investors. So, the initial question was whether there was some sort of business to salvage or whether the fate of the company would be a liquidation of the portfolio. Certainly, the servicing of a $1 billion portfolio had value, but the "sale" of that value was daunting in a more-than-troubled market. More importantly, the largest investors wanted nothing to do with any kind of continued or reorganized ML.

The liquidation options were two-fold:

A pooling plan in which all of the notes and deeds of trust were placed essentially in a pool, liquidated, and the proceeds divided on a per investment basis; or
The somewhat "business as usual" liquidation of the portfolio.

The largest investors were firmly against a pool plan, even though the financial analysis showed that creditors would likely receive a larger distribution. The sentiment of many of the investors was that "I selected my investment and I'm going to stick with it."

Two plans were eventually filed, one by the OIC and the other by ML. They differed in three major respects: structure, financing, and the collection and use of the spread and fees. The OIC proposed a plan in which the investors would transfer their note and deed of trust interests to individual limited liability companies, about 47 in number, which would be managed by a single entity and serviced by another. Investors were given the option on the ballot to transfer their interests. It proposed exit financing which would be secured by the interests and it waived all spread and fees. Investors were given an unsecured claim called "Investor Damages," representing the difference between the amount of their notes and the amount eventually received. These amounts would be paid from a liquidating trust which would hold the remaining assets of the estate and the estate causes of action. The RevOps, Radical Bunny and general unsecured creditors would share in the trust as well.

The ML plan entailed a structure similar to the way it had operated in the past. Financing, however, was to be secured by the spread and fees and not investor interests, and investors would be given an across-the-board deficiency claim to be paid by the spread and fees. The investors, Radical Bunny, the RevOPs, and general unsecured creditors would also have an interest in the spread and fees and in a liquidating trust similar to that proposed by the OIC.

The initial OIC plan and disclosure statement were filed on January 21, 2009. The OIC disclosure statement was denied on March 24, 2009 and the OIC subsequently amended and eventually obtained approval of its disclosure statement on April 3, 2009. During this time period, Radical Bunny was somewhat of a wild card. It agreed to be a co-proponent of ML's initial plan, but on the eve of filing, reneged. ML filed on March 4, 2009. After additional negotiation, Radical Bunny agreed to be a co-proponent of an amended ML plan which had committed exit financing. However, again on the eve of filing, Radical Bunny again reneged. ML filed its amended plan and disclosure statement on May 12, 2009.

Balloting and The Rush to Confirmation
Despite the support of the main investor classes, the OIC plan was met with about 15 objections, including Radical Bunny and ML. The VTL's, RevOps, Radical Bunny which were all separately classified, voted against the plan. Initial confirmation was scheduled for Wednesday, May 13, 2009. The Court set final confirmation for Monday, May 18, 2009 giving the parties two business days for discovery and preparation.

The Turning Legal Issue
By final confirmation, the OIC had resolved most of the objections except those raised by an individual investor, ML and Radical Bunny. The RevOps announced that they probably had a deal but it was not finalized. The turning point ended up being a ruling from the Court on a motion filed by Radical Bunny a few weeks prior to confirmation.

The OIC's plan proposed classes for "Investor Damages," for unpaid principal and interest on what investors expected to receive; that is, a sort of deficiency claim. In addition, it proposed treatment for the VTL's although they were not creditors of ML. Radical Bunny filed a motion under Bankruptcy Rule 3013 to challenge the inclusion of these classes. Of principal importance was Radical Bunny's argument that the investor claims should be subordinated based on Section 510(b) of the Bankruptcy Code. The basis of the argument was that any damages claimed by investors related to the purchase or sale of a security, i.e. the interests in the borrower notes, and thus were subject to mandatory subordination under 510(b). It also filed a motion challenging the RevOp claims. The motions became known as the 510(b) motions.

Radical Bunny argued the 510(b) motions on the first day of final confirmation and the Court took the matter under advisement. Radical Bunny continued to prosecute its objection to the OIC plan as did ML. However, in the middle of trial, the Court ruled on the motions and denied all relief. That was the turning point. Radical Bunny determined it would no longer resist confirmation of the OIC plan. At that point, ML and the Mahakian Group believed a continued confirmation battle would not be in anyone's best interest and withdrew their objections to the OIC plan. It was confirmed and became effective on June 15, 2009.

Conclusion
Many issues could have been fought; perhaps a better plan could have been achieved by all parties, but the driving force was the need to emerge from bankruptcy. When asked why he had decided at the last to support the OIC plan although his client would receive more under the ML plan, one of the lawyers said the OIC will just continue the fight. Without payments from borrowers, the company was out of cash and was administratively insolvent. Each time there seemed to be a shoreline in sight; it was only the eye of the storm.

Unfortunately, borrowers are still not paying, the real estate market is not yet recovering, mechanic lien holders still claim priorities in a substantial number of the real estate projects, and investors are not receiving any distributions. Extensions have been sought to convince investors who did not agree to transfer their interests to the new limited liability companies to do so. But, a plan has been confirmed and a navigation of sorts set. As lawyers for ML were sitting at the ML offices preparing for final confirmation, the ML sign outside of the office fell down-there was no wind. Was it a signal that it was the end of the storm, or as time will tell, was it the beginning of another.

Recent Changes to Arizona Foreclosure Law Repealed

On September 4, 2009, Governor Brewer signed House Bill 2008, which repeals Senate Bill 1271 and its changes to the Arizona anti-deficiency statute. The real estate community's efforts were successful; and the recent changes to the law sought out by the lending industry, signed by Governor Brewer on July 1, 2009, and scheduled to go into effect on September 30, 2009, have been repealed.

As a result of this repeal, property owners (including owners of second homes and investment properties) in the state of Arizona owning qualified real estate (residential property on two and one-half acres or less and utilized for either a single one-family or single two-family dwelling) will continue to receive the protections afforded by Arizona's anti-deficiency statute.

To view the original client alert, or to recap on the details of SB 1271, visit our website. If you have any questions or concerns about this change in Arizona's foreclosure law, contact Brian N. Spector.

Trademark Fights Take Shape During Tough Economy

As companies fight for new business and look to keep what they already have, protection of a company's core identity is more important than ever.

Words, slogans and designs that you use to identify and distinguish your goods and services from others are eligible for federal registration with the U.S. Patent and Trademark Office (the "PTO"). A federal trademark registration gives a company presumptive ownership and the exclusive right to use the trademark in connection with the goods and services identified in the federal registration. For this reason, it is important to not only protect your brands through federal registration, but to also monitor the trademark registration activities of others.

Three recent cases show the importance of protecting your brand, and monitoring the actions of others:

1. Recently, The Laptop Company, owner of the online shopping service "BongoBing," made a preliminary filing with the PTO in opposition to Microsoft's application for federal registration of the "Bing" trademark for its new search engine. The BongoBing website provides information on products primarily in the home and garden area. The website is designed to look like a search engine, where you can search or "Bongo" for products.

Although The Laptop Company claims trademark rights to BongoBing, it has never filed an application for federal trademark registration. The company has received an extension through December 16, 2009, to formally oppose the registration of "Bing."

2. Oprah Winfrey and her production company, Harpo Productions, Inc., are trying to stake Oprah's exclusive claim to the term "Aha! Moment." Last year, the insurance company Mutual of Omaha filed an application for registration of the slogan "Official Sponsor of the Aha Moment," which became part of a national advertising campaign in February. After the Mutual of Omaha mark was approved by the PTO, it was published for opposition by third parties. When no opposition papers were filed, the PTO issued a Notice of Allowance.

On the same day the Notice of Allowance was issued, Oprah's lawyers sent a "cease and desist" letter to Mutual of Omaha, claiming that the slogan violates Oprah's rights in the "Aha Moment" and demanding that the company cease use of the mark. Not to be outdone, Mutual of Omaha filed a lawsuit in federal court days later, asking a judge to allow the company to use its slogan without interference from Oprah. The litigation is ongoing.

In the meantime, Harpo has filed its own applications for federal registration of "Aha! Moment," one of which (for magazine columns) was published for opposition on September 1, 2009.

3. When consumer electronics retailer giant Best Buy learned that a division of United Technologies known as the "Geek Patrol" was providing the same computer repair services as the Best Buy "Geek Squad," the company went straight to federal court with allegations of trademark infringement, unfair competition, and deceptive trade practices. Best Buy identified an online directory listing for the Geek Squad that stated "GEEK PATROL we can send a Squad of geeks to you" and "WE ARE THE BEST BUY." The lawsuit, filed last month, has resulted in some changes to the Geek Patrol website. Time will tell who ultimately prevails in this real life "geek drama."

For more information regarding the issues in this publication, please contact Brad Hartman via email at bhartman@jsslaw.com or via telephone at 602.262.5842.

Google's AdWords Program Continues to Challenge Trademark Owners and The Courts

The debate over the open sale of trademarks to trigger online advertising at Google has been heating up. Google AdWords allows anyone to bid on keywords that, when searched by others, wins the owner high placement in the search results page based on a combination of factors. This means that your company can bid on the word "shoes," for example, in order to have your footwear company placed prominently among the search results.

But what if you want to use the NIKE trademark to trigger an ad for your footwear website? And what if you don't even sell NIKE shoes? In most instances Google allows any company to bid on keywords and place advertising using another company's trademark.

Courts across the United States have reached different conclusions on whether Google's use of trademarks as AdWords constitutes "trademark use in commerce," a necessary element of a successful trademark infringement lawsuit. The 9th Circuit, which includes Arizona and California, has held that the sale of trademark-protected words in the AdWords program is a "use in commerce" for purposes of federal trademark law. Courts in the 2nd Circuit, which includes New York, have held otherwise, holding that Google's actions are not a "use in commerce" under federal trademark law. The courts have largely accepted Google's contention that there is no trademark use in commerce because any use of the mark is internal only, and Google had never "used the mark" publicly by placing the trademark on any goods, containers, advertisements, or anything else visible to the public.

This split between east and west, or 2nd and 9th circuit, may be changing. Recently, the 2nd Circuit Court of Appeals for New York reversed a lower court's determination on the "use in commerce" issue. In Rescuecom v. Google, the Second Circuit found that selling trademarks as search engine advertising keywords can be a "use in commerce." "What Google is recommending and selling to its advertisers is Rescuecom's trademark," said the Court's ruling. "Google displays, offers, and sells Rescuecom's mark to Google's advertising customers when selling its advertising services."

We haven't seen the end of this issue. Other cases are pending against Google, and Google is said to be liberalizing its policy to permit use of third-party trademarks in some ads themselves. It remains to be seen whether the 2nd Circuit will distinguish a competitor's purchase of trademarks for use in keyword searches from Google's sale of trademarks.

For more information regarding the issues in this publication, please contact Brad Hartman via email at bhartman@jsslaw.com or via telephone at 602.262.5842.

Tax Client Alert: Deadlines Approaching For Special NOL Carrybacks

NOTE: An update to this client alert was posted on December 29, 2009.

Time is running out for many businesses wishing to take advantage of the expanded business loss carryback option included in the 2009 recovery law. Eligible calendar-year corporations have until September 15, 2009 to file the appropriate forms. Eligible individuals have until October 15, 2009 to choose this expanded carryback option.

This carryback provision offers small businesses that lost money in 2008 an excellent way to quickly obtain some much needed cash if the business was profitable in previous years. This option is only available for a limited time, so small businesses should consider it carefully and act before it is too late.

Under the American Recovery and Reinvestment Act (ARRA), enacted in February, many small businesses that had expenses exceeding their income for 2008 can choose to carry the resulting loss back for three, four or five years, instead of the usual two. This means that a business that had a net operating loss (NOL) in 2008 could carry that loss on their books as far back as tax-year 2003. Not only could this mean a special tax refund, but the refund could be larger, because the loss can be spread over as many as five tax years, rather than just two.

This option may be particularly helpful to eligible small businesses with a large loss in 2008. A small business that chooses this option can benefit by:

Offsetting the loss against income earned in up to five prior tax years,
Getting a refund of taxes paid for up to five prior years,
Using all or part of the loss now, rather than waiting to claim it on future tax returns.

The option is available for an eligible small business (ESB) that has no more than an average of $15 million in gross receipts over a three-year period ending with the 2008 tax year. Unless the appropriate election is made prior to the referenced deadlines, the taxpayers will not be eligible to take advantage of the expanded carryback period.

Many taxpayers are also revisiting whether losses that arose from 2008 taxable transactions generated ordinary losses, or capital losses. Ordinary losses may be eligible for the expanded carryback treatment. Capital losses only can be carried forward to future tax year, and then only can be utilized to offset future capital gains, or, to a very limited extent, the ordinary income of the taxpayer.

Each case a business or individual may face is unique and may require legal advice. If these changes apply to you, or you have other tax related questions, please contact either Jack N. Rudel or Richard C. Smith.

Antitrust and Trade Associations: Why Compliance Matters

Recent events have highlighted the need for trade associations such as IDEA to be aware of - and take proactive steps to comply with - antitrust laws. In May 2009, the Obama administration made its position known on antitrust enforcement: Speaking to the U.S. Chamber of Commerce, Assistant Attorney General Christine A. Varney of the Justice Department's antitrust division remarked that the relaxation of antitrust enforcement at the outset of the Great Depression was a mistake and that vigorous enforcement must accompany efforts to revive the distressed economy. Earlier, in March, the Federal Trade Commission (FTC) required the National Association of Music Merchants (NAMM), a trade association of musical instrument sellers, to enter a consent decree that tightly restricted the organization's activities for years. This ruling was considered a wakeup call to all trade associations.

IDEA's leadership has historically remained sensitive to antitrust concerns and has steered the organization and its members clear of unlawful conduct. But given a renewed focus on antitrust enforcement generally and the role of trade associations in particular, this is a good time to review how and why IDEA conducts its meetings and guides members toward compliance.

Overview of Antitrust
Antitrust law aims to maintain competitive markets in the face of business conduct that might seek to increase profits by eliminating competition. For simplicity, let's consider there to be two main categories of antitrust laws: those regulating the activities of a single dominant firm or monopoly, generally addressed by Section 2 of the Sherman Act, and those regulating joint action among competitors, addressed by Section 1 of the Sherman Act.

Another area of antitrust law pertains to challenged conduct. The antitrust laws only forbid restraints of trade that are considered "unreasonable." Courts and agencies therefore apply a so-called Rule of Reason, examining the nature of the conduct, the market in which it occurs and the positive and negative impacts it may have on competition in the relevant market. This is a complicated, economics-driven inquiry with general rules but few concrete guideposts.

By contrast, certain marketplace conduct is considered anticompetitive (and illegal) per se, having no redeeming positive effects on competition. Agreements to fix prices, rig bids, divide territories or allocate customers or market segments fall into this category of business activity. Even if the argument can be made that this conduct benefits consumers, it is prohibited. Many times this conduct will bring harsh criminal penalties as well as civil suits.

Trade Association Activities
Activities of trade associations have been suspect since before the founding of this nation. Writing in 1776, Adam Smith warned, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." (Wealth of Nations [1776], Vol. I, Ch. 10, pt. 2.) On the other hand, cooperation, education and information exchanges through trade associations most frequently generate improved efficiencies, technological advances and better value for consumers, so nobody opposes the ongoing existence of the organizations. Antitrust regulators try to keep the balance tipped toward the benefit side.

The most common dangers posed by trade associations are (1) anticompetitive conduct by the association itself and (2) association provision of resources and facilities to abet member collusion. In the first category are exclusionary actions such as membership rejections or expulsions for anticompetitive reasons (e.g., price discounters); denying non-member access to commercially crucial association services or trade show participation; discriminatory standard setting; codes of ethics that restrict advertising, business relationships, pricing, competitive bidding or services offered; and collection and dissemination of non-public price-signaling information. The IDEA board, professional staff and counsel must remain knowledgeable about the rules and nuances surrounding these activities and assure that a proper balance is struck. To date, they have been quite successful in carrying out these responsibilities.

The second category involves joint action by members to enhance profitability by constraining the marketplace. IDEA is different from many other trade associations in that the nature of the district energy industry offers scant incentive for members to conspire against the public. District energy system operators generally do not compete against each other; nor do they generally sell their heating/cooling/energy output in a consumer market. So there is no incentive for them to conspire to keep output low, prices high or the number of competitors small. IDEA members who are service providers, vendors or suppliers to the district energy industry have little incentive to collaborate to stabilize prices or markets, as this could directly harm the owner/operator members. Therefore IDEA is an unlikely forum for such endeavors.

Even though anticompetitive conduct is unlikely, IDEA should remain vigilant in overseeing the discussion agenda at membership gatherings because the consequences of faltering can be severe:

A violation of the antitrust laws carries potential penalties that include criminal prosecution with fines of up to $1 million per violation for individuals and $100 million for corporations and/or jail sentences of not more than 10 years and civil remedies of treble damages, attorney's fees and injunctive relief.
Trade associations can be found liable for the antitrust violations of their agents acting within the scope of their apparent authority - i.e., the agent appears to be acting in the ordinary course of the association's business. Associations generally are liable for actions of member volunteers (including board members and commission/committee members) taken under the auspices of the association, even if the specific actions were not authorized by the association. No ratification by the trade association of the agent's conduct is required for a finding of liability.
Membership in a trade association that has been found to have engaged in unlawful behavior may be used as a basis to infer complicity in anticompetitive behavior. If a court finds that a member had knowledge of unlawful behavior, the court may infer participation. Thus, if a member knows or should have known that the association was involved in unlawful behavior, that member may be deemed to be a co-conspirator.

Given the risks, it follows that IDEA should be sensitive to antitrust concerns as it plans and conducts its affairs. IDEA, like any trade association, should take affirmative steps to ensure that none of its public pronouncements or other activities could be misconstrued as facilitating, condoning or calling for any concerted action that violates the antitrust laws. These include control over meeting agendas and requiring adherence to the agenda. IDEA's Antitrust Policy Statement (see sidebar), read at the outset of formal gatherings, is designed to educate members about significant prohibited conduct and to attempt to protect the membership in the event that someone does not take it seriously.

Lessons from NAMM
In the recent consent enforcement action noted above, the FTC charged that NAMM, the association of musical instrument manufacturers and sellers, enabled and encouraged the exchange of competitively sensitive pricing information among its members, primarily by sponsoring discussions of minimum advertised pricing (MAP) policies. (It is noteworthy that MAP policies are legal, though complicated to implement properly, and advising members about the rules seems reasonable; but conducting meetings tending to help many musical instrument sellers adopt MAP policies stepped over the line.)

The consent decree (see sidebar for highlights) requires appointment of an antitrust compliance officer (who for the first three years must be antitrust counsel) to approve agendas, prepared remarks and materials for all association events and board meetings and personally attend the functions. It also mandates annual antitrust training for staff and board members, implementation of mechanisms for reporting violations of antitrust laws and discipline of violators, reading of an antitrust compliance statement at the beginning of meetings and recording of each panel discussion and presentation at association events. The compliance officer must submit annual written reports to the FTC confirming compliance for 10 years, and the order remains in effect for 20 years. (For details on the NAMM case, including complaint, decision and order, consent agreement and related documents, go to www.ftc.gov; look for In the Matter of National Association of Music Merchants, Inc., Docket No. C-4255, [March 4, 2009]).

Of course, the NAMM is a qualitatively different organization from IDEA. It is made up of companies that compete directly with each other for sales of musical instruments to the public. Discussions of MAP policies also involved sharing of price, cost and profit margin information among competitors, which the authorities consider unlawful even if no price-fixing agreement was ever reached. IDEA's members would be unlikely to benefit from this kind of collaboration. Regardless of these differences, however, the case is very instructive. Antitrust practitioners have generally agreed that, with the possible exception of recording every event, the NAMM order should be considered a ‘best practices guide' for all trade associations. Happily, the IDEA leadership already has in place procedures and an Antitrust Compliance Manual implementing these best practices. (Members may download and read the manual in the Members Section on the association's Web site: www.districtenergy.org.) Members should refer periodically to that manual for general guidance and should have antitrust counsel available for the times when detailed analysis is needed.

A Patented Solution: Failing to File a Patent for a New Technology Could Cost a Company More than Money

It is arguably one of the most exciting moments for a technology entrepreneur - seeing that invention for the first time. Whether it's a new software program, mechanical device, or a breakthrough biotech discovery, the feeling is always the same. Pure elation. If you're a technology entrepreneur you know what feeling I'm talking about. You spend months, possibly years, working towards this moment. Now that you're here, you're ready to turn this exciting innovation into a business. But before you take that costly leap of putting together a company and going to market, consider one very important step that can save you, and your company, everything you've worked for - the elusive patent.

Who needs it? Many technology companies and entrepreneurs initially feel they don't need, or just can't afford, patent protection at the very initial stages of their business development. "No one else could develop this right now in the exact same way we have," or "It's already protected by trade secret laws," or "It's going to cost a lot of money right now, so we'll wait until the product is making us a profit." The truth is, not filing a patent to protect your proprietary technology could cost a great, great deal more in the end and might even make your company less attractive to investors and business partners.

Companies in a wide variety of technology fields increasingly rely on patents as a key tool to protect their proprietary inventions. For example, companies in the high-tech industry (software, semiconductors, etc.) and the life sciences/biotechnology industry (pharmaceuticals, medical devices, etc.) are spending more and more money on research & development and, thus, are increasingly looking to patents as a mechanism for protecting this expensive investment.

If you're a typical technology startup, you will likely need to find early-stage, mid-stage and, eventually, late-stage investors for capital to continue to fund your research & development and pay the tremendous costs associated with commercializing your products and services, potentially worldwide. Angel investors to venture capitalists are increasingly scrutinizing the adequacy and strength of a company's intellectual property assets as a part of the investor's decision to invest in that company. More than ever, investors are particularly expecting a company to have either filed for patent protection or already have some patents. Another significant ramification of failing to obtain adequate patent protection is that early, mid and late stage investors may place a significantly lower valuation on your company. Thus, taking steps to file for patents, and then eventually obtaining patents, is often a critical and significant step in proving credibility to any kind of investor.

Another major benefit of patent protection is using your patents as a legal mechanism to protect your company's most critical proprietary technology from infringement by competitors and others. Competition is fierce in the high technology and biotech/life sciences industries and your competition may knowingly, or inadvertently, use your proprietary technology in your competitor's goods or services to gain market share. Your patent is often a valuable tool to combat these serious situations and could be a key factor that differentiates your company from your competition, or even provides the life line that keeps your company in business.

Many technology companies, particularly startups, are not in a position to completely commercialize their proprietary technology in every country in the world and in every "field of use" applicable to that proprietary technology. So, technology companies are often searching for competent parties who can be given a license to manufacture products, or perform services, that utilize the proprietary technology in a particular geographic area, in a specific "field of use", or both. Potential licensees, however, will increasingly scrutinize the level of patent protection given to your proprietary technology before they commit to being a licensee. The main reason for this increased scrutiny is that the potential licensee will ultimately need to spend more money to further develop your invention (into a final product or service) and to develop the costly infrastructure needed to efficiently manufacture and/or distribute a final product or service that uses your technology. Thus, a potential licensee wants to make sure your technology is adequately protected before the licensee is willing to make this tremendous investment to commercialize your technology. So, taking steps to file for patent protection can increase your company's ability to find proper licensees. Patent protection can also increase your negotiating leverage when entering into contracts with licensees and could have a significant impact on the level of royalties and other compensation that licensees agree to pay you for the use of your proprietary technology. Indeed, potential licensees who still want rights to your technology very often negotiate significantly lower royalty payments if you have failed to obtain proper patent protection because the licensee deems your technology to simply be unprotected "trade secrets." As a bottom line, taking steps to obtain proper patent protection can potentially increase the revenue stream to your company from others that want to use your technology.

There is no denying that it can be costly to file for patent protection. But protecting your patent rights is often a valuable investment in your company's future. With proper patent protection, you can head into the technology marketplace with a leg up, securing your business' long-term prospects, and ensuring that all of your hard work doesn't go to waste.

An Important Change Affecting Arizona Foreclosure Law

On July 1, 2009, Governor Brewer signed into law an important change to Arizona's anti-deficiency statute. Previously, a lender foreclosing a deed of trust on qualified real estate (i.e., residential property of two and one-half acres or less and utilized for either a single one-family or single two-family dwelling) could not bring an action to recover any difference between the amount of its claim and the amount obtained by the foreclosure sale. As a result of the change, the protection now only applies to a foreclosure sale of such residential property that is used by the borrower as a dwelling for at least six consecutive months. The borrower has the burden of proving that.

This change in the law was sought by the lending industry. It was intended to take away the protection previously afforded to those who purchased residential real estate as rental and investment property.

A number of questions already have arisen regarding this change in the law. A few of them and the possible answers are set forth below:

Question: To receive protection, must the borrower have used the property for the six consecutive months immediately preceding the foreclosure sale?

Answer: No. The change appears intended to take away protection from borrowers who purchased residential property for speculation and investment. Accordingly, it should not apply to a borrower who, for example, initially lived in the property (for at least six months) but later turned it into a rental or for other reasons moved out. That also is consistent with a plain reading of the statute, which does not specify that the usage must occur immediately prior to the sale.
Question: Are the owners of second (i.e., vacation) homes protected?

Answer: Given the intent behind the change -- to take away protection previously afforded to speculators and investors -- vacation home owners ought to be protected if they can demonstrate that they used the property for six consecutive months. Arguably, usage need not be as a primary residence; it also can be the more sporadic kind associated with a second home. It could be argued that if the legislature wanted to limit protection to one's primary residence, it could have said that or used the term "resided" instead of "used."
Question: Does the change apply to owners who purchased and borrowed against property in reliance upon the protection afforded under the old law?

Answer: Yes. The change applies to all foreclosure sales that occur after September 30, 2009 - regardless of when the property was purchased or the loan was made - and, therefore, to sales of property owned by investors who purchased and borrowed in reliance upon the protection afforded under the old law. It remains to be seen whether such owners can successfully challenge the applicability of the change to transactions made in reliance upon the prior law.

According to recent newspaper reports, the Arizona Realtors Association and real estate industry lobbyists currently are working to get this change in the law repealed. Time will tell whether those efforts will be successful and/or whether the new law will be clarified to address the above questions.

If you have any questions or concerns about this change in Arizona's foreclosure law, contact Brian N. Spector at bspector@jsslaw.com or 602.262.5977.

NOTE: On September 4, 2009, Governor Brewer signed House Bill 2008, which repeals Senate Bill 1271 and its changes to the Arizona anti-deficiency statute. Please view our updated Client Alert.

Federal Minimum Wage Increase

Effective July 24, 2009, the federal minimum wage provisions contained in the Fair Labor Standards Act (FLSA) were increased to $7.25 per hour. Please note that many states also have minimum wage laws. In cases where an employee is subject to both state and federal minimum wage laws, the employee is entitled to the higher minimum wage. Overtime pay at a rate not less than one and one-half times the regular rate of pay is required after 40 hours of work in a workweek.

The Fair Labor Standards Act establishes minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in Federal, State, and local governments.

Could You be Sued if Your Customer Database is Breached?

In the age of computer hacking and identity theft, more and more attention is being focused on the obligation of businesses to protect the security of personally identifiable information stored on its computers and in its databases.

Most businesses retain electronic records containing personal information about employees, vendors, and customers. Does holding that personal information and data create a duty to conceal and protect that information from others on behalf of the person about whom the data relates? Most courts have held that no implied duty exist. If you properly obtain non-confidential data from your employees, customers or vendors, you have the right to use it. The fact that you know your customer's home address and phone number, for example, does not create a duty to keep that information secure. Indeed, the customer's name, address and phone number may be known to many individuals and businesses.

But some employee, customer and vendor information is more sensitive, and may be delivered to your business under confidentiality agreements or under circumstances sufficient to imply a duty to protect the information from disclosure. For example, social security numbers, bank account information, personal health information provided for insurance purposes, and other sensitive data could be used by others for improper purposes. If it is foreseeable that damages could result from the public disclosure of sensitive personal, financial or health information, a business is wise to protect that information to the greatest extent possible.

Encrypt. Current laws generally apply only to "unencrypted personal information." All computer data containing sensitive information should be encrypted and opened only with a password to prevent unauthorized access.
Limit. Business policies and practices should limit access to sensitive data to those individuals with a need to use the particular data in the course of their job duties.
Train. Train employees on the need to secure and protect sensitive data from unauthorized access, including personal information as well as company information, such as marketing plans and strategies, product designs, and manufacturing processes. Additionally, train employees on how to spot unauthorized access to sensitive data so that your company can be vigilant in identifying data theft and complying with laws that require prompt notice to impacted individuals. Evidence of employee training can help the company avoid a punitive damages award in the event of unauthorized access.
Monitor. Today's network technologies can help you identify unauthorized data access attempts, such as multiple erroneous password entries, access to the database from an IP address or location outside the company, file modifications that evidence copying or emailing of sensitive data, or after-hours access to a secure database.

If your database is ever breached, the worst thing you can do is ignore the breach and hope that no one will find out or nothing will be used improperly. Be warned that there are state and federal laws that require businesses to take specific actions to promptly notify affected individuals and assist those individuals with protecting their financial records and credit rating.

Use of Celebrity Images in Advertising Has Risks

Clothing retailer American Apparel has agreed to pay Actor/Director Woody Allen $5 million to settle a lawsuit brought by Allen when he was featured in an American Apparel billboard campaign dressed as a Hasidic rabbi from his classic 1997 comedy, "Annie Hall." American Apparel defended the use of Allen's image as a satiric and social statement on a public figure, protected as free speech by the First Amendment to the U.S. Constitution. American Apparel said the billboards were designed to inspire dialogue, not to sell clothing.

Allen's attorneys disagreed, claiming there was no protected speech involved, but rather pure commercial advertisement rooted in the unauthorized use of Allen's image to promote American Apparel. Even though the American Apparel billboards came down within a week of Allen's initial complaint, Allen claimed that was long enough to falsely imply that Allen sponsored, endorsed, or was otherwise associated with American Apparel or its products.

The right of publicity is a person's exclusive right to use, and to prevent the unauthorized use of, his or her name, likeness, or other aspect of his or her persona for commercial gain. To use it without permission allows that celebrity (or any person) to file a claim against the business. The line between commercial speech and free speech may be fuzzy, but the American Apparel billboards seem to have been firmly planted on the commercial side of the line. If you would like to use celebrity images in your own advertising - even the images of deceased celebrities or celebrities lesser known than Woody Allen - it is best to obtain advance and unequivocal permission from the celebrity or the holder of his or her publicity rights. A business owner also would be wise to avoid using in advertisements words, logos, or designs that can be associated with other companies or products, which may raise claims under the federal Lanham Act.

Whether or not American Apparel would have succeeded with its defense will never be known. But we do know that American Apparel learned an expensive lesson: Using celebrities to endorse a product without their permission is going to get a business owner into trouble.

Act Quickly: Facebook is Creating New Opportunities and Challenges for Businesses, Individuals and Trademark Owners

This Friday night at 12:01 a.m. Eastern Time (9:01 p.m. PDT), Facebook will be releasing "vanity URLs" to registered Facebook users, in what is sure to be a landrush for businesses and individuals to adopt a unique, easy to remember URL for their Facebook profile and home page.

Until now, Facebook profiles have been identified on the Internet with a long series of nonsensical numbers (e.g., http://www.facebook.com/profile.php?id=0012343567). Beginning Friday evening, users will be able to obtain an easy-to-remember name for their Facebook pages, issued on a first-come, first-served basis (e.g., http://www.facebook.com/jsslaw). User names must be at least five characters in length and can only include alphanumeric characters (A to Z, 0-9) or periods. Generic words will not be available. To obtain a vanity URL, the Facebook account for your brand, product or organization must have been live on Facebook prior to May 31, 2009, and have a minimum of 1,000 fans.

Trademark holders interested in preventing their trademarks from being registered as usernames can submit their information to Facebook. Owners are required to submit a registration number for the trademark to be protected, and owners of multiple marks must submit a separate form for each mark to be protected.

Doing so will help prevent your valuable intellectual property from being registered and associated with a Facebook user. As they say, an ounce of prevention is worth a pound of cure.

Act quickly - the landrush begins Friday, June 12th at 9:01pm PDT.

The Next Chapter? In Tough Times, Filing for Chapter 11 Can be a Viable Solution

Bankruptcy. To many it is a word that invokes fear, mostly due to misunderstanding. For businesses struggling during these tough economic times, Chapter 11 bankruptcy can actually be an ally. Once businesses understand what bankruptcy entails, and how to determine if it is the right option for them, it can be much easier to face the process.

Download the related file to the right to read the full article:

A Legal Eye on Real Estate

Real estate transactions are very complicated. To ensure a smooth transition many people hire a real estate attorney to guide the process. Bruce May of Jennings, Strouss & Salmon has been practicing real estate law in Arizona for over 30 years. Here he answers some of the most common questions about hiring a real estate attorney and the local real estate market.

May, 60, earned his law degree in 1978 from the University Of Oregon School Of Law and his undergraduate from Princeton University. He has extensive experience in representing local, regional and national developers, homebuilders, institutional and individual investors in all phases of the development process. His areas of expertise include acquisition, disposition and development of land for large-scale, master planned projects, retail centers, apartments, offices, industrial developments, resorts and other incomeproducing projects. He also is experienced in land planning, subdivision regulation, liquor licenses, acquisition and development financing, purchase and sale agreements, leases, partnership and management agreements, business asset acquisition, management and disposition, office and retail leases and acquisition and sale of property for locations in various states. May's professional affiliations include The American College of Real Estate Attorneys, American Bar Association and the International Association of Attorneys and Executives in Corporate Real Estate. He also serves as a member of the Phoenix Art Museum, Phoenix Community Alliance, Valley Partnership and the Phoenix Arts District Community Development Corporation.

Does a person really need to hire a real estate attorney when they buy real estate? Why?
May: "Yes. An attorney brings to a transaction expertise, experience and a level of sophistication and, often, creativity that are essential to a well-considered acquisition.

At what point during a project, acquisition or disposition should a real estate attorney get involved?
May: "In the very beginning. Real estate transactions are very complicated. To ensure a smooth transition many people hire a real estate attorney to guide the process. We handle everything from acquisition to disposition and the success of the disposition depends significantly on the manner of acquisition."

Who are your clients?
May: "As a real estate attorney I represent owners, lenders, borrowers, investors, developers, contractors, brokers, property managers, title insurers, escrow agents, municipalities and syndicators."

Do you represent tenants?
May: "Yes, I negotiate leases and enforce tenant rights. In this market I typically do more work for landlords."

Do you work alone on most transactions or as part of a legal team?
May: "One attorney can work a deal, but given the size and nature of the transaction it is often a team effort. I work with a number of attorneys in my office on real estate transactions and I assist in drafting core or ancillary documents."

What services do you provide to a developer buying raw land, for example?
May: "I provide a number of services. A few of them include:

Identification and formation of entity to acquire title.
Negotiate a purchase contract that ensures the property is evaluated sufficiently and meets the needs of the client, or enables the client to terminate the contract if it does not.
Ensure proper due diligence including title and survey review, leases, covenance, conditions and restrictions and other related documents and issues.
Negotiate the loan documents that will enable the buyer to acquire and develop property on satisfactory terms.
Create legal infrastructure that will enable the developer to pursue its short and long-term plans.
Negotiate construction contracts for any improvements that may need to be modified or constructed.
Negotiate joint venture agreements with third party investors or other developers for coordinated undertaking.
Enter into development agreements with municipalities or other government entities."

What type of transactions do you handle most often in the Phoenix market?
May: "Over the past year, the real estate market in Phoenix has been up and down. So most of what I've been doing lately is working out obligations that have gone into default and enforcing remedies for existing arrangements. On the transactional side, I've been representing buyers and sellers of improved property such as industrial and office buildings and retail."

When guiding your clients, what skills are critical to your success?
May: "I consider experience, expertise, flexibility and creativity the four elements necessary for client success. You also have to be an expert at closing the deal, which means being thorough, prepared and capable of adapting to the dynamic situations that closings often require."

How do you stay on top of all the new regulations?
May: "I conduct a lot of transactions that require review of current law. I also read a lot. I spend hours reviewing publications that offer insight into developing trends in real estate law, recent cases and current solutions or troubles people encounter in the area I work."

How has the downward shift in the real estate market affected your business?
May: "Business has lightened up since the turn of the real estate market. There is no money in this market and no one is spending money. Arizona has been affected by the collapse of the financial market as much as any state in the United States and that's no exaggeration. To pursue development you have to have money. To dispose of property and make money you have to have someone that wants to buy and assume property ownership. A year or two ago that was not an issue. But in the current climate it's very difficult. My crystal ball isn't any clearer than anyone else's, but I'm optimistic that by 2010 everything will have adjusted itself."

How does a potential client find a real estate attorney?
May: "Word of mouth is a good way, or through publications that rank attorneys in accordance with their real estate expertise. A good source for people to use is The Best Lawyers in America. I've been listed in this publication for 25 years along with a handful of other attorneys in the city."

Arbitration Update: More on Judicial Review of Arbitration Awards

Last fall, I wrote a paper about the conflict between Federal law and California law relating to judicial review of arbitration awards. (See Jennings Strouss web site (www.jsslaw.com), Judicial Review of Arbitration Awards, Michael R. Palumbo, November 12, 2008). That paper discussed the diametrically opposed conclusions of the U.S. Supreme Court case Hill Street Associates v. Mattel, --- U.S.---, 128 S. Ct. 1396, 170 L.Ed. 2d 254 (2008) and the California Supreme Court decision in Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 190 P.3d 586 (2008). In sum, these cases inform us that parties to arbitration contracts in California, who base their arbitration contracts on California statutes, may provide for judicial review of an arbitrator's decision, while parties who seek arbitration under the Federal statutory scheme may not increase judicial review of arbitration decisions beyond the strict terms of the Federal statute. This paper focuses on the development of Federal law in this area in light of the Hill Street Opinion.

As noted in the earlier paper, The Federal Arbitration Act (FAA), which can be found at 9 U.S.C.A. § 1. et seq., restricts the right of appeal of an arbitration decision. Under the FAA grounds for judicial intervention in an arbitration award include where the award was procured by "corruption," "fraud" or "undue means" and where the arbitrators were "guilty of misconduct" or "exceeded their powers." Grounds for modifying or correcting an award, as compared to vacating an award, include "evident material miscalculation," "evident material mistake" and "imperfections in matter of form not affecting the merits."

Although it is not specifically listed in the FAA, "manifest disregard" has been an acceptable judicially created basis for reviewing arbitration awards for sometime. The U.S. Supreme Court implicitly recognized the approach in Wilko v. Swan, 346 U.S. 427, 436-37, 74 S. Ct. 182, 98 L. Ed. 168 (1953) where, citing the FAA, it stated: "Power to vacate an [arbitration] award is limited.... the interpretations of the law by the arbitrators in contrast to manifest disregard [of the law] are not subject, in the federal courts, to judicial review for error in interpretation." [Before Hill Street, all federal appellate circuits and many state courts, but not Arizona, recognized the manifest disregard doctrine.(Coffee Beanery, Ltd. v. WW, LLC, 300 Fed. Appx 415, 2008 WL 4899478 (6^th, Cir. 11/14/08)]

In Hill Street, the Supreme Court held that the FAA provided the exclusive grounds to vacate or modify an arbitration award. 128 S. Ct. at 1404. Although it was not directly at issue in Hill Street, because of this holding, and the fact that the FAA does not list "manifest disregard", federal district and appellate courts have reached opposing views on the continued viability of the manifest disregard standard for reviewing arbitration awards. [In Hill Street, the Supreme Court was equivocal in discussing the "manifest disregard" standard. Without deciding, it stated: "Maybe the term "manifest disregard" was meant to name a new ground for review, but maybe it merely referred to the § 10 grounds collectively, rather than adding to them. Or, as some courts have thought, manifest disregard may have been shorthand for § 10 (a) (3) or § 10 (a) (4), the subsections authorizing vacatur when the arbitrators were "guilty of misconduct" or "exceeded their powers". 128 S. Ct. at---] As more fully discussed below, the Ninth Circuit, Second Circuit and the Sixth Circuit federal appellate courts believe that manifest disregard has continuing vitality, while the First Circuit, the federal District court from Minnesota and the Supreme Court of Alabama (applying the FAA) disagree.

What is the manifest disregard doctrine? "...[R]eview under the doctrine of manifest disregard is severely limited. ...It is highly deferential to the arbitral award, and obtaining judicial relief for arbitrator's manifest disregard of the law is rare." Duferco Int'l Steel Trading v. T. Klaveness Shipping A/S, 333 F.3d 383, 388 (2d. Cir. 2003) The manifest disregard doctrine allows a reviewing court to vacate an arbitration award only in "those exceedingly rare instances where some egregious impropriety on the part of the arbitrators is apparent." (Id.) A federal court cannot vacate an arbitral award merely because it is convinced that the arbitration panel made the wrong call on the law. On the contrary, the award should be enforced, despite a court's disagreement with it on the merits, if there is a "barely colorable justification" for the outcome reached. Wallace v. Buttar, 378 F.3d 182, 194 (2d. Cir. 2004 )

Several elements must exist before the court can find manifest disregard. First, the law that was allegedly disregarded must be clear and explicitly applicable to facts before the arbitrators. Misapplication of ambiguous law dos not constitute manifest disregard. Second, the law must be improperly applied, leading to an erroneous outcome. If the result is justified for other reasons, the doctrine is inapplicable. Third, the law must be known by the arbitrators and its applicability must have been pointed out by one of the parties. Duferco, 333 F.3d at 389-90. According to the Sixth Circuit, an arbitrator acts with manifest disregard if "(1) the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) the arbitrators refused to heed that legal principle." Merrill Lynch Pierce Fenner & Smith., Inc. v. Jaros, 70 F.3d 418, 421 (6^th Cir. 1995.)

In Comedy Club, Inc. v. Improve West Associates, 553 F.3d 1277 (9 Cir. 2009), the Ninth Circuit explained why it concluded that manifest disregard is still viable after Hill Street Associates. The Ninth Circuit acknowledged that Hill Street stands for the proposition that the FAA provides the exclusive grounds to modify or vacate an arbitration award. 553 F.3d at 1290. However, it rejected Improv West's argument that since manifest disregard is not listed in the statute, it cannot be used. Noting that the Supreme Court in Hill Street did not directly address the manifest disregard doctrine, but rather listed several readings of the doctrine (see above), it would continue to utilize its prior precedent that "the manifest disregard ground for vacatur is shorthand for a statutory ground under the FAA, specifically 9 USC § 10 (a) (4), which states that the court may vacate ‘where the arbitrators exceeded their powers.'" (Id.) In other words, where an arbitrator meets the elements of manifest disregard summarized above, he has exceeded his powers and the reviewing court can properly vacate the arbitration award.

Using a somewhat different rationale, the Second Circuit Court of Appeals reached the same conclusion in Stolt-Nielsen, SA v. Animalfeeds International Corp., 548 F.3d 85 (2nd Cir. 2008). With respect to Hill Street, the Second Circuit noted that the Supreme Court "declined to resolve [the manifest disregard] question explicitly, noting instead that it had never indicated, in Wilko or elsewhere, that "manifest disregard' was an independent basis for vacatur outside the grounds provided in section 10 of the FAA." 548 F.3d at 94. The Second Circuit explained that it viewed the "manifest disregard" concept as a mechanism to enforce the parties' arbitration agreement and not a judicial review device.

We must therefore continue to bear the responsibility to vacate arbitration awards in the rare instances in which the arbitrator knew of the relevant legal principle, appreciated that this principle controlled the outcome of the disputed issue and nonetheless willfully flouted the governing law by refusing to apply it. (Cite omitted) At that point the arbitrators have "failed to interpret the contract at all (cite omitted), for parties do not agree in advance to submit to arbitration that is carried out in manifest disregard of the law. Put another way, the arbitrators have thereby "exceeded their powers, or so imperfectly executed them that a mutual, final and definite award upon the subject matter was not made. (Cite Omitted.).

Id at 95.

In its decision upholding the applicability of the manifest disregard principle, the Sixth Circuit simply stated, "In light of the Supreme Court's hesitation to reject the "manifest disregard" doctrine in all circumstances, we believe it would be imprudent to cease employing such a universally recognized principle. Accordingly, this Court will follow its well-established precedent...." Coffee Beanery, Ltd. v. WW, LLC, 300 Fed Appx. 415 (6 Cir. 2008).

In contrast to the cases discussed above, three courts from distinctly different jurisdictions have concluded that the manifest disregard standard did not survive Hill Street. Those courts are the First Circuit Federal Court of Appeals, the Federal District Court from Minnesota and the Alabama Supreme Court. The First Circuit case is Ramos-Santiago v. United Parcel Service, 524 F.3d 120 (1st. Cir. 2008) Ramos-Santiago did not involve the FAA, so the issue was not before the court. Nevertheless, in a footnote, the Court stated: "We acknowledge the Supreme Court's recent holding in Hall Street Associates v. Mattel, Inc., --- U.S.---, 128 S. Ct. 1396, 1401-04, 170 L. Ed. 2d 254 (2008), that manifest disregard of the law is not a valid ground for vacating or modifying an arbitral award brought under the Federal Arbitration Act."

In Prime Therapeutics LLC v. Omnicare, Inc., 555 F. Supp. 2d 993 (D. Minn. 2008), the Minnesota Federal District Court engaged in an extensive discussion of Hill Street and its impact on manifest disregard. The Court acknowledged that the Eight Circuit, where it is located and under whose precedents it is governed, had recognized the manifest disregard doctrine. 555 F. Supp. at 997. The Court read Hill Street as rejecting arguments that the statutory grounds for vacating or modifying an arbitration award were not exclusive. Rather, said the District Court, "the Supreme Court held that Sections 10 and 11 of the FAA provide the exclusive grounds for vacating and modifying an arbitration award." Id. at 998. The Court pointed out that the Supreme Court emphasized that there was "no hint of flexibility" in the FAA language and that the arbitration award "must" be confirmed "unless" one of the specific grounds set out in Sections 10 and 11 of the Act is present. Id. at 998-99. The Court went on to asked "But does this suggest that courts can no longer vacate an arbitration award based on judicially-created grounds such as "manifest disregard" of the law? After Hall Street, this Court believes the answer to that question is yes." Id. at 999.

In Hereford v. D.R. Horton, Inc., --- So.2d---, 2009 WL 104666 (Ala. 1/9/09), the Alabama Supreme Court was required to review the actions of a lower state appellate court in the context of an arbitration agreement that was governed by the FAA. Alabama courts had previously recognized that the manifest disregard doctrine controlled arbitrations under the federal scheme. The question before the Hereford court was whether the manifest disregard doctrine continued to apply after Hill Street. Noting that the Supreme Court in Hill Street "rejected the conclusion that it had adopted manifest disregard as an additional, non-statutory ground for relief from an arbitrator's decision" (2009 WL 104666at * 5), the Alabama Supreme Court held "that manifest disregard is no longer an independent and proper basis under the Federal Arbitration Act for vacating, modifying or correcting an arbitrator's award." (Id.)

In conclusion, the debate about judicial review of arbitration awards and the continued applicability of the "manifest disregard" doctrine will continue in the various federal and state courts until the Supreme Court again speaks on the issue. However, one thing is clear: if you are arbitrating under the aegis of the FAA and are in the federal courts, your ability to obtain judicial review of an arbitration award is, at best, very limited. And, if the Supreme Court decides that the manifest disregard doctrine no longer has any vitality, the scope of review will be limited even further.

If you are interested in preserving a right to appeal an arbitrator's award, you need to be careful to adopt the California approach discussed in the earlier article and then hope that your jurisdiction will agree with the California Supreme Court.

COBRA Revisions to the American Recovery and Reinvestment Act of 2009

The Department of Labor has just made model notices available to assist employers in complying with the COBRA provisions in the American Recovery and Reinvestment Act of 2009 (ARRA). ARRA made temporary changes to the health benefit provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), as well as continuation coverage under similar state laws.

Under ARRA, eligible former employees, enrolled in their employer's health plan at the time they lost their jobs, are required to pay only 35 percent of the cost of COBRA coverage. Employers must treat the 35 percent payment by eligible former employees as full payment, but are entitled to a credit for the other 65 percent of the COBRA cost on their payroll tax return.

Most employers should have already received the revised version of the "Employer's Quarterly Federal Tax Return", Form 941. This form is used to claim the new COBRA premium assistance payments credit, beginning with the first quarter of 2009.

Employers must maintain supporting documentation for the credit claimed. This includes:

Documentation of receipt of the employee's 35 percent share of the premium;
For insured employers, a copy of invoice or other supporting statement from the insurance carrier and proof of timely payment of the full premium to the insurance carrier;
For self-insured employers, proof of the premium amount and proof of the coverage provided to the
assistance eligible individuals;
Proof of each assistance eligible individual's election of COBRA coverage and continued eligibility for COBRA coverage at any time during the period from September 1, 2008 to December 31, 2009;
Declaration of the former employee's involuntary termination.

The premium reduction applies to those employees involuntarily terminated, for reasons other than gross misconduct, between September 1, 2008 and December 31, 2009. The benefit is limited to nine months per employee.

Employers may need to retroactively credit employees who made payments for periods starting after February 17, 2009 and are also required to offer a second chance to employees who did not elect the coverage, or cancelled the coverage, no later than April 18, 2009.

Each case an employer may face is unique and may require legal advice. If these recent changes apply to your company, or you have other employment questions, please contact either Valerie Walker or John Egbert for more detailed information.

Why You Absolutely Need To Know Something About Bankruptcy: Designed for Those Wittingly or Unwittingly Drawn into the Bankruptcy Arena

When someone utters that dreaded "Bankruptcy" word, many people cringe and immediately conjure up images of debtors' prisons, insolvency, and in the wake of the recent Enron and WorldCom scandals, fraud and deceit. But, bankruptcy is really not such a horrific phenomenon from either the debtor or creditor perspective. Filing a bankruptcy does not necessarily mean an entity is in terminal financial
distress. Instead, bankruptcy can be an extremely useful business tool for a company to accomplish a beneficial sale of assets, obtain new financing or achieve a capital restructure. Creditors and potential
investors or purchasers can benefit from these aspects of bankruptcy just as much as the entity that files. Even in dire situations where a company is financially troubled, with knowledge and planning the debtor and its creditors can often salvage a decent outcome for all those concerned. But, there are traps for the unwary. These are the reasons why you really need to know something about the "B" word.

Please see the attached document for the complete brochure.

Employers Face Changes to the Americans with Disabilities Act (ADA)

Beginning on January 1, 2009, employers will have to comply with a new set of rules when it comes to disability discrimination in the workplace. On that date, recent amendments to the Americans with Disabilities Act ("ADA") will go into effect.

The Changes:

Since its enactment in 1990, the ADA has extended protections from discrimination and the right to reasonable accommodations to individuals who have a physical or mental "impairment" that "substantially limits" one or more "major life activity." Because the courts have interpreted those terms narrowly, the focus of ADA analysis over the past eighteen years has been on whether the individual is "disabled," and therefore eligible for ADA protections at all. This focus significantly limited the number of employees who could benefit from the ADA. For example, on the one hand, employees whose impairments do not cause "substantial" limits are not protected, but on the other hand, if their impairments are so "substantial" that the employees cannot perform the essential functions of their jobs, they are also not protected. Thus, only those employees within the narrow band between "substantially limited" and "too substantially limited" benefited from the ADA.

The recent amendments are intended to expand the definition of who is disabled so that the focus shifts from whether the employee qualifies for ADA protections to whether discrimination has occurred or reasonable accommodations can be made. Among other things, the amendments:

reject the U.S. Supreme Court's interpretation that "substantially limits" means "prevents or severely restricts," and calls for a less demanding standard;
prohibit consideration of mitigating measures such as medication, hearing aids or accommodations (other than ordinary eyeglasses or contact lenses) when determining whether an impairment constitutes a disability;
expand and clarify what fits within the definition of "major life activities;" and
provides that an individual who is merely regarded as having an impairment (regardless of whether he actually has an impairment or whether the impairment rises to the level of a disability) is protected from disability discrimination, but is not entitled to reasonable accommodations.

What the Changes Mean:

The amendments to the ADA mean that more employees (and applicants for jobs) will fit within the protections of the ADA. Employers will likely be required to make more accommodations for disabilities and will need to exercise greater caution when making employment decisions affecting individuals with physical or mental impairments. These changes, however, do not apply retroactively to decisions made prior to the January 1, 2009, effective date of the amendments.

Recommendations:

To ensure compliance with the revisions to the ADA we recommend that employers consider doing the following before the amendments take effect:

Recognize that more individuals are going to qualify for reasonable accommodations;
Train frontline supervisors to understand that any link between an employment decision and an impairment may give rise to a "regarded as" claim of discrimination; thus, supervisors must avoid comments about employees' impairments;
Establish a process for centralized decision making when employment decisions involve employees with physical or mental impairments and when employees request accommodations; and
Review policies and practices to ensure ADA compliance, particularly those related to post-offer medical examinations (choosing to revoke an offer of employment based on such an examination may give rise to a "regarded as" claim); and
Review and update (or, if necessary, create) job descriptions for all positions.

Judicial Review of Arbitration Awards

Alternative Dispute Resolution (ADR) generally means arbitration or mediation. Mediation is a non-binding process where a neutral third-party intermediary attempts to bring the disputing parties together to resolve a dispute voluntarily. Arbitration, on the other hand, is a binding process where the third-party neutral has the authority to, after considering the parties' respective positions through an evidentiary proceeding, make decisions on the issues that the parties must accept.

For the past decade or longer, ADR has been the darling of lawyers and clients, who seek alternatives to the prolonged and costly process of court litigation. This is reflected in the following facts: the number of disputes resolved by ADR has increased dramatically; traditional arbitration organizations have expanded the scope of their services to include mediation and other ADR activities; new arbitration organizations have been formed to compete with the traditional providers; and more and more lawyers are advertising their services as mediators and arbitrators. This article deals with a particular aspect of arbitration - the ability of parties to obtain judicial review of the decision of the arbitrator, in other words, an appeal.

State and Federal Arbitration Statutes
Each state and the Federal system have their own statutory arbitration scheme. The Federal Arbitration Act (FAA) can be found at 9 U.S.C.A. § 1. et seq. Many states, like Arizona, model their arbitration regimes on the Uniform Arbitration Act.[i] Typically, the governing arbitration statutes restrict the right of appeal of an arbitration decision. The Arizona statute, following the Uniform Act, provides that a court can review an arbitrator's decision only in the following circumstances: where the award was procured by corruption, fraud or other undue means; evident partiality by a neutral arbitrator; where the arbitrator(s) exceeded his powers; where the arbitrator(s) conducted the hearing contrary to law or to the substantial prejudice of one of the parties; and where the adverse party contested the arbitration and did not participate in the proceeding.[ii] Applying these provisions, Arizona courts have consistently recognized the limited role of trial courts in reviewing the arbitration award.[iii] Under the FAA grounds for vacating an arbitration award include where the award was procured by "corruption," "fraud" or "undue means" and where the arbitrators were "guilty of misconduct" or "exceeded their powers." Grounds for modifying or correcting an award include "evident material miscalculation," "evident material mistake" and "imperfections in matter of form not affecting the merits."[iv]

It should be noted that neither the Uniform/Arizona Act nor the Federal Act provides an appeal in circumstances where one party believes that the arbitrator(s) erred with respect to factual findings or application of law. In fact, there are many court decisions from numerous jurisdictions, including Arizona, that uphold the rejection of appeals on those grounds.[v] And, many courts have gone so far as to say that there is no right to contest an arbitration award even where the arbitrator clearly ignored the facts or the law.[vi]

To deal with what many perceive to be the unjust results of allowing an arbitrator such wide discretion, many lawyers have attempted to insert provisions in contractual arbitration agreements that require arbitrators to apply the law of the jurisdiction to the facts and provide the parties with a right to appeal the arbitrator's rulings if they believe that the arbitrator exceeded his authority by deviating from that standard. This drafting practice has resulted in one of the hot issues relating to arbitration practice over the past few years. The issue is whether parties to an arbitration agreement can contractually agree to a judicial review provision that will be enforceable in the courts. This issue stems from the conflict between the accepted concept that arbitration agreements are contracts between the parties who have the right and power to determine their own processes, and the traditional review limitations found in the various arbitration enabling statutes that are based on the long-held polices of cost saving and finality. As reflected in the cases discussed below, the answer to the question depends on the language of the arbitration agreement and the law of the jurisdiction that governs the arbitration process.

The starting point of the discussion lies in the fact that most courts view arbitration agreements as contracts, to be shaped by the parties through negotiations just as any other contract. And, because the parties have made their own deal, they are bound by it.[vii] The California Supreme Court has expressly held that in private arbitration, "[t]he scope of arbitration is...a matter of agreement between the parties" and "[t]he powers of an arbitrator are limited and circumscribed by the agreement or stipulation of submission."[viii] Other courts that have similarly held include the United States Supreme Court.[ix]

On the other hand, courts also generally recognize two other countervailing principles: the first is that parties enter arbitration agreements in order to obtain quicker, less expensive, final resolution of disputes[x]; and, second, that an arbitrator is free to decide matters submitted to him as he or she sees fit.[xi]

The tensions among these competing principles are reflected in the different treatments of the issues in this year's decisions of the United States Supreme Court in Hall Street Associates, LLC v. Mattel, Inc., --- US---, 128 S. Ct. 1396, 170 L. Ed 2d. 254 (2008) (applying the Federal Arbitration Act) and the California Supreme Court in Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal.4th 1334, 190 P.3d 586 (2008) (applying California's Arbitration Act). As more fully explained below, in Hall Street, the United States Supreme Court held that parties to an arbitration contract could not expand the review powers set out in the FAA. However, in Cable Connection, the California Supreme Court allowed the parties to do exactly that under the California statute.

Hall Street involved a lease dispute. After a bench trial in Federal District Court on some issues, the parties proposed to resolve the remaining issues by arbitration. Their arbitration agreement required the court to vacate, modify or correct any award if the arbitrator's findings of fact were not supported by substantial evidence or where the conclusions of law were erroneous. Although the procedural history is somewhat convoluted, essentially, after the arbitration, the District Court, applying the agreement's legal-error review standard, vacated the arbitrator's award. The Ninth Circuit Court of Appeals reversed on the grounds that the expanded review provisions were unenforceable. The Supreme Court agreed with the Ninth Circuit, rejecting the argument that arbitration is a matter of contract and that the FAA reflects a congressional desire to enforce such contracts.[xii]

However, the Supreme Court left open a huge loophole. The Court emphasized that its decision was based entirely on the FAA's judicial review mechanisms, and that it "decides nothing about other possible avenues for judicial enforcement of awards." The Court noted that the FAA is not the only way into court for parties wanting review of arbitration awards.[xiii] Other possible avenues into the Federal court system include state statutory or common law[xiv]; and, other alternatives including the Alternative Dispute Resolution Act of 1998 (28 USCA § 651. et seq.).[xv] Clearly, the Supreme Court did not issue a broad ban on judicial review of arbitration awards - "We express no opinion on these matters beyond leaving them open for Hall Street to press on remand."[xvi]

The California Supreme Court in Cable Connections, Inc v. DirecTV, Inc., 44 Cal.4th 1334, 190 P.3d 586 (2008) recently took a different tact in the context of the California Arbitration Act, which is very similar to the Arizona statute (and the Uniform Act). Similar to the FAA and the Uniform/Arizona Act, the CAA allows judicial review to vacate or modify an arbitration award under the following circumstances: (1) where the award was procured by corruption, fraud or undue means; (2) issued by corrupt arbitrators; (3) affected by prejudicial misconduct on the part of the arbitrators; or (4) in excess of the arbitrators' powers.[xvii]

In Cable Connections, Inc. the California Supreme Court decided that California's rule would be that parties in arbitration may obtain judicial review of the merits of an arbitration award by express agreement. The Court held that the following clause, providing for judicial review of an arbitrator's decision, was enforceable under state law: "The arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for any such error." The California Supreme Court reasoned: "[T] failure to provide for [traditional judicial review] by statute does not mean the parties themselves may not do so by contract."[xviii] "If the parties constrain the arbitrators' authority by requiring a dispute to be decided according to the rule of law and make plain their intention that the award is reviewable for legal error, the general rule of limited review has been displaced by the parties' agreement."[xix] The Court went on to state: "Accordingly, policies favoring the efficiency of private arbitration as a means of dispute resolution must sometimes yield to its fundamentally contractual nature, and to the attendant requirement that arbitration shall proceed as the parties themselves have agreed."[xx] In sum, noted the Court, objections to expanded judicial review "are outweighed by the freedom of contract that is fundamental to arbitration..."[xxi]

Very significant in the analysis of the California Supreme Court was its emphasis on the need for express language granting judicial review of the arbitrator's decision. In approving the language quoted above, the Supreme Court distinguished the provision before it from other similar provisions that had come before the California appellate courts in recent years, which had been rejected as being too vague or too implicit to create the right to appellate review. Examples of those cases are Baize v. Eastridge Companies, LLC,[xxii] which included the phrases "the arbitrator shall apply California law" and "shall be constrained by the rule of law"; and Marsch v. Williams,[xxiii] California law "shall govern the interpretation and effect" of the contract.

Although the Arizona Court of Appeals has stated that a decision of an arbitrator on a question of fact or of law is final and conclusive, except when they conflict with the express guidelines or standards set forth or adopted in the arbitration agreement,[xxiv] Arizona appellate courts have not addressed these specific issues. Thus, even though the Smitty's Super-Valu language may suggest a position consistent with the California Supreme Court in Cable Connections, we do not know what the Arizona appellate courts will decide on this issue. Nevertheless, the lesson of these cases is clear: If you want to have the potential right to appeal an arbitration award, you should do the following:

You should make sure that you do not include a provision that the matter is to proceed under the Federal Arbitration Act; rather, make sure it is to proceed under the state's version of the Uniform Act or, maybe even better, the California Arbitration Act; and,
You should make sure the judicial review provision is very explicit. Clauses that are the slightest bit vague stand to be rejected.

[i] 1956 Uniform Arbitration Act (ULA) §§ 1 et seq.; A.R.S. § 12-501, et seq.

[ii] A.R.S. § 12-1512(A)(1-5).

[iii] See Fisher on behalf of Fisher v. National General Ins. Co., 192 Ariz. 366, 965 P.2d 100 (App. 1998) (Arbitrator's decision is generally final and conclusive; the Uniform Arbitration Act provides very limited grounds for the trial court to deny confirmation of an arbitration award.)

[iv] 9 U.S.C.A. §§ 10 and 11.

[v] Pavelich v. Farmers Ins. Co., 127 Ariz. 170, 618 P.2d 1096 (App. 1980) (Trial court can not substitute its view of evidence for that of arbitrator) and Hirt v. Hervey, 118 Ariz. 543, 578 P.2d 624 (App. 1978) (same).

[vi] Verdex Steel & Const. Co. v. Bd. of Supvr., Maricopa County, 19 Ariz. App. 547, 509 P.2d 240 (1973) (Even though a court reviewing an arbitration award might consider some rulings erroneous, the rulings are binding unless they result in an improper expansion of the arbitrator's powers.).

[vii] Arizona cases on this point include Valdiviezo v. Phelps Dodge Hidalgo Smelter, Inc., 995 F. Supp. 1060 (D. Ariz. 1997) (Arbitration is a matter of contract and a party cannot be required to arbitrate any dispute which he has not agreed to arbitrate.) and Smitty's Super-Valu, Inc. v. Pasqualete, 22 Ariz. App. 178, 525 P.2d 309 (1974) (The boundaries of the arbitrator's powers are defined by the agreement of the parties.).

[viii] Moncharsh v. Heily & Blase, 3 Cal. 4^th 1, 8-9, 832 P.2d 899, 902, 10 Cal. Rptr. 2^nd 183, 186 (1992) (citations omitted).

[ix] See, Hall Street Associates, LLC v. Mattel, Inc., --- U.S.---, 128 S. Ct. 1396, 1402 (2008) (arbitration agreements are on equal footing with all other contracts); First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 947 (1995) ("...[T]he basic objective [of arbitration agreements is] to ensure that commercial arbitration agreements, like other contracts, are enforced according to their terms...and according to the intentions of the parties."); and Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614, 625 (1985) (the Federal policy served by the FAA is "at bottom a policy guaranteeing the enforcement of private contractual arrangements.").

[x] Canon School Dist No. 50 v. WES Const. Co., Inc., 180 Ariz. 148, 882 P.2d 1274 (1994) and Old Republic Ins. Co. v. St. Paul Fire & Marine Ins. Co., 45 Cal App. 4^th 631, 638 (1996) ("the primary purposes of arbitration, quicker results and early finality").

[xi] See, e.g. Moncharsh, 3 Cal. 4^th 1, 10-12, 832 P.2d 899 ("arbitrators, unless specifically required to act in conformity with rules of law may base their decision upon broad principles of justice and equity and in doing so may expressly or impliedly reject a claim that a party might successfully have asserted in a judicial action..."; judicial deference to an arbitrator's findings of fact and application of law is based on the fact that the parties to the agreement knowingly take the risk of such error as a "trade off" in order to obtain speedy decisions.). See also Moshonov v. Walsh, 22 Cal. 4^th771, 775-777 (2000) ("When parties contract to resolve their disputes by private arbitration, their agreement ordinarily contemplates that the arbitrator will have the power to decide any questions .... Inherent in that power is the possibility the arbitrator may err in deciding some aspect of the case. Arbitrators do not ordinarily exceed their contractually created powers simply by reaching an erroneous conclusion on a contested issue of law or fact, and arbitral awards may not ordinarily be vacated because of such an error for the arbitrator's resolution of theses issues is what the parties bargained for in the arbitration agreement.").

[xii] Interestingly, before the Supreme Court's Hall Street decision, the Federal Circuits were split on the issue - 3 agreeing with unenforceability (Eighth, Ninth and Tenth Circuits) and 5 holding that the parties could expand review by contract (First, Third, Fourth, Fifth, and Sixth Circuits). (128 S. Ct. 1403, fn. 5.)

[xiii] Id. at 1406.

[xiv] Id.

[xv] Id. at 1407.

[xvi] Id.

[xvii] Code Civ. Proc., § 1286.2(a)(4).

[xviii] 44 Cal. 4^th at 1357, 109 P.3d at 601-02, emphasis in original.

[xix] 44 Cal. 4^th at 1355, 109 P.3d at 600, emphasis in original.

[xx] 44 Cal. 4^th at 1358, 109 P.3d at 602, quoting Vandenberg v Superior Court, 21 Cal App 4^th 815, 831 (1999). (Emphasis in original.)

[xxi] 44 Cal. 4^th at 604, 109 P.3d at 1361.

[xxii] 142

Each state and the Federal system have their own statutory arbitration scheme. The Federal Arbitration Act (FAA) can be found at 9 U.S.C.A. § 1. et seq. Many states, like Arizona, model their arbitration regimes on the Uniform Arbitration Act.[i] Typically, the governing arbitration statues restrict the right of appeal of an arbitration decision. The Arizona statute, following the Uniform Act, provides that a court can review an arbitrator's decision only in the following circumstances: where the award was procured by corruption, fraud or other undue means; evident partiality by a neutral arbitrator; where the arbitrator(s) exceeded his powers; where the arbitrator(s) conducted the hearing contrary to law or to the substantial prejudice of one of the parties; and where the adverse party contested the arbitration and did not participate in the proceeding.[ii] Applying these provisions, Arizona courts have consistently recognized the limited role of trial courts in reviewing the arbitration award.[iii] Under the FAA grounds for vacating an arbitration award include where the award was procured by "corruption," "fraud" or "undue means" and where the arbitrators were "guilty of misconduct" or "exceeded their powers." Grounds for modifying or correcting an award include "evident material miscalculation," "evident material mistake" and "imperfections in matter of form not affecting the merits."[iv]

You should make sure that you do not include a provision that the matter is to proceed under the Federal Arbitration Act; rather, make sure it is to proceed under the state's version of the Uniform Act or, maybe even better, the California Arbitration Act; and,
You should make sure the judicial review provision is very explicit. Clauses that are the slightest bit vague stand to be rejected.

[i] 1956 Uniform Arbitration Act (ULA) §§ 1 et seq.; A.R.S. § 12-501, et seq.

[ii] A.R.S. § 12-1512(A)(1-5).

[iv] 9 U.S.C.A. §§ 10 and 11.

[viii] Moncharsh v. Heily & Blase, 3 Cal. 4^th 1, 8-9, 832 P.2d 899, 902, 10 Cal. Rptr. 2^nd 183, 186 (1992) (citations omitted).

[xiii] Id. at 1406.

[xiv] Id.

[xv] Id. at 1407.

[xvi] Id.

[xvii] Code Civ. Proc., § 1286.2(a)(4).

[xviii] 44 Cal. 4^th at 1357, 109 P.3d at 601-02, emphasis in original.

[xix] 44 Cal. 4^th at 1355, 109 P.3d at 600, emphasis in original.

[xx] 44 Cal. 4^th at 1358, 109 P.3d at 602, quoting Vandenberg v Superior Court, 21 Cal App 4^th 815, 831 (1999). (Emphasis in original.)

[xxi] 44 Cal. 4^th at 604, 109 P.3d at 1361.

[xxii] 142 Cal App. 4th 293 (2006).

[xxiii] 23 Cal App. 4^th 238, 245 (1994).

[xxiv] See Smitty's Super-Valu, note 7.

Cal App. 4th 293 (2006).

[xxiii] 23 Cal App. 4^th 238, 245 (1994).

[xxiv] See Smitty's Super-Valu, note 7.

Exploring the Unthinkable in Lawyer Discipline: Disbarment, Suspension and Reinstatement

Fortunately, most lawyers will never have to contemplate a day when they will receive an order of the Arizona Supreme Court suspending or disbarring them.[i] For those lawyers whose discipline cases include the possibility of a long-term suspension or disbarment, however, planning early for discipline can be important.[ii] This is true even in cases where the lawyer has a sound defense that could result in dismissal of all charges, or mitigation that could dramatically reduce the sanction.

It is often possible to analyze a range of potential sanctions before the State Bar states its sanction position, which often occurs before a formal complaint is filed. If the upper end of possible sanctions includes a long-term suspension (six months and one day or longer), or disbarment, then the respondent lawyer is well-advised to consider the reinstatement process early, ideally while she is preparing her initial response to the State Bar's screening investigation.

This is not to say that a lawyer facing potential disbarment or a long-term suspension should give up and not present a defense. As in any litigation, an early risk-benefit analysis can allow a lawyer to determine where best to invest her financial, professional, and emotional resources. Even in those cases that will involve a vigorous defense, early consideration of the reinstatement process can be an integral and effective part of the lawyer's overall planning and strategy if the allegations could result in disbarment or a long-term suspension.

A few preliminary concepts help explain why early consideration of reinstatement is important. First, disbarment is not permanent in Arizona. After five years, a disbarred lawyer may retake the Bar exam and apply for reinstatement.[iii] A lot can happen in five years. A lawyer who believes her professional life is over after disbarment may have another perspective five years later. Even a disbarred lawyer (or a lawyer who has received a long-term suspension) who does not want to resume the practice of law may nevertheless apply for reinstatement to remove the stigma and demonstrate that she has the character to practice law.

Second, even lawyers who are suspended for six months or less technically must be reinstated before they can resume their practice. As discussed below, failure to follow procedural steps at the beginning and end of suspension can delay (or impede) the lawyer's reinstatement.

Third, any disbarment or long-term suspension requires the lawyer to apply for reinstatement, which can be complex and onerous. Reinstatement starts with a voluminous application that requires disclosure of personal information. Thereafter, the applicant must present evidence at a hearing and wait for review by the Disciplinary Commission[iv] and the Arizona Supreme Court before her reinstatement becomes effective. Given the proof necessary to be reinstated, having a defined plan in place at the start of the disbarment or long-term suspension is almost essential.

Rules Applicable to All Suspended or Disbarred Lawyers

An order of suspension or disbarment is effective thirty days after the Supreme Court issues it.[v] This does not mean, however, that a lawyer can take on new clients, or new assignments for existing clients, for the next thirty days: "Respondent, after entry of a judgment of disbarment or suspension, shall not engage in the practice of law, except that during the period between entry and the effective date of the order, respondent may complete on behalf of any client all matters that were pending on the entry date."[vi] If the lawyer has not planned for the order in advance, she may be busy over the next ten days. For pending matters (active or inactive), Rule 72 of the Arizona Supreme Court Rules requires the disbarred or suspended lawyer, within ten days of the date of the order, to provide written notice to all clients, any co-counsel, any opposing counsel, and each court and division.[vii] The lawyer must also return client property, including unearned fees and files "notwithstanding any claim of an attorney lien."[viii] The lawyer must also move to withdraw from any pending litigation where the client does not obtain replacement counsel.[ix] Finally, within ten days of the date of the order, the lawyer must file an affidavit with both the Disciplinary Commission and the Supreme Court, and serve a copy on Bar counsel, attesting that she has met all requirements of Rule 72, and providing other information.[x]

These requirements apply to every suspension, from thirty days to five years.[xi] Although disbarment and suspension orders refer to Rule 72, and many attorneys comply with most of those requirements, failure to file the affidavit (a "Rule 72(e) affidavit") and serve it on Bar counsel is a relatively common problem. Because reinstatement requires an applicant to attest to or prove "compliance with all applicable discipline orders and rules,"[xii] failure to file and serve the affidavit could complicate the reinstatement process. Thus, in this respect, reinstatement begins during the first ten days after the disbarment or suspension order.[xiii]

Because the rules covering the first ten days of a disbarment or suspension can be onerous (and come at a time when the lawyer likely is not feeling motivated), some lawyers begin the process before receiving the order. The lawyer discipline process usually leaves a lawyer time between the Disciplinary Commission's recommendation of disbarment or suspension and the Supreme Court's order. Lawyers may prefer to start winding down their practices (even for a short-term suspension) before the order is issued for several reasons, including a desire to talk personally to clients and explain the Court's anticipated action, discuss and obtain client consent on the amount of fees (if any) due for refund, transfer files to replacement counsel, and move to withdraw where necessary. A lawyer who anticipates the order could have nothing left to do under Rule 72 after the order issues, except the Rule 72(e) affidavit. Even that can be prepared in advance.[xiv]

A smooth transition into disbarment or suspension can also benefit the lawyer in the reinstatement process. Because suspension or disbarment cases often involve prejudice to one or more clients, both the lawyer and the client(s) may find closure through the lawyer's explanation of what happened and acknowledgement of responsibility.[xv] During the reinstatement process, the State Bar will contact the complainants (and perhaps other former clients) to ask their opinion on reinstatement. A client who believes the lawyer closed her practice professionally and ethically, and who talked to the lawyer about the misconduct, is more likely to support reinstatement than a client who believes the lawyer did not care. A complainant's negative opinion about reinstatement usually is not dispositive in a reinstatement case, but it still must be overcome. In contrast, having a complainant support reinstatement can be a positive factor.

Reinstatement After a Short-Term Suspension

A suspension of six months or less is considered short term and usually does not require the lawyer to apply for reinstatement. Nevertheless, the lawyer cannot simply resume her practice when her suspension ends. Rule 64(e) of the Arizona Supreme Court Rules requires the lawyer to file an affidavit stating that she has complied with all requirements of the suspension order and paid all costs and expenses. Those requirements include the suspension period, the Rule 72 requirements discussed above, and costs. They may also include restitution, which must be paid before reinstatement.[xvi]

The Rule 64(e) affidavit, like the Rule 72(e) affidavit, must be filed with the Supreme Court Clerk and the Disciplinary Clerk and served on Bar counsel. The State Bar has ten days after service of the affidavit to file and serve a response. If the State Bar does not file a response, it is deemed to consent to reinstatement, and the Clerk may issue an order reinstating the lawyer. [xvii] If the State Bar files a response, however, the lawyer cannot resume practice until the Court reviews the matter. In either case, the lawyer may not resume her practice until the Clerk issues an order.[xviii]

Failure to comply with the reinstatement affidavit requirement can be costly. If the affidavit is not filed within sixty days of the end of the suspension period, the lawyer must follow the same reinstatement process as lawyers who have been disbarred or suspended for more than six months.[xix] The full reinstatement process, as described below, can be long and difficult, and the lawyer cannot practice while it is pending.

There are two potential "traps," then, for the unwary lawyer who receives a short-term suspension: (1) the Rule 72(e) affidavit must be filed within ten days of the suspension order; and (2) the Rule 64(e) affidavit must be filed within 60 days of the end of the suspension. Because failure to file either affidavit can have serious consequences, lawyers facing a possible short-term suspension should prepare in advance.

Reinstatement After Disbarment or Long-Term Suspension

Reinstatement for disbarred and long-term suspended lawyers can be difficult in Arizona. Indeed, certain lawyers face a rebuttable presumption that they are disqualified for reinstatement - those who have been convicted of a misdemeanor involving a "serious crime" or any felony.[xx] Thankfully, relatively few Arizona lawyers are disbarred or suspended for any criminal conduct, much less a felony or misdemeanor involving a serious crime. Lawyers who fall under that category, however, are not alone in facing an arduous reinstatement process.

The stakes are high for any lawyer seeking reinstatement: if an application is denied, the applicant cannot reapply for one year.[xxi] Thus, a lawyer who risks disbarment or a long-term suspension, or who already is under a disbarment or suspension order, should devote the time and resources necessary to prepare and assess the likelihood of success.

Preparing the application can take weeks, and once it is filed, the process can go on for months. (Likely because of the length of the process, the rules permit filing the application 90 days before the end of the suspension period.[xxii]) The application (in the form of a motion) contains an array of personal and financial information. These requirements are contained in Rule 65(a), Arizona Supreme Court Rules, and include, for the period of rehabilitation, such information as: a detailed list of employment; a statement of monthly earnings and other income from all sources; all residences; all financial obligations; and a series of questions related to civil and criminal matters and other professional licenses.[xxiii] In addition, the lawyer is required to submit all state and federal income tax statements during the rehabilitation period.[xxiv]

While, in the underlying discipline case, the State Bar bore the burden of proving its case by clear and convincing evidence[xxv], the roles reverse on reinstatement. The applicant must prove by clear and convincing evidence "the lawyer's rehabilitation, compliance with all applicable disciplinary orders and rules, fitness to practice, and competence."[xxvi] Meeting the burden requires forethought.

Fitness and Competence. Every disbarred lawyer, and any suspended lawyer who has not applied for reinstatement for five years, must pass the Bar exam.[xxvii] Even lawyers who have not been out of practice for five years must nevertheless prove their competence. If retaking the bar exam is not required, a lawyer can prove competence by showing that she has remained abreast of the law, including proof of employment in a law-related field (but not the unauthorized practice of law), meeting CLE requirements, or other similar activities.[xxviii] Proof of fitness can include a successful employment history, preferably with support from the employer or immediate supervisor.

Compliance with Applicable Orders and Rules. The requirement to prove compliance with all applicable orders and rules starts with Rule 72, including the Rule 72(e) affidavit (discussed above). It also includes proof of payment of State Bar costs and any restitution. Lawyers should not wait to pay restitution until they are preparing for reinstatement. Last-minute payments imply indifference. Lawyers with serious financial hardship should communicate with the individuals to whom they owe restitution and, if possible, make installment payments to show good faith. All lawyers who owe restitution should keep records of their payments, including proof of their efforts to find individuals who may have moved.

Rehabilitation. All required elements of proof for reinstatement are important, but none is harder to prove, nor ultimately more important, than rehabilitation. In 2004, the Arizona Supreme Court re-defined the requirement of proving rehabilitation in certain cases and, in so doing, gave some respondent lawyers reason to consider their eventual reinstatement even while they prepare their defense to the underlying case.

In re Arrotta was a post-disbarment reinstatement case where the misconduct included a guilty plea to federal felony charges. [xxix] The applicant presented character and law-related employment evidence to prove rehabilitation. The Court, finding that evidence insufficient, established a sliding scale of necessary proof: "the more serious the misconduct that led to disbarment, the more difficult is the applicant's task of showing rehabilitation."[xxx] Specifically, after Arrotta, it will not be enough simply to complete the sanction: " ‘[N]either the fact that Applicant has been sufficiently sanctioned, nor the mere passage of time, is enough to warrant reinstatement.'"[xxxi] Moreover, while accepting responsibility for misconduct is a factor for consideration, an applicant "must demonstrate more than that he has led a blameless and law-abiding life while disbarred."[xxxii]

Under Arrotta, proof of rehabilitation requires that an applicant "must first establish by clear and convincing evidence that he has identified just what weaknesses caused the misconduct and then demonstrate that he has overcome those weaknesses." [xxxiii] An applicant can meet this burden through testimony from a mental health professional, participation in community or charitable organizations, specialized instruction or education, or similar evidence.[xxxiv]

Although Arrotta involved a post-disbarment reinstatement resulting from criminal misconduct, its standards have been considered in long-term suspension cases where the misconduct was deemed dishonest. Nothing in Arrotta requires a lawyer to consider reinstatement standards while preparing her defense to the discipline case; however, any lawyer accused of dishonest conduct can benefit from an early look ahead to her possible reinstatement case. This is especially true if the lawyer cannot rebut the alleged facts. Because a year (or more) can pass between the initial allegation and the ultimate decision in a lawyer discipline case, a lawyer can use that period to identify and develop evidence of the "weakness" that led to the misconduct at any early date, and start to engage in activity designed to overcome that "weakness."

This process of identifying and controlling the "weakness" that caused misconduct can lead to changes in a lawyer's practice, changes that the lawyer must be willing to embrace. Some such changes can be substantial (e.g., changing jobs and/or areas of practice) but some can be minor (e.g., engaging in better training and other techniques to improve staff retention and loyalty). Either way, a pro-active approach to rehabilitation could affect the outcome of the discipline case. However, affecting the outcome should be neither the expectation, nor the sole purpose, of the process. The lawyer's efforts must be sincerely undertaken and seriously implemented for their own sake. They must be genuine. If the alleged conduct is serious, there is no guarantee that the result will be a lesser sanction.

When a discipline case alleges serious misconduct (including any allegation of dishonesty), and where the State Bar is seeking disbarment or a long-term suspension, if the lawyer can prove both the "weakness" that created the conduct and also that the solution to the "weakness" exists and has a track record of success, it will be a different case than one where the lawyer offers neither a credible defense nor a reason to save her career. Such a case will, at the very least, contain contemporaneous evidence of the Arrotta factors, which can serve, if necessary, as a strong foundation for the lawyer's subsequent reinstatement.

[i] Only the Arizona Supreme Court can censure, suspend or disbar a lawyer. Ariz.R.Sup.Ct. 60(a). Similarly, only the Court can reinstate a suspended or disbarred lawyer. Id., 65(b)(5).

[ii] This article does not cover reinstatement after summary suspension by the State Bar Board of Governors for failure to pay dues or meet annual CLE requirements. A lawyer under such suspensions must apply to the Board within two years and prove she has cured the deficiency that caused the suspension. The Board has authority to reinstate the lawyer. Id., 64(f).

[iii] Id., 64 (c), (d).

[iv] The Disciplinary Commission of the Supreme Court is, in essence, the court of appeals for lawyer discipline cases. See id., 49(c).

[v] Id., 72(d).

[vi] Id. (emphasis added).

[vii] Id., 72(a).

[viii] Id., 72(c).

[ix] Id., 72(b).

[x] Id., 72(e). The additional information consists of a list of all other state, federal and administrative jurisdictions in which the lawyer is admitted to practice, and the lawyer's residence and other addresses for receiving communications.

[xi] While any length of suspension up to five years is permissible, the minimum length of suspension that the Court imposes is 30 days. Thirty-day suspensions are increasingly rare.

[xii] Id., 65(b)(2).

[xiii] Failure to file a Rule 72(e) affidavit, if all other Rule 72 requirements were met, usually is not fatal to a reinstatement application that meets the applicant's burden of proof in all other respects. However, such a failure is a hurdle to jump from the outset and can show either the lawyer's negligence or indifference to the applicable rules at the start of the period of suspension or disbarment.

[xiv] Taking these steps in anticipation of the order would not be appropriate in a case that the lawyer believes the Supreme Court is likely to review. Nor is it necessary to start the process too early, in effect extending the disbarment or suspension period. A lawyer may also opt to prepare all necessary notices in advance, but not send them until the order issues.

[xv] If there is pending or potential civil litigation against the lawyer arising out of the same transactions or events, the lawyer should consult with her defense counsel before taking this step.

[xvi] Note that failure to have filed the Rule 72(e) affidavit may be considered failure to comply with the suspension order.

[xvii] Id., 64(e)(2)(A).

[xviii] Id., 64(e)(2)(B).

[xix] Id.

[xx] Id., 64(b). "Serious crime" is defined as "any crime, a necessary element of which ... involves interference with the administration of justice, false swearing, misrepresentation, fraud, willful extortion, misappropriation, theft, or moral turpitude, including a conspiracy, a solicitation of another, or any attempt to commit a serious crime."

[xxi] Id., 64(a)(4).

[xxii] Id., 64(e)(1).

[xxiii] Id., 65(a)(1). Lawyers with real estate licenses should note that they may have an obligation to report their lawyer discipline to the Arizona Department of Real Estate. Failure to do so may become an issue for the lawyer's State Bar reinstatement process.

[xxiv] Id., 65(a)(2)(C). The lawyer may move for a protective order sealing the tax statements and any other private information. The lawyer may also redact any private information -such as Social Security numbers-- from documents filed in support of the application.

[xxv] Id., 57(i)(3).

[xxvi] Id., 65(b)(3).

[xxvii] Id., 64(c).

[xxviii] CLE is not mandatory for suspended or disbarred lawyers.

[xxix] 208 Ariz. 509, 96 P.3d 213 (2004).

[xxx] Id., 208 Ariz. at 512, 96 P.3d at 216 (citations omitted).

[xxxi] Id., quoting In re Robbins, 172 Ariz. 255, 256, 836 P.2d 965, 966 (1992).

[xxxii] Id., 208 Ariz. at 515, 96 P.3d at 219.

[xxxiii] Id., 208 Ariz. at 513, 96 P.3d at 217 (emphasis added).

[xxxiv] Id., 208 Ariz. at 516, 96 P.3d at 220.

The 'B' Word: Bankruptcy Isn't Always a Bad Thing

The word "bankruptcy" sends chills down the spines of many business owners and executives as they envision certain financial demise.

But bankruptcy is no longer the frightening phenomenon it once may have been, particularly in the business realm. Chapter 11 bankruptcy has become an extremely useful business tool for a company to reorganize its operations, accomplish a sale of assets, obtain new financing or achieve a capital restructure.

The following are examples of challenges a business often faces:

A new business has not quite met revenue expectations.
The equity structure is outdated or unworkable.
The business owns excess real property it wants to sell or the business wants to acquire additional property.
The business has been threatened with litigation.
The business wants to refinance, but the lender has expressed concern about financial or other issues.
The owners of the business want to merge with another entity.

The most common use of the Chapter 11 bankruptcy process is one designed to restructure the company's balance sheet. A company that wants to extend or refinance onerous debt, eliminate burdensome contracts or leases, and/or bring in new capital can generally accomplish these goals by a Chapter 11 filing that provides these opportunities and a temporary safe haven.

But Chapter 11 isn't just for severely financially distressed entities. There are myriad other business reasons for filing a bankruptcy. For example, bankruptcy may be a good alternative for a client who owns some troubled properties and other healthy ones. Structuring a "roll up" and then using the bankruptcy process to propose a long-term solution can provide the necessary and ultimate protection for the distressed properties. Other common business transactions such as sales, mergers and acquisitions may be accomplished in a more beneficial fashion for all parties under the protective umbrella of Chapter 11.

A general knowledge of bankruptcy and the benefits it can provide will arm business owners, management and their advisors with a repertoire of creative solutions to meet business challenges and attain the companies' ultimate goals.

An overview
The purpose of a Chapter 11 bankruptcy is to reorganize. It may include restructuring debt, altering operations, eliminating equity, selling assets or any combination of these things. The reorganization is accomplished through a document called a "plan of reorganization" in which the debtor describes how it intends to pay creditors or treat equity interests. Creditors and equity interests have the opportunity to vote in favor of or against the plan. The aim is to have the plan confirmed by the bankruptcy court, at which time it becomes a binding contract on all affected parties.

A Chapter 11 proceeding is commenced quite easily by filing a simple two-page "petition" with the bankruptcy court. At the time of the filing, an "estate" is created and all assets owned by the debtor prior to the filing are considered to be property of that estate. The debtor is referred to as the "debtor in possession" (DIP). Filing of the case triggers an immediate imposition of an injunction called an "automatic stay." The stay prevents creditors from proceeding with any action against the DIP, and entitles the DIP some "breathing room" while assets are marshaled or while a reorganization is being developed.

In many respects, the general operations of a business continue in Chapter 11 as they did prior to the filing. The DIP can continue to buy inventory, produce products and sell merchandise as long as the transactions are in the ordinary course and scope of business. Nevertheless, certain actions such as the payment of pre-petition debt, the use of cash proceeds that may be subject to a lien, and the sale of major assets are prohibited unless the bankruptcy court approves them.

The plan of reorganization sets forth the means for payments to the company's creditors. The general rule is that all claimants on the same level must be treated equally and must be paid in full before the next level can receive payment. Other provisions include financing arrangements or capital contributions and the composition of the company's management.

The final step is plan "confirmation" by the bankruptcy court. In order for the DIP to confirm a plan, it must obtainthe affirmative vote of all the classes of creditors it has proposed. However, the bankruptcy code permits the DIP to confirm a plan even if it doesn't have all the needed votes, as long as the plan complies with certain specific sections of the code. Once the plan is confirmed, a bindingcontractbetween the debtor and its creditors is created and the debtor emerges from bankruptcy. All previous obligations to and claims by creditors are discharged and are replaced by therepayment orother obligations created by the plan. The "reorganized" debtor can have a fresh start.

Of course, there are many specifics and nuances to each bankruptcy case. For a comprehensive read on bankruptcy, you can download this guide at www.jsslaw.com/publications.aspx.

Download the realted file to the right to read the full article:

Adapting Your Licensing Strategy to Recent Patent Law Changes

Recent patent cases have changed important aspects of the law surrounding patent licensing. These changes will impact the preparation and interpretation of license agreements and license negotiation strategies in general. If your organization licenses patents, either as the licensor or the licensee, it is imperative that your organization and your legal counsel become aware of these significant changes in the law and how they will impact your organization's licensing strategies.

Three federal court decisions, MedImmune v. Genentech, KSR v. Teleflex, and Sandisk v. STMicroelectronics, have (individually and when analyzed together) made it easier for a patent licensee to challenge a licensor's patents and to potentially invalidate those patents.

* In MedImmune, the U.S. Supreme Court ruled that a licensee may challenge the validity, enforceability, and non-infringement of a licensor's patent without first breaching its license agreement, as previously required. Now a licensee may continue to pay royalties to the licensor "under protest" or with "reservation of rights" and still challenge the licensor's patent without being in breach of the license agreement and without facing possible infringement damages.
* In KSR, the U.S. Supreme Court altered the "obviousness" standard for determining the patentability of an invention. This decision arguably narrows the scope of patentable subject matter and makes it easier for a patent to be found invalid because of "obviousness." Patent holders whose claims combine prior art are especially vulnerable to these patent challenges. Moreover, thousands of existing patents whose validity was secure under the old standard might be susceptible to invalidation.
* In SanDisk, the U.S. Court of Appeals for the Federal Circuit held that the actual controversy needed to support a declaratory judgment action seeking to invalidate a patent was satisfied when two parties (e.g. potential licensor and potential licensee) reached adverse legal positions regarding potentially infringing activities, even if the patent owner expressly disclaimed any intention to sue.

Restructuring Future Patent Licenses and Altering Negotiation Strategy

In view of these cases, a patent holder (i.e. licensor) should negotiate more cautiously with a potential licensee and structure the potential license agreement to include new provisions that create economic disincentives to discourage a licensee from challenging the licensor's patent.

Conversely, a licensee should be aware that patent holders may begin negotiating more aggressively to include these types of provisions and should consider provisions that may help to preserve some of the pro-licensee impact of these recent cases.

The following are some pro-licensor strategies and provisions that should be considered in view of these recent cases:

* Termination Right if Licensee Challenges: Grant licensor the right (exercisable at licensor's sole election) to terminate the license if licensee challenges the validity, enforceability, or scope of the licensed patent in any claim, cross-claim, counterclaim or defense before any court, arbitrator, or administrative agency in any jurisdiction (even outside the license territory). Grant licensor the right to terminate if the licensee pays a royalty "under protest" or with a "reservation of rights."
* Notification Prior to Challenge: Require licensee to provide licensor with written notice explaining the basis for challenging the validity, enforceability, or scope of licensed patent. Also require a "grace period" to allow licensor to evaluate assertions, and a mandatory period for renegotiating the license agreement with licensor prior to filing the challenge.
* Forum Selection Provision: Licensors may now want greater control over the selection of the courts in which licensee may seek any challenge. Thus, specify the courts where a licensee must bring any challenge to the validity, enforceability, or scope of the patent and provide the licensee's consent to personal jurisdiction.
* Right to Raise Royalty Rate During Challenge: Grant licensor the right (exercisable at licensor's sole election) to raise the royalty rate during pendency of any challenge or if the licensee loses a challenge. Also grant licensor the right to recover costs and attorneys fees related to a challenge.
* Seek More Royalty Payments Upfront: Licensors may now want to obtain more upfront royalty payments from licensee and specify that these payments are non-refundable.
* Avoid Declaring Adverse Positions: Licensors must be more mindful of their tactics and statements in attempting to leverage negotiating posture. During negotiations, try to avoid referring to the potential licensee's activities as "infringing," and try to avoid offering patent claims, elements, and/or infringement analyses that suggest the potential licensee's current activities are already covered by licensor's patents.

The following are some pro-licensee strategies and provisions that should be considered in view of these recent cases:

* Awareness of Licensor's Reaction to Recent Cases: Licensees should expect that licensors will increasingly seek some or all of the above contract provisions during license negotiations as licensors become more aware of the potential implications of these recent patent cases on the licensor's patent rights.
* Place Royalties in Escrow During Challenge: A Licensee should try to include a provision that requires the placement of some (or possibly all) royalty payments into an escrow account during the pendency of a challenge, particularly a challenge concerning a fundamental patent right.
* Require Licensor to Disclose Additional Prior Art: Licensees should try to require a licensor to disclose to the licensee all additional prior art that is discovered during the term of the license agreement. Such information could assist the licensee in evaluating the ongoing strength of the licensor's patent rights.
* Require Licensor to Pay Attorneys Fees and Cost if Challenge is Successful: A Licensee should also try to include a provision that requires the licensor to pay the licensee's attorneys fees and other reasonable costs upon completion of a successful patent challenge.

Ultimately, the decisions in MedImmune, KSR, and SanDisk should alert patent holders of the potential risk for increased challenges to their patents from licensees and may provide licensees with increased rights during the license term. These cases will also require both parties to re-evaluate their negotiation strategies and the structure of all future patent license agreements.

Please feel free to contact any of the following attorneys in Jennings, Strouss & Salmon's Intellectual Property practice group to discuss the impact that these cases may have on your existing or future patent license agreements or patent rights in general.

Acquiring Good Sites for Medical Facilities

Bruce May authored an article entitle Acquiring Good Sites for Medical Facilities. It appeared in AZRE Magazine's May-June 2008 issue.

Preparing Your Company for Sale to Maximize Value

Business owners and management are often so consumed with operating and growing their businesses they do not adequately prepare their company for sale. When those owners finally decide (or need) to sell their businesses, they may miss opportunities to maximize the value of their company or minimize the tax impact of the proposed transaction. Poorly prepared companies may even face a dearth of buyers for their business.

Deficiencies in key areas can discourage potential buyers from bidding for the company, delay the transaction (which increases the chances it will not close) or lead to a lower purchase price. Similarly, unaddressed problems can result in greater retained liability of the seller or reduced payouts on earn-outs. The expense of trying to resolve the issues while in negotiation often far exceeds the cost a seller would have spent fixing them before the transaction arises.

Conversely, sellers who adequately prepare their company for sale can be more opportunistic when engaging in transactions and often can negotiate better results for their equity owners, employees and other constituents. Transactions with prepared companies can close faster with less expense.

Sale transactions can result from a variety of circumstances. Prospective purchasers and their advisors often approach a seller. Sellers may seek to sell due to their impending retirement or the death of key personnel. Some will sell due to financial difficulties or a similar crisis. Others will sell as a strategic method of growing the business or to gain better access to capital, markets and products. Regardless of the reasons, a company that is prepared for sale will generally fare better in the sale negotiations than those that have not undertaken proper efforts.

When to Prepare for a Sale
To help maximize the value of a company (as well as the after tax net proceeds from the transaction), business owners should devote attention to preparing their company for sale as early as possible. Those preparations can even commence when preparing the Company's organizational documents. Shareholder and operating agreements often identify the rights and obligations among the equity owners with respect to the sale of their interests. Addressing those issues at the outset can help owners and management avoid disputes at the time of a prospective transaction.

Starting early in the process can have additional benefits. For example, business owners can integrate a potential sale with their estate planning process, to help minimize estate and gift tax obligations. Those owners could benefit from valuing their business and transferring assets to their estate well before the sale. Similarly, converting the form of the business entity from one type to another, such as from a taxable corporation to a limited liability company, will have tax ramifications that should be carefully analyzed with the company's advisors. Those actions could affect the net proceeds to the seller, but may need time to have a significant benefit.

Business owners can still do much to prepare for a sale even after discussions with the buyer have begun. The negotiation and due diligence process often provides adequate time to address many issues. Some may even be resolved with the knowledge, consent and perhaps encouragement of the prospective buyer.

Assembling an Advisory Team
Prospective sellers should consider the identification and engagement of experienced professionals to assist throughout the sale process. The advisory team typically includes investment bankers (sometimes called business brokers or advisory intermediaries) and legal, tax, accounting and financial advisors. In-house professionals, who know the buyer, and experienced and objective outside professionals can form a powerful advisory team.

Experts in other areas should be engaged as appropriate for the transaction. Knowledgeable advisors in various disciplines, such as information technology, can be added as needed. Purchasers entering into a new industry or market can benefit from hiring consultants to advise on those issues. International transactions often warrant engagement of qualified professionals in each jurisdiction.

Sellers should consider hiring legal counsel early in the process to assist with the engagement of the other professionals, to address regulatory and legal issues in structuring the transaction, to evaluate duties of the management to the equity owners and to serve as a resource to their client. Some acquisition intermediaries may discourage hiring counsel until later, to permit them greater freedom in structuring the business terms of the transaction, as well as the terms of their own engagement. Experienced counsel, however, should facilitate, not hinder, those processes, while helping the seller to protect its interests.

Preparing for a Sale
Among the steps to prepare for a sale, sellers should consider evaluating the following issues. Of course, the list is not exhaustive, and the advisory team can identify other areas of review particular to the seller.

Company Records
Buyers will scrutinize the company's contracts, customer correspondence, organizational documents, minute books, accounting, tax and financial records, patents and similar rights and other important documents.

Compensation Arrangements
Sellers should evaluate whether key personnel need incentives to remain with the company during and after a sale. Employees react differently to change, and the loss of key personnel during a potential sale can adversely impact the proposed transaction. Sellers should not assume that the transaction process can be consummated in secret, and employees often know or suspect a transaction is in process long before management discloses the prospective transaction.

Employee Policies
Companies should assure that appropriate policies and agreements are in place to protect its trade secrets, patents and other intellectual property. It is often difficult to implement those policies while trying to consummate a transaction, especially if the parties are trying to maintain confidentiality. Buyers will also review other company policies, plans and procedures to evaluate their sufficiency.

Litigation and Other Known Problems
Most companies have some problems, such as ongoing litigation, customer claims and similar issues. Appropriate resolution of those items can help maximize a company's value, but doing so often cannot be achieved prior to entering negotiations with the buyer. The advisory team can help guide the seller to the best method of presenting the matter to the buyer, as well as to help negotiate the impact of those issues on the proposed transaction.

Together with its advisors, business owners can take steps to prepare their company for sale. The advisors can also identify and negotiate with prospective bidders and prepare the company's sale strategy. An integrated team approach permits a business owner to benefit from the expertise of its team members and may relieve the burden on the seller, who must still operate the company throughout the process, as well.

Business owners would be well advised to adequately prepare their company for sale. The effort and expense should inure back to the seller in higher net proceeds and a faster and smoother process. Sellers can benefit from those preparations, regardless of the circumstances leading to the sale or when they commence the process, although greater flexibility remains for those who begin the process well before a prospective sale.

Integration-The Key to a Successful Merger

No buyer acquires another company anticipating the transaction will fail. Nevertheless, a surprising number of mergers and acquisitions yield results far below projections. Many acquired companies are later resold to new buyers or spun-off within a few years, allegedly because the new business was not a "strategic fit." Regardless of the reasons given, many of those transactions underperform because the buyer did not devote sufficient attention to the integration of the businesses.

Ideally, a successful integration permits the combined enterprise to operate as a synthesized unit on the closing date, with a minimum of disruption to customers, personnel, productivity and operations. Employees are motivated and cross trained on the products and services of the combined enterprise. Employees can communicate with each other, customers and vendors through compatible systems in the appropriate languages. Policies and procedures are synthesized and incorporate best practices. Compensation and benefit programs recognize and reward retained personnel in effective ways. Disruptions from the elimination of redundant positions are minimized and consummated promptly. Service levels to customers equal or exceed prior levels. Financial results improve and continue over a sustained period.

The Danger of Delay
Due to its critical importance to the success of the transaction, buyers should commence integration preparations as far in advance of the transaction as possible. Many purchasers delay integration planning until just before the closing, to save effort and expense. Their limited staff resources are often otherwise engaged. Confidentiality considerations may limit the ability to introduce necessary personnel to the potential transaction. Similar reasons are offered for why the integration efforts are postponed.

Delay, though, can exacerbate the difficulties in achieving a smooth and prompt synthesis of the companies. Frustration caused by the disruption in the integration can result in loss of key employees, customers and good will. Failure to properly assess the impact of disparate methods of operation could result in delays in production or delivery of services. Ignoring the impact of foreign laws could result in false starts in implementing new procedures or wasteful litigation, leading to further delay and expense.

Buyers can commence integration planning early, without undue expense, and focus additional resources as the transaction progresses. Purchasers should seek relevant information during negotiation and due diligence to assess integration aspects needing attention. A cohesive acquisition and integration plan should be seamless. Buyers that have never acquired another company should commence the process earlier than those who have completed the process multiple times, to provide sufficient time to develop an approach to each issue. Nevertheless, every transaction will have its own particular aspects that warrant attention, even for experienced buyers.

The Integration Team
The integration team should have the capacity to effectively identify and develop solutions to the integration issues. Often, the acquisition team will contain many of the personnel qualified to analyze those aspects: executives, attorneys, human resources, accountants and tax professionals, operations experts, information technology personnel, and others. If in-house expertise does not exist, or confidentiality or other reasons prevent including those personnel in the early analysis, outside consultants can be engaged on a confidential basis.

Care should be taken to be sure that the integration team evaluates the ability to achieve projected results on the anticipated timetable. The acquisition team may have incorporated assumptions into the projections that are not achievable due to delays caused by the integration process.

As noted below, if the acquisition team will be diverted to other transactions shortly following the closing, buyers might consider designating one or more persons responsible for the integration who will continue to focus on those efforts after the closing.

Aspects of Integration
Proper integration planning should review all aspects of the business, focusing on implementing the best employee, administrative, operational, and marketing programs available to the combined enterprise. Additional integration planning is appropriate for transactions between companies in different industries or with foreign operations.

Employees
Perhaps the hardest but most important aspect of integration planning is determining the compatibility of employee cultures. Some employers have prospered with results-oriented "survival of the fittest" systems, while others foster more collaborative, nurturing environment. Buyers may mistakenly assume that the same incentives for their employees will also motivate the new workforce. Compensation works for some, while recognition and intellectual challenge are necessary components for others. Proper assessment of employee cultures can help buyers implement effective programs. Employee training will also help to educate new workers on accepted methods of operation and expected performance levels.

Compensation and benefit programs of the target company should be evaluated to determine which model should survive and for how long. Buyers should not assume that their existing programs are necessarily the best, and should consider adopting the best practices of each group.

Buyers should also evaluate the impact of the transaction structure and terms on executive and employee motivation. For example, if earn-out performance targets are difficult to achieve, the sellers may have little incentive to help drive performance as planned. Buyers may achieve better long-term results by offering the seller's executives a significant incentive to help achieve maximum performance, rather than trying to keep the purchase price to a minimum.

Administration and Operations
Communication, accounting and information technology systems will need to sync as soon and seamlessly as possible. Those issues may be particularly difficult to achieve if the companies operate in different countries and in different languages. Converting the accounting, tax and information technology systems into a cohesive, technologically compatible system may involve significant time and expense. Meanwhile, an effective interim solution will need to function before a more permanent solution can be implemented.

Policies and procedures of the enterprise should be introduced to the employees with proper training. If the business combination brings the enterprise into a new jurisdiction, the new policies and procedures should be reviewed for legal compliance as well as their conformity to local customs and methods of operation. Personnel from the seller's operations can help identify potential roadblocks and solutions.

Significant time may be required to obtain required licenses and permits necessary for the purchaser to operate the business. The parties can often structure the transaction to minimize the impact of the delay.

Customer and Vendor Relations
Proper integration planning will enable the company to communicate with its customers and critical vendors promptly following the first public announcement of the transaction. Customers should be educated on new products and services available to them. Vendors will seek assurance that their receivables will be paid and will want to know the impact of the transaction on their relationship with the company. Although many issues may not be known, buyers are well advised to prepare answers to as many of the anticipated questions as possible. Similarly, they may want to develop a small team prepared to respond to unanticipated issues, to help maintain consistency in approach.

Sustained Efforts Help Generate Success
Integration efforts should continue well beyond the consummation of the transaction, to help assure that the two companies are merged in more than name and financial results. The integration of employees and cultures takes time. Too often, companies focus on the next transaction and fail to complete integration of prior deals. Executives may leave integration to their operations personnel, who may have different incentives in making integration decisions. For example, administrators may make personnel decisions favoring co-workers whose skills are known to them, rather than to thoroughly evaluate all qualified candidates from both organizations.

Companies can facilitate the integration process in a variety of ways. They might designate a liaison who offices at the seller's location. The liaison could be responsible for the successful integration of the two businesses and be given appropriate authority to help facilitate the combination. He or she can serve as a resource for the employees of the acquired business and help instill in them the new cultural values of the buyer, while advocating for the new employees and their needs, as appropriate.

Devoting time and resources to allow key executives and employees to meet personally and to see the operations of the other can help strengthen intercompany relationships. Buyers have often met with success by conducting strategic meetings with the seller's personnel at all levels of the organization, listening to their suggestions, concerns and aspirations.

Regardless of the methods undertaken, buyers who devote attention to integration early in the process, and who sustain a focused effort on it, can greatly enhance the prospects for success in their acquisitions. Moreover, the efforts expended should result in improved results and more satisfied customers and employees.

A Brief Glossary of U.S. Mergers & Acquisitions Terms

Mergers and acquisitions involve complex business and legal transactions, which carry an entire lexicon that may be unfamiliar to buyers and sellers, particularly parties from other jurisdictions. The following glossary includes terms commonly used in United States acquisition transactions. The descriptions are intended to be descriptive, rather than to constitute legal definitions. Because similar terms may carry different connotations in other countries, it is advisable to check with experienced professionals on proper usage in the relevant jurisdictions.

Accretion / Dilution

An accretive acquisition increases earnings per share. Conversely, a dilutive one decreases earnings.

Baskets and Caps

In negotiating indemnity provisions, the parties sometimes agree that a party need not indemnify the other unless the damages exceed a minimum amount, called a "basket." Sometimes baskets are a "true basket," where a seller is not liable for damages below that amount. Other times, the basket is merely a "threshold" or "tipping basket," in which case once that level of damages has been reached, the buyer can seek indemnity for all of its damages, including for those below the threshold. The parties may agree that certain liabilities (often for the breach of some of the representations and warranties) will not exceed a maximum level, called a "cap."

Break Fees

Corporate laws in many jurisdictions may impose a duty on the board of directors to consider a superior offer, notwithstanding a contractual prohibition on negotiating with other potential bidders. Some agreements provide for the payment of a fee to the proposed buyer if the seller accepts a better offer from another bidder. That fee is often called a "break fee."

Data Rooms / Virtual Data Rooms

A "data room" is a place where a company's records and other due diligence materials are placed for inspection by prospective buyers. Data rooms can be a physical location. Alternatively, companies may scan those documents into a website, called a "virtual data room" to permit inspection from a distance through secure internet connections.

Defensive Measures / Shark Repellant

Companies may implement "defensive measures" (sometimes called "shark repellant") to help resist being acquired by another company, or to permit a greater opportunity to negotiate better price and terms with the bidder. Common defensive measures include "poison pills," which often permit the target company's shareholders to purchase additional equity to dilute the bidder, "staggered boards," which provide for the election of directors in annual tranches, making it more difficult for the bidder to replace a majority of entire board quickly, and supra-majority voting requirements. Business entity and securities laws may govern the adoption of defensive measures. Companies should consider their duties to equity holders and others in determining whether these measures are in the Company's best interests. Investors often resist defensive measures, due to their impact on potential sale transactions.

Dilution

See "Accretion/Dilution" above.

Disclosure Statements

See "Proxy Statements / Disclosure Statements" below.

Earn-Outs

Buyers sometimes agree to only pay a portion of the purchase price if the business performs at specified levels over time. The deferred portion of the purchase price is referred to as an "earn-out." Earn-outs are often measured on sales, revenue or net income targets. Earn-outs can be used to help bridge disagreements over a target company's value, as well as to motivate the sellers to help contribute to the future success of the business.

Fairness Opinions

A "fairness opinion" is issued by an independent valuation firm to provide comfort to the equity owners of a seller that the consideration offered for their shares is fair.

Greenmail

Some bidders for a company will acquire a large block of the target's equity and then threaten to launch a hostile tender offer for more shares unless the target purchases that block of stock at a premium. That tactic is often called "greenmail."

Hart-Scott-Rodino Approval

The Hart-Scott-Rodino Antitrust Improvements Act requires larger companies to provide the U.S. government with advance notice of a pending acquisition, so the government can review the anti-competitive impact of the proposed transaction. The filing fees can be quite steep and are payable by the seller unless the parties agree otherwise.

Holdbacks

Buyers may withhold payment of a portion of the purchase price (or that portion is placed into escrow with an escrow agent) to provide security for the seller's indemnity obligations. The withheld amounts are often referred to as a "holdback."

Hostile Takeovers / Hostile Tender Offers

A process whereby a bidder attempts to acquire a target company when the target's management does not wish the company to be acquired on those terms. In a hostile transaction, the bidder will seek to acquire ownership of the company directly from its equity owners. A "tender offer" is a process in which shareholders tender their shares to a bidder in exchange for an offered amount of consideration. Tender offers are regulated by business entity and securities laws, especially for public companies.

Lock Up Provisions

Buyers attempt to prevent target companies from selling to another prospective buyer through contractual restrictions sometimes known as "lock up" provisions. Lock ups can include use of voting agreements by significant equity owners, "no-shop" provisions discussed below and other methods.

Management Agreements

See "Transition Services Agreements / Management Agreements" below.

"Mini WARN Acts"

See "WARN Act / Mini-WARN Acts" below.

No Shop Provisions

Contractual restrictions on engaging in negotiations with other bidders are called "no shop" provisions. If the sellers have a fiduciary obligation to consider unsolicited offers and eventually accept another, they may be required to pay a break fee, discussed above.

Poison Pills

See "Defensive Measures" above.

Proxy Statements / Disclosure Statements

A proxy statement is a disclosure document describing the material features of a transaction to be voted on by the equity owners when they are asked to give a voting proxy to another. If the equity owners are not being asked to approve the matter, applicable law often requires that they be furnished with similar information through a disclosure statement. Proxy solicitations and disclosure statements are regulated by business entity and securities laws.

Reverse Mergers

A reverse merger is a process in which an active, non-public company merges into a shell company with no significant operations but has a class of equity securities registered with the securities administrators (such as the U.S. Securities and Exchange Commission). In that manner, the private company can rapidly become a public one.

Shark Repellant

See "Defensive Measures" above.

Staggered Boards

See "Defensive Measures" above.

338(h)(10) Elections

This section of the U.S. Internal Revenue Code of 1986 allows the parties to treat a sale of stock as if it were a sale of assets, which may be beneficial for tax purposes.

Transition Services Agreements / Management Agreements

Transition services or management agreements are frequently used to enable a seller to provide services to the buyer for an interim period until the buyer is able to assume those duties. The agreements set forth the rights, obligations and terms under which those services will be performed. Transition services agreements are often used while buyers obtain necessary licenses and permits, or implement technological conversions necessary to operate the newly acquired company.

Virtual Data Rooms

See "Data Rooms / Virtual Data Rooms" above.

WARN Act and Mini-WARN Acts

The Worker Adjustment and Retraining Notification Act requires that companies provide the employees and the U.S. government with advance notice of mass layoffs before those employees may be terminated. Many states have similar laws (called "Mini-WARN Acts") , but the thresholds for when the notices are required may differ.

The Need for Attorney Coordination In Electronic Discovery

Electronic discovery issues are a big part of contemporary litigation. On December 1, 2006, new Federal Rules of Civil Procedure dealing with electronic discovery took effect. The purpose of the Federal Rules amendments was to put discovery of electronically stored information (ESI) on essentially equal footing with discovery of paper documents. Many states, including Arizona, have followed suit. However, given the nature of ESI, there are a multitude of more complex production problems than are usually confronted with traditional document discovery. This reality is clearly illustrated in the opinion of the United States District Court for the Southern District of California in Qualcomm Inc. v. Broadcom Corp. (Case # 05-CV 1958-B BLM) (January 7, 2008), a case in which the Court, because of severe electronic discovery problems, ordered Qualcomm to pay $8.5 million in fines, and referred its outside lawyers to the California State Bar for possible disciplinary proceedings.

Factual Summary –Three Hundred Thousand Pages of Relevant Documents not Produced

The Court’s ruling stemmed from Qualcomm’s failure to produce tens of thousands of documents (mostly e-mails) that had been requested by Broadcom. Qualcomm had initiated a patent infringement suit against Broadcom, contending that Broadcom had improperly used video coding that belonged to Qualcomm. Broadcom defended the allegations by, among other things, alleging that Qualcomm had, as early as 2002 and early 2003, participated in a standards setting body (the Joint Video Team - JVT) which was involved in establishing protocols that created relevant standards for the video coding. Qualcomm’s participation in the JVT in 2002 or early 2003 during the creation of the standard in question would have given Broadcom a defense to Qualcomm’s suit.

Broadcom sought information concerning Qualcomm’s participation in and communications with the JVT through various discovery devices, including requests for production of documents. In response to an interrogatory, Qualcomm denied its participation in the JVT during the relevant time frame, insisting that it had submitted proposals to the JVT in 2006, but had no earlier involvement. Involvement in the 2006 time frame was irrelevant to Broadcom’s defense. Broadcom noticed the depositions of Qualcomm employees with the corporation’s best knowledge of its involvement in the JVT. Qualcomm did nothing to prepare the witnesses for the depositions, including significantly failing to search their computers for relevant documents or emails. At the time trial was to start, after all discovery was finished, Broadcom had failed to uncover any significant information about Qualcomm’s involvement in the JVT during the relevant time frame.

During witness preparation in the course of trial, one of Qualcomm’s lawyers discovered 21 separate emails on the laptop of one of Qualcomm’s witnesses that related to involvement in the JVT in late 2002. Qualcomm’s lawyers decided not to produce these documents, rationalizing that they were not responsive to Broadcom’s discovery requests and decided not to conduct any other investigation for relevant documents. However, serendipitously, Broadcom’s counsel asked the right questions on cross-examination and Qualcomm’s employee was forced to admit the existence of the 21 emails. The 21 emails were then produced by Qualcomm and were considered by the Court and the jury. After the trial, the judge found that Qualcomm and its lawyers had wrongfully concealed the JVT information. As a result the trial court ordered Qualcomm to pay Broadcom’s litigation fees, plus interest, voided two of Qualcomm’s patents, and then referred the matter to the Federal Magistrate to determine possible sanctions against the Qualcomm lawyers.

During the Magistrate’s investigation, Qualcomm and its lawyers continued to resist Broadcom’s efforts to determine the scope of Qualcomm’s discovery violations. However, Qualcomm was forced to admit that it has thousands of relevant unproduced documents (46,000 documents totaling more than 300,000 pages) that revealed facts inconsistent with their arguments during the litigation.

The Magistrates’ Findings – Qualcomm and its Lawyers Failed to use Good Faith

The Magistrate characterized the episode as an “incredible discovery violation.”

The Magistrate found that Qualcomm had the ability to identify its employees and consultants who were involved in the JVT, to access and review their computers, data bases and emails, to talk with the involved employees and to refresh their recollections if necessary, to ensure that those testifying about the corporation's knowledge were sufficiently prepared and testified accurately, and to produce in good faith all relevant and requested discovery, but failed to do so. This is a good, succinct summary of the discovery responsibilities of any litigant.

Regarding the attorneys’ actions, the Magistrate commented that it is inconceivable that talented lawyers such as those involved in the case failed to discover facts that should have made them question their client’s actions. Thus, while the Magistrate could not conclude that the lawyers intentionally hid documents (at least before trial), there was no doubt that the lawyers suspected that there were unproduced documents and blindly ignored the obvious. The lawyers had a duty to control the process so that it met the expectations of the system and failed to do so. The lawyers’ derelictions enabled Qualcomm to thwart the discovery process and make the trial a fraud on the Court and jury.

The Magistrate noted that the Federal discovery rules are premised on the good faith of those involved in the discovery process (clients and counsel). The process breaks down when good faith is absent. This is even more so in these days of electronic discovery when the chances are that lawyers and clients are less likely to touch or look at all documents in their custody and control. The Magistrate, perhaps intending to instruct future litigants stated:

For the current “good faith” discovery system to function in the electronic age, attorneys and clients must work together to ensure that both understand how and where electronic documents, records and emails are maintained and how to best locate, review and produce responsive documents. Attorneys must take responsibility for ensuring that their clients conduct a comprehensive and appropriate document search.

Lessons – Be Prepared for the Inevitable Electronic Discovery

The lessons of the Qualcomm case are clear. Outside lawyers should preferably, when there is a long-term relationship with the client, participate with the client in establishing an electronic discovery protocol before litigation arises. This protocol should include sensible electronic document retention policies, procedures for litigation holds (suspension of document destruction when a claim is likely), the search methods for determining the existence of relevant electronic information (there are software packages available that examine and catalog a network’s electronic documents), and review protocols (determining whether electronic information is confidential, privileged, relevant, etc). Necessarily, this process should inclu de an interface between the client’s IT and records management department and the lawyer’s IT department, as well as counsel themselves. When the relationship is ad hoc, i.e. arising on a case by case basis, the electronic discovery plan should be one of the first things addressed after notice of the claim. Outside lawyers, as those who are on the front line in the discovery process, should have great influence and be given deference on decisions regarding what databases should be searched, what search terms are used and ultimately what data should be produced in any given matter. Proceeding in this fashion will go a long way toward avoiding situations like the one that got Qualcomm and its lawyers in so much trouble.

Offering Multi-Product Package Discounts: Let the Seller Beware

Thousands of sellers, from cable television and Internet service operators to fast food restaurants and book dealers, offer bundled discounts, as do large commercial enterprises that sell to other businesses. But what, if any, risk may a business face if it sells multiple products as a package when the price for that package is less than what the business charges if those products are purchased individually? As matters stand today, there is no clear cut answer to that question. As a result, the practice of offering bundled discount packages can be risky because, at least in some circumstances, the practice may violate federal antitrust law.

To understand why a business should be concerned requires an understanding of the two leading federal antitrust cases that have analyzed the issue of bundled discounts: LePage's Inc. v. 3M Co., 324 F.3d 141 (3d Cir. 2003), cert. denied, 542 U.S. 953 (2004) and Cascade Health Solutions v. PeaceHealth, 502 F.3d 895 (9th Cir. 2007).

3M, the manufacturer and seller of transparent tape under the Scotch brand name, was sued by LePage's, which sold transparent tape, called private label tape, under the names or brands of various retailers, such as Office Depot and Wal-Mart. LePage's tape sold at a lower price than did 3M's branded tape. 3M decided to compete in the private label market, and when it did, it began offering discount, promotional, and cash incentive programs to its customers that purchased other 3M products in addition to Scotch tape. LePage's maintained that, as a result, it lost substantial transparent tape business to 3M.

PeaceHealth operated hospitals that provided a range of services, from basic care to advanced, or tertiary, care in Lane County, Oregon. Cascade Health Solutions operated the only other hospital in that county, and throughout most of its history, that hospital provided only basic care. PeaceHealth began offering discounts of 35-40 percent on tertiary care to health insurance companies if they, in turn, agreed to make PeaceHealth their exclusive provider for all hospital services, including basic care. Because of that, Cascade maintained, it lost substantial business to PeaceHealth.

In LePage's, the Third Circuit Court of Appeals decided that 3M's discount programs violated federal antitrust law (section 2 of the Sherman Act). The court did so even though the bundle was priced above 3M's cost to manufacture the bundled products so that 3M was still earning a profit from those products, including the tape, despite the discount. In effect, the court decided to sweep broadly and concluded that such bundling programs are unlawful whenever a small competitor cannot compete by matching the discount that its competitive rival offers because that smaller competitor does not offer the same range or variety of products as the competitive rival that sells the bundled discount package.

The Ninth Circuit Court of Appeals in PeaceHealth decided not to follow the LePage's decision. Instead, the Ninth Circuit observed that bundled discounts can be beneficial because they can result in lower prices to consumers. Still, the court was not willing to say that bundled discounts are always beneficial because it also recognized that, in some circumstances, such discounts can be anticompetitive if they limit or prevent sales by a more efficient competitor that does not offer as diverse a product line. To determine when bundled discount packages are beneficial, or procompetitive, the court adopted a "discount attribution" test. The test works this way. First, the full amount of all discounts given for the bundle is calculated. Second, that amount is then allocated only to the product that competes with the product offered by the smaller competitor. (Thus, for example, using the LePage's case as an illustration, the total value of all of 3M's discounts, promotions, and other incentives would be allocated to transparent tape.) For purposes of the test, that allocation results in what is called the "competitive price" of the competing product. Third, that competitive price is then compared with the bundled discounter's average variable cost for the competing product, and if the competitive price is above the average variable cost, the bundling does not violate the federal Sherman Act.

So, with both LePage's and PeaceHealth, on the books, where does that leave us? For businesses that are dominant players in a market for one or more products, the answer is this: in a state of uncertainty. (Although what constitutes a "dominant" market position is not clearly defined, it appears that something that at least approaches, if not exceeds, fifty percent is required when a violation of the Sherman Act is alleged.)

For those businesses that operate in states that are located in the Ninth Circuit (Arizona, Nevada, California, Washington, Oregon, Montana, Idaho, Hawaii, and Alaska), PeaceHealth provides at least some comfort because it allows sellers an opportunity to show that their package discounts promote competition. For businesses that operate in the Third Circuit (Pennsylvania, New Jersey, and Delaware), however, it appears that there is a flat prohibition against bundling for businesses that dominate a product's market. For businesses that operate elsewhere, knowing which of those two approaches will gain approval, or whether another approach will be adopted, is at most a guessing game.

As of March 2008, only one reported post PeaceHealth case has dealt with the issue of bundling. Although in Southeast Missouri Hospital v. C.R. Bard, Inc., the court was not required to make a final decision about whether bundling was lawful, the court appeared to indicate that, as the case progressed, it would allow a seller that offered a bundled discount package the opportunity to show that doing so was pro-competitive.

The United States Supreme Court has shown some interest in considering antitrust issues in recent years. The substantially different approaches taken by the Third and Ninth Circuit Courts and the need for certainty may prompt the Supreme Court to consider a bundling case in the near future. Supreme Court Justice Samuel Alito was one of ten members of the Third Circuit panel of judges that decided LePage's in 2003. He voted with the three-judge minority against what many consider a broad, standardless rule prohibiting bundled discounts.

Until then, adding further to the uncertainty is a report by the Antitrust Modernization Commission, which urges an approach that is similar but not identical to the method used in PeaceHealth. Congress established the bipartisan Commission in 2002 to examine whether the federal antitrust laws should be modernized. In its final report, which was submitted in 2007, the Commission proposed a three-part test for bundled discount packages: (i) as in PeaceHealth, determine whether the "competitive price" (as described above) is above or below the incremental cost for the competitive product; (ii) if below, determine whether, in the short term, the seller is likely to recoup its losses; and (iii) determine whether the bundled package has had or will likely have an anticompetitive effect. The Ninth Circuit in PeaceHealth rejected the second part of that test, reasoning that bundled discount packages could be anticompetitive even though the seller may still earn a profit from them, and rejected the third part, reasoning that it was redundant because it amounted only to a restatement of the first part of the test.

Meanwhile, even the PeaceHealth test itself may create uncertainty for a multi product company that wishes to discount some of its products. Before doing so, that company needs to determine which of its products to include in the analysis that produces the hypothetical "competitive price." This becomes especially difficult when the company is faced with several competitors or several competitive products instead of just one, as in PeaceHealth and LePage's. Further, applied literally, PeaceHealth could lead to a determination of illegality when one of several products in a bundle has a competitive price below its average variable cost but accounts for only a small percentage of the company's sales.

In short, whether operating within or outside those states that make up the Ninth Circuit, a business with a significant market position in one or more products that wishes to compete by offering bundled discounts would be well-served to proceed with great caution. That becomes especially true because even if the practice of offering a bundled discount does not violate the Sherman Act, the seller may still be exposed to a claim for a violation of another federal antitrust law, namely unlawful tying under section 3 of the Clayton Act. (The difference between bundled discounts and tying is that, typically, a seller that offers a bundle is also willing to sell the bundled products individually, while a tying arrangement makes the purchase of one product contingent on the purchase of another product, as for example, if the seller of a computer printer requires purchasers to buy the seller's toner or paper as well.)

Concern about being faced with a tying claim cannot be dismissed lightly by business planners because, in at least one way, it may be easier for a small company to succeed in a lawsuit against a large competitor by maintaining that the bundled discount package is really a tying arrangement. That is because the degree of market power possessed by the seller of the package that must be shown is likely to be less when it can be characterized as a tying arrangement rather than a bundled discount. Although an analysis of tying law is beyond the scope of this article, it should be noted that, in PeaceHealth, the court indicated that, even if a bundling arrangement passed the discount attribution test, it might not pass the test for an unlawful tying arrangement should it turn out that only a few customers were choosing not to take the bundle. In other words, the PeaceHealth opinion could be read to mean that, when a bundled discount package is so successful that few purchasers choose to buy the products individually, that may be evidence of a tying arrangement.

This memorandum is provided for informational purposes only and is neither intended to be legal advice nor should be treated as such.

The Four Paths of Dispute Resolution

In today's complex and multifaceted business environment, conflict between businesses is inevitable. Economic competition is fierce, and change is occurring at a faster rate than ever before. Given these facts, many progressive businesspeople realize that emphasis needs to be placed on resolving conflict, as conflict cannot be completely avoided.

This article focuses on four different ways of resolving conflict between business organizations--negotiation, mediation, arbitration and litigation. As one moves up this ladder from negotiation, conflict resolution becomes more complex, and more outside agents are needed to assist in resolving the conflict. For example, a business may be able to resolve a conflict by simple negotiation, and this happens regularly. However, once a dispute reaches mediation or arbitration, a neutral third party, and likely a lawyer, are necessary. For the most complex step on this ladder, litigation, the assistance of the court system and lawyers are essential.

This article provides practical information for the businessman or businesswoman on the basics of these four methods of dispute resolution, and some helpful hints on practical strategies for resolving disputes.

Negotiation

Most business disputes are resolved by negotiation between the parties to the dispute. Successful negotiators realize that they must stay focused on their goals, be well-prepared for the negotiation, and know the parameters of what might be accomplished in negotiation by understanding the organization's goals, its relationship with the other negotiating party, and the alternatives if no agreement is reached. Most business negotiations are undertaken without the assistance of lawyers or other third parties. However, when negotiations become complex or resort to legal processes seems likely, those involved may want to consider hiring a lawyer.

What might a lawyer add to the negotiation process? First, a fresh set of eyes on the problem is normally helpful, especially because lawyers negotiate all the time. Second, lawyers will be able to give the businessperson a good idea of the legal landscape surrounding the dispute, and the consequences that might ensue if the negotiation does not result in an agreement. Third, lawyers are creative, and may be able to come up with strategies for structuring a settlement that had not occurred to the parties. Finally, a lawyer may be able to assist by writing a demand letter or even by preparing a complaint (drafted for possible use in court) to be given to the other side, which may cause the opposing party to change its calculus of the negotiation and potential outcomes.

What are some signals that would indicate that it is time to have a lawyer become involved in an ongoing negotiation? If the other side uses a lawyer, or makes threats involving a lawyer or legal action, it is time for you to consult a lawyer. Certainly, if the other side sends a demand letter, files legal action, or you receive legal papers, you should hire a lawyer without delay. If you feel that the negotiation is entering an area which is outside of your expertise, is taking too much of your time, or the dispute is festering without resolution, a lawyer should be considered. Finally, if the stakes are high or particularly important to the business, you should consult a lawyer because it is a good bet that the other side has or shortly will.

Mediation

Mediation is a process by which the disputing parties hire a neutral third person to assist them in resolving their dispute. The key to understanding mediation is that, while the mediator assists the parties in attempting to reach a negotiated settlement, the decision to settle is up to the parties and cannot be imposed by the mediator. Keeping this in mind will help distinguish between mediation and arbitration, which is discussed below.

Mediators are skilled professionals who work with the parties and their lawyers to take them through a process which is designed to lead to a resolution of the dispute. The mediation itself may take from several hours to several weeks or longer, and the mediator generally keeps the parties working toward a settlement until the mediator determines that further efforts will not be fruitful, or until one of the parties decides not to continue. If you are considering mediation, it is best to look for a mediator with special mediation training, who has experience and a good track record in successfully mediating disputes.

Mediators are generally paid for their services, with the calculus being that the cost of the mediation will likely be less than the cost of continuing the dispute. Depending on the preference of the mediator, the parties may or may not be asked to prepare a written statement prior to the mediation. Prior to the date of the mediation, the party representatives should meet with their attorney to plan a strategy for the mediation, and to discuss possible settlement options.

On the day of the mediation, the parties will meet at a pre-arranged location with appropriate facilities for mediation, and the mediator takes the parties through a process, designed to some degree ahead of time but with enough flexibility so that it can be changed to fit the circumstances. The process usually involves having the parties speak together under the supervision of the mediator for some period of time, as appropriate, and then break up into separate meetings, with the mediator shuttling between the parties, discussing the dispute, its merits, and possible resolution strategies. While every mediation is unique, most share the caucus format with the mediator speaking in turn to the parties, who are in separate rooms.

Mediators normally require that a person with the authority to resolve the dispute be present at the mediation. Other persons may also be present, including other representatives of the parties and the parties' respective attorneys. The attorneys are generally at the mediation to advise the parties as to their legal rights, and possible settlements, because the mediator is not in a position to offer the parties legal advice. The presence of attorneys is also useful because if a settlement is reached, the lawyers are normally charged with documenting the settlement, which may be drawn up at the mediation, or shortly thereafter.

Mediation proceedings are generally confidential, in order to encourage a frank exchange of information and settlement proposals. If you are involved in a mediation, you should make sure of the ground rules about confidentiality prior to the mediation. While what is discussed in the mediation generally cannot be used later by one party against the other, if there is something in the context of the mediation that you would prefer the other side not know at all, for tactical or other reasons, you should make sure to instruct the mediator that he or she should not share those particular facts with the other side when he or she meets with them during the caucus process.

If there is no successful outcome in mediation, the parties are free to continue the dispute resolution process on their own, through negotiation, or utilizing arbitration or litigation. If the mediation is not successful at first, there is no reason the parties cannot agree to mediate on another occasion, or mediate a portion of their dispute, using the same or a different mediator.

Arbitration

Arbitration, like mediation, utilizes the services of one or more neutral third parties. That is pretty much where the similarities between arbitration and mediation end. In arbitration, unlike in mediation, the arbitrator or arbitrators will listen to the presentation of the lawyers for each side of the dispute, and then render a binding decision which normally can be taken to court and enforced like a court judgment. In addition to the traditional type of arbitration discussed here, there are many other types of alternative dispute resolution, including mock trials, the use of advisory juries or judges, non-binding arbitration, high-low arbitration, or a form specifically designed by the parties.

An arbitration looks much like a court proceeding, with the primary differences being that arbitration is done in a private setting with rules that are generally less formal than the rules that govern civil litigation. While the rules that govern arbitration may differ slightly depending on the organization that is conducting the arbitration, arbitration is generally speedier and less costly than going through a court trial. In arbitration, discovery is generally more limited than in civil litigation, and the presentation of evidence at the arbitration hearing is less formal. Depending on the complexity of the dispute, an arbitration may be heard by one, three or more arbitrators. The arbitrators are compensated for their time by the parties pursuant to the arbitration rules or agreement.

Once a decision has been reached in arbitration, no appeal is generally allowed unless there has been some type of fundamental unfairness that goes to the heart of the arbitration process. Examples of the kind of serious unfairness that would have to be necessary to justify an appeal would be an arbitrator not revealing that he was related to one of the parties, or an arbitrator being unduly influenced through unauthorized contact, or the like. Generally, once the arbitration is over, the winning party takes the arbitration award to a court with jurisdiction and converts that arbitration award into a validly enforceable judgment, and there is no appeal.

Attorneys play a leading role in the arbitration proceeding, as evidence is gathered and presented through documents and witnesses much as it would be in a court trial. The rules of arbitration, while generally less complex than civil litigation rules, are still intricate, and the substantive rules of law that will govern the outcome are the same. Unlike mediation, arbitration will lead to a dispute resolution in which one of the parties emerges with a decision in its favor.

Litigation

Litigation refers to the resolution of a conflict between parties through use of a municipal, state or federal court to render a decision on the dispute. Although litigation is sometimes necessary, many view it as a last resort because it is both expensive and time- consuming. For business organizations, an attorney is necessary for litigation because many state and federal courts require that a business organization appear through an attorney, except in small disputes in small claims courts.

The first step in the civil litigation process is to meet with your attorney and review the facts, documents and witnesses that would be involved in civil litigation. If the attorney has assisted in one of the other dispute resolution procedures described above, this process may be expedited. At this stage, if it has not been done already, the attorney may write a pre-complaint demand letter to the other side in a last attempt to settle the matter before resorting to court action. At this stage, with an attorney involved, the mere threat of litigation may cause the other side to reconsider its position.

In general, the civil litigation process goes through several stages, consisting of the complaint and answer, disclosure and discovery, pretrial motions, trial, and possibly one or more appeals. The length of time and the expense involved are likely to be considerable, but will vary depending on the complexity of the case, the number of documents, the number of witnesses, the number of adverse parties, and whether the matter might be able to be resolved by motion or settlement prior to trial. Each of these phases is discussed below.

The complaint is the document that initiates the litigation through its filing with the court. Most civil litigation rules provide that the complaint is supposed to be a plain and direct statement of the underlying facts, the allegations about how the complaining party has been wronged and the relief sought. There may be changes coming in this area because the U.S. Supreme Court has recently decided a case which may require more detail in the complaint under certain circumstances. Once the complaint has been filed and the various filing fees paid, the complaint is then served on the defendants, who are then given a relatively short period of time, normally between 20 and 60 days (depending on the circumstances), to file their answer, which responds to the allegations of the complaint. It is at this point if a defendant has a claim back against the plaintiff, that the defendant may consider filing a counterclaim against the plaintiff as part of the answer process.

Once the complaint, answer and any counterclaims are on file, the case moves to a stage known as disclosure and discovery. Most civil litigation rules now require a mandatory disclosure of basic information about the case by each party within a month or two of the filing of the last answer. The amount of disclosure, and the detail necessary, are governed by the applicable state or federal rules, and may vary widely. At the same time, the parties may engage in their own discovery, which consists of asking the opponents for admissions, documents or to answer questions under oath in a deposition. The discovery process tends to take up a good deal of time, and can be expensive both from an attorney's fee viewpoint and because of the time that must be invested by the principals of the business. Discovery may also be directed to email and other electronically stored information, which adds a level of complexity and expense that has recently been addressed for the first time in the federal and Arizona rules governing disclosure and discovery.

Once the discovery and disclosure phase is over, the parties may file a motion with the court asking that it resolve the case without a trial. In general, these motions will make the point that the party filing the motion should win the case because there are no disputed facts which make a court trial or jury trial necessary, and that the party filing the motion is entitled to a decision in its favor on the existing undisputed facts. If any of these motions are successful, that may end the case or reduce the issues for trial.

The most intense, complex and expensive part of civil litigation is the trial, which, depending upon the issues and the preferences of the parties, may be a trial to the judge or to a jury. Depending on the complexity of the case, a trial may take from less than one day to several months. Unless there is a mistrial, the decision-maker at trial, whether that is the judge or the jury, will render a decision at the end of the trial which determines the outcome, which decision may be in favor of one party or the other, or it may be a mixed verdict which grants some relief but denies other relief. Once the trial is over, attorneys may file post-trial motions to clarify the verdict or to ask for a new trial. If these motions are successful, the trial may start over. If these motions are not successful, the case proceeds to the stage in which one party or the other may file an appeal.

In most jurisdictions in the United States, so long as the time frames are observed and the proper documents are filed, the losing party at trial is entitled to one appeal as of right. This is commenced by filing a notice of appeal. The parties are then given several months to make submissions in writing to the appeals court arguing either to overturn the trial decision or to uphold it, depending on the party's viewpoint. Many times, but not always, there will be an oral argument before a panel of several appellate judges, who listen to the arguments of the attorneys before making a decision. The decision of the first appeals court may uphold the trial result, may reverse the trial result, or may send the case back to the trial court for further proceedings to clarify the issues. Once the decision of the appeals court is made, there may be another level of appeal to a higher court, but generally this appeal is taken only on important issues, in discretion of the court. If another appeal is not accepted by the higher appeals court, the opinion of the first appeals court stands.

As one may see from this description, the civil litigation process can be both time-consuming and expensive, as the filing fees, discovery costs, and attorney's fees over time may add up to a significant amount. This is why we almost always recommend that the parties engage in some type of alternative dispute resolution, such as mediation or arbitration, before a lawsuit is sent to trial.

Dispute Resolution Agreements

One way to exercise some control over the dispute resolution process is to insert a pre-dispute resolution clause into any contract that the business may execute. These pre-dispute clauses, which are generally enforceable, may specify mediation, arbitration, or some other dispute resolution mechanism prior to either side invoking court action. In this way, a business may be able to avoid the expense of litigation while designing in the pre-dispute clause a method for resolving any disputes that may arise.

In a pre-dispute clause, it is generally beneficial for the parties to be as specific as possible about the process, the mediation or arbitration service that will provide the services, the number and selection of any third party neutrals, the rules to be used, the location, and the governing law. Some parties even specify that a mediation take place first, and if the mediation is not successful, that only then will the parties proceed to arbitration. Your attorney will be able to help you in considering the various options and in drafting a pre-dispute resolution clause.

We hope this article has been helpful in sorting through some of the ways that disputes are handled by business entities. It is sometimes necessary for the parties to a dispute to employ outside agents such as mediators or arbitrators, as well as attorneys, in assisting to satisfactorily resolve a dispute. The roles and degree of involvement of the outside parties depends on the complexity of the dispute and the form of dispute resolution that is selected. The key to resolving disputes is to do so satisfactorily, and as quickly and as inexpensively as the circumstances permit.

Jennings, Strouss & Salmon stands ready to assist you in evaluating the various options, or in assisting you with negotiation, mediation, arbitration or litigation.

The FMLA Expands to Benefit Military Family Members

Employers with 50 or more employees should be aware of two new Amendments which expand the Family and Medical Leave Act ("FMLA") to provide job-protected leave to employees caring for wounded soldiers and to immediate family members of reservists called to active duty. The FMLA was initially created to help employees balance the demands of the workplace with the needs of their families by allowing eligible employees in certain situations to take up to 12 weeks of unpaid job protected leave. The new Amendments are consistent with this original purpose but are directly geared toward providing aid for the families of service members.

Eligibility

Under the new Amendments, FMLA eligibility requirements for employers and employees remain unchanged. The FMLA currently provides leave for all employees working in a facility which employs 50 or more people (or within 75 miles of that location) that have been employed for at least 12 months and have worked 1,250 hours. Therefore, in order for an employee to be eligible for leave under these new Amendments, they must meet the criteria established under the 1993 enactment.

The Amendments

The First Amendment to the FMLA allows an employee 12 weeks of job-protected leave for a "qualifying exigency" arising out of the employee's spouse, son, daughter, or parent being on active duty or having been notified of an impending call to active duty. The term "qualifying exigency" has not yet been defined by the Department of Labor ("DOL"), but more than likely the term anticipates situations where a family member's deployment to active service causes disruption in an employee's life, thus necessitating leave. Though the regulation will not go into effect until the DOL formally defines the term "qualifying exigency," the DOL is encouraging employers to provide this type of leave to employees who may qualify in the interim.

The Second Amendment provides job protected leave to spouses, parents, children, or next of kin caring for recovering military service personnel who develop a serious injury or illness while serving in the armed forces. This Amendment was signed into law on January 28, 2008, and is the first expansion of the FMLA since its enactment in 1993. This Amendment entitles an employee to a maximum of 26 weeks of leave during a single 12-month period. An employee may still take 12 weeks of leave for a reason other than military care leave, however, the total amount that the employee may take, of both military and other FMLA leave, is 26 weeks. A husband and wife who work for the same employer may be limited to taking a total of 26 weeks of leave during a 12-month period for military care leave.

Employer Rights Under the New Amendments

When practical, employees must give their employer reasonable notice when taking leave under the new Amendments. In regard to leave requested under a "qualifying exigency," an employer can require certification of an impending call to active duty from the requesting employee. Likewise, an employer can also request that an employee provide certification from a healthcare provider when requesting military care leave.

Steps Employers Should Take to Comply With the Amendment

Employers who are subject to the requirements of FMLA should incorporate these new changes into the FMLA policy they are required to have in their employee handbook, and notify their employees of these changes in their policy. It is also critically important that the employer's personnel who are responsible for implementing FMLA leave be instructed on these changes and how to properly implement them.

The law firm of Jennings, Strouss & Salmon is available to advise your organization concerning these FMLA changes, and to assist with updating your FMLA policy. Please contact the Chair of Jennings, Strouss & Salmon's Labor and Employment Department, John J. Egbert for more information.

Federal Court Stops New Patent Rules, for Now

On Wednesday, on October 31, 2007, the United States District Court for the Eastern District of Virginia (Judge James Cacheris), following a last minute hearing that day, issued a decision temporarily enjoining the United States Patent and Trademark Office (USPTO or PTO) from implementing new rules that were to become effective just a few short hours later (Not only would the rule changes have been applied the next day, they would have been retroactively applied to many already-filed applications). For the time being the former rules will remain in effect.

The new rules, among other things, would effectively limit both the number of claims filed in each patent application and the number of ‘continuation' applications that may stem from any original patent application (click here to view the pdf, or visit the following website: http://www.uspto.gov/web/offices/com/sol/notices/72fr46716.pdf).

In his Order (see Memorandum Opinion, 10/31/2007) granting GlaxoSmithKline's (GSK) Motion for TRO and Preliminary Injunction,[1] Judge Cacheris temporarily barred enforcement of the new USPTO rules "giving the Court time to consider the validity of the Final Rules before they go into [e]ffect."

The Court considered four factors when determining whether to bar implementation of the new rules: (1) likelihood of success on the merits, (2) irreparable harm if the rules go into effect as scheduled, (3) the balance of hardships between the parties, and (4) the public interest. The Court found that each of the four factors weighed in GSK's favor.

Specifically, the Court found that GSK had shown a likelihood of success on four of the seven[2] issues raised by GSK, finding that:

1. Because the PTO only has authority to make procedural rule changes, not substantive changes to the patent law (which Congress must make), "GSK raises serious concerns as to whether the Final Rules comport with the Patent Act" and "there remains a serious question as to whether the Final Rules even qualify as procedural."
2. Federal Circuit law "suggests that a decision by the PTO to limit the number of continuing applications would run contrary" to the current patent statute permitting any number of continuing applications so long as the continuing application "is filed by an inventor ... named in the previously filed application [and] filed before the patenting or abandonment of or termination of proceedings on the first application." Because there "is no statutory basis for fixing an arbitrary limit" of continuing applications, the Court found that "GSK has demonstrated a likelihood of success on this issue."
3. "the Final Rules retroactively alter the bargain on which inventors like GSK rely in making their decision to surrender their rights." The Court specifically noted that although patent applications themselves do not constitute vested rights, inventors voluntarily sacrifice their trade secret rights in exchange for seeking a patent. "The Final Rules thus impair GSK's right to this bargain" and "GSK has demonstrated a real likelihood of success on the issue."
4. "GSK has raised serious concerns as to whether a reasonably prudent person would be able to comply with the ESD (examination support document) requirements," indicating that the new ESD is impermissibly vague and potentially in violation of the Administrative Procedure Act, and finding "that GSK has demonstrated a real likelihood of success on this issue."

The Court also found that "GSK is likely to suffer irreparable harm if the preliminary injunction is not granted" for several reasons, including:

1. "When the Final Rules go into effect, inventors lose some of the patent protection on pending applications they had come to rely upon under the current system. GSK would be unable to sue to reinstate lost patent protection or obtain monetary compensation if the Final Rules are vacated."
2. "a ‘[plaintiff] should not be forced into the position of choosing to either violate an allegedly invalid ordinance and suffer the inherent consequences of doing so or comply with the same and suffer a loss with little hope of recovery.'"
3. "the uncertainty caused by the regulations will cause harm to [GSK's] investments and provide a disincentive to their filing of new patent applications for researching new pharmaceutical products."
4. "there is still some question as to whether following the complicated steps outlined by the PTO will indeed guard against lost patent protection [and] GSK will be unable to recover their losses if the Final Rules are ultimately determined to be invalid."

Further, the Court determined that "although the hardship to the PTO is not nonexistent, the uncertainty and loss of investment suffered immediately by GSK tilts the balance of the hardships in their favor." And finally, that "that the public interest is most served by continuing the status quo and granting the TRO," specifically finding that:

Allowing implementation of rules that may or may not remain in effect is likely to cause much greater uncertainty and squelching of innovation than a preliminary injunction giving the Court time to consider the validity of the Final Rules before they go in [e]ffect.

In this case, the preliminary injunction order is immediately appealable to the Federal Circuit, which could only review the injunction for abuse of discretion (a standard of review that favors GSK in upholding the preliminary injunction). The USPTO could also proceed in filing a motion for summary judgment, forcing the Court to finally decide the issue, and appeal that judgment if the Court ultimately ruled in GSK's favor. However, it is unlikely the Court would reach a decision on the summary judgment motion before sometime in February.

[1] In the case of Tafas v. Dudas before Judge Cacheris, several plaintiffs joined GlaxoSmithKline in attempting to block the new rules. Other parties included the American Intellectual Property Law Association (AIPLA); IBM; Élan; Hexas, LLC; the Roskamp Institute; Tikvah Therapeutics; SanDisk; and Senator Charles Schumer (D, NY), each filing briefs or declarations supporting blocking the new rules.

[2] Glaxo challenges to the new rules included: (1) the USPTO did not have authority to enact the new rules because they are substantive rule changes; (2) the new rules on continuations are inconsistent with § 120, (3) the new rules on Requests for Continuing Examination are inconsistent with § 132, (4) the restrictions on number of claims are inconsistent with §§ 111-112, (5) the rules are arbitrary and capricious, (6) retroactively applying the rules to previously-filed patent application is not permissible, and (7) the examination support document (ESD) requirement is impermissibly vague.

Recent Developments In U.S. Discovery For Use In Foreign Tribunals Under § 1782 U.S.C.

U.S. Federal Courts in the last few years have issued a number of decisions expanding the scope of 28 U.S.C. § 1782, a federal statute that allows parties to use U.S. discovery procedures to obtain evidence for foreign and international legal proceedings.

The statute in question provides as follows:

§1782. Assistance to foreign and international tribunals and to litigants before such tribunals.

(a) The district court of the district in which a person resides or is found may order him to give his testimony or statement or to produce a document or other thing for use in a proceeding in a foreign or international tribunal, including criminal investigations conducted before formal accusation. The order may be made pursuant to a letter rogatory issued, or request made, by a foreign or international tribunal or upon the application of any interested person and may direct that the testimony or statement be given, or the document or other thing be produced, before a person appointed by the court. By virtue of his appointment, the person appointed has power to administer any necessary oath and take the testimony or statement. The order may prescribe the practice and procedure, which may be in whole or part the practice and procedure of the foreign country or the international tribunal, for taking the testimony or statement or producing the document or other thing. To the extent that the order does not prescribe otherwise, the testimony or statement shall be taken, and the document or other thing produced, in accordance with the Federal Rules of Civil Procedure.

A person may not be compelled to give his testimony or statement or to produce a document or other thing in violation of any legally applicable privilege.

(b) This chapter does not preclude a person within the United States from voluntarily giving his testimony or statement, or producing a document or other thing, for use in a proceeding in a foreign or international tribunal before any person and in any manner acceptable to him.

Although § 1782 dates back to the mid 19th century, it did not receive widespread attention until recently. In 2004, the United States Supreme Court in Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241, 124 S. Ct. 2466, 1592 L. Ed.2d 355, clarified and expanded the extent to which parties may use U.S. discovery procedures to obtain testimony and documents for use in litigation and other proceedings outside the United States. The Supreme Court made it clear that documents and testimony can be secured from U.S. sources for use not only in matters pending before courts and tribunals but also matters pending before bodies of a quasi-judicial or administrative nature. The court also made it clear that there is no reciprocal foreign discoverability requirement for use of § 1782.

The Supreme Court in Intel declared that the District Courts have broad discretion to decide whether to order a witness or entity to provide testimony and documents. The Intel case involved a complaint alleging that Intel had violated European competition law in a proceeding before the Directorate-General for Competition of the Commission of the European Communities. The Commission rejected plaintiff's request for documents that Intel had previously produced in a private antitrust lawsuit between Intel and a third party in the U.S. District Court in Alabama. Plaintiff then filed an application under 28 U.S.C. § 1782(a) in the U.S. District Court for the Northern District of California where Intel was located seeking an order for production of the documents. The District Court rejected the request on the basis that the Commission had already declined to order the production. The Court of Appeals reversed the decision and remanded the case to the District Court to rule on the merits of plaintiff's application. The Supreme Court accepted review of the case and affirmed the Court of Appeals decision.

The Supreme Court emphasized the wide discretion which the District Court has in granting or rejecting § 1782(a) requests. It stated that there are four main factors that the District Court should consider on ruling on such a request. The first is that the need for § 1782(a) aid is generally not as apparent when evidence is sought from a participant in the foreign proceedings since the foreign tribunal would have jurisdiction over those appearing before it and could itself order the evidence produced.

Secondly, the Supreme Court noted that the District Court "may take into account the nature of the foreign tribunal, the character of the proceedings underway abroad, and the receptivity of the foreign or court or agency abroad to U.S. Federal Court judicial assistance."

The third factor is that "a district court should consider whether § 1782(a) requests conceal an attempt to circumvent foreign proof-gathering restrictions or other policies of a foreign country for the United States." Intel's argument that policy reasons required a foreign discoverability requirement was rejected.

Fourth, the Supreme Court pointed out that the District Court can reject or modify unduly intrusive or burdensome requests.

On remand, however, the District Court exercised its discretion, considered the substance of the application and denied it for three reasons. The first was that Intel was already a participant in the Commission proceedings and the Commission had jurisdiction over Intel to require production. The District Court further observed that the Commission was not receptive to judicial assistance from U.S. Courts and, finally, that plaintiff's application appeared to be an attempt to circumvent the Commission's decision.

A significant aspect of the decision is that the District Court cannot deny the application merely because the testimony or documents would not be discoverable in the foreign jurisdiction. The Court broadly interpreted the phrase "a proceeding in a foreign or international tribunal" to include foreign administrative and quasi-judicial proceedings. The Court also stated that the proceeding for which discovery is sought must only be within reasonable contemplation and need not either be pending or imminent at the time the discovery is sought.

Several cases in the District Courts following the Intel decision reached varying results based largely on differing factual situations during 2004 and 2005.

In December 2006, the U.S. District Court in Atlanta decided In re Application of Roz Trading, Ltd., WL 3741078, N.D. Ga. Dec. 19, 2006, a case which has attracted considerable attention because it extended the scope of § 1782(a) to include applications for discovery of evidence from U.S. entities for use in international arbitration proceedings. Roz Trading was a Cayman Islands company involved in a dispute with Coca Cola which was subject to international arbitration in Vienna. Roz applied in U.S. District Court for an order requiring Coca Cola's parent in the U.S. to produce documents for use in the Austrian arbitration proceedings. The request apparently had not been directed first to the arbitral tribunal. The Court nevertheless concluded that Roz Trading "meets the requirements of the statutes, and is, thus entitled... to seek judicial assistance for use in the foreign proceeding."

Prior to 1964, the statute had referred only to "judicial proceedings." Congress then amended it to include "a proceeding before a foreign or international tribunal." Hans Smit, who served as Reporter to the Commission and Advisory Committee on International Rules of Judicial Procedure, foreshadowed Roz Trading in a law review article stating that "tribunal" includes "administrative and arbitral tribunals." 65 Colum. L. Rev. 105, 1026-27 and nn. 71, 73 (1965).

The U.S. District Court in New Jersey in April, 2007 concluded that an arbitral tribunal covened pursuant to an agreement that disputes between nationals of the two countries would be resolved by "arbitration governed by international law" was sufficiently governmental in nature even under earlier more restrictive pre-Roz Trading interpretations to allow the granting of a § 1782 discovery request. In re Oxus Gold, PLC, Misc. 06-82, 2007, U.S. District LEXIS 24061 (D.N.J. 2 April 2007).

On September 13, 2007 a Minnesota court affirmed an earlier ex parte granting of a
§ 1782(a) discovery order at the request of Hallmark Capital, a Canadian corporation, which was a claimant in an arbitration in Israel, for production of documents by a non-party shareholder/officer of the defendant in the Israeli arbitration involving breach of contract to pay a finder's fee. The individual to whom the request was directed resided in Minnesota, and the documents were located there. (U.S. District Court District of Minnesota In re: Application of Hallmark Capital Corporation, Civil No. 07-MC-39 (JNE/SRN).

Several other U.S. District Court cases in 2006 involved applications for § 1782 discovery orders. In Fleishman Inn v. McDonald's Corp., 466 F. Supp. 2d 1020, 25 IER Cases 1482, the District Court in Illinois granted a § 1782 discovery order at the request of a former chief executive of a Brazilian company for use in two Brazilian lawsuits involving wrongful termination of employment.

In Phillips v. Veierwaldes, 466 F.3d 1217, C.A. 10 (Colo) 2006, a court in Colorado granted a § 1782 discovery order at the request of English estate administrators for production of documents in an accounting of U.S. assets and liabilities of a decedent's partnership for use in an estate account case in England.

In Lopes v. Lopes, 180 Fed. Appx. 874, 2006 WL 1308542, a Florida court granted an ex parte § 1782 discovery order at the request of a resident of Brazil for the production of bank account documentation regarding accounts in the name of the applicant's husband in connection with divorce proceedings in Brazil.

Section 1782 has found particular application in intellectual property disputes. For example, in In re Proctor & Gamble Company, 334 F. Supp.2d 1112 (E.D. Wis. 2004) the manufacturer defendant in a patent infringement suit was allowed to obtain discovery in the U.S. for use in proceedings in five different countries. The District Court emphasized the greater efficiency involved in ordering discovery from persons located in the district rather than having to proceed first in the five foreign nations.

In Infineon Technologies A.G. v. Green Power Technologies, Ltd., 2005 U.S. Dist. LEXIS 11187, (D. D.C., 2005) a declaratory action concerning validity of a patent, the district court applied Intel factors, balanced them and granted the defendant's request for production of documents for use in a German proceeding similar to the proceedings before the district court. See also U.S. Philips Corp. v. Iwasaki Elec. Co., 142 Fed. Appx. 516, 2005 WL 1874992.

Not surprisingly there are divergent views concerning the expanded scope of § 1782(a) discovery orders. In favor of this trend is the argument that increasing globalization frequently involves two or more jurisdictions and the ability to obtain testimony and documents from litigants or third parties for use in a proceeding or in multiple proceedings permits parties to streamline gathering of relevant evidence, reduces overall legal costs and results in a quicker more cost-effective resolution of multi-jurisdictional litigation on the merits or by way of settlement.

In countering arguments for a more restrive interpretation, courts and commentators also point to the wide discretion of the District Courts to grant or deny assistance, the protections which the court can impose against overly broad requests and the right of the foreign tribunal to accept or reject the evidence produced. Hope is also expressed that the U.S. approach will encourage foreign countries to provide reciprocal means of assistance to U.S. courts and litigants.

On the other hand, opponents of an expansive interpretation of § 1782 particularly criticize its application to private arbitration proceedings. They argue that while judicial assistance for the purpose of obtaining evidence for an arbitration may exist in many countries, generally any application for judicial assistance is subordinate to the prior approval or permission of the arbitral tribunal. Fear is expressed that § 1782 is not suited for use in connection with arbitration proceedings and may open the door to possible judicial interference by U.S. Courts with the arbitral process which would be contrary to the parties expectations when agreeing to arbitration. The argument is made that a U.S. Court should not substitute its own judgment for that of the parties' arbitral tribunal and the parties may have agreed to the arbitration proceeding precisely because they do not wish to be subjected to interim court orders.

It is further argued that the general absence of reciprocity places persons who reside or are found in the U.S. at a disadvantage since there is generally not a comparable disclosure obligation in the home country of the applicant. Foreign companies outside the reach of U.S. Courts would thus be given a discovery weapon against U.S. opponents that could not in turn be used against the foreign parties. It has been suggested in some quarters that Congress should intervene to reverse or limit the extension of § 1782(a), especially as it applies to arbitration proceedings.

In spite of these arguments, the trend is clearly to expand the scope of § 1782.

In utilizing § 1782, several provisions need to be kept in mind by the practitioner. Discovery may be sought from "a person" who "resides or is found" in the district in which the application for assistance is filed. As previously discussed, the discovery request need not be directed to a party to the litigation and the term "person" has been read to encompass various types of organizations, including corporations, partnerships and other associations. Sovereign governments, however, do not qualify as persons under this provision. At least one case has limited the scope of this statute to evidence physically located within the United States. In re Application of Sarrio, S.A., 119 F. 3d 143 (2d Cir. 1997). Orders are generally limited to testimony and production of documents and not interrogatories or requests for admissions.

Some controversy continues to exist concerning whether the discovery sought must involve evidence that would be discoverable under the laws of a foreign jurisdiction. The majority of courts seem to hold that § 1782(a) does not require that evidence be discoverable under foreign law, but where the request is made by a private litigant rather than the foreign tribunal, some courts apply a foreign discoverability requirement to prevent use of § 1782(a) to circumvent the foreign jurisdiction's discovery rules and to avoid putting U.S. litigants at a disadvantage if their right to discovery in the foreign jurisdiction is limited or non-existent.

Since the trial court has great discretion and judicial assistance under § 1782(a) is not mandatory the district courts have wide latitude in determining whether and to what extent to grant or deny applications. They also have great discretion imposing terms and conditions on the discovery, including the assessment of costs.

U.S. District Courts, including post-Intel decisions, continue to hold that while there is no reciprocity or discoverability requirement in the foreign jurisdiction, § 1782 cannot be used to circumvent rulings of a foreign tribunal or where the foreign tribunal is not receptive to U.S. judicial assistance. Schmitz v. Bernstein, 376 F.3d 79 (2nd Cir. 2004); In re Servico Pan Americano Deproteccion, 2004 U.S. Dist. LEXIS 24430 (SDNY 2004).
The courts have generally interpreted the provision concerning recognition of privilege as including both federal and constitutional privileges as well as statutory immunity and privileges provided under foreign law.

The statute allows the order to require following the practice and procedure of the foreign country but "to the extent... the order does not prescribe otherwise, the testimony or statement shall be taken and the document or other thing produced in accordance with the Federal Rules of Civil Procedure."

Finally § 1782(b) recognizes that testimony or documentary evidence may be provided voluntarily by a person within the United States for use in a proceeding in a foreign or international tribunal.

With the increasing globalization of litigation and arbitration, the use of discovery requests under § 1782(a) will undoubtedly continue to increase. Although recent cases have given considerable guidance, there is still room for disagreement and controversy among the courts as well as the possibility of intervention by Congress. This is an area which will be of increasing importance to lawyers involved in international litigation or arbitration. Overall, the expansion of § 1782's scope seems consistent with the multi-jurisdictional character of international litigation and arbitration.

Safe-Harbor Procedures for Dealing with Social Security “No-Match Letters”

On August 15, 2007, the Department of Homeland Security published its final rules which create a safe-harbor procedure that employers may choose to follow when they receive a letter from the Social Security Administration (SSA) informing them that the combination of an employee name and social security number being used by that employee does not match SSA's records. These letters are commonly called "no-match letters." The rules will become effective on September 14, 2007. [Note: On August 31, 2007, a federal judge in California issued an order which temporarily prohibits the Department of Homeland Security from relying on no-match letters, by themselves, as evidence that employers had constructive knowledge that the employee was not authorized to work in this country. That order also prohibits the Social Security Administration from issuing no-match letters to more than 140,000 employers. Thus, the scope and effect of the safeharbor regulations related to no-match letters is currently uncertain. Employers should consult with legal counsel before making decisions about whether (or how) to implement the safeharbor procedures.] This safe-harbor procedure may be of particular interest to Arizona employers because of the onerous requirements of the recently-enacted Legal Arizona Workers Act.

Under Federal immigration statutes, it is unlawful for an employer to continue to employ workers "knowing" they are not authorized to work in the United States. "Knowing" includes not only actual knowledge but also the concept of "constructive knowledge" - knowledge that may fairly be inferred from facts and circumstances. An employer's receipt of a no-match letter can be evidence that the employer had constructive knowledge if the employer fails to take reasonable steps after receiving the letter. The new rules outline a step-by-step procedure which employers may choose to follow, and which the Department of Homeland Security will deem reasonable and sufficient to eliminate the no-match letter as evidence that the employer had constructive knowledge that the employee involved was not authorized to work.

The actions required and the timeframes within which they must be accomplished to fit within the safe harbor are summarized in the following chart:

Timeframe: Day 0

Action: Employer receives no-match letter from SSA

Timeframe: 0-30 days

Action: Employer checks its own records to see if the discrepancy results from a typographical, transcription or similar clerical error in its records, or in its communication to SSA. If there is such an error, employer corrects it and verifies with SSA that the name and number, as corrected, match SSA's records.

Timeframe: 0-90 days

Action: If the review of the employer's records does not resolve the discrepancy, employer promptly asks employee to confirm that employer's records are correct. If they are not correct, employer corrects them with the information provided by employee and verifies with SSA that the name and number, as corrected, match SSA's records. If employer's records are correct according to employee, employer advises employee of the date the no-match letter was received and asks employee to resolve the discrepancy with SSA within 90 days of the receipt date. If employee resolves discrepancy, employer verifies with SSA that the name and number match SSA's records.

Timeframe: 90-93 days

Action: If employer is unable to verify with SSA within 90 days, employer completes a new Form I-9 for employee as if employee were newly hired; however, employee may not rely on any document containing the disputed social security number.

If the no-match discrepancy is not resolved and if the employee cannot produce adequate documentation to complete the new Form I-9, the employer must either terminate the employment relationship or risk being found to have constructive knowledge that the employee is not authorized to work.

Employers are not required to follow this safe-harbor procedure.It simply provides a clear method for employers to exercise reasonable care in addressing no-match letters.There may be other reasonable methods to respond to no-match letters that will prevent a finding of constructive knowledge, but they do not provide the benefit of a "safe-harbor."If an employer chooses to follow the safe-harbor procedure, it should do so uniformly to avoid discrimination claims.Thus, the employer should require all employees who fail to resolve no-match discrepancies to fill out a new Form I-9, and should apply a uniform policy to all employees who refuse to participate or whose Form I-9 verification is unsuccessful.

This safe-harbor procedure has limited application.It prevents a finding of constructive knowledge based on the no-match letter only; it does not prevent finding that an employer has actual or constructive knowledge for some other reason.Also, it does not apply when an employer learns of a SSA no-match discrepancy by any means other than a no-match letter, such as through participation in the U.S. Citizenship and Immigration Services' Employment Eligibility Verification Program ("EEV" formerly known as the "Basic Pilot Program").

Under the newly-enacted Legal Arizona Workers Act, all Arizona employers will be required to participate in the EEV beginning January 1, 2008.As a result, they will likely learn of SSA no-match discrepancies within just a few days of hiring the employee and without the need of a no-match letter.As noted above, the safe-harbor procedures in these new rules technically do not apply to this situation.Nevertheless, liability under the Legal Arizona Workers Act is based on intentionally or knowingly hiring or employing an unauthorized worker. Careful compliance with the safe-harbor procedures will likely be helpful evidence that the employer neither intended nor knew that its employees lacked work authorization.Accordingly, Arizona employers should consider whether they want to incorporate the safe-harbor procedures into their employment policies and practices.

If you have any questions or concerns about the new Safe-Harbor Procedures, contact the Chair of Jennings, Strouss & Salmon's Labor and Employment Department, John J. Egbert.

Arizona's New Employer Sanction Law

Arizona has enacted the nation's most aggressive legislation aimed at preventing the employment of unauthorized workers. Dubbed the "Legal Arizona Workers Act," this new law goes into effect January 1, 2008.

The new law imposes two significant requirements on all Arizona employers:

It prohibits employers from intentionally or knowingly employing unauthorized workers; and
It requires employers to verify the employment eligibility of newly hired employees through the federal government's Employment Eligibility Verification Program ("EEVP").

Unlike current federal immigration laws that use monetary penalties, the sanction under the Arizona law could be the permanent loss of all business licenses:

Penalties for Knowingly Employing

4 Must terminate the worker(s)
4 3-year probation (during which employer must file quarterly reports)
4 Business licenses may be suspended for up to 10 business days.
4 Must sign affidavit affirming that it has terminated all unauthorized workers and will not knowingly or intentionally employ unauthorized workers in the future (failure to file this affidavit within 3 business days after the employer is found to be in violation will result in suspension of all business licenses until it is filed)
4 A second violation during the probation period results in permanent revocation of all licenses

Penalties for Intentionally Employing

4 Must terminate the worker(s)
4 5-year probation (during which employer must file quarterly reports)
4 Business licenses must be suspended for at least 10 days
4 Must sign affidavit affirming that it has terminated all unauthorized workers and will not knowingly or intentionally employ unauthorized workers in the future (suspended licenses will remain suspended at least until the affidavit is filed)

4 A second violation during the probation period results in permanent revocation of all licenses

The new law provides two ways for employers to protect themselves:

Use the federal government's Employment Eligibility Verification Program ("EEVP") for newly hired employees. If it turns out that an employee is not authorized to work, proof that the employer verified that worker's eligibility through EEVP creates a rebuttable presumption that the employer did not act knowingly or intentionally. Information about EEVP is available from the U.S. Citizenship and Immigration Services, (888) 464-4218 or at http://www.uscis.gov/files/nativedocuments/EEV_FS.pdf
Fully comply with the I-9 documentation process for all employees. Good faith compliance with this process is an "affirmative defense" that the employer did not act knowingly or intentionally.

There is substantial uncertainty and confusion concerning this new law and its future. On the same day that Governor Napolitano signed the legislation into law, she noted several aspects of the law that she believed needed correction, and suggested to the leadership of the Legislature that a special session should be called. There appears to be a strong possibility of a special session occurring before the end of this year. Additionally, various employers have already filed suit in federal court, asserting the new law is unconstitutional on several grounds.

What should Arizona employers do prior to the new law's effective date (January 1, 2008)?

Monitor developments as they occur;
Carefully audit current I-9 files and ensure that appropriate policies and practices are in place;
Consult with legal counsel to evaluate whether participating in the federal government's Employment Eligibility Verification Program before the mandatory start date may be beneficial for your organization.

If you have any questions or concerns about the new Arizona Law, contact your Jennings Strouss attorney, or the Chair of our firm's Labor and Employment Department, John Egbert at 602-262-5994 or jegbert@jsslaw.com.

Things to Consider When Selling Your Business or Buying Another: A Guide to the Merger and Acquisition Process

Buying or selling a business can be an exhilarating, yet bewildering and all-consuming endeavor. You have spent countless hours building your business and now can consider this significant change. Yet, the demands of your business will continue throughout the time you spend evaluating and pursuing an extraordinary transaction.

This Guide provides an overview of the transaction process and offers suggestions to help prepare you for some of the business and personal impacts you may encounter throughout and after the process.

Participating in Technology Standards-Setting Organizations

The decision of whether your company should join a standards-setting organization (SSO), and if so, which one and on what terms, can have significant implications for your company's future. If you are not already familiar with the business and legal ramifications of SSOs, you should take another look.

Consider the following scenario: Late one afternoon, you receive a frantic call from one of your company's engineers. He or she wants to join a SSO so your company can align its upcoming product launches with what appears to be an emerging industry standard. The problem is that the engineer needs you to sign the Membership Application today because the SSO's next meeting is tomorrow morning. The engineer e-mails you a link to the Application, which is, thankfully, only a few paragraphs long. It looks pretty straightforward so you e-mail the engineer telling him to go ahead and sign up for membership in the SSO. With this matter "resolved", you turn back to other business, unaware that you may have just given up your company's right to control some of its most lucrative proprietary technology.

In this scenario, the way that SSOs function and the specifics of their membership terms can have a profound effect on your company's business. If you're not sure how SSOs could effect your company, this article is intended to provide you with some basic information on SSOs.

What are "Standards" and "SSOs?"

Technology standards promote greater interoperability and compatibility among technologies and products, which in
turn increase the likelihood of industry acceptance for a given technology or
product. While standards-setting organizations ("SSOs") are sometimes sponsored by governments (a model common in the European Union), private SSOs are becoming more prevalent, particularly in the USA. A private SSO is an industry group that develops and publishes technology specifications (also called "standards") in the interest of facilitating interoperability and compatibility. Some of these SSOs also establish compliance programs to certify that a particular product or process
is compliant with the specification. Private SSOs can be formed relatively quickly in response to perceived needs for common standards within a given industry.

Industry sectors that have seen recent and rapid growth in the number of SSOs include computer hardware and software, the Internet, wireless/telecommunications, semiconductors, electronic funds transfer/finance, cable and advanced television and even medical devices. Without common standards developed by SSOs, companies in these industries might promote incompatible technologies, which could harm the companies as well as consumers. The interoperability pursued by SSOs is becoming increasingly important as technologies converge, requiring an ever greater level of compatibility between products and services.

Benefits of Participating in SSOs

Though SSOs are often promoted by major technology companies, membership can be a benefit to mid- and smaller-sized companies because participation in an SSO can give these companies a voice in the development of standards that might impact their industry for years to come. At this point, you might be thinking that joining an SSO is probably a no-brainer for your business. And you might be right. There are many potential benefits to participating

in an SSO, including the possibility of increased market acceptance of your product, the ability to help create new markets that would not exist absent broad industry agreement on a new standard (e.g., next-generation wireless) and the ability to spread substantial research and development costs across multiple SSO members.

There are, however, potential pitfalls to joining an SSO-or the wrong SSO-which could prove to be detrimental to your business. Generally, these pitfalls fall into two categories: business and legal risks.

Business Risks

If your company joins an SSO that promotes an "old" or "losing" standard, there is a possibility that your market share will decline, perhaps precipitously. Trying to play "catch up" in such a situation (if catching up is even possible) can prove to be prohibitively expensive. New product development can be substantially delayed while standards issues are being worked out, and existing products can rapidly approach obsolescence as competing standards evolve and flourish. To avoid these negative business effects of failing to join the right SSO, it is critical for you to ensure that your business evaluates competing SSOs in an
attempt to discover which standards have the potential to become winners by achieving broad industry acceptance and which SSOs have goals and purposes in accord with your company's business plan. Moreover, it is important to examine the organizational structure and governance of any SSO you are thinking of joining because these elements will determine the extent and nature of your company's participation in the SSO's activities and its obligations as a member.

Legal Risks

Among the most significant legal risks posed by indiscriminately joining an SSO is the possibility that your company will have inadvertently relinquished some of its most crucial intellectual-property rights without even realizing it. It is not uncommon for SSOs to have membership applications or agreements available on their Web sites, some of which can be "executed" online. These agreements can often be short, sometimes incorporating other documents by reference. Signing one of these agreements can result in your company being bound by all of the SSO's policies and rules, which could include duties to: (i) disclose confidential patents and other intellectual property; (ii) license certain company patents and other intellectual property, sometimes royalty-free, to other SSO members and adopters seeking
to implement the specification; and (iii) share, or even surrender, ownership of
your company's contribution to the specifications developed by the SSO. Thus,
it is essential for a company to carefully review all documents related to SSO membership in light of the legal consequences related to your company's invaluable intellectual property rights. Further legal risks associated with SSO membership include the possibility of antitrust liability to the extent that activities of the SSO and its member companies are deemed anticompetitive with respect to companies that cannot or are not permitted to use the SSO's standard.

Conclusion

SSOs will increase in importance in a wide range of technology-oriented industries as companies, often competitors, see the benefits of finding greater interoperability and compatibility of technology. SSO membership is already a necessary part of doing business for many technology companies. While SSO membership may help catapult your company toward success, the decision to join a particular SSO is fraught with complexity and should not be undertaken lightly. The attorneys at Jennings, Strouss & Salmon, have developed considerable experience in helping clients with these critical issues.

Failure To Perfect A Lien On A Motor Vehicle Within The Time Periods Prescribed By Arizona Statutes Can Result In...

Failure To Perfect A Lien On A Motor Vehicle Within The Time Periods Prescribed By Arizona Statutes Can Result In The Creditor's Loss Of Such A Lien-Particularly In Bankruptcy

Lenders who finance motor vehicle purchases, and the purchasers who buy the vehicles normally expect the vehicle dealer to "quickly" handle the paperwork to perfect the creditor's lien and have it noted on the title. Noting the lien on the title is a requirement under Arizona law. However, processing lien documentation "quickly" seems not to be the case with many motor vehicle dealers in Arizona and the consequences are potentially disastrous for lenders who finance motor vehicle purchases.

It is normally assumed that the "paperwork" processed by the dealer on motor vehicles purchased in Arizona will be done quickly and title applications, perfection of liens, and other appropriate filings made on a "next day basis." Since it is apparent that this does not happen, Bankruptcy trustees have developed a burgeoning "cottage industry" to knock the lenders out of contention when the vehicle purchaser files Bankruptcy. The primary problem is that the dealers are not processing the lien perfection paperwork within the time required under Arizona statutes.

The following is a brief summary of the statutes which apply.

A.R.S. § 28-2131 provides that any interest asserted in a vehicle required to be titled is not valid if the requirements of the law are not met. Pursuant to A.R.S. § 28-2132 and §28-2133, all liens and encumbrances against a titled vehicle are required to be set forth on that title, with the Department of Motor Vehicles maintaining an index of all recorded liens and encumbrances. The filing and issuance of a new certificate of title is constructive notice to creditors of the owner or subsequent purchasers of all liens and encumbrances against the vehicle described in the certificate of title.

Under A.R.S. § 28-2132, the applicant's signature on the application for title or registration only is consent for the lien or encumbrance to be indicated by the Department of Motor Vehicles on its official title record for the vehicle. On receipt of the application, the Department shall endorse on the application the date and hour it was received at the registering office of the Department

Any interest asserted in a vehicle required to be titled is not valid as to judgment and execution creditors if the requirements of the law are not met. A.R.S. § 28-2131 and A.R.S. § 28-2133(C). The constructive notice date to creditors of all liens against a vehicle described in a new certificate of title is the time of receipt and filing of the application for title and/or registration by the Department or the registered office. A.R.S.§ 28-2133(B).

Pursuant to A.R.S. § 47-9324(A), a purchase money security in collateral takes priority over any conflicting security interest in the same collateral or proceeds so long as the security interest is perfected at the time the Debtor receives possession of the collateral or within 20 days thereafter.

Under Arizona law, a lien against a motor vehicle is deemed to be perfected on the date the application for title reflecting that lien is endorsed with a stamped date of receipt by the Department of Motor Vehicles. See North v. Desert Hills Creditor, 310 B.R. 152, 160 (Bankr. Ariz. 2004).

Under Ninth Circuit law, (applicable in Arizona) a creditor's post-petition perfection of its lien against the vehicle is void. In re Lockridge (Pierce v. Conseco), 303 B.R. at 456 (Bankr. Ariz. 2003). Thus, a creditor's perfection of its security interest in the vehicle is avoidable as an unauthorized post-petition transfer under 11 U.S.C. §549. Pursuant to 11U.S.C. §363(f), the trustee may sell property free and clear of any interest in such property if the interest is in bona fide dispute.

Bankruptcy law provides, under 11 U.S.C. §362(a)(5), that any act to perfect against property of a debtor any lien to the extent such lien secures a claim that arose before the commencement of the bankruptcy case is a violation of the automatic stay.

Summary

What is occurring on a regular basis, at least in Arizona, is that people are buying vehicles, shortly thereafter filing bankruptcy, and the trustees in bankruptcy are avoiding the liens of the creditors who finance the purchase of the vehicles because the paperwork has not been filed by the dealer within the 20-day period required under Arizona law. This enables the trustee to take possession of the vehicle, have it sold, the proceeds deposited into the bankruptcy estate, and the lien creditor left with a claim in bankruptcy or litigation with the trustee to attempt to arrive at a compromise in the bankruptcy action. Since the problem was caused by the dealer, or the creditor's agent, by not getting the paperwork filed and the lien properly perfected within the time required under Arizona law, the creditor will hopefully have recourse against the dealer. However, this can be time consuming and result in legal expense and the creation of an adversarial relationship with the dealer.

As a motor vehicle finance creditor, the best prevention is explicit communication to the dealer or its agent to ensure that the paperwork is properly processed, on a timely basis. The contract between the creditor and the motor dealer should explicitly provide for full recourse by the creditor against the dealer in the event of the dealer's failure to perfect the lien and loss of the lien rights. This should include a provision for recovery of all costs and legal expenses.

Relief for the Financially Troubled School District

Brian Spector's article "Relief for the Financially Troubled District" has been published in the magazine, The School Administrator, a magazine published by the American Association of School Administrators.

Here is blurb from Brian's article... "A school district can fall prey to financial troubles, sometimes due to economic forces beyond its control that can affect its tax base and ability to retire debt." For a discussion of the school district's options for addressing its financial plight, please see the attached document.

Unsolicited Fax Advertisements Can Be Costly

Anyone who uses e-mail is familiar with "spam." E-mail boxes are flooded every day with unsolicited offers to take out a mortgage, refinance a debt, or transfer funds for a mysterious foreign millionaire. While Congress debates legislation that would regulate spam, an established law that prohibits a more old-fashioned method of sending unsolicited advertisements deserves attention. Unsolicited advertisements sent to facsimile machines have been illegal under federal law since 1991. A recently passed Arizona law also regulates such advertising. The laws aim to protect targets of unsolicited advertising, but may result in severe penalties to those who are unwittingly in violation and unaware of the consequences.

The Telephone Consumer Protection Act of 1991 Congress passed the Telephone Consumer Protection Act (TCPA) in 1991. 47 U.S.C.A. § 227 (2003). The TCPA regulates the use of automatic dialing machines and prerecorded voice messages. The TCPA also prohibits using fax machines, computers, or other devices to send unsolicited advertisements to a fax machine." An "unsolicited advertisement" under the TCPA is "any material advertising the commercial availability of any property, goods, or services which is transmitted to any person without that person's prior express invitation or permission." The TCPA has survived several constitutional challenges.

The penalties for violating the TCPA are substantial. The Federal Communications Commission (FCC) enforces the TCPA and may fine the fax senders. In 2002, the FCC fined one business over $1 million for sending 152 unsolicited faxes. There is also the potential for civil lawsuits. The TCPA allows recipients of unsolicited fax advertisements to recover either their actual monetary loss or $500 per occurrence. This amount may triple if a court finds that the sender willfully or knowingly violated the TCPA. In other words, the sender of unsolicited fax advertisements may be held civilly liable for $1,500 per fax. While this alone is a shocking amount, consider that unsolicited fax advertisements are likely sent en masse. Senders may potentially incur enormous civil damages at the touch of a button. For example, a class action lawsuit against Hooters Restaurants of Augusta, Georgia for sending 7,926 unsolicited fax advertisements resulted in a judgment of nearly $12 million - $1,500 for each fax sent.

Arizona Law

In addition to the Telephone Consumer Protection Act, Arizona now has its own statute governing unsolicited fax advertisements. H.B. 2346, 46th Leg., 1st Reg. Sess. (Ariz. 2003). On May 12, 2003, Governor Napolitano signed a bill requiring senders of unsolicited commercial fax advertisements to include their name, address, fax number, and local or toll-free telephone number on the fax. Anyone who receives an unsolicited fax may contact the sender and request that no further faxes be sent. If, after three business days, the recipient receives another fax from that sender, the recipient may charge the sender $5 for each page received. Collection is up to the recipient.

The Arizona bill was intended to augment the TCPA, but the TCPA is far more restrictive. For example, under the Arizona bill, the $5 per page penalty is available only when more faxes are sent after the recipient notifies the sender. The collection of the penalty is up to the recipient, but may not be a worthwhile pursuit. Many unsolicited faxes must be received just to cover collection costs. Under the TCPA, however, the sender of unsolicited fax advertisements is liable for the $500 per fax penalty when the fax is sent. There is no need for the recipient to first notify the sender before the sender incurs liability. Also, the available damages make collection a potentially lucrative activity.

Conclusion

Fax advertising is an inexpensive way to distribute information about products or services. However, it can become very expensive when the advertisements are sent without prior authorization. The federal and state laws give rights to recipients of unsolicited fax advertisements. These rights must be recognized and respected. Ideally, a sender would attempt to get express permission from a recipient. At the least, a sender should comply with the federal and state identification requirements and respond promptly to recipients' requests to be removed. Otherwise, a sender may be found liable for far more than the paper and ink costs incurred by the recipient, and a seemingly innocuous activity can severely affect a business.

For more information about this topic, please contact John. G. (Jack) Sestak, Jr., at 602.262.5827 or jsestak@jsslaw.com. Research assistance for this article was contributed by summer associate Christopher M. Goodman, who is attending the University of Arizona College of Law.

About the Author . . .

John G. (Jack) Sestak, Jr. has practiced for 30 years in the areas of business and commercial litigation and transactions. In his litigation practice, he has represented companies of all sizes in matters such as contract disputes, securities litigation and arbitration proceedings. He has represented owners and contractors in construction disputes and lawsuits, and has represented employers in employment and employment termination matters. He has represented professionals, including law firms, accounting firms, engineers and architects, in negligence actions.

In addition to his litigation practice, Mr. Sestak handles business and commercial transactions of all kinds, providing counsel and advice to a variety of clients in connection with business planning as well as dispute avoidance and resolution.