Today's General Counsel (Formerly Executive Counsel), V8 N6, December 2011/January 2012

DEC 2011 /JAN 201 2 VOLUME 8 / NUMBER 6 E X ECUTI V ECOUNSEL.INFO

T H E

M A G A Z I N E

INTELLECTUAL PROPERT Y

Still Unresolved: Business Method Patents Insurance Coverage for IP Disputes NPEs Take a Judicial Hit Double Time at the ITC Lessons from the Backdating Scandal Climate Change Litigation and Insurance Who Needs a Non-Compete?

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DISCOVERY

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Editor’s Desk

The disarray of our nation’s patent system is evidenced in several recent cases discussed in this issue of Executive Counsel. The validity of business method patents is the subject of Stephen Glassman’s article and, as he points out, it’s a question on which the Court of Appeals for the Federal Circuit, a forum devoted to settling intellectual property issues, is sharply divided. A previous attempt by that court to resolve the question of business method patents in a way that supported them was undermined by the Supreme Court’s decision in Bilski v. Kappos, in 2010.

Now the Federal Circuit seems to be of two minds, with one recent panel deciding a case in a way that would make many such methods eligible for protection, and another panel deciding in a way that would render them ineligible.

Glassman’s conclusion, that uncertainty will be the norm for a long time to come, won’t be much comfort to law department attorneys – especially those in financial services – who wonder whether their portfolio’s crown jewels are in jeopardy, or to independent software vendors who agonize about a patent system that strangles creativity.

The software vendors’ nightmare is exemplified by a 2010 decision in the Canadian Federal Court, Amazon v. Commissioner of Patents, which upheld the patentability of a business method consisting of one click of a mouse to make a purchase.

The ruling is being appealed.

Daniel McDonald and Joe Lee discuss a July Federal Circuit decision that makes it more difficult for non-practicing entities (aka patent trolls) to force settlements with the threat of prolonged litigation. But it’s still not impossible, and many

2

practicing entities will continue to bridle against a system they believe is unfair and irrational.

Meanwhile, Peter Selvin points out that companies involved in intellectual property litigation routinely fail to invoke coverage under both their general liability and D&O insurance policies. As a result they end up paying costs that might have been absorbed by their liability carriers. In another coverage-related article, F. William Brownell and Curtis Porterfield explain why general liability policies provide a defense in the event of environmental litigation based on damages caused by climate change.

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

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INSURANCE COVERAGE FOR CLIMATE CHANGE LAWSUITS

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F. William Brownell and Curtis D. Porterfi eld Liability unsettled, but a clear duty to defend.

Anna M. Grizzle and Claire F. Miley Not an easy checklist.

By Roy M. Palk and Samuel R. Brumberg Incentives beckon, costs may lurk.

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Departments Editor’s Desk Executive Summaries

2 10

40

E-DISCOVERY

HUMAN RESOURCES

28 | A Seventh Circuit Pilot Program to Reduce the E-Discovery Burden

43 | Leveling the Playing Field with Non-Competes

David J. Kessler, Emily Johnston and David Schwartz Making cooperation palatable.

31 | Changing the Discovery Paradigm INTELLEC TUAL PROPERT Y

17 | Uncertainty about Business Method Patents 6

Steven J. Glassman Contradictory decisions in the Federal Circuit.

19 | Don’t Overlook Insurance Coverage in IP Disputes Peter S. Selvin A burden the company may not have to bear.

22 | Federal Circuit Opens Door to Bad-Faith Penalties Against NPEs Daniel McDonald and Joe Lee Ruling discourages patent trolls.

Scott Green Value chain analysis for law fi rms.

By Peter Bulmer Chance of litigation remote with welldrafted agreements.

GOVERNANCE

46 | Lessons from the Options Backdating Scandal

By Stuart L. Gasner Vague rules, no blame.

34 | Social and Mobile Media and E-Discovery Jake Frazier Still time to develop a process.

37 | Eight Practical Suggestions for Mitigating Risk In Keyword Search Lisa Stortenbecker and Thomas Bonk Keys to better culling.

40 | Defending Enhanced Document Review Tools Ann G. Fort and Gregory S. Kaufman Reliability and repeatability may be scrutinized.

25 | Discovery is Swift And Expansive at the ITC Rodney R. Sweetland III and Michael McManus An unforgiving procedural schedule.

47

CANADA / CROSS-BORDER

47 | Canadian Tax Issues for CrossBorder Executives Harris Kligman and Don Beadle A Canada-U.S. treaty lays out the ground rules.

49 | Cherry Picking in the U.S.A. Divya Balji Strong Canadian dollar goes looking.

Editor-in-ChiEf Robert Nienhouse

PubliSher Julie Duffy

MaNagiNg eDiTOr David Rubenstein

execuTive eDiTOr Bruce Rubenstein

MaNagiNg DirecTOr, execuTive cOuNSel iNSTiTuTe Neil Signore

arT DirecTiON & PhOTO illuSTraTiON MPower Ideation, LLC

buSiNeSS MaNager Amy Ceisel

DirecTOr Of circulaTiON Carol Spach

Contributing Editors and WritErs

8

Divya Balji Don Beadle Thomas Bonk F. William Brownell Samuel R. Brumberg Peter Bulmer Ann G. Fort Jake Frazier Stuart L. Gasner Steven J. Glassman Scott Green Anna Grizzle Emily Johnston Gregory S. Kaufman

David J. Kessler Harris Kligman Mike Koehler Joseph Lee Daniel McDonald Michael McManus Claire Miley Roy M. Palk Curtis D. Porterfield Sarah Pray David Schwartz Peter Selvin Lisa Stortenbecker Rodney R. Sweetland III

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Editorial advisory board Dennis Block GREEnBERG TRAuRIG, LLP

Thomas Brunner Wiley Rein

Jerome libin suTHeRland, asBill & BRennan

Timothy malloy mc andReWs, Held & malloy

Peter Bulmer

Jean mcCreary

JACKSOn LEWIS

nixon peaBody

James Christie Blake Cassels & GRaydon

steven molo mololamken

adam Cohen

Thurston moore

FTi ConsulTinG

HunTon & Williams

Thomas Frederick WinsTon & sTRaWn

Jamie Gorelick WilmeRHale

Robert Haig kelley dRye & WaRRen

Jean Hanson

Ron myrick FinneGan HendeRson

Robert profusek Jones day

art Rosenbloom CHaRles RiveR assoCiaTes

George Ruttinger

FRied FRank

CRoWell & moRinG

Robert Heim

Jonathan s. sack

deCHeRT

dale Heist WoodCoCk WasHBuRn

Joel Henning Joel HenninG & assoCiaTes

sheila Hollis duane moRRis

david katz WaCHTell, lipTon, Rosen & kaTz

steven kittrell mCGuiReWoods

moRvillo, aBRamoWiTz, GRand, iason, anello & BoHReR, p.C.

victor schwartz sHook, HaRdy & BaCon

Jonathan schiller Boies, sCHilleR & FlexneR

Robert Townsend CRavaTH, sWaine & mooRe

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Executive Summaries INTELLEC TUAL PROPERT Y PAGE 17

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PAGE 22

Uncertainty About Business Method Patents

Don’t Overlook Insurance Coverage in IP Disputes

Federal Circuit Opens Door To Bad-Faith Penalties Against NPEs

By Steven J. Glassman Kaye Scholer LLP

By Peter S. Selvin Raines Feldman LLP

By Daniel McDonald and Joe Lee Merchant & Gould

No

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A split has developed in the Federal Circuit Court of Appeals. It comes after the Supreme Court’s decision in Bilski v. Kappos, in which it invalidated the patent at issue but held that business methods can be patented even if they do not pass the “machine or transformation” test.

A series of recent Federal Circuit decisions since then reflect remarkably different judicial approaches, specifically regarding the scope of the “abstract idea” exception to otherwise patent-eligible inventions.

It remains to be seen whether the appellate court will soon reconcile these approaches.

The court’s approach in CyberSource v. Retail Decisions would leave many business methods ineligible for patent protection, whether they were implemented by humans or computers. In CyberSource the court said that “the basic character of a process claim drawn to an abstract idea is not changed by claiming only its performance by computers.” CyberSource also applied the pre-Bilski preemption test: Claims that as a practical matter preempt the use of an abstract idea are not patent-eligible.

By contrast, the appeals court’s approach in Ultramercial v. Hulu would render many business methods eligible for protection. The panel there wrote that the abstract idea exception was a “coarse filter” which would screen out only inventions that were “manifestly abstract.”

Until the split is resolved, the author suggests that in-house counsel carefully analyze the facts of each case to ascertain whether the claims involve mental steps and preempt use of an underlying abstract idea.

Companies involved in IP litigation routinely fail to invoke coverage under both traditional and non-traditional insurance policies, according to the author.

Traditional policies include Comprehensive General Liability (CGL) and Directors and Officers (D&O) insurance. CGL policies may cover, for example, both “advertising injury” and “personal liability,” both of which may be alleged in connection with some IP matters. Advertising injury has been interpreted by courts to apply to trademark, trade dress and copyright infringement and, less commonly, unfair competition. Personal injury coverage, with regard to “disparagement, could be implicated in a trade libel matter.

D&O coverage also may apply in the context of IP litigation – for patent infringement claims, among others – by way of its applicability to negligent or even intentional “wrongful acts.”

The author cites specific examples where CGL or D&O policies have covered liabilities arising from a variety of IP related allegations, including patent infringement claims and misappropriation of trade secrets.

The author suggests that companies, especially those with significant IP portfolios or that do a lot of online sales business, also consider some of the newer specialized insurance products, such as IP infringement insurance and “IP Value Insurance.” The latter may indemnify for the loss of revenue or value associated with intellectual property that loses value as a result of challenges to its validity or enforceablility. Also available are policies that specifically address computer and cyberspace-related liabilities that may be related to IP matters.

In July 2011 the U.S. Court of Appeals for the Federal Circuit issued an opinion addressing a situation in which an NPE litigated in “bad faith” by exploiting the high cost of defending complex litigation to extract nuisance value settlements from defendants. The opinion (Eon-Net LP v. Flagstar Bancorp) suggests that the Court of Appeals for the Federal Circuit considers the underlying business strategy of many NPEs – to leverage the high cost of patent litigation to extract settlements – as itself constituting evidence of bad faith.

The NPE, Eon-Net, accused Flagstar of infringing its patents, which were directed to methods of processing information from documents. Flagstar refused to pay the licensing fee and fought the lawsuit.

The district court dismissed the infringement claims, leveled $141,000 in sanctions and awarded Flagstar $489,000 to cover its attorney fees and legal costs. The fees and sanctions were based on the district court’s finding that the Eon-Net suit was “objectively baseless” and that Eon-Net had brought the case in bad faith.

Flagstar took a significant financial risk when it spent nearly $500,000 to avoid paying $75,000. The strategy worked, as Flagstar’s decision to fight a meritless claim eventually allowed it to recoup its fees and more.

More importantly, the company has sent a message to other NPEs, and it should benefit from that for years to come. Perhaps most important of all, the authors say, NPEs in general have reason to look at this decision as a warning that there are risks and consequences to bringing meritless cases.

DEC 201 1 / JAN 2012 E X ECUTIV E COUNSEL

Executive Summaries INTELLEC TUAL PROPERT Y PAGE 25

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PAGE 31

Discovery is Swift and Expansive at the ITC

A Seventh Circuit Pilot Program to Reduce the E-Discovery Burden

Changing The Discovery Paradigm

By Rodney R. Sweetland III and Michael McManus McKool Smith

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E-DISCOVERY

Section 337 proceedings at the U.S. International Trade Commission usually involve allegations that imported goods have infringed patents and trademarks. The primary remedy is an exclusion order blocking infringing imports from entering the United States.

Discovery practice in Section 337 investigations is different than discovery in district courts. District court litigation affords the parties time to compensate for mistakes or develop new theories. At the ITC, there is little flexibility built into the schedule.

There is also no waiting for a scheduling order or conference of the parties to commence discovery. It starts the day after the investigation is instituted by the Commission. The early start combined with the tight deadlines means that counsel should serve initial requests on the very first permissible day. A hearing in a Section 337 proceeding generally occurs within eight months of filing the complaint. The procedural schedule, accordingly, is unforgiving.

Third-party discovery represents the most significant difference between discovery at the ITC and district courts.

In Section 337 proceedings one must apply to the Administrative Law Judge for a subpoena to a third party, and must show relevance and necessity. Applications typically are granted where a party seeks relevant information in a timely manner. Problems sometimes arise in executing subpoenas and in enforcement, and counsel advising third-party recipients of subpoenas may consider such limitations in their recommendations, although it would be self-destructive for any company to tarnish its reputation by disregarding Commission orders.

By David J. Kessler, Emily Johnston and David Schwartz Fulbright & Jaworski LLP

Since the 2006 amendments to the Federal Rules of Civil Procedure, practitioners and courts have been trying to apply them, but clear direction is lacking. Attempts often reduce to a call for “increased cooperation,” but that hasn’t been effective, the authors say, because cooperation translates into greater risk for whichever party has the biggest cache of discoverable information. This kind of risk will persist unless there is greater certainty, consistency and agreed upon boundaries in the rules for production of electronically stored information.

Now, according to the authors, a pilot program in the Seventh Circuit is showing promise, because it sets ground rules that provide the certainty and consistency that’s required. The program, which was implemented in October 2009, is based on six formalized Principles. They are (1) cooperation and proportionality, (2) early focus on e-discovery, (3) a designated e-discovery liaison for each party, (4) identification of the scope of preservation, (5) the provision of a framework for effective negotiation, and (6) the provision of an incentive for judicial education on e-discovery matters.

The Principles require preservation requests and responses to be specific, proportional and focused on the relevancy of information rather than its form. Preservation requests are limited in part by identifying six categories of electronically stored information that presumptively should not be preserved or discoverable.

The Seventh Circuit Pilot Program “creates a framework for effective cooperation and negotiation,” the authors conclude, and courts and judges nationwide should consider adopting it.

By Scott Green WilmerHale

Law firm value is driven by the client’s desired outcome, and that may be as simple as predictable costs or as difficult as an unequivocal trial victory.

Adopting this paradigm empowers a law firm to better analyze, organize and deliver outstanding value to its clients.

“Value chain analysis” is applicable to law firms, including to the work involved in discovery, the author says. Discovery is a service that tends to be idiosyncratic, with each matter handled differently. Sometimes discovery is performed by associates at the law firm’s office. A benefit to this structure is that the matter team is performing the review and is immediately aware of relevant documents.

But this efficiency comes at a substantial cost, as associates can bill at more than $300 hour.

Another scenario has this work done by less expensive contract attorneys, under supervision, at an off-site facility. This fulfills the client’s desire to balance lower cost attorneys with experienced firm lawyers.

Contract attorneys, however, vary in quality, and there are a seemingly unlimited number of systems that can be used to host and review documents.

Thus, the obvious conclusion is that discovery is a standard process without any real standardization.

According to the author, law firms, particularly Am Law 100 firms with locations in major metropolitan cities, must seek low-cost, high quality and standardized alternatives to these discovery activities. To drive down costs for discovery services, his firm opened an attorney-staffed business services center in a U.S. market with less expensive housing and living costs.

E-DISCOVERY PAGE 34

Social And Mobile Media and E-Discovery

By Jake Frazier Compliance, Governance and Oversight Council

When it comes to e-discovery, companies typically distinguish between individual accounts and companymanaged media. There has been some over-dramatization about how social and mobile media play into e-discovery rules. The fact is that e-discovery regulations do not pose an immediate threat to corporations. Rather, there is time for legal departments to begin a considered and pragmatic approach to preserving and collecting information from mobile devices and social media.

Relevance of the information should be the primary determinant of whether social and mobile media must be preserved or produced. For mobile content and company-provided social media channels, identical information is often available on central servers. This makes it unlikely that collection from devices and employee accounts will produce unique and relevant information.

Only a small portion of social media actually falls under a company’s “possession, custody and control,” and would need to be preserved and possibly produced. Third-party sites and services used by individuals at their own discretion and for their own accounts may be off limits under the Stored Communications Act (SCA).

The law applies to YouTube videos posted as “private,” Facebook and MySpace profiles, wall posts when not available to the general public, and similar content communications. The SCA bars improper access, and it specifies criminal penalties for violation.

Courts have quashed subpoenas that would violate the SCA. The first and best practice for controlling costs is ensuring that in-house and outside counsel fully understand the company’s technologies and capabilities.

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DEC 201 1 / JAN 2012 E X ECUTIV E COUNSEL

Executive Summaries E-DISCOVERY

HUMAN RESOURCES

PAGE 37

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PAGE 43

Eight Practical Suggestions for Mitigating Risk in Keyword Search

Defending Enhanced Document Review Tools

Leveling the Playing Field with Non-Competes

By Ann G. Fort and Gregory S. Kaufman Sutherland Asbill & Brennan

By Peter Bulmer Jackson Lewis

Every major e-discovery vendor now offers its own twist on the “predictive coding” approach to categorizing electronic documents gathered for litigation review. Predictive coding applies decisions about a subset of the documents to the rest of the collection, without having reviewers examine each record.

When these tools are used for early case assessment or to make sense of the documents produced by the other side, they can be an excellent way to identify the most relevant documents as quickly as possible. But users of these tools generally do not understand how those commonalities are identified and why documents are excluded as irrelevant. Therefore using these tools to determine which documents are not going to be produced can be controversial. Indeed, vendors have identified one major obstacle to widespread adoption of these automated approaches: uncertainty about their judicial acceptance.

Under the current standards, whatever the method of review employed, it will be judged on whether it was reasonable. Federal Rule of Civil Procedure 26 specifically requires counsel to make a “reasonable inquiry” to satisfy its duties in responding to discovery requests. Reasonableness will be determined on a case-by-case basis, but both the technology and the review process must be appropriate to the tasks.

According to a recent court case, should a challenge arise, the selecting party should expect to support its selection with information from qualified and experienced people, “based on sufficient facts or data and using reliable principles or methodology.”

The term “non-compete agreement” often is used to encompass several distinct restrictions on an employee’s post-employment actions. They fall into four categories: The pure noncompete restriction, which prohibits an individual from working in a competitive position; the “non-solicitation” restriction, which allows individuals to engage in any employment they want, but restricts them from soliciting a defined subset of the employer’s actual or prospective customers; the “noraiding” restriction, which prohibits individuals from soliciting a defined subset of their co-workers; and the “non-disclosure” or “confidentiality” restriction, which requires individuals not to use, disclose, or otherwise jeopardize the confidentiality of closely held information.

A myth in this area of the law is that post-employment restrictions are not enforceable, so they are not worth the bother. When drafted properly not only are they enforceable, they are enforced.

More important, a properly drafted restriction enhances the credibility of an enforcement threat. Many individuals will make an effort to honor their contractual promises rather than risk litigation, and the practical realities of the enforcement process favor a well-drafted restriction. A company rarely seeks enforcement without giving notice, which often prompts negotiation. The lawyer for the former employee, and the lawyer for her or his new employer, will be more flexible and willing to compromise in meeting your demands if the threat of enforcement is real. Thus, through deliberate drafting in the beginning, you increase the likelihood that the substance of the restriction will be honored, without litigation.

By Lisa Stortenbecker and Thomas Bonk Document Technologies, Inc. (DTI)

Keyword searching, in order to cull electronically stored information before release for a formal attorney review, is challenging. Narrow searches may cull out relevant documents.

Broad searches yield false positives.

The goal should be to minimize the number of non-relevant documents presented for the more expensive formal review conducted by attorneys, and the authors provide practical tips for doing that.

Perform an iterative assessment of search results. In this context, iterative means that the case team, in concert with a search expert, performs the search, evaluates the results, then adjusts the search criteria as needed.

To minimize the number of relevant documents left behind, sample the documents that have not been identified by the keyword search.

Assess carefully with regard to personal names, as they may be rendered in unexpected ways. Keep in mind that email addresses are commonly used in electronic communications as substitutes for a formal personal name.

Carefully assess the results of acronym searches, as these often yield false positives. Files containing no searchable text cannot be easily identified by standard searching methods. Scanned hard copy documents made searchable with optical character recognition may require a different keyword search strategy. Educate the resources used for performing the search. The software application used, as well as the competency of the person performing the search, may significantly influence the final result. Perform a traditional review on a small set of documents as a proof of concept.

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

Executive Summaries

GOVERNANCE

CANADA /CROSS-BORDER

POINT-COUNTERPOINT

PAGE 45

PAGE 47

PAGE 50

Lessons from the Options Backdating Scandal

Canadian Tax Issues for Cross Border Executives

Should Congress Amend the Foreign Corrupt Practices Act?

By Stuart L. Gasner Keker & Van Nest LLP

By Harris Kligman and Don Beadle Kestenberg Rabinowicz Partners LLP

with Sarah Pray Open Society Policy Center and Mike Koehler Butler University

PAGE 49

Cherry Picking in the U.S.A.

By Divya Balji mergermarket

When the Wall Street Journal ran an article about backdating stock options in 2006 (“Perfect Payday”), it unleashed a torrent of internal investigations at hundreds of public corporations.

Billions of dollars in accounting restatements soon followed, along with shareholder and derivative lawsuits, SEC proceedings and a few criminal prosecutions.

According to the author, who represented clients caught in the backdating scandals, “you never know what obscure area of corporate policy is going to be the fuel for the next Bonfire of the Vanities.” In his opinion much of the energy devoted to options backdating litigation was a waste of resources.

What often emerges in such cases, he says, is that the options backdating story was complicated. The rules for pricing options and determining the proper date of the grant were complex, and responsibility for the process was widely diffused, with decisions being made by operational supervisors, finance, committees of the board, the whole board, and management.

Even reputable auditors often failed to detect (or chose to ignore) options backdating that was going on under their noses. Under such circumstances, it is impossible to hold an individual outside director responsible.

He cites a recent appeals court ruling in one of his firm’s cases that exonerated the defendant, agreeing with the district judge that there was no evidence of wrongful intent. The court questioned the materiality of options dating disclosures, typically a sentence or two in a footnote to the company’s financial statements.

Balji of mergermarket writes that the rate of Canadian companies buying in the United States is outpacing that of U.S. companies looking to make acquisitions in Canada. This has been particularly true in financial services, where Canadian banks have been able to cherry pick assets and companies that will allow them to pursue growth.

As 2011 draws to an end, the volatility in capital markets due to uncertainty about the European debt crisis and the slowdown in the Chinese economy might slow the pace of M&A activity, but Canadian companies still will be opportunistic buyers in the United States.

While Canadian companies understand the need to get more involved in emerging markets, the challenge of taking advantage of these markets remains.

Kligman and Beadle outline various tax considerations for U.S. citizens who cross the border to work at merged or acquired entities. An American resident earning $10,000 (Cdn) or less in Canada avoids the requirement to pay Canadian tax. Americans earning more than that may still be able to avoid the Canadian tax if they meet certain requirements involving physical presence in Canada and the residency of the employer.

Failure to file a Canadian tax return while tax is owing can result in a penalty of up to 17 per cent of the outstanding balance. Where there are repeated failures to file, the Canadian Revenue Agency may assess a penalty of up to 50 per cent of the tax owing.

Recently, the IRS has begun an initiative to collect non-filer penalties from non-residents that should have filed tax returns, as they see this as an easy way to increase tax revenue without hurting the U.S. economy. It will be only a matter of time before the CRA follows suit with a similar initiative.

The U.S. Chamber of Commerce is spearheading a drive to amend the Foreign Corrupt Practices Act. It suggests, among other proposals, that a company be able to invoke the existence of a corporate compliance policy as a defense.

Sarah Pray of the Open Society Policy Center argues that the Department of Justice already takes compliance programs into account at charging and sentencing. Creating a compliance defense, she says, could allow a company to escape liability for its intentional acts simply by virtue of having a policy it doesn’t follow. Bribery, says Pray, negatively impacts corporations with reputation damage and distorted prices.

Consumers lose when they are no longer guaranteed the fairest price subject to competition and the open market.

Mike Koehler of Butler University calls the FCPA a fundamentally sound statute that nevertheless should not be immune from scrutiny.

He says existing DOJ policy regarding compliance merely lessens the impact of legal exposure. It does not adequately recognize a company’s commitment to compliance, which should be recognized as a matter of law when a non-executive employee acts contrary to pre-existing policies.

He takes exception to claims that an FCPA compliance defense would reward “fig leaf” or “purely paper” compliance, or eliminate corporate criminal liability under the FCPA. A compliance defense would not be relevant to corrupt business organizations, activity engaged in or condoned by executive officers, or activity by any employee if it occurred in the absence of pre-existing compliance policies and procedures.

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PAGE 54

PAGE 58

PAGE 62

Insurance Coverage for Climate Change Lawsuits

Don’t Let Regulatory Issues Derail A Healthcare Deal

Weighing Pros and Cons of Power Co-Generation

By F. William Brownell and Curtis D. Porterfield Hunton & Williams LLP

By Anna M. Grizzle and Claire F. Miley Bass, Berry & Sims PLC

By Roy M. Palk and Samuel R. Brumberg LeClair Ryan

Although no court has imposed liability on a defendant for damages allegedly caused by climate change, defendants have incurred millions of dollars defending these claims. Thus, the duty to defend, even without liability, may prove to be invaluable.

Since the duty to defend is contractual, whether a policyholder is entitled to coverage will turn on the law of the jurisdiction and the insurance contract at issue. The analysis to which courts universally adhere considers whether there exists a possibility that any single allegation will give rise to liability within the terms of coverage.

Standard form general liability policies require an insurer to defend the policyholder against suits seeking damages for bodily injury, personal injury or property damage caused by an “occurrence,” usually defined as an “accident, including a continuous or repeated exposure to substantially the same general harmful condition.”

In determining whether an accident occurred, courts consider whether the alleged damage is unexpected and unintended.

General liability policies should also provide indemnity coverage for damages caused by the policyholders. If a claim is potentially covered, the burden shifts to the insurer to argue whether any policy exclusions apply. Insurers in global warming cases may argue that a policy’s pollution exclusion bars coverage. Such an argument is unlikely to succeed for several reasons, among them that carbon dioxide serves many natural and necessary purposes and thus is not a pollutant in the sense that term is usually understood.

Regulatory issues arising during healthcare industry transactions can cause major problems. Even minor violations of healthcare laws can kill a deal, significantly alter the economic expectations of the parties or lead to settlements or judgments in the millions of dollars.

One of the strictest of applicable statutes is the Stark Law, regarding physician self-referral. The Stark Law mandates strict liability, meaning innocent violations can trigger penalties.

Even inadvertently failing to renew a lease or overlooking a signature on an agreement could result in Stark liability. Another federal law, commonly known as the Anti-kickback Statute, makes it a criminal offense to knowingly offer, pay, solicit, or receive any remuneration to induce or reward referrals of items or services reimbursable by a federal health care program.

A health care company looking to merge, sell, go public, or solicit new investment should conduct internal due diligence before proceeding. This may include a compliance audit, consisting of an audit of the company’s coding and billing practices, and an analysis of financial relationships with physicians or other referral sources.

If a health care regulatory issue does arise during a deal, the laws and facts should be checked carefully to determine if there is in fact a violation.

If there clearly is a need to repay a federal health care program, consider the available disclosure alternatives.

With careful planning, healthcare companies can minimize the chances of a deal being derailed by a healthcare regulatory issue.

New technologies combined with government incentives have created new opportunities for energy users to seek out diverse sources of supply and potentially reap significant economic benefits for doing so. Issues of cost and risk are primary. The team studying the project should include experts in a variety of areas, including technology, markets, and legal issues. Each of these can have a major impact on project risk as well as securing financing.

Ascertain what the allowances are in your state for “net metering” (selling power back to the grid), and whether there are other policies that might give the system certain competitive advantages.

Some projects and incentives will require special fuels that could increase the company’s ongoing expenses. If the system needs bio-gas rather than standard gasoline, for example, this factor must be weighed along with whatever government incentive there might be.

The team also should look closely at liability and insurance issues. The major investments themselves must be insured, but that may affect other areas of the plant’s insurance footprint, as well. Installation, maintenance and operational risks all must be carefully considered. If equipment is being installed, when does title and risk transfer? Confirm that the entire system works properly prior to accepting delivery.

According to the American Public Power Association, renewable sources make up about 36.1 percent of the fuel mix for plants coming online in 2011.

That number is certain to increase in years to come.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Intellectual Property

Uncertainty about Business Method Patents Split in the Appeals Court

Business Method Patents

Yes

The Federal Circuit

No

By Steven J. Glassman

W

hat is potentially a major split has developed within the Court of Appeals for the Federal Circuit in the aftermath of the U.S. Supreme Court’s decision in Bilski v. Kappos. In that case, the Court invalidated the patent at issue, but held more broadly that business methods can be patented even if they do not pass the “machine or transformation” test.

The split leaves a cloud of uncertainty affecting any industry that wishes to protect its methods of doing business, particularly where those methods are implemented electronically. This problem affects the banking, financial services, e-commerce, insurance and advertising industries, among others.

This article will review a series of recent Federal Circuit decisions that reflect remarkably different judicial

The court’s approach in CyberSource would likely lead to the ineligibility for patent protection of many business methods. approaches on this issue, specifically regarding the scope of the “abstract idea” exception to otherwise patent-eligible categories of inventions. It remains to be seen whether the appellate court will

soon reconcile these approaches.

In CyberSource v. Retail Decisions (decided August 16, 2011), the Federal Circuit panel provided a specific test and an open view of the abstract idea exception to patentable subject matter. Different panels in Ultramercial v.

Hulu (decided September 15) and in Classen v. Biogen (decided August 31) provided much vaguer tests and a narrow view of the exception.

The Ultramercial panel sought to distinguish and limit CyberSource, but did not consider either the factual similarities of the differently-decided cases or the Supreme Court precedent underpinning CyberSource.

ABSTRACT AND “MANIFESTLY ABSTRACT”

If applied in future cases, the court’s approach in CyberSource would likely leave many business methods ineligible for patent protection, regardless of whether they were implemented by humans or computers. CyberSource dealt specifically with methods of detecting fraud in credit card transactions. The decision invalidated both method and computer readable medium claims on the basis that “methods which can be performed mentally, or which are the equivalent of human mental work, are unpatentable abstract ideas ...”

Applying Supreme Court precedents that caution against using the “draftsman’s art” to avoid the patent eligibility

issue, CyberSource declared that “the basic character of a process claim drawn to an abstract idea is not changed by claiming only its performance by computers, or by claiming the process embodied in program instructions on a computer readable medium.”

CyberSource also applied the preemption test of pre-Bilski Supreme Court cases, i.e., that claims which as a practical matter preempt the use of an abstract idea are not patent eligible.

By contrast, the court’s approach in Ultramercial would likely render many business methods eligible for patent protection. The panel there relied on the proposition that the abstract idea exception was a “coarse filter” which would only screen out inventions that were “manifestly abstract.” Ultramercial specifically held that a method for distributing copyrighted products over the internet in exchange for watching an advertisement was patent-eligible because the claims forced consumers to view and possibly interact with advertisements and were “likely to require intricate and complex computer programming,” and the invention “as a whole” ... “involves an extensive computer interface.”

The claims recited multiple steps, including providing a product for sale on an internet site, restricting public access, and allowing consumer access after agreeing to view an advertisement.

The Ultramercial panel sought to

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distinguish CyberSource as involving “a series of purely mental steps,” which it said constituted a “particularly narrow” exclusion from patent eligible processes.

Notably, Ultramercial did not comment on CyberSource’s invalidation of

The court’s approach in Ultramercial would likely render many business methods eligible for patent protection.

18

computer readable medium claims, or CyberSource’s holding that “the basic character of a process claim drawn to an abstract idea is not changed by claiming only its performance by computers, or by claiming the process embodied in program instructions on a computer readable medium.” Nor did the Ultramercial panel allude to the preemption concept discussed in prior Supreme Court cases and in CyberSource.

COLLISION COURSE

While the holdings of CyberSource and Ultramercial may arguably be reconcilable on their facts, the different philosophical approaches of the panels suggests a direct collision course in future cases.

Since it was only the “underlying invention” in CyberSource that involved “purely mental steps,” did the Ultramercial panel implicitly endorse the full approach of CyberSource, i.e., that the performance of mental steps by computers did not make the claims patentable? Or did the Ultramercial panel just ignore the computer applications aspect of CyberSource? Did Ultramercial implicitly apply, or just ignore, the “underlying invention” analysis of CyberSource? Was the Ultramercial panel implying that its “underlying invention” did not involve “purely mental steps” because it involved the internet? Because it “likely” required “intricate and complex computer programming”? The answers to these questions are not clear.

The underlying philosophical

disagreement of the judges is further reflected in the Classen decision, decided only a few weeks earlier on remand from the Supreme Court in light of the Bilski decision, which dealt with an entirely different type of patent. The majority in Classen cast aspersions on use of the abstract exception, characterizing it as merely a “course eligibility filter” through which most inventions would pass. However, the dissenting judge felt that all of the claims in Classen were abstract and “staggeringly broad,” and that none of the claims were patent-eligible.

On its face, Classen would not appear to apply to other types of abstract ideas, such as business methods. However, the disparate opinions in Classen reveal a fundamental policy disagreement among Federal Circuit judges that may better explain the disparate outcomes in CyberSource and Ultramercial. In Classen, the majority relied heavily on a prior decision in Research Corp.Techs. v. Microsoft (December 10, 2010), which for the first time stated that to come within the abstract exception to patent eligibility, inventions had to be “manifestly abstract.” Moreover, the majority in Classen clearly stated its preference for deciding patentablility on other grounds, such as obviousness and indefiniteness of the invention.

The appeals court appears to be deeply divided on the scope of the abstract exception to patent-eligible subject matter after Bilski.

The vehement dissent in Classen, taking an approach more akin to that in CyberSource, instead relied on Bilski, prior Supreme Court decisions in Benson and Flook, and the “preemption” doctrine – which views abstraction through a lens of whether the claim would as a practical matter preempt all uses of an underlying abstract idea. The

dissenting opinion in Classen disagreed not only with the Classen majority, but also with the “manifestly abstract” test announced in Research Corp.

What does all of this mean? The appeals court appears to be deeply divided on the scope of the abstract exception to patent-eligible subject matter after Bilski and how to apply it. The Ultramercial panel’s attempt to distinguish CyberSource only masks the underlying philosophical differences among the judges and the uncertainty hanging over all business method type patents. Relying on “manifest” abstractness or alleged “functional and palpable” applications is likely to lead to unpredictable decisions subject to the discretion of a particular panel.

It is also noteworthy that while the Supreme Court in Bilski said that the machine or transformation test should remain an important clue to patent eligibility, none of the recent Federal Circuit cases have been decided on that basis.

It would not be surprising if the Federal Circuit decided to take an upcoming case en banc in an attempt to resolve these uncertainties and to answer some of the major questions left unanswered by the Supreme Court in Bilski.

So what are in-house counsel to do while such uncertainty reigns? In the interim, the best approach seems to be to carefully analyze the facts of each case to ascertain whether the claims involve mental steps and preempt use of an underlying abstract idea. Unfortunately for now, unpredictability is likely to be the norm. ■

Steven J. Glassman is a partner at Kaye Scholer LLP. He is experienced as a federal prosecutor, trial lawyer, patent examiner and appellate advocate. He has been lead counsel and has litigated complex cases before federal juries and judges for more than 30 years, including in securities, commodities, patent and technology, and bankruptcy cases. sglassman@kayescholer.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

Intellectual Property

Don’t Overlook Insurance Coverage in IP Disputes

By Peter S. Selvin

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I

20

nsurance coverage is often a hida competitor’s goods or services in a under a company’s D&O policy. This is den asset on a company’s balance communication or advertisement. In because the trigger for coverage under sheet. Nowhere is this more evident such an instance, a claim of trade libel such a policy (a “Wrongful Act”) is sufthan in the area of IP litigation, where might be covered under this portion of ficiently broad to cover a wide range of companies involved in trademark, a CGL policy. alleged or actual wrongdoing, whether copyright, patent, unfair competition D&O insurance is designed to, negligent, reckless or even intentional. and trade secret litigation routinely fail among other things, reimburse a comThus, in a recent New York case, patto invoke coverage under both their pany for the cost of providing a legal ent infringement claims were held to be traditional and non-traditional insurdefense of its officers and directors. Alpotentially within the coverage proviance policies. As a result they end up though this insurance is typically consion applicable to “wrongful acts.” financing both defense and indemnity sidered in connection with shareholder Misappropriation of trade secrets. costs that should have been absorbed suits or securities litigation, it can also Claims of IP theft or misappropriaby their liability carriers. provide broad coverage in the context tion of trade secrets are difficult to fit Traditional insurance products of IP litigation. This is because coverinto the coverage parameters of typical include Comprehensive General Liabilage under a D&O policy is triggered CGL or D&O policies. Nevertheless, a ity (CGL) and Directors and Officers by the commission of a “wrongful minority of cases have found cover(D&O) insurance. Recent case law act” on the part of a company’s direcage under the “advertising injury” has confirmed that these policies may tors or officers, and under applicable provisions of CGL policies. The theory provide coverage in the context of IP case law a “wrongful act” can be any behind some of these cases has been litigation in ways that may be counternegligent or even intentional misconthat the theft of a customer list (or intuitive and overlooked. duct. Moreover, if the D&O policy also other trade secrets) may constitute When a company is sued for tradeprovides so-called “entity coverage,” one of the enumerated “offenses” in mark or copyright infringement – or such coverage could serve as a resource advertising injury coverage, such as for torts such as defa“misappropriation mation or invasion Both comprehensive general liability and D&O of advertising ideas of privacy – the first or the style of doing policy to consult is the policies may provide coverage in ways that may business.”

CGL Policy. It typicalWhere misapproly will contain at least priation of trade sebe counter-intuitive and overlooked. two forms of coverage crets overlaps a claim that could be implifor unfair competition, cated in connection with IP litigation: when the company itself is a defendant there may be additional coverage opso-called “advertising injury” coverage in IP litigation. portunities. For example, several cases and “personal liability” coverage.

The following examples illustrate have held that the “disparagement” by Advertising injury coverage has the some circumstances in which CGL and one company of another’s goods, prodgreatest potential application to IP D&O policies have been found to cover ucts or services may trigger coverage disputes. It’s been interpreted by the liabilities associated with IP litigation. under the personal injury portion of a courts to apply to trademark infringePatent infringement claims. Several CGL policy. Thus, a claim arising from ment, trade dress infringement, copyrecent U.S. cases have found coverage trade libel or product disparagement right infringement and, in rarer cases, under CGL policies for patent infringe- may well be covered. to unfair competition. The touchstone ment, where the underlying technolD&O policies may be even more of advertising coverage is establishing ogy is used as part of an insured’s applicable to these kinds of claims. In that the claim or injury has arisen in advertising activities. Thus, in one one recent case, the court determined connection with the insured’s advertis- recent case, the court determined that that a D&O carrier was obligated to ing activities. The precise scope and patent infringement was covered under reimburse the company and its officers meaning of “advertising activities” the “misappropriation of advertising for defense and settlement fees in an IP will depend on the law of the jurisdic- ideas” offense, where infringed softtheft/trade secrets case. In another case, tion involved. ware itself constituted or embodied the the court held that a claim alleging misBy contrast, personal injury covadvertising technique. appropriation of confidential informaerage typically addresses, among In another case, involving a car manu- tion was covered under D&O policy. other things, a libelous, defamatory facturer, the court found coverage for Statutory claims. The “violation of or disparaging communication, or a infringement of a business method patent right of privacy” offense contained in a violation of another’s right of privacy. arising out of the manufacturer’s “build CGL policy’s “advertising injury” covThe concept of “disparagement” is your own vehicle” feature on its website. erage has found application in a numkey, as it could be implicated where a Coverage for patent infringement ber of statutory contexts that involve IP company is deemed to have disparaged claims is even more likely to be found issues. For example, a recent case held

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

Intellectual Property

such coverage applied for alleged violations of the Electronic Communications Privacy Act by an insured. In that case, the court found that claims arising from a company’s use of a software program to track information about customers’ internet activities for use in marketing efforts were covered under the CGL policy.

In another case, the court held that an insured’s violation of its customers’ right of privacy was triggered by the insured’s “publication” of information contained on credit card receipts, and hence coverage was found under the company’s CGL policy.

Some newer insurance products that have been developed in recent years also may be worth exploring in the context of IP disputes, especially for companies with large IP portfolios or those engaged in significant online sales activities.

Among these newer products is “IP Value Insurance.” Its principal purpose is to indemnify for the loss of revenue or value associated with IP assets (e.g., trademarks, copyrights or patents) which lose value as a result of challenges to their validity or enforceablility.

Another new product is IP infringement insurance, which indemnifies for defense costs, and potentially for judgments or settlements, arising out of claims for infringement that may be asserted by third parties. This form of insurance is especially important because it fills a coverage gap left by

CGL and D&O policies. This gap may be of particular concern with respect to patent infringement claims, because CGL policies typically will not provide coverage for such claims unless the infringement is directly tied to the insured’s “advertising activities.”

Computer network and cyberspace liability issues have also spawned new insurance products worth considering. Although traditional policies may cover some risks in this area, computer network and cyberspace liability policies should be considered by companies that are engaged in significant online sales activities.

The need for such policies is highlighted by a few hypotheticals: If a company’s computer network is disabled, even temporarily, it could mean a loss of both important data and business income while the system is down. Traditional property and business interruption policies ordinarily will not respond to such losses because information that is stored electronically generally is not held to be tangible property.

In the same vein, suppose that your company’s computer network inadvertently passes on a computer virus to a customer’s or a client’s computer system. Or suppose that one of your employees sends a personal email, or posts a message on a blog or message board, that disparages or defames a third person. The claims arising from

these kinds of activities wouldn’t necessarily be covered under traditional insurance policies.

To fill the gap, several new policy forms have been developed. Among these is the so-called “network security” policy that addresses, among other risks, fraud and extortion, denial of service attacks, sabotage and business interruption, viruses, and negligent security. In addition, there are so-called “cyber-liability” or “cyber-risk” policies, specifically designed to address such risks as invasion of privacy, online trespass and certain intellectual property infringements.

The bottom line is that companies involved in IP disputes ought not to assume that they are obligated to bear all the economic consequences. They may find coverage in their traditional insurance policies and, in some cases, new insurance products that have been developed in recent years. ■

Peter S. Selvin is a trial attorney with the Beverly Hills, California, office of Raines Feldman LLP. He specializes in commercial litigation, including international litigation, and insurance coverage. pselvin@raineslaw.com

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Intellectual Property

Federal Circuit Opens Door to Bad-Faith Penalties against NPEs

By Daniel McDonald and Joe Lee

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Intellectual Property

L

egal entities that own patents but do not make products covered by these patents, commonly known as non-practicing entities (NPEs), or “patent trolls,” have attracted much media attention in recent years, primarily due to their propensity for filing lawsuits against companies that actually produce products related to such patents. A frequent tactic by the NPEs is to leverage the high cost in time and money of defending against a patent lawsuit, and use it to extract settlements or “licensing fees” from businesses that produce something.

In September, 2011, as part of the America Invents Act, Congress ordered a study of the consequences of litigation by non-practicing entities with respect to the economy, inventors and job creation. Congress intends to use the study to determine what if any changes in the law are warranted.

In the meantime the typical licensing “negotiations” with NPEs will often follow this script: Patent holder: You infringe our patent. Pay us $100,000 to license it, or we will sue.

Alleged infringer: Your patent does not cover our product and is invalid.

Patent holder: It will likely cost you millions to defend against the lawsuit, and the defense will disrupt your business. Pay us $100,000 or we will sue.

At this point, many businesses opt to pay up and avoid the lawsuit altogether. The high cost and burden of defending against a patent suit compared to the relatively low cost of “licensing” results in a situation where the merits of the lawsuit become almost irrelevant to the negotiations.

On July 29, 2011 the U.S. Court of Appeals for the Federal Circuit, in Eon-Net LP v. Flagstar Bancorp, issued an opinion addressing the situation where an NPE litigated in “bad faith” by exploiting the high cost of defending complex litigation

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Intellectual Property

to extract nuisance value settlements from defendants. Eon-Net (the NPE) had accused Flagstar of infringing its patents, which were directed to methods of processing information from documents. Eon-Net demanded that Flagstar pay it $75,000 for a license to practice the patented inventions.

Flagstar explained that it did not practice the patent methods because it did not process information from documents.

It instead processed information from a Website. Eon-Net argued that its patents were not limited to processing documents

The opinion suggests that the Federal Circuit considers the underlying business strategy of many “non-practicing 24

entities,” in and of itself, to constitute evidence of bad faith. in hard copy form, so Flagstar’s method of processing information from websites fell within the scope of its patents.

Flagstar refused to pay the licensing fee and fought the lawsuit. The claims were ultimately interpreted by the district court to cover only products that process information from hard copy documents, not from websites. The district court dismissed the infringement claims, leveled $141,000 in sanctions and awarded Flagstar $489,000 to cover its attorney fees and legal costs. The fees and sanctions were based on the district court’s finding that the Eon-Net suit was “objectively baseless” and that it had brought the case in bad faith.

The court made the objectively baseless finding even though Eon-Net’s infringement position had some support. Eon-Net’s infringement position was supported by the fact that the patent claims, which define the scope of the invention, were not on their face limited to processes that involved

documents in hard copy form. The hard copy limitation was based on the text in the written description portion of the application.

Moreover, an argument could be made that processing hard copy documents is equivalent to processing electronic documents. The court finding that Eon-Net’s suit was objectively baseless suggests that the claim needs to be supported by arguments that are more then just plausible. Being able to make an argument that the accused product infringes is not enough to avoid a finding that the lawsuit is objectively baseless; the argument also must be sound.

The court found that Eon-Net brought the lawsuit in bad faith largely because the suit was brought to extract a nuisance value settlement by exploiting the high cost imposed on Flagstar to defend against Eon-Net’s claims. In deciding that the lawsuit was brought in bad faith the court noted a number of characteristics of the lawsuit that are typical of suits brought by NPEs: • Eon-Net had filed nearly identical patent infringement complaints against a plethora of diverse defendants, and each time it demanded a quick settlement for a price far lower than the cost to defend the lawsuit.

• Eon-Net has the ability to impose disproportionate discovery costs on Flagstar, because it did not itself practice the invention.

• Eon-Net placed little at risk when filing the suit because, since it is not a competitor of Flagstar, it was not exposed to counterclaims These factors, which are characteristic of NPE litigation, weighed in favor of the court’s finding that the suit was brought in bad faith. The concurring opinion suggests that the Federal Circuit considers the underlying business strategy of many NPEs – to leverage the high cost of patent litigation to extract settlements – as itself constituting evidence of bad faith.

In traditional litigation between competitors, an award of attorney fees to the prevailing party is very unlikely even when the merits of the lawsuit

are weak and the case is dismissed before trial. This case suggests that when a non-practicing entity brings a weak patent case against a defendant, there is a decent chance that the NPE could be ordered to pay the defendant’s attorney fees and costs because a finding of bad faith is likely.

Flagstar took a significant financial risk when it spent nearly $500,000 to avoid paying $75,000. The strategy worked, as Flagstar’s decision to fight a meritless claim eventually allowed it to recoup its fees and more. More importantly, the company has sent a message to other NPEs, and from that it should benefit it for years to come.

Perhaps most important of all, NPEs in general have reason to look at this decision as a warning that there are risks and consequences to bringing meritless cases. ■

Daniel McDonald is a partner at Merchant & Gould in Minneapolis and chair of the firm’s Litigation Practice Group. He has represented clients in cases involving a broad spectrum of technologies, from software, digital imaging, telecommunications and electronics to apparel, aerospace, printing, and materials handling. A trial attorney, his litigation practice includes patent, copyright, trademark/trade dress and trade secret litigation issues, with an emphasis on electronics, software, and internet issues. dmcdonald@merchantgould.com

Joe Lee is Of Counsel with Merchant & Gould in Minneapolis.

His practice focuses on patent related matters, including both litigation and patent prosecution. jlee@merchantgould.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Intellectual Property

Discovery is Swift and Expansive at the ITC

By Rodney R. Sweetland III and Michael McManus

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W

ith the proliferation of local rules and judges’ unique orders, discovery practice in U.S. district courts is anything but uniform. There are, for example, innumerable unwritten discovery conventions that only a local counsel with extensive experience in the particular venue can navigate successfully. Anyone coming to the Eastern District of Texas for the first time understands this reality.

Discovery practice in Section 337 investigations at the U.S. International Trade Commission (ITC) is no less idiosyncratic. Section 337 proceedings usually involve intellectual property rights, including allegations that im-

to discovery combined with the tight deadlines means that counsel should serve initial requests on the very first permissible day. A hearing in a Section 337 proceeding is generally conducted within eight months of filing the complaint. The procedural schedule, accordingly, is unforgiving.

DISCOVERY LIMITS

A Section 337 party may obtain discovery regarding any unprivileged matter relevant to: • any claim or defense (including the nature, custody, condition and location of tangible things).

• the identity of persons having

cess. The Commission Rules provide no limits to the number of available discovery requests.

The Ground Rules promulgated by some ALJs, though, do impose limits, albeit extravagant ones by district court standards (e.g., 175 interrogatories).

Just as work expands to fill the time available for completion, discovery at the ITC expands to whatever discovery limits, if any, are imposed.

Somewhat more expansive discovery is expected and desired by both parties, given the stakes at the ITC. Even with the need for greater discovery, parties will inevitably experience a declining marginal utility of additional requests. To avoid service

Discovery at the ITC expands to whatever discovery limits, if any, are imposed.

26

ported goods have infringed patents and trademarks. The primary Section 337 remedy is an exclusion order that blocks infringing imports from entering the United States.

Any litigant coming to the ITC expecting it will run according to the general guidelines in a district court may be making an erroneous assumption of case-dispositive proportions.

As the ITC emerges as the premiere patent litigation forum, executives and in-house counsel must be as familiar with its nuances as they are with other preferred patent venues.

From a plaintiff’s perspective, beginning discovery in district courts often seems agonizingly slow. As a consequence, defendants have weeks to erode the plaintiff’s head start. At the ITC, however, there is no waiting for a scheduling order or conference of the parties to commence discovery. It starts the day after the investigation is instituted by the Commission.

Moreover, deadlines for discovery responses are a mere 10 days at the ITC, although in practice the 10day limitation results in formalistic responses with substantive responses following. Nevertheless, the early start

knowledge.

• the appropriate remedy for a violation of Section 337.

• the appropriate bond for the respondents.

That makes the scope of discovery under Section 337 broader than in a conventional patent case. This is because of the additional elements of proof enumerated in the statute. The domestic industry requirements for the complainant and the remedy and bonding issues for respondents implicate more than the monetary damages available in district courts.

Administrative Law Judges (ALJs) often reject claims of undue burden or “over breadth” out of hand. Section 337 investigations are inherently complex, generally involving highly sophisticated technology and staggering amounts of commerce.

The size of discovery, therefore, will be proportionately larger than all but the most notable district court cases.

Participants in this forum, even the unwilling, cannot be heard to complain of the stiff price of admission. The stakes are so high that all parties must avail themselves of this generous due pro-

of 175 interrogatories and perhaps multiples of that number of requests for admissions, parties are welladvised to enter into stipulations in areas where there can be no legitimate areas of disagreement.

Most ALJs require respondents to file a notice of prior art upon which they intend to rely in order to argue that the patent is invalid (or for any other purpose) three to six months after the investigation is instituted.

Further, ALJs typically require identification of experts three to five months after institution, and expert reports on infringement and validity shortly thereafter. Accordingly, it is necessary to engage expert witnesses and consultants to be substantively involved in the preparation of the case at the earliest opportunity.

COMPELLING DISCOVERY

As with district courts, a party dissatisfied with discovery responses may move to compel. Discovery disputes are so pervasive at the ITC that all of the currently active ALJs require a twice monthly “Discovery Committee” meeting for the parties to meet and confer.

Under the ALJs’ Ground Rules,

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Intellectual Property motions to compel may only be filed after an impasse is reached during a Discovery Committee meeting. The speed of Section 337 investigations does not afford the luxury of waiting to bring discovery disputes to the

vary by ALJ. If the third party chooses to disregard a subpoena, however, the ALJ has no authority to order compliance. In spite of the ostensibly national reach of ITC authority, because of the body’s administrative nature

tory (discovery requests to a foreign country). Requests for a recommendation to the district court, like all other discovery requests, must come as close to the inception of the case as possible.

Mastery of successful discovery

Third-party discovery represents the most significant difference between discovery at the ITC and district courts.

ALJ’s attention once such an impasse is reached. Hurdles in filing a motion to compel tend to reward stonewalling at the ITC, just as in district courts.

Non-monetary and monetary sanctions are theoretically available at the ITC for failure to comply with a discovery order. The non-monetary sanctions redress prejudice and are occasionally granted.

Monetary sanctions are simply not worth pursuing. The ALJs at the ITC consistently have demonstrated an almost preternatural facility for avoiding the temptation to engage in satellite litigation, such as cost-shifting motions, which consume so much time and attention at the district court level.

Third-party discovery represents the most significant difference between discovery at the ITC and district courts. In district court litigation, counsel need only issue a subpoena from the district in which he or she seeks the information. Admission to practice in that district is not even a prerequisite so long as one is authorized to practice in the trial court. In Section 337 proceedings, however, one must apply to the ALJ for issues of a subpoena to a third party. Such an application must show the relevance and necessity of the information sought.

Applications for subpoena typically are granted where a party seeks relevant information in a timely manner.

Problems sometimes arise, however, in executing the subpoena.

As with district courts, a third party may move to quash a subpoena. The time allowed to move to quash will

ALJs must look to U.S. district courts for enforcement of their subpoenas.

This involves a certification by the ALJ to the Commission for enforcement, which then must determine whether to authorize its Office of the General Counsel to file for enforcement of the subpoena with a U.S. district court (which, because of the Commission’s presence in the District of Columbia, is that district court). This tortuous procedure is rare.

A lesson from this process is that requests for third-party subpoenas must be filed immediately after the institution of the investigation, along with the service of party discovery requests. Counsel advising third-party recipients of Commission subpoenas may consider enforcement limitations in making recommendations, but it would be self-destructive for any company to tarnish its reputation by disregarding Commission orders. Additionally, a publicly traded corporation or one that may find itself before the Commission as a party in the future must be mindful of the consequences of noncompliance.

International third-party discovery must proceed according to the Hague Convention. Although an ALJ may directly issue letters rogatory to some countries, there is a dispute by certain signatories of the Hague Convention as to whether the ITC is an appropriate tribunal to make such a request.

If the evidence sought is in a country disputing the status of the ITC, then an ALJ may directly recommend to the U.S. District Court for the District of Columbia for issuance of letters roga-

practices in district courts does not equal effective discovery in Section 337 litigation. District court litigation affords the parties cushions of time to compensate for mistakes or to develop new theories. There is no such flexibility built into the schedule at the ITC. The significant differences between ITC and district court procedures do not afford counsel the luxury of onthe-job training. ■

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Rodney R. Sweetland III is a principal in the Washington D.C. office of McKool Smith. He handles intellectual property litigation and complex commercial cases in the U.S. International Trade Commission, U.S. district courts and circuit courts of appeal. rsweetland@mckoolsmith.com

Michael McManus is a principal in the Washington D.C. office of McKool Smith. He is registered to practice before the U.S. Patent and Trademark Office and handles patent-related litigation before the U.S. International Trade Commission and U.S. district courts. mmcmanus@mckoolsmith.com

dec 201 1 / jan 2012 E X ECUTIV E COUNSEL

E-Discovery

A Seventh Circuit Pilot Program to Reduce the E-Discovery Burden

By David J. Kessler, Emily Johnston and David Schwartz

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ourts and litigants alike have struggled to apply the 2006 amendments to the Federal Rules of Civil Procedure. “Cooperation” has become the byword, but calls for cooperation without additional guidance haven’t been very effective at reducing the burden of discovery.

As things stand currently, the risks of cooperation rest entirely on the party with more data, which may find itself confronting an opponent that insists on following data trails into never-ending rabbit holes or engaging in discovery-on-discovery sideshows.

Meanwhile, courts may be unwilling to really engage the discovery process or try to limit its scope.

The risks of cooperation can be reduced by greater certainty and consistency in defining “reasonable” and the establishment of presumptive limits or boundaries. Where the scope and limits of discovery are more certain, the party with the greater amount of data is more willing to address and negotiate discovery issues because it can better estimate how the court will limit its obligations. This will be perceived as entailing less risk and less cost than just avoiding the issue and praying that a particular data source or issue will never be raised. But generally speaking that hasn’t happened.

The chances that it will happen may have gotten significantly better as the

result of the Seventh Circuit Electronic Discovery Pilot Program, which was implemented in October 2009.

This program is based on formalized “Principles Relating to the Discovery of Electronically Stored Information,” implemented via standing order by all participating judges. The Principles and standing order were drafted with the intent of providing “early and informal information exchange on commonly encountered issues relating to evidence preservation and discovery.”

Now in its second phase, the Seventh Circuit’s pilot program has earned a mostly positive reception from judges and attorneys. Its success is due to the fact it is concise and easy to understand,

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E-Discovery

and it’s judicially endorsed and enforced. By setting basic ground rules, it essentially provides the certainty necessary for cooperation.

The program’s formal Principles consist of six primary elements: (1) cooperation and proportionality; (2) early focus on e-discovery; (3) a designated e-discovery liaison for each Basic party; (4) identification of the scope of preservation; (5) the provision of a framework for effective negotiation; and (6) the provision of an incentive for judicial education on e-discovery matters.

While promoting cooperation, proportionality, early communication and education as the primary tools to rein in electronic discovery does not distinguish the Seventh Circuit program from other guidance and protocols, it goes one step farther by establishing a framework to negotiate the issues, particularly with respect to preservation.

Each side has a baseline from which to work. This doesn’t mean the baseline will be the rule in every case, but both parties know it’s a default that should be altered only where that’s warranted by particular facts.

This framework has the blessing of the courts, which makes it clear that if a party, without good cause, demands broader discovery than what is established by the baseline, the court is unlikely to support it.

Preservation is important because it dictates the scope of discovery. Overly broad preservation can multiply the expense of litigation. Unfortunately, case law provides nebulous best practices, which have been interpreted to mean everything from all electronic data must be preserved indefinitely to limited data on discrete subjects in a single custodian’s possession should be preserved over a brief period.

The Seventh Circuit’s Principles limit the nature and breadth of preservation requests and the scope of preservation, in part by identifying six categories of electronically stored information that presumptively should not be preserved or discoverable. A requirement for designating an e-discovery liaison identifies a person on each side who can best

and data sources from the equation, the Principles limit the discussion to more helpful exchanges regarding data relevancy rather than methods of preservation.

The Principles also say that preservation efforts must be reasonable and proportional, and they must not extend to information in ground rules provide the certainty six enumerated categories of ESI for which discovery is not typically available. necessary for cooperation.

There is a recognition that identification of the preservation scope cific, proportional, and they must focus is “a fact specific inquiry that will vary on the relevancy of information rather from case to case.” than its form. The Principles do not Nevertheless, the Principles set forth require sending preservation requests several preservation requirements that or responses but instead seek to ensure effectively provide a framework. First, that should parties employ one of these preservation efforts must be reasonable methods, they do so with proportionaland proportionate, and if there is any ity in mind. They explicitly disfavor dispute regarding the scope of a party’s “vague and overly broad” preservation efforts, the parties must explain to each requests and resulting orders. Instead, other and then to the court why the they require that they be “reasonable in scope” and mindful of the proportional- efforts are or are not reasonable and proportionate under Rule 26(b)(2). ity factors set forth in Rule 26 of the Second, to avoid abuse, the PrinFederal Rules of Civil Procedure. ciples reduce any incentive for “disBeyond explicitly integrating proporcovery-on-discovery” by requiring the tionality into preservation, the Seventh parties to communicate first about Circuits Principles are not a radical whether it is necessary, and to explore change from prior guidance to counpotential alternative means for obtainsel and parties. But they go farther by ing the information. listing examples of specific and useful information to include in preservation Requests and responses requests, such as names of parties, the factual background and potential legal must focus on the claims, and the relevant time period.

Noticeably absent from these lists is any reference to data sources. The comrelevancy of information mittee acknowledged at the outset that too often early discovery exchanges rather than its form. “begin with unhelpful demands for the Third, to ensure compliance with preservation of all data, which often are followed by exhaustive lists of types the Principles’ requirements on preservation, the parties must communicate of storage devices.” about the issue early and often.

Arguments about data sources Fourth, and most important, the miss the real issue of whether the data Principles specify six ESI categories in question is actually relevant. The that generally are not discoverable. The producing party is responsible for findPrinciples specify that if a party intends ing relevant data in its possession. The to request preservation of any such opposing party should not be able to data, it must do so early in the process. dictate where the other side looks for These six categories are: that data, nor should they be provided a roadmap of the producing party’s 1. “Deleted,” “slack,” “fragmented” or information technology system. By “unallocated” data on hard drives. removing discussion of storage devices facilitate resolution of the issues.

The result is a process with something closer to bright-line rules and therefore more context for negotiation than is generally found in the Federal Rules, the Advisory Notes or case law.

According to the Principles, preservation requests and responses must be spe-

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2. Random access memory (RAM) or other ephemeral data.

3. On-line access data, such as temporary internet files, history, cache and cookies.

4. Data in frequently and automatically updated metadata fields, such as last-opened dates.

5. Backup data that is substantially duplicative of data that is more accessible elsewhere.

6. Other forms of ESI whose preservation requires extraordinary affirmative measures not utilized in the ordinary course of business.

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The presumption is that in most cases, the preservation of these items is not reasonable or proportional, because the likelihood of their containing materially relevant information is slim and the potential costs are significant.

Under the Principles, parties are placed in a well-bounded negotiating sphere where discrete issues can be resolved, and time, energy and costs can be minimized. For example, parties are

no longer able to demand backup tapes or other information caches without good cause.

We think that counsel should promote this framework beyond the Seventh Circuit and that courts nationwide, or even individual judges, should consider adopting it, or something like it. The Seventh Circuit Pilot Program does not change the law of e-discovery or preservation. Rather, it creates a

David Kessler is a partner in the New York office of Fulbright & Jaworski. He is co-head of the firm’s E-discovery and Information Governance practice, working with the firm’s litigation group on information management, e-discovery, data privacy and intellectual property litigation. dkessler@fulbright.com

framework for effective cooperation and negotiation. Without such a framework, cooperation is likely to remain a risk. ■

Emily Johnston is counsel in the Dallas office of Fulbright & Jaworski. She works with clients on their electronic discovery and information lifecycle needs. ejohnston@fulbright.com

David Schwartz is an associate in the New York office of of Fulbright & Jaworski, where he works with the Litigation and E-Discovery and Information Governance practice groups. dschwartz@fulbright.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

E-Discovery

Changing the Discovery Paradigm

By Scott Green

The view of many lawyers is that business concepts such as the value chain do not apply to their profession. They see activities like “inbound logistics,” which are unrecognizable to them, as irrelevant. But explain that inbound logistics is conflicts clearance and new matter intake, and the view begins to change.

The value chain concept, as introduced by Michael Porter in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance, recognizes that every business unit has primary and support activities, and that those activities add value to the end product, thus creating margin. Most litigation encompasses

managing risk, and thus it implements conflicts checks and other quality control procedures for new clients.

For most controversy practices, discovery will take place early in the life-cycle of the matter. An army of junior attorneys parse thousands of documents to identify those that support or weaken their client’s position. Once discovery is completed, more senior attorneys will strategize and organize briefs for the court. If the case does not settle after discovery is finished and the briefs are filed, the parties go to court. Talented trial lawyers will argue their client’s position, and hopefully obtain a favorable verdict.

gENErIC LITIgATIoN VALUE CHAIN SUPPorT

Firm Infrastructure

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Legal Talent Technology MArgIN

VALUE CHAIN ANALYSIS

an intake process, discovery, strategy development, brief preparation, and if not settled, a trial and post-trial services such as enforcement.

All these are value-added activities.

There are support activities as well that enable lawyers to do their jobs, such as client billing, human resource management, attorney recruitment, various technology solutions, and even procurement. So while many lawyers do not see the value chain as applicable to the profession, those firms that embrace the concept will be well-positioned to build sustainable competitive advantage.

Presented below is a generic litigation

PrIMArY

T

he current economic environment has made law firm clients more sensitive to costs, including legal fees. Low cost – and more predictable cost – have become primary objectives in the legal marketplace.

Contributing to budget concerns is the exploding volume of electronic data, which drives up the cost of document discovery in litigation cases until it sometimes exceeds the cost of preparing and trying a case.

The response of the legal community has been alternative fee arrangements, such as fixed and collared fees, to provide the predictable costs that clients value. But all services do not have the same perceived value. At times clients may place greater value on a task with a higher, more unstable price tag. In high stakes litigation, the desired outcome is to obtain a favorable settlement or verdict, and cost is secondary to survival.

Thus, desired outcomes – whether they are predictable costs, trial victories, or something in between - are what drive value. Adopting this paradigm empowers a law firm to better analyze, organize and deliver outstanding value to its clients.

Procurement & Support Services

Marketing and Business Development

Matter Intake, Conflicts Checks

Discovery

Strategy, Brief Filings and Trial Preparation

Trial

Post Trial Services

review Hosting

Discovery Activities

Loading

value chain that controversy lawyers might find relevant to the services they provide. This admittedly simplistic value chain is a critical first step that rationalizes the basic primary and support activities of a litigation matter.

Successful partners regularly focus on the hard work of building recognition in a crowded marketplace. For them, marketing and business development is a primary activity. Matter intake is another primary activity.

Firm management is concerned about

Our generic litigation value chain also describes three main discovery activities: Litigation Support (loading), Hosting, and Document Review. Litigation Support obtains data and prepares it for loading into a document review database. This is a time-intensive task, as data needs to be decompressed and its corruptions addressed, and then properly organized and loaded into the database. The document review database houses the data and brings search and coding capability to bear.

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services, as well as discovery services. approach for their desired outcome of Finally, professional attorneys review The discovery attorneys there trade the low, predictable costs. Furthermore, system outputs and make judgments there are a seemingly unlimited number partner track for an improved work-life regarding responsive, non-responsive balance and greater job security. of systems that can be used to host and and privileged documents.

Highly trained discovery attorneys review documents.

Once the major components of the are extremely efficient at document Thus, the obvious conclusion is service have been identified, the cost production. They become experts at that discovery is a standard process of each process needs to be calculated. reviewing and analyzThe proper way to ing data in the firm’s do that is to identify chosen technologies. We all the resources and OUTCOME = Document provide a bundled, fixed related costs associHigh Quality at Low, Review price option, based on ated with each activity, Predictable Cost either a per document and the time it takes to charge or per gigabyte deliver the desired outcalculation, whichever come. Many firms are method is preferred now able to calculate by the client. A recent fully allocated matter Bundled, evaluation of a matprofitability, but few Fixed Priced ter involving 225,000 have a robust activityOffering documents found that based costing system.

Data our integrated predicNevertheless, even Hosting Preparation tive coding reduced the imperfect calculations & Loading time required to proyield surprising and duce the documents by useful results.

64 percent and reduced WHY DISCOVERY the fees charged to the IS COSTLY client by 52 percent.

Discovery is a service Stand-alone vendors that tends to be idiosyncratic. Every may be able to offer a lower price but without any real standardization. Law matter is handled differently. Someproductivity and quality may be comfirms often approach discovery with a times discovery is performed by associmade to order solution, as if the desired promised. It takes a sophisticated buyer ates at the law firm’s office. There is a to understand the math. The value chain outcome were similar to a trial victory benefit to this structure as the matter model can help law firms identify and rather than quality, low cost document team is performing the review and is quantify the options. production. This approach fails to immediately aware of any relevant doc- recognize the differences among the deThere are many other areas that uments. They can walk a high priority sired outcomes of each primary activity. lend themselves to advanced managedocument (“smoking gun”) down the ment concepts, and law firms are in It results in operational inefficiencies, hall to the partner in charge, who can leads to poor matching of the appropri- the very early days of adopting such act on it in real-time. But this efficiency tools. We believe that firms will either ate resources for the job at hand and comes at a substantial cost, as associembrace such approaches or continue creates billings that are excessive. ates can bill at more than $300 hour. to cede large amounts of their practice The problem is getting worse as the At other times, this work is done to other providers. ■ volume of electronic data continues to by less expensive contract attorneys grow. It is incumbent upon law firms, under supervision at an off-site facilparticularly Am Law 100 firms with Scott Green ity. This fulfills the client’s desire to locations in major metropolitan cities, is the Execubalance lower cost contract attorto seek low-cost, high quality and stantive Director neys with experienced firm lawyers. dardized alternatives to these discovery of WilmerHale Contract attorneys, however, vary in activities. In our case, the firm recogand a graduquality. Some are good, some are not, nized that in smaller cities there was ate of Harvard and some are simply untrained. The a deep pool of skilled and motivated Business finished product is just “thrown over attorneys who require far less comSchool. He the wall” when completed, requiring pensation than partner track associhas published the matter team to absorb and react to ates working in big cities. With that in several books and articles on managewhat they find. This structure is also mind, we opened a business services ment and is a member of the AICPA inefficient, but for many clients the Business and Industry Hall of Fame. center in a less expensive market to perceived savings make it the preferred scott.green@wilmerhale.com drive down costs for housing support

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DEC 201 1 / JAN 2012 E X ECUTIV E COUNSEL

E-Discovery

Social and Mobile Media and E-discovery

By Jake Frazier

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

E-Discovery

A

ccording to data collected by the monitoring service Pingdom, 30 billion pieces of content (links, notes, photos, etc.) are shared on Facebook each month, and 25 billion tweets were sent in 2010.

The International Telecommunications

Union estimates that around 6 trillion text messages were sent out in 2010.

How much of this information can be said to be in an organization’s “possession, custody and control,” as those terms are defined by the courts? How can this information be collected and preserved? How much will it cost to discover and produce relevant information in the event of a lawsuit?

There has been some over-dramatization about how social and mobile media play into e-discovery rules. When it comes to e-discovery, companies typically distinguish between individual accounts and company-managed media, including a company’s Facebook page and collaboration sites.

This dichotomy exists on the mobile side as well, with employeepurchased laptops and smartphones that are not connected to corporate servers vs. company-issued devices that are. The fact is, e-discovery regulations do not pose an immediate and large threat to corporations.

Rather, there is time for legal departments to begin a considered and pragmatic approach to preserving and collecting information from mobile devices and social media.

According to a recent Compliance, Governance and Oversight Council (CGOC) survey, practices for preserving and collecting information from mobile devices generally look just at company-issued devices that access centralized

email servers, and target only the server location for email collection, bypassing the devices themselves.

Financial institutions carefully control text messaging from mobile devices by regulated personnel, and instant messaging is centralized (and therefore managed at the server). Across the financial services, automotive, healthcare, and pharmaceutical industries, companies infrequently collect text, images and data saved on devices. Government inquiries, employee disputes and internal investigations may require manual collection.

Practices for preserving and collecting social media are ill-defined, and a number of companies have no e-discovery experience. Companies are just now exploring the preservation and collection of data from internally and externally facing sites. Some have begun defining what obligations may extend to third-party hosted sites and content, as well as how posted content in these sites may be of use in their own claims or defenses. According to the CGOC survey, no company cited the need for or had identified an enterprisegrade social or mobile media collection automation tool.

Once an organization understands the types of social and mobile media that pose legal risk, the next step is to understand the regulatory environment for specific companies and industries. For example, SEC and Financial Industry Regulatory Authority (FINRA)-regulated entities have unique requirements pertaining to social media channels. FINRA has issued specific guidance.

INSIGHT FROM MOCK TRIALS

To probe deeper into discovery issues related to social and mobile media, two CGOC-sponsored mock discovery hearings were held recently. They were presided over by Andrew J. Peck, a U.S. Magistrate Judge in the Southern District of New York.

In the first scenario, an individual brings a civil suit against a large retailer, claiming he was hurt in a fall at a store and that the retailer was negligent in not cleaning a spill. The retailer, however,

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has been informed by the plaintiff’s ex-wife that photos of the plaintiff jet skiing after the accident may exist on a private section of his Facebook page.

In the second scenario, a drug company has submitted a new drug for clinical trials. However, dozens of employees in R&D already know it will not pass, based on their clinical expertise and inside information concerning regulator feedback. These employees appear to have shorted the stock and may have posted pertinent information on a social media site. The stock has plummeted. A pension fund alleges insider trading, and threatens a lawsuit. The fund requests that all handheld devices and home computers of the R&D team be preserved, and that all social media postings be preserved or made accessible to the plaintiff. The drug company wishes to cooperate with the pension fund but finds that the cost just to find all the requested information would be up to $250,000.

These mock hearings reveal that both companies have the same responsibility to preserve social media data under their possession, custody and control in order to avoid the risk of spoliation and sanctions. The hearings also reveal that targeted and reasonable discovery requests can significantly reduce costs.

They affirm the wisdom of discovery negotiations before trial, under guidelines set forth in the Sedona Cooperation Proclamation and the “meet and confer” process under Rule 26F of the Federal Rules of Civil Procedure.

KEY E-DISCOVERY CONSIDERATIONS

• Is it relevant? Relevance of the information should be the primary determinant of whether social and mobile media must be preserved or produced.

• Is it unique? For mobile content and company-provided social media channels, identical information is often available on central servers.

This makes it unlikely that collection from devices and employee accounts will produce unique and relevant information.

• Is the data in your possession, custody and control? Only a small

portion of social media actually falls under a company’s possession, custody and control, and would need to be preserved and possibly produced. Third-party sites and services used by individuals at their own discretion and for their own accounts may be off limits under the Stored Communications Act (SCA). Case law is unclear for sites like Facebook and MySpace.

The SCA does apply to YouTube videos posted as “private,” Facebook and MySpace profiles, wall posts when not available to the general public, and similar content communications. The SCA bars improper access, and specifies criminal penalties for violation. Courts have quashed subpoenas that would violate the SCA. Permission from the account holder may be required to collect data for litigation, but courts have been willing to compel such permission.

• Determine how to collect social media information. Consider the ethics of collecting data that may not be in your possession, custody or control.

In addition to SCA prohibitions, pretexts such as befriending someone to gain access to their profile pages is unethical. If a person has made information generally available, it may be possible and prudent to collect it.

However, be mindful of the chain of custody this creates and the implications for authenticating the information. Also consider whether a site’s terms-of-use restrictions on collecting user data without consent applies to collection for litigation purposes. Collecting this information is a manual exercise, and few third-party services or tools exist to facilitate collection. Facebook and Twitter allow content to be extracted, but format is not preserved in the extraction process. A chronological “transcript” may be sufficient for early case assessment and to facilitate review. Alternative forms of collection may be needed for production.

Collecting social media from third-party services is typically

done page by page, often by creating an image of the page or capturing the page in PDF, and it requires special attention to comments, threads, “likes” and links on any given page to ensure an accurate replica. An alternative would be the tools used to capture software demonstrations. Corporate training departments may already have these tools, but advice of counsel is important because the law is unsettled.

• Control Costs. The first and best practice for controlling costs is ensuring that in-house and outside counsel fully understand the company’s technologies and capabilities. As noted above, use the Sedona Cooperation Proclamation and Rule 26F of the Federal Rules of Civil Procedure to control the scope and expense of discovery at its earliest stages. Carefully consider relevance, uniqueness, and methods of capture.

The scope of discovery requests related to social and mobile media have remained relatively small and typically focused on an individual.

Companies may have time to incorporate new technologies into their records management, governance and e-discovery policies and procedures. Nevertheless, the twists and turns real cases will take are unpredictable, so the goal should be to update policies and procedures before a potentially costly lawsuit occurs. ■

Jake Frazier is a faculty member of the Compliance, Governance and Oversight Council (CGOC) and co-chair of its Working Group on Social Media. He was a founding member of CGOC’s Electronic Discovery Reference Model (EDRM) work group and is an active member of the Sedona Conference. cgoc@cgoc.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

E-Discovery

Eight Practical Suggestions for Mitigating Risk in Keyword Search

By Lisa Stortenbecker and Thomas Bonk

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K

eyword searching, in order to cull electronically stored information before release for a formal attorney review, is too often conducted with no insight into the context of the results. As a result, overly narrow searches may inadvertently cull out relevant documents, while overly broad searches yield false positives, thus increasing the volume of documents presented for the linear review and increasing the project cost.

The goal should be to minimize the number of non-relevant documents presented for the more expensive formal review conducted by attorneys.

Reducing those enormous ESI collections to manageable data sets is challenging. There are risks in using keywords as an automated method of culling, and those risks are becoming more serious, thanks to an increasingly educated judiciary and more frequent objections from opposing parties about search protocols.

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Those with the most to lose may not realize that decisions made in the design and execution of a keyword search significantly impact the quality of the final result. Here are eight practical tips for doing it right: Tip 1: Perform an iterative and disciplined assessment of search results. (In this context, iterative means that the case team, in concert with a search expert, performs the keywords search, evaluates the results, then makes adjustments to the search criteria as needed. The process is repeated until the final results can be deemed satisfactory.)

Case teams are inclined to immediately jump into the traditional document-by-document linear review process without consideration for the costs of reviewing nonrelevant documents. A disciplined approach to utilizing keywords to identify only relevant documents

dec 201 1 / jan 2012 E X ECUTIV E COUNSEL

E-Discovery

can reap benefits of both cost and time savings.

This strategy requires a level of patience by the case team, along with a commitment to invest upfront time and energy in the careful assessment and analysis of the keyword search results. The iterative approach requires back-and-forth assessments and adjustments to refine the syntax and criteria used.

This often can be accomplished in concert with a search expert who is well versed in the nuances of executing and refining a keyword search. A subject matter expert – typically an attorney with extensive knowledge of the background and context of the matter – should work closely with a search expert.

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Tip 2: To minimize the number of relevant documents left behind, sample the documents that have not been identified by the keyword search. Even a cursory (i.e., nonstatistical) review of the keyword search results can mitigate the risk of missing relevant documents that don’t contain the defined keywords.

Such a review also may demonstrate that some level of diligence was performed to validate that the search criteria were effectively doing the culling.

In addition, some modern search software applications include statistical functionality to randomly sample a small quantity of documents for formal review. If a statistically significant sample does not contain any relevant documents, the documents not identified by the search may be considered not relevant for diligence purposes. The standard to be met is to act reasonably and in good faith compliance with discovery obligations.

The risk being mitigated is that a highly relevant document will be found by some alternate method later in the litigation timeline.

Counsel may then be required to explicitly define the process that was used to identify, collect, cull, review, and produce documents.

Employing a formal validation process at the critical point where documents are defined as “probably not relevant” will likely demonstrate that an appropriate standard of care was used.

use of social networking applications increases, consider alternative ways to identify personal names.

Examples include Twitter names (@charlessmith), blog aliases and instant messaging names.

Tip 3: Assess the search carefully with regard to personal names.

Searching for personal names is a common and reasonable way to

Tip 4: Carefully assess the results of acronym searches, as these often yield false positives. Acronyms are common in nearly all business communication and are likely to proliferate with the emergence of a generation that’s using them (LOL, btw, gr8t, etc.) in social communication media.

Searching for acronyms can present extraordinary challenges because the term being sought may represent a shorthand version of a name or phrase that suggests high relevance, but also could occur in common use with a completely different context.

For instance, the acronym DC could represent a common project name like “Destiny Code” that suggests high relevance. The same acronym could also appear in the email signature address block (Washington, DC) of participants. Most search software provides the ability to isolate and remove obvious false positive hits.

A subject matter expert – typically an attorney with extensive knowledge of the background and context of the matter – should work closely with a search expert. identify documents of interest, but within a large and varied collection of data, they may be rendered in unexpected ways. Searching “Charles Smith,” for example, may appear to be simple enough, but it may be necessary to consider nicknames like Chuck, Charlie, and Chas, as well.

Use proximity search syntax to anticipate the possible inclusion of an intervening middle name or middle initial and the possible bidirectional ordering of the names.

As an example, a search should seek to find Charles adjacent to Smith in either direction within one intervening word or letter, as in Charles E. Smith or Smith, Charles E. Also keep in mind that email addresses are commonly used in electronic communications as substitutions for a formal personal name. A well-crafted search also includes all known business and personal email addresses, such as charles.smith@acme.com, csmith@ yahoo.com, etc. In addition, as the

Tip 5: Recognize that files containing no searchable text cannot be easily identified by standard keyword searching methods. Examples of ESI that contain no readily searchable text include audio\video, Visio, AutoCAD, eFax, PDFs with no embedded text, scanned TIF images, photos in JPG and GIF format and password protected or encrypted files.

Assessment of potential relevance in common unsearchable ESI requires a different approach, but do not exclude it from attorney review simply because it cannot be identified by a keyword search. To decide whether to include these kind of of ESI for formal attorney review, use other criteria, such as the type of matter, location (e.g., the iTunes folder), feedback from custodian interviews, and the results of a cursory

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

E-Discovery

review of these types of ESI by a member of the case team.

Tip 6: Scanned hardcopy documents made searchable with optical character recognition may require a different keyword search strategy.

The OCR process commonly used to allow for searching ESI created from scanned hard copy documents often produces inaccuracies. Utilize “fuzzy search” functionality, common to many search software applications, to try to identify variations of text.

For example, the word “earnings” may be identified within OCR text as “3arnlngs” or “eorn1ngs” or “earning5,” depending on the font and legibility of the source hardcopy document’s typeface. A skilled search technician will provide guidance on how to properly utilize these fuzzy search features.

Tip 7: Properly vet and educate the resources used for performing the search. The software application used, as well as the competency of

the person performing the search, may significantly influence the final result. Nuanced differences in syntax used among different applications can result in an entirely different result.

The person performing the search should be prepared through training and experience with the tool. If the search technician is not a member of the case team, it’s helpful to provide this person with a general overview of the matter and the goals of the search process.

Tip 8: Perform a traditional review on a small set of documents as a proof of concept. Time pressures notwithstanding, a carefully thought-out search strategy includes preliminary validation of the keywords specification, by way of an evaluation of a comparatively small set of documents with a traditional linear documentby-document review.

Investing additional time and effort early in the process can greatly reduce the overall timeline, the final cost of the project, and

the compliance risk associated with a production or regulatory request. ■

Lisa Stortenbecker is a Solutions Architect at Document Technologies, Inc., consulting with law firms on ediscovery and ESI issues. She heads DTI’s Chicago project manager team. lstortenbecker@dtiglobal.com

Thomas Bonk is vice president of professional services at DTI and a frequent speaker and panelist at law schools and industry user groups discussing the management of ESI for litigation. tbonk@dtiglobal.com

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DEC 201 1 / JAN 2012 E X ECUTIV E COUNSEL

E-Discovery

Defending Enhanced Document Review Tools

By Ann G. Fort and Gregory S. Kaufman

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

E-Discovery

E

very major e-discovery vendor now offers its own twist on the “predictive coding” approach to categorizing electronic documents that have been gathered for litigation review. Broadly speaking, predictive coding applies decisions made about a subset of the documents to the rest of the collection, without having reviewers examine each record.

Typically these approaches use software that searches for commonalities among documents already identified as relevant, then searches for other documents in the collection with those characteristics. Still other tools use complex linguistic or sociological algorithms to analyze the data and identify patterns of communication and other markers that can be used to find interrelated communications and documents that are

key word approach to “relevance” or “responsiveness” that clearly results in over-production of irrelevant documents, while failing to produce relevant documents that contain words or phrases not yet known to the parties. Until more courts address these tools head-on, these review methods will be analyzed under prevailing law.

Under the current standards, whatever the method of review employed, it will be judged on whether it was reasonable. Federal Rule of Civil Procedure 26 specifically requires counsel to make a “reasonable inquiry” to satisfy its duties in responding to discovery requests.

Reasonableness will be determined on a case-by-case basis, but both the technology and the review process must be appropriate to the tasks

Having an audit trail for the chosen methodology will be critical to defending the reasonableness of the review and production process. relevant to the dispute, even if they do not contain the exact key words identified by the parties.

When these tools are used for early case assessment or to make sense of the electronic documents produced by the other side, they can be a great way to identify the most relevant documents as quickly as possible. But users of these tools generally do not understand exactly how those commonalities are being identified, and why documents are being excluded as irrelevant.

Therefore, using these same tools to determine which documents are not going to be produced can be controversial. Indeed, vendors have identified one major obstacle to widespread adoption of these automated approaches: uncertainty about their judicial acceptance.

Of course, the status quo isn’t perfect. We have grown accustomed to a

required of them. Focusing on the technological piece of the reasonableness determination, a trio of cases – United States v. O’Keefe; Equity Analytics, LLC v. Lundin; and Victor Stanley, Inc. v. Creative Pipe, Inc.– that speak to the use of electronic tools for search, review and production are instructive.

In Victor Stanley, Magistrate Judge Grimm, a leading e-discovery authority, stated that the message to be taken from O’Keefe and Equity Analytics is that “when parties decide to use a particular ESI search and retrieval methodology, they need to be aware of literature describing the strengths and weaknesses of various methodologies . . . and select the one that they believe is most appropriate for its intended task.”

Should a challenge arise, the selecting party should expect to support its choice with information from qualified

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E-Discovery

and experienced people, “based on sufficient facts or data and using reliable principles or methodology.”

These cases suggest that the methodology, which includes the

decisions made and rules applied, in addition to statistically validating the results of the process.

These emerging technologies can be a positive influence on the dis-

of, or at least be able to deal effectively with, the ever-growing sea of data. The benefits will be felt by clients and counsel alike. Reviews should be more efficient and less

If the relevant 20 percent of documents are teed up for review, the client’s best interests may be served when the lawyers who are providing substantive representation on the case review those documents.

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technology, will not be found reasonable if it is nothing more than a “black box” – a computer system that operates without an understandable, defensible method. Nor do these courts suggest that, for software programs using algorithms to execute searches, the specific algorithms will be dissected and judged. Rather than require public disclosure of all computer algorithms, courts may look to the reliability portions of the Federal Rule of Evidence 702 (“Testimony by Experts”) test – i.e., the results must be the product of reliable principles and methods, and of the reliable application of those principles and methods.

The touchstone of reliability is repeatability – the ability to get the same results using the same process inputs every time the process is used. Whether the methodology involves clustering, concept searching or predictive coding, the reasonableness of how the technology was used may rest on a party’s ability to demonstrate that the results can be replicated.

Therefore, having an audit trail for the chosen methodology will be critical to defending the reasonableness of the review and production process.

While no two concepts, clustering or predictive technologies are identical, the limited guidance from the courts suggests that whichever one is used, it should have the ability to provide an audit trail so the party can demonstrate repeatability. Predictive review methodologies should – and most purport to – provide an audit trail of

covery process for all involved. Cost pressures have resulted in expanded use of contract attorneys, outsourcing and off-shoring for initial review.

Contract attorneys are a necessity when 80 percent of total linear review cost involves the identification of irrelevant documents. However, the use of active learning technologies may change these metrics and result in a portion of document reviews being done by trial counsel.

If the relevant 20 percent of documents are teed up for review, the client’s best interests may be served when the lawyers who are providing substantive representation on the case review those documents. Instead of just making correct responsiveness and privilege calls, those associates will gain important knowledge and insight into the case, while completing the most relevant part of the document review.

In cases where parties are uncomfortable relying on sampling and statistical analyses to avoid reviewing the presumptively irrelevant documents, contract or offshore reviewers may be used at greatly reduced rates to slog through documents not expected to be responsive, to ensure that nothing relevant has been excluded. Limiting the work of the low cost reviewers reduces the risk that they will make inconsistent or incorrect responsiveness or privilege determinations.

As more parties use these technologies and more courts accept them, U.S. businesses may finally get ahead

costly for clients, and focus more sharply on making the client’s case. ■

Ann G. Fort is partner and member of the Intellectual Property Practice Group at Sutherland Asbill & Brennan, in the Atlanta office. Her work encompasses patent infringement, licensing disputes, trade secret protection and unfair competition. She handles cases in federal and state courts, as well as in arbitrations and mediations. ann.fort@sutherland.com

Gregory S. Kaufman is a partner and member of the Litigation Practice Group and Energy Compliance Team in the Washington D.C. office of Sutherland Asbill & Brennan. He advises energy and securities industry clients on a range of issues, including regulations, government investigations, litigation, internal risk, commodities trading and derivative products and internal investigations, with a special focus on e-discovery issues. He is a member of the Sedona Conference and the firm’s E-Discovery and Information Management practice group. greg.kaufman@sutherland.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Human Resources

Leveling the Playing Field with Non-Competes

By Peter Bulmer

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U

nless you are in a commodity business, where price is the only issue for customers, your competitors probably have restrictive employment covenants in place. These covenants protect their assets from being transferred to you, whether by theft or by way of the transfer of employees who bring knowledge and relationships with them. These agreements affect their competitive position, and without something similar in place you are at a competitive disadvantage.

If you do have restrictive employment covenants in place, but they have not solved the problem which led to their implementation, you are similarly disadvantaged. Implementing at least some of the restrictions discussed in this article will put you on a level playing field.

First, here is a quick description of

the terms used to distinguish the various restrictive employment covenants informally referred to as “non-competes.”

These are followed by a more detailed look at the purpose each serves.

The term “non-compete agreement” often is used in a generic sense to encompass several distinct restrictions on an employee’s post-employment actions in the marketplace. These fall into four categories.

First is the pure “non-compete” restriction, which prohibits an individual from working in a competitive position, period.

Second is the “non-solicitation” restriction, which is more narrow than a non-compete. The non-solicitation restriction allows individuals to engage in any employment they want, but restricts them from soliciting a defined subset of the employer’s

actual or prospective customers.

Third is the “no-raiding” restriction, which prohibits individuals from soliciting a defined subset of their co-workers.

Fourth is the “non-disclosure” or “confidentiality” restriction, which requires individuals not to use, disclose, or otherwise jeopardize the confidentiality of closely held information.

The pure, generic non-compete restriction acts to deny your competitors the unique skills, abilities, relationships and knowledge possessed by your company’s key executives. The fact is that executives’ skills, abilities, relationships and knowledge ordinarily are obtained through employment with the company. They did not possess them beforehand. Moreover, these characteristics are so enmeshed in the executive’s knowledge base that he or she, having

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Human Resources

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taken a substantially similar job with a competitor, could not reasonably be expected to do that job without making use of that unique knowledge.

It is the combination of some or all of these characteristics that render the executive uniquely positioned to inflict irreparable harm on the company’s business. Think of a senior vice president who has helped build the business over the years and then suddenly quits to join a competitor. This person may not know every company customer, proprietary process, or marketing or business development plan, but few if any company employees are as intimately familiar with the business and its strengths and weaknesses.

Many jurisdictions recognize the unfair threat posed by permitting such executives to immediately compete with the former employer, but unless there is a contractual restriction on the executive’s ability to compete, the company may be left with no legal option to prevent it.

The “non-solicitation” restriction protects the relationships that the company has built with its customers.

Most sales persons believe the customer belongs to them. They brought the customer into the company, or they took a small customer and over time transformed it into a large customer.

They spent their evenings and other free time in quasi-social activities with the customer, and they learned to relate to that customer’s particular needs, wants, and habits. Usually they do not appreciate that the company paid them to do all of those things, that their efforts were on behalf of the company, and that the fruits of those efforts belong to the company.

On the contrary, sales persons usually believe they are free to leverage these customer relationships at their next employer – and they may be correct in that belief, unless they are contractually bound not to solicit their former accounts for a period of time.

Whereas the non-solicitation restriction protects your customer relationships, the “no-raiding” restriction prevents a former employee from leveraging former co-worker relationships to raid your workforce of its best

performers. It can be harmful enough to lose one valued employee, but to lose a group of them all at once can be devastating.

Similar to the way sales persons view “their” customer relationships, most employees see their knowledge of, and relationship with, their former colleagues as personal to them, rather than as something that comprises an asset of the company. As with non-solicitation restrictions, however, most jurisdictions permit a company to protect itself contractually from such raiding.

Finally, the non-disclosure (or confidentiality) restriction protects your information from being used against you and from being disseminated publicly.

At the very least, having this restriction in place makes employees more aware of the importance you place on the information they will have access to, and it removes any doubt from their mind as to what information must neither be used nor disclosed.

You don’t want to be in the position in court of having an employee testify that he or she didn’t know that this particular information was considered confidential, or that “no one told me this was anything special.”

The non-disclosure restriction may be the single most important of the post-employment restrictions. Courts are aware that businesses are increasingly dependent on knowledge, and the ear of the judge often is more attuned to the plea to “protect information” than they are to what sounds like a plea to “prevent competition.”

It is true that many jurisdictions have some version of the Uniform Trade Secrets Act, which protects trade secrets (as defined in the statute), even in the absence of any contractual restriction.

However, relying solely on this law is insufficient. First, for something to qualify as a “trade secret,” you must have taken reasonable measures to keep it secret.

Even if your information does not qualify as a trade secret under statute, the common law affords protection to “confidential” information. Having a contractual provision restricting use of your sensitive information is a fact courts consider when determining

whether you have taken “reasonable measures” under the statute as well as the common law.

The biggest myth in this area of the law is that post-employment restrictions are not enforceable, so they are not worth the bother. In fact, when drafted with an eye to the day when they may need to be enforced, not only are they enforceable, they are enforced.

More important, a properly drafted restriction enhances the credibility of an enforcement threat, for at least two reasons. First, many individuals will make an effort to honor their contractual promises rather than risk litigation. Second, the practical realities of the enforcement process favor a welldrafted restriction. A company rarely seeks enforcement without first giving notice of its intent to do so.

This notice usually generates a conversation, if not a negotiation, between the parties. The lawyer for the former employee, and the lawyer for her or his new employer, will be more flexible and willing to compromise in meeting your demands if the threat of enforcement is real. Moreover, by eliminating a challenge to the face of the restriction – that is, by taking away the argument that as drafted it is unenforceable – the credibility of the threat to enforce it is enhanced.

Thus, through deliberate drafting in the beginning, you increase the later likelihood that the substance of the restriction will be honored, without litigation. ■

Peter R. Bulmer is a partner in the Chicago office of Jackson Lewis. He represents management nationwide in all facets of employment and labor law. He also represents employers in prosecuting and defending claims of unlawful competition. Mr. Bulmer is a member of the Executive Counsel Editorial Advisory Board.

BulmerP@jacksonlewis.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO DEC 201 1 / JAN 2012

Governance

Lessons from the Options Backdating Scandal The Archeology of Compensation Litigation

By Stuart L. Gasner

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I

f litigating a lawsuit about compensation issues is a lot like doing a “dig” at an archeological site, the options backdating scandal was a veritable Pompeii.

When the Wall Street Journal ran its famous “Perfect Payday” article in 2006, it unleashed a torrent of internal investigations at hundreds of public corporations, which in turn led to billions of dollars in accounting restatements, as well as scores of shareholder and derivative lawsuits, SEC proceedings, and for an unlucky few, criminal

prosecutions. It was as if a Vesuvius had erupted, with the flow of lava freezing in place a decade of compensation practices. Legions of prosecutors and defense lawyers were soon on the scene, chisels and brushes in hand.

I represented a variety of clients caught up in the options backdating mess. They ranged from CEOs and outside directors to staffers in HR. The outcomes ranged from informal interviews followed by prompt exoneration to multi-year campaigns that included indictments and SEC trials. After docu-

ment production in the millions of pages, a mountain of depositions, and in some cases weeks of trial, what did this archeological dig at the options backdating site uncover about compensation policy?

For one thing, we learned that much of the energy devoted to options backdating litigation was probably an enormous waste of resources. That was certainly a subtext of the court’s opinion earlier this summer in our case, Securities and Exchange Commission v.

Shanahan, in which the Eighth Circuit

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Governance

Court of Appeals affirmed the dismissal of the SEC’s case against an outside director at a prominent corporation in St. Louis, someone who had the unenviable job of being assigned to the Compensation Committee in the late 1990s.

In addition to exonerating the defendant by agreeing with the district judge that there was no evidence of wrongful intent, the court went out of its way to

Oxley changed the rules to require that options grants be reported to the SEC shortly after the grant. Before Sarbanes Oxley, a remarkable number of companies apparently backdated their grant dates. After Sarbanes-Oxley, they didn’t.

If stopping backdating was the goal, Congress could say “mission accomplished” after passing Sarbanes-Oxley and devising a sensible, clear rule.

Tax policies in the 1990s penalized companies that paid salaries to their executives in excess of $1 million by not allowing those salaries to be deductible.

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question the materiality of options dating disclosures – which were typically a sentence or two in a footnote to the company’s financial statements, and a footnote about a non-cash accounting entry that only a CPA could appreciate.

In retrospect, one wonders whether the SEC’s time and energy would have been better spent investigating the Madoff fraud, the safety and stability of housing-based derivatives, or any number of other more worthy pursuits.

What we also learned is how much influence Congress has over compensation practices, and how legislative policies can drive executive behavior in unexpected ways. One “layer” that I uncovered in my archeological digs was that tax policy in the 1990s effectively forced corporations to rely heavily on options to compensate their top executives, penalizing companies that paid salaries to their executives in excess of $1 million by not allowing those salaries to be deductible. That in turn put pressure on options to make a ton of money, which in turn created an incentive to push the envelope in pricing options, which in turn led to an epidemic of backdating at hundreds of companies. The “dig site,” in other words, ended up covering an enormous landscape, mostly thanks to Congress.

Another layer of the excavation revealed that Congress not only created the conditions that led to options backdating, it also stopped it. Sarbanes-

But of course, merely stopping a practice is not the end of the story, especially when the “Bonfire of the Vanities effect” kicks in. Once there’s a scandal and a toxic brew of publicity, politics, and pressure on enforcers to “do something,” the path to litigation is pretty much set.

With options backdating, it was set the day the Wall Street Journal published “Perfect Payday.” Whether the path leads to the doorstep of any particular executive is largely a matter of luck.

That leads to the next layer of excavation, and laborious hours spent with the litigation equivalent of chisel and brush, trying to find evidence to reconstruct the reality of what happened with respect to any particular client who is the target of an investigation or a defendant in a lawsuit.

What was extraordinary about the options backdating cases, though, was how little could be clearly seen at the dig site. Unlike the excavation of Pompeii, which revealed with macabre precision streets, buildings and people caught in everyday activities, the late 1990’s backdating site revealed only shards of pottery and the dim outlines of the village.

Scores of people were typically involved in the process of granting, accounting for, and preparing options paperwork, but years later few remembered the details of what no doubt seemed at the time to be ministerial tasks. Others chose not to be available, or shaded their stories to point

blame in other directions. Many records were lost or incomplete.

What often emerged was that the options backdating story was immensely complicated. The rules for pricing options and determining the proper date of the grant were complex, and responsibility for the process was widely diffused, with decisions being made by operational supervisors, HR, Finance, committees of the board, the whole board, and upper management. Even reputable auditors often failed to detect (or chose to ignore) that options backdating was going on beneath their noses.

Under these circumstances, the Eighth Circuit got it right in SEC v.

Shanahan when it concluded it was simply impossible to hold an individual outside director responsible.

So what lessons for the future? Hiring good auditors, reliable CFOs and controllers, and skilled lawyers will help prevent being thrown into the dig site, especially if coupled with an attitude of trying to do the right thing. Keeping good records and having a sensible document destruction policy may make any future excavation easier.

However, in the end you never know what obscure area of corporate policy is going to be the fuel for the next Bonfire of the Vanities. It could be anywhere, as long as there are executives making what the public perceives as too much money, some “grey area” accounting, and an enterprising reporter or disgruntled employee to light the match. ■

Stuart L. Gasner is a partner at Keker & Van Nest LLP in San Francisco and a former federal prosecutor. His practice centers on white collar criminal defense and the representation of venture-backed technology companies in litigation. He was lead counsel for the defendant in Securities and Exchange Commission v. Shanahan, in which the Eighth Circuit Court of Appeals affirmed the dismissal of the SEC’s case. sgasner@kvn.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Canada/Cross–Border

Canadian Tax Issues for Cross-Border Executives

By Harris Kligman and Don Beadle defined the term “reasonable,” but it has indicated that pro-rating the individual’s annual salary (including performance bonuses) by a ratio of the number of days worked in Canada divided by total work days in the year would be an acceptable approach.

American residents earning more than $10,000 of employment income in Canada may still be able to avoid the requirement to pay Canadian tax on that income, if they meet the following three requirements:

C

anada is the United States’ largest trading partner, with an export and import total of $429.6 billion in 2009 alone. In addition to the large volume of trade, Canada is traditionally a country that most Americans feel comfortable visiting (12,503,000 trips to Canada

by Americans in 2008, per Canada’s national agency for statistics). Moreover, since the implementation of the North American Free Trade Agreement, American executives are crossing the Canada-U.S. border increasingly frequently, to work with clients and pursue new business opportunities.

Traditionally, it was common for cross-border business persons from the United States to ignore the potential Canadian tax obligations that would arise from their trips across the 49th parallel.

In recent years, the Canada Revenue Agency (CRA) and the Internal Revenue Service (IRS) have begun working much more closely with their respective border officials, and as a result many U.S. business people are being refused entry into

Canada, based on the fact that they are not current with the required Canadian tax filings that arose as result of their stays in Canada.

Canadian tax rules specify that foreigners performing employment duties in Canada will be taxed in Canada on the first dollar of Canadian-sourced employment income that they earn.

However, under the Canada-U.S. tax treaty, the two countries have outlined specific rules which allow tax residents of one country to escape taxation of employment income earned in the other country, assuming certain tests are met.

For example, an American resident earning $10,000 (Cdn) or less of employment income in Canada automatically avoids the requirement to pay Canadian tax on the income earned while working in Canada.

Based on CRA’s interpretations, the allocation of the portion of the individual’s annual salary that should be allocated to the work performed in Canada must be done on a reasonable basis. The CRA has never officially

• They were not physically present in Canada for more than 183 days in any 365 day period that begins or ends in the calendar year in which they earned the employment income.

• Their employment income was not paid to them by an entity that was resident in Canada.

• The cost of their employment income was not borne by (i.e. could not be deducted by) a permanent establishment in Canada.

It may seem simple to ensure that these requirements are met, but there are some important points to be considered.

For example, the 183-days test includes not only work days, but also any vacation days spent in Canada. Additionally, the employee, as a representative of the U.S. employer in Canada, may trigger the requirement that the employer file a Canadian corporate income tax return, and cause the employer to have a portion of its income taxed in Canada.

Non-Canadian companies are taxable in Canada when they carry on business within Canadian borders (e.g. solicit orders or offer goods for sale in Canada or perform services in Canada).

Under the Canada-U.S. tax treaty, the two countries have set out specific rules under which U.S. companies

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Canada/Cross–Border would not be taxable in the foreign location, even though they still have an obligation to file Canadian tax returns. For example, as part of the agreement, U.S. companies are taxable in Canada only if they carry on business in Canada through a “permanent establishment.” While a permanent establishment is essentially a physical place of business, a U.S. company that does not have an actual physical location in Canada is still deemed to have a permanent establishment if it has employees working in Canada and any of the following three tests are met:

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• Any employee has and habitually exercises in Canada the authority to conclude contracts on behalf of the U.S. employer.

• Any single employee performs services on behalf of the U.S. employer for a period of 183 or more days in Canada during any 12 month period, and 50 per cent or more of the gross active business revenue of the U.S. company is derived from the services performed by that employee in Canada during that period.

• The employees (one employee or in aggregate) perform services in Canada on behalf of the U.S. employer for 183 days or more in any 12 month period with regard to one project (or connected projects) for customers that are resident of Canada or have a permanent establishment in Canada.

If an employee meets any of these three tests, his or her U.S. employer will be deemed to have a permanent establishment in Canada and will become liable for Canadian tax. This would require the U.S. employer to file a Canadian tax return, determine the portion of the company’s income that is allocated to that Canadian permanent establishment and pay Canadian tax on the income.

In addition, given the employer’s permanent establishment in Canada and the fact that the employee’s salary would now be eligible to be deducted by the employer from its Canadian income earned through that permanent establishment, the employee would

now be required to file a Canadian tax return and allocate a portion of his or her salary to be taxed in Canada.

Because a portion of the U.S. employee’s income would now be taxable in Canada, the U.S. employer would be required to withhold taxes at source and remit the tax to the CRA on the employee’s behalf. (This is similar to the withholding faced in the U.S. where the payments are made to the IRS.) Within 60 days of the end of the calendar year, the employer would also be required to issue a T4 (the Canadian equivalent to a W-2), which the employee would then use to file his or her Canadian income tax return.

Canada levies various penalties on employers that do not withhold and remit the appropriate tax and do not issue, or issue late, the appropriate employment slips to their employees.

These penalties can be levied on a per-employee basis. This means that for employers with multiple employees working in Canada the penalty can be quite significant.

If the U.S. corporate employer has a related corporation in Canada, it may be appropriate to structure so that the Canadian salary (and the salaries of the other employees working in Canada), and the revenue earned from the Canadian customers, can be allocated to the Canadian corporation. This would eliminate the U.S. employer’s obligation to pay Canadian tax and to file a Canadian corporate tax return, but would not alleviate the employee’s responsibility to file a Canadian tax return and pay Canadian tax on the Canadiansourced employment income.

In addition to the penalties that may be levied on foreign corporate employers, the CRA can levy penalties on any foreign individuals that do not file the appropriate income tax returns or pay the appropriate Canadian income tax.

If one fails to file a Canadian tax return while tax is owing, a late filing penalty of up to 17 per cent of the outstanding tax balance could be assessed. Where there are repeated failures to file, CRA may assess a penalty of up to 50 per cent of the tax owing. In addition to the penalty, CRA will also assess interest on any balance owing.

Recently, the IRS has begun an initiative to collect non-filer penalties from non-residents that should have filed tax returns, as they see this as an easy way to increase tax revenue without hurting the U.S. economy. It will be only a matter of time before the CRA follows suit with a similar initiative.

Where penalties become an issue, consideration should be given to CRA’s voluntary disclosure program, which encourages taxpayers that have failed to file tax returns to come forward on their own. The CRA may waive all penalties which would have been assessed.

To be eligible, the taxpayer must not have been notified by the CRA of their outstanding filing requirements.

Given the complexity of the rules, a U.S. resident who carries on business in Canada, regardless of the level of activity, should get competent advice from Canadian tax advisors experienced in cross-border issues. ■

Don Beadle is tax manager at Kestenberg Rabinowicz Partners LLP, chartered accountants. He has practiced in the tax area for the past 10 years, specializing in the taxation of Canadian executives working abroad and American executives working in Canada. dbeadle@krp.ca

Harris Kligman is a tax partner at Kestenberg Rabinowicz Partners LLP, chartered accountants, in Markham, Ontario. He heads a five-person tax department providing a range of corporate, personal, sales tax, estate planning, U.S.-Canada cross border and other international tax services to the firm’s predominantly owner-managed business clients. hkligman@krp.ca

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

Canada/Cross–Border

Cherry Picking in the U.S.A.

By Divya Balji

T

he United States has always been the investment destination of choice for Canada. However, the market has changed. The rate of Canadian companies buying in the United States is outpacing that of U.S. companies looking to make acquisitions in Canada.

Over the past nine to 10 months, the overall M&A activity of Canadian companies looking to the United States to make acquisitions has increased due to weaker economic circumstances in the United States and the strong purchasing power of the Canadian dollar. With Canada representing only four percent of global capital markets, companies will need to diversify by looking south of the border and globally as they grow.

“These are all contributing factors to Canadian companies becoming buyers in the U.S.,” said Kristian Knibutat, Canadian Deals Leader for PwC. He explained that the weaker U.S. economy has provided a plethora of M&A opportunities for Canadian buyers.

This has been particularly prevalent in

The rate of Canadian companies buying in the United States is outpacing that of U.S. companies looking to make acquisitions in Canada. the financial services sector, where Canadian banks have been able to cherry pick assets and companies in the United States that will allow them to grow and expand their business.

TD Bank Group has made several U.S. acquisitions in order to expand its business lines. Its most recent purchase was of MBNA’s USD 8.5bn Canadian credit card portfolio from

Bank of America, in August. TD worked with Torys LLP on this deal, and MBNA worked with Blake, Cassels & Graydon LLP, according to mergermarket data.

Before that, TD spent USD 6.3bn to acquire Chrysler Financial Services from Cerberus Capital Management in April. TD had worked with Torys LLP and Simpson Thacher & Bartlett LLP on this acquisition. Cerberus worked with Schulte Roth & Zabel LLP. Since 2008, when the Canadian dollar pushed past parity, there has been a spike in cross-border acquisition activity. The strength of the Canadian dollar has helped bridge the valuation gap between buyers and sellers. The strength and stability of the Canadian economy has allowed companies to continue to maintain strong balance sheets with available cash on hand, which has created more buyers in the market place.

According to Knibutat, Canadian pension funds, now active in direct investments as opposed to a fundof-funds approach, are also pursuing larger acquisitions in the United States.

“These funds are looking to other markets and geographies to invest in, and the United States market has an attractive quality to it,” he said.

He pointed as an example to the USD 5.6bn acquisition of Kinetics Concept by a consortium of investors led by Apax Partners, and including Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSP Investments). Kinetics worked with Morgan Lewis & Bockius LLP, Skadden Arps Slate Meagher & Flom LLP and Sullivan & Cromwell LLP on this deal.

The consortium worked with Andrews Kurth LLP, Epstein Becker & Green PC, Kirkland & Ellis LLP, Simpson Thatcher & Bartlett LLP, Torys LLP and Weil Gotshal & Manges LLP.

As 2011 draws to a close, the volatility in capital markets due to uncertainty about the European debt crisis and the slowdown in the Chinese economy might keep M&A deal activity at a slower pace, but Canadian companies will likely still be opportunistic buyers in the United States.

While Canadian companies understand the need to get more involved in the emerging markets, the challenges of how to take advantage of these markets remain.

“Ultimately, the U. S. market place still has a number of key elements that make it a comfortable place to shop,” Knibutat said. ■

Divya Balji joined mergermarket, an independent mergers and acquisitions intelligence service, in June 2007 as a financial reporter and became Canada bureau chief in August 2009.

She oversees the company’s M&A coverage in Canada, with a specific focus on energy and mining. Prior to working with mergermarket, she completed her degree in Economics & Mathematics at the University of Toronto.

Divya.Balji@mergermarket.com

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Point-Counterpoint

Should Congress Amend the Foreign Corrupt Practices Act?

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

The U.S. Chamber of Commerce is spearheading a drive to change the FCPA. The Chamber proposes: • adding a corporate compliance defense.

• limiting a company’s successor liability for the prior actions of a subsidiary it has acquired.

• adding a willfulness requirement for corporate criminal liability, similar to the standard for individuals.

• a limit on a company’s liability for acts of a subsidiary.

• that a clear definition of “foreign official” be made part of the statute.

Following are two points of view about the proposed amendments. The Chamber of Commerce was offered the opportunity to explain why its proposed changes are necessary but declined. Mike Koehler’s piece supports one of the Chamber’s key proposals.

Compliance Policy Should Count

By Mike Koehler

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he Foreign Corrupt Practice Act is a fundamentally sound statute that was passed

by Congress in 1977 to prevent bribery of foreign government officials in order to advance business interests. It is the most important U.S. law governing international business, but that does not mean that it should be immune from scrutiny. The current FCPA reform debate is healthy.

A common sense reform proposal I support is amending the FCPA to include a compliance defense. Under current law, an organization with pre-existing FCPA compliance policies and procedures, and which is otherwise making good faith efforts to comply with the FCPA, can face legal liability when any employee acts contrary to its policies and procedures. Indeed, one of the ironies of this new era of FCPA enforcement is that several companies have resolved FCPA enforcement actions or were otherwise subject to FCPA scrutiny during the during the same general time period that they were publically recognized as highly ethical companies. continued on page 52

The Proposed Amendments are Dangerous

By Sarah Pray

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he proposed amendments from the U.S. Chamber of Commerce would make it easier to get away with bribery. Amid the talk about competitiveness, prosecutorial discretion, and compliance programs, it is easy to lose sight of the fact that the FCPA was enacted to stop criminal behavior that has real consequences.

Bribery negatively impacts corporations with reputation damage and distorted prices. Governments that encourage corrupt practices lose public confidence. And consumers lose when they are no longer guaranteed the fairest price, subject to competition and the open market.

One proposed amendment is to define the term “foreign official,” the category that the FCPA covers. But it would be nearly impossible to create a definition of foreign official that would work in every country in the world, given the variety of political, social, and economic contexts. Moreover, this would by definition legislate who it is continued on page 53

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Compliance Policy Should Count continued from page 51

Under current law, an organization with pre-existing FCPA compliance policies and procedures might benefit from its commitment to compliance when the DOJ considers its charging decisions and when the DOJ makes a sentencing recommendation. However, these incentives merely lessen the impact of legal exposure. Pre-existing FCPA compliance is relevant only in the opaque, inconsistent and unpredictable world of DOJ internal decision-making.

Thus the current FCPA enforcement environment does not adequately recognize a company’s good faith commitment to FCPA compliance. It does not provide good corporate citizens a sufficient return on their compliance investment.

Such a commitment should be recognized as a matter of law when a non-executive employee acts contrary to pre-existing FCPA compliance policies and procedures. Contrary to the claims of some, an FCPA compliance defense would not reward “fig leaf” or “purely paper” compliance, or eliminate corporate criminal liability under the statute.

A compliance defense would not be relevant to corrupt business organizations, activity engaged in or condoned by executive officers, or activity by any employee if it occurred in the absence of pre-existing compliance policies and procedures.

An FCPA compliance defense is not a new idea. Such a defense passed the House of Representatives in the 1980s during the last substantive FCPA reform debate. The justification and rationale for a compliance defense at that time was slim in comparison to now, given that today most U.S. companies engage

in international business during an era of everincreasing and aggressive FCPA enforcement.

Nor is a compliance defense novel. Many countries that are, like the United States, signatories to the OECD Convention have a compliance-like defense in their domestic laws Despite its firm institutional opposition to an FCPA compliance defense, the DOJ already gives it de facto recognition in its Opinion Procedure Release program and through its non-prosecution and deferred prosecution agreements. Thus an FCPA compliance defense accomplishes, among other things, the policy goal of removing factors relevant to corporate criminal liability from the world of DOJ decision-making and establishing a more transparent, consistent, and predictable model.

An FCPA compliance defense is supported by a growing chorus of former DOJ officials, which makes DOJ’s current opposition to it look suspiciously like an attempt to protect a lucrative enforcement program rather than a principled position.

What is most needed to advance the FCPA’s objective of reducing foreign bribery is not ad hoc enforcement or the current “baby carrots” approach. More robust FCPA compliance will best be incentivised through a compliance defense amendment. A compliance defense is likely to reduce instances of improper conduct and thereby advance the law’s objectives. It also will increase public confidence in FCPA enforcement actions and allow the DOJ to better allocate its limited prosecutorial resources to cases involving corrupt business organizations and individuals who actually engage in the improper conduct. ■

More robust FCPA compliance will best be incentivized through a compliance defense amendment to the FCPA.

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Mike Koehler, Assistant Professor of Business Law at Butler University, has testified before Congress on the FCPA. His views are informed by a decade of law firm practice during which he conducted FCPA investigations, negotiated resolutions to FCPA enforcement actions with government enforcement agencies, and advised clients on FCPA compliance and risk assessment. mjkoehle@butler.edu

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO dec 201 1 / jan 2012

The Proposed Amendments are Dangerous continued from page 51

okay to bribe. Companies should not bribe anyone, officials or otherwise.

The Chamber also suggests that the FCPA should be amended to give companies “credit” for their compliance programs. The Department of Justice has stated unequivocally that they already take compliance programs into account at both the sentencing and charging phases.

Importantly, for a corporation to be held criminally liable under the FCPA, it must be shown beyond a reasonable doubt that the company acted with actual knowledge and corrupt intent. This is a high bar. Creating a compliance defense could allow a company to escape liability for its intentional acts simply by virtue of having a compliance program.

This is also why adding a “willfulness” requirement to the corporate criminal liability standard does not make sense. You should not need to know exactly which provision of the FCPA you are violating. The fact that there are intentional acts of bribery should be enough to render a corporation responsible.

The Chamber has proposed eliminating successor corporate criminal liability for acquiring companies. This would create a perverse incentive to avoid investigations into the misdeeds of the company being acquired.

Companies should not be able to escape liability through restructuring. Similarly, eliminating liability of a parent company for the acts of a subsidiary encourages decreased oversight by the parent.

One of the Chamber’s justifications for

these amendments is supposed “prosecutorial overreach” by the Department of Justice. This is a myth. There has been a modest number of FCPA cases (140 in the last 10 years). Notably, the DOJ prosecutes foreign companies as well as American ones. Eight of the 10 largest FCPA settlements were with foreign companies. The argument that this law puts American companies at a competitive disadvantage rings hollow.

For decades, the United States was the vanguard of the anti-bribery movement. We enacted the FCPA at a time when in some countries bribes were tax-deductible.

However, the United States is no longer in the lead. The United Nations Convention Against Corruption and the UK Bribery Act go further than the FCPA by outlawing facilitation payments and all commercial bribery, not just that of foreign officials.

On one hand, this is a sign of success. By blazing the trail, we’ve created the space for these other important tools in the international fight against bribery. Now is no time to weaken the FCPA and put the United States behind the curve – and worse, slow the global momentum against corruption. We dare not risk sending a signal by amending the FCPA that the United States is no longer serious about combatting bribery and corruption.

For more detailed responses to the Chamber’s proposals, see “Busting Bribery: Sustaining the Global Momentum of the Foreign Corrupt Practices Act,” by Harvard Law Professor David Kennedy and Northeastern Law Professor Dan Danielsen, at www.soros.org. ■

Eliminating successor corporate liability for acquiring companies would create a perverse incentive to avoid investigating possible misdeeds of

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the company being acquired.

Sarah Pray is a policy analyst at the Open Society Policy Center in Washington D.C., where she primarily focuses on advocacy and policy priorities for Africa.

She formerly was the coordinator of the Publish What You Pay United States coalition, advocating for corporate and government transparency and accountability in the oil, gas and mining industries. spray@ospc.com

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Insurance Coverage for Climate Change Lawsuits

By F. William Brownell and Curtis D. Porterfield

Climate change litigation is a reality for many companies today.

It began a decade ago, as part of a two-pronged strategy by states and others to force federal action to limit greenhouse gas emissions.

Over the past decade, companies in the energy, chemical and other industries have become the targets of such litigation. Some plaintiff attorneys have opined that it could grow into another wave of litigation similar to that launched against the tobacco industry. Now, many companies, even those not yet facing climate change suits, are looking to their liability insurance policies to see what coverage is provided and the protections they can expect.

In September of 2011, the Supreme Court of Virginia decided the first climate change insurance coverage case, holding in favor of the carrier. The AES Corp. v. Steadfast Insurance Co. decision, however, should have little precedential value. This article examines why, under existing law, policyholders should expect their insurance carriers to honor climate change litigation claims

Coverage Under General Liability Although no court has yet imposed liability on a defendant for damages allegedly caused by climate change, defendants have incurred millions of dollars defending these claims. Thus, the duty to defend, even without liability, may prove to be valuable to the insured. Since the duty to

defend is contractual, whether a policyholder is entitled to coverage will turn on the law of the jurisdiction and the particular insurance contract at issue.

Whether there is a duty to defend is determined at the beginning of litigation. The courts universally adhere to an analysis that considers first whether there is a possibility that any single allegation will give rise to liability that falls within the terms of coverage.

The duty to defend is broader than the duty to indemnify in order to protect the insured from the outset. A delayed defense is, in effect, no defense at all and irreparably harms the insured. Accordingly, carriers are understandably cautious in denying a defense obligation.

Standard form general liability policies require an insurer to defend the policyholder against suits seeking damages for bodily injury, personal injury or property damage caused by an “occurrence,” as that term is defined in the policy. Most policies define occurrence as an “accident, including a continuous or repeated exposure to substantially the same general harmful condition.”

In determining whether an accident occurred, courts consider whether the alleged damage is unexpected and

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F. William Brownell

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is a partner in the Washington D.C. office of Hunton & Williams, where he leads a broad practice of environmental litigation, regulation and counseling.

He represents corporate defendants in global climate change litigation. bbrownell@ hunton.com

Curtis D. Porterfield, a partner in the Los Angeles office of Hunton & Williams, represents corporate policyholders in complex insurance coverage litigation.

He has litigated and tried cases for coverage of environmental, director and officers, general liability, alien torts, fiduciary liability and toxic torts claims. cporterfield@ hunton.com

unintended. Jurisdictions differ regarding whether the act or the resulting harm must be unintended and unexpected. In many jurisdictions, negligent harm, or a lack of intent to cause the specific harm alleged, if proven, will constitute an accident or occurrence. In these jurisdictions, allegations of negligent or unintentional harm will trigger the duty to defend.

To date, whenever climate change actions have sought damages, they have alleged property damage which, by nature, occurred over extended periods of time, often decades or more. Accordingly, under most general liability policies, exposure to such long-term, continuous, harmful conditions arguably triggers insurance coverage each year in which the harm is alleged to have occurred.

Duty To Indemnify General liability policies should also provide indemnity coverage for damages proven to be caused by the policyholders. While no climate change case has concluded with a settlement or

excludes “[b]odily injury or property damage arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of pollutants: At or from any premises, site or location which is or was at any time owned or occupied by, or rented or loaned to, any insured…”

3. A “total” pollution exclusion excludes “the ‘contamination’ of any ‘environment’ by ‘pollutants’ that are introduced at any time, anywhere, in any way.” It also excludes “any ‘bodily injury,’ ‘personal and advertising injury’ or ‘property damage’ arising out of any such ‘contamination.’”

But a pollution exclusion is not necessarily a bar to claims arising out of climate change. For instance, as illustrated in California v. General Motors Corp., if the carbon dioxide emissions at issue are released from third-party sources such as automobiles, the claim is outside the scope of an “absolute” pollution exclusion be-

The duty to defend is broader than the duty to indemnify in order to protect the insured from the outset of litigation. judgment, liability resulting from the occurrence could take various forms, including monetary damages, injunctive relief, remediation costs, monitoring expenses, etc. If and when there is an award or settlement, policyholders may consider looking to environmental insurance coverage cases for guidance on recoverable damages for property damage under a general liability policy.

If a claim is potentially covered, the burden shifts to the insurer to argue whether any policy exclusions apply. Insurers in global warming cases may argue that a policy’s pollution exclusion bars coverage, but such an argument is unlikely to succeed.

Three versions of the pollution exclusion are commonly seen in commercial liability policies: 1. The “original pollution exclusion,” incorporated into liability policies starting circa 1971, excludes “[b]odily injury or property damage arising out of the discharge, dispersal, release or escape of smoke, vapors, fumes, acids, alkalis, toxic chemicals, liquids or gases, waste materials or other irritants, contaminants or pollutants into or upon land, the atmosphere or any water course or body of water,” unless the release was sudden and accidental.

2. An “absolute pollution exclusion,” incorporated into policies starting circa 1985,

cause the emissions are not released at or from an insured’s location. Similarly, unintended harm resulting from intentional emissions is generally not barred by an “original pollution exclusion” because such damage is “accidental.”

Most important, carbon dioxide may be outside the scope of any pollution exclusion.

Although carbon dioxide is the most ubiquitous offender in global warming claims, carbon dioxide also serves many natural and necessary purposes. Indeed, humans exhale carbon dioxide and plants consume carbon dioxide for survival.

Therefore, it is unclear how a ubiquitous and necessary substance such as carbon dioxide could ever be considered a pollutant.

This argument poses definite challenges for insurers. If courts find that it is within the reasonable expectation of the insured that carbon dioxide is not a pollutant as that term is used in the insurance context, these existing pollution exclusions will be inapplicable and pose no hurdle to establishing coverage under general liability policies arising out of alleged climate change damages.

In conclusion, whether liability will ever be imposed on a defendant for damages allegedly caused by climate change remains to be seen. In the meantime, however, policyholders named as defendants in such lawsuits should expect their insurance contracts to respond with a defense. ■

Don’t Let Regulatory Issues Derail a Healthcare Deal

By Anna M. Grizzle and Claire F. Miley

Regulatory issues arising during healthcare industry transactions can cause major problems. Even minor technical violations of healthcare laws can kill a deal, significantly alter the economic expectations of the parties or lead to settlements or judgments in the millions of dollars.

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One of the strictest of the applicable statutes is the Stark Law, regarding physician self-referral. The Stark Law (with some exceptions) prohibits physicians from referring Medicare patients for certain designated health services, including imaging, lab services, and drugs, to an entity with whom the physician or immediate family member has a financial relationship.

The Stark Law mandates strict liability, meaning innocent violations can trigger penalties. Even inadvertently failing to renew a lease or overlooking a signature on an agreement could result in Stark liability. The result could include civil penalties up to $15,000 for each “tainted” referral, exclusion from Medicare and exposure to whistleblower lawsuits under the False Claims Act. Another federal law, commonly known as the Anti-kickback Statute, makes it a criminal offense to knowingly offer, pay, solicit, or receive any remuneration to induce or reward referrals of items or services reimbursable by a federal health care program. While the Anti-Kickback Statute is intent-based, meaning that a violation must be committed “knowingly,” courts have held that if even “one purpose” of an otherwise legitimate transaction is to induce referrals, the transaction violates the Anti-Kickback Statute. Violations are felonies, punishable by fines of up to $25,000, imprisonment up to five years,

exclusion from federal health care programs and civil monetary penalties Complex billing rules also govern reimbursement for Medicare services. Violations that are considered “conditions for payment” result in an overpayment from Medicare. With recent changes in the law, health care providers and suppliers must report and return identified overpayments within 60 days. These new repayment obligations have also raised the stakes for Stark and Anti-Kickback violations, since compliance with these statutes is generally considered a “condition for payment.”

A health care company looking to merge, sell, go public, or solicit new investment should conduct internal due diligence before proceeding. This may include a compliance audit, consisting of an audit of the company’s coding and billing practices and an analysis of financial relationships with physicians or other referral sources. The identification of financial relationships may necessitate a review of meeting minutes, payment ledgers and time sheets, as well as contracts with physicians.

dec 2011/jan 2012 E X ECUTIVE COUNSEL

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Anna M. Grizzle is a member of the law firm Bass, Berry & Sims, in the firm’s Healthcare Industry Practice Group, where she focuses exclusively on representing healthcare providers and companies in operational and compliance matters, investigations, and litigation. agrizzle@ bassberry.com

Claire F. Miley is a member of the law firm Bass, Berry & Sims. Her practice is devoted exclusively to health law, both regulatory and transactional, including fraud and abuse analyses, contracting, reimbursement analyses, self-referral issues, joint ventures, management relationships, group practice and compensation issues, and operational issues. cmiley@bassberry.com

The audit should be carefully documented, so that if self-disclosure becomes necessary the company can show that it took prompt corrective action to address any problems. Consider using outside counsel to maximize the chance of maintaining attorney-client privilege and to assist in determining if self-disclosure is warranted.

Even when a seller has prepared carefully, a serious health care regulatory issue may arise during the deal. If it does, the parties should conduct an analysis to determine whether or not the matter actually involves a violation of any healthcare law. These laws are complex, and they come with technical definitions, numerous exceptions, and hundreds of pages of interpretive commentary by regulatory agencies.

What initially looks like a major regulatory problem might prove not be an issue.

In some cases, review may yield inconclusive results. The parties might then conclude that disclosure is not necessary and close the deal despite the ambiguities. They might negotiate stronger indemnification language or a purchase price adjustment.

If it’s clear that a healthcare law has been breached, with a resulting overpayment, the overpayment must be returned. To do so, several options are available. If there were non-intentional billing or clerical errors, the best approach may be simply to refund any overpayment to the Medicare contractor. This process generally involves completing a refund form, available on the contractor’s website, and refunding the overpayment by remitting a check or allowing recoupment of the overpayment through offset of future payments.

In cases where the overpayment results from a “technical” Stark violation, such as failing to obtain a signature on an otherwise compliant contract with a physician, the parties may wish to use the Stark voluntary self-referral disclosure protocol (the so-called SRDP) developed by the Centers for Medicare and Medicaid Services (CMS). An SRDP disclosure must take place within 60 days after an entity has identified a Stark law violation that resulted in a Medicare overpayment. If CMS makes a settlement offer and the disclosing party accepts it, the disclosing party will be released from further Stark law liability.

Importantly, however, an SRDP settlement will not release the entity from liability under other health care laws, such as the AntiKickback statute. Also, keep in mind the SRDP process can be lengthy. By the time a selling party reaches a deal with CMS, the deal with a prospective buyer may have fallen apart.

In cases where there is evidence of potential fraud or a potential Anti-Kickback violation, the parties may wish to consider the provider self-disclosure protocol from the Office of the Inspector. Although going this route will not result in an absolute reprieve, it may mitigate the severity of penalties and avoid the cost and disruption of a full-scale government audit and investigation. Note the OIG self-disclosure protocol cannot be used for Stark-only violations, i.e. those that do not also implicate the AntiKickback Statute. The OIG requires a minimum settlement of $50,000 to resolve any kickbackrelated matter that is self-disclosed.

The OIG and SRDP protocols are not the only options for resolving identified overpayments. A self-disclosure to the local U.S. Attorney’s office may allow for a timely settlement of liability in advance of a deal. Alternatively, some providers may choose to simply refund any overpayment resulting from a regulatory violation to the Medicare contractor (in the same way that they might do for a billing or clerical error). By doing so, the provider would no longer be retaining a known overpayment in violation of law. However, this does not bring the same degree of closure and certainty as a government settlement.

Every health care deal is unique, but several clear takeaways emerge from recent transactions and government settlements. First, a seller contemplating a deal should conduct a thorough internal audit in advance of the transaction. Second, if a health care regulatory issue does arise during a deal, the laws and facts should be checked carefully to determine if there is in fact a violation. Third, if there clearly is a need to repay a federal health care program, consider the available disclosure alternatives.

With careful planning, healthcare companies can minimize the chances of a deal being derailed by a healthcare regulatory issue. ■

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Weighing Pro and Cons of Power Co-Generation

By Roy M. Palk and Samuel R. Brumberg

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ew technologies combined with government incentives have created opportunities for energy users to seek out diverse sources of supply and potentially reap significant economic benefits for doing so. A thoughtful strategy on distributed generation or cogeneration is advisable for all companies, even if generation is not part of their core business.

What kinds of questions should executives ask when looking at this issue, and which answers should either raise flags or engender confidence?

Issues of cost and risk are primary. The team studying and potentially executing the project should include experts in a variety of areas, including technology, markets and legal issues. Each of these can have a major impact on project risk as well as securing financing.

Without proper mitigation of the risks, lenders may balk. Nor will lenders be enthusiastic about backing firms that lack experience in operating, maintaining or repairing alternative energy equipment. A well rounded team of experts, along with proper maintenance and warranty contracts, can help ensure the project’s financial modeling is informed and realistic.

For example, imagine a company that bought a fuel cell for $250,000. From the perspective of the c-suite, the fuel cell is essentially a black box. It can be turned off or on, but the company cannot break it open to conduct routine repairs or maintenance.

This has important implications for the contract. Does the fuel cell come with a warranty or service contract? If the fuel cell ends up being nothing but a big paperweight sitting outside the building, what recourse does the company have?

Will the manufacturer stop servicing “1.0” once its ballyhooed launch of “2.0” hits the market?

Likewise, some projects and incentives will require special fuels that could increase the company’s ongoing expenses. If the system needs bio-gas rather than standard gasoline, for example, this factor must be weighed along with whatever government incentive there might be. Indeed, the bio-gas market is a mess in California. If that $6 premium turns into, say, a $13 premium, what would happen to the project?

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Risk assessment for renewable projects also must take operational concerns into account.

If the unit goes out and the company has been depending on it for some quantity of power, what will the replacement cost be? Should the company go to the market to buy that power?

dropped on its way to be installed, your imagined savings might evaporate. Or worse, if an untrained, unqualified, unlicensed or uninsured installer is doing work on that new technology, what would happen if he or she were to be injured? What would happen if incompetent

Ensure that any potential deal rises or falls based on its business merits, even if it does happen to mesh perfectly with a high-priority corporate strategy.

Roy M. Palk 64

is an attorney and 40-year veteran of the energy business.

He is a senior energy industry advisor for LeClairRyan. roy.palk@leclairryan. com

Samuel R. Brumberg is an associate at LeClairRyan. His practice is focused on counseling electric utility, cooperative, end-user and telecommunications industry clients. He also assists companies nation-wide with fuel cell and solar projects. samuel.brumberg@ leclairryan.com

What are the appropriate responses for short or long-term failures and their attendant costs?

How will that replacement power get delivered?

If the company is required to buy only renewable replacement power, is such power available? If the company depends on the plant for base load and needs to keep a monitoring or data center operating 24/7, and the plant goes out, can replacement power be obtained quickly enough and at the right price?

Along with such operational concerns, the team also should look closely at liability and insurance issues. The major investments themselves must be insured, of course, but that in turn may affect other areas of the plant’s insurance footprint. Physical changes caused by installation of the new fuel cell, for example, might impede some plant operations and force foot traffic through a higher-risk area. How will this affect insurance?

Installation, maintenance and operational risks all must be carefully considered. If equipment is being installed, when does title and risk transfer? Confirm that the entire system works properly prior to accepting the risk of delivery.

Throughout the process, the team must remain clear-eyed about the deal. Sometimes business people want so badly to get it done that it begins to take on a life of its own. Ask how closely the deal is associated with the company’s brand or corporate identity. If the answer is “very – it’s part of what defines the company,” it can be hard to let go, but sometimes nixing a problematic deal is the best course. A potential deal should rise or fall based on its business merits, even if it happens to mesh perfectly with a high-priority corporate strategy.

Sometimes cultural considerations do end up overriding business considerations, but usually price trumps all and you’d be on solid legal ground to let it do so. However, good lawyers also will remind you that a cheap product, cheap installation or cheap operations and maintenance are no bargain if they do not simultaneously offer quality, and they may cost you more in the end.

If you’ve got a new fuel cell that gets

installers caused damage to other parts of your facility? Such scenarios are often subordinated to price, not because they are unimportant, but because they are remote. Counsel should make sure you consider them, then let you decide.

Of course along with such doomsday scenarios, companies should assess potential benefits.

Economic incentives are a big part of that. These include the potential role of tax credits or the sale of renewable energy certificates in offsetting some of the capital expense associated with renewable projects. Depending on the local utility’s tariff rate, the company could not only save on its energy costs, it might also receive credits for staying off the grid for certain periods of time and using its own supplemental power. Renewable energy credits are sometimes available for specific types of technologies, as well.

Ascertain what the allowances are in your state for “net metering” (selling power back to the grid), and whether there are other policies that might give the system certain competitive advantages. For example, a state might have a policy of never buying electricity generated with coal. That state, if it buys from off-the-grid sources, could become a big energy customer for your company.

But also keep in mind the possibility that government incentives can change or expire.

Not long ago, few American businesses would have thought seriously about investing in distributed generation, alternative energy or net-metering projects, but today interest is growing rapidly. According to the American Public Power Association, renewable sources make up about 36.1 percent of the fuel mix for new plants coming online in 2011. That number is certain to increase in years to come.

As executives and their counsel contemplate these investments, they need to ask tough questions about costs, benefits and potentially significant legal and liability issues. At the strategic level, the goal is to plan for an overall energy policy that makes the most sense for the individual company’s needs. At the tactical level, the goal is to make the best possible deal even while considering the risks these new technologies represent. ■

ABA International members come from more than 90 countries, and include private practitioners from across the globe as well as in-house counsel, academics and lawyers in the public sector.

REGISTRATION IS NOW OPEN Our Spring Meeting 2012 is shaping up to be our largest ever with over 1,500 attendees expected. Participate in over 70 cutting-edge CLE programs, twice daily networking breaks and evening receptions at some of the most exclusive venues New York City has to offer.

PROGRAMMING HIGHLIGHTS INCLUDE: • Witness/Participant in Legal History: A Conversation with Ben Ferencz • Update of the Implementation of Key Dodd-Frank and EU Financial Market and Bank Reforms • Managing Through Crisis: Corporate Counsel’s Perspective • Think Before You Tweet – What Everyone Should Know About Social Media • Wither Wall Street? – The Impact of Technology and Globalization on International Financial Markets • The New York Advantage: The Creation of Special New York Court Dockets to Streamline and Resolve International Disputes

For more information or to register, please visit

ambar.org/ILspring2012

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