Today's General Counsel (Formerly Executive Counsel), V9 N6, December 2012/January 2013 by Today's General Counsel

dec/jan 2013 VOLUMe 9 / nUMBeR 6 e x ecuti v ecounsel.info

T H E

M A G A Z I N E

F O R

T H E

G E N E R A L

C O U N S E L ,

C E O

C F O

E-DISCOVERY

Start with Good Information Management INTELLECTUAL PROPERT Y

What You Should Never Say to Competitors

Litigation Over Social Media Accounts

How to Confront a Non-Practicing Entity

Whistleblowers Empowered “Inherently Dangerous Products”

Transfer Pricing of Intellectual Property

Five Troublesome Litigation Trends

Third Party Submissions in Pending Patents

Are Franchisees Contractors or Employees?

Mandatory Arbitration in Consumer Contracts

CANADA/ CROSS-BORDER

Canada’s New Anti-Trust Enforcement GOVERNANCE

Easier to Prove Aiding and Abetting

Social Media:

secure it now

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Editor’s Desk

If you’re still the kind of Luddite who questions the value of social media, be sure to read John G. Browning’s article in this issue of Executive Counsel. Browning references a case in federal court in which the plaintiff is specific on that matter. PhoneDog, a product reviewer, claims damages based on the “market value” of its Twitter followers, which it pegs as $2.50 per follower per month. Browning provides an overview of emerging case law about a question no one ever asked until a few years ago: If an employee and employer share in creating content, making connections, and bringing in customers through social media sites, who owns the account, the content and the benefits generated? He also cites some reasons why these issues are becoming increasingly important: For example, three-quarters of companies responding to a survey conducted last summer said they do about 25 percent of their marketing on social media. Couple the growth of that form of marketing with the blurry line that presently exists between personal time and company time spent on Facebook, Twitter, LinkedIn, etc., and you have the ingredients for a litigation explosion. Allegations such as unauthorized use and access, invasion of privacy, Lanham Act violations, civil conspiracy and violations of the Computer Fraud and Abuse Act (CFAA) have already been leveled by both employers and employees in social media related lawsuits. Cloud computing is another technology that has the potential to generate litigation, in this case related to attorney/client privilege and the obligation to maintain confidentiality. Judith Lockhart and Emily Milligan have some good suggestions about how service contracts should be structured to avoid those problems, especially in the health care and financial services industries.

Attorney Paul E. Benson discusses trends in litigation, technology-based and otherwise. Wage-and-hour lawsuits are on the rise, with many plaintiffs seeking remedies for “themselves and others similarly situated.” Benson notes that damages in those cases can be huge and the trend is likely to continue, since the Department of Labor is implementing a new initiative to shift the burden of compliance to the employer rather than relying on enforcement interventions.

Bob Nienhouse, Editor-In-Chief Editor@executivecounsel.info

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Features

Page

54 46 48

THE ERA OF THE WHISTLEBLOWER HAS ARRIVED Michael Matthews and Melissa Coffey Broader reach, more protections.

FIVE LITIGATION TRENDS THAT CAN KEEP BUSINESS OWNERS AWAKE AT NIGHT Paul E. Benson False advertising, wage-and-hour head the list.

Judith Lockhart and Emily Milligan Nervous about the cloud.

FRANCHISORS WINCE AS SOME COURTS RE-LABEL FRANCHISEES AS EMPLOYEES James Mulcahy New iteration of the independent contractor controversy.

MITIGATING LITIGATION RISK OF INHERENTLY DANGEROUS PRODUCTS Lori B. Leskin and Adrienne D. Gonzalez Gas can manufacturer flames out.

ADDRESSING SECURITY RISKS IN THE NEW TECHNOLOGIES

HAS THE SUPREME COURT CLEARED THE TRACKS FOR MANDATORY ARBITRATION IN CONSUMER CONTRACTS? By David Mills, Daniel Prichard and Alyssa Saunders A long history of tension between Federal Arbitration Act and populist-minded states.

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DEC/JAN 2013 E X ECUTIV E COUNSEL

Departments Editor’s Desk Executive Summaries

INTELLEC TUAL PROPERT Y

21 | Copyright Issues Proliferate on the Net

E-DISCOVERY

18 | Using Discovery and Information Management Technology Efficiently Mark Walker Manage upstream, save money downstream.

Miles McNamee Link maybe, cut and paste no.

24 | What Not to Say to Competitors, Post-Medimmune Eligio C. Pimentel and Michael Carrozza 300-page infringement summary not advised.

28 | How to Confront an NPE Deborah (Bea) Swedlow

Settlement may work, but it can make you a future target.

30 | TaxAdvantaged Transfer Pricing for Intellectual Property

GOVERNANCE

By Robert J. Misey, Jr.

Brian Neil Hoffman It’s easier to prove.

Royalty or shared ownership?

38 | New Standards for Aiding and Abetting

HUMAN RESOURCES

34 | Third Party Submissions in Pending Patents By Michael T. Siekman and Oona M. Johnstone A way to influence a competitor’s application.

42 | Your Company May Not Own its Social Media Accounts John G. Browning Litigation erupts as the boundaries dissolve.

CANADA / CROSS-BORDER

37 | Canada’s New Appetite for Antitrust Litigation Nikiforos Iatrou and Scott McGrath The remedy was dissolution.

Page 28

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Editor-in-ChiEf Robert Nienhouse

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MaNagiNg eDiTOr David Rubenstein

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arT DirecTiON & PhOTO illusTraTiON MPower Ideation, LLC

busiNess MaNager Amy Ceisel

DirecTOr Of circulaTiON Carol Spach

Contributing Editors and WritErs

Paul E. Benson John G. Browning Michael Carrozza Melissa Coffey Adrienne D. Gonzalez Brian Neil Hoffman Nikiforos Iatrou Oona M. Johnstone Lori B. Leskin Judith Lockhart Michael Matthews Scott McGrath

Miles McNamee Emily Milligan David Mills Robert J. Misey, Jr. James Mulcahy Eligio C. Pimentel Daniel Prichard Alyssa Saunders Michael T. Siekman Deborah (Bea) Swedlow Mark Walker

Editorial advisory board Dennis Block GREENBERG TRAuRIG, LLP

Thomas Brunner Wiley Rein

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DEC/JAN 2013 E X ECUTIV E COUNSEL

Executive Summaries E-DISCOVERY PAGE 18

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PAGE 24

Using Discovery and Information Management Technology Efficiently

What Not to Say to Competitors, Post-Medimmune

By Miles McNamee Copyright Clearance Center

By Eligio C. Pimentel and Michael Carrozza McAndrews, Held & Malloy

As companies realize the extent of their own copyrighted works, they also find they are prolific users of the copyrighted content of others. Most articles, newsletters, graphics and images that find their way into the workplace are subject to copyright protection. Email is the primary vehicle by which workers move information. Surveys have found that 80 percent of employees use it to send links or to attach documents, and that nearly half of knowledge workers cut-and-paste content into e-mails. Sending a link is often in compliance with copyright law, while attaching documents or cutting and pasting often is not. One survey found that fifty-one percent of workers erroneously believe that information obtained online or in print, at no charge, can be shared without copyright holders’ permission. Many workers pay no attention to copyright, and more than half of workers surveyed either don’t think about copyright or don’t care. Subscriptions and publishing agreements are somewhat helpful. Some publishers sell licenses that let employees share articles from specific periodicals, journals, or newsletters within their companies. Rights aggregation and licensing services provide broader protections, streamlining the rights process and covering much of the content employees need to use and share. As copyright compliance evolves, companies must keep tabs on employees and monitor how they use and distribute content. By partnering with expert service providers, companies can help ensure proper content sharing and avoid costly mistakes.

Prior to the Supreme Court’s decision in MedImmune v. Genentech, courts used a “reasonable apprehension of suit” test developed by the Federal Circuit to determine whether there was an actual controversy sufficient to allow for declaratory relief in matters of potential patent infringement. To find declaratory judgment jurisdiction, courts looked for an express or implied threat of an impending patent infringement lawsuit. This was a high standard for a plaintiff, and it also meant that a patentee could safely communicate regarding its patent rights and negotiate licensing terms with a defined and limited risk of creating actual controversy. But in MedImmune, three cases were cited in which there was declaratory judgment jurisdiction despite lack of threats of an impending lawsuit. The Court reasoned that the wiser approach to declaratory relief was the “totality-of-the-circumstances” standard articulated in Maryland Casualty. The new standard adopted in MedImmune forced the Federal Circuit to reconsider how and when party communications give rise to actual controversy. MedImmune lowered the bar for determining declaratory judgment jurisdiction in all patent cases. Since MedImmune, the Federal Circuit has found jurisdiction in nearly every case involving communications between parties. This makes it difficult for lawyers to advise clients on what they can say to competitors without triggering an actual controversy, and a potential lawsuit. The authors cite recent Federal Circuit decisions to illustrate what not to do when communicating with a competitor.

By Mark Walker Document Solutions, Inc.

INTELLEC TUAL PROPERT Y

A common misperception is that if we could figure out the right e-discovery technology, a lot of money could be saved. The reality, the author says, is that we should be focusing the discussion on workflow instead of technology costs. If data is managed well upstream, it makes a huge impact on any future discovery costs downstream. This does involve technology, but it begins with a strong information management (IM) system, coupled with sound data filtering and review of workflows. IM policy sets up rules governing how documents are classified, managed and either archived or destroyed when no longer needed. Every business should establish an IM policy, no matter the industry, company size or type of data. Priorities and future needs should be assessed to determine what platform best suits a company’s requirements. Among the many questions that should be asked are: How often do you need to collect, search and review data? Do you have an in-house team that is experienced in discovery processes? Is your company sued often enough to warrant a complete enterprise system, or would it make more sense to employ a smaller, scalable system? Do you need to be able to reuse work product? There is an expense for technology, but when the right platforms are working together, significant savings on discovery costs are realized. Additional benefits include advanced security, superior file management, accelerated data processing, enhanced quality control, detailed reporting and improved defensibility.

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Executive Summaries INTELLEC TUAL PROPERT Y PAGE 28

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How to Confront an NPE

Tax-Advantaged Transfer Pricing for Intellectual Property

Third Party Submissions in Pending Patents

By Robert J. Misey, Jr. Reinhart Boerner Van Deuren s.c.

By Michael T. Siekman and Oona M. Johnstone Wolf, Greenfield & Sacks P.C.

The IRS has 160 pages of transfer pricing regulations. They can appear intimidating, but they can also offer a powerful tool to lower the taxes of a multi-national corporation. Although the IRS regulations provide a lengthy list of intellectual property for tax purposes, IP can be broken down into trade intangibles (i.e., patents, trademarks, designs, models), marketing intangibles (i.e., brands), and know-how (i.e., trade secrets). Transfer pricing professionals consider IP as anything not tangible that provides a return in excess of routine. The author explains several methods of transfer pricing and analyzes their relationship to the IRS methods for determining the royalty for IP. They involve inter-company transactions and focus on the tax impact of differentiating between the appropriate transfer pricing methodology for a royalty from licensing the IP, or in the alternative, entering a cost sharing arrangement that shares the ownership of the IP. Multi-nationals may view the maze of IRS regulations with respect to the transfer pricing of IP as complex, but nonetheless they should consider taking advantage of them to save taxes. First, the multi-national must identify the IP. Second, the multi-national has to determine whether one party will incur all the development costs and license the IP to the other party or whether the parties will enter a cost-sharing arrangement. Third, and finally, the multi-national will have to plan the proper defense through the use of either contemporaneous documentation or an advance pricing agreement.

A significant provision of the America Invents Act defines a procedure by which a third party can submit publications, as well as a description of their relevance, into the file of a pending patent application at the U.S. Patent and Trademark Office. Thus what had almost always been an exclusively ex parte process (one that excludes third party involvement) between the applicant and the USPTO is now open to third parties. Patent applicants are advised to take advantage of this rule change with regard to their competitorsâ&#x20AC;&#x2122; applications, while also preparing for competitorsâ&#x20AC;&#x2122; submissions into their own applications. Third party submissions could be particularly useful when they focus on limiting a particular element of published claims. Ideally, that would result in the claims being limited to exclude that particular embodiment, as well as a clear prosecution history estoppel which would prevent recapture of the embodiment by the patentee. Those submitting third party submissions should recognize they will be putting the applicant on notice that its invention may be of commercial importance. They might also be strengthening the patent by having the best prior art considered by the USPTO. Overall, the AIA third party submissions provision represents an important strategic opportunity for third parties who are ready to influence their competitorsâ&#x20AC;&#x2122; patent prosecution. Patent applicants will need to be prepared to respond to what previously would have been viewed as improper interference with the ex parte prosecution of their applications.

By Deborah (Bea) Swedlow Honigman Miller Schwartz and Cohn LLP

In the vocabulary of intellectual property practice, a non-practicing entity (NPE) is a company whose business model consists of acquiring and enforcing patents through cease and desist demands, licensing schemes or lawsuits. NPEs generally have no interest in developing or selling products or services. They generate revenue by threatening legal action and extracting settlements from companies that allegedly infringe their patents. The 2011 America Invents Act addresses NPEs with provisions intended to discourage the NPE strategy of filing lawsuits against multiple but unrelated defendants. The flow of lawsuits, however, has yet to subside. As a result a company confronting an NPE must continue to evaluate the comparative risks of litigating or settling. Moreover, settlement and knock-out litigation are not the only alternatives. A new industry has emerged, through which companies can buy and license patents in particularly NPE-heavy fields (such as e-commerce and wireless telecom) in order to gain some control and leverage. Companies within this industry differ in their modus operandi. Some, such as Intellectual Ventures or Acacia Research, aggregate patents and seek to offensively monetize them through licensing or even litigation. Others, such as RPX Corporation, offer defensive alternatives. Legislative efforts have focused on statutory amendments that would require plaintiffs (including NPEs) to pay defendant legal costs if the suit is unsuccessful, and not just in exceptional cases. Working with legal counsel to develop pre-emptive strategies, including potential relationships with patent aggregators, is a cost effective approach to mitigating risk.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Executive Summaries

CANADA /CROSS-BORDER

GOVERNANCE

HUMAN RESOURCES

PAGE 37

PAGE 38

PAGE 42

Canada’s New Appetite for Antitrust Litigation

New Standards for Aiding and Abetting

Your Company May Not Own its Social Media Accounts

By Nikiforos Iatrou and Scott McGrath WeirFoulds LLP

By Brian Neil Hoffman Morrison Foerster

By John G. Browning Lewis Brisbois Bisgaard & Smith

Commissioner of Competition v CCS Corporation, decided in May 2012, was only the sixth litigated merger in Canada’s history. In bringing – and winning – the case, the Canadian Competition Bureau demonstrated to the Canadian marketplace that antitrust enforcement will have to be taken seriously. According to the authors, investors and companies doing business in Canada would be wise to take heed of these developments. The Commissioner’s case was that the transaction prevented competition that had not yet arisen – in contrast to the standard mergers case, where the allegation is that the transaction will lessen pre-existing competition. By the time the Commissioner brought her case, the deal had already closed. This caused the issue of remedy to play a central role in the hearing. The Commissioner won the case, demonstrating that the merger prevented competition in the hazardous waste disposal market in Northeastern British Columbia. CCS Corporation was ordered to sell off the key assets it acquired through the merger. The case is notable for several reasons, chief among them the fact that, at $6.1 million dollars, the size of the deal fell well below the mandatory reporting thresholds in Canada. Historically, the Competition Bureau only took an interest in mergers that exceeded the notification thresholds. Although everyone knew that even small deals could be challenged, until the CCS decision, deals that fell under mandatory reporting thresholds tended to fly beneath the enforcer’s radar. That is no longer the case.

In a recent case, SEC v. Joseph F. Apuzzo, a three-judge panel of the Second Circuit Court of Appeals made it significantly easier for the SEC to hold individuals liable for aiding and abetting another’s securities fraud. The Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, and amendments contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act, also make it more likely that the SEC will pursue aiding-and-abetting charges against individuals. In view of these developments, executives should take steps to minimize their potential individual liability. The first step, the author suggests, is to instill a culture of compliance within the organization. He recommends involving experts early in the process. In-house staff in key departments (e.g. accounting and legal) should be involved in drafting and finalizing public disclosures, and the company’s auditors and lawyers should be consulted regularly. The author notes that whistleblower programs have been given sharper teeth, and executives should now assume that whenever an issue is reported within the company, the SEC may have received the same information. No red flags should be ignored. In addition, D&O policies should be reviewed to determine coverage for SEC actions. In some instances, policies advance defense costs, and sometimes they extend coverage to SEC investigations as well as filed litigation. Making sure the company has appropriate insurance will alleviate the significant financial burden an SEC investigation can create, avoiding some unpleasant surprises.

As employees promote themselves as well as their companies on social networking platforms, some questions inevitably arise. If an employee and the employer share in creating content, making connections, and bringing in customers through such social media sites, who owns the social media account, not to mention its content or the benefits that it generates? And what, for that matter, is a Facebook fan or a Twitter follower worth? The answers are far from clear, and litigation over these issues continues to dot the legal landscape. The author discusses a number of these cases. In one of them a company named PhoneDog claims damages based upon a supposed Twitter follower “market value” of $2.50 each, per month. In another case a company’s former president filed suit when the company continued to use a Linkedin site she had used to promote herself as well as the company. She alleged, among other things, invasion of privacy and violations of the Lanham Act, claiming that she lost potential business contacts because those searching for her on LinkedIn would have been confused and unable to send a message to her. The federal court dismissed all of her federal claims, but it allowed state common law claims to proceed to trial. The author suggests addressing ownership and access issues in any applicable employment agreement, including by way of a stipulation that the ex-employee must promptly return all social media login and password credentials upon termination.

DEC/JAN 2013 E X ECUTIV E COUNSEL

Executive Summaries

PAGE 46

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The Era of the Whistleblower has Arrived

Mitigating Litigation Risk of Inherently Dangerous Products

By Michael Matthews and Melissa Coffey Foley & Lardner LLP

By Lori B. Leskin and Adrienne D. Gonzalez Kaye Scholer LLP

Five Litigation Trends that can Keep Executives Awake at Night

In recent years there has been a major expansion in the scope of whistleblower incentives and protections. A former banker at UBS recently received $104 million for reporting alleged tax evasion by UBS. This is believed to be the largest ever tax-related whistleblower award to an individual. The award was made pursuant to 2006 amendments to the I.R.S. whistleblower program, as part of the Tax Relief and Health Care Act of 2006. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act brought a major expansion of the class of potential whistleblowers, and in August of 2012 the SEC issued its first award under the whistleblower bounty program created pursuant to Dodd-Frank. The whistleblower provisions came on the heels of False Claims Act revisions that also broaden the reach of whistleblowers, first in 2009 through the Fraud Enforcement and Recovery Act (FERA), and then again in 2010 as part of the Affordable Care Act. Companies should have appropriate internal controls in place, and they should utilize audits to identify potential issues. Mechanisms for internal reporting of potential misconduct should be established, with enough resources made available to adequately investigate and act on them. Given the broad anti-retaliation provisions in many of the whistleblower laws, companies should also ensure that there is sufficient documented non-retaliatory justification to support any adverse employment action taken against an employee. They should use exit interviews to identify issues, and ask employees to confirm the absence of issues.

This articles addresses the litigation threat to companies whose products are inherently dangerous. By way of example, the authors consider the case of Blitz USA, a gasoline container manufacturer which announced that it would cease operations last June. Blitz attributed its demise to the cost of product liability lawsuits brought by plaintiffs alleging personal injury associated with the use of gasoline containers. These injuries typically resulted from practices expressly warned against in the safety guidelines imprinted outside of every container. The authors suggest three things a company might consider as a defense against this kind of litigation: First, restrict access. The perceived benefit would have to be weighed against the logistics and the impact on sale. Limiting consumer access and requiring informed consent reduces the size of the user population and can also help weed out lazy or incompetent users. Second, require informed consent. Products would need to be accompanied by warnings disclosing risks, with the additional step of requiring an acknowledgment that the warnings have been received. While not forcing people to use their common sense, this does make them acknowledge that they have been advised of the proper way to use the product. Third, solicit an advisory opinion from the regulator. Depending on the industry and the circumstances, seeking an advisory opinion may be useful, not to prevent litigation, but rather to aid the company in defending itself and dispensing with a claim as quickly and cost-effectively as possible.

By Paul E. Benson Michael Best & Friedrich LLP

The author identifies several trends in litigation that should be of concern to executives. First on his list is false advertising claims. These include false benefit claims, false claims about how the product is constituted and false claims about performance. False advertising claims can extend to almost any product or service, but are particularly popular in the food and beverage space. Proposition 37, though recently rejected by California residents, sheds light on the future of false advertising claims: If you wanted to label something as “all natural,” you’d have to verify how it is grown and what type of seed it is derived from. Wage and hour litigation is a fastgrowing type of litigation in the labor and employment context. The Department of Labor is implementing an initiative, as part of its Strategic Plan for Fiscal Years 2011-2016, to “shift the burden of compliance to the employer or other regulated entity rather than relying exclusively on enforcement interventions. No more `catch me if you can’ regulation and enforcement.” The thread that ties these litigation trends together is exorbitant expense for a company once it becomes a target. The issues involved in these matters are complex, and therefore typically take longer to resolve. Motion practice is more common, and discovery costs – mostly relating to producing electronic communications – are substantial. The author recommends a number of strategies intended to address these kinds of matters before they actually come up.

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DEC/JAN 2013 E X ECUTIV E COUNSEL

Executive Summaries PAGE 54

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Addressing Security Risks in the New Technologies

Franchisors Wince as Some Courts Re-Label Franchisees as Employees

Has the Supreme Court Cleared the Tracks for Mandatory Arbitration in Consumer Contracts?

By Judith Lockhart and Emily Milligan Carter Ledyard & Milburn LLP

The emergence of cloud computing over the past several years has triggered new information security concerns. Despite the fact that more service providers are offering increased levels of security and 24-hour support, the idea of placing large amounts of confidential data in the cloud makes many lawyers cringe and continues to prevent many businesses and law firms from migrating to the cloud. Both lawyers and their clients are obligated to keep certain types of information secure. Lawyers must protect a client’s confidential information by taking reasonable steps to prevent its inadvertent disclosure by third parties (like cloud service providers) that the lawyer has retained to assist in providing services to the client. Several states (including, Arkansas, California, Indiana, Masschusets, Nevada, Rhode Island, Texas and Utah) have enacted statutes imposing data security obligations on any entity that has access to personal data. Lawyers and their clients must be aware of risks posed by emerging technologies, as well as now commonplace technologies like smartphones and other mobile devices, and take reasonable steps to ensure that client and other data is secure. The authors provide a number of suggestions for how cloud service agreements should be structured. Lawyers must take into account the professional and ethical obligations in the jurisdictions where they practice. Clients also must take into account the various federal and state laws that govern the use of confidential personal data, particularly in the health care and financial services industries.

By James Mulcahy Mulcahy LLP

The franchise community was shaken following a series of court decisions that relabeled franchisees as employees of the franchisor. Jani-King and Coverall North America, two of the largest commercial cleaning franchisors, have been busy defending themselves from labor law claims brought by franchisees seeking minimum wage, overtime pay, and other employment-related benefits. Franchisors operating in California can breathe a sigh of relief after the California District Court in Juarez v. Jani-King granted summary judgment in favor of Jani-King, finding that the franchisor did not exercise sufficient control over the plaintiff franchisees to render them employees. But recent court decisions may be eroding the Cislaw standard, which has been a balwark for franchisors. For example, earlier this year, in the case of Patterson v. Domino’s Pizza, LLC, a franchisee employee named Domino’s Pizza as a defendant in her lawsuit for sexual harassment. Consistent with Cislaw, the trial court found that the franchisee was an independent contractor, and that the franchisee’s employee was “not an employee or agent of ... Domino’s .” But in June 2012, the California Court of Appeals, surprisingly, reversed and remanded the case back to the trial court for a jury trial. Meanwhile, with some success, some franchisors are looking to state legislatures to clarify that franchisees are not employees. Until the court and/or legislatures set more defined boundaries for the franchisor and franchisee relationship, more lawsuits by creative plaintiffs’ attorneys are likely.

By David Mills, Daniel Prichard and Alyssa Saunders Dow Lohnes LLPC

Bilateral arbitration clauses (clauses that require arbitration and waive class proceedings), which have become common in standard consumer and employment contracts, have been targeted by class action lawyers and consumer groups. In the past two terms, the Supreme Court bolstered private arbitration of consumers’ and employees’ commercial disputes. In 2011, AT&T Mobility LLC v. Concepción rejected the argument that a class waiver in a service contract’s arbitration provision was “unconscionable” because only a class action could vindicate smallvalue consumer claims. Nevertheless, consumers continue to challenge arbitration agreements on a number of grounds, some of which might find their way to the Supreme Court for another round. Plaintiffs have attempted to identify distinctions between the California law that the Federal Arbitration Act preempted in Concepción and other state laws. They have also attacked arbitration agreements at the contract formation level. Some lower courts have held arbitration provisions unenforceable owing to provisions allowing the contracts to be changed without notice. Congress could reverse the Supreme Court’s pro-arbitration jurisprudence by passing legislation to curtail the Court’s broad interpretation of the FAA. Several bills were introduced post-Concepción but stalled in committees. The Court’s interpretation of the FAA and corresponding support of agreements to forgo the courthouse in favor of a private arbitral forum seem unwavering. Nevertheless, plaintiffs have been persistent and creative in attacking arbitration agreements. It seems unlikely that the matter is settled.

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DEC/JAN 20 13 E X ECUTIV E COUNSEL

E-Discovery

Using Discovery and Information Management Technology Efficiently By Mark Walker

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

E-Discovery

e have a serious problem with the costs associated with preservation, categorization and production of electronically stored information. We hear the fussing almost daily. In the “2012 Global 250 General Counsel Survey on eDiscovery,” conducted by the eDiscovery Solutions Group, the two biggest frustrations among general counsel can be summed up as: (1) we keep too much stuff and (2) this was all supposed to be cheaper by now. Technology was supposed to save us all time and money, but here’s an interesting fact: According to a study released in February by the RAND Corporation’s Institute for Civil Justice, only 19 percent of all discovery costs come from technology spending and just eight percent are attributable to the collection process. So, where does the other 73 percent go? It goes to attorneys’ fees incurred during document review. The common misperception is that if we could figure out the right technology to use for discovery, a lot of money could be saved. The reality is that we should be focusing the discussion on workflow instead of technology costs. If data is managed well upstream, it makes a huge impact on any future discovery costs downstream. Yes, this involves technology, but it starts with a strong information management system coupled with sound data filtering and review of workflows.

INFORMATION MANAGEMENT AND WORKFLOW

Information Management (IM) policy sets up rules governing how documents are classified, managed and either archived or destroyed when no longer needed. Every business – no matter the industry, company size or type of data – should establish an IM policy. Once established, the policy needs to be audited and enforced. My company was recently involved with a case where there was a need to collect data, targeted by date range and specific custodians, from a small firm of about 30 employees. Unfortunately, the firm had no IM policy. With no clas-

sification or management of data, files could be stored anywhere, by anyone. That kind of environment makes it impossible to implement “best practices.” After many custodial interviews and much data mapping, the end result was the collection of almost all their data, from nearly every custodian and covering multiple years – which meant that discovery costs for the technology were upwards of $200,000, before legal fees or review. Those kinds of costs will significantly impact a small company, and they become exponentially larger as the company size grows. Yet this lack of sound IM policy is becoming a common story. Managing data at the front end of the ESI lifecycle makes all the subsequent work of collecting, culling, searching and reviewing much more efficient and therefore less expensive.

provider. Another may allow for simplified litigation holds, data preservation, data acquisition and filtering, but have very limited archiving capabilities. Devices customized according to technical and business requirements can be placed behind a company’s firewall to map all data locations and remotely collect as needed from any medium connected to the network. Priorities and future needs should be assessed to determine what platform best suits a company’s requirements. How often do you need to collect, search and review data? Do you have an in-house team that is experienced in discovery processes? Is your company getting sued often enough to warrant a complete enterprise system, or would it make more sense to employ a smaller, scalable system? What outside service providers are you partnering with, and

Managing data at the front end of the ESI lifecycle makes all the subsequent work of collecting, culling, searching and reviewing much more efficient and therefore less expensive.

The dilemma is that effective data management takes constant supervision, and most companies won’t do it if it is a manual process. In an ideal world, if money were no object, companies would deploy technology that autoclassifies data based on predetermined rules. However, that kind of enterprise system can be very expensive, often costing tens of thousands, sometimes millions of dollars, making it viable for only a small number of companies. In response, we are starting to see more bottom-line friendly platforms that provide a compromise. One solution may include only the ability to archive and manage data, making it available and easy to collect by an internal IT department or outside service

how flexible are their systems? Do you need to be able to reuse work product? These are some of the many questions that need to be asked. Additionally, research and testing are recommended to ensure that a proposed solution performs as advertised. For example, there are some platforms that try to cover the entire electronic evidence life cycle when their technology is really best suited for only a specific section. Many tech companies will allow for a proof-of-concept test within your environment to ensure that the platform will provide the desired results. It can also be helpful to talk with current and previous users of the product to understand what they did or didn’t like.

Dec/jan 20 13 E X ECUTIV E COUNSEL

E-Discovery

Working with technology-agnostic service providers or consultants can be an effective way to determine the right customized discovery solution for any company’s needs. A trusted outside service provider that uses a variety of tools will understand which ones work well together and be able to tailor the technology for your environment, providing flexibility and scalability for future needs. A consultant can also help you utilize your existing technology more fully in lieu of purchasing a new solution that may not be necessary.

and other custom filters are also becoming more common. However, newer technology that offers sampling methods, keyword analytics and predictive coding enables more strategic culling and searching based upon objective criteria. These methods result in smaller, targeted data sets to review, they have measurable success rates, and they are highly defensible and reliable. Data sampling provides an essential method of checks and balances. It ensures that responsive documents are properly identified and reviewed, and it safeguards against inadvertent produc-

The goal is to find the best solution that works today and still be able to adapt your process to accommodate new techniques and technologies as they become available. 20 The goal is to find the best solution that works today and still be able to adapt your process to accommodate new techniques and technologies as they become available. DOCUMENT FILTERING AND REVIEW

A RAND study released last February noted that most money spent on discovery – about 73 percent – is devoted to the review of documents for relevance, responsiveness and privilege. This is not new information, but the RAND report provides objective measurements from real projects. It makes sense for companies to focus on this review stage to save money. Additionally, attorneys want to save time by not reviewing lots of nonresponsive documents. Objective data filtering is common and can cover multiple options, such as known file removal, file type/ category, de-duplication and date range, to name a few. More subjective advanced keyword filtering (including natural language, Boolean, phonic, wildcard, stemming and numeric)

tion of privileged documents. Data sampling can also be used to define and corroborate key terms. The process of keyword analytics fully analyzes a statistically valid data sample and proposes key terms, which are validated through attorney review and feedback. This provides the confidence that the terms applied to the data universe are effective and are yielding the best possible results. Predictive coding takes key term validation one step farther by noting the percentage of responsiveness for each document. Similarly, predictive ranking lists documents according to their level of responsiveness. These technology-assisted review tools allow attorneys to make the best use of their time. According to the RAND study, predictive coding has the potential to reduce human review time by as much as 80 percent. The benefits of technology don’t stop there. There is software that can provide detailed information about data – including contents, attachments and metadata – immediately after it is collected. Being able to get this kind

of information early, before any data is processed,, greatly assists with case strategy, cost forecasting, filter creation and more. Cross matter management is a relatively new methodology that allows work product to be accessed across multiple matters. Documents don’t need to be collected, reviewed or coded again because the system remembers and holds the files in a central repository, ready to be re-used in new cases. Technology can be customized to providing myriad alternate options. Analytics can be run for quality control, such as to ensure that no emails are missing from a collection. Review platforms can be modified to automate tasks such as the creation of privilege logs, witness files, or to handle multiple productions. The possibilities are endless. The farther upstream technology is implemented, the more widespread the downstream results. Technology-based tools are constantly changing and improving. New protocols and techniques are being developed every month. Yes, there is an expense for technology, whether it’s handled internally or outsourced to a reliable service provider. However, when the right platforms are working together, you’ll find significant savings on discovery costs, and many additional benefits. They include advanced security, better file management, accelerated data processing, enhanced quality control, detailed reporting and improved defensibility. ■

Mark Walker is Vice President of Operations at Document Solutions, Inc., an e-discovery and digital forensics company. A technology pioneer, he has presented at numerous conferences and has authored a number of award-winning books, articles and white papers on trial, discovery and the application of technology. mwalker@dsi.co

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Intellectual Property

lthough the digital workplace thrives on information sharing, the heart of that collaboration is in fact copyrighted work. As more and more employees are exchanging information with the click of a mouse, rights-holders are keeping pace in order to protect their work. For companies, copyright compliance has evolved into a hot button issue , and corporate counsel need to take the lead.

dec/jan 2013 E X ECUTIV E COUNSEL

Intellectual Property

Even careful corporate agreements, made with due diligence, can fall short of securely covering the stores of copyrighted material in the information workplace. Infringement can be costly. In January 2012, Warren Communications News filed a $19.5-million lawsuit against a subscriber for making unauthorized copies of a daily newsletter. That amount is approximately what was granted in damages to publisher Lowry’s Reports by a federal court jury several years ago, on a substantially similar infringement claim. The turbulent evolution of information exchange has taken the workplace by storm. Swapping information is easy, swift and all-encompassing, and as a result companies have been slow to recognize the likelihood of rampant copyright infringement. However, two important changes percolating through various corporations have elevated the profile of copyright concerns and compliance. The first involves companies’ realization of the extent and amount of their own copyright-protected content. While traditionalists long associated copyright with creative works like music and books, copyrighted materials actually exist everywhere in corporations. For the first time, due to its strategic and economic value, corporate content is beginning to attract attention, particularly with regard to how freely it can slip out across the Web. Major companies now are turning their attention to copyright after years of emphasizing patents and trademarks. Therein lies the second big shift. As companies uncover troves of copyrighted works to protect, they also realize they are prolific users of the content of others. Most of the articles, newsletters, research papers, graphics, videos and images of all kinds that find their way into the workplace are subject to copyright protection. The use of thirdparty content, so simple to share in the digital age, is mushrooming. EASY TO SHARE

Email is the primary vehicle by which

workers move information. A whopping 80 percent of employees use it to send links to content or to attach documents, according to an extensive report published in 2010 by research firm Outsell Inc. Nearly half of surveyed knowledge workers actually cut-and-paste content directly into e-mails. Sending a link is often in compliance with the obligations created by copyright law, while attaching documents or cutting and pasting often is not, but users often fail to see the distinction. Other distinctions are ambiguous as well. One is the difference between free information and freely shareable information. Fifty-one percent of survey respondents believe erroneously that information they obtain online or in print, at no charge, can be shared without the copyright holders’ permission. A significant proportion of workers pay no attention to copyright. In fact, more than half of the workers surveyed either don’t think about copyright or simply don’t care. The news isn’t all bad. Forty-seven percent do say they now think about copyright before forwarding information. That may be why information managers say copyright is more important than it was a year ago, according to a survey by research firm FreePint. LEGAL TRENDS SPELL TROUBLE

One factor boosting awareness is the spike in infringement-related news stories, nearly all of which relate to consumer violations. Most corporate infringement lawsuits settle out of court and include confidentiality clauses. Penalties for copyright infringement around the world vary. In the United States, most copyright holder plaintiffs seek actual or even statutory damages, which can be substantial, as they were in the aforementioned Lowry’s Reports case. Outside the United States, copyright owners’ main weapons are injunctions. Companies that ignore injunctions can face contempt findings. In copyright cases in and outside the United States, courts often order the infringer to pay the plaintiff’s

legal fees and court costs. In addition to the legal ramifications of infringement, companies also face bottom-line risks arising from damage to their reputations. An important first step in mitigating your company’s infringement risk is to educate employees about compliance and put policies in place. The research firm Outsell found that while most employees know their companies have copyright policies, they don’t know how these policies work. More than three-quarters think their organizations have such policies. But the fact that a troubling 44 percent say they don’t know the policy details actually underscores the need for companies to construct mechanisms leading to compliance. Subscriptions and publishing agreements are helpful but limited. Some publishers sell licenses that let employees share articles within their companies from specific periodicals, journals or newsletters. In some cases, licenses are limited by location, offering content-sharing rights within countries but not across geographic borders. Rights aggregation and licensing services provide better, broader protections. They streamline the rights process and cover large portions of the content employees need to use and share. As copyright compliance continues to evolve, companies must keep tabs on their employees and monitor the ways they use and distribute content. By partnering with expert service providers, you can help your organization ensure proper content sharing and avoid costly mistakes. ■

Miles McNamee is vice president, licensing and business development, at Copyright Clearance Center, a notfor-profit organization that creates innovative licensing and content solutions. mmcnamee@copyright.com

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DEC/JAN 2013 E X ECUTIV E COUNSEL

Intellectual Property

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Intellectual Property

What Not to Say to Competitors, Post-MedImmune By Eligio C. Pimentel and Michael Carrozza

ou arrive at your law office to find numerous emails and voicemails from the general counsel of your largest client. One of its biggest competitors released a product that is indistinguishable from a highly profitable product your client sells. He is demanding you prepare a letter he can fire off to “take this guy down.” But what can you say without triggering declaratory judgment jurisdiction? Prior to the Supreme Court’s decision in MedImmune v. Genentech, the answer was more clear. Courts used a “reasonable apprehension of suit” test developed by the Federal Circuit to determine whether there was an actual controversy sufficient for declaratory relief. To find declaratory judgment jurisdiction, courts looked for an express or implied threat of an impending patent infringement lawsuit. While this was a high standard for a plaintiff, the corollary was that a patentee could safely communicate regarding its patent rights and negotiate potential licensing terms with defined, limited risk of creating actual controversy. Then came the MedImmune decision. In that case, the Supreme Court put the “reasonable apprehension of suit” test under fire when it cited three cases in which there was declaratory judgment jurisdiction despite

the lack of threats of an impending lawsuit. Thus, the Court reasoned that the wiser approach to declaratory relief was the “totality-of-the-circumstances” standard articulated in Maryland Casualty. This new standard, adopted in MedImmune, forced the Federal Circuit to reconsider how and when party communications give rise to an actual controversy.

The Court has reasoned that the wiser approach to declaratory relief was the “totality-ofthe-circumstances” standard articulated in Maryland Casualty. MedImmune lowered the bar for determining declaratory judgment jurisdiction in all patent cases. In fact, since MedImmune, the Federal Circuit has found jurisdiction in nearly every case involving communications between parties. This has made it exceedingly difficult for lawyers to advise clients on what they can say to competitors without triggering an actual controversy, and a potential lawsuit.

dec/jan 2013 E X ECUTIV E COUNSEL

Intellectual Property Several cases heard by the Federal Circuit since MedImmune have provided valuable perspective concerning this standard, including some guidance on what to avoid. • Do not communicate a patent infringement analysis of its products to your competitor. Because SanDisk v. STMicroelectronics was on appeal while MedImmune was decided, MedImmune was one of the first cases to consider how communications should be analyzed in light of the new

royalties to ST.” Thus, there was a substantial controversy between parties having adverse legal interests. SanDisk clearly outlines what not to do. Don’t communicate a detailed infringement analysis to your competitor. • Do not make public statements that indicate you are pursuing a licensing or litigation strategy. In Micron v. MOSAID the court found jurisdiction based on MOSAID’s intellectual property strategy and pub-

Since MedImmune, the Federal Circuit has found jurisdiction in nearly every case involving communications between parties. 26

totality-of-the-circumstances test. STMicroelectronics contacted SanDisk to discuss a possible crosslicensing agreement on patents related to flash technology. During one meeting, ST gave a presentation that illustrated how SanDisk’s products potentially infringed numerous claims from each of ST’s 14 patents. ST even provided SanDisk with a 300-page summary of the analysis. When discussions fell apart, SanDisk filed a declaratory judgment action against ST, seeking a ruling of non-infringement and invalidity. The district court dismissed the declaratory action holding “that no actual controversy existed.” But the Federal Circuit reversed, finding that even though ST did not expressly charge SanDisk with infringement or express an intention to file suit, for purposes of the licensing negotiations “ST communicated to SanDisk that it had made a studied and determined infringement determination and asserted the right to a royalty based on this determination.” On the other hand, SanDisk “maintained that it could proceed in its conduct without the payment of

lic statements. MOSAID, the owner of several patents directed to DRAM chips, sent letters to four DRAM manufacturers, including Micron, suggesting they license its technology. Four years went by without MOSAID contacting, mentioning or threatening Micron. Yet Micron ultimately obtained declaratory judgment jurisdiction. This was because during those four years MOSAID began suing the manufacturers when they refused to take licenses. Eventually three of the four manufacturers settled, leaving only Micron. When “press reports predicted that Micron posed the obvious next target,” Micron filed suit. If this were not enough for jurisdiction, the Federal Circuit found MOSAID’s “public statements and annual reports also confirm its intent to continue an aggressive litigation strategy.” Accordingly, advise clients it is imperative to be mindful of what is released in public statements or documents, because it can create an actual controversy for purposes of declaratory judgment jurisdiction. • Do not refer to your competitor’s product when speaking of your

patent,or give a shortened time period to respond to a request. In HP v. Acceleron, the patentee sent HP a letter requesting “an opportunity to discuss [its] patent . . . related to [HP’s] Blade Servers.” The letter was written in a friendly tone, sought a “productive atmosphere,” did not mention licensing or infringement or assert patent rights, and even sought agreement from HP that Acceleron had not “created any actual case or controversy regarding [its] patent.” The letter requested to hear back from HP within two weeks. HP responded that it was not interested in talking unless Acceleron would agree to a 120-day standstill on any litigation. Acceleron did not agree. Instead it responded with virtually the same letter as the first. HP responded once again as well – this time with a complaint for declaratory relief. Here, the absence of traditional indicators of an actual controversy was of no concern to the Federal Circuit. To the contrary, the panel explained that “the purpose of a declaratory judgment action cannot be defeated simply by the stratagem of a correspondence that avoids the magic words such as ‘litigation’ or ‘infringement.’” The court found an actual controversy because Acceleron identified itself as the owner of the ‘021 patent, which it described as relating to Blade Servers, and HP disagreed. Further, “Acceleron took the affirmative step of twice contacting HP directly,” and twice imposing a two-week deadline for HP to respond. The moral of this story: An actual controversy may be found no matter how inviting you make a discussion sound. • Do not accuse your competitor’s customers or vendors of infringement. Threats of lawsuits or accusations of infringement directed to third parties generally will not trigger declaratory judgment jurisdiction unless that third-party’s business is somehow related to the competitor’s business. For example, an actual controversy may be created where a competitor’s customer is accused of direct infringement and the competitor would be liable for induced or contributory infringe-

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Intellectual Property

ment. Or, if the competitor is bound to indemnify a third party, then threatening the third party will create an independent ground of jurisdiction for the competitor. ABB Inc. v. Cooper Industries illustrates both of these scenarios. Cooper licensed its patented technology to ABB, which then outsourced manufacturing to Dow Chemicals. Also, ABB agreed to indemnify Dow against infringement claims by Cooper. Believing that the license agreement precluded ABB from outsourcing to third parties, Cooper informed Dow that it would defend its

its decision.” Sardesai, apparently not considering the new post-MedImmune test, responded that yes, Avery had performed an analysis of 3M’s product with respect to Avery’s patents and would “send claim charts.” Despite Avery never sending the charts, 3M filed a declaratory judgment lawsuit. The district court dismissed the case for several reasons, including the informal nature of the telephone conversations and the fact that Avery “did not provide a detailed infringement analysis or propose deadlines for 3M to respond.”

An obvious question that should be posed to clients in light of the Federal Circuit’s about-face on the matter is, “What is the purpose of contacting your competitor in the first place?” rights should Dow manufacture products covered by Cooper’s patents. ABB in turn filed a declaratory judgment action “seeking a declaration that its activities were authorized under the license agreement.” Finding jurisdiction, the Federal Circuit held that “ABB had an interest in determining whether it would incur liability for induced infringement, and it had an interest in determining whether it would be liable for indemnification, which turned on whether Dow would be liable for infringement.” • Do not say you will send claim charts. 3M v. Avery Dennison indicates how low the jurisdictional bar has been set. Avery’s Chief IP Counsel (Raj Sardesai) telephoned 3M’s Counsel (Kevin Rhodes) to discuss two of Avery’s patents. Sardesai stated that 3M’s product “may infringe” Avery’s patents and that licenses were available. Rhodes informed Sardesai that 3M had rejected the licensing proposition. Rhodes also asked for any information that would “cause 3M to revisit

The Federal Circuit disagreed. It found that Sardesai’s use of the phrase “may infringe,” rather than “does infringe,” was immaterial in light of Sardesai stating that licenses were available. Further, it did not matter that claim charts were never sent because Sardesai stated the charts would be forthcoming. In the five years since MedImmune, the Federal Circuit’s declaratory judgment standard has completely changed. The cases above illustrate the difficulty in discerning where an actual controversy ends and the hypothetical begins. An obvious question that should be posed to clients in light of the Federal Circuit’s aboutface on the matter is, “What is the purpose of contacting your competitor in the first place?” If your client is looking to start the damages clock, then the communication should charge its competitor outright with infringement, i.e., provide actual notice. This is because the communication is likely to create a controversy.

Thus, actual notice and declaratory judgment jurisdiction are inextricably linked together. But, rather than jeopardize whether actual notice was provided by making only vague references of infringement in an attempt to avoid an actual controversy, it is better to make the claim confidently and be prepared to face a declaratory judgment action – or better yet, file a preemptive complaint. If, on the other hand, you merely want to deter your competitor, then the communication needs to be much more careful. While the Federal Circuit has provided some guidance as to what can be said without creating an actual controversy, some district courts have been unwilling to find an actual controversy where the patentee merely provided its competitor with notice of patents, and nothing more. Advising clients what to communicate to competitors post-MedImmune is very difficult. Anything you say truly can be held against you. ■

Eligio C. Pimentel is a shareholder at Chicagobased McAndrews, Held & Malloy. He practices in all areas of intellectual property, with an emphasis on patent and trade secret litigation. He is registered to practice before the U.S. Patent and Trademark Office. epimentel@mcandrews-ip.com

Michael Carrozza is a summer associate at McAndrews, Held & Malloy in Chicago, and a registered patent agent. He is a third-year law student at The John Marshall Law School, where he is editor-in-chief of The Review of Intellectual Property Law. mcarrozza@mcandrews-ip.com

DEC/JAN 2013 E X ECUTIV E COUNSEL

Intellectual Property

How to Confront an NPE By Deborah (Bea) Swedlow

ven if you have yet to square off with an NPE, known more pejoratively as a patent troll, if you sell, market, manufacture, or develop products, goods or services, especially in industries where they are active, you likely recoil at mention of the term. NPEs are companies whose business model consists of acquiring and enforcing patents through cease and desist demands, licensing schemes, or lawsuits. NPEs generally have no interest in developing or selling products or services. Rather, they generate revenue by threaten-

ing legal action and extracting settlements from companies that allegedly infringe their patents. Because NPEs sell nothing, they have little to lose by aggressively enforcing a patent portfolio. Unlike the defendant in an NPE lawsuit, NPEs possess little to no discovery (documents or information) to exchange during a lawsuit, one of the most costly activities for a party in litigation. Court dockets continue to be clogged with filings by NPEs, even after enactment of the 2011 Leahy-Smith America Invents

Act. That law included provisions intended to discourage the NPE strategy of filing lawsuits against multiple but wholly unrelated defendants. Before Congress acted, an NPE could join any number of defendants, based in different locations and offering disparate products or services, in one lawsuit and in a forum chosen at the convenience of the NPE, based on a perception of that jurisdiction as one that favored patent owners. Now, an NPE can join multiple defendants together only if certain conditions are met.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Intellectual Property

The intent of these provisions of the American Invents Act was to put a dent in the number of lawsuits filed by NPEs, on the assumption that the expense of having to pursue litigation in multiple jurisdictions against multiple defendants would discourage them. The flow of lawsuits, however, has yet to subside, and as a result a company having to confront an NPE must continue to evaluate the comparative risks of litigating or settling. A demand letter from an NPE can seem daunting, especially to a smaller or start-up venture without a large cadre of

lawyers. NPEs have become savvy about identifying targets. Company don’t receive a demand letter by accident, and playing ostrich will not make the NPE go away. The company may have been targeted because of its success, its marketing efforts to promote a brand, or its appearance in key lists of successful companies in some relevant industry. For whatever reason, the NPE has the target in its sights. There is no one approach to responding to an NPE demand. Target companies have options to weigh and risks they must try to minimize.

Even before responding to a demand letter or lawsuit, target companies – with legal counsel involved – should do some leg work. In addition to reviewing the patent, do some research to determine who is behind the threat. Investigate other lawsuits filed by the same entity to determine whether it tends to settle early or litigate. Use legal counsel to communicate with other companies who have been targeted or sued by the NPE. These co-targets can provide invaluable information about the NPE’s intentions and practices. And be continued on page 33

DEC/JAN 2013 E X ECUTIV E COUNSEL

Intellectual Property

Tax-Advantaged Transfer Pricing for Intellectual Property By Robert J. Misey, Jr.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Intellectual Property

andling the transfer pricing of intellectual property is similar to issue coverage in an election year. The intellectual property attorney, the tax attorney, the accountant, and the economist all have opinions. However, unlike in a democracy, only one opinion matters, the opinion of the Internal Revenue Service. The IRS has written transfer pricing regulations encompassing 160 pages. Those regulations can appear intimidating, but also can offer a powerful tool to lower a multi-national’s taxes. What is intellectual property? Although the IRS regulations provide a lengthy list of intellectual property for tax purposes, IP can be divided among trade intangibles (i.e., patents, trademarks, designs, models, etc.), marketing intangibles (i.e., brands), and know-how (i.e., trade secrets). Transfer pricing professionals consider IP as anything not tangible that provides a return in excess of a routine return. Example: “SailCo,” a Chicago-based sail manufacturer, creates a new design for a sail from which both SailCo and its subsidiary in the British Virgin Islands (BVISub) will manufacture and profit. Even though not patented, the design constitutes IP. THE ARM’S LENGTH PRICE

The transfer price is the arm’s length price. The principles of Internal Revenue Code section 482 require pricing inter-company transactions at arm’s length. Inter-company transactions include, among many others, the transfer of rights to use IP (i.e., a license for a royalty). The remainder of this article will focus on the tax impact of differentiating between the appropriate transfer pricing methodology for a royalty from licensing the IP and, in the alternative, the related parties entering a cost sharing arrangement that shares the ownership of the IP. Example: SailCo has extensive research and development facilities in Chicago to create new products. SailCo wants to create a new super-sail for sailing both the Great Lakes and the Caribbean. SailCo can either incur all the R&D expenses at its Chicago facility

and license the design to BVISub for a royalty or enter a cost sharing arrangement with BVISub. If SailCo decides to incur all the R&D expenses itself, SailCo will own the resulting IP and BVISub must pay SailCo a royalty, the amount of which will impact taxes in the United States, a high-tax jurisdiction. The IRS regulations specify the following methods for determining the royalty for IP: • The comparable uncontrolled transaction method. • The two profit split methods. • The comparable profits method. Under the comparable uncontrolled transaction (CUT) method, the arm’s length royalty is the royalty charged for comparable IP in transactions between unrelated parties. To be comparable, the IP must be used in connection with similar products or processes in the same general industry or market and must have similar profit potential. This means that if if SailCo could find a similar type of sail design that unrelated parties license under comparable circumstances and obtain the actual royalty rates, SailCo could use the CUT method. However, SailCo would be unlikely find similar IP that satisfies this high standard of comparability. In fact, the CUT method rarely works.

residual profit split method, each related party earns a return for its routine contributions before splitting any residual profit based on the relative value of the IP that each party contributes. SailCo will likely use the comparable profits method (CPM) to determine the arm’s length royalty. The CPM determines the royalty as the amount of the licensee’s return in excess of the routine return (expressed as a range). More specifically, the CPM requires (1) finding companies comparable to the licensee, (2) constructing a range for the routine return, the middle 50 per cent of the returns of the comparable companies, and (3) determining the royalty by the amount of the licensee’s return in excess of the routine return. Example: With the use of the supersail design, the financial results of BVISub, the licensee, are as follows: • • • • •

Sales: $20 million Cost of goods sold: ($12 million) Operating expenses: ($ 2 million) Operating profit: $ 4 million 20 percent return on sales

A search finds eight sporting goods companies in the Caribbean for which the routine return on sales is a range of 7 percent to 15 percent. BVISub’s 20 percent is attributable to BVISub’s use of SailCo’s IP. As a result, to report a return on sales that is within the range of 7 per

The transfer price is the arm’s length price. The principles of Internal Revenue Code section 482 require pricing inter-company transactions at arm’s length. The two profit split methods have theoretical appeal, but are impractical and therefore rarely used. Under the comparable profit split method, the allocation of the combined profit between related parties is based on how unrelated parties engaging in similar activities allocate their combined profit. Under the

cent to 15 per cent, BVISub should pay a royalty on its excess return in an amount that provides the opportunity to place the income in the most tax-advantaged jurisdiction to SailCo. This royalty could be a percent of sales anywhere SailCo chooses between 13 and 5 percent (BVISub’s 20 per cent minus the

dec/jan 2013 E X ECUTIV E COUNSEL

Intellectual Property 7 per cent low end of the range = a 13 per cent royalty and BVISub’s 20 per cent minus the 15 per cent high end of the range = a 5 per cent royalty). If BVISub’s return is not above the range, then a royalty to SailCo is not necessary. In lieu of later receiving a royalty for the resulting design from its R&D expenses, SailCo can enter a cost sharing arrangement with BVISub. A cost sharing arrangement is a written agreement between related parties that provides for the sharing of the costs of developing IP. More specifically, the costs are

If one party to the cost sharing arrangement brings pre-existing IP to the cost- sharing arrangement, the other party will have to make a buy-in payment. The amount of a buy-in payment is currently a hotly contested IRS audit issue. DEFENDING TRANSFER PRICING PRACTICES

When the IRS makes a transfer pricing adjustment of $5 million or more, or determines that an inter-company price is either less than half of or more than twice the actual arm’s length price, the

IRS without an audit, the APA’s prefiling procedure permits a taxpayer’s attorney to engage in a pre-filing conference on a no name basis with the IRS to gauge the reaction of the IRS toward entering an APA. Although multi-nationals may view the maze of IRS regulations with respect to the transfer pricing of IP as complex, they should consider taking advantage of them to save taxes. First, the multi-national must identify the IP. Second, the multi-national has to determine whether one party will incur

To obtain certainty that there will not be a transfer pricing adjustment from an IRS audit, a taxpayer may seek an advance pricing agreement (APA) with the IRS. 32 shared in proportion to the reasonably anticipated benefits, based on measures such as units sold, sales, or profit. If a party’s share of costs is inconsistent with its share of the reasonably anticipated benefits, a balancing payment may be required between the parties to adjust their respective costs. Example: SailCo anticipates spending $1 million this year on R&D for a super-sail design. SailCo reasonably anticipates that 40 per cent of the market for the super-sail will be in the Caribbean. If SailCo enters a cost sharing arrangement with BVISub, SailCo should charge BVISub $400,000 (the 40 per cent anticipated share of the market x the $1 million of R&D expenses). Accordingly, BVISub would own the Caribbean rights to the super-sail design and not have to pay a royalty for its future use. SailCo will want to balance the tax impact of currently reducing its deductible expenses under a cost sharing arrangement against incurring all the deductible expenses and later receiving a royalty.

IRS will impose a penalty equal to 20 per cent of the additional tax. The only way to avoid the penalty is to contemporaneously document the transfer pricing practices by the due date of the tax return. The documentation must provide a business description, a thorough analysis of the inter-company transactions, a detailed functional analysis of the related parties, a review of the transfer pricing methods resulting in the method chosen, and an economic analysis showing the arm’s length nature of the transfer pricing. This documentation not only protects the taxpayer from a penalty, but should justify the planning and often persuades the IRS that a transfer pricing adjustment is unnecessary. To obtain certainty that there will not be a transfer pricing adjustment from an IRS audit, a taxpayer may seek an advance pricing agreement (APA) with the IRS. In an APA, SailCo and the IRS would agree to an arm’s length royalty for the next five years. Although SailCo may be leery about providing information about its operations to the

all the development costs and license the IP to the other party or whether the parties will enter a cost sharing arrangement. Third, and finally, the multi-national will have to plan the proper defense for its planning through the use of either contemporaneous documentation or an APA. ■

Robert J. Misey, Jr. is a shareholder at Reinhart Boerner Van Deuren s.c. and chair of the firm’s International Practice. He concentrates in the areas of international taxation and tax controversies, working with clients from a variety of industries including manufacturing, service, energy, retail and entertainment. He previously specialized in transfer pricing matters for the IRS Chief Counsel in both Washington, DC, and San Jose, California. rmisey@reinhartlaw.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Intellectual Property

How to Confront an NPE continued from page 29 sure to determine whether another party may be responsible for indemnifying you. There are a number of possible pre-response strategies, but the first step should be contacting legal counsel to discuss alternatives. Though you may consider engaging the NPE in a non-confrontational manner, without legal counsel’s assistance, the NPE is unlikely to go away without a payment and license. This can create a host of legal complexities. How you respond to an NPE threat, and how quickly, can impact negotiations and positions in any subsequent litigation. The negotiations may not be simple. The NPE may be seeking to extract a large payment and comprehensive license. Or it may be pursuing smaller payments from multiple defendants, to amass a war chest that it plans on using against a deep-pocketed target. Either way, NPEs often set arbitrary early deadlines, after which they will dramatically increase settlement numbers, so as to encourage early settlement. Choosing to settle and be done with an NPE is no easy choice. Settling can be expensive. Legal fees and licensing costs associated with negotiating settlements can run to tens and even hundreds of thousands of dollars. But do not choose to settle merely because the prospect of litigation seems daunting. Yes, patent litigation is expensive. A defendant in patent litigation should expect significant legal fees, and it should also budget for potential damage awards. Settlement may create a domino effect. NPEs look to outcomes of past lawsuits when looking for new targets. A company that settles early with one NPE is a perfect target for the next. So while early settlement may be appealing, the unintended result may be increasing your visibility to other NPEs. Outright settlement and knock-out litigation are not the only alternatives, however. A new industry has emerged to combat patent-aggregating NPEs. Companies in the new industry buy and license patents in particularly NPE-

heavy fields (such as e-commerce and wireless telecom) in order to gain some control and leverage. The companies differ in philosophy. Some, such as Intellectual Ventures or Acacia Research, aggregate patents and seek to offensively monetize them through licensing or even litigation. Others, such as RPX Corporation, offer defensive alternatives. RPX, headquartered in San Francisco, has amassed a large portfolio of high value patents but promises not to assert its portfolio offensively. Rather, RPX offers an alternative to traditional settlement and litigation by selling memberships to companies targeted by trolls. Client members pay RPX an annual fee for perpetual licenses to the RPX patent portfolio. RPX further seeks out licenses from active NPEs, offering its members dismissal from litigation and marketing membership to new clients defending themselves in patent litigation matters where RPX has acquired a license. The appeal of RPX is obvious. It handles negotiations for licenses and has the look and feel of patent insurance during the membership period. But RPX does not come cheap. Fees to join are based on company size and revenue, but even for a small company a real financial commitment is required. While RPX may sound like patent insurance, it is not. Companies considering joining RPX should be mindful that RPX provides only license protection from patents within the RPX portfolio. RPX cannot guarantee members that they will be free from NPE threats. Moreover, RPX itself has been criticized by NPEs and by some targeted for RPX membership. as anti-trust violators and extortionists. RPX is presently defending a lawsuit, brought by an NPE, Cascades Computer Innovation, which asserted anti-trust violations against RPX and some of its member clients for price fixing and conspiracy to restrain trade in violation of federal and state laws. The Cascades lawsuit remains pending while the defendants await a ruling on a motion to dismiss.

RPX has also been accused of orchestrating NPE enforcement of patents while simultaneously offering its membership to those targeted by NPEs. Kaspersky Lab submitted a complaint to the White Collar Crime Division of the FBI in early 2011, alleging that RPX threatened to damage Kaspersky’s business reputation and embroil the company in patent litigation if the company did not join its membership. The concerns about RPX’s business model, as well as its cost, should be weighed against the expense and risks associated with settlement or litigation. Companies targeted by NPEs have options, and they should be discussed with legal counsel familiar with the issues. Companies threatened by troll demands can also take heart from the fact that Congress seems to know that it needs to address the patent troll epidemic. Legislative efforts have focused on statutory amendments that would require plaintiffs (including NPEs) to pay defendant legal costs if the suit is unsuccessful, and not just in exceptional cases. Meanwhile a company on the receiving end of an NPE demand, or a company active in a technology field that is targeted by NPEs, must be prepared. You need not concede defeat, but you do need to be thoughtful in your approach to the risk. Working with legal counsel to develop preemptive strategies, including potential relationships with patent aggregators like RPX, is a cost effective approach to mitigating risk. ■

Deborah (Bea) Swedlow is a partner at Honigman Miller Schwartz and Cohn LLP, in the Intellectual Property Litigation practice. She counsels clients in a variety of industries, including media and entertainment, automotive, pharmaceuticals and technology/information. bswedlow@honigman.com

dec/jan 2013 E X ECUTIV E COUNSEL

Intellectual Property

Third Party Submissions in Pending Patents By Michael T. Siekman and Oona M. Johnstone

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Intellectual Property

significant provision of the America Invents Act (AIA) that took effect in September 2012, one that has received little attention, is a new method by which a third party can submit publications, as well as a description of their relevance, into the file of a pending patent application at the U.S. Patent and Trademark Office. Analogous to Third Party Observations in Europe, this provision represents a stark departure from previous USPTO practice. What had almost always been an exclusively ex parte process (one that excludes third party involvement) between the applicant and the USPTO is now open to third parties. Patent applicants should take advantage of this rule change regarding their competitors’ applications, while also preparing for competitors’ third party submissions into their own applications.

The AIA third party submissions provision meaningfully broadens the opportunity for public involvement in patent examination, while eliminating the former third party submission provision. Most importantly, third party submissions must be filed within the six month period after the application is published or before the mailing of a first Office Action rejecting a claim, whichever occurs later (unless a notice of allowance has already been mailed, in which case it is too late). In practice, this means third party submissions can be filed, in almost all cases, for at least six months after publication, and often substantially later. No longer will a party have to guess that a competitor’s patent application was pending to file a protest before publication. Under the AIA, a party will be able to monitor its competitors’

What had almost always been an exclusively ex parte process between the applicant and the USPTO is now open to third parties. Previous options for third party submissions during the examination of pending applications were narrow and almost never used. One option was a protest, which must be filed before the application is published (or before the mailing of a notice of allowance if that happens first). However, protests are rarely filed because the existence of an application is not publicly known until the application is published, and once the application is published, it is too late to file a protest. A second option was the former third party submission procedure, under which patents or publications could be submitted within two months of the publication date (or the mailing of a notice of allowance if it happens first). However, only a list of the references could be submitted. Because any explanation of the relevance of the submitted references was prohibited, these submissions were also rarely filed.

published patent applications and, if necessary, file a third party submission within six months of publication. Also and importantly, a third party will be able to submit patents, published patent applications, or other printed publications accompanied by a concise description of their relevance. The statute and rulemaking are clear that these are not limited to prior art, and they need only be of “potential relevance to the examination of the application.” Thus, the submission can relate to any other ground considered during examination, including issues such as enablement, written description, and even best mode, which remains a ground of patentability considered during examination. The submission must be accompanied by a fee of $180 for up to 10 documents, but there is no fee for a first submission of up to three documents. While the submission must

be signed, the real party in interest need not be identified, and a law firm otherwise having no connection to the third party can be used to file the submission, similar to a Request for Ex Parte Reexamination. Documents and their descriptions submitted under the new third party submission procedure will be treated like those submitted with an Information Disclosure Statement (IDS). In other words, they will be considered by an examiner in the regular course of examining an application, and the examiner will provide with the next Office Action a list of the submitted documents and an indication of which ones have been considered. An examiner will apply the documents in an Office Action only as he or she deems necessary and will not otherwise comment on the documents or their descriptions. Documents considered by an examiner will also appear on the cover of the patent that issues from the application in which they were submitted, separately identified from those cited by the USPTO and the applicant. PROSECUTION STRATEGIES

Under the AIA, third party submissions are permissible for all pending applications, regardless of filing date, as of September 16, 2012. To take advantage of this rule change, companies should develop strategies to monitor competitors’ pending applications for potential third party submissions. Third party submissions offer the chance to greatly influence a competitor’s patent prosecution, an opportunity that has previously been unavailable, to the frustration of many companies. A third party submission gives a third party the chance to have the first word on patentability (at least in an area of concern to the third party), provides the examiner with ready-made rejections to adopt, and puts the examiner on notice that any patent granted from the application might be subject to further scrutiny in a post-grant proceeding. In addition, a third party can resubmit a document already of record in an application. For example, if the applicant has mis-characterized a

dec/jan 2013 E X ECUTIV E COUNSEL

Intellectual Property reference in the Background section of the patent application or buried a key reference in a lengthy IDS, a third party can re-submit that reference, pointing out its particular relevance to the examiner. Thus, a third party can use pre-issuance submissions to influence which portions of documents an examiner will focus on during examination. While there is no limit to the number of documents that can be submitted, the idea is to make the examiner’s job easier, not to give the examiner another stack of references to review. If at all possible, take the USPTO’s strong hint that “the submission of a limited number of documents is more likely to assist in the examination process” and submit no more than three references for no fee. Third party submissions could be particularly useful when focused on limiting a particular element of

art considered by the USPTO. At least until recently, these considerations have held down the number of Third Party Observations filed in Europe in favor of waiting to oppose an issued patent. One reason European patent attorneys recommended holding prior art until the opposition period was that the Opposition Division will generally include the examiner who granted the patent in the first instance, who would be inclined to maintain the patent over the same prior art because he has already considered the issue. In the United States, that consideration does not exist regarding third party submissions. The examiner will not participate in either Post-Grant Review or Inter Partes Review. Third parties will need to weigh the risks of putting the patent applicant on notice – and creating an opportunity for the applicant to obtain a stronger

Patent applicants whose applications receive a third party submission should endeavor to identify the third party, who may represent a potential licensee or infringer. published claims. For example, where a published application contains claims covering a particular embodiment that a company desires to practice but knows or suspects there is prior art concerning that embodiment, the company could submit prior art focused on that embodiment. Ideally, that would result in the claims being limited to exclude that particular embodiment, as well as a clear prosecution history estoppel preventing recapture of that embodiment by the patentee. THE DOWNSIDES

Of course, those submitting third party submissions should recognize that they will be putting the applicant on notice that its invention may be of commercial importance. A submission might also result in strengthening a resulting patent by having the best prior

patent – against the chance of preventing a potentially threatening patent from even issuing. Patent applicants whose applications receive a third party submission should endeavor to identify the third party. It represents a potential licensee or infringer, and its technology. They should also consider adjusting their prosecution strategy in response to the apparently confirmed commercial value of the application, potentially including a more robust continuing application strategy than would have otherwise been the case, to capture the competitor. Finally, patent applicants receiving a third party submission should consider responding to the submission. While there is no requirement for an applicant to do so, there is no prohibition either. Applicants could consider filing remarks in the form of a Preliminary Amendment

and/or requesting an interview. Unlike protests, third party submissions need not be served on the applicant. The USPTO will notify applicants of third party submissions only via the e-Office Action program. Therefore, all patent applicants who are not already enrolled in the USPTO’s e-Office Action program should consider enrolling, or arranging to monitor their application files in the USPTO’s Patent Application Information Retrieval program via a watch service. Overall, the AIA third party submissions provision represents an important strategic opportunity for third parties who are ready to influence their competitors’ patent prosecution. Patent applicants will need to be prepared to respond to what previously would have been viewed as improper interference with the ex parte prosecution of their patent applications. ■

Michael T. Siekman is co-chair of the Biotechnology Group at the intellectual property firm of Wolf, Greenfield & Sacks P.C., in Boston. He counsels clients in the biotechnology and pharmaceutical industries on a range of intellectual property matters, including patent prosecution and portfolio strategy, interferences, due diligence, licensing, opinions, and litigation. He has extensive experience extending patent terms in the U.S. and abroad. msiekman@wolfgreenfield.com

Oona M. Johnstone is a patent agent in the Biotechnology Group at the intellectual property firm of Wolf, Greenfield & Sacks, P.C. in Boston. She assists the firm in biotechnology patent prosecution. Her areas of scientific expertise include genetics, molecular and cellular biology and biochemistry. ojohnstone@wolfgreenfield.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Canada/Cross–Border

Canada’s New Appetite for Antitrust Litigation Cross-Border Mergers will be Scrutinized By Nikiforos Iatrou and Scott McGrath

elanie Aitken, who was appointed head of Canada’s Competition Bureau in 2009, resigned her post in September, 2012. As Commissioner, Ms. Aitken’s most lasting achievement will be her highly visible enforcement program. Most notably, Ms. Aitken can point to the decision of the Competition Tribunal in Commissioner of Competition v CCS Corporation. That case marks the first time since 2006 that the Competition Bureau challenged a merger before Canada’s Competition Tribunal, and it’s only the sixth litigated merger in Canada’s history. In bringing – and winning – the case, Ms. Aitken demonstrated to the Canadian marketplace that antitrust enforcement plays an important role in Canada. Inves-

tors and companies doing business north of the border would be wise to take heed of these developments. The case is notable for several reasons, chief among them the fact that – at $6.1 million dollars – the size of the merger fell well below the mandatory reporting thresholds in Canada. Historically, the Competition Bureau took an interest only in mergers that exceeded the notification thresholds. Although everyone knew that even small deals could be challenged, until the CCS decision deals that fell under mandatory reporting thresholds tended to fly beneath the enforcer’s radar. That is no longer the case. Moreover, the Commissioner’s case was that the transaction prevented competition that had not yet arisen, as

opposed to the standard mergers case where the allegation is that the transaction will lessen pre-existing competition. This made for a tougher case to prove, but also led the Tribunal to take a forward-looking approach to merger analysis – an approach that CCS Corporation is currently challenging on appeal. Lastly, the case was notable because, by the time the Commissioner brought her case, the deal had already closed. This caused the issue of remedy to play a central role in the hearing: Should the entire deal be unwound, or just those portions of the deal that the Tribunal determined were anti-competitive? In the event, the Commissioner won the case, proving that the merger prevented competition in the hazardous-waste disposal market in Northeastern British Columbia, and CCS was ordered to sell off the key assets it acquired. CCS has appealed the decision to the Federal Court of Appeal, but win or lose, the lesson from this case is that even relatively small transactions can get caught up in Canada’s antitrust regime, especially with an enforcer that is not afraid to flex its muscles. THE $77 MILLION THRESHOLD

CCS – the acquiror in this case – owns the only two hazardous waste landfills in the Northeastern part of British Columbia. These landfills are specially designed for the permanent disposal of solid hazardous waste, most of which is generated by oil and gas companies as a by-product of drilling for and producing oil and natural gas. Complete Environmental Inc., the party that CCS acquired, owned (through a subsidiary) certain lands on the Alaska Highway located in Northeast British continued on page 45

DEC/JAN 2013 E X ECUTIV E COUNSEL

Governance

New Standards for Aiding and Abetting By Brian Neil Hoffman

ecently, in SEC v. Joseph F. Apuzzo, a three-judge panel of the Second Circuit U.S. Court of Appeals made it significantly easier for the SEC to hold individuals liable for aiding and abetting another’s securities fraud. The Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, and amendments contained in the Dodd-Frank Wall

The precise level of substantial assistance required, however, has been open to debate. In SEC v. Joseph F. Apuzzo,, the Second Circuit ruled that the SEC may prove that an individual provided substantial assistance to securities fraud by showing that the individual “in some sort associate[d] himself with the venture, that he participate[d] in it as something that

Because the Janus decision foreclosed SEC 38

enforcement action against many executives who could not be found to be “makers” of false or misleading statements, the SEC has been more actively pursuing executives as aiders and abettors in the illegal conduct.

Street Reform and Consumer Protection Act, also make it more likely that the SEC will aggressively pursue aidingand-abetting charges against individual officers and directors. In view of these developments, executives can and should take steps to minimize their potential individual liability. To prove that an individual aided and abetted a securities law violation, courts have long held that the SEC must prove (1) the existence of a primary violation by another, (2) the aiding-and-abetting defendant’s knowledge of the primary violation and (3) that the aiding-and-abetting defendant provided “substantial assistance” to the primary violation.

he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” The Second Circuit specifically refused to impose a higher burden, which would have required proof that a defendant proximately or directly caused the primary violation. The panel noted the important deterrence role played by SEC enforcement actions, and posited that “many if not most aiders and abetters would escape all liability” if the higher burden applied. The court, instead, relied on long-standing criminal aiding-and-abetting authority to clarify that the SEC need only meet the more relaxed standard to prove “substantial assistance.”

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Governance

dec/jan 2013 E X ECUTIV E COUNSEL

Governance

The Second Circuit applied its newly articulated standard to the SEC’s allegations in the Apuzzo case. In that case, the SEC had sued the former CFO of Terex Corporation for purportedly aiding and abetting another company, United Rentals, Inc., to fraudulently misstate its revenues. The SEC alleged that United Rentals sold

liberalization of secondary liability standards, in a way that will help the SEC in its efforts to do just that. Two other recent changes in the law will also play an important role. First, the 2010 Dodd-Frank Act amended the federal securities laws – for example, Exchange Act Section 20(e) – to expand the SEC’s authority to pursue secondary actions.

against many executives who could not be found to be “makers” of false or misleading statements, the SEC has been more actively pursuing executives as aiders and abettors in the illegal conduct. The Dodd-Frank Act and the Second Circuit’s Apuzzo decision make it easier for the SEC to maintain these secondary violations.

Allowing actions against “reckless actors” as well as “knowing” actors has emboldened the SEC to pursue aiding-and-abetting cases against executives individually for their role in an entity’s alleged fraud.

equipment to a third party at inflated prices (immediately recognizing the revenue). United Rentals then leased the equipment back for a specified time period. At the end of the lease, Terex sold the equipment on behalf of the third party, guaranteeing the third party a specified minimum return that caused Terex to suffer a loss. According to the SEC, United Rentals had entered into secret side agreements with Terex, whereby United Rentals purported to prepay for equipment purchases, but in fact reimbursed Terex for its losses from the equipment sales. Apuzzo signed the side agreements on behalf of Terex, and allegedly approved inflated invoices sent to United Rentals in one transaction and was aware of (but did not personally approve) inflated invoices in a second transaction. The Second Circuit, applying the aiding-and-abetting standard that it articulated, found that these allegations sufficiently pleaded that Apuzzo aided and abetted United Rentals’ violations of multiple provisions of the Securities Exchange Act of 1934. SEC MORE LIKELY TO PURSUE AIDING AND ABETTING

For years, the SEC has been under intense pressure to bring securities fraud charges against individuals. The Apuzzo case represents a continued

Before the revisions, the SEC could only pursue actors who “knowingly” aided and abetted securities fraud. The DoddFrank Act specifically expanded the pool of potential defendants to include anyone who “knowingly or recklessly” aided and abetted securities fraud. Although still a tough burden to satisfy, allowing actions against reckless actors has emboldened the SEC to pursue aiding-and-abetting cases against executives individually for their role in an entity’s alleged fraud. Second, the Supreme Court’s June 2011 Janus decision limited the scope of potential primary violators for at least certain provisions of the securities laws. Specifically, the Supreme Court held that only the “maker” of a statement – “the entity with authority over the content of the statement and whether and how to communicate it” – may be held liable for violating Exchange Act Section 10(b), and Rule 10b-5 thereunder. Typically, only the filing entity – and the few senior executives who signed filings or to whom challenged quotes are attributed – may be charged with primary violations under the Janus standard. Yet, post-Janus, the SEC keeps a keen eye on other executives it believes may be charged with secondary liability. Simply put, because the Janus decision foreclosed SEC enforcement action

Executives, therefore, face an increased likelihood that they will be charged for aiding and abetting another’s alleged fraud. STEPS TO REDUCE POTENTIAL LIABILITY

Executives should take certain steps in the regular course of their business, not only to help avoid ultimate liability, but also so that defense counsel can use those steps to argue against the SEC bringing an enforcement action in the first place. First and foremost, instill a culture of compliance at all levels of the organization. Senior executives should endeavor to set a law-abiding tone at the top. Executives at every level should take steps to ensure that their entity has adopted, and follows, relevant and effective compliance policies and procedures. These policies and procedures must be appropriately communicated to personnel throughout the organization – including to outposts abroad (particularly concerning issues such as Foreign Corrupt Practice Act compliance). Documentation should be followed up with sufficient training. In other words, striving to conduct business legally should always be one of your primary business goals. Second, involve the experts. SEC enforcement actions may involve disclosure nuances or complex accounting

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Governance

matters. Opinions may differ about the correct course of action. Executives, therefore, should not be shy about soliciting the advice of experts. In-house staff in key departments (such as accounting and legal) should be involved in drafting and finalizing public disclosures, and in other business decisions, as well. In addition outside experts – such as the

within the crosshairs of an SEC investigation if they ignored red flags that were brought to their attention by whistleblowers. Fourth, dealings with other entities are relevant. In Apuzzo, the Second Circuit held that the SEC properly sought to hold Apuzzo liable for assistance provided to a fraud committed as a

could be substantial, particularly if a matter progresses through a protracted investigation and litigation. Before trouble arises, executives and entities should review their D&O insurance policies to determine coverage for SEC actions. Sometimes, policies advance defense costs, and sometimes they extend to SEC investigations as well as

The Second Circuit held that the SEC properly sought to hold Apuzzo liable for assistance provided to a fraud committed as a result of another company’s accounting decisions.

company’s auditors and lawyers – should be consulted regularly. For executives of regulated entities, subject matter experts should be consulted on key areas of potential exposure (for example, experts in valuation or mutual fund governance issues). Engaging a full team to assist in making important decisions – and documenting the process as it evolves – can play a key role in helping executives demonstrate a lack of involvement in fraud. Third, never intentionally ignore a red flag of potential securities fraud. An internal investigation may be appropriate, sometimes an investigation conducted by independent outside counsel, and effective corrective action should be taken. In 2011, the SEC revamped its whistleblower program to allow individuals to receive cash rewards for reporting potential fraud to the agency. In August, 2012, the SEC made its first payment to an individual under this program. The agency is receiving a large number of high-quality whistleblower tips, and it has made other changes to streamline the staff’s ability to quickly investigate potential issues. Executives thus should assume that whenever an issue is reported within the company, the SEC also may have received the same information. Executives may find themselves squarely

result of another company’s accounting decisions. Similarly, many entities and individuals have been subject to liability under the Foreign Corrupt Practices Act for actions taken by third-party consultants, or for the pre-acquisition conduct of recently acquired entities. Executives thus should ensure that they ask the right questions about their company’s relationship and business with third parties. Fifth, consider personal motive. Although not an element of any claims, motive plays an important role in shaping SEC enforcement actions. The staff frequently discusses motive when making charging decisions, and motive is critical to framing the staff’s presentation during litigation. The SEC frequently focuses on an executive’s individual stock trades to assess fraudulent motive. Adopting an automatic, predetermined trading plan – a Rule 10b5-1 plan – is a simple way to eliminate, or at least limit, adverse inferences. Disclosing the existence of the plan publicly and noting when trades are made under the plan may provide additional business, and evidentiary benefits as well. Finally, cover the expenses. Fighting, or even settling, an SEC enforcement action can have a profound negative impact on one’s livelihood. The costs of hiring experienced SEC defense counsel

filed litigation. Making sure that the company has appropriate insurance in place will go a long way to alleviate the potentially significant financial burden an SEC investigation can create and will help to prevent unpleasant surprises once the SEC sends its subpoena. Nothing can completely eliminate all risks of an SEC enforcement action involving executives. Yet taking these steps may help experienced SEC defense counsel argue that an executive should not be charged with aiding and abetting a securities fraud, or be charged directly. ■

Brian Neil Hoffman is Of Counsel in Morrison Foerster’s Securities Litigation, Enforcement, and WhiteCollar Crime Group. He recently served as a Senior Attorney in the SEC’s Division of Enforcement. He now represents entities and individuals in government and self-regulatory organization investigations and proceedings, conducts corporate internal investigations and defends against shareholder class action and derivative lawsuits. bhoffman@mofo.com

DEC/JAN 2013 E X ECUTIV E COUNSEL

Human Resources

Your Company May Not Own Its Social Media Accounts By John G. Browning

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

Human Resources

he was a great hire. She helped establish your company’s presence online by starting and cultivating Facebook pages and Twitter feeds that raised your corporate profile. But now she’s left for greener pastures with one of your competitors. and no one seems to be able to even log in to these social media accounts, much less continue to use them. Even worse, your former employee is now claiming those Facebook “fans” and Twitter “followers” belong to her. How did this happen, and what can you do? It is a scene that has played out in boardrooms across America. More and more companies are harnessing the commercial possibilities of social media. With over 1 billion users on Facebook worldwide, over 178 million unique visitors to Twitter in February 2012, and with 65 percent of adult Americans on at least one social networking platform, businesses have realized that there’s money to be made from being “liked” on Facebook and followed on Twitter. In a July 2012 survey of 400 U.S. businesses with between $5 million and $50 million in annual revenue by Edge Research (commissioned by software

a blurring of the boundaries between online work and personal lives, as individuals increasingly access their social media accounts during the workday. As employees promote themselves as well as their companies on social networking platforms, an inevitable tension results. If an employee and employer share in creating content, making connections, and bringing in customers through such social media sites, who owns the social media account, not to mention the content on it or the benefits it generates? And for that matter, what is a Facebook fan or a Twitter follower worth? CASE LAW EVOLVING

The answers are far from clear, as litigation over these issues continues to dot the legal landscape. For example, in a 2010 New York federal court case, Sasqua Group, Inc. v. Courtney, an executive search firm maintained that the LinkedIn connections and Facebook relationships with clients cultivated by a former employee were actually trade secrets belonging to the firm. The court soundly rejected that view, holding that the contact information

maintained the company’s Twitter and Facebook presences, generating content for and promoting her employer. Ms. Maremont also had personal social media accounts. While she was on a leave of absence following a car accident, personnel from the design group continued to post on all of these accounts without Maremont’s permission. She brought suit for this unauthorized use and access, among other claims, and in December of 2011 the court denied the employer’s motion for summary judgment. With the potential that an employer could be exposed to liability for unauthorized use of an account maintained by an employee (even if it was created at work and was ostensibly work related), it becomes increasingly important for businesses to clearly delineate who owns or is an authorized user of a social media account. Another 2011 case, Ardis Health, LLC v. Nankivell, underscores the importance of such documentation. Ardis, a producer of herbal and beauty products, hired Ashleigh Nankivell as a “video and social media producer” to tout the company’s products. Nankivell’s contract contained typical “work for hire”

The company claimed at least $340,000 in damages, based upon a supposed “market value” of Twitter followers of $2.50 each per month, multiplied by the number of Twitter followers and the number of months of alleged use. company Vocus Inc.), 77 percent of the companies responded that they spend a quarter or more of their marketing efforts on social media. Another 73 percent acknowledged adding social media management to the duties of at least one employee in recent years. In fact, experts predict that 2012 will mark the first time that spending on online advertising will surpass the total dollars spent on print advertising. At the same time, the ubiquitous nature of social media has resulted in

and professional details were hardly protected secrets in an age where “everyone ... puts it out there for the world to see because people want to be connected now.” Companies also have to be careful about their own treatment of boundaries between individuals and job-related social media activities. In Maremont v. Susan Fredman Design Group, a 2011 Illinois federal court case, the director of marketing (Maremont) for a Chicagobased interior design firm started and

provisions, and stipulated that she would return all confidential information to her employer upon termination. After Nankivell was fired in the summer of 2011, Ardis sought injunctive relief, including the return of passwords and access information for the social media accounts that she managed. Recognizing the critical need for up-to-the minute access in social media marketing, the New York federal court ordered Nankivell to return the passwords and restore the company’s access to these accounts.

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Human Resources

Another case over social media profile ownership, Eagle v. Edcomm, Inc., is gearing up for trial in federal court in Pennsylvania. Dr. Linda Eagle started Edcomm, a banking education company, in 1987. In 2008, as president of the company, Eagle established an account on the popular business-oriented social networking site LinkedIn. She used the account not only to promote Edcomm, but to foster her business reputation, as well as to connect with family, friends,

confusion. However, it did allow her state common law claims, like invasion of privacy, to proceed to trial. VALUING A “FOLLOWER”

With companies like the ones discussed above actively encouraging employees to utilize social media as a marketing tool, litigation over ownership of social media accounts is likely to become more common. Assessing value, however, remains a moving target.

The former CEO claimed that she lost potential business contacts because those searching for her on LinkedIn would have been confused and unable to send a message to her.

and colleagues. In October 2010, Edcomm was acquired by Sawabeh Information Service Company (SISCOM). The new ownership assisted those who stayed on (Eagle had remained as CEO) with maintaining their LinkedIn accounts. On June 20, 2011, Eagle was terminated, and she was unable to access her LinkedIn account. By then, Edcomm (using Eagle’s password) had accessed her account, changed the password, and then changed Eagle’s account profile to display the name and photo of the new CEO, Sandy Morgan. (Strangely, the rest of Eagle’s profile – her honors and awards, recommendations and connections – remained on the page.) Eagle filed suit, claiming invasion of privacy, misappropriation of her identity, Lanham Act violations, civil conspiracy, tortious interference, and violations of the Computer Fraud and Abuse Act (CFAA). Among other allegations, she claimed that she lost potential business contacts because those searching for her on LinkedIn would have been confused and unable to send a message to her. In October, 2012, the federal court dismissed all of her federal claims largely based on her inability to show actual loss of business opportunities or

PhoneDog, LLC v. Noah Kravitz, in federal court in California, may eventually provide some much-needed guidance. Kravitz was employed by the interactive mobile phone news and reviews site PhoneDog, as a product reviewer, from April of 2006 to October, 2010. When Kravitz left, he continued to use the “@PhoneDog_Noah” Twitter account through which he had amassed 17,000 followers. Kravitz eventually changed his Twitter handle to @noahkravitz, but PhoneDog sued, claiming misappropriation of trade secrets, interference with economic advantage, and conversion. Interestingly, PhoneDog claims at least $340,000 in damages, based upon a supposed “market value” of Twitter followers of $2.50 each per month (multiplied by the number of Twitter followers and the number of months of alleged use). Although the court recently denied Kravitz’s motion to dismiss, proving damages in such a case presents certain obstacles for companies like PhoneDog. Can Twitter followers be a trade secret when a list of followers is readily displayed on an account’s homepage, easily accessible to competitors and pretty much everybody else? And does value actually lie

in followers – who can choose at any time not to follow – or in the content of the tweets themselves? Because of these unsettled issues in a still-developing area of law, businesses need to take steps to protect themselves. One crucial strategy is to implement social media policies that not only clarify who owns the social media accounts and the content on them, but also specify who has access rights when the employment relationship ends. Such policies should be careful to define any employee-operated accounts as business-related, in part because of recently-enacted laws in California, Maryland, Illinois and other states that now restrict employers’ access to “personal” social media accounts. (“Personal” is undefined in the California statute and is a potential gray area that is ripe for future disputes.) Another important step is to address these ownership and access issues in any applicable employment agreement, stipulating that the ex-employee must promptly return all social media login and password credentials upon termination. In fact, if at all possible, get the access information before terminating the employee. With an ounce of prevention, your company’s customers can continue to “like” your products and services while your social media presence remains secure, not held hostage by an ex-employee. ■

John G. Browning is the founding partner of the Dallas office of Lewis Brisbois Bisgaard & Smith, where he handles a wide range of civil litigation in state and federal courts. He is also an adjunct professor at SMU Dedman School of Law and Texas Wesleyan School of Law, teaching courses on social media and the law, and he is the author of The Lawyer’s Guide to Social Networking: Understanding Social Media’s Impact on the Law (West 2010), and two forthcoming books on social media and the law. jbrowning@lbbslaw.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

Canada/Cross–Border

Canada’s New Appetite for Antitrust Litigation continued from page 37 Columbia. Beginning in 2006, Complete sought the necessary approvals to establish, construct and operate a hazardous waste landfill at the site. After a lengthy, uncertain and expensive regulatory process, the necessary approvals were obtained in February, 2010. Soon thereafter, the individuals who owned Complete began approaching a number of players in the waste management industry, including CCS, for expressions of interest. By the summer of 2010, CCS had entered into a binding agreement to buy Complete, and the deal closed in January, 2011, for roughly $6 million. To put that transaction size into context, in Canada, unless a deal is valued at over $77 million, the transacting parties do not need to notify the Competition Tribunal. One of CCS’s competitors brought the deal to the Bureau’s attention, and the transaction closed over the Bureau’s objection that the merger would maintain CCS’s monopoly for hazardous waste disposal services. The Commissioner brought her case challenging the merger three weeks after the deal closed. The Commissioner argued that CCS had substantially prevented competition that would have arisen if a competitor, rather than CCS, built and operated a landfill at the site. The case culminated in a trial that took place in November and December of 2011. The Commissioner asked that the Tribunal either dissolve the deal – which would have led to the vendors buying back the assets from CCS – or order CCS to sell off the site and associated regulatory permits. The Tribunal released its decision in May 2012. It came to the following conclusions. First, it agreed with the Commissioner that the merger was likely to substantially prevent competition for the supply of secure landfill services. The Tribunal relied on CCS’s internal documents which predicted that, absent the acquisition, CCS stood to lose a great deal of money, market power, and margins if a competitor operated the site as a landfill. These documents hinted at the likelihood of a price war in

the region, bespeaking competition that the Commissioner alleged was thwarted as a result of the merger. The Tribunal also noted that in neighboring Alberta, where CCS faces competition from other secure landfill operators, landfilling prices were significantly lower. In terms of remedy, the Tribunal was not convinced that dissolution would lead to a prompt sale and timely opening of a competitive landfill. Instead, the Tribunal ordered CCS to sell the assets relating to the landfill site, including the regulatory permits. The sale would have to be to a purchaser approved by the Commissioner. The Tribunal ordered that, if CCS was unable to sell the acquired assets within a specific period of time, a trustee would be charged with completing the sale on CCS’s behalf. COMPETITION LAW RISK

For those contemplating mergers in Canada, cross-border or otherwise, some important lessons can be taken from the CCS decision : • Size Does Not Matter. Though the merger was valued at roughly $6 million, well below the mandatory reporting threshold in Canada, the Commissioner decided to challenge it before the Tribunal. For parties to a merger, regardless of its size, a competition law risk assessment should be undertaken to minimize the risk of a subsequent challenge. The Commissioner has one year after closing to challenge a merger. • Vendors Beware of Dissolution. The Commissioner showed in this case that she is willing to pursue the remedy of dissolution, which has serious consequences for vendors. In future mergers, vendors would be wise to think seriously about the allocation of post-closing competition law risk. Although dissolution was not ordered in this case, the vendors were required to hire legal counsel to defend lengthy litigation that no doubt proved to be a substantial disruption. The Tribunal did not bar

dissolution from being the most appropriate remedy in future cases. It simply said that in this case, dissolution would not prompt competition any faster than a sale by CCS. • Regarding Future Competition. Finally, the CCS case is a reminder that the Commissioner can and will challenge a merger not only when it lessens existing competition, but if it is seen to prevent future competition. The property at issue in the CCS case was not an operational secure landfill. It was not competing with CCS. And, on the Tribunal’s findings, it would not have competed with CCS for more than two years after the merger. Still, the Tribunal ordered a sale. Parties looking to enter into transactions need to consider not only what the competitive landscape would be like today, absent the transaction, but the likely future competitive market as well. This will not always be an easy task, but as the Tribunal decision shows, it’s one that must be undertaken. ■

Nikiforos Iatrou is a partner at WeirFoulds LLP. His practice focuses on complex business litigation and competition law. He acted as counsel to the Commissioner of Competition in the CCS case. niatrou@weirfoulds.com

Scott McGrath is an associate at WeirFoulds LLP. He practises in a broad range of civil litigation matters, with emphasis on insolvency and competition litigation. smcgrath@weirfoulds.com

DEC/JAN 2013 E X ECUTIV E COUNSEL

The Era of the Whistleblower Has Arrived

By Michael Matthews and Melissa Coï¬&#x20AC;ey

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC/JAN 2013

or more than a century, companies involved in federal government contracting have been well aware of the temptation available to their employees to eschew internal reporting of potential wrongdoing in favor of trying to strike it rich through a whistleblower action under the federal False Claims Act. Recent changes to the federal False Claims Act (FCA), among other factors, have contributed to increasing recoveries under the law, including an all-time record of over $9 billion recovered in the federal government’s recently concluded fiscal 2012. Federal government contracting, however, covers a minority of the roughly 150-million person workforce in the United States. More notable is the recent massive expansion of the scope of whistleblower incentives and protections through other legislative changes, so as to cover an exponentially larger swath of America’s workforce. Below we have outlined some of the more prominent expansions and related whistleblower developments in recent years. (In addition, there have been developments, beyond the scope of this article, that apply to specific industries – e.g., in provisions of the 2011 Food Safety Modernization Act, which provided broad whistleblower protections for reporting violations of FDA regulations.) We are entering a new era, what some are calling the “era of the whistleblower.” THE 2006 IRS AMENDMENTS The results of the recent expansion of whistleblower incentives and protections are now starting to appear regularly in the headlines. For example, Bradley Birkenfeld, a former banker at UBS, recently received $104 million for reporting alleged tax evasion by UBS. That’s believed to be the largest ever tax whistleblower award to an individual. Mr. Birkenfeld received the award pursuant to the 2006 amendments to the I.R.S. whistleblower program, as part of the Tax Relief and Health Care Act of 2006. The amendments added a provision to the Internal Revenue Code that requires the I.R.S. to give whistleblowers a minimum of 15 percent and a maximum of 30 percent of the collected proceeds resulting from any action addressing underpayment of taxes or violations of the tax laws brought to IRS attention. The prior version of the statute permitted but did not require whistleblower awards and capped the awards at $10 million. In the current statute, there is no dollar-figure cap on awards.

The award to Mr. Birkenfeld brought widespread attention to the IRS whistleblower program and can be expected to create ripple effects in the coming years. WHISTLEBLOWER PROTECTIONS UNDER DODD-FRANK The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act has brought a second major expansion to the class of potential whistleblowers in the last few years, to the possible detriment of any company or person subject to the purview of the Securities and Exchange Commission. In August 2012, the SEC issued its first award under the whistleblower bounty program created pursuant to Dodd-Frank. The award was $50,000, or 30 percent of the amount collected by the SEC, the maximum allowed. The Dodd-Frank Act substantially expanded incentives and protections for whistleblowers alleging violations of securities laws and regulations. Whistleblowers who provide the SEC with original information that leads to a successful enforcement action in which monetary sanctions exceed $1 million will receive an award of not less than 10 percent and not more than 30 percent of the monetary sanction. The SEC thus far has not required whistleblowers to report internally at their companies before going to the SEC, although not doing so may reduce awards. Nor do whistleblowers even need to be employees to report potential violations. The SEC is just beginning to announce whistleblower awards under these provisions, and many companies will start feeling the effects of increased employee reporting to the SEC over the next several years. The Dodd-Frank Act also provided for a private cause of action for a whistleblower alleging retaliation by his or her employer. The statute does include some limitations on who can receive awards. Precluded, among others, would be individuals who are convicted of a criminal violation related to the enforcement action at issue, who gain the information through the audit of financial statements already required under the securities laws, or who fail to submit the information in the form required by the SEC. Federal district courts, however, have indicated thus far that such limitations may be interpreted narrowly, at least at the motion to dismiss stage. And in several reported decisions, courts have held that a whistleblower need not report the complaint to the SEC to continued on page 51

Mitigating Litigation Risk

of Inherently

Dangerous Products Tips for ManufacTurers By Lori B. Leskin and adrienne D. Gonzalez

his past June, Blitz USA, a manufacturer of gasoline containers, announced that it would cease operations after an unsuccessful attempt to reorganize through Chapter 11 bankruptcy. Blitz representatives attributed its demise, in large part, to soaring litigation costs associated with product liability lawsuits brought by plaintiffs alleging personal injury associated with the use of the gasoline containers.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec/jan 2013

According to the company, these suits typically involved injuries resulting from practices expressly warned against in the safety guidelines imprinted on the outside of every gas container. The majority of the suits involved adults who used gasoline to start or accelerate a fire. The company spent $30 million defending product-liability suits and owes $3.5 million in lawyer fees.

The Consumer Product Safety Commission has refused to issue mandated standards for these products. On July 31, 2012, the company closed, putting 117 employees out of work. “We appreciate the support of our employees and their families in our efforts to reorganize and develop a viable business plan. Unfortunately, we were not able to address the costs of the increased litigation associated with our fuel-containment products,” said Rocky Flick, president of the Miami-based manufacturer. There is nothing unique about a company going out of business, and any company engaged in the manufacture and marketing of products that will be used by consumers has experience defending itself against personal injury lawsuits. What does appear to set the Blitz USA story apart is the industry trade group’s assertion that despite several requests to do so, the Consumer Product Safety Commission, the regulatory body tasked with overseeing this industry, has refused to issue mandated standards for these products. Industry is often accused of resisting efforts by regulatory bodies to issue additional standards to improve the safe and effective use of products. Yet, in 2008, Public Citizen, the non-profit watchdog group, issued a report titled “Hazardous Waits,” accusing the CPSC of unreasonable delays in providing the public with information about dangerous products after the manufacturer has reported an issue. In the case of gasoline containers, the industry has been pushing for regulation, but it would appear that the CPSC has decided that since user error rather than inherent product danger is the cause of these injuries, there is no need to issue standards. The CPSC may have also rationalized that no matter how many ways you seek to warn people about the appropriate use of inherently dangerous but useful products, there will inevitably be people who fail to follow instructions and suffer for it. In fact, there is no way to completely prevent consumers from injuring themselves by misusing products. And as companies are all too aware, defending against even a frivolous lawsuit requires the investment of financial resources before there is dismissal, summary judgment or victory at trial. Nevertheless, there are certain possibilities a company should evaluate as defenses against litigation, particularly with products whose level of danger appears to be obvious:

Dec/jan 2013 E X ECUTIV E COUNSEL

• Informed Consent. This means products are accompanied by warnings that adequately disclose risks. Taking the additional step of requiring an acknowledgment that the warnings have been received, while not forcing people to use their common sense, does make them acknowledge that they have been advised of the proper way to use the product.

Lori Leskin is a partner at Kaye Scholer LLP, and co-chair of the Product Liability group. She handles all aspects of litigation strategy for complex nationwide and multi-district litigations involving a variety of products. lori.leskin@ kayescholer.com

Adrienne Gonzalez is an associate at Kaye Scholer LLP. She focuses her practice in the area of product liability. She is experienced in all phases of litigation, from discovery through the appellate process, and has participated in trials in state and federal courts across the country. She serves as an editor of the ABA Minority Trial Lawyer newsletter. adrienne.gonzalez@ kayescholer.com

to be weighed against the logistics of doing so, and the impact on sales, but it’s worth evaluating. Limiting consumer access and requiring informed consent reduces the size of the user population, but it can also help weed out lazy or incompetent users. • Advisory Opinions from Regulators. Depending on the industry and the circumstances,

Gasoline containers present the dilemma of what to do when a product is not dangerous unless combined with something that is inherently dangerous. Consumers have the right to decide for themselves whether the benefit of using a particular product is worth assuming the risks. A company is entitled to the protection conferred by providing consumers with sufficient information to make their decision. If the product is available through a retail seller or other third party, the manufacturers would have to rely on the sellers to implement this process. That creates more headaches, but it would be worth the aggravation if it ultimately limited a company’s exposure. • Restricting Access. There are restrictions as to where and under what conditions most inherently dangerous products can be sold. Gasoline containers present the dilemma of what to do when a product is not dangerous unless combined with something that is inherently dangerous. Gasoline is highly regulated. In certain states, for example New Jersey, it can be dispensed only by a service station employee who has been trained, and for whom the station maintains a certificate signed by both the attendant and the station operator. The perceived benefit associated with restricting access to the product would have

seeking an advisory opinion may be useful, not to prevent litigation but to aid the company in defending itself and dispensing with a claim as quickly and cost-effectively as possible. Judges and juries expect that most products in this country, dangerous or not, are governed by regulatory agencies tasked with protecting the public. Manufacturers are expected to follow the existing rules. But plaintiffs often don’t argue that the rules were broken, but rather that more should have been done to protect against injury. A manufacturer facing an increasing number of claims might consider seeking an advisory opinion on a proposed course of action to address the issue. While this will not prevent litigation, it can serve to bolster the defendant’s argument that the company acted reasonably. While it may seem appealing to blame the CPSC for Blitz USA’s plight, there is no way to know whether mandatory guidelines would have saved the company. Preventing litigation may be the goal, but the more likely benefit would be equipping the company to mount a defense, making it less palatable to plaintiff lawyers, who hopefully will bypass the hassle and expense in favor of easier pickings ■

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Era of the Whistleblower continued from page 47

benefit from the law. (In a number of these cases, however, the courts did dismiss on other grounds.) BROADENED FCA WHISTLEBLOWER PROVISIONS The Dodd-Frank whistleblower provisions came on the heels of several FCA revisions that attempt to broaden the ability of whistleblowers to proceed, first in 2009 through the Fraud Enforcement and Recovery Act (FERA), and then again in 2010 as part of the Affordable Care Act (ACA). The FCA includes whistleblower provisions that allow private citizens with evidence of fraud to sue, on behalf of the government, to recover the funds paid under government contracts or programs. Private whistleblowers suing under the FCA can receive as much as 30 percent of the government’s recovery. The FCA also includes treble damages provisions and penalties for each false claim. FERA revised the FCA in several ways. First, Congress attempted to broaden the scope of liability under the FCA’s false statements provision in response to decisions that had limited the FCA’s reach, particularly as to subcontractors and grantees. FERA also amended the “reverse false claims” provision of the FCA and amended the definition of “obligation” to add “the retention of any overpayment,” which is particularly significant for health care providers. Building on the FERA amendments, Congress attempted to broaden the scope of the FCA further through the ACA, particularly as to the FCA’s public disclosure bar, which prohibits whistleblowers from bringing FCA suits based upon public disclosures when the whistleblowers are not original sources. The ACA amendments attempted to narrow the scope of public disclosures defendants can invoke and to broaden whistleblowers’ ability to claim original source status. This prevents dismissal pursuant to the public disclosure bar where whistleblowers can show “knowledge that is independent of and materially adds to the publicly disclosed allegations.” The ACA also provided for an express duty to refund and report Medicare and Medicaid overpayments within 60 days, which as discussed above constitutes an “obligation” under the FCA. The 2009 American Recovery and Reinvestment Act, while not amending the FCA,

expanded the range of potential defendants in whistleblower retaliation actions to include private companies receiving stimulus funding. Contractors and subcontractors that receive state funds are also subject to potential liability under state versions of the FCA, many of which have likewise been expanded in recent years (most recently, California, on September 29, 2012). Companies can therefore be subject to potential false claims liability for contracts or subcontracts with all levels of government. IMPLICATIONS Whistleblower protections have expanded far beyond those included in the original federal FCA, which was enacted in 1863 to address frauds perpetrated on the federal government by contractors during the Civil War. With Dodd-Frank, all companies subject to SEC jurisdiction are now potential whistleblower targets, and the 2006 IRS whistleblower amendments have increased the risk of any taxpayer potentially facing whistleblower reporting. Companies should recognize that the class of potential whistleblowers, and the incentives provided to them to report alleged wrongdoing to the government, have undergone a massive expansion in the last several years. Companies should ensure that they have the appropriate internal controls in place, as well as audits to identify potential issues. Companies also should establish and internally publicize clear and effective mechanisms for internal reporting of potential misconduct, and they should ensure there are sufficient resources to investigate and act appropriately on any such claims. Given the broad anti-retaliation provisions in many of the whistleblower laws, companies should also ensure that there are documented legitimate, non-retaliatory reasons to support any adverse employment action taken against employees, and use exit interviews to identify issues and ask employees to confirm the absence of issues. Companies should also assess potential insurance coverage, as well as employment agreements that appropriately limit incentives to bring whistleblower actions (though not to limit incentives to report wrongdoing). Even if the era of the whistleblower has arrived, taking such actions should help companies mitigate the potential liability and the disruptions caused by it. ■

Michael P. Matthews is a partner and vice chair of the Government Enforcement, Compliance & White Collar Defense Practice at Foley & Lardner LLP, working out of the firm’s Tampa and Washington D.C. offices. mmatthews@ foley.com

Melissa Coffey is a senior counsel in the Tallahassee office of Foley & Lardner LLP. She works with Mr. Matthews in False Claims Act and government enforcement litigation. mcoffey@foley.com

DEC/JAN 2013 E X ECUTIV E COUNSEL

Five Litigation Trends That Can Keep Executives

Awake at Night By Paul E. Benson

n today’s world, all litigation can be frightening, but certain trends stand out. The five listed below all have the potential to keep a lot of business owners up at night. (1) False Advertising Claims. If it’s too good to be true, it probably isn’t, and someone will sue you for it. False advertising is a current “claim du jour,” forcing companies to pay out millions for unsubstantiated statements. These claims take countless forms, but usually include false benefit claims, false claims about how the product is constituted (“all natural” or “100% pure”) or false claims about the product’s performance. False advertising claims can extend to almost any product or service, but are particularly popular in the food and beverage space. Proposition 37, though recently rejected by California residents, sheds light on the future of false advertising claims: If you wanted to label something as “all natural,” you’d have to verify how it is grown and what type of seed it is derived from. Why are these claims so scary? First, they are typically brought as class actions, among the most expensive and lengthy forms of litigation. If a class is certified, large settlements often follow,

because business owners do not want to run the risk of trial. Second, false advertising claims are sexy and tend to get press coverage. This can cause damage to the company’s line of business and reputation if consumers come to believe, rightly or wrongly, that they cannot trust what you say about your product. If you want to avoid these claims. make sure the product’s message is valid and be prepared to produce evidence supporting the accuracy of your statements. And, as always, be sure you have insurance coverage for these types of cases. (2) Wage and Hour Litigation. Wage and hour litigation is one of, if not the fastest growing type of litigation in the labor and employment context. Disgruntled current or former employees, and the lawyers lining up to represent them, seek unpaid wages for themselves and often for “others similarly situated.” Additionally, the Department of Labor is implementing a new initiative, as part of its Strategic Plan for Fiscal Years 2011-2016, to “shift the burden of compliance to the employer or other regulated entity rather than relying exclusively on enforcement interventions. No more ‘catch me if you can’ regulation and enforcement.”

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Claims for unpaid wages can relate to automatic deductions for meal and rest breaks, work completed before or after a shift, “donning” and “doffing” work gear, rounding time up or down, and work completed remotely. Issues also arise concerning whether a worker is categorized as an employee or an independent contractor, or as “exempt” or “non-exempt” under the wage and hour laws. Like false advertising claims, wage and hour claims are often brought as class and collective actions because the unpaid activity is typically alleged to be part of a policy or practice affecting a group of workers. Damages claims in these cases can be huge. The good news is that employers can reduce their exposure to this kind of action by being proactive. Make sure your timekeeping and pay policies comply with the wage and hour laws, and routinely update those policies to keep pace with legal developments, which are occurring rapidly because of the large number of these cases being brought. Once your policy is current, train managers and employees on the policy and reinforce this training regularly. You should also create an internal process to ensure that hours and wages are tracked correctly and implement a com-

plaint system to report suspected inaccuracies. If an employee does file suit alleging unpaid work, hire an attorney who knows the complex landscape of wage and hour litigation. (3) Litigation to Cure Society’s Ills. Americans have a strong desire to protect those who cannot protect themselves. Litigation in this realm has morphed into lawsuits over efforts to protect society from itself. New York City’s Board of Health recently approved a measure to ban “sugary drinks” larger than 16 ounces from restaurants, delis, movie theaters and stadiums. Mayor Bloomberg defends the measure as targeting New York’s ever-increasing obesity rate. Opponents of the measure have launched a lawsuit trying to block implementation of the ban, arguing that the Board of Health doesn’t have the authority to pass such a measure. continued on page 57

n g s e c u r it y r i s s e isk dr

Ad n th e n ew tech nologies s i

ith Lockhart and Emily Milliga By Jud n

he protection of confidential information in the digital age can be a delicate subject, especially with an emerging technology that is not widely used or easily understood. The challenge to both lawyers and their clients is not only to raise and resolve concerns about these emerging technologies (like the cloud), but also to remain vigilant and avoid complacency with now commonplace technologies like smartphones and other mobile devices.

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The emergence of cloud computing over the past several years has triggered valid concerns about the security of confidential information. Cloud computing refers to storage and maintenance of data by a third-party service provider that makes the data available to the end-user over the Internet. Instead of being required to purchase hardware and software, the end user subscribes to a cloud service that stores, manages, and allows the user to access and process the data remotely. There are a number of models for cloud services, ranging from private clouds operated for a single organization, to community clouds shared by several organizations, to public clouds, which are available either for free (e.g. Google) or for a fee based on usage. In addition to basic storage and backup of email, data and documents, cloud-based services allow lawyers and clients to seamlessly collaborate on their work. They can simultaneously edit and review documents, share files, manage litigation schedules, host deal rooms, and conduct electronic discovery through websites that are accessible through logins and passwords. In the past, these collaborative activities were accomplished through private extranets, but increasingly they are taking place by way of the cloud, because of the potential cost savings, scalability and expertise that cloud service providers can offer. Still – and despite the fact that more service providers are offering increased levels of security and 24-hour support – the idea of placing large amounts of confidential data in the cloud makes many lawyers cringe and continues to prevent many businesses and law firms from migrating to the cloud. Further complicating matters is that large amounts of confidential information – whether stored in the cloud or on the client’s or lawyer’s own servers – are now being accessed from portable devices like smartphones, tablets, and laptops. This raises additional and serious security issues, particularly if a device is lost, stolen or is being used on a network that is not secure or encrypted. Both lawyers and their clients are obligated to keep certain types of information secure. Lawyers must protect a client’s confidential information by taking reasonable steps to prevent its inadvertent disclosure by third parties (like cloud service providers) that the lawyer has retained to assist in providing services to the client. Ethics advisory opinions in a number of jurisdictions (including Arizona, Iowa, New Jersey, New York, North Carolina and Oregon)

Multiple candidates should be evaluated with regard to security features and well as willingness to negotiate key terms and provisions in the cloud service agreement.

have found that it’s permissible for lawyers to store client information in the cloud, but that they also must exercise reasonable care to ensure that the service provider keeps data secure and confidential, and that they are able to reconfirm that the provider’s security measures remain effective as the technology evolves. In addition, the American Bar Association Commission on Ethics recently proposed that Model Rule of Professional Conduct 1.6 be amended to require lawyers to make “reasonable efforts” to protect the confidentiality of electronically information. Clients must also protect confidential information. Companies that use their own clouds or contract directly with providers to store privileged and/or confidential information need to make sure they take reasonable measures to ensure the information is protected. Several states (including, Arkansas, California, Indiana, Massachusetts, Nevada, Rhode Island, Texas and Utah) have enacted statutes imposing data security obligations on any entity that has access to personal data. In addition, numerous industry-specific regulations and guidelines have been established. Among them: the Health Insurance Portability and Accountability Act (HIPAA) mandates that the U.S. Department of Health and Human Services establish standards for safeguarding the privacy of individually identifiable health information, including information transmitted and/or maintained in electronic media. The Gramm-Leach-Bliley Act contains extensive privacy regulations concerning the collection and distribution of personal and financial information by banks, insurers, security firms and other financial institutions.

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Also, the Financial Industry Regulatory Authority has established for its members standards for the supervision of outsourcing to third-party vendors, like cloud service providers. Similarly, in July of this year, the federal financial regulatory agencies issued a joint statement providing guidelines to financial institutions seeking to outsource cloud-computing services. Compliance with these and other security and confidentiality requirements in the context of cloud services begins with due diligence in the selection of a provider. Multiple candidates should be evaluated with regard to security features and well as willingness to negotiate key terms and provisions in the service agreement. Due diligence should include reaching out to known customers of the provider, and determining whether the provider undergoes voluntary third-party audits (preferably a SSAE No. 16 audit), and generally whether the vendor is an established company with a record of reliability. The service agreement should be appropriate for the client’s particular security needs and comply with the lawyer’s ethical obligations. Where possible, the cloud service agreement should:

Judith Lockhart, a litigator and employment lawyer, is the managing partner of Carter Ledyard & Milburn LLP in New York City. She is also Chair of Meritas, a global alliance of independent law firms. lockhart@clm.com

Emily Milligan is counsel at Carter Ledyard & Milburn LLP in New York City. A commercial litigator focusing on employment law, she was co-chair of the 2011-12 Meritas Leadership Institute. milligan@clm.com

• Specify a robust security program that limits the number of personnel with access to data and limits access to data through passwords and keys, firewalls, virus protection, encryption and remote back-up of data. • Require immediate notice of any data or security breach. • Require the cloud service provider to use third-party auditors to review compliance with security programs and procedures. • Clearly define data ownership and require that customer data be used only as instructed or to fulfill a contractual or legal obligation of the vendor. • Specify that data be maintained in its original format and that metadata be preserved. • Identify the location at which the data will be stored and the location of remote backup. • Warrant that the service will be up, running and accessible 99.9 percent of the time. • Provide indemnity for any security breach or loss of data that results from the negligence or wrongdoing of the cloud service provider. Most providers limit their liability with respect to any loss of data as a result of hacking or cybercrime. • Clearly define the customer’s exit rights upon termination of the relationship with the cloud service provider, including destruc-

tion of any customer data within a specified time after the agreement is terminated and delivery of the data to the customer at no charge. The period of time should be long enough to enable the customer to move the data to another provider. In addition, when negotiating the agreement, pay careful attention to any provisions that establish routine deletion of data and address advanced search capabilities for data stored in the cloud. Security features of existing technologies should also be periodically revisited by both lawyers and their clients. This includes but is not limited to the security features protecting smartphones, tablets and laptops. The use of these devices now permeates the legal profession. Over 93 percent of respondents to a recent survey of the 174 member firms of Meritas Law Firms Worldwide reported they frequently use smartphones or tablets in their law practice. Given the widespread use of these devices, lawyers as well as their clients should implement a few straightforward measures to safeguard data stored or transmitted by way of these mobile devices: • Establish guidelines relating to which employees should be issued mobile devices or given access to work emails or files through a mobile device they already own. • Require password protection for all mobile devices. • Back up data that is sent to or received from a mobile device. • Systematically purge unnecessary data from mobile devices to limit the possibility of unintended disclosure. • Use software that allows a device to be remotely located and/or disabled if it is lost or stolen. • Require mobile device users to confirm that their Wi-Fi network is secure and encrypted. • Restrict the use of public Wi-Fi networks to nonconfidential and non-proprietary information. Lawyers and their clients must be aware of risks posed by existing and emerging technologies and take reasonable steps to ensure that client and other data is secure. Lawyers must take into account the professional and ethical obligations in the jurisdictions where they practice. Clients must take into account the various federal and state laws that govern the use of confidential personal data, particularly in the health care and financial services industries. ■

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Five Litigation Trends continued from page 53

However, many experts believe that like Bloomberg’s measure restricting the use of trans fats in restaurants, the “sugary drink ban” will become another mainstay in New York City restaurants. The focus on curing society’s ills does not end with sugary drinks and trans fats. There has already been significant litigation over the historic use of lead pigment in paint, the accessibility and the right to own handguns, and the consumption of alcohol on Native American lands, to name a few. The future looks bright for this type of litigation. With advancing technology, there is an increase in consumer skepticism and fear. The use of nanotechnology and genetically engineered foods are already the subject of lawsuits. The public’s concerns about junk food, video games and “Red 40” further illustrate that where a potential risk exists, a lawsuit could follow. To ward off such lawsuits, you need to stay current on social, political, and legal events. Know where the public’s spotlight is aimed at a particular time in history, and in particular know if it is shining on your business. Take advantage of industry and trade associations. These groups can help identify coming trends and provide useful information and services. (4) Technology & Social Media Litigation. Almost every employee has access to the Internet, social media sites and smartphones with built-in camera, video and audio recording functions. This makes it a major challenge for business owners to control the information traveling into and out of the company. Employee use of these technologies has led to a wave of lawsuits, including claims involving copyright and trademark, the Federal Trade Commission’s guidelines for advertising and full disclosure, privacy, defamation, libel, slander, and even wrongful termination. With regard to the use of Facebook, the National Labor Relations Board recently found that an employer did not violate the National Labor Relations Act when it fired a salesman who posted embarrassing pictures and comments about an incident at the dealership on Facebook. The NLRB noted that the question came down to “whether the salesman was fired exclusively for posting photos of an embarrassing and potentially dangerous accident at an adjacent Land Rover dealership, or for posting mocking comments and photos with co-workers about serving hot dogs at a luxury BMW car event.” The comments

regarding “hot dogs” might be protected under the NLRA because it concerned the effect low-cost food might have on the dealership’s image and on commissions. This case demonstrates, among other things, the fact that businesses need to have carefully crafted social media policies that are clearly communicated to employees. Businesses must consider whether any activity prohibited by the policy is protected under the NLRA. Policies that include broad prohibitions that may stifle an employee’s complaints about working conditions will likely fail the NLRB’s test, whereas more narrowly written policies are more likely to pass. Once your policy is in place, train your employees early and often. Make sure they understand what is and is not acceptable use of social media. Finally, develop a public relations strategy before something goes viral. If you are trying to create a strategy on the fly, you will be too late. (5) Costly Litigation. The thread that ties all these litigation trends together is the exorbitant expense that they can saddle a company with once it becomes a target. While the potential for huge damage awards may keep you up at night, so too can the costs of a defense. Why does it cost so much for businesses to defend themselves? The issues involved in these litigation trends are complex, and that means these cases typically take longer to resolve, motion practice is more common, and discovery costs, mostly relating to producing electronic communications, are substantial. To address this situation, companies need to develop creative solutions. Pay attention to technological advances that can help reduce the overall time a lawyer spends on your case. Make sure your company has an electronic records management system in place before a lawsuit is filed, and investigate whether new software such as predictive coding can be used to reduce the number of documents requiring individual human review. To further reduce costs, discuss alternative fee arrangements with your lawyers. Law firms are becoming more flexible with their fee structures and may be willing to offer fixed-fee billing, task-based or “phased” billing, and pre-arranged budgets with a “collaring” arrangement to handle these types of cases. If you have a plan in place to tackle these issues before they hit your company, there is a good chance you’ll be counting sheep while others are laying awake counting costs. ■

Paul E. Benson is a partner at Michael Best & Friedrich, LLP, chair of the firm’s Product and Tort Liability Litigation Focus Group and former chair of the firm’s Litigation Practice Group. He has been involved in litigation nationwide in the areas of product liability and personal injury litigation, class action, and multi-district, toxic tort, intellectual property, insurance and commercial litigation. pebenson@ michaelbest.com

Franchisors Wince as Some Courts Re-Label Franchisees as Employees Franchisors Look to State Legislatures

By James Mulcahy

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mployee misclassification is a potential issue lurking in all industries. The franchise community was recently shaken up following a series of court decisions that relabeled franchisees as “employees” of the franchisor. JaniKing and Coverall North America, two of the largest commercial cleaning franchisors, have been defending themselves from labor law claims brought by franchisees seeking minimum wage, overtime pay, and other employment-related benefits. In March 2010, a federal district court judge in Massachusetts ruled that Coverall franchisees were employees, irrespective of the “independent contractor” classification in the parties’ contracts. More recently, on June 8, 2012, the Massachusetts District Court granted summary judgment in favor of a class of Jani-King franchisees, finding that the franchisees were employees of Jani-King. The Massachusetts litigation has led to similar employee misclassification lawsuit filings across the country. Franchisors operating in California can breathe a sigh of relief after the California District Court in Juarez v. Jani-King granted summary judgment in favor of Jani-King, finding that the franchisor did not exercise sufficient control over the plaintiff franchisees to render them employees. Franchisors also obtained favorable results in the states of Minnesota and Kentucky. While California may serve as a safe harbor for franchisors from employee misclassification liability, plaintiffs’ attorneys in California are still capitalizing on the court’s confusion over the franchisor/franchisee relationship to attack franchisors. Since 1992, franchisors operating in California have relied on the protections of the California Appellate Court’s ruling in Cislaw v. Southland Corp. It held that franchisees are deemed agents only if “the franchisor exercises complete or substantial control over the franchisee.” But recent court decisions appear to be eroding the Cislaw standard. Earlier this year, in the case of Patterson v. Domino’s Pizza, LLC, an employee of a Domino’s Pizza franchisee named Domino’s Pizza as a defendant in her lawsuit alleging sexual harassment by another employee of the franchisee. Consistent with Cislaw, the

trial court found that the franchisee was an independent contractor, and that the franchisee’s employee was “not an employee or agent of ... Domino’s ... for purposes of imposing vicarious liability,” and granted summary judgment in favor of Domino’s Pizza. But on June 27, 2012, the California Court of Appeals, surprisingly, reversed and remanded the case back to the trial court for a jury trial on the sexual harassment claims against Domino’s Pizza. Round Table Pizza is another large pizza restaurant franchisor that operates in the western United States. Ted Storey, General Counsel and Vice President, Business Development, for Round Table Pizza, was recently questioned about the effect the Domino’s Pizza case may have on the franchising industry. According to Mr. Storey, “[w]e are occasionally included as a co-defendant in lawsuits against our franchisees in either slip and fall or employment cases. We usually have no trouble getting out of these cases by relying upon the decision in Cislaw to persuade plaintiff’s attorney to dismiss us from the case or through summary judgment. But the [Domino’s Pizza] case has caused me concern because, at least on its face, it appears to erode the Cislaw decision.” Applying an analysis similar to that in the Domino’s Pizza case, on July 31, 2012, the California Court of Appeals found that restaurant franchisor Denny’s could be held liable for injuries to a patron of one of its franchisee’s restaurants on an agency theory. In Terrelle Ford v. Palmden Rests., the plaintiff brought a negligence action against Denny’s and its franchisee after being attacked by members of a street gang who were known to frequent the restaurant. The lower court granted summary judgment in favor of Denny’s, finding that it could not be held liable for the franchisee’s acts or omissions with respect to instituting appropriate security measures at the restaurant because the franchisee was not its agent. The California Court of Appeal reversed. In its ruling, the appellate court found that the plaintiff alleged facts sufficient to show that the franchisee was Denny’s “ostensible agent.” In a losing effort, Denny’s argued that “if the law ultimately holds franchisors routinely liable for continued on page 64

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Has The Supreme Court Cleared The Tracks for Mandatory Arbitration in Consumer Contracts? By David Mills, Daniel Prichard and Alyssa Saunders

ver the past few terms, a divided Supreme Court has cleared the tracks for enforcement of private arbitration clauses in consumer contracts. State courts had laid down obstacles, by way of state law doctrines that would invalidate bilateral arbitration clauses, i.e., clauses that waive class actions. The Court has swept most of these aside, ruling that federal law favoring arbitration preempts state laws that stand as obstacles to arbitration. However, one argument – that mandatory arbitration prevents consumers from vindicating their statutory rights – could stop the A-train in its tracks. HISTORY In 1925, Congress passed the Federal Arbitration Act (FAA), in response to widespread state court

hostility toward mandatory arbitration clauses. At the time, judges routinely invalidated such clauses, often finding them unenforceable on the ground that mandatory arbitration stood at odds with judicial policy designating the courts as the preferred forum for resolving disputes. Congress in 1925 – believing arbitration offered procedural advantages of efficiency, lower cost and timeliness – disagreed. It enacted the FAA to reverse these practices and require judicial enforcement of arbitration agreements on terms equal to those applicable to other contracts. In 1983, the Supreme Court entered the debate in earnest, holding that the FAA embodied a “liberal federal policy favoring arbitration

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agreements.”Subsequent cases confirmed that this modern pro-arbitration jurisprudence applied in state as well as federal courts. In the years following, the Court found that the parties’ consent to arbitrate was the paramount consideration and instructed judges to give effect to arbitration clauses according to their terms, notwithstanding state law rules that might otherwise bar arbitration of claims. Fast-forward to 2010. Bilateral arbitration clauses (clauses that require arbitration and waive class proceedings), which have become common in

standard consumer and employment contracts, have been targeted by class action lawyers and consumer groups. In the past two terms, the Supreme Court significantly boosted private arbitration of consumers’ and employees’ commercial disputes. First, in Stolt-Neilsen S.A. v. AnimalFeeds Int’l Corp., the Supreme Court held that a corporation could not be compelled to submit a dispute to class arbitration absent its consent in the arbitration agreement, despite perceived inefficiency and expense of requiring bilateral arbitration. Next, in Rent-A-Center, West, Inc. v. Jackson, the Supreme Court upheld an arbitration agreement in an employment contract that required the arbitrator to determine the enforceability of the agreement, despite the plaintiff’s challenge to the contract as a whole, based on the parties’ unequal bargaining power. Then in a landmark 2011 decision, AT&T Mobility LLC v. Concepción, the Supreme Court solidified its pro-arbitration approach by rejecting the argument that a class waiver in a wireless telephone customer service contract’s arbitration provision was invalid as “unconscionable” because only a class action could vindicate small-value consumer claims. The Court held that the FAA preempted California state law that invalidated arbitration agreements containing class waivers in such cases, because that California law stood as an obstacle to the FAA’s goal of giving effect to the terms of arbitration agreements. The Court examined the ways in which class arbitration differed from bilateral arbitration, found the differences to be material and substantive, and held that parties had good reasons to decline to participate in class arbitration. Most recently, the Court decided CompuCredit Corp. v. Greenwood, which upheld enforcement of an arbitration agreement containing a class waiver, where the claim arose under a federal statute that was silent as to the arbitrability of claims. The Court determined that the contractual “right to sue” provision granted consumers the legal right to recover damages for statutory violations, but did not give consumers a right to litigate in a judicial forum where an arbitration agreement required otherwise.

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David E. Mills is

a member at Dow Lohnes, in the Washington D.C. office. He has been with the firm since 1986, except for a three-year period during which he was Assistant U.S. Attorney in the District of Columbia. His practice includes complex commercial disputes, class actions, telecommunications litigation, intellectual property, media and technology cases, securities fraud and government investigations. dmills@dowlohnes. com

Daniel D. Prichard is senior counsel at Dow Lohnes, in the Washington D.C. office. He represents media, high-technology, and educational clients in a wide variety of complex commercial disputes, class action lawsuits and other matters. dprichard@ dowlohnes.com

that an adhesion contract with inadequate disTHE POST-CONCEPCIÓN closure of these limitations would be procedurARBITRATION LANDSCAPE Many companies are wondering whether the dust ally unconscionable. Other courts have held that agreements conhas settled sufficiently for them to redraft their arbitration agreements once and for all. The Supreme taining arbitration provisions were unenforceable Court has certainly provided substantial comfort for those who want assurance that Class-action lawyers have gained courts will enforce private agreements to some traction using language from the arbitrate. Nevertheless, consumers continue 1985 Mitsubishi Motors Corp decision, to challenge arbitration agreements in the arguing that the cost of pursuing an commercial context on a number of grounds, individual arbitration often exceeds the some of which might find their way to the potential recovery, and only class Supreme Court for another round. proceedings, in court or in arbitration, First, plaintiffs have attempted to identify distinctions between can vindicate consumers’ statutory rights. the California law that the FAA preempted in Concepción and other state laws that would invalidate class action because they were illusory owing to proviwaivers in arbitration agreements. Several courts, sions allowing the contracts to be changed including the Third, Eighth, and Eleventh Circuits, without notice. One possible response is that have rejected this argument and applied Concep- where a plaintiff attacks the enforceability of a ción to analogous state laws and doctrines, includ- contract as a whole, the arbitrator rather than a ing the court in a recent case in which Dow Lohnes court should consider the issue. A third strategy that plaintiffs recently embraced prevailed on behalf of a consumer service provider. is based on the Supreme Court’s 1985 decision This approach has had some minor sucin Mitsubishi Motors Corp. Although the Court cesses however, including in a Massachusetts upheld judicial enforcement of an international trial court that distinguished the arbitration arbitration agreement governing a dispute arising agreement in Concepción due to its “prounder American antitrust law, it noted that “so long consumer incentives,” and a North Carolina as the prospective litigant effectively may vindicate trial court that distinguished the characteristics of the arbitration proceedings at issue. On the whole, [his or her] statutory cause of action in the arbitral forum,” the antitrust statute would continue “to however, merely distinguishing Concepción serve both its remedial and deterrent function.” has not proved fruitful. Plaintiffs’ class action lawyers have used A second route plaintiffs have used to this language to argue that, if consumers can circumvent the Concepción decision is to attack arbitration agreements at the contract demonstrate that they cannot vindicate their formation level. For example, the Missouri Su- statutory rights, an agreement to arbitrate should not be enforced. They argue that bipreme Court revoked an arbitration clause not lateral arbitration is prohibitively expensive because of a perceived defect in an agreement for any individual consumer because the cost to arbitrate, but rather because the plaintiff “demonstrated unconscionability in the forma- of pursuing an individual arbitration often tion of the agreement” under state contract law exceeds the potential recovery in the arbitration, and only class proceedings (in court or principles. And the Kentucky Supreme Court recently held that Concepción “constrained” it in arbitration), which allow for shared costs, to find a contract with an arbitration clause and can effectively vindicate consumers’ statuclass action waiver enforceable, but cautioned tory rights.

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This “vindication of statutory rights” argument has gained traction in some courts. Prior to Concepción, the First Circuit applied this argument to bar arbitration in Kristian v. Comcast, a federal antitrust case that also included state claims, finding that a class mechanism ban was prohibitively expensive and would deter the plaintiffs from pursuing recovery. After Concepción, the Second Circuit held in In re American Express Merchants’ Litigation (known as “AmEx III”) that an arbitration agreement containing a class waiver was not enforceable because a class action was the “only economically feasible means for plaintiffs” to enforce their federal statutory rights. And the Ninth Circuit recently decided to rehear en banc a case in which a panel had reversed a trial court decision that arbitration prevented effective vindication of broad public rights. Some other courts appear receptive to the argument that prohibitive costs of bilateral arbitration might bar enforcement of an arbitration agreement, although the plaintiffs in those particular cases had marshaled insufficient evidence of costs. However, there are a number of reasons why an attack on arbitration clauses under the Mitsubishi

about class arbitration, it would appear inconsistent for the Court to invalidate an arbitration agreement on federal law grounds because it does not provide for class arbitration. LOOKING AHEAD All of these issues are before state and federal courts today, and we are likely to see a multiplicity of decisions and rationales in the coming months. One case to watch (a case that has visited the Supreme Court once already) will give the Court the opportunity to define the contours of Mitsubishi this term. On November 9, 2012, the Supreme Court granted an American Express petition for certiorari of AmEx III, which squarely raises Mitsubishi as a basis to invalidate a mandatory arbitration agreement. This case and others bubbling up to various state and federal appellate courts are worth watching. It is also worth watching Congress, which could reverse the Supreme Court’s pro-arbitration jurisprudence by passing legislation to curtail the Court’s broad interpretation of the FAA. Several bills were introduced post-Concepción, but stalled in committees.

Alyssa T. Saunders is an associate in the Litigation Group at Dow Lohnes, in the Washington D.C. office. asaunders@ dowlohnes.com

Congress could reverse the Supreme Court’s pro-arbitration jurisprudence by passing legislation to curtail the Court’s broad interpretation of the FAA. “vindication of statutory rights” theory is likely to fail. First, as the Ninth Circuit and other courts have held, whatever the scope of the doctrine, it applies only to federal statutory claims and does not reach state statutory claims. While some courts have declined (or failed) to address this limitation, it seems compelling. While the FAA preempts state law that conflicts with congressional objectives, under the Mitsubishi argument, a court might find that competing congressional objectives underlying another federal statute would prevail over the objectives of the FAA. That cannot be true for state statutes. Second, the Supreme Court has never applied the Mitsubishi argument to prohibit the enforcement of arbitration agreements requiring bilateral arbitration, and its recent decisions in Stolt-Nielsen and Concepción suggest it would be unwilling to do so. Given its skepticism

One possible outcome of these developments is that Congress would use the Mitsubishi rationale to insert into new statutes clear statements of intent to grant class action rights or to prohibit mandatory arbitration in certain cases. The Consumer Financial Protection Bureau (CFPB) also could weigh in pursuant to its authority under Dodd-Frank to restrict the use of mandatory pre-dispute arbitration agreements in certain cases, following a public inquiry on arbitration that the CFPB launched in the spring of 2012. The Court’s interpretation of the FAA and corresponding support of agreements to forgo the courthouse in favor of a private arbitral forum seem unwavering. Nevertheless, plaintiffs have been persistent and creative in attacking arbitration agreements, and it seems unlikely that the matter is settled. ■

Dec/jan 2013 E X ECUTIV E COUNSEL

Franchisors Wince continued from page 58

Jim Mulcahy is the founding and managing partner of Mulcahy LLP, a boutique firm specializing in competition litigation, including antitrust, intellectual property, and franchise and distribution law. He has more than 30 years of experience, including as general counsel of American Suzuki. A trial lawyer, he has served as a faculty member at the National Institute for Trial Advocacy and for the College of Trial Advocacy. jmulcahy@mulcahyllp. com

the wrongful acts of its franchisees and their employees, franchisors will either quit franchising or, at the very least, charge much higher fees.” The Domino’s Pizza and Denny’s opinions have served as catalysts for plaintiffs’ attorneys to assert agency claims against franchisors previously rejected by Cislaw. For example, in May of this year, a former employee of a Jack In The Box franchisee filed a lawsuit asserting a panoply of claims arising out of the alleged sexual harassment by one of the franchisee’s employees. As in the Domino’s Pizza case, the plaintiff included the franchisor as a defendant, alleging that the franchisee is, in this case, the agent of Jack In The Box. This case is currently pending before the California Superior Court. On October 10, 2012, the California Supreme Court agreed to review the Appellate Court’s decision in the Domino’s Pizza case on the lone issue of whether Domino’s Pizza is entitled to summary judgment on plaintiff’s claim that Domino’s Pizza is vicariously liable for tortious conduct by a supervising employee of a franchisee. The California Supreme Court’s ruling and analysis will hopefully provide much needed guidance for the lower courts on the issues of agency and franchising. How can franchisors avoid liability from their “independent contractor”? Sandra Trenda, Chief Legal Officer for Great Clips, notes there is “cause for alarm any time courts start to blur the distinction between employee and franchisee.” She says that Great Clips, which has more than 3,000 franchise locations, takes action to clarify its position as the franchisor and not employer. “We have to keep these boundaries clear,” she says. In addition to taking affirmative steps to keep the franchisor/employer boundaries clear, franchisors must also spend the time educating the courts on the business of franchising. As Storey, the Round Table Pizza GC and vice president, puts it, “[w]hat I am reminded of when I read the [Domino’s Pizza] and Jani-King cases is something that we have all contended with for years in the franchising field – educating the courts on how franchising works. “We really have to make concerted and focused efforts to educate courts one way or another on how franchising works,” Storey says. “When you have courts in Massachusetts citing to Jani-King’s website to show that Jani-King is in the business of cleaning offices, it makes you question the court’s knowledge of franchising.” In application, however, it may be difficult to keep the boundaries clear when control is an innate part of both franchising and respondeat

superior relationships. The Federal Trade Commission distinguishes franchising from mere licensing when the putative franchisor has the “authority to exert a significant degree of control over the franchisee’s method of operation.” Similarly, the distinction between an employee and independent contractor is decided based on the amount of control exerted by the hiring party in the performance of the job. Defining both franchising and employment/agency relationships on the issue of control is conceptually problematic and appears to be difficult for the courts to decipher. Instead of relying on the courts to make this distinction, those interested in preserving the franchise business model are already addressing this issue with the state legislatures. The state of Georgia has led the way in recognizing the benefits of a franchise model, and has recently enacted legislation to ensure franchise investments are available to its citizens going forward. In April of this year, the Georgia General Assembly unanimously passed House Bill 548, codifying franchisor-franchisee relationships by providing that “individuals who are parties to a franchise agreement shall not be considered employees.” The enactment of House Bill 548 should allow franchising in Georgia to continue to thrive as a growing economic force in all business sectors. According to Dean Heyl, the Director of State Government Relations for the International Franchise Association, the IFA is diligently working on similar legislation in the states of Delaware, Indiana, Massachusetts and Nebraska. If these misclassification and agency issues can occur in the franchise context – a business model that is defined by the desire to be one’s own boss - it can occur in any industry that relies heavily on independent contractors. This includes nonfranchised business models, such as quick service gas stations and minimarts, janitorial services, editors, taxicab drivers, commercial trucking, express mail operators, software developers, grocery store sushi chefs, to name a few. In fact, the IFA believes that the court rulings “could bring into question the legitimacy of every business that relies on contractually related firms as sources of revenue.” Until the court and/or legislatures set more defined boundaries for the franchisor and franchisee relationship, we can reasonably expect more lawsuits by aggressive and creative plaintiffs’ attorneys asserting employment and agency theories of liability, coupled with a studied reluctance by trial courts to summarily dismiss these lawsuits prior to trial. ■

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