Today's General Counsel, V14 N4, August/September 2017 by Today's General Counsel

AUG/SEPT 2017 VOLUME 1 4 / NUMBER 4 TODAYSGENER ALCOUNSEL.COM

PROTECTION Find the Right Cyber Insurance Policy New IP Protection for Fashion Industry Guarding Trade Secrets and Confidential Information An Underutilized Protection for Patents Harnessing Technology For Legal Compliance Ancient Documents and Hearsay in E-Discovery Countdown to New FASB Rules Food Company Executives at Risk A “Day of Rest” in California

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aug / sept 20 17 toDay’s gEnEr al counsEl

Editor’s Desk

Bipartisanship is a word you see regularly in the news, usually in an article decrying the fact that there isn’t any. But cybersecurity might transcend politics. Last month 38 governors from both parties signed a compact pledging commitment to joint efforts that protect state systems and data. Maybe some day there will be a national plan, but for now U.S. companies have to fend for themselves. The good news is that insurers are stepping up to provide some protection, even if it’s after the fact. In this issue of Today’s General Counsel, L.D. Simmons, Joshua Davey and Lowndes Quinlan provide a primer for buying the right cyber policy. They advise looking at the coverage under your existing policies to start, but be warned. Cyber risks are increasingly being excluded from general liability, property and D&O policies. Robert Yonowitz explains how to implement another kind of data protection program, one designed to safeguard your trade secrets. The fundamentals – restricting access to servers, automatic email copying, password protocols, etc. are among the steps that experts also advise for cyberattack protection, yet it is surprising how many companies haven’t put them into practice. An IP protection that has been available since 1999, but rarely used, is discussed in an article by Thomas McNulty and Peter Lando. It can be employed if a competitor copies your idea while your patent application is pending. The Delaware courts have an outsized impact on corporations, especially in the M&A arena. Timothy Miller counsels caution in agreeing to reliance disclaimers in light of some recent decisions there. He suggests including strong fraud carve-outs in merger agreements, and resisting the inclusion of reliance disclaimers.

Caveat emptor is so thoroughly ingrained in the America psyche that even sophisticated companies can be sandbagged when they enter commerce in a country where a different attitude prevails. Regular contributor Niki Iatrou and his co-author Kayla Theeuwen describe one such situation. Two manufacturers conspire to raise a price in the U.S., a third who follows suit cannot be sued. Read their article to see how that scenario is playing out in Canada. Caveat venditor.

Bob Nienhouse, Editor-In-Chief

bnienhouse@TodaysGC.com

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Features

50 52 56 58 4

How To ConduCT a SuCCeSSful InTernal MISConduCT InveSTIgaTIon Jeffrey Klink and David P. Nolan One tip: Interview the subject last.

fraud Carve-ouTS and THe unInTended ConSequenCeS of relIanCe dISClaIMerS In M&a TranSaCTIonS Timothy A. Miller The only legitimate basis for a reliance disclaimer is to avoid litigation costs over fraud claims that have no merit.

“uMbrella daMageS” foreCaST for Canada Nikiforos Iatrou and Kayla Theeuwen Price fixers may be liable to umbrella purchasers in Canada.

THe lIMITS of “Sole dISCreTIon” In ConTraCTS Mark D. Erickson and David B. Clark Unfettered discretion can’t be used to render the terms of a contract illusory.

CoST SavIngS THrougH “legal ProCureMenT” Silvia Hodges Silverstein Procurement is a natural ally of Legal.

C o lu m n s

worKPlaCe ISSueS federal Protection for lgbT employees and Students

THe anTITruST lITIgaTor legalities of Promotions and allowances

baCK Page fronT burner Countdown to new faSb rules

Mark T. Phillis Despite the change in administration, protection for LGBT employees remains part of the EEOC’s plan.

Jeffery M. Cross Manufacturers can’t favor one retailer over another.

Samir Bodas Public companies are dragging their feet.

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aug/ sept 2017 toDay’s gener al counsel

Departments Editor’s Desk

L abor & EmpLoymEnt

Executive Summaries

16 New Laws Complicate Employee Marijuana Use Rules Robert Nichols and Eric Lai Reasonable accommodation obligations apply in many states.

18 What a Day of Rest Means in California David Goldman Apprise employees of their right and stay neutral about exercising it.

22 Understanding the New Laws on Pay Equity Elizabeth S. Washko A privileged audit of pay equity might be called for.

24 Implementing an Effective Trade Secrets/Confidential Information Protection Program Robert Yonowitz Both physical and legal security are required. E-DiscovEry

28 Ancient Documents, Hearsay and Upcoming Changes Bob Rohlf Become familiar with new FRE amendments, and leverage them.

cybErsEcurit y

30 Buying the Right Cyber Insurance Policy L.D. Simmons, Joshua D. Davey and Lowndes C. Quinlan Understand the nature and extent of your risks. intELLEc tuaL propErt y

34 Provisional Patent Rights— An Underutilized Protection Thomas McNulty and Peter Lando Threat of provisional royalties can deter infringers before a patent issues.

38 New IP Protection for Fashion Industry Kimberly A. Warshawsky Copyrights for design features. compLiancE

40 Harnessing Technology For Legal Compliance By Suzanne Rich Folsom and Kristyn J. Hyland Map vulnerabilities to inform internal controls.

44 Advising Food Company Executives at a Time of Increased Regulatory Risk Maggie Craig and Stefanie Fogel Compliance plan for prevention, privilege for mitigation.

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art dirECtion & photo illustration MPower Ideation, LLC ContriButing Editors and writErs

Samir Bodas David B. Clark Maggie Craig Jeffery Cross Joshua D. Davey Mark D. Erickson Stefanie Fogel Suzanne Rich Folsom David Goldman Kristyn J. Hyland Nikiforos Iatrou Jeffrey Klink Eric Lai Peter Lando

Thomas McNulty Timothy A. Miller Robert Nichols David P. Nolan Mark T. Phillis Lowndes C. Quinlan Bob Rohlf Silvia Hodges Silverstein L.D. Simmons II Kayla Theeuwen Kimberly A. Warshawsky Elizabeth S. Washko Robert Yonowitz

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Executive Summaries L ABOR AND EMPLOYMENT

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What a Day of Rest Means in California

New Laws Complicate Employee Marijuana Use Rules

Understanding the New Laws on Pay Equity

By David Goldman Wendel, Rosen, Black & Dean LLP

By Robert Nichols and Eric Lai Bracewell LLP

By Elizabeth S. Washko Ogletree Deakins

Before deciding Mendoza v. Nordstrom, the Ninth Circuit Court of Appeals had to ask the California Supreme Court for an interpretation of California’s “day of rest” statutes. The statutes provide that an employer cannot cause its employees to “work more than six days in seven.” This does not apply when the total hours of work “do not exceed 30 hours in any week or six hours in any one day thereof.” The Ninth Circuit did not know what that meant. According to the Supreme Court’s interpretation, a day of rest is guaranteed for each workweek, but six consecutive days of work across more than one workweek are not prohibited. The exemption only applies to employees who never exceed six hours of work on any day of the workweek. An employer causes an employee to go without a day of rest when it induces the employee to forego rest to which he or she is entitled. The obligation is to apprise employees of their right and “maintain absolute neutrality” as to the exercise of that right. However, it is not forbidden to allow an employee to independently choose not to take a day of rest if that employee is fully apprised of the entitlement. Employers with California employees should take this opportunity to clarify their policies and avoid at least one of the potholes that can add to employee costs and potential liability for violating the day of rest statutes.

While the first wave of medical marijuana laws beginning in 1996 generally left intact the rights of employers to prohibit and test for marijuana use, a number of new medical marijuana laws include employment-related protections for individuals using medical marijuana. As a result, employers need to re-examine their approach to medical marijuana. On May 23rd, a Rhode Island court held that an employer violated state law when it denied employment to a medical marijuana cardholder who admitted she could not pass the pre-employment drug test. The employment protections of the Rhode Island law represent a departure from most earlier medical marijuana statutes. As employers began litigating issues related to the early laws, a pattern developed. State courts consistently ruled that employer conduct was not restricted by the laws governing medical marijuana use. Legislatures have increasingly limited how employers may address medical marijuana use. This complicates an already problematic situation for multi-state employers. In the majority of states, employers may still prohibit employee marijuana use and mandate tests without limitation. However, a small but growing number of states require a more measured approach. Be careful about taking action simply because an employee admits to being a cardholder, and recognize that reasonable accommodation obligations exist for medical marijuana use pursuant to disability discrimination laws in many states. Watch for further developments from state legislatures with new marijuana laws pending.

California passed its Fair Pay Act in 2015, ostensibly to tighten existing laws prohibiting pay discrimination and to eliminate pay disparities between men and women. Effective Jan. 1, 2016, it modified existing law regarding who may qualify as an appropriate “comparator” for purposes of analyzing a pay disparity. It also modified an employer’s burden of proving that a pay disparity is justified by legitimate factors. Massachusetts, New York and Maryland followed suit with their own updated pay equity legislation, and California has additional legislation pending that will further amend the Fair Pay Act. Many other states and cities have since enacted their own laws. The stated purpose of these laws is to prevent perpetuation of the pay gap between men and women. If a female applicant is already underpaid, then relying on her salary history when establishing starting pay will only perpetuate the gap. The author lists several steps that employers that have traditionally incorporated prior pay inquiries into their hiring processes should consider to address the trend. Among these are pay equity audits, which many employers are conducting to determine potential risks. The audits enable them to identify pay disparities within appropriate comparative groups. The pay equity landscape continues to change, as state and local jurisdictions implement their own laws and regulations designed to combat pay disparities. Employers need to keep abreast of these new laws and be prepared to make the changes necessary to comply with them.

TODAY’S GENER AL COUNSEL AUG/ SEPT 2017

Executive Summaries E-DISCOVERY

CYBERSECURIT Y

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Implementing an Effective Trade Secrets/Confidential Information Protection Program

Ancient Documents, Hearsay and Upcoming Changes

Find the Right Cyber Insurance Policy

By Bob Rohlf Exterro, Inc.

By L.D. Simmons II, Joshua D. Davey and Lowndes C. Quinlan McGuire Woods LLP

Controlling the burgeoning costs of e-discovery was a prime driver behind the 2015 amendments to the Federal Rules of Civil Procedure. Under the radar during the same time period, there was activity by the Judicial Conference Advisory Committee on the Federal Rules of Evidence to add to the list of self-authenticating evidence under FRE 902. This brought little commentary because the changes proposed were seemingly not controversial. However, proposed changes to the FRE 803(16) hearsay exception for ancient documents (those that would be excluded as hearsay except for the fact that they are older than 20 years) were controversial. Attorneys specializing in environmental cases, toxic torts, child sexual abuse cases and other areas presented strong arguments in favor of retaining the ancient document exception. They claimed that these documents were often the only proof of institutional actions and knowledge available. Negative comments were even received from eight U.S. Senators, indicating that abrogating this rule was undermining the will of Congress in certain federal litigation. The Committee decided to allow the exception in all cases in which it was currently being used, but eliminate it going forward. Thus, January 1, 1998, was a “fair date for addressing the rise of ESI.” Beginning on December 1, 2017, the rule will define statements in ancient documents as statements in a document that was prepared before January 1, 1998, and whose authenticity is established. E-discovery teams should become familiar with, and leverage, these new FRE amendments.

Cyber insurance policies have evolved rapidly over the last several years as the insurance industry seeks to align available coverage with risk and demand while avoiding massive losses. Insurers offer first and third party insurance. First party coverage insures for losses to the policyholder’s own data, lost income or other harm to the business resulting from a data breach, cyber-attack or ransomware attack. Third party coverage insures for liability to third parties, including customers and governmental entities. Understanding the nature and extent of your risks is the first step. Companies in some areas are at high risk for exposing personally identifiable information. The major risk to a utility may be the disruption of physical operations through attacks on networks. Companies should purchase coverage that is tailored to their risks. Your standard first and third party policies may provide some protection from cyber risks, and it is important to understand what coverage may be available under your existing policies. However, insurers are increasingly excluding cyber risks from standard commercial general liability, property, and directors and officers liability policies. A broker experienced in placing cyber insurance can identify insurers who offer the product most suited to your needs and help negotiate favorable terms and price. Legal counsel can assist the company in evaluating risks and the scope of coverage offered under cyber policies. Working together, a team including your broker and outside counsel can ensure that you purchase the right coverage with appropriate terms and conditions.

By Robert Yonowitz Fisher & Phillips

With the easy portability of information enabled by technology, it’s important for in-house counsel to implement a trade secrets/confidential business information protection program. Such a program will have two principal components: physical security and legal security. It must include measures taken during the employment relationship as well as the extremely important exit interview process. In respect to physical security, restrict access to servers, routers, and individual databases to those whose jobs require it. Consider using an enterprise “vault” within the company’s email system to make automatic, non-deletable copies of all emails. Keep locations containing the company’s computer hardware and backup devices locked. Establish password protocols for all employees. Train employees on their confidentiality obligations, and establish consistent exit interview procedures. In respect to legal security, requiring employees to sign a confidentiality agreement is an essential element of an effective trade secrets protection program. It should define a company’s trade secrets, as distinguished from business confidential information. It should prohibit unauthorized use or disclosure of trade secrets and confidential information, but not restrain or prohibit employees from seeking alternate employment or competing. It should also contain a severability provision, which allows a court to sever independent clauses that are found to be unenforceable while leaving the rest of the agreement intact. Companies should conduct a once a year review of changes in their jurisdictions’ laws and be willing to amend their agreements when changes in the law require it.

aug/ sept 2017 today’S gEnEr al counSEl

Executive Summaries intellec tual ProPert y

comPliance

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Provisional Patent Rights—An Underutilized Protection

New IP Protection for Fashion Industry

Harnessing Technology for Legal Compliance

By Thomas McNulty and Peter Lando Lando & Anastasi LLP

By Kimberly A. Warshawsky Ballard Spahr LLP

By Suzanne Rich Folsom U.S. Steel and Kristyn J. Hyland Bloomberg Law

Historically, there was almost nothing that could be done if a competitor copied your idea while a patent application is pending. Under a 1999 revision to the patent laws, however, a patent applicant can seek a reasonable royalty for sales of goods and services that are covered by a claim of a subsequently issued patent. These are known as “provisional rights,” because no action to recover can be brought until after the patent actually issues. The patentee must prove that the accused infringer had actual notice of the published patent application. The fact that the published application is available through the PTO’s website or other commercial databases is insufficient. The patentee must also demonstrate that the claims that ultimately issue are substantially identical to the claims as published in the application. If you had to amend the claims, you would not be able to obtain provisional rights stemming back to the publication date. But an applicant can request republication to correct errors in the initial publication, to publish amendments to the specification or claims, or to publish replacement drawings. Notify the putative infringer and provide a copy of the application. Develop a record of amendments made to clarify claim language rather than change claim scope. Upon making substantive amendments, have the application republished, and provide a copy of the republished application to the infringer. These steps should serve to dissuade copiers, and provide for damages for the time between publication and issuance.

Fashion brands in the United States have no specialized laws to protect their designs and innovations. They must rely upon existing intellectual property laws to protect what they create. They have increasingly relied upon design patents and trade dress to protect and enforce their rights, but often the industry has moved on to something new by the time the design patent issues, and trade dress requires proof of secondary meaning. In its March 2017 decision, in Star Athletica, LLC v. Varsity Brands, the Supreme Court held that design features can be afforded copyright protection, provided the design (1) could be seen as a work of art separate from the “useful article” upon which it was placed and (2) would otherwise qualify for protection under the Copyright Act. The Court expressly abandoned the distinction between “physical” and “conceptual” separateness between the design and the useful article. Instead, the Court ruled that a design element is “separate” from an article’s utilitarian aspects for purposes of Section 101 if the design or feature can exist as its own pictorial, graphic or sculptural work that is not itself useful once separated. Star Athletica provides fashion brands with the option to protect designs and artistic elements in an affordable and straightforward manner. The Supreme Court has provided much needed clarity and consistency for those seeking registrations and enforcement, which means that designers and fashion brands can better plan their IP and protection strategies.

Data analytics is a powerful tool that corporate legal departments can harness to help achieve their regulatory and compliance objectives. Essential steps include conducting a thorough risk assessment and mapping vulnerabilities to inform the imposition of strong internal controls. Potentially negative events that would impede regulatory, compliance and ethics objectives are identified by type. At that point, a risk-rating formula can be constructed. Successful third-party due diligence is a vital component of a compliance program. It too requires the clarity that technology brings to important risk-related data. Ideally, a company with overseas operations would conduct reviews of all its third-party relationships, but that standard is unrealistic. The implementation of a robust risk analysis system allows the company to rank the levels of due diligence needed for each third-party vendor, and then assign the appropriate weight to each factor. With an algorithm designed to take numerous risk factors into account, an effective risk analysis and profile can be constructed. This process gives corporate legal departments a solution that provides the ability to customize the analysis for specific factors. While no amount of law or regulation will completely eliminate illegal activity, we do know that a robust, ethical compliance program can help prevent violations as well as mitigate damage if violations do occur, and we now have powerful tools to drive additional positive results. The highest-performing companies have integrated compliance and ethics into the fabric of their culture and business operations.

TODAY’S GENER AL COUNSEL AUG/ SEPT 2017

Executive Summaries FEATURES PAGE 44

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Advising Food Company Executives at a Time of Increased Regulatory Risk

How to Conduct a Successful Internal Misconduct Investigation

Fraud Carve-Outs and the Unintended Consequences of Reliance Disclaimers in M&A Transactions

By Maggie Craig and Stefanie Fogel DLA Piper

Food companies need to be aware of the increasingly litigious environment surrounding food products, which now also includes the risk of criminal enforcement against both the company and its individual executives for violations of the Federal Food, Drug, and Cosmetic Act (FDCA). Risk for executives is amplified in light of the strict liability, no-intent standard for FDCA violations being invoked by courts nationwide, particularly in cases of egregious behavior, willful negligence, or knowing violations of safety, sanitation and adulteration regulations. Risk also exists where executives should have known about, or could have prevented, the violation but did not do so. Specifically under the Park Doctrine, responsible corporate officers can be held criminally liable without a showing of intent or knowledge, so long as the officer had the authority to prevent or correct the violation. While there is uncertainty as to the trajectory of food regulation, the current FDA administration apparently remains committed to enforcement of the Park Doctrine. Here are four best practices for inhouse counsel: (1) build a defensible, customized compliance plan and conduct routine audits of their own facilities and those of key third party partners; (2) properly staff and train the supply chain, engaging with senior management to assess legal and regulatory implications associated with supply chain risk; (3) address issues of non-compliance including, as essential tools, a crisis management plan and recall protocol; and (4) be prepared for government investigations, understand who owns privilege and who can waive privilege, and reiterate Upjohn warnings as appropriate.

By Jeffrey Klink and David P. Nolan Klink & Co.

By Timothy A. Miller Valle Makoff LLP

Organizations of all sizes confront issues of misconduct. Setting aside allegations that must be investigated in a very specific way under state and federal labor and employment laws (sexual harassment or claims of bias, for example), there is a specific path that investigations should follow in order to determine if misconduct allegations have merit. Begin by assessing the allegations. Carefully and discreetly analyze the issues, including the source or sources of the complaint. If you determine that the issues are specific and appear to have substance, assign appropriate personnel and other resources. Write the investigative plan – a flexible written overview of how to proceed – and follow it. Identify those whose conduct will be under review. Always perform background checks on the subjects to assess conflicts of interests, and obtain relevant public records. In many cases, start with document and email retention, and review those documents before talking to people. Conduct site visits if appropriate, and then conduct interviews of knowledgeable people. Interview the subjects last, once you understand the facts. Review. Do you need to perform additional investigation? Conclude the investigation in a timely and effective manner. This would include removing bad actors. Institute internal controls to prevent future misconduct. Draw fair conclusions, without hyperbole, and issue recommendations to improve processes. A thoughtful stepby-step internal investigation methodology will reduce risk and liability for your organization, maximize the opportunity to stop misconduct and improve controls.

Delaware and New York courts routinely uphold reliance disclaimers to limit representations and warranties forming the basis of an M&A agreement to those expressly stated in the contract. M&A agreements often contain various forms of fraud carve-outs, providing that limitations in the contract apply “except in cases of fraud.” Recent court trends counsel caution in agreeing to reliance disclaimers and recognize the validity of strong fraud carve-outs in M&A agreements. A 2016 decision by the Delaware Superior Court – JCM Innovation Corporation v. FL Acquisition Holdings, Inc. – provides a basis for a defrauded buyer to argue that strong fraud carve-outs should control over contractual limitations on remedies, including reliance disclaimers. The court allowed fraud claims to proceed, highlighting a fraud carve-out in the reliance disclaimer that preserved “any rights that Purchaser has with respect to . . . any intentional misconduct by Seller.” The only legitimate basis for inclusion of a reliance disclaimer is avoidance of litigation costs in the event of nonmeritorious fraud claims. If a seller complains about litigation risk/cost, consider agreeing to limited threshold Alternative Dispute Resolution at the pleading stage as a condition precedent to litigation. This will mitigate any legitimate concern that remorseful buyers will be able to press meritless fraud claims through expensive discovery. Buyers should avoid the unintended consequences of reliance disclaimers by including strong fraud carve-outs in their merger agreements, and resisting the inclusion of unchecked reliance disclaimers.

AUG/ SEPT 2017 TODAY’S GENER AL COUNSEL

Executive Summaries FEATURES

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“Umbrella Damages” Forecast For Canada

The Limits of “Sole Discretion” in Contracts

Cost Savings Through “Legal Procurement”

By Nikiforos Iatrou and Kayla Theeuwen Weirfoulds LLP

By Mark D. Erickson and David B. Clark Haynes and Boone

By Silvia Hodges Silverstein Buying Legal Council

A customer buys a product from Manufacturer A. Two other dominant manufacturers of the product (B and C) previously conspired to raise prices. Although Manufacturer A was not part of that conspiracy, it nonetheless raised its prices to match those set by the dominant manufacturers. The customer has therefore overpaid. The question that is the subject of divergent decisions in Canada is whether Manufacturer A’s customer — an “umbrella purchaser” — can sue Manufacturers B and C for the overpayment. In Godfrey v. Sony Corporation, May 2016, the British Columbia Supreme Court (BC’s superior trial court) parted ways with the only express consideration of whether umbrella purchasers have a cause of action. The plaintiffs asserted a breach of the price-fixing provisions of the Competition Act. The Court certified the statutory cause of action, holding that it was not plain and obvious that the umbrella purchasers did not have a cause of action. The Court recognized that allowing umbrella claims is inconsistent with restitution law. However, in the Court’s view, the Act allows any person “who has suffered loss or damage” as a result of prohibited conduct to sue and recover an amount equal to the loss or damage. Godfrey is under appeal. If the decision takes hold, U.S. companies that have participated or are alleged to have participated in price-fixing conspiracies may be liable to umbrella purchasers in Canada, a prospect that does not hold true for U.S. umbrella purchasers under U.S. federal law.

Companies often enter into contractual relationships that give them “sole” or “absolute” discretion to make strategic business decisions. But in many states a covenant of good faith and fair dealing is implied in every contract, and that prevents one party from engaging in conduct that would deny the other party the benefits of the contract. Because a possible breach of the implied covenant turns on whether a party acted in good faith, whether a breach occurred is ordinarily a question of fact. The implied covenant cannot be extended to create obligations not contemplated in the contract. It is limited to assuring compliance with the express terms of the contract. That is particularly important when a company is granted “sole” or “absolute” discretion to act under a contract. Courts have held in such instances that the implied covenant cannot be used to trump a grant of discretionary power if the express purpose of a contract is to grant unfettered discretion, and if the grant of that unfettered discretion does not render the contract illusory. The authors use examples from lawsuits to illustrate their points, and conclude by stating that two steps should be taken to ensure that a contractual grant of “sole” or “absolute” discretion is effective. The grant of discretion should be clear and unencumbered by ambiguous or conflicting rights, and separate and guaranteed consideration should be provided to avoid assertions that the grant of discretion makes the contract illusory.

For many years, GCs and in-house attorneys resisted the influence of legal procurement. Meantime, legal spending for many companies grew as litigation risks increased, government oversight required more detail, and rates increased as major firms competed on pay for top legal minds. Now resistance to the concept is softening, and it is not uncommon for a Fortune 500 company procurement department to have multiple individuals dedicated to sourcing legal services. This is particularly true in some tightly regulated industries, such as pharmaceutical and financial services. The Buying Legal Council’s 2017 survey asked legal procurement professionals how much, as a percent of total spending with legal services providers, they believed their efforts have helped save the organization. According to the survey, companies making even minimal use of procurement professionals save an average of 11 percent on their legal spend. That number reaches 23 percent for companies that devote more effort to the process. Length of tenure correlated with greater success. Legal procurement is still a new profession. However, it is clear that when legal procurement professionals are supported, they can be successful and contribute to a company’s success; and the longer they are in these positions, the more valuable they become. GCs that give them a chance to prove themselves will find them to be an asset. Success comes when year-to-year spending is decreasing, average paid rate is improving and unnecessary legal work is avoided.

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MAY 2018

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aug / sept 2017 today’s gener al counsel

Labor & Employment

What a Day of Rest Means in California By David Goldman

egislators don’t always choose their words carefully when they write the law, and it’s not surprising that the Ninth Circuit Court of Appeals felt it had to ask the California Supreme Court for an interpretation of California’s “day of rest” statutes. On May 8, 2017, that court gave its answer. If you operate a business with employees in California, you will want to pay attention to that answer in order to avoid scheduling missteps that will lead to exposure for violations.

California’s day of rest statutes, found in Labor Code Sections 580-558.1, provide that an employer cannot “cause” its employees to “work more than six days in seven.” This prohibition, however, does not apply when the total hours of work “do not exceed 30 hours in any week or six hours in any one day thereof.” The Ninth Circuit did not know exactly what that meant. This particular controversy arose in a lawsuit by former employees of Nordstrom Inc. who worked in California, in

a case entitled Mendoza v. Nordstrom. On occasion, Nordstrom employees were asked to fill in for another employee, with the result being that some employees worked more than six consecutive days. During each of these periods, some but not all of the employees’ shifts lasted six or less hours. The employees sued Nordstrom in a class action in state court in California, claiming that Nordstrom had violated the guaranteed day of rest statutes, as well as California’s Labor Code Private Attorney General’s Act,

today’s gener al counsel aug / sept 2017

Labor & Employment which allows employees to sue on becould have read that an employer will half of the State of California to recover not cause an employee to work more regulatory fines and keep a portion of than six days “straight” or “consecuthe fines recovered. tively,” but it did not do so. Since Nordstrom is a company orgaThe Supreme Court concluded that a nized with a principal place of business day of rest is guaranteed for each workin another state, Nordstrom removed week. Importantly, this means that six the lawsuit to the Federal Court, based consecutive days of work that stretch upon diversity of citizenship jurisdicacross more than one workweek are tion. Ultimately, the U.S. District Court not prohibited. held a trial and determined that the day The second question was: Should the of rest statute should be calculated on exemption to the “day of rest” guarana rolling basis for any tee apply so long as the seven consecutive days. employee works 6 hours If on any one It also determined that or less at least one day the day of rest guarantee of the applicable workday an employee week or only when an did not apply so long as an employee had at least employee works no more one shift of six hours or works more than than 6 hours on all days less during that same of the workweek? period. Finally, the trial The Supreme Court six hours, a day court determined that explained that the Nordstrom did not cause of rest must be exemption from the day the employees to work of rest statute only apmore than six consecuprovided during plies to employees who tive days because it did never exceed six hours not force them to work work on any day of that workweek. of those days. the workweek. If on any Dissatisfied, the one day an employee employees appealed the works more than six decision to the Ninth Circuit Court of hours, a day of rest must be provided Appeals, which asked the California during that workweek. Supreme Court to “resolve unsettled Third, the court was asked: What questions of California law.” must an employer do to “cause” an The federal appellate court asked employee to go without a day of rest? the California Supreme Court three The Supreme Court decided that questions. First, is the required day of an employer causes an employee to go rest calculated by the workweek or without a day of rest when it induces an on a rolling basis for any consecutive employee to forego rest to which he or seven-day period? she is entitled. The court held that cause The Supreme Court acknowledged required some motivating or inducing that the language of the statute was action, “not simply the passive failure to “manifestly ambiguous.” A reasonable prevent action.” Rather, an employer’s interpretation could mean an employee obligation is to apprise its employees of cannot be required to work more than their right to a day of rest and “maintain six consecutive days in seven or that absolute neutrality” as to the exercise of during a workweek the employee would that right. However, it is not forbidden be entitled to at least one day of rest, to allow an employee to independently although the relevant statute did not choose not to take a day of rest, but only contain the word “week” in it. But if that employee is fully apprised of the the Supreme Court noted that if the entitlement to take a day of rest. legislature intended to protect any seven What’s the takeaway? consecutive days of work, it could have Employers should always define chosen more specific language rather when their workweek begins and ends than using the phrase “more than six in their policy and procedure handbooks days in seven.” For example, the statute and manuals. As the Mendoza decision

makes clear, the day of rest statutes do not guarantee employees will not work more than six consecutive days of work. Rather it provides that in each workweek one day of rest is to be provided. Accordingly, more than six consecutive days of work across more than one workweek is not prohibited by law. Further, if an employee is fully apprised of his or her right to have a day of rest, an employee may voluntarily choose to forego that rest day (and get paid) without liability for the employer. Therefore, employers would be wise to update their employee handbooks to expressly apprise employees of their right to one day of rest during the workweek. Employers may also choose to develop acknowledgment forms for employees to sign if and when they choose to forego that one day of rest. Do not forget that even if an employee voluntarily chooses to work a seventh day in a workweek, a non-exempt employee will nevertheless be entitled to overtime pay for such work according to the Industrial Welfare Commission, Wage Orders, Section 3(A)(1)(a) and (b). Employers with California employees should take this opportunity to clarify their policies and avoid at least one of the potholes that can add to employee costs and potential liability for violating the day of rest statutes. ■

David Goldman is an employment lawyer with the Oakland, Californiabased law firm Wendel, Rosen, Black & Dean LLP. dgoldman@wendel.com

aug / sept 2017 today’s gener al counsel

Labor & Employment

New Laws Complicate Employee Marijuana Use Rules By Robert Nichols and Eric Lai

hile the first wave of medical marijuana laws that began in 1996 generally left intact the rights of employers to prohibit and test for marijuana use, a number of the newest medical marijuana laws now include employment related protections for individuals using medical marijuana. As a result, employers need to reexamine their approach to medical marijuana. A new Rhode Island decision illustrates the dilemma. On May 23rd, a Rhode Island court held that an employer violated state law when it denied employment to a medical marijuana cardholder who admitted she could not pass the pre employment drug test. When she applied, she disclosed she was a medical marijuana cardholder. The employer’s policies prohibited the illegal use of drugs on company property, and provided that all applicants would be tested. The policy, however, did not state that a positive result would cause the employer to withdraw an offer. When the employer informed the applicant that she would not be hired because she was a cardholder, she filed suit under the state’s medical marijuana and disability discrimination laws. The Rhode Island medical marijuana law provides that “[n]o school, employer or landlord may refuse to enroll, employ, or lease to, or otherwise penalize, a person solely for his or her status as a cardholder.” The Act also provides that “[a] qualifying patient cardholder who has in his or her possession a registry identification card shall not be denied any right or privilege for the medical use of marijuana.” In order to qualify for such a card, an individual must have a “debilitating medical condition” that “substantially limits one or more major life activities under the Act.” In its decision, the court rejected

today’s gener al counsel aug / sept 2017

Labor & Employment the employer’s argument that the decision not to hire the individual was based solely on her use of marijuana and not her underlying disability. The court noted that separating the medical condition from its treatment would circumvent the intent of the disability discrimination law. Specifically, the court observed that individuals could not obtain registry identification cards without a “debilitating medical condition,” and employers had an obligation to reasonably accommodate qualified individuals with disabilities. The employment protections of the Rhode Island law represent a departure from most earlier medical marijuana statutes. Beginning with the passage of a California law in 1996, a series of states adopted laws permitting medical marijuana use. In the next several years

drug use into consideration in making employment decisions.” In 2009, the Montana Supreme Court considered whether an employer’s termination of an employee who did not disclose his use of medical marijuana and then failed a drug test was unlawful. The employee alleged that by firing him over his medical marijuana use, the employer failed to offer a reasonable accommodation as required under the Americans with Disabilities Act and the Montana equivalent statute. The state’s Supreme Court, however, rejected these arguments, concluding that the Montana medical marijuana statute “clearly provides that an employer is not required to accommodate an employee’s use of medical marijuana.” Yet another state followed suit in 2011 when the State of Washington’s

The court concluded that the medical marijuana law did not “regulate the conduct of a private employer or protect an employee from being discharged because of authorized medical marijuana use.” In 2015, the Colorado Supreme Court considered a challenge to the termination of a medical marijuana user that was premised on a different theory. The plaintiff, a quadriplegic employee, was terminated from employment with Dish Network after testing positive for the use of marijuana. This Colorado case was novel in that rather than relying on language in a disability law or in the medical marijuana law itself, the employee argued that Dish violated the state’s “lawful activities” law that bars employers from terminating an employee based upon

The court noted that separating the medical condition from its treatment would circumvent the intent of the disability discrimination law.

following the California enactment, at least seven other states adopted medical marijuana laws including Alaska, Arizona, Colorado, Maine, Nevada, Oregon and Washington. DISCRIMINATION DESPITE STATE LAWS

As employers began litigating issues related to the laws, a pattern developed from a series of state court opinions. In particular, these courts consistently ruled that employer conduct was not restricted by the laws governing medical marijuana use. For instance, the California Supreme Court concluded in 2008 that the state’s medical marijuana law did not prevent employers from regulating off duty marijuana use and did not require employers to reasonably accommodate medical marijuana use. Accordingly, the court concluded that “an employer may require preemployment drug tests and take illegal

Supreme Court issued its decision concerning an employee who was terminated following a positive drug test result. The employee, who was using marijuana pursuant to the state’s medical marijuana law, had informed the employer that she was using medical marijuana before submitting to her employer’s drug test. When the positive result came back, the employee was terminated. In response, the employee sued, claiming that the termination violated Washington’s medical marijuana law. Looking to the language of the Washington medical marijuana statute, the court noted that employers were not required to accommodate medical marijuana use “in any place of employment.” Although the employee argued that “the statute implicitly requires an employer to accommodate an employee’s medical marijuana use outside the workplace,” the court rejected this argument based on an analysis of the statute’s language.

engagement in “lawful activities” away from work. The employee argued that because the medical marijuana use was not illegal under state law, his conduct was lawful outside activity for which he could not be penalized by his employer. The court, however, rejected this argument based on its conclusion that the marijuana use did not qualify as “lawful” activity because the conduct was still illegal under federal law. This Colorado decision echoed an important theme that arises in a variety of court decisions. Specifically, courts recognize that while states may enact medical marijuana laws, the use of marijuana for medical purposes or otherwise remains illegal under federal law. NEW LAWS INCLUDE EMPLOYMENT PROTECTIONS

Responding to pressure from medical marijuana supporters in recent years, legislatures have increasingly

aug / sept 2017 today’s gener al counsel

Labor & Employment

limited how employers may address medical marijuana use. For instance, as referenced earlier, the Rhode Island law provides that employers cannot discriminate solely based on an individual’s status as a medical marijuana cardholder. The Connecticut medical marijuana law includes comparable language. A number of the state statutes dealing with medical marijuana also provide certain employer protections. For example, under the Arizona statute, employers may prohibit employees from using or being impaired by marijuana during working hours. The difficulty with the concept of “impairment” is the subjectivity of the term. Some experts have concluded that impairment associated with marijuana use ends within several hours of the use while other researchers believe that impairment can continue for a much longer period. Given this uncertainty concerning “impairment,” managing employee marijuana use can prove to be extraordinarily difficult. In addition to providing a nondiscrimination provision, New York’s medical marijuana law categorically classifies authorized users as having a “disability” under the state’s disability

before, working hours. As a result, in a variety of states, it is uncertain whether an employer can take action against a medical marijuana user for a positive test result. BEST PRACTICES GOING FORWARD

Unless a multi-state employer wants to wholly abandon its normal practices with regard to marijuana, employers will need to adopt a state specific approach to employee use of medical marijuana. In the vast majority of states, employers may still prohibit all marijuana use and test for marijuana without limitation. However, a small but growing number of states require a more measured approach. Employers should be careful about taking action simply because an employee admits to being a cardholder. While employment action on this basis may be permissible in some states with medical marijuana laws, it is unlawful in a number of other states. In certain states with medical marijuana laws that impose restrictions on employers—including, for example, New York, Rhode Island and Connecticut—an employer may need to modify its drug testing program. Specifically,

While states may enact medical marijuana laws, the use of marijuana for medical purposes or otherwise remains illegal under federal law.

discrimination law. As a result, employers in New York may have an affirmative duty to reasonably accommodate authorized marijuana users. One significant complication for employers associated with these protections is the impact on marijuana testing. Marijuana tests generally cannot differentiate between an employee’s authorized, off duty use of medical marijuana and an employee’s unauthorized use of marijuana during, or shortly

employers must refrain from taking action against an employee who produces a positive result and participates in the state’s medical marijuana program. While most states with employment protections still prohibit employees from reporting to work impaired, a positive test provides no reliable indication that the employee reported to work “impaired.” Employers need to recognize that, in a number of states, reasonable accommodation obligations exist for medical

marijuana use pursuant to the state’s disability discrimination laws. Thus, employers should assess their drug policies to ensure they are consistent with the laws of the states in which they have employees. Finally, employers should watch for further developments from state legislatures with new marijuana laws pending and continue to comply with federal drug testing requirements, including Department of Transportation regulations, to the extent applicable. ■

Robert Nichols is a partner with Bracewell LLP in Houston He represents employers in litigation, administrative investigations and inspections, and concerns related to employment. bob.nichols@bracewell.com

Eric Lai is an associate in Bracewell’s labor and employment practice in Houston. He counsels clients on employment law matters, and represents employers in administrative proceedings and state and federal litigation. eric.lai@bracewell.com

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NOVEMBER 1

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AUG / SEPT 2017 TODAY’S GENER AL COUNSEL

Labor & Employment

Understanding the New Laws on Pay Equity By Elizabeth S. Washko

“salary” and “pay” to include all forms alifornia passed its Fair Pay Act in is of great concern to many employers, of compensation, including benefits and 2015, ostensibly to tighten exist- prohibited employers from asking job applicants about their current pay or incentives, although some of the laws do ing laws prohibiting pay discrimisalary, and pay or salary history. not define these terms and others specify nation and to eliminate pay disparities The Massachusetts law marked the just certain types of compensation. between men and women. Effective Jan. beginning of a trend. Other states and Other provisions that vary from 1, 2016, it modified existing law regardcities – Oregon, Delaware, New York jurisdiction to jurisdiction include ing who may qualify as an appropriate City and Philadelphia among them – prohibitions against screening applicants “comparator” for purposes of analyzhave passed similar laws applicable based on salary histories; prohibitions ing a pay disparity. It also modified an to private employers. Puerto Rico has against requiring that an applicant’s employer’s burden of proving that a pay passed similar legislation, and many prior salary meet a certain minimum disparity is justified by legitimate factors. more states and cities are considering or maximum; restrictions on how an Also in 2016, Massachusetts, New York such laws. In some cases the legislaemployer may use the salary history and Maryland followed suit with their tion has been passed and is awaiting that an applicant voluntarily provides; own updated pay equity legislation. gubernatorial or mayor approval. In whether and when an employer can Then, in 2017, California amended its confirm an applicant’s salary Fair Pay Act so it history; the requirement that emapplied to race and ployers post notices of the laws ethnicity. California The theory is that if a female applicant in their workplaces or in job has additional legislapostings; and the requirement tion pending that will is already underpaid compared to her that employers provide informafurther amend the tion about, or in some cases pubFair Pay Act. male counterparts, then asking about her lish, minimum or any pay ranges Meanwhile, a for the applicable position. number of other Importantly, no law in effect states and cities salary history when hiring and establishing thus far prohibits an employer have passed or are from asking an applicant about considering pay eqher starting pay based on that history his or her salary or compensation uity legislation that expectations. would affect what will only perpetuate that pay gap. The stated purpose behind constitutes legitimate these laws is to prevent the perreasons to justify a petuation of the pay gap between pay difference, the addition, some jurisdictions, including men and women. The theory is that if burdens of proof in pay discrimination New York state and New Orleans, have a female applicant is already underpaid cases, enforcement provisions (such as passed prior pay legislation that apcompared to her male counterparts, increased damages and penalties), and then asking about and relying on her employer policies relating to confidenti- plies only to governmental agencies. The primary focus of these laws is to current salary or salary history when ality and hiring practices. hiring her, and establishing her starting This article addresses certain aspects prohibit employers from asking about or requiring job applicants to provide pay based on that salary history, will of these new laws that employers need information regarding their current only perpetuate that pay gap. On the to be aware of, with practical guidance salaries or salary histories in connection other hand, requiring employers to make on actions employers should consider with the application and hiring process. starting pay decisions based on how in response. But some laws go further, by prohibiting they value the position (in addition to employers from seeking such information other factors, like education and expeNO PRIOR PAY INQUIRIES When Massachusetts passed its new from other sources, such as an applicant’s rience) is thought to have the desired pay equity law in 2016, the provision current or former employer, or the intereffect of increasing parity. that received the most attention, and net. Generally, these laws define the terms Critics of these laws raise a number of

TODAY’S GENER AL COUNSEL AUG / SEPT 2017

Labor & Employment

concerns, including constitutional ones. The Philadelphia Chamber of Commerce has filed a lawsuit asserting, among other arguments, that the Philadelphia ordinance banning prior pay inquiries violates the First Amendment. Other concerns are practical. Some employers argue that information regarding prior salary and benefits enables them to determine whether it makes sense to invest time and effort to pursue a particular candidate. If the candidate’s current pay and benefits far exceed those contemplated for the position at issue, the employer’s hiring efforts may be better spent on other candidates. Other employers assert that prior salary information enables them to

make an offer that is more likely to be accepted. That is, that knowledge about an applicant’s current salary indicates how much the employer may need to offer within an applicable salary range. For high-earning positions that may include a variety of compensation opportunities and incentives outside the base salary, it also may be difficult to fashion an appropriate offer without information about what the applicant is currently earning in pay, incentives and other benefits. Compounding the challenge for employers is the fact that these laws are being passed with differing restrictions in various states and cities, resulting in requirements for a multi-state employer

or even multi-city employer within a single state. Regardless of the theoretical underpinnings of these laws, unless they are challenged and overturned, they will require many employers to rethink and revise important aspects of their hiring processes. Employers that have traditionally incorporated prior pay inquiries into their hiring processes should consider taking several steps now to address the trend: • Understand the current law on this issue in the states and cities where they operate, and make sure they track pending and newly passed continued on page 27

aug / sept 2017 today’s gener al counsel

Labor & Employment

Implementing an Effective Trade Secrets/Confidential Information Protection Program By Robert Yonowitz

ith the easy portability of information now enabled by technology, it’s more important than ever for in-house counsel to implement a trade secrets/business confidential information protection program. Such a program will have two principal components: physical security and legal security. Companies are entitled to judicial protection for their trade secrets and confidential information only if they employ reasonable physical security measures to protect them. Thus, they

are critically important. They include measures taken during the exit interview process, as well as during the employment relationship. It is hard to argue that a company employs reasonable security measures if it exercises them only at the inception of the employment relationship, and not at the time when the information is most at risk: at the cessation of the employment relationship. This article will also focus on the dos and don’ts of the confidentiality/ non-disclosure agreements that all

companies, regardless of jurisdiction, should employ. These agreements are as essential as physical security measures in establishing that the company is employing reasonable measures to ensure the secrecy of its confidential/ trade secret information. PHYSICAL SECURITY MEASURES

If a company wants a court to treat its trade secrets and business confidential information as such, it must itself treat that information as confidential. Physical security measures should include:

today’s gener al counsel aug / sept 2017

Labor & Employment 1. Restrict access to servers, routers, and individual databases to those whose jobs require it. With customer databases, consider limiting employee access only to those customers that the employee deals with. 2. Consider key-stroke surveillance software to actively monitor usage of all company computer networks. This software can track, log, identify and inform the company’s designated representative of any unauthorized access or unpermitted use of any database. 3. Keep wire closets, server rooms, phone closets, file cabinets and other locations containing the company’s principal computer hardware and backup devices locked at all times. Use sign-in/ sign-out sheets for hard copy files to maintain a chain of custody. 4. Consider using an enterprise “vault” within the company’s email system (either in the cloud or on a redundant dedicated backup server) to make automatic, non-deletable copies of all emails sent or received on the company’s email system. This auto-archiving feature helps preserve only “copies” of important documents and email and is extremely helpful in forensic investigation of trade secret theft, as a way to find emails that departing employees sent to themselves and then deleted in the hope they would not be found. 5. Establish password protocols for all employees. Do not let employees pick their own passwords, as they are likely to pick passwords that are easily discoverable (like a pet’s name). Instead, assign passwords that consist of random letters and numbers. (There is software that will create these passwords.) Change passwords every 10 to 30 days, and make sure company policy prohibits sharing of passwords among employees. As a matter of policy, immediately delete an employee’s password and all network access rights immediately upon cessation of employment. 6. Implement a computer, internet, email and electronic communications policy that makes clear to all employees that they have no expectation of privacy in their use of company computers and other devices, and that the company has the right to monitor, log and conduct

surveillance on all company computer activities. This policy is essential to permit companies to investigate potential trade secret/business confidential information theft. The policy should also provide for employee consent to the inspection, by the company, of any devices used by the employee (even personally-owned devices) that contain company information. 7. Watermark all confidential documents (paper and electronic) with the words “Confidential Information – Property of Company.” 8. Train employees on their confidentiality obligations. Training should include making clear the kind of information that is to be treated as confidential.

Restrict access to servers, routers, and individual databases to those whose jobs require it. 9. Consider using confidentiality provisions with customers and vendors who are permitted to see information the company wants treated as confidential. 10. Establish consistent exit interview procedures. They should include requiring the departing employee to return all company equipment (especially phones and computers). They should also be required to return – not destroy – all paper and electronic data in their possession or control that contains trade secrets/confidential information. If the information resides on personal devices owned by the employee and the company implements the recommendations in item six above, then the company should make arrangements with the departing employee to have a company representative inspect the devices for the purpose of identifying, copying and then deleting the information. 11. Where an employee had regular access to confidential information,

the company should image all work computers, phones, hard drives and removable storage media (i.e., thumb drives, zip drives) and store those images before those devices are reissued to another employee. If the devices will not be reissued, the devices should be stored securely for later forensic inspection in the event of suspected theft of trade secrets or confidential information. Similarly, email mailboxes of such employees, especially from the last 60 to 90 days of employment, should be duplicated and preserved for potential future forensic examination in the event of suspected misappropriation. 12. Disable all account password, VPN and other access privileges, so as to prevent future remote access. 13. Require departing employees to sign a termination certificate, certifying they have returned all company property and confidential information. LEGAL SECURITY MEASURES

Requiring employees to sign a confidentiality agreement is an essential element of an effective trade secrets protection program. Courts have held that, in itself, it is sufficient evidence that a company has taken reasonable measures to ensure protection of confidential or trade secret information. However, if these agreements are too broad in scope or duration, they will not be enforced. Thus, it’s critical to understand the limits and key components of an effective confidentiality agreement. 1. It should separately and accurately define a company’s trade secrets, as distinguished from business confidential information. The best practice is to interview the key business and technology players, in order to identify the company’s processes, formulas, and analytical data, as a way to define the proper “labels” or categories of secret information. Not all information that a company believes is secret qualifies as a trade secret. Interviews will also identify confidential business information – information that is not available to the public, competitors, or customers. To qualify as business confidential information, a company must establish that

AUG / SEPT 2017 TODAY’S GENER AL COUNSEL

Labor & Employment this information is provided to employees on a need-to-know basis and that employees are made aware they must treat the information as confidential. Once identified, descriptive labels (such as “all information in the company’s

contain a severability provision, which allows a court to sever independent clauses that are found to be unenforceable while leaving the rest of the agreement intact. 8. Confidentiality agreements should have choice of law provisions that utilize

As a matter of policy, immediately delete an employee’s password and all network access rights immediately upon cessation of employment.

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CRM system”) should be used to define the information’s parameters. 2. Confidentiality agreements should prohibit unauthorized use or disclosure of trade secrets and confidential information, but not restrain or prohibit employees from seeking alternate employment or from competing. 3. In states that prohibit noncompetes, or non-solicitation covenants that prohibit solicitation regardless of whether trade secret/confidential information is used, companies can still have provisions that restrict employees from soliciting customers when such solicitation is done through the use of confidential information or trade secrets. 4. Confidentiality agreements should prohibit employees from soliciting or recruiting co-workers to quit their jobs or join a competitor, but they should not prevent employees from hiring coworkers. 5. Confidentiality agreements should require the return of all trade secret/ confidential information at the time of termination or resignation. During the exit interview departing employees should be required to sign a termination certificate, certifying that such information has been returned. These agreements should consent to having such information recovered from all devices, even personal devices, as part of the exit interview process. 6. Confidentiality agreements should also inform employees that they are prohibited from bringing to the company the trade secrets or confidential information of former employees or third parties. 7. Confidentiality agreements should

the law of the state where the employee is domiciled unless the company is a multi-state employer. In that case, many states will allow a company to choose the law of the state where central operations are located so as to ensure consistency in enforcement of such agreements regardless of the particular company location. In states that permit it, companies with multiple locations should also consider using a choice of forum provision, selecting a forum where the headquarters is located to ensure consistent enforcement regardless of location. 9. A company should conduct a once a year review of changes in its jurisdiction’s laws to ensure continuing enforceability, and it should be willing to amend its agreements when changes in the law require it. ■

Robert Yonowitz is a partner in the Irvine office of Fisher & Phillips. He is the co-chair of the firm’s Employee Defection & Trade Secrets Practice Group, a national practice concentrating on issues surrounding employee defection, employee recruitment and trade secrets protection. ryonowitz@fisherphillips.com

today’s gener al counsel aug / sept 2017

Labor & Employment Pay Equity

continued from page 23 legislation that may affect them. • Review existing hiring policies, practices and documents – including job postings, applications, and interview questions – to determine what modifications may be required to comply with the applicable laws. • Review the company’s approach

performing the same jobs in different jurisdictions. TRANSPARENCY REQUIREMENTS

Many of the newly passed or pending pay equity laws prohibit restrictions on employees discussing their pay with others and/or from inquiring about pay. With respect to employees protected by the National Labor Relations Act, these laws are superfluous. It has long been

No law in effect thus far prohibits an employer from asking an applicant about his or her salary or compensation expectations. to setting starting pay, considering such issues as what role prior pay information has played in those decisions, whether such information is useful and appropriate, and how starting pay decisions can be made without such information. • Communicate with those employees responsible for making hiring and starting pay decisions, to make sure they understand these laws and their role in ensuring compliance. This may constitute a significant culture change for some employees, and training may need to be provided. • Employers operating in multiple jurisdictions need to decide whether to comply with these laws only where they are in effect or to apply the policy and document modifications across the board. Given the relatively small number of laws currently in effect, employers may be inclined to limit policy and practice modifications only to those locations directly affected. This approach, however, could pose challenges, including the administrative challenge of having differing policies in different jurisdictions; having to continuously add locations and modify policies as the laws change in new jurisdictions; and potential risks associated with applying different policies to employees

the case that discussion of compensation by these employees qualifies as protected “concerted” activity, and it may not be prohibited. These new laws, however, expand this kind of protection to everyone in the company, including supervisors. None of the laws currently in effect require an employer to provide inquiring employees with information regarding their coworkers’ compensation, but they do preclude employers from retaliating against employees who ask the question. Again, these legislative changes may require a cultural shift, policy modifications, and good communication with company leadership and human resources – and perhaps some training.

Some states are providing explicit incentives for employers to conduct pay audits. Under the Massachusetts law that was scheduled to go into effect in July, an employer defending a pay discrimination claim under the statute may, as an affirmative defense, assert that it has completed a self-evaluation of its pay practices “in good faith” within the three years prior to the commencement of the claim, and has made “reasonable progress” toward eliminating gender-based wage differentials. It is unclear exactly how this defense would work in practice. In order to rely on it, an employer likely would have to waive attorney-client or work-product privilege covering such a self-evaluation. Moreover, there is not yet any guidance as to what may qualify as a good faith evaluation of pay practices or reasonable progress toward eliminating pay differentials. Oregon included a similar provision in its recently-enacted pay equity legislation, and similar provisions can be found in other proposed and pending legislation from other cities and states. Employers operating in states with this type of available defense should factor such provisions into their analysis of whether to conduct a pay audit, and, if so, how to conduct it. The pay equity landscape continues to change, as state and local jurisdictions implement their own laws and regulations designed to combat pay disparities. Employers need to keep abreast of these new laws and be prepared to make the changes necessary to comply with them. ■

PAY EQUITY ANALYSES AS AFFIRMATIVE DEFENSE

Given the proliferation of state and local laws that focus on pay discrimination, and in many cases increase the burden of defending such claims, many employers are conducting pay equity audits to determine potential risks. These audits, conducted under privilege, enable employers to identify pay disparities within appropriate comparator groups, determine whether those disparities can be explained by legitimate factors, and where appropriate correct disparities that cannot be explained.

Elizabeth Washko is co-chair of the Pay Equity Practice Group at Ogletree Deakins and the managing shareholder of the firm’s Nashville office. liz.washko@ogletree.com

aug / sept 2017 today’s gener al counsel

E-Discovery

Ancient Documents, Hearsay and Upcoming Changes By Bob Rohlf

ontrolling the burgeoning costs of e-discovery was a prime driver behind the 2015 amendments to the Federal Rules of Civil Procedure. Both in the lead up to the amendments and subsequently, there was lots of noise about pending changes to the rules. Under the radar during the same time period, there was activity by the Judicial Conference Advisory Committee on the Federal Rules of Evidence to add to the list of self-authenticating evidence under FRE 902. This activity brought almost no commentary from practitioners, primarily because the changes proposed were seemingly noncontroversial. By a strange quirk of fate, the Advisory Committee considered addressing the latest categories of evidence (i.e., electronically stored information) while at the same time proposing changes to FRE 803(16), the hearsay exception for ancient docu-

that some forms of ESI documentation were approaching the 20-year mark— and those documents could be potentially admissible at trial under FRE 803(16). Capra was clearly not a fan of the ancient documents rule as it applied to paper documents, and was highly concerned about lawyers applying it to “terabytes of easily retrievable data potentially admissible for their truth simply because they are old.” HEAT OVER FEDERAL RULES OF EVIDENCE

The exponential growth in electronic data made the need for change to FRE 803(16) even more pressing. And Capra, as the reporter to the Judicial Conference Advisory Committee on Evidence Rules, was in a good position to bring attention to the problem. In addition to the problem of ESI vol-

The theory is that older writings transcend a current controversy, making them more likely to be reliable. ments (those that would be excluded as hearsay except for the fact that they are older than 20 years). The exception is based on the theory that older writings transcend a current controversy, making them more likely to be reliable. These two subject matters are more connected than one might think. A 2015 Yale Journal of Law & Technology article by Daniel Capra, “Electronically Stored Information and the Ancient Documents Exception to the Hearsay Rule: Fix It Before People Find Out About It”, called attention to the fact

umes, the Committee reasoned that the ancient documents exception confuses authenticity of a document with reliability of the contents of that document. Hence, the Advisory Committee proposed changes that were published for public comment. The Advisory Committee received 222 comments on changes to the evidence rules compared to over 2300 comments for changes to the Federal Rules of Civil Procedure; so not much heat was generated over impending changes to the FRE. Of the 222 comments, few

concerned changes to Rule 902(13) and (14). Public commentary generally supported the additions, but many suggested clarification tweaks to the Committee notes. Most of the commentary received by the Committee focused on FRE 803(16), generally opposing the elimination of the ancient documents rule. Capra stated, “The public comment was the most one-sided negative set of comments that the Evidence Rules Committee has yet received.” Attorneys specializing in environmental cases, toxic torts, product liability, bankruptcy, rail and maritime, latent diseases and child sexual abuse cases presented strong arguments in favor of retaining the ancient document exception. They claimed that these documents were often the only proof of institutional actions and knowledge available. Negative comments were even received from eight U.S. Senators, indicating that abrogating the ancient documents rule was undermining the will of Congress in certain federal litigation. The Committee was surprised at the volume of negative input. The Advisory Committee had unanimously recommended eliminating FRE 803(16). However, with an assumption that the ease and low cost of storing electronic documents would ultimately lead to a crisis down the road, they determined that doing nothing was an unacceptable alternative. NO SAFE HARBOR

The Committee decided to allow the exception in all the cases in which it was currently being used, but to eliminate it going forward, thus preventing the use of FRE 803(16) from becoming a “safe harbor” for unreliable ESI in future cases. To achieve this, the Committee

today’s gener al counsel aug / sept 2017

E-Discovery

chose an arbitrary date as a cutoff for ancient documents. They decided that January 1, 1998, met the goal of not affecting the current cases highlighted in public commentary, and was a “fair date for addressing the rise of ESI.” Beginning on December 1, 2017, the rule will define statements in ancient documents as statements in a document that was prepared before January 1, 1998, and whose authenticity is established. Changes to both Rules 803 and 902 were aimed at addressing issues unique to ESI and at reducing the cost of litigation. The Rule 803 amendment heads off the potential difficulty of massive

volumes of data “aging” into the rule. Amendments to Rule 902 brings cost savings by streamlining the process of authenticating certain kinds of electronic data offered as evidence. Rule 902 deals with types of electronic evidence that are unlikely to require authentication in the first place and only rarely disputed. The following exceptions were added to the hearsay rule, alleviating the need to call a witness at trial: (13) certified records generated by an electronic process or system and (14) certified data copied from an electronic device, storage

medium or file, if authenticated by a process of digital identification, as shown by certification of a qualified person. FRE 902(13) sets a presumption that machinegenerated information, such as computer log files or registry reports are authentic and can be relied upon, and are therefore self-authenticating. The benefits of the change to proponents of this evidence are the cost and time savings associated with substituting a certificate from a qualified person for continued on page 33

AUG / SEPT 2017 TODAY’S GENER AL COUNSEL

Cybersecurity

Buying the Right Cyber Insurance Policy By L. D. Simmons II, Joshua D. Davey and Lowndes C. Quinlan

n May 12 a massive ransomware attack, dubbed “Wannacry”, infected more than 300,000 computers in 99 countries. The perpetrators threatened to destroy data if the ransom was not paid by a deadline. Few ransoms were paid but the cost of recovering lost data, repairs and patches following the attack is estimated at $8 billion world wide. A group known

as the “Shadow Brokers,” who claimed responsibility, have threatened additional attacks; and cyber security experts have expressed concern the threat is real. In the fallout from the Wannacry attack, many companies have expressed renewed interest in cyber insurance. But where to begin? Cyber policies have evolved rapidly over the last several years as the insurance industry seeks to align

available coverage with risk and demand while avoiding massive losses. First, companies should understand what risks cyber policies do and do not cover. Insurers offer first- and third-party insurance for cyber losses. First-party coverage insures for losses to the policyholder’s own data, lost income or other harm to the policyholder’s business resulting from a data breach, cyber-attack

today’s gener al counsel aug / sept 2017

Cybersecurity

or ransomware attack. Third-party coverage insures for the liability of the policyholder to third parties, including customers and governmental entities. AVAILABLE COVERAGES

Available third-party coverages include: • Litigation. Covers the costs associated with civil lawsuits, judgments, settlements or penalties resulting from a cyber event, including class action litigation and claims for violation of privacy laws. • Government and regulatory. Covers the legal, technical or forensic services necessary to assist the policyholder in responding to governmental inquiries relating to a cyber-attack and/or coverage for defense costs, fines and penalties resulting from a governmental investigation or regulatory proceeding. • Management liability. Covers claims against directors, officers, and management of an insured company arising from cyber events. • Cyber induced bodily injury and property damage. Covers bodily injury or property damage resulting from a cyber event, such as a hack of an autonomous or semi-autonomous vehicle. • Credit monitoring. Covers the costs of credit monitoring, fraud monitoring or other related services provided to affected customers or employees.

• Crisis management. Covers crisis management and public relations expenses incurred to educate customers concerning a cyber event and the policyholder’s response. • Business interruption. Covers lost income and related costs where a policyholder is unable to conduct business due to a cyber event or data loss. • Extortion/Ransomware. Provides coverage for costs associated with the investigation of threats to commit cyber-attacks against the policyholder’s systems and for payments to extortionists who threaten to obtain and disclose sensitive information. RECOMMENDATIONS FOR BUYERS

Understanding the nature and extent of your risks is the first step. Banks, healthcare companies and retailers necessarily focus on the risk of the exposure of personally identifiable information. On the other hand, a major risk to a utility or energy company may be the disruption of critical businesses or physical operations through attacks on networks.

security practices. Cyber insurance is only one component of your plan for responding to data security incidents. Ensure that you have adequate processes in place to mitigate cyber risk, including routine patching of software applications. Insurers will request this information for the underwriting process, and it pays to be prepared. With the variety of coverages offered by insurers today, it is important to focus on purchasing coverage for the specific risks you face. Cyber policies are not standardized. Many terms and exclusions are negotiable. It is worth the effort to obtain several coverage proposals and to select a policy that best meets your needs. Secure appropriate limits and sublimits. One of the most important steps a company can take in evaluating cyber risk is to assess the anticipated costs. To the extent possible, you should try to match your limits of liability with your realistic exposure in the event of a cyber loss. Also, pay attention to sublimits for specific coverages (such as for crisis management expenses, notification costs and regulatory investigations), which are

Insurers are increasingly excluding cyber risks from standard commercial general liability, property and D&O policies.

Available first-party coverages include: • Forensic investigation. Covers the legal, technical or forensic services necessary to assess whether a cyberattack has occurred, to assess the attack’s impact and to stop an attack. • Computer data loss and restoration. Covers physical damage to, or loss of use of, computer related assets, including the costs of retrieving and restoring data, hardware, software or other information stolen, destroyed or damaged. • Notification costs. Covers the costs to notify customers, employees or other victims, including notice required by law.

Companies should purchase coverage that is tailored to their risks. Your standard first- and third-party policies may provide some protection from cyber risks, and it is important to understand what coverage may be available under your existing policies. However, insurers are increasingly excluding cyber risks from standard commercial general liability, property, and directors and officers liability policies. Understanding your existing coverage will enable you to purchase the type of insurance you need. It is important to review your data

found in most policies. These sublimits are often inadequate, but many carriers are willing to negotiate on the size of the sublimit, sometimes with no increase in premium. Cyber policies rely heavily on definitions. Frequently, numerous terms within a defined term are specially defined by the policy. Although tedious, analyzing these definitions is necessary to ensuring that your company obtains the coverage it needs. For example, at least one insurer defined “computer systems” in a way that excluded systems run by outside contractors. For any policyholder who

aug / sept 2017 today’s gener al counsel

Cybersecurity

relies on an outside vendor or has operations in the Cloud, this definition could leave a large hole in coverage. Beware of exclusions. Often, coverage for a loss or claim depends on the language in the policy exclusion as opposed to the language in the grant of coverage. Because cyber insurance is a relatively new product, policy language is not standardized. Policies may contain exclusions that have been cut and pasted from other insurance forms, and the exclusion may not belong. If an insurer is not willing to remove an objectionable exclusion or limitation, ask your broker to obtain a quote from a carrier who will. Seek retroactive coverage. Cyber policies restrict coverage to breaches or losses that occur after a specific date, or the “retroactive date.” In many cases, this is the inception date of the policy. This means that there would be no coverage for breaches that occurred before that date. Because breaches may go undetected for some period of time, it is

data through personal computers to buy insurance that covers such losses. A data loss may cause not only the loss of information but also could result in regulatory actions against your company. You should consider whether your insurance policy covers regulatory investigations or regulatory actions arising from a cyber incident. As you consider the purchase of cyber insurance, be certain to involve all potential constituencies within the company. You are more likely to purchase the right policy with the right limits if you include all the divisions that should have input into the insurance-buying decision. You should ensure that your indemnity agreements work hand-in-hand with your cyber insurance. For example, many cyber policies have retentions and require that the retention be satisfied by the insured. Insurers may interpret this language to require that the insured pay the retention out of its own pocket and

Many carriers are willing to negotiate on the size of the sublimit, sometimes with no increase in premium.

important to purchase coverage with the earliest possible retroactive date. Evaluate coverage for data restoration costs. Many cyber insurance policies do not cover costs to replace, upgrade or maintain a computer system that was breached. Data restoration costs are potentially prohibitive. Any company facing the risk of a data breach should take steps to ensure that its policies cover the costs of putting the company back in the position it was in before the breach. Consider coverage for loss of information on unencrypted devices. Although many firms encrypt company-owned laptops, personally owned computers and storage devices often are not. It is important for firms facing a loss of

that a payment by a third party, such as a vendor under an indemnity agreement, would not satisfy the retention. This is a subject for negotiation with the insurer during the underwriting process. Follow through. Cyber insurance should not be a product you purchase and then simply renew from year to year without further analysis. Because cyber risk and cyber coverage continue to evolve, take the opportunity to reevaluate their risks and the adequacy of their coverage at renewal time. Companies rarely have the expertise in house to do all of these things. A broker experienced in placing cyber insurance can identify the insurers that offer the product most suited to your needs

and help negotiate favorable terms and price. Legal counsel can assist the company in evaluating risks and the scope of coverage offered under cyber policies. Working together, a team including your broker and outside counsel can ensure that you purchase the right coverage with appropriate terms and conditions. ■

L.D. Simmons II co-chairs the insurance recovery practice at McGuireWoods LLP. He represents corporate policyholders in a wide range of insurance coverage disputes arising under many types of policies. He is active in the insurance coverage bar and is a frequent speaker on insurance and risk management topics. lsimmons@mcguirewoods.com

Joshua D. Davey is a partner at McGuireWoods LLP. He represents policyholders in a variety of insurancerelated matters, including negotiation and litigation of disputed claims and counseling clients on the purchase of insurance and related risk-management issues. jdavey@mcguirewoods.com

Lowndes C. Quinlan is counsel at McGuireWoods LLP. He focuses his practice on the recovery of insurance assets for policyholders in complex insurance coverage disputes. He has extensive experience handling claims involving information technology. lquinlan@mcguirewoods.com

TODAY’S GENER AL COUNSEL AUG / SEPT 2017

E-Discovery

Ancient Documents

computer. It is important to note that Rule 902(14) is limited to authenticacontinued from page 29 tion, and any attempt to satisfy a heara live witness, and the shift of burdens. say exception has to be made indepenNo longer is the proponent required to dently. Thus, an opponent can challenge establish authenticity. It will be up to the the admissibility of copied data on other opponent to challenge any of the records grounds. that qualify under this exception to the A few years ago, it was apparent hearsay rule. that growing volumes of electronic data Section 902(14) substitutes the require- were having a huge impact on litigation. ment for a live witness by a certificate, Electronic data made cases more comissued by a person qualified to make such plex, and often more expensive. Recognizing that the pursuit of justice was in jeopardy, Some forms of ESI documentation members across the bar undertook are approaching the 20-year mark. actions to deal with the situation facing them. Some tackled the Federal Rules an assessment, and attesting that a copy of Civil Procedure, while others took of ESI taken from an electronic device on the Federal Rules of Evidence. Both is identical to the original found on the resulted in changes that, hopefully, will device. reduce the impacts that ESI brings to The example commonly cited is the litigation. Both address the huge (and presentation of an email copied from a growing) volumes of data that can be

presented in a case, and both provide ways to reduce some of the costs associated with litigation. Although many of us in the “Sedona Bubble” are knowledgeable about the FRCP amendments, it is clear that e-discovery teams also should become familiar with, and leverage, these new FRE amendments. ■

Bob Rohlf, Esq. has broad experience in law and has managed business process improvement projects in companies in the transportation, energy, manufacturing, electronics, foods and leisure sectors. He has experience with general business and patent litigation, as well as environmental regulatory agencies. He is Director of Exterro, Inc. and a member of the Oregon State Bar. bob.rohlf@exterro.com

TO D AY S G E N E R A L C O U N S E L . C O M

aug / sept 2017 today’s gener al counsel

Intellectual Property

Provisional Patent Rights—An Underutilized Protection By Thomas McNulty and Peter Lando

our business develops an exciting new idea, one that could shape the field for years to come. You quickly file a patent application and bring the idea to the market, only to have a competitor copy it and undercut your pricing. Your patent attorney tells you it could be several years before your application is allowed as a patent. What can you do to stop your competitor in this circumstance? Historically, there was almost nothing that could be done while the application was pending. A patent cannot be enforced until it has issued. Under a 1999 revision to the patent laws, however, a patent applicant can seek a reasonable royalty for sales of goods and services that are covered by a claim of a subsequently issued patent. The rights to reasonable royalties under the statute are known as “provisional rights,” because no action to recover can be brought until after the patent actually issues. Moreover, the royalty period does not begin until the publication of the application having substantially identical claims to those of the issued patent. Nevertheless, the threat of royalties accruing can often deter competitors

today’s gener al counsel aug / sept 2017

Intellectual Property from encroaching on a market while the application is pending. This deterrent effect can be important. According to U.S. Patent and Trademark Office data, the average time between the filing of an application and its issuance is 25.4 months, with some technology areas averaging more than 30 months. Given that an application generally publishes about 18 months after the earliest priority filing, this leaves a period of seven to 13 months in which provisional rights can be obtained. Moreover, should you be aware of a third party offering goods or services that you believe are covered

of the claims are identical, not merely whether different words have been used. It makes no difference whether the scope has been broadened or narrowed, or whether the accused product or process would have been covered by both the published and issued claims. Emphasizing the difficulty of meeting this requirement, the courts have noted that it is difficult to conceive of many situations in which the scope of a rejected claim that became allowable when amended is not substantially changed by the amendment. Because claims are frequently amended during

So what should you do while the claims are pending? First, you should put the putative infringer on actual notice by sending them a copy of the published application. You can demand the infringer cease copying the claimed invention and/or offer them a license. While this notice has no legal effect, and the applicant cannot take legal action unless and until a patent issues, the threat of a royalty may spur the accused party to stop their activity or take a license, rather than invest costs in development and sales of a product that may ultimately be subject to an injunction.

The threat of royalties accruing can often deter competitors from encroaching on a market while the application is pending. by claims in your application, you can request early publication, at which point the PTO will publish as soon as possible, generally about 14 weeks after the request is made. TWO BIG HURDLES

To obtain provisional rights, a patentee must overcome two significant hurdles. First, the patentee must prove that the accused infringer had actual notice of the published patent application. This requirement has been interpreted by the courts to mean that the accused infringer must actually have the published application in hand. The fact that the published application is available through the PTO’s website or other commercial databases where it might be found is insufficient. The second hurdle is that the patentee must demonstrate that the claims that ultimately issue in the patent are substantially identical to the claims as published in the application. This is a significant barrier in obtaining provisional rights damages; to meet this requirement, the claims must be “without substantive change.” In making this determination, the court considers whether the scope

prosecution, provisional rights are not often awarded. It is possible to make claim amendments without giving up provisional rights. An amendment that merely clarifies the terms of a claim is not a substantial change. There is no per se rule as to when an amended claim is substantially identical; to make this determination, the court must review the claims, specification, prosecution history and prior art to determine the scope of the original and amended claims. An amendment that clarifies the text of the claim or makes it more definite without affecting its scope will not preclude provisional rights. For example, claim amendments that remove redundant limitations have been found to be substantially identical. In another situation, a court upheld a finding that the addition of limitations that simply expressed what was already implicit in the claims did not change the claim scope. These types of cases are rare, however; and in most circumstances, amendments made to overcome a rejection will be found to have changed the scope of the amended claims and eliminate the availability of provisional rights.

If an entity offers and/or sells goods or services covered by the claims of your application, but you had to amend the claims to overcome a rejection from the PTO, you likely will not be able to successfully obtain provisional rights stemming back to the publication date. All is not lost, however. Patent applicants can use a little-known provision to regain the protection of the provisional rights statute. REPUBLISH WITH AMENDED CLAIMS

Once the claims have been amended, an applicant can have the application republished with the amended claims. Under the PTO’s rules, an applicant can request publication to correct errors in the initial publication, to publish amendments to the specification or claims or to publish replacement drawings. The cost for republication is very modest— currently $430 in fees to the PTO. Once the application has republished, provisional rights become available from the date of republication on the amended claims. This appears to be a rarely used approach to the problems posed by the “substantially identical” requirement.

AUG / SEPT 2017 TODAY’S GENER AL COUNSEL

Intellectual Property While the PTO does not publish statistics on republications, a casual investigation suggests that republication occurs in less than 0.2 percent of U.S. patent applications (and among PCT applications, only about 0.5 percent were republished with

Notify the putative infringer immediately upon publication, and provide a copy of the published application. Develop a record during prosecution of amendments made to clarify claim language rather than change claim scope.

It is possible to make claim amendments without giving up provisional rights.

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amended claims). Further, the authors were able to identify only a single case in which this approach was even suggested. In that case, the plaintiff’s patent application published in 2002. After the claims were narrowed in prosecution to overcome rejections based on prior art, the amended patent application was republished in 2007. The patent issued in 2010, and plaintiff brought suit that same day, alleging patent infringement and seeking provisional rights damages based on the original 2002 publication. The court granted the defendants’ motion to dismiss the count seeking provisional rights based on the 2002 publication for failure to state a claim, finding the amendments to the claims “undoubtedly narrowed the scope of the claims, thereby effecting a substantial change.” The court noted, however, that although provisional rights were not available arising out of the 2002 publication, the defendants had provided no reasons why the claims of the subsequent 2007 publication were not substantially identical to those of the issued patent, suggesting that provisional rights based on a republication would be permissible. The court ultimately dismissed the complaint without prejudice to the bringing of a case for provisional rights based on the subsequent publication, effectively blessing this approach. So in our scenario above, when you have a product or process on the market that is covered by claims of an application that has yet to issue, be sure to take appropriate steps to preserve your rights to provisional damages.

Upon making substantive amendments, have the application republished, and provide a copy of the republished application to the infringer. These steps should serve to dissuade copiers, and provide for damages for the time between publication and issuance, where copiers would proceed with an infringing activity. ■

Thomas McNulty, Counsel at Lando & Anastasi, LLP, handles all areas of intellectual property, with a focus on litigation. TMcNulty@Lalaw.com

Peter Lando is a founding partner of Lando & Anastasi, LLP. His practice involves all areas of intellectual property and related transactions. PLando@Lalaw.com

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T O D AY S G E N E R A L C O U N S E L . C O M / S U B S C R I B E

aug / sept 2017 today’s gener al counsel

Intellectual Property

New IP Protection For Fashion Industry By Kimberly A. Warshawsky

ashion is big business in the United States and it is becoming more fast paced and more competitive with each passing year. U.S. laws have not kept up, however, and, unlike their European counterparts, fashion brands in the United States have no specialized laws to protect their designs and innovations. Rather, designers and design houses must rely upon existing intellectual property laws and schemes to protect that which they create. This is often easier said than done. DESIGN PATENT AND TRADE DRESS DRAWBACKS

Traditional intellectual property laws— patent, trademark and copyright—each protect different bundles of rights, and not all designs will qualify for protection. This is especially true when designers and fashion brands are looking to protect only the look and feel of a product or a design, rather than a technological innovation inherent within the product. In recent years, fashion brands have

increasingly relied upon design patents and trade dress to protect and enforce their rights. Design patents, which protect the ornamental elements of a product, give the owner a 14-year monopoly on that design. The design must be new and original and not otherwise “obvious” when considering pre-existing designs. Fashion is based on the creation of trends, though, and even new designs tend to build or improve upon common concepts and patterns. Design patents also take time, averaging over one year between the date of filing and the date of issuance. By the time the design patent issues, the industry has often moved on to something new and different. Trade dress, which can protect a shape or color, also protects the distinctive elements of a commercial product. Trade dress requires proof of secondary meaning, which means that a fashion brand must establish that consumers associate the distinctive elements to be protected with a

single brand. Showing this association takes time, which fashion designers and brands do not always have in the fast-changing fashion world. Emerging designers also may not have enough of a following to be able to show that the elements for which they seek protection have any meaning to a consumer, let alone the more substantial secondary meaning that is required under the Trademark Act. Copyright laws can also present significant limitations for fashion brands, depending upon the design to be protected and later enforced. Although the Copyright Act of 1976 protects original works, it expressly prohibits copyright protection of “useful articles,” i.e., those articles having an “intrinsic utilitarian function.” Because clothing is inherently “useful,” design elements placed on, in or surrounding clothing (or any other “useful article”) can be protected only if the design incorporates “pictorial, graphic or sculptural features that can be identified separately from, and are

today’s gener al counsel aug / sept 2017

Intellectual Property capable of existing independently of, the utilitarian aspects”—17 U.S.C. § 101. Determining whether a design is physically or conceptually separate “enough” for copyright protection is not easy; and until March of this year, the analysis was dependent largely upon which circuit would decide. Indeed, before March 2017, there were nine different tests by which physical and conceptual separability could be judged, and the results under each test were far from consistent. COPYRIGHTS FOR DESIGN FEATURES

Enter the Supreme Court and its March 2017 decision, in Star Athletica, LLC v. Varsity Brands, Inc. Star Athletica dramatically simplified and expanded the world of fashion and copyrights. The Court held 6 to 2 that design features can be afforded copyright protection under Section 101 of the Copyright Act, provided the design (1) could be seen as a work of art separate from the “useful article” upon which it was placed and (2) would otherwise qualify for protection under the Copyright Act. The decision provides, for the first time, a single definitive test to determine separability and copyright eligibility. Unlike prior tests, it focuses on the design itself instead of any aspects of the useful article. Both Varsity Brands and Star Athletica market and sell cheerleading uniforms. Respondent Varsity Brands had applied for and obtained over 200 copyright registrations for differing combinations and arrangements of chevron striping on its various uniforms. Varsity Brands alleged that Star Athletica infringed five of its registered designs and it therefore brought suit in the Western District of Tennessee. The district court entered summary judgment against Varsity Brands, holding that the striping was not eligible for copyright protection because the designs were in and of themselves utilitarian since the uniforms were identified as cheerleading uniforms. On appeal, the Sixth Circuit reversed, and the Supreme Court granted certiorari on the issues of (1) the appropriate test to determine when a feature of a useful article was protectable under Section 101 of the

Copyright Act, and (2) the appropriate judicial deference to be given to decisions of the Copyright Office. In affirming the Sixth Circuit’s decision, the Supreme Court expressly abandoned the distinction between “physical” and “conceptual” separateness between the design and the useful article. Instead, the Court ruled that a design element is “separate” from an article’s utilitarian aspects for purposes of Section 101 if the design or feature can exist as its own pictorial, graphic or sculptural work that is not itself useful once separated. The Supreme Court made clear that courts no longer need to consider the design’s effect on the useful article itself, nor do they need to determine whether the article is useful for its intended purpose after the design feature is removed. According to the Court’s reasoning, because the chevron striping could qualify as original artwork if it were removed from the uniform and placed on a canvas, it must be subject to copyright protection while on the uniform. The medium upon which the design was placed should not matter. It is important to note that the Court did not decide whether the chevron stripes were themselves original and thus subject to copyright protection once removed from the cheerleading uniform. The Court also did not opine as to the level of deference to be given to the Copyright Office, and it is thus not clear whether a copyright registration will hold the same presumption of validity as a patent or trademark registration issued by the Patent and Trademark Office. The Court did, however, make it clear that prior precedent holding that the shape, cut and dimensions of clothing—including necklines, sleeves, skirt shapes, etc.—cannot be protected, because those elements are inherently useful. Justice Ginsberg concurred in the judgment and agreed that the striping could be given copyright protection, but she did not join the Court’s opinion. According to Justice Ginsberg, the Court did not need to engage in a separability analysis, because the designs were not designs of useful articles, but rather were graphic works reproduced on a useful

article. Justices Breyer and Kennedy dissented, arguing that the chevron designs were specifically incorporated into the cheerleading uniform and were not “capable of existing independently” of the utilitarian cheerleading uniform. The long-term effect of Star Athletica on the fashion industry remains to be seen. Copyrights are relatively inexpensive and easy to get. There is, at this point, little oversight by the Copyright Office, and copyright registrations are more likely than not to be issued. Fashion brands have significant incentive to file copyright registrations for new designs and patterns that meet the Star Athletica separability test. That said, the fashion industry moves quickly, and there is a significant split among fashion brands regarding protection for designs. A successful brand will start a trend, which at some level is spurred by some copying. Increased protection of designs will undoubtedly impact a brand’s ability to join the trend. Star Athletica provides fashion brands with the option to protect its designs and artistic elements in an affordable and straightforward manner, regardless of whether the copyright registrations are ultimately enforceable and/or enforced. The Supreme Court has provided much needed clarity and consistency for those seeking registrations and enforcement. That means that designers and fashion brands can better plan their IP and protection strategies. ■

Kimberly A. Warshawsky is a partner at Ballard Spahr LLP. She is the Practice Leader of the Trademarks and Copyrights Groups, and a member of the Intellectual Property Litigation Group. She has filed and defended against cybersquatting claims and Uniform Domain Name Dispute Resolution Policy complaints. Ms. Warshawsky also represents clients in IP litigation matters. warshawskyk@ballardspahr.com

aug / sept 2017 today’s gener al counsel

Compliance

Harnessing Technology for Legal Compliance By Suzanne Rich Folsom and Kristyn J. Hyland

he global emergence of Big Data is undeniable, and the value that it brings is enormous. Today more information is being collected and made available, and advanced algorithms enable companies to see the full contours of this library of information, allowing them to better interpret it in order to pinpoint trends – and, importantly, to recognize deviations from the norm. Simply put, data analytics is a powerful tool that corporate legal departments can harness to help achieve their regulatory and compliance objectives. This capability arrives at precisely the right time. Put to work effectively, it will make a material difference for corporate legal departments struggling to fight corruption against the current backdrop of evolving compliance standards, a borderless global economy and supply chain, an ever-growing base of partners and

company’s senior management team and board of directors, a potentially significant diminution of brand equity, financial repercussions, and some obvious openings for the competition. It’s no surprise, therefore, that in the Association of Corporate Counsel’s 2017 Chief Legal Officers (CLOs) survey, 74 percent of the respondents said that ethics and compliance issues are at the top of their worry list and “what keeps them awake at night.” Their concerns are well placed. Over the past 10 to 15 years, U.S. regulators have simultaneously escalated their enforcement efforts and added the power of negative publicity (the “name and shame” strategy) to their arsenal. As the ACC survey notes:

The continued emphasis on compliance is not surprising given that law departments report having to handle an average of just under three (internal and external) While no form of automation can compliance-related investigations in the replace the collective knowledge past year. In the most extreme cases, departof the embedded compliance ments are handling as many as 10 or more team, the power of data and investigations. And with 28 percent of analytics can provide previously respondents saying they were targeted by unavailable depth of insight. a regulatory agency in the past two years, there is a distinct suppliers, and a workforce that’s spread possibility that one in four CLOs around the world. are addressing regulatory issues It’s now well understood that the costs in addition to other complianceof corporate noncompliance are extenrelated investigations. sive and complex. There are the obvious tangible costs – the fines, sanctions, and These startling statistics underscore lawsuits that can take years to resolve. the value that a robust compliance and More pernicious are the long-term damethics program can offer to companies, ages. They include the distraction of the and they make the case that regulatory

compliance is no longer an expense to be minimized. Rather it’s an investment, to be maximized. The development, implementation and maintenance of a best-in-class compliance program is daunting, but doable. While no form of automation can replace the collective knowledge of the embedded compliance team, the power of data and analytics can provide previously unavailable depth of insight. Together this “smart pair” of team knowledge and data technology can help to assess compliance risk, provide third-party due diligence analysis, assist with employee training, and drive ongoing compliance program monitoring and management. COMPLIANCE RISK ASSESSMENTS

To establish a strong ethics and compliance program, essential steps include conducting a thorough risk assessment to identify vulnerabilities, and then mapping those vulnerabilities to inform the imposition of strong internal controls. Potentially negative events that would impede the achievement of regulatory, compliance and ethics objectives are identified by type. At that point a risk-rating formula can be constructed. The equation focuses on two key factors: occurrence likelihood (probability), and the significance of its impact (consequence), such that: Risk = Likelihood x Consequence. To begin this rating process, a quantitative value must be assigned to the likelihood that an event will occur, as well as to its impact if it should occur. There are many methods for making this measurement. One effective approach is the 5 x 5 Risk Matrix. An assessment score of one to five can be provided, using the following criteria as a guide:

today’s gener al counsel aug / sept 2017

Compliance

Figure 1

Figure 4

LikeLihood (ProbabiLity oF occurrence) evaluation

description

Certain

Risk event will be experienced

High

16 – 25

Probable

Risk event is highly likely to occur

Medium

9 – 15

Possible

Some appearances of the risk event may occur

Low

3–8

Remote

Appearances of the risk event may occur, but it is unlikely

Minimal

1–2

Improbable

Appearances of the risk event are highly unlikely

risk rating Score

Figure 2

Finally, each rating is collected to form an overall Compliance Risk Register.

conSequence (SigniFicance oF imPact) evaluation

description

Catastrophic

Likely to have devastating impact to organization

Critical

Potential for severe/long term impact to organization

Moderate

Potential for intermediate impact to organization

Minor

Potential for slight impact to organization

Negligible

No significant impact to organization

Figure 5

As the individual ratings are entered into the 5x5 Risk Matrix, an overall risk assessment score is then calculated:

risk Level

consequenc

Likelihood

comPLiance riSk regiSter

risk item

Score

descriptio

Score

riSk aSSeSSment rating

Figure 3

conSequence

LikeLihood

Source: Suzanne Rich Folsom et al., Corporate Practice Portfolio Series (BNA).

aug / sept 2017 today’s gener al counsel

Compliance

Once the assessment ratings have been determined, the assessments for each identified risk can be aggregated to form an overall map. In turn, these results support an analysis of risks on the individual level and allow for the identification of risk relationships and interdependencies. As areas of accumulated risks are identified, the compliance team is better able to prioritize its actions so as to reduce the maximum amount of risk first. At the same time, the output of this review provides an informed stimulus (and the accompanying data) for more granular analysis and the implementation of appropriate risk responses. Figure 6

compliance heat map and risk prioritization 5 1 3

impact

tiers 1

tiers 2 11

12 tiers 3 – 4

3 likelihood

date tier 1 1 2 3 4

Successful third-party due diligence is a vital component of a compliance program, and it too requires the clarity that technology brings to gathering and interpreting important risk-related data. Ideally, a company with overseas operations would conduct exhaustive reviews of all its third-party relationships, but the reality of resource and budget constraints makes that standard unrealistic. Instead, the implementation of a robust risk analysis system allows the company to rank the levels of due diligence needed for each third-party vendor, and then assign the appropriate weight to each factor. With an algorithm designed to take numerous risk factors into account, an effective risk analysis and profile can be constructed. This process gives corporate legal departments a solution that provides speed, accuracy and the ability to customize the analysis for specific factors, and the weight of each factor. For third-party due diligence, these risk factors include: • Specific geographic location. • Industry type (as detailed as possible). • Ties to the host government and/or specific host government officials. • The proposed compensation structure. • Full summary of the services to be provided. This information is collected on a standardized questionnaire that is filled out by the potential third-party partner. When completed, it is uploaded into a portal that automatically calculates a risk rating. The process is shown on page 43. LEARNING MANAGEMENT SYSTEMS

5 6 tier 2 7 8 9 10 tier 3 11 tier 4 12

risk item identification

THIRD-PARTY DUE DILIGENCE

Compliance systems are only as effective as those who use them, so effective training is imperative. Once a program such as this one is in place, companies can use technology to help drive the employee training rollout. Ideally, a tailored online Learning Management System (LMS) is built to emphasize the power and usability of technology to deliver better outcomes. Many companies find that LMS training is an effective and economical approach, given its ability to reach a geographically and

today’s gener al counsel aug / sept 2017

Compliance

Figure 7

input information • Request that the proposed third-party complete a standardized questionnaire

Calculate risk rating

Automatically Determine risk Level

• Portal automatically will calculate the risk rating from the questionnaire

• The portal automatically will determine the risk level dependent on the potential thirdparty’s answers on the quetionnaire.

• Input information from the standardized questionnaire into the portal

functionally diverse employee base inexpensively and simultaneously. Where needed, language barriers can be overcome, and employees always have the ability to pace their study and go back to review an earlier point. A number of online platforms are now available, several of which have functionality that allows the compliance group to: • Assign specific courses to certain employees or departments. • Schedule training for those courses that need to be completed yearly. • Track and gather data on employees’ training progress. • Create a customized training curriculum on a specific topic. This approach allows for customized online training courses that can be mapped directly to an organization’s policies and procedures. For employees in regions of the world where internet access is limited or non-existent, accommodations will need to be made (such as deploying courses that require less bandwidth, or utilizing more printed materials). For many companies, the addition of in-person training is also effective. It allows employees to ask questions, engage in hypotheticals, have spontaneous discussions with colleagues, and collectively benefit from a group educational environment. Training should be supplemented with periodic emails, detailing the latest compliance headlines, any changes to the company’s compliance or ethics programs, and additional training courses. PROGRAM MONITORING

Often, once the compliance program is in place, the hard work begins: establishing the process for monitoring internal controls. This effort can vary in form and

• Due diligence level will be based on the risk level.

frequency, but regardless of industry it requires a methodical approach, and technology can it more efficient. As data is collected, process and business improvements result. The larger the enterprise, the more difficult and time-consuming this regular upkeep can be, which is all the more reason to embrace a solution that includes a technology component. The aggregated results of a whistleblower hotline reporting process, for example, can provide a company with data that indicates breakdowns of internal controls; geographic-focused or department-level problems; the need for additional training or the adjustment of a policy; or a combination of factors. In other words, the broad view that technology provides, and its ability to generate a dashboard-level summary and analysis, gives compliance executives the input they need to act.The monitoring program should be set up so that data is stored at one central location for regular review. The data forms a primary risk summary that is measured against the company’s risk profile. In turn, tracking the corrective actions for each incident provides a basis to ensure that pending corrective actions are balanced and appropriate. This consistent treatment and tracking of resolution activity and steps taken to prevent future similar misconduct is critical in demonstrating uniformity and fairness. Not surprisingly, the Federal Sentencing Guidelines identify these criteria specifically, and therefore measurement and progress against them is important. While no amount of law or regulation will completely eliminate illegal activity, we do know that a robust, ethical compliance program can help prevent violations as well as mitigate damage if violations do occur, and we now have powerful tools to drive additional positive results. It’s not a coincidence that the

highest-performing companies globally are those that have integrated compliance and ethics into the fabric of their culture and business operations. Automation can never replace a strong compliance team or a C-Suite and board committed to an ethical culture, and it shouldn’t. But it would be a mistake to ignore the power and value that technology can bring to a world-class ethics and compliance program. ■

Suzanne Rich Folsom is General Counsel, Chief Compliance Officer and Senior Vice President – Government Affairs at U. S. Steel. She oversees legal, regulatory, compliance, corporate governance, environmental affairs, security, aircraft, and labor and employment matters and is a member of the executive management team who also spearheads the company’s worldwide public policy and government affairs initiatives. She has responsibility for ensuring the profitability of the USS real estate division and oversight for the company’s joint ventures worldwide. Her former positions include Counselor to the President of the World Bank Group and Director of its Department of Institutional Integrity. srfolsom@uss.com

Kristyn J. Hyland is a deputy editorial director in Bloomberg Law’s Corporate, Tech & IP unit, where she oversees content development in the areas of Delaware law, governance, compliance, securities and antitrust. An occasional speaker on these topics, she also writes for Bloomberg Law’s Corporate Transactions Blog. She has more than a decade of experience developing tools and content for corporate practitioners. khyland@bna.com

aug / sept 2017 today’s gener al counsel

Compliance

Advising Food Company Executives at a Time of Increased Regulatory Risk By Maggie Craig and Stefanie Fogel practices for in-house counsel.

ood companies need to be aware of the increasingly litigious environment surrounding food products, and that it now includes the risk of criminal enforcement against both the company and its individual executives for violations of the Federal Food, Drug, and Cosmetic Act (FDCA). Risk for executives is amplified in light of the strict liability, no-intent standard for FDCA violations being invoked by courts nationwide, particularly in cases of egregious behavior, willful negligence, or knowing violations of safety, sanitation and adulteration regulations. Risk also exists where executives should have known, or could have prevented, the violation but did not do so. Specifically under the Park Doctrine, responsible corporate officers can be held criminally liable without

a showing of intent or knowledge, so long as the officer had the authority to prevent or correct the violation. While there is uncertainty as to the trajectory of food regulation, the current FDA administration apparently remains committed to enforcement of the Park Doctrine. By following a simple road map food companies can mitigate this risk, protecting consumers while also protecting the company’s critical asset: its brand. In broad outline, in-house counsel must build a sustainable compliance program, implement appropriate policies and procedures that fit the company’s culture, keep management informed about best practices and potential gaps, and be prepared in the event of violations and/or enforcement activity. As a practical guide, here are four best

Build a Defensible, Customized Compliance Plan. Promote a “tone from the top” by actively supporting compliance efforts. This would include having senior management engage in compliancerelated messaging, training and budget discussions. Work with the business to determine the best integration plan. The details will vary in light of the company’s culture. For example, how compliance plans are formatted, phrased, and presented may differ for a highly institutionalized and formal company as compared to a family-run operation, or a start-up company focused on innovation. Early in the process, identify the necessary elements to meet FDA, USDA, and DOJ expectations to ensure the company can demonstrate robust controls in the event of an investigation or inquiry. Key elements include ensuring Good Manufacturing Practices (GMPs) are updated and implemented, and both Food Safety Modernization Act (FSMA) preventive controls and Foreign Supplier Verification Program requirements are implemented. The company should also conduct routine audits, both of its own facilities and those of key third party partners, and review the results for potential gaps. Maintaining documentation of a company’s compliance plan is not

today’s gener al counsel aug / sept 2017

Compliance

only required under FSMA, but it also substantiates the company’s efforts in the event of enforcement. Finally, the compliance plan must mandate continual active oversight and monitoring, knowing that DOJ will not accept delegation of tasks as a valid defense for breakdowns in the supply chain.

risk of criminal liability for the company and individuals. Diffuse this culture of training throughout the company at all levels, tailoring it for specific functions, such as food safety, quality assurance and logistics.

Address Issues of Non-Compliance. When non-compliance issues are Properly Staff and Train the Supply anticipated or actually present, in-house Chain. Effective risk mitigation counsel must be prepared to guide the requires collaboration and compliance business with remedial measures. A criat all steps in the supply chain. From sis management plan and recall protocol ingredient sourcing and product intake are essential, as is the ability to accurately to inventory management and ultimate track and trace inventory, both upstream consumer delivery, compliance at each and down. Proactively identifying and step plays a role in the overall compliaddressing gaps on a regular basis, and ance plan. having a crisis response plan as a founIn-house counsel should actively dation, will aid in navigating future engage with senior management to incidents. guide decision making and assess legal When violations or potential violaand regulatory implications associated tions occur, respond quickly and take an with supply chain risk. Key issues for active role in addressing the risk rather than delegating authority. Do not ignore prior FDA, USDA, Under the Park Doctrine, or local authorities’ responsible corporate officers can warnings or inspections. Acknowledge and remediate the be held criminally liable without issue, and maintain an transpara showing of intent or knowledge, appropriately ent dialogue with the authority. Adhere to so long as the officer had the the company’s crisis response plan and authority to prevent or correct ensure communications are made under the violation. privilege where appropriate, while the company determines next collaboration include advising on propsteps. If the underlying issue dictates, erly allocating resources and budget conduct a thorough, properly scoped to avoid critical gaps in both personnel and properly staffed internal investigaand equipment; ensuring cross-function- tion, documenting root cause, process, al transparency to pinpoint the critical and any interim mitigation measures. skills and expertise that impact prodFinally, prepare to implement corrective uct quality and consumer safety; and action in response to the investigation’s identifying a clear reporting structure, findings. with defined employee responsibilities to Be Prepared for Government avoid gaps in reporting or lack of notice Investigations. If an issue of nonregarding expectations. compliance escalates to government Senior management and those carinvestigation, in-house counsel must rying out critical functions must be be prepared to advise the company on educated not only about the compliance the dual challenge of defending itself plan and crisis management, but also the

while also cooperating with authorities. While the company and individuals need not over-volunteer information, they should never bury or misrepresent facts. In advising and preparing the company, understand who owns privilege and who can waive privilege, reiterating Upjohn warnings as appropriate. Consider also that DOJ has clearly articulated that government cooperation is “all or nothing,” meaning all facts and key individuals must be disclosed. Companies must consider the implications, including increased pressure on those involved and whether disclosure waives privilege. In-house counsel would also be wise to recommend retaining outside counsel, who play a critical role both in providing substantive legal advice and in maintaining privilege where it’s possible to do so. ■

Stefanie Fogel is a partner in the Boston office of DLA Piper and co-chair of the firm’s Food & Beverage sector. Her practice is focused on multi-national food and consumer product regulation and compliance, food and consumer product recall response, corporate compliance, and commercial, class action and multi-plaintiff litigation. stefanie.fogel@dlapiper.com

Maggie Craig is an associate in DLA Piper’s Boston office. Her practice is focused on regulatory compliance and litigation matters, with emphasis on food and beverage, nutrition and dietary supplements, consumer products, product recalls, and consumer fraud class actions. maggie.craig@dlapiper.com

aug/ sept 20 17 today’s gener al counsel

work pl ace issues

Federal Protection for LGBT Employees and Students By Mark t. Phillis

ver the past six months, three U.S. Courts of Appeals have issued decisions addressing whether, and to what extent, the prohibition on sex discrimination under Title VII of the Civil Rights Act of 1964 and Title IX of the Education Amendments of 1974 afford protections against discrimination based on sexual orientation, and gender identity and expression. The cases arose in part due to an increased focus on these issues by the Equal Employment Opportunity Commission, other federal agencies, LGBT advocacy organizations and private litigants. There is no federal law that expressly prohibits discrimination against LGBT employees in the private sector. The only express protection provided at the federal level is Executive Order 13672, which prohibits federal government contractors from discriminating against their employees based on their sexual orientation, gender identity or expression. In 22 states and the District of Columbia, however, employees are protected under

Mark t. Phillis is a shareholder at Littler Mendelson. He handles a wide range of employment issues with a focus on those related to the Family and Medical Leave Act and the Americans with Disabilities Act. He serves as co-chair of the firm’s Diversity and Inclusion Council and was one of the founding shareholders of the Pittsburgh office. mphillis@littler.com

state anti-discrimination laws from discrimination based on their sexual orientation. In 20 of those states and the District of Columbia, employees also are protected against discrimination based on their gender identity or expression. DISCRIMINATION CLAIMS UNDER TITLE VII

In April of this year, in Hively v. Ivy Tech Community College, the Court of Appeals for the Seventh Circuit,

in a 7–3 en banc opinion, became the first appellate court to hold that Title VII’s prohibition on sex discrimination protects employees from discrimination based on their sexual orientation. All of the other courts of appeals that have addressed the issue have reached the opposite conclusion. In Hively, the Seventh Circuit overruled its prior holding that Title VII does not prohibit discrimination based on sexual orientation. Its decision rested on two independent legal theories.

today’s gener al counsel aug/ sept 20 17

First, the Seventh Circuit relied on the Supreme Court’s ruling in Price Waterhouse v. Hopkins, in which the Supreme Court ruled that sex stereotyping—discriminating against a woman because she does not behave or present in a stereotypically feminine way—is sex discrimination prohibited by Title VII. The Seventh Circuit ruled that discrimination against employees based on their sexual orientation is “paradigmatic sex discrimination” because it is based on

ing a claim alleging discrimination based on sexual orientation, Zarda v. Altitude Express, the Second Circuit granted the petition for rehearing en banc. DISCRIMINATION CLAIMS UNDER TITLE IX

Early in February , the Supreme Court appeared to be poised to decide whether the protections against discrimination based on sex under Title IX protect students from discrimination based on their

missioners have stated that the EEOC will continue to process charges of discrimination based on sexual orientation and gender identity or expression. The decision of the Second Circuit to grant rehearing en banc may lead it to join the Seventh Circuit in extending the coverage of Title VII, or it may create a split in the circuits that may be used to seek review by the Supreme Court. If the Eleventh Circuit also grants the petition for rehearing en banc, its ruling could

If a woman is discriminated against because she is in a relationship with a woman, but she would not have been discriminated against if she were in a relationship with man, that constitutes unlawful associational discrimination.

assumptions about the proper behavior of someone of a given sex—that they should have an intimate relationship with someone of the opposite sex. Second, the majority ruled that discrimination based on sexual orientation is associational discrimination, relying on part of Loving v. Virginia, in which the Supreme Court struck down Virginia’s law prohibiting interracial marriage. The Court reasoned that if a woman is discriminated against because she is in a relationship with a woman, but she would not have been discriminated against if she were in a relationship with man, that constitutes unlawful associational discrimination. Two other courts of appeals had addressed this issue in March. In Christiansen v. Omnicom Group, Inc., and Evans v. Georgia Regional Hospital, the Second and Eleventh Circuits, respectively, ruled that a claim filed by a lesbian or gay employee alleging sex stereotyping or gender nonconformity could be brought under Title VII, but a claim based on an employee’s sexual orientation could not be. After the Hively decision was issued, petitions for rehearing en banc were filed in both cases. In another Second Circuit case involv-

gender identity or expression. In Grimm v. Glouchester County School Board, the Supreme Court agreed to hear a case filed by a transgender high school student over his right to use the boys’ restroom. The decision by the court of appeals had been based in large part on guidance issued by the Department of Education and Department of Justice, which was rescinded by the current administration. However, the Supreme Court remanded the case for further consideration. At the end of May, in Whitaker v. Kenosha United School District, the Seventh Circuit upheld an injunction a trial court had issued to enjoin the school district from requiring a transgender male student to use either the girls’ restroom or gender neutral restrooms. The finding was that he was likely to prevail on a claim of sex stereotyping, and a claim that the school district’s actions violate right to equal protection under the Fourteenth Amendment. TAKEAWAYS FOR EMPLOYERS

Despite the change in administration, extending the protection of Title VII to LGBT employees remains part of the EEOC’s strategic plan. Two EEOC com-

be used in a similar fashion. It is difficult to predict whether the Supreme Court would take up one or more of these cases, or whether it will wait until other courts of appeals rule before it considers the issue. Although the landscape in the courts is uncertain, given the EEOC’s positon and the fact that 22 states and the District of Columbia already prohibit discrimination based on sexual orientation, employers may want to consider joining the 93 percent of companies in the Fortune 500 that prohibit discrimination based on sexual orientation, and the 75 percent that also prohibit discrimination based on gender identity and expression. Employers may want to ensure that their personnel policies and training programs address these types of discriminatory practices. ■

AUG/ SEPT 20 17 TODAY’S GENER AL COUNSEL

T H E A N T I T R U S T L I T I G AT O R

Legalities of Promotions and Allowances By Jeffery M. Cross

any of my clients manufacture or produce products that they sell to retailers who resell to consumers. Sometimes the products are sold to retailers through distributors. My clients often want to help their retailers promote the resale of their products through various promotions and allowances. My advice to these clients is grounded in Section 2(d) and 2(e) of the Robinson-Patman Act, and the Guides for Advertising Allowances and Other Merchandising Payments and Services, issued by the FTC. The Robinson-Patman Act is the principal federal statute directed at price discrimination. The principal provision of the Act is Section 2(a). It bars direct or indirect discrimination in pricing. Sections 2(d) and 2(e) of the Robinson-Patman Act generally prohibit a “seller,” in this case a manufacturer of products, from paying allowances or furnishing services to promote the resale of the seller’s products unless the allowances or services are offered to all competing “customers” (such as retailers) on proportionally equal terms. Section 2(d) covers “payments” made by the manufacturer to the retailers to promote the resale of the products.

Jeffery Cross is a columnist for Today’s General Counsel and a member of the Editorial Advisory Board. He is a partner in the Litigation Practice Group at Freeborn & Peters LLP and a member of the firm’s Antitrust and Trade Regulation Group. jcross@freeborn.com.

Section 2(e) covers the “furnishing of services or facilities” to a retailer to promote the resale. An injury to competition is required in order to incur a penalty under Section 2(a). The injury can be proven by actual diversion of sales to the favored retailer or a presumption created by a substantial price difference over a significant time period. No injury to competition is required to be penalized under Sec-

tions 2(d) and 2(e). In this regard, these sections are a form of strict liability. Consequently, it is very important that those counseling manufacturers make sure that payments or services provided by the manufacturer are primarily used to promote resale by the retailer, rather than primarily to promote initial sale to the retailer or the distributor. The latter payments or services are covered by Section 2(a), not Sections 2(d) and 2(e).

TODAY’S GENER AL COUNSEL AUG/ SEPT 20 17

A private plaintiff suing for a violation of all three sections would have to show causation and actual damages. If successful, the plaintiff would be awarded three times actual damages and could also recover attorney’s fees and costs. The government, which rarely brings suit under Robinson-Patman, could obtain injunctive relief; and the FTC, under its authority pursuant to Section 13(b) of the FTC Act, could impose a fine. Examples of promotions and allowances made to retailers in connection with resale of the manufacturer’s products include cooperative advertising, handbills, in-store demonstrators and demonstrations, catalogs, cabinetry, displays, prizes or merchandise for conducting promotional contests. The overarching principle of Sections 2(d) and 2(e) is that the manufacturer cannot cause a retailer to be at a competitive disadvantage to another retailer in the resale of the manufacturer’s products. This principle means that two retailers that are not in competition do not have to be offered promotions and allowances on proportionally equal terms. For example, promotions and allowances may be offered to retailers in one geographic market but not to retailers in another geographic market. However, the fact that retailers are in different channels of distribution does not mean that the retailers do not com-

pete. New forms of commerce such as the Internet may be in competition with others, such as brick-and-mortar stores. If they are, then the retailers are entitled to proportionally equal promotional allowances and services. The FTC Guides were issued in 1969 at the invitation of the Supreme Court in a case entitled F.T.C v. Fred Meyer, Inc. Consequently, the Guides are often called the “Fred Meyer Guides.” The Guides are not binding regulations, but are advisory interpretations providing assistance to businesses seeking to comply with Sections 2(d) and 2(e) of the Act. Although the Guides are consistent with case law, the FTC has sought to provide guidance in some areas where no definitive guidance is provided by the case law. Although the Guides do not have the force of law, they are useful, particularly on the requirement that promotions and allowances be offered on “proportionally equal terms.” The Guides provide valuable examples in this regard. The Guides note that there is no single way prescribed by law to offer all competing retailers promotional services and allowances on proportionally equal terms. Any method that does so may be used. This can be done most easily, according to the Guides, by basing the payments made or the services furnished on the dollar volume or the quantity of product purchased during a specified period. However, one of the

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examples states that a manufacturer should not provide an allowance or service on the basis of rates graduated according to the amount of goods purchased, as for instance, one percent of the first $1,000 purchased per month, two percent of the second $1,000 per month, and three percent over these amounts. Implicit in this example is the idea that such a scheme places smaller retailers at a competitive disadvantage to larger retailers. The Guides note that manufacturers should take reasonable steps to ensure that promotional services and facilities are useable, in a practical sense, by all competing customers. An example of guidance that I have given clients is that when all retailers cannot accommodate “endcap” displays for the manufacturer’s products, the manufacturer may have to make counter racks available as an alternative. The manufacturer has the obligation to inform all retailers of the promotions and allowances plan. This is true even for those payments, services or facilities made through wholesalers and distributors. Promotions and allowances can be a valuable tool for manufacturers to help their retailers resell their products to the consumer. However, care must be taken that the proffered promotions and allowances meet all the requirements of the Robinson-Patman Act. ■

AUG/SEPT 2017 TODAYâ&#x20AC;&#x2122;S GENER AL COUNSEL

How to Conduct a Successful Internal Misconduct Investigation B Y J EFFREY K LINK

AND

D AVID P. N OLAN

rganizations of all sizes confront issues of misconduct. Whether they arise through hotline disclosures, internal audit findings or some other way, these issues can be resolved efficiently and properly when the investigators are experienced, and not seeking to make the project into a career case. Setting aside allegations that must be investigated in a very specific way under state and federal labor and employment` laws (think sexual harassment or claims of bias, for example), there is a specific path that investigations should follow in order to

determine if misconduct allegations have merit. Before beginning an investigation, understand and follow the rule of law and all applicable company policies and procedures. Never impugn the reputations of anyone. Then, to successfully resolve misconduct issues and minimize risk, follow these seven steps. â&#x20AC;˘ Step One. Begin by assessing the allegations. Carefully and discreetly analyze the issues, including the source or sources of the complaint. Are these new concerns or repeats of prior troubling reports? Are the allegations

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• Step Four. Identify the subjects, meaning those whose conduct will be under review. Always perform background checks on the subjects to assess conflicts of interests, and obtain relevant public records. • Step Five. Regarding documents: In many cases, start with document and email retention, and review those documents before talking to people. Conduct site visits, if appropriate, and then conduct interviews of knowledgeable people. Interview the subjects last, once you understand the facts. • Step Six. Review. Do you need to perform additional investigation? If there is a legitimate problem that needs to be addressed, coordinate your activities with supervisors, management and/or the board. • Step Seven. Conclude. Finish the investigation in a timely and effective manner. This would include removing bad actors. Institute internal controls to prevent future misconduct.

specific and credible? Do they appear to be vindictive? If you determine that the issues are specific enough and appear to have substance, move to step two. • Step Two. Assign and use appropriate personnel and other resources. Determine, based upon the project, who will be performing the investigation. Make sure they are qualified, experienced, and able to understand the consequences of their actions. • Step Three. Write the investigative plan – a flexible written overview of how to proceed – and follow it.

Keep in mind that the investigative plan drives action, and it must be thoughtful and sequential. Investigations can be resolved more quickly when the plan is time-sensitive and orderly, and conducted in a way that protects the reputations of those under suspicion. Interview people only after you have read the relevant documents and can pose appropriate questions. Re-interview where needed. A few caveats: Understand that multiple parties (often employees colluding with vendors) might be involved in misconduct. Many problems are bigger than they appear. Therefore, keep the flow of information to a limited group and be discreet to avoid compromising your efforts. Employees and vendors will absolutely talk about things they were asked to keep secret. Rumors fly fast and hamper employee morale and productivity. In fraud matters where material funds are at issue, make sure to determine whether your organization has fidelity insurance to cover losses attributable to crime, and if so make a timely notice of a possible claim. Sometimes the initial assessment will be relatively easy to dismiss (e.g., “I am an employee at a company factory. My supervisor has had lunch with the vendor who provides us with goods. Please investigate.”) Here is one, on the other hand, that could have merit: “My supervisor just awarded a contract to ABC vendor, which his wife owns. The bids were faked. The supervisor’s wife is not the named owner, but she does run ABC.” This is continued on page 55

Jeffrey Klink is the CEO of Klink & Co., a global risk consultancy that performs FCPA compliance services, due diligence, and fraud investigations, primarily for large, global public companies, with special expertise in China, Russia, India, and throughout Africa. A former Justice Department prosecutor, he teaches a course on FCPA compliance for the University of Pittsburgh Katz Graduate School of Business, and he speaks and writes frequently on fraud and compliance issues. jklink@klink-co.com

Fraud Carve-Outs and the Unintended Consequences of Reliance Disclaimers in M&A Transactions By Timothy A. Miller

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elaware and New York courts have long upheld reliance disclaimers to limit the representations and warranties forming the basis of a merger or acquisition agreement to those expressly stated in the contract. M&A agreements often also contain various forms of fraud carve-outs, which generally provide that various limitations in the contract apply “except in cases of fraud.” A buyer obtaining a fraud carve-out may be surprised to learn that it may nevertheless be precluded from asserting extracontractual fraud claims based on the legal consequences of the reliance disclaimers. Recent trends in Delaware and New York law counsel caution in agreeing to reliance disclaimers and recognize the validity of strong fraud carve-outs in M&A agreements.

Reliance Disclaimers

the agreement or specify precisely that upon which it did rely. The Chancery Court in FdG Logistics views this as a “critical” distinction that “strike[s] an appropriate balance between holding sophisticated parties to the terms of their contracts and simultaneously protecting against the abuses of fraud.” New York courts, as discussed in Harsco Corp. v. Segui (Second Circuit. 1996), also examine the specificity of the disclaimer: Where a party “specifically disclaims reliance upon a particular representation in a contract, that party cannot, in a subsequent action for common law fraud, claim it was fraudulently induced to enter into the contract by the very representation it has disclaimed reliance upon.” But unlike Delaware, courts in New York do not require the disclaimer to be made from the point of view of the buyer. It is enough under New York law for the buyer to acknowledge in the agreement that the seller made no representations other than those contained in the agreement.

The venerable axiom that fraud vitiates every contract is deeply rooted in our common law. Accordingly, a rational buyer might believe that though it limits the scope of representations Does a Fraud Carve-Out Trump an Otherwise and warranties guaranteed by the seller in the merger agreement, all bets would be off in the Extra-Contractual Fraud? A recent decision by the Delaware Superior Court case of outright fraud. But courts in Delaware provides a basis for a defrauded buyer to argue and New York enforce reliance disclaimers even that strong fraud carve-outs should control over in the face of specific allegations of intentional contractual limitations on remedies, including extra-contractual misrepresentation to avoid a reliance disclaimers. In a 2016 case, JCM Innovaperceived “double fraud” – the alleged extration Corporation v. FL contractual fraud of the Acquisition Holdings, seller and the fraud of The best way for a buyer to Inc., the buyer alleged the buyer in falsely repextra-contractual fraud resenting that it did not preserve extra-contractual claims based in part on rely on extra-contractual allegedly fraudulent estirepresentations. As exmates of future warranty plained by the Delaware fraud claims is to just say costs, despite its express Chancery Court in a 2006 case, Abry Partners V, L.P. no to the inclusion of broad disclaimer of reliance on “projections, estimates v. F&W Acquisition LLC, and other forecasts.” courts treat the disclaimer reliance disclaimers. Noting that “Delaware as an admission and reprehas a strong public policy sentation of a sophisticated buyer that, in entering into the transaction, distaste for fraud,” the court allowed the fraud claims to proceed. It highlighted a fraud carve-out it in fact did not rely on any representations not in the reliance disclaimer itself that preserved “any expressly stated in the agreement. rights that Purchaser has with respect to . . . any In Delaware, as discussed in the 2016 Chanintentional misconduct by Seller.” The Court also cery Court case, FdG Logistics LLC v. A&R highlighted four fraud carve-outs contained in the Logistics Holdings, Inc., the agreement must conexclusive remedies provision alone: “The Exclutain a clear and affirmative disclaimer of reliance sive Remedy Provision explicitly sets forth JCM’s “from the point of view of the aggrieved party … options for claims under the Agreement. JCM can to ensure the preclusion of fraud claims for extrago through the indemnification process, or it can contractual statements.” It is not enough for the bring fraud claims.” seller to disclaim representations outside the four In a slightly different context, the Chancery corners of the agreement. The buyer must agree Court in Eni Holdings, LLC v. KBR Group that it did not rely on any representations outside

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Timothy A. Miller founded the Silicon Valley office of Valle Makoff after 14 years as a litigation partner at Skadden, Arps, Slate, Meagher & Flom. His practice is focused on commercial, fiduciary and securities litigation, claims of trade secret misappropriation, unfair and anti-competitive business practices, business and investment fraud. He routinely advises buyers and sellers regarding drafting and litigation of provisions related to post-closing disputes in M&A transactions, including contract claims for indemnification or extra-contractual claims for fraud. tmiller@vallemakoff. com

Holdings, LLC (2013) declined to dismiss a fraud claim brought outside the contractual limitation period. Although the limitations provision at issue did not contain a fraud carve-out, the Chancery Court focused on fraud carve-outs applicable to the exclusive remedies provisions in general. This suggests that the fraud carve-out will control even where it is not contained in the specific provision at issue. A seller may argue that a reliance disclaimer constitutes a factual admission that the buyer did not rely on extra-contractual representations, and therefore no fraud claim exists to be “carved out.” But this is a legal fiction invented by the Delaware and New York courts to “balance” the enforceability of contracts between sophisticated parties and the “venerable public policy to guard against fraud.” The Chancery Court held that the balance tips back to the buyer if the agreement does not contain a clear and affirmative disclaimer of reliance from the buyer’s point of view. A defrauded buyer could argue that a strong fraud carve-out also tips Delaware’s precarious balance back toward the public policy against fraud where fraud pollutes the diligence process. (See E.I. DuPont de Nemours & Co. v. Florida Evergreen Foliage, a 1999 Delaware Supreme Court case that allowed claims for fraudulent inducement of a settlement agreement and release based on fraud in the litigation discovery process.) In New York, the legal fiction supporting the enforcement of reliance disclaimers posits that a sophisticated buyer should be free to disclaim reliance on the “mix of data and information supplied to it” in pre-merger due diligence, as the court said in DynCorp v. GTE Corp. (S.D.N.Y. 2002). If so, sophisticated parties should likewise be able to use fraud carve-outs to restore the buyer’s ability to claim actual reliance on the “total mix” of information in cases of fraud. Preserving Extra-Contractual Fraud Claims

The Chancery Court’s reverence for the sanctity of contracts places buyers in a difficult position when asked to agree to extensive reliance disclaimers in a merger or acquisition agreement. As that court said in the 2006 Abry Partners case, “The enforcement of non-reliance clauses recognizes that parties with free will should say no rather than lie in a contract.” Accordingly, the best way for a buyer to preserve extracontractual fraud claims is to just say no to the inclusion of broad reliance disclaimers. Sellers no doubt will complain that reliance disclaimers are “industry standard.” But the justifications for those provisions do not withstand scrutiny.

Citing “the need for commerce to proceed in a rational and certain way,” the Chancery Court said in Abry that it “respect[s] the ability of sophisticated businesses ... to make their own judgments about the risk they should bear and the due diligence they undertake, recognizing that such parties are able to price factors, such as limits on liability.” But it is not possible for a buyer to price fraud into the deal because if it has been defrauded it has no knowledge of the misrepresented or omitted facts. The notion that buyers agreeing to reliance disclaimers in fact did not rely on the myriad of information provided in due diligence is contrary to common sense. Indeed, a sophisticated buyer (such as a private equity professional, officer, or director) may be duty bound to consider the “total mix” of information not only in closing the deal, but also in deciding the extent to which it will limit a buyer’s remedies (through a disclaimer or otherwise). Accordingly, fraudulent manipulation of the “total mix” of information provided in due diligence should vitiate the reliance disclaimer. The only legitimate basis for inclusion of a reliance disclaimer is the avoidance of litigation costs in the event of non-meritorious fraud claims. If a seller complains about litigation risk/cost, consider agreeing to limited threshold Alternative Dispute Resolution (ADR) at the pleading stage as a condition precedent to litigation. For example, the fraud carve-out could include an agreement to submit any potential fraud claims (extra-contractual or otherwise) to limited mandatory arbitration before an arbitrator (or panel) experienced in the resolution of fraud claims at the pleading stage, and require the arbitrator(s) to determine whether the fraud claims satisfy the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995, as that statute has been interpreted in the federal courts (or specify a particular jurisdiction, such as the Second or Ninth Circuit). The parties could further agree that no discovery and no court action would be permitted unless the fraud claim survives the ADR pleading stage, and include a “loser pays” attorneys’ fees provision applicable only to the ADR proceeding. This threshold ADR will mitigate any legitimate concern that remorseful buyers will be able to press meritless fraud claims through expensive discovery proceedings. In sum, sophisticated buyers should avoid unintended consequences of reliance disclaimers by including strong fraud carve-outs in their merger agreements and resisting the inclusion of unchecked reliance disclaimers. ■

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Misconduct Investigation

of where the information resides, follow company data privacy policies and other rules of the road. continued from page 51 In cases where there might be potential violaa common kind of complaint these days, when tions of the law, document a chain of custody and vendor misconduct is rampant. Note that in secure original data and documents. This is importhis case the allegations are specific and names tant if you should decide to bring a civil action or are provided. refer the case to a prosecutor. In many cases, however, determining whether When interviewing knowledgeable persons, an allegation of misconduct is meritorious can keep the circle small and tight as possible. If you be difficult. Here are some additional tips to aren’t sure whether someone is “safe,” then talk keep in mind. to others first. As noted above, do not show bias, Assign and utilize appropriate resources. If the but take into consideration the relationships allegation suggests a potential violation of the law between the subjects and others. rather than a company policy, it may pose signifiA good investigator will always ask several cantly more risk and liability to the company, its questions where the answers are already known, employees and management. Potential violations to help determine reliability. of the law should be investiInterviews deemed to be gated with appropriate tools especially important should and personnel, including always be conducted by two Interview the experts able to understand investigators in a comfortable the risks. Violations in this and non-confrontational setsubjects last, once category include bribery and ting. Prior to the interview, derecordkeeping matters, fraud, termine who will lead the inyou understand conflicts of interest, and terview. Prior to interviewing counterfeiting. subjects, perform a thorough the facts. When an allegation inanalysis of all the evidence volves only a policy violation, and double and triple check perhaps travel or entertainyour findings. Use available ment abuse, human resources or in-house mandocuments, emails, and other evidence to quesagement resources might be sufficient to resolve tion the subjects. Have a detailed outline of key the case. questions, based on the evidence. When looking Where data needs to be retrieved, secured, and at more than one subject consider interviewing analyzed or finances need to be reviewed, use a everyone at or about the same time to avoid lies forensic expert. If the safety of an employee or and deceit. Confront the alleged wrongdoers only third-party is at risk, law enforcement authoriwhen all the evidence is in. ties should be consulted as soon as possible and If you are considering termination, follow security measures should be put in place. company termination policy and procedures. As referenced above, when investigating alCancel the subject’s access to the IT network legations of sexual harassment or claims of bias, and building, secure company assets, and use the government has put forth specific guidelines company security staff if needed. regarding how and when the investigation should After the investigation is concluded, evaluate be performed. Follow these guidelines to the letter. the case to determine what policy, procedures, (EEOC.gov is a great place to start to understand and/or controls could be improved, and whether these issues). new controls need to be implemented to prevent Appropriate research on both the complainant the misconduct from re-occurring. and the subject(s) of the allegation may include a Finally, draw fair conclusions, without hyreview of personnel records, criminal and civil liti- perbole, and issue recommendations to improve gation histories, media research, and social media. processes. An investigative report full of flowery Obtain and review available documents. This language detracts from its serious purpose. process can be designed in a way that will not The main thing to keep in mind is that a alert the subject. In today’s digital world, evithoughtful step-by-step internal investigation dentiary documents may reside on the company methodology will reduce risk and liability for server, company-owned laptops, as well as in your organization, maximize the opportunity emails, text messages, social media, telephone to stop misconduct, and improve controls. ■ records, the cloud, video recordings, photographs, and other public and internal records. Regardless

David P. Nolan is vice president of Klink & Co., where he directs the firm’s global risk consulting and corporate investigations practices. He has directed investigations and due diligence projects for numerous Fortune 500 companies in over 90 countries. A former corruption investigator for the City of New York, he has more than 30 years experience and is a frequent speaker on compliance, fraud prevention and investigation, and international due diligence. dnolan@klink-co.com

“Umbrella Damages” Forecast For Canada C RO S S - B O R D E R S E L LE R S B EWA R E 56

By Nikiforos Iatrou and Kayla Theeuwen

customer buys a product from Manufacturer A. Unbeknownst to the customer, two other dominant manufacturers of the product (B and C) previously conspired to raise prices. Although Manufacturer A was not part of that conspiracy, it nonetheless raised its prices, inspired by the pricing set by the dominant manufacturers. The customer has therefore overpaid. The question that is the subject of divergent decisions in Canada is whether Manufacturer A’s customer—an “umbrella purchaser”—can sue Manufacturers B and C for the overpayment. In Godfrey v. Sony Corporation (2016) the British Columbia Supreme Court (BC’s superior trial court) certified a class action suit that included such “umbrella purchasers.” Three months later, the Ontario Superior Court of Justice (Ontario’s superior trial court) followed Godfrey and certified a class that included umbrella purchasers (Fanshawe College v. Hitachi).

At the same time, an appellate court in Ontario affirmed that “umbrella purchasers” have no cause of action, due to the prospect of indeterminate liability, in Shah v. LG Chem, Ltd. Here, we examine which way the winds are blowing in Canada, and whether we might see a coming storm of umbrella damage claims.

UMBRELLA LIABILITY The theory behind umbrella liability is that price fixing and other cartel-like activity can create an “umbrella” of prices that are above the prices that would prevail in a competitive market. This umbrella enables non-cartelists to set prices higher than they otherwise would. Customers, both direct and indirect, of the non-cartelist sue the cartelists to recover damages and overcharges. These customers are

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referred to as “umbrella purchasers.” In Canada, umbrella damages are typically sought pursuant to s. 36 of the Competition Act, which allows for recovery of damages for violations of the criminal conspiracy provisions of the Act, including price fixing.

UMBRELLA DAMAGES IN THE UNITED STATES AND THE EUROPEAN UNION The U.S. Supreme Court’s decision in Illinois Brick Co v. Illinois made it clear that – except in states that have statutorily reversed the decision – indirect purchasers do not have a cause of action for having been unlawfully overcharged as a result of cartel activity. However, the Court has never expressly excluded the standing of a plaintiff seeking damages in an umbrella pricing case. U.S. courts have taken divergent approaches on whether an umbrella purchaser has standing to sue. For example, in the Petroleum Products litigation in 1982, the 9th Circuit took the approach that umbrella damages are not recoverable under U.S. federal law since they are speculative and complex. In contrast, the Northern District of California recently refused to apply Petroleum Products in the 2014 case of County of San Mateo v. CSL, Ltd., holding that it cannot be assumed that umbrella damages are disallowed under California law. In the European Union, the main obstacle for recovering umbrella damages has historically been whether a direct causal link exists between the anti-competitive conduct and the harm suffered by the umbrella purchaser. However, the 2014 decision of the European Court of Justice in Kone AG v ÖBB-Infrastruktur AG changed the prevailing wisdom. The ECJ accepted that, in principle, a non-cartelist may be guided by the price set by cartelists, and that overcharges could therefore be transferred to customers of the non-cartelists. It also introduced a presumption on the foreseeability of damages, and recognized that umbrella purchasers should be awarded damages if they could prove that the non-cartelist was influenced by the presence of the cartel when establishing its prices.

UMBRELLA DAMAGES IN CANADA The law in Canada is similarly in flux, as

demonstrated by the recent Godfrey, Fanshawe, and Shah cases. In the Godfrey decision the BC Supreme Court expressly parted ways with the Ontario Superior Court of Justice in Shah. The certification judge’s decision in Shah was, at the time, the only express consideration in Canada of whether umbrella purchasers have a cause of action. The proposed plaintiffs in Godfrey brought an action alleging that the defendants participated in a global, criminal price-fixing cartel that increased or maintained the price that consumers in British Columbia paid for optical disc drives (ODDs) – memory storage devices that read and/or record data on optical discs – and other products containing ODDs, which are found in computers and video game consoles to read CDs, DVDs and Blu-ray discs. The proposed class included umbrella purchasers who indirectly purchased ODDs from non-defendant manufacturers. The plaintiffs asserted a breach of the price-fixing provisions of the Competition Act. The court certified the statutory cause of action, holding that it was not plain and obvious that the umbrella purchasers did not have a cause of action for the damages. The court recognized that allowing umbrella claims is inconsistent with restitution law, since the defendants were not enriched by the umbrella purchaser’s purchase. However, in the Court’s view, the Act does not base relief on a theory of restitution. Rather it allows any person “who has suffered loss or damage” as a result of prohibited conduct to sue and recover an amount equal to the loss or damage. The Act is, therefore, concerned with compensating losses rather than restoring ill-gotten gains. The BC court held that the possibility of indeterminate liability for defendants does not militate against affording umbrella purchasers a cause of action. The court disagreed with certain policy considerations raised by the certification judge in Shah for limiting the duty of care in negligence. The court held that, in most price-fixing cases, the defendants are dominant and, as a result, it is reasonable to assume that in most cases, “the number of purchases from non-cartel members will not exceed the number of purchases from cartel members.” The BC court relied on Kone to conclude that causation is built into the umbrella theory of pricing. It stated that even though umbrella claims could result in defendants being held liable for the pricing decisions of non-defendants, continued on page 61

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THE LIMITS OF “SOLE DISCRETION” IN CONTRACTS By Mark D. Erickson and David B. Clark

ompanies often enter into contractual relationships that give them “sole” or “absolute” discretion to make strategic business decisions under the contract. But what are the limits to this discretion? The company has negotiated for the express power under the contract to act as it sees fit. But in many states a covenant of good faith and fair dealing is implied in every contract, and that covenant prevents one party from engaging in conduct that would deny the other party the benefits of the contract. Given this conflict, companies entrusted with sole contractual discretion must ensure that their agreement and subsequent conduct do not expose them to liability.

IMPLIED “COVENANT” Numerous jurisdictions imply a covenant of good faith and fair dealing to contracts, recognizing that it’s meant to prevent a contracting party from engaging in conduct which, while not technically transgressing the express covenants, frustrates the other party’s rights to the benefits of the contract. The implied covenant not only imposes upon each

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contracting party the duty to refrain from doing anything that would render performance of the contract impossible by any act of its own, but also the duty to do everything that the contract presupposes that the party will do to accomplish its purpose. Because a possible breach of the implied covenant turns on whether a party acted in good faith, it is not surprising that whether a breach occurred is ordinarily a question of fact. Defeating a cause of action for breach of the implied covenant as a matter of law is therefore often a difficult task. That being said, the implied covenant’s reach is inherently limited by the terms of a contract. It cannot be extended to create obligations not contemplated in the contract. Instead, it is limited to assuring compliance with the express terms of the contract. This overarching rule—that the implied covenant cannot be used to create new contractual duties—is particularly important when a company is granted “sole” or “absolute” discretion to act under a contract. Courts in various jurisdictions have held in such instances that the implied covenant cannot be used to trump a grant of discretionary power if the express purpose of a contract is to grant unfettered discretion, and if the grant of that unfettered discretion does not render the contract illusory.

DEMONSTRATING EXPRESS PURPOSE TO GRANT SOLE DISCRETION Two cases that concern the grant of absolute contractual discretion – Wolf v. Walt Disney Pictures & Television and April Enterprises, Inc. v. KTTV – show that avoiding contractual ambiguity and contradictions is critical to establishing an express contractual purpose to grant unfettered discretion. In Wolf, Disney was given the contractual right to promote the characters from the “Roger Rabbit” franchise in a wide variety of contexts, including through movies and merchandising. Significantly, the contract did not obligate Disney to use the characters, and Disney could also assign or license its rights “as it saw fit.” In exchange, the plaintiff received a percentage of Disney’s revenues from the use. The plaintiff asserted that Disney breached the implied covenant by entering into promotional agreements that involved no monetary consideration. The court rejected the plaintiff’s assertion. It held that because Disney was given the right to act as it “saw fit,” and because Disney also had the right to refrain from acting at all, an implied good faith requirement would conflict with the grant of express contractual discretion. The court therefore

held there was no breach of the implied covenant as a matter of law. In contrast, where the provisions of the contract are unclear or contradict one another, sole discretion may not prevail over the implied covenant. In April Enterprises, a contract provision allowed the defendant to erase tapes of a television show produced by the plaintiff after broadcast. But at the same time, another provision gave the plaintiff the right to sell the old shows in syndication. The plaintiff brought

The overarching rule that the implied covenant cannot be used to create new contractual duties is particularly important when a company is granted “sole” or “absolute” discretion to act under a contract. suit for breach of the implied covenant after it discovered that the defendant had erased some of the tapes. On appeal from a dismissal of the complaint, the court acknowledged the “traditional rule” that a covenant of fair dealing will not be implied to vary the terms of an unambiguous contract. However, the court reversed the dismissal because the contradictory provisions – one allowing the defendant to delete shows and the other allowing the plaintiff to sell them through syndication – could be reconciled by implying a good faith requirement to the contract. As the court explained, implying the covenant of good faith would avoid the “senseless” result of allowing the defendant to erase tapes after the plaintiff had reached a syndication deal. The differing results in Wolf and April Enterprises illustrate why a company should ensure that any grant of sole contractual discretion is unambiguous. The Wolf contract did not include conflicting contractual rights, and the contract’s express purpose was clear – to give Disney sole discretion to determine how and whether to market and promote the characters. In contrast, the parties in April Enterprises had conflicting contractual rights – the defendant could erase the shows, but the plaintiff had syndication rights

Mark Erickson is a partner at Haynes and Boone, in the Orange County office. He has been focusing on business disputes through litigation, arbitration and mediation for over 30 years, and he appears on a regular basis in Bay Area courts. He handles a wide range of commercial and real estate litigation, including contract, trade secrets, healthcare law, and business governance and dissolution disputes. mark.erickson@ haynesboone.com

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for the shows. And while the April Enterprises Court acknowledged that “at trial extrinsic evidence may explain the apparent contradictions between these terms in some way which favors an absolute unqualified right to erase the tapes,” the conflicting provisions defeated any chance of ending the lawsuit at the pleading stage.

The differing results in Wolf and April Enterprises illustrate why a company should ensure that any David Clark is an

associate in the Litigation Practice Group in the Orange County office of Haynes and Boone. His practice includes a range of complex litigation involving patents, licensing and contract disputes. He has represented clients in various industries, including biotech, semiconductor, apparel and real estate. Before becoming an attorney, he worked as an electrical engineer in research and development. david.clark@haynesboone.com

grant of sole contractual discretion is unambiguous. Thus, it is imperative that a company seeking to avoid a similar result ensures that no conflicting discretionary rights exist under a contract, and that the express purpose of granting sole discretion is clear.

AVOID THE ILLUSORY CONTRACT ARGUMENT The risk of an illusory contract increases when a contract includes a grant of “sole” or “absolute” discretion. Third Story Music, Inc. v. Waits provides a roadmap for avoiding this risk, and it concerns guaranteeing consideration under the contract. Here, the defendant had the right to sell certain musical recordings, “all upon such terms and conditions as we may approve,” and could “at our election refrain from any or all of the foregoing.”

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“Informative and worth reading.” T OD AY S G E NE R A L C OUN S E L . C OM / S UB S C R IB E

In exchange, the plaintiff was entitled to a royalty on those sales as well as a separate guaranteed payment. A dispute arose over the defendant’s refusal to release a particular album, and the plaintiff brought a cause of action for breach of the implied covenant. The trial court sustained a demurrer, relying on the clause in the agreement permitting the defendant to refrain from taking any action. The appellate court explained that the “refrain from action” provision raised the issue of an illusory promise. And it further explained that if the potential royalties were the only consideration under the contract, a promise to use good faith would necessarily be implied in the contract to avoid that illusory promise. Doing so, of course, would prevent the dismissal of the plaintiff’s cause of action for breach of the implied covenant. However, the court held that because of the separate guaranteed payment, “whether or not an implied covenant is read into the agreement, the agreement would be supported by consideration and would be binding.” The court therefore recognized the grant of sole discretion without implying a good faith requirement, and it affirmed the lower court’s dismissal. Thus, as Third Story Music shows, a company seeking to avoid an illusory contract when being granted sole discretion should ensure that at least some consideration is guaranteed under the contract for the other contracting party. Two steps should be taken to ensure that a contractual grant of “sole” or “absolute” discretion is effective. First, the grant of discretion should be clear and unencumbered by ambiguous or conflicting rights. Second, separate and guaranteed consideration should be provided, to avoid assertions that the grant of discretion makes the contract illusory. ■

today’s gener al counsel aug/sept 2017

Umbrella Damages

the defendants and struck the umbrella dam‑ ages claim. continued from page 57 On appeal, however, the Ontario Divisional the non‑defendants’ pricing decisions were not Court agreed with only the third of the five rea‑ truly independent, but had been distorted by sons – indeterminate liability – and denied the a cartel. umbrella purchasers’ proposed claim. The Court Finally, the court opined that allowing held that extending liability to the defendants umbrella purchasers to bring claims furthers for harm occasioned to the umbrella purchas‑ certain goals of the Act, including compensa‑ ers would render that liability indeterminate tion, deterrence and behavior modification. and uncircumscribed. Citing an earlier Supreme The appeal in Godfrey was heard in June 2017, Court of Canada decision, the Divisional Court and is currently under reserve. held that, in cases of pure economic loss, a duty Months after the Godfrey decision, a judge of care should only be recognized where the on the Ontario Superior Court of Justice, in class of plaintiffs, the time and the amounts in Fanshawe College v. Hitachi issue are determinate. followed the BC court’s rea‑ The Divisional Court recog‑ soning and certified a class that nized its deviation from the BC Price fixing can included umbrella purchasers. decision in Godfrey, but noted Fanshawe is now under appeal, that there was no explana‑ create an “umbrella” tion in Godfrey about why and a decision has yet to be re‑ leased. In tandem, Shah v. LG the policy rationales regarding of prices that are Chem, Ltd. was once again indeterminate liability were winding its way through the not compelling in considering Ontario court system, this time above the prices that whether umbrella purchasers through the appellate court— could advance a claim. The the Ontario Divisional Court. court stated that even though would prevail in a Shah was a class ac‑ “there may be a maximum tion brought on behalf of competitive market. exposure established (that is, all persons in Canada who the entirety of the market),” have purchased rechargeable this could not “change the fact lithium‑ion batteries— that the defendants have no regardless of who manufactured the battery and control over their liability exposure.” whether the battery was bought directly from The court held that the umbrella purchasers’ a manufacturer, or indirectly—with the battery claim would expose the defendants to indeter‑ packaged within an electronic device (such as a minate liability, that they therefore did not have laptop or cell phone). a cause of action and that they could not bring At the certification stage, the defendants had their class action claim. argued five reasons why the umbrella purchas‑ If the Godfrey decision takes hold across ers’ claim did not disclose a cause of action: (1) Canada, U.S. companies that have participated s. 36 of the Act is not a substantive law provi‑ or are alleged to have participated in price‑fixing sion, and cannot create a novel cause of action; conspiracies may find themselves liable to um‑ (2) assuming that s. 36 could create a cause of brella purchasers in Canada, a prospect that does action, allowing a claim by umbrella purchas‑ not hold true for U.S. umbrella purchasers under ers would be inconsistent with restitutionary U.S. federal law. Godfrey is under appeal. So is law; (3) assuming that s. 36 could introduce a Fanshawe. If the appellate decisions in those cases cause of action, the defendants’ liability would upholds the certification of the umbrella claims, be indeterminate and contrary to legal policy it will likely be time for those who sell goods, about economic loss torts; (4) the proposed directly or indirectly in or into Canada, to seek new cause of action would be unjust because some shelter from the gathering storm. ■ the defendants would be liable for the indepen‑ dent pricing decisions of non‑defendants; and (5) to the extent that tort law plays a role in be‑ havior modification and deterring wrongdoing, there is no need to extend liability to include compensation for umbrella purchasers. The certification judge in Shah agreed with

Nikiforos Iatrou, recognized as one of Canada’s prominent competition litiga‑ tors, leads WeirFoulds LLP’s antitrust group. He was counsel to Canada’s Commis‑ sioner of Competition from 2009‑2012, and is now routinely retained on civil, regulatory and criminal matters. niatrou@weirfoulds. com

Kayla Theeuwen is an associate at WeirFoulds LLP. She practices with a team of litigators that specialize in resolving complex commercial and multi‑jurisdictional disputes in Canada and the Eastern Carib‑ bean, as well as anti‑ trust matters across Canada. ktheeuwen@weirfoulds.com

aug/sept 2017 today’s gener al counsel

Cost Savings Through “Legal Procurement” By Silvia Hodges Silverstein

L 62

egal procurement has come a long way since DuPont’s former general counsel Tom Sager referred to it as a four-letter word in his foreword to the Legal Procurement Handbook. He nevertheless went on to say that “it is incumbent on the general counsel and her outside counsel to apply greater sourcing discipline to our profession to create competitive advantage for her respective corporate clients.” The day-to-day work of procurement professionals was never taught to lawyers in law school. It is an area in which most general counsel and other in-house attorneys have little experience. For many years, GCs and in-house attorneys resisted the influence of legal procurement, perhaps feeling that procurement departments were intruding onto their turf. They felt privileged and not subject to the same scrutiny as other major purchasers at companies. Meantime, legal spending as a line item for many companies grew as litigation risks increased, government oversight required more detail, and rates increased as major firms competed on pay for top legal minds. These days resistance to the concept is softening, and it’s not uncommon for a Fortune 500 company procurement department to have multiple individuals dedicated to sourcing legal services. This is particularly true in some tightly regulated industries, such as pharmaceutical and financial services. Given how much these companies spend on legal services, it is not surprising they have taken the lead in this area, thereby leveraging the experience of professionals trained in data analysis to manage spending and increase efficiency in hiring outside counsel. SURVEY DEMONSTRATES RESULTS

A recent study conducted by the Buying Legal Council shows why legal procurement is on the rise, why corporate counsel and procurement professionals are natural allies, and why there is reason to expect that relations between them will become more productive over time. Our 2017 Legal Procurement Survey posed a number of questions regarding purchasing decisions, cost control, analyses and trends, to legal procurement professionals in both U.S. and international companies. We received 101 responses, with the majority of respondents – 52.8 percent – from companies with more than $25 billion USD in revenue, which places them in the Fortune 100 for a U.S. company or the international equivalent for a foreign corporation. Another one quarter worked at

companies with $4.1-25 billion USD in revenue, or the equivalent of a Fortune 500 corporation. More than half of survey participants came from three highly regulated industries that traditionally are big spenders on legal services: banking/financial services/insurance (21.1 percent), chemicals/pharmaceuticals/biotech (18.4 percent) and energy/utilities (13.2 percent). Other respondents came from a wide variety of industries, including healthcare, consumer goods, telecommunications and IT, media, transportation and real estate/construction. The survey asked respondents this question: “How much, as a percent of total spending with legal services providers, do you believe your efforts have helped save the organization in the last year?” What we heard from legal procurement professionals gets to the main reason the C-suite is embracing legal procurement. Even though we are nearly a decade out from the Corporate 2008 financial meltdown, most companies counsel and are still looking to cut costs where they can, procurement and the numbers tell us legal procurement professionals provides an effective way to do that. Acare natural cording to the survey, companies making even minimal use of allies. procurement professionals save an average of 11 percent on their legal spend. That number reaches 23 percent for companies that devote more effort to the process. We also wanted to isolate out factors that affect the success of a legal procurement effort and supports the work of legal procurement professionals. The survey revealed that the most successful practitioners used a variety of approaches. These include working with a preferred provider list of outside law firms, implementing billing guidelines, sending RFPs, using alternative fee arrangements or project-based budgets, negotiating discounted hourly rates, conducting invoice audits, and working with alternative legal service providers. That list contrasts with the much shorter list of tactics employed by respondents who self-identified as being the least successful.

today’s gener al counsel aug/sept 2017

They were able to negotiate lower hourly rates, but did not make use of higher-level tools and strategies.The survey indicates a likely explanation for this discrepancy: tenure. Legal procurement is still a relatively young profession. The average length of a career in this area right now is 3.5 years. Therefore many legal procurement professionals are still learning how to apply their specialized skills and knowledge to the world of sourcing legal services. The survey found that the longer a legal procurement professional has worked in legal services, the more likely it is that person is able to use the full range of tools and activities. Almost every tool is used more as legal procurement professionals mature in their career. The length of tenure within a particular company also plays a role. Experience matters, and it bears on connectivity inside the organization, as well as skill. It takes time to nurture legal procurement skills. More experienced legal procurement professionals not only feel more successful in a general sense, but they also say they perform better on the specific metric of saving money for their companies. The survey classified respondents according to how long they had worked in legal services: “Newbies,” who have been in legal procurement for 18 months or less; “mid-lifers,” who had been doing it from two to four years; and “veterans,” with experience of five or more years. The survey found a direct correlation between experience and how much legal procurement professionals were able to save their company. Newbies and mid-lifers saved their employers an average 8.6 percent on legal spend. With veterans it was close to 15 percent. CRUCIAL RELATIONSHIP WITH LEGAL

One of the most significant findings from the survey was the crucial role that general counsel and the legal department play in the success of the legal procurement professionals. The better the relationship between the legal department and procurement, the more successful procurement professionals feel they can be. For those respondents who said they are “most successful,” 66.7 percent reported that they felt they were in “partnership” with their legal department. Sixty percent of those who said they had “above average success” reported a relationship with the legal department that was at least “collegial.” Toward the other end of the scale, 76.2 percent of legal procurement professionals who had “below average success” also had a “reluctant” relationship with legal, and one third of the “not successful” group said they had no relationship with the legal department.

The legal procurement professional’s length of service also correlates to the strength of the relationship with the legal department. Many “newbies” (46.2 percent) reported a reluctant relationship with legal, and 15.4 percent said they had no relationship at all. “Mid-lifers” fare better, with 13 percent reporting a partnership with legal and 47 percent saying things are collegial, but 40 percent still reporting a reluctant relationship. Among “veterans,” the relationship is much better: 36.4 percent viewed themselves as in partnership with legal and 54.5 percent reported collegial relationships. There were no veterans who said their relationship with legal was non-existent. It’s clear that a GC aligned with the procurement process makes a decisive difference. The survey found that problems related to “conflicts and misunderstandings” are improving for most companies, but slowly. More than half (55.1 percent) of legal procurement professionals who responded said they had a good relationship with legal. This contrasts sharply with the situation just a few years ago when most legal departments and GCs still viewed procurement with suspicion. However, 44.9 percent of respondents reported either a reluctant relationship or none at all.

TAKEAWAYS FOR GCS

The 2017 Legal Procurement Survey makes clear GCs have a significant role to play in the success of legal procurement, and the more the relationship between procurement and legal looks like a partnership, the more successful procurement will be. There is also a feedback loop at work. Legal procurement professionals who feel successful are more likely to make use of the full spectrum of tools and strategies at their disposal, which leads to greater cost-savings for their employer, which in turn reflects favorably on the GC. For their part, C-suite executives can worry less about runaway legal costs when legal and procurement work together. Legal procurement is still a new profession and there will be growing pains. It is clear, however, that when legal procurement professionals are supported they can be successful and contribute to a company’s success, and the longer they are in these positions, the more valuable they become. It may take time and patience to develop a tolerance for a new way of doing things, but GCs that give them a chance to prove themselves will find them to be an asset. They will know they are successful when their year-to-year spending is decreasing, their average paid rate is improving, and they are avoiding unnecessary legal work. ■

Silvia Hodges Silverstein is the executive director of the Buying Legal Council, the international trade organization for legal procurement, and an adjunct professor at Columbia Law School and Fordham Law School. She is the editor of the Legal Procurement Handbook. silvia@buyinglegal.com

aug / sept 20 17 today’s gener al counsel

B A C K PA G E F R O N T B U R N E R

Countdown To New FASB Rules

N By samir Bodas

New reveNue recogNitioN rules issued by the Financial Accounting Standards Board (FASB) in Revenue from Contracts with Customers (ASC 606) are scheduled to take effect over the next two years. But with just a few months to go until public companies are required to make the switch, the majority are dragging their feet. The 2016 PwC Revenue Recognition Survey revealed just how unprepared some businesses are. When asked to assess the progress they had made towards implementing the new rule, 77 percent of respondents admitted they had either not started an assessment or not completed one. Only 13 percent claimed to have implemented the standard. While publicly traded companies must apply the new standard to annual reporting periods beginning after December 15, 2017 and private companies after December 15, 2018, companies that have chosen early adoption of the standards are already beginning to feel the impact of the changes. These standards will have a significant bearing on balance sheets across every industry. But the full effect of the new rules goes even further. They change how companies manage the interdependent agreements between their customers, suppliers and vendors. As the framework for those agreements, contracts will need to adapt to the changes along with the systems and processes used to manage them. According to FASB, the core principle of the new rule is “... to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To do that, companies will need to have clause-level visibility in their contracts and the ability to track delivery against the scope of work. It’s not as simple as recognizing revenue at the completion of the contract, or using an average samir Bodas is CEO across the contract term. of Icertis, an enterprise Contract management contract management systems will also need the ability software provider. to look at existing contracts to samir@icertis.com

understand how the new rules will change their current revenue forecasts. Other challenging scenarios include tiered pricing, volume discounts, modifying or combining contracts, calculating transaction prices, as well as reporting on bundled goods and services. The upside? The the new rules should simplify the preparation of financial statements and provide a consistent framework to address revenue issues. According to the PwC survey, areas that will be most impacted are accounting policies and IT systems. Specifically, when respondents were asked to rate level of difficulty in implementing the new standard, the two areas with the most concern were revisions to system controls and contract reviews. To prepare for the new standards, general counsel first need to assess their current business processes, resourcing and internal controls. To identify problem areas and work through solutions, many organizations have created a revenue recognition team that includes representatives from sales, IT, operations, legal, investors and human resources. To see if you are ready, determine if your current contract management system has these capabilities: • Automatic tracking of version history for purposes of an audit. • A high degree of cross-department collaboration. • Ability to measure contract turnaround time. • A centralized repository. • Integration into ERP systems or other relevant applications. • Ability to modify the contract management lifecycle to accommodate new workflows and clause templates. • A holistic view of the inter-dependencies between contracts. • Ability to perform deviation analysis on 3rd party paper. • Support for variations in language, workflows and templates based on regional needs. • Controls over the entire contract life cycle, for either buy-side or sell-side. By taking the time to make a thoughtful assessment of their contract management systems, companies can be ready when the deadline arrives. ■

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