Author: National Law Forum

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The New Wave of Insurance Construction Defects? Four States Enact Statutes Favoring Coverage for Faulty Workmanship

Recently posted in the National Law Review an article by Clifford J. Shapiro and Kenneth M. Gorenberg of Barnes & Thornburg LLP about whether construction defects are covered by commercial general liability (“CGL”) insurance policies and briefly discuss four new statutes in various states.

 

 

Courts across the country remain split on the issue of whether claims alleging construction defects are covered by commercial general liability (“CGL”) insurance policies. The primary battle ground has been whether such claims involve an accidental “occurrence” within the meaning of the CGL policy coverage grant. Now this issue is getting substantial attention from state legislatures. Four states recently enacted new legislation addressing insurance coverage for construction defect claims, and each statute favors coverage,albeit in different ways and to varying degrees. These statutes signal that the battle over whether construction defects constitute an “occurrence” may have shifted from the courts to state legislatures. The four new statutes are discussed briefly below.

Colorado

Section 13-20-808 of the Colorado Code, effective May 21, 2010, creates a presumption that a construction defect is an accident, and therefore an “occurrence” within the meaning of the standard CGL insurance policy. To rebut this statutory presumption, an insurer must demonstrate by a preponderance of the evidence that the property damage at issue was intended and expected by the insured. The statute expressly does not require coverage for damage to an insured’s own work unless otherwise provided in the policy, leaving that potentially to be decided by Colorado’s courts. In addition, the act does not address or change any policy exclusions, the scope of which will also remain an issue possibly to be determined in court. Thus, it appears that the Colorado statute resolves in favor of coverage that construction defect claims give rise to an accidental “occurrence” under the CGL policy coverage grant, but leaves most other insurance issues affecting coverage in the construction defect context subject to further attention by the courts.

Hawaii

Chapter 431, Article 1 of the Hawaii Revised Statutes provides that “the term ‘occurrence’ shall be construed in accordance with the law as it existed at the time that the insurance policy was issued.” The statute does not declare what the “the law” is now or what “the law” was at any time in the past. However, the preamble explains that the appellate court decision in Group Builders, Inc. v. Admiral Ins. Co., 231 P.3d 67 (Hawaii 2010) “invalidates insurance coverage that was understood to exist and that was already paid for by construction professionals,” and that the purpose of the statute is to restore the coverage that was denied. While not necessarily clear from the appellate court decision, coverage arguably was denied for both defects in the insured’s own work and also consequential property damage caused by faulty workmanship.

Thus, it appears that the legislature’s intent was to allow insurers to deny coverage under policies issued after May 19, 2010 to the extent permitted by the courts based on Group Builders and whatever further judicial decisions may follow, but to require application of the more favorable judicial interpretations of coverage for construction defects that the Hawaii legislature believes existed before that time. In other words, the Hawaii statute appears to be an attempt to preserve more favorable treatment of coverage for construction defect claims for projects currently underway which were insured under policies issued before Group Builders was decided.

This approach, of course, still leaves it to the courts to interpret the applicable law with respect to any particular claim (i.e., the law that existed at the time the policy was issued). But we cannot help but think that the Hawaii courts may be influenced going forward to find more readily in favor of coverage due, at least in part, to the part of the preamble to the legislation that states: “Prior to the Group Builders decision … construction professionals entered into and paid for insurance contracts under the reasonable, good-faith understanding that bodily injury and property damage resulting from construction defects would be covered under the insurance policy. It was on that premise that general liability insurance was purchased.”

Arkansas

Arkansas Code Section 23-79-155 (enacted on March 23, 2011) requires CGL policies offered for sale in Arkansas to contain a definition of occurrence that includes “property damage or bodily injury resulting from faulty workmanship.”It is unclear whether this requirement applies to policies previously issued. The act also states that it does not limit the nature or types of exclusions that an insurer may include in a CGL policy. Thus, the numerous exclusions related to construction defect claims contained in the typical CGL insurance policy are not affected by the Arkansas statute, and the judicial decisions that have interpreted those exclusions presumably remain good law.

South Carolina

Enacted on May 17, 2011, South Carolina Code Section 38-61-70 provides that CGL policies shall contain or be deemed to contain a definition of occurrence that includes property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself. However, whether the South Carolina statute will change the law in South Carolina is unclear because the statute was immediately challenged in court. On May 23, 2011, Harleysville Mutual Insurance Company filed a complaint in the South Carolina Supreme Court seeking injunctive relief and a declaration that the new statute violates several provisions of the U.S. and South Carolina constitutions, particularly with respect to existing insurance policies at issue in pending litigation.

Conclusion

The new state statutes are intended to overrule, at least to some extent, judicial decisions that denied insurance coverage for construction defect claims. The thrust of these statues is to require construction defects to be treated as an accidental “occurrence” within the meaning of the CGL insurance policy. As such, the legislation generally should make it easier for policyholders in the affected states to establish at least the existence of potential coverage for a construction defect claim, and thereby more easily trigger the insurance company’s duty to provide a defense. Whether these statutes will also result in increased indemnity coverage for construction defect claims, however, remains to be seen. Among other things, the statutes generally do not alter the exclusions that already apply to construction defect claims, and they leave the interpretation of the meaning of these exclusions to the courts.

In short, while this new wave of statutes increases the complexity and divergence among the states of this already fractured area of the law, they also appear to increase the likelihood of insurance coverage for construction defect claims in Colorado, Hawaii, Arkansas and South Carolina.

© 2011 BARNES & THORNBURG LLP

Payments by Enron are "Settlement Payments" under the Bankruptcy Code's Safe Harbor Provisions

An interesting article recently published in the National Law Review  by David A. Zdunkewicz of  Andrews Kurth LLP  regarding the Second Circuit Court of Appeals protecting  payments made by Enron to redeem commercial paper prior to maturity as “Settlement Payments” under the Bankruptcy Code’s Safe Harbor Provisions.

In a matter of first impression in In Re: Enron Creditors Recovery Corp., v. ALFA, S.A.B. DE C.V., et al., No. 09-5122-bk(L) the United States Court of Appeals for the Second Circuit sided with two holders of Enron’s commercial paper who received prepetition payments redeeming the paper prior to its stated maturity. The price paid by Enron to redeem the debt was considerably higher than the market value of the debt.

Enron argued that the payments were either preferential or constructively fraudulent transfers and were not “settlement payments” under section 546(e) of the Bankruptcy Code because (i) the payments were not “commonly used in the securities trade,” (ii) the definition of “settlement payment” includes only transactions in which title to the securities changes hands and, therefore, because the redemption was made to retire debt and not to acquire title to the commercial paper, no title changed hands and the redemption payments are not settlement payments, and (iii) the redemption payments are not settlement payments because they did not involve a financial intermediary that took title to the transacted securities and thus did not implicate the risks that prompted Congress to enact the safe harbor.

The Second Circuit rejected each of Enron’s arguments, holding that the payments qualified as “settlement payments” under the Bankruptcy Code’s safe harbor provisions.

As to Enron’s first argument, the Court disagreed that the payments must have been common in the securities trade to qualify as a settlement payment under the Bankruptcy Code. Section 741(8) of the Bankruptcy Code defines “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.” Enron argued that the phrase “commonly used in the securities trade” modified each of the preceding terms in section 741(8), not only the immediately preceding term. The Second Circuit disagreed and held that the phrase “commonly used in the securities trade” only modified the immediately preceding term in Section 741(8), i.e. it only modified “similar payment.” Thus there is no requirement that the payments made to the holders be common in the securities trade.

As to Enron’s second argument, the Second Circuit found nothing in the Bankruptcy Code or the relevant caselaw to exclude the redemption of debt securities from the definition of a settlement payment. Accordingly, there is no requirement, as Enron argued, that title to the securities change hands for the payment to be considered a settlement payment under the Bankruptcy Code.

Finally, the Second Circuit rejected the third argument advanced by Enron. Enron argued that the redemption of debt did not constitute a settlement payment because it did not involve a financial intermediary that took a beneficial interest in the securities during the course of the transaction. Thus, the argument goes, the redemption would not implicate the systemic risks that motivated Congress to enact the safe harbor provision for settlement payments.

The Second Circuit rejected the argument and held that the fact that a financial intermediary did not take title to the securities during the course of the transaction is a proper basis to deny safe-harbor protection, joining the Third, Sixth, and Eighth Circuits in rejecting similar arguments. The Court stressed that § 546(e) applies to settlement payments made “by or to (or for the benefit of)” a number of participants in the financial markets and it would be inconsistent with this language to restrict the definition of “settlement payment” to require that a financial intermediary take title to the securities during the course of the transaction.

While each case must be determined on a case-by-base analysis, the Second Circuit’s ruling in Enron reflects a continued trend among the Court of Appeals to broadly interpret the safe harbor provisions of the Bankruptcy Code and protect covered transactions.

© 2011 Andrews Kurth LLP

 

 

 

 

 

Avoid Employer Liability with Safe Harbor Provisions under GINA

Recently posted in the National Law Review an article by George B. Wilkinson and Anthony “T.J.” Jagoditz of Dinsmore & Shohl LLP regarding the recently-enacted federal Genetic Information Non-Discrimination Act of 2008, otherwise known as “GINA”.

Employers should take note of the recently-enacted federal Genetic Information Non-Discrimination Act of 2008, otherwise known as “GINA”. Effective January 10, 2011, Congress added yet another acronym to the long list of federal laws impacting today’s employers (OSHA, ADA, FMLA, ADEA, etc). This new law prohibits an employer from requesting an employee’s genetic information and that of his/her family. The Act applies to requests for medical records,independent medical examinations, and pre-employment health screenings.

An employer may not request information about an employee’s health status in a way that is likely to result in exposure of genetic information of the employee and his/her family (which includes relatives up to the fourth degree). “Genetic information” is classified as genetic tests, the manifestation of a disease or disorder, and participation in genetic testing (i.e. studies by market-research firms sampling medications). Clarifications regarding sex, age, and race are not considered genetic information. Family history is considered genetic.

Fortunately, GINA provides safe-harbor language which is designed to protect employers. Inclusion of the safe-harbor language (which is contained within the statute itself) is important in medical records requests and in communicating with physicians who are doing independent examinations. This safe-harbor language will render receipt of the genetic information inadvertent, and therefore allow the employer to avoid liability under GINA.

If the safe-harbor language is given to a health care provider and genetic information is provided, the employer must “take additional reasonable measures within its control” to make sure that the violation is not repeated by the same health care provider. However, such measures are not defined in the act.

© 2011 Dinsmore & Shohl LLP. All rights reserved.

U.S. Supreme Court Stresses Importance of Commonality in Decertifying Massive Sex Discrimination Class of 1.5 Million Wal-Mart Employees

 Barnes & Thornburg LLP‘s Labor and Employment Law Department recently posted in the National Law Review an article about the U.S. Supreme Court’s reversing the largest employment class certification in history

In Wal-Mart, Inc. v. Dukes, reversing the largest employment class certification in history, the U.S. Supreme Court appears to have limited the circumstances in which federal courts can certify class actions – and not just in employment cases. The Court held that the lower federal courts had erred by certifying a class that included 1.5 million female employees from virtually every part of the country. The plaintiffs sought injunctive and declaratory relief, punitive damages, and backpay as a result of alleged discrimination by Wal-Mart against female employees in violation of Title VII of the Civil Rights Act of 1964. 

The Supreme Court held that class certification was improper because the class failed to meet the “commonality” requirement of Federal Rule 23(a)(3), which provides that a class can be certified “only if…there are questions of law or fact common to the class…” The Court noted that the mere allegation of “common questions” is insufficient under Rule 23. “Th[e] common contention… must be of such a nature that it is capable of classwide resolution – which means that determination of its truth or falsity will resolve an issue that is central to the validity of each one of the [individual class members’] claims in one stroke.” 

The Court held that the Wal-Mart class did not meet the standard for commonality, because the evidence showed that Wal-Mart gave discretion to its supervisors in making employment decisions. The named plaintiffs “have not identified a common mode of exercising discretion that pervades the entire company… In a company of Wal-Mart’s size and geographical scope, it is quite unbelievable that all managers would exercise their discretion in a common way without some common direction.” The Court concluded that, “Because [the named plaintiffs] provide no convincing proof of a company-wide discriminatory pay and promotion policy, we have concluded that they have not established the existence of any common question.”

The lack of commonality found in Wal-Mart can arise in class actions of many kinds. Under Wal-Mart, a question is “common” under Rule 23(a)(3) only if it can be decided on a class-wide basis. In the past, many named plaintiffs, and some lower courts, have overlooked this essential point. And, as in Wal-Mart, in many cases a claim of commonality will fail precisely because there is no way to rule on the question without addressing the individual facts relating to each purported class member. Wal-Mart makes clear that such a lack of commonality is sufficient to defeat class certification.

In addition to meeting all of the requirements of Rule 23(a), a class must comply with one of the three subparts in Rule 23(b). The trial court in Wal-Mart had certified the class under Rule 23(b)(2), which allows a class where the defendant’s alleged conduct “appl[ied] generally to the class, so that final injunctive or declaratory relief is appropriate respecting the class as a whole…”   Another issue before the Supreme Court was whether such certification was proper where the class sought recovery of substantial backpay based on Wal-Mart’s alleged discrimination.

The Court ruled that the purported class could not be certified under Rule 23(b)(2),  holding that “claims for individualized relief (like the backpay at issue here) do not satisfy the Rule.” The Court said that Rule 23(b)(2) “does not authorize class certification when each class member would be entitled to an individualized award of monetary damages.”

Under the analysis in Wal-Mart , in the vast majority of class actions seeking a monetary recovery, the class can be certified (if at all) only under Rule 23(b)(3). Class certification under that provision is often more difficult, because a class plaintiff must prove that common questions “predominate” over individual questions and that a class action is “superior” to individual actions.  In addition, under Rule 23(c)(2)(A), individual notice must be given to all members of a Rule 23(b)(3) class at plaintiff’s expense, while such notice is optional, within the trial court’s discretion, if the class is certified under Rule 23(b)(2).

Wal-Mart is an important case in the area of employment law; but the Supreme Court’s holdings on the requirements of Rule 23 are likely to be helpful in defending class actions of all kinds

© 2011 BARNES & THORNBURG LLP

CFPB has no plan to ban financial products, Warren tells GOP-led committee

Recently posted in the National Law Review by Shirley Gao of the Center for Public Integrity about the new Consumer Financial Protection Bureau:

The new Consumer Financial Protection Bureau, which opens for business next week, does not plan to ban specific financial products, presidential adviser Elizabeth Warren told Congress.

Banning fraudulent financial products and services “is a tool in the toolbox, and that’s where it should stay,” Warren testified at a Republican-led House Oversight and Government Reform hearing on Thursday, the Wall Street Journal, Politico and other media reported. “We have no present intention to ban a product, but we are still learning about what’s out there” she said.

Republicans on the panel, who questioned Warren at a contentious hearing in late May, grilled Warren about whether the CFPB may try to outlaw payday loans and try to regulate new car loans.

“The American people have a right to know how the bureau will advance and enforce its regulatory assignment,” said Committee Chairman Darrell Issa, a California Republican. “Consumers deserve opportunities to choose between lending alternatives and other financial tools that establish credit and give buyers the chance for affordable enhancements to their standards of living.”

A C-span video of the three and one-half hour hearing is posted here. 

Banks push to weaken derivatives rules – In a potential win for big banks, federal regulators are considering a weaker version of a plan that initially sought to limit a big bank from controlling more than 20 percent of any one derivatives exchange.

The Commodity Futures Trading Commission is now privately discussing a lower cap after aggressive lobbying by Wall Street, the New York Times Dealbook reports.  How aggressive?  CFTC officials have held almost 50 private meetings with players including mega-banks such as Goldman Sachs Group Inc. and Morgan Stanley.

New financial data office – A new Treasury Department office tasked with collecting data from banks, hedge funds and brokerages is yet another example of government overreach and a likely target for hackers, Republicans warned Thursday at a House hearing.

The Office of Financial Research was created by the Dodd-Frank reform law with the power to collect and analyze company-specific data to help regulators pinpoint systemic risks to the economy.

The new office “has very broad power and authority with very few checks and balances,” said Texas Republican Randy Nuegebauer . “There is no limit to the information you can require from a company.”

Oil payment rules – Human rights groups urged the Securities and Exchange Commission to hurry up and finalize an energy industry anti-corruption rule that was tucked into the Dodd-Frank law.

The proposed SEC rule would force oil, natural gas and other energy companies listed on U.S. stock exchanges to disclose exactly how much each pays to overseas governments to acquire drilling and production rights. Energy companies have fought the SEC plan, saying the requirement would be overly burdensome and costly.

Reprinted by Permission © 2011, The Center for Public Integrity®. All Rights Reserved.

Evaluating Insurance Policies After Japan’s Earthquake

Posted on July 14, 2011 in the National Law Review by Risk Management Magazine of Risk and Insurance Management Society, Inc. (RIMS) information about an essential first step is to review insurance coverages for losses caused by natural catastrophes.

Shock and tragedy were the emotions most felt throughout Japan when the March earthquake and tsunami ravaged the nation. But companies doing business there have since moved on to planning mode, looking for ways to mitigate their losses, both those already suffered and the inevitable ones to come from similar exposures in the future.

An essential first step is to review insurance coverages for losses caused by natural catastrophes. Of particular importance is the potential availability ofcontingent business interruption insurance coverage for lost sales to Japanese customers or lost supplies from Japanese producers.

Property insurance policies obviously cover direct property damage caused by natural disasters. But those same policies also cover other types of business losses. Time element coverage pays for the lost profits when damaged property affects a policyholder’s day-to-day operations. The amount covered generally depends on the time it takes to resume normal business operations. Time element coverage can be triggered by damage either to the policyholder’s property or a third party’s property, and the most common kinds are business interruption, extra expense and contingent business interruption.

Business Interruption

The purpose of business interruption coverage is to restore the policyholder to the financial position it was in before the property damage occurred. To recover these losses, the lost profits, at a minimum, must relate to the event that caused the policyholder’s property damage. Once the insured demonstrates covered property damage, the measure of the loss generally is the difference between expected profits during the recovery period after the event and actual profits during that period, less any unrelated losses.

Perhaps the only recent U.S. event comparable to Japan’s earthquake is Hurricane Katrina. In Consolidated Cos. v. Lexington Ins. Co., the Fifth Circuit Court of Appeals ruled that business interruption losses resulting from Hurricane Katrina were covered without requiring proof to a level of specificity that the loss stemmed solely from damage to the policyholder’s property as a result of the hurricane. The insurance carrier argued that the policyholder had to prove what its likely performance would have been had Katrina taken place but not damaged the policyholder’s property, reasoning that, even absent damage to the policyholder’s property, profits would have been reduced because of the generally depressed economic conditions following the hurricane. Instead, the court concluded that the loss should be calculated as if Katrina had not struck at all.

Coverage for this interdependent business interruption loss can extend to locations that are distant from the damaged property if the policyholder can show that the undamaged facility operated in concert with the damaged one. An example would be a policyholder’s remote facility outside of Japan that cannot receive inventory because of damage to the policyholder’s manufacturing plant in Japan.

Extra Expense

Extra expense coverage aims to cover additional costs the policyholder incurs to minimize or avoid interruption of its business. Examples of such coverage are: additional utility costs needed to resume business operations; additional costs to store business equipment; moving costs to relocate to temporary facilities; and costs expended for the temporary repair or replacement of property. Most policies also contain a related coverage, similar to extra expense, typically called expense to reduce loss coverage, to reimburse additional costs incurred to mitigate property damage.

Contingent Business Interruption

Many policies protect against profits lost when a policyholder’s supplier or customer cannot conduct business because of property damage “of the type” covered under the policyholder’s policy. This coverage would provide, for example, recovery to a manufacturer of computers outside of Japan that suffers lost profits as a result of a supplier’s inability to provide required components because of damage to the supplier’s Japanese facility. Similarly, a policyholders’ profits affected by property damage to the facilities of a Japanese customer are recoverable. Covered costs also include losses incurred when a civil authority prevents access to the policyholder’s facilities, or when damage to property in the vicinity of the insured property prevents ingress to, or egress from, the policyholder’s facility.

John Banister, Erica Dominitz, Barry Fleishman, Helen Michael, Carl Salisbury and Caroline Spangenberg are all partners at Kilpatrick Townsend & Stockton.

Risk Management Magazine and Risk Management Monitor.  Copyright 2011 Risk and Insurance Management Society, Inc. All rights reserved.

eDiscovery for Pharma, Biotech & Medical Device Industries

The National Law Review is pleased to inform you of IQPC’s e-Discovery for Pharma, Biotech & Medial Device Industries Conference in Philadelphia on October 24-25, 2011.  We’ve provided some information on the conference for your convenience:

Mastering eDiscovery and Information management strategies and best practices fit for life sciences industries

Why attend eDiscovery for Pharma?

  • Learn from industry leaders who have successfully implemented technology solutions that have reduced cost and errors in eDiscovery production. Network with government and industry leaders who are influencing the practice and procedure of eDiscovery in the Pharmaceutical, Biotech and Medical Device Industries.
  • Prepare your organization with defensible information management techniques specifically geared toward global pharmaceutical data.
  • Join peer discussions on industry hot topics such as predictive coding, cloud computing and legal holds.
  • Avoid mistakes and costly sanctions for eDiscovery misconduct and Federal Corrupt Practices Act investigations.
  • Benchmark your internal processes and evaluate their effectiveness in practical scenarios.

Hear Perspectives from:

  • Edward Gramling, Senior Corporate Counsel at Pfizer
  • John O’Tuel, Assistant General Counsel at GlaxoSmithKline
  • Chris Garber, eDiscovery Manager atAllergan, Inc
  • HB Gordon, eDiscovery Analyst, Legal Affairs, Teva Pharmaceuticals USA
  • David Kessler, Partner at Fulbright & Jaworski
  • Phil Yannella, Partner at Ballard & Spahr

View Full Speaker List

IRS Defends Discretion to Withhold Section 1256 Exchange Designation for ISOs

Recently posted at the National Law Review by William R. Pomierski of  McDermott Will & Emery an article about the IRS defending its decision not to designate independent system operators as qualified board or exchange:

The IRS defended its decision not to designate independent system operators asqualified board or exchange (QBE) principally on the grounds that, as a matter of law, it is not required to designate any exchanges as QBEs under Category 3 of Section 1256 Contracts.

In Sesco Enterprises, LLC (Civ. No. 10-1470, D.N.J. Nov. 16, 2010), the Internal Revenue Service (IRS) defended its discretion to refrain from extending qualified board or exchange status under Code Section 1256 to U.S. Federal Energy Regulatory Commission (FERC)-regulated independent system operators.  The district court dismissed the taxpayer’s claim that the IRS acted arbitrarily and capriciously when it refused to classify electricity derivatives that traded on independent system operators as “Section 1256 Contracts.

Section 1256 Contracts in General

For federal income tax purposes, a limited number of derivative contracts are classified as Section 1256 Contracts.   Absent an exception, Section 1256 Contracts are subject to mark-to-market tax accounting and the 60/40 rule.  The 60/40 rule characterizes 60 percent of the net gain or loss from a Section 1256 Contract as long-term and 40 percent as short-term capital gain or loss.  Corporate taxpayers often view Section 1256 Contracts as tax disadvantageous, relative to economically similar derivatives that are not taxed as Section 1256 Contracts, such as swaps, unless the business hedging or some other exception is available.

Section 1256 Contract classification is limited to regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options and dealer securities futures contracts, as each is defined in the Internal Revenue Code.   Unless a derivative falls within one of these categories, it is not a Section 1256 Contract, regardless of its economic similarity to a Section 1256 Contract.

Except for foreign currency contracts, Section 1256 Contracts are limited to derivative positions that trade on or are subject to the rules of a qualified board or exchange (or QBE).  QBE status is extended only to national securities exchanges registered with the U.S. Securities and Exchange Commission (SEC) (a Category 1 Exchange); domestic boards of trade designated as contract markets by the U.S. Commodities Futures Trading Commission (CFTC) (a Category 2 Exchange); orany other exchange, board of trade or other market that the Secretary of the Treasury Department determines has rules adequate to carry out the purposes of Code Section 1256 (a Category 3 Exchange).

Category 1 and Category 2 Exchange status is automatic.   Category 3 Exchange status, however, requires a determination by the IRS.  In recent years, Category 3 Exchange designation has been extended to four non-U.S. futures exchanges offering products in the United States: ICE Futures (UK), Dubai Mercantile Exchange, ICE Futures (Canada) and LIFFE (UK).

Sesco Challenges IRS Discretion to Withhold Category 3 Exchange Designation

According to its website, the taxpayer in Sesco (Taxpayer) is an electricity and natural gas trading company. The facts of the case indicate that it traded electricity derivatives (presumably INCs, DECs, Virtuals and/or FTRs) on various independent system operators or regional transmission organizations regulated by the FERC (collectively, ISOs).  Because ISOs are not regulated by the SEC or the CFTC, they cannot be considered Category 1 or Category 2 Exchanges for purposes of Code Section 1256.  To date, no ISO has been designated as a Category 3 Exchange by the IRS.

According to the facts in Sesco, the Taxpayer took the position on its return that derivatives trading on ISOs were Section 1256 Contracts eligible for 60/40 capital treatment.  The IRS denied Section 1256 Contract status on audit.  Somewhat surprisingly, a footnote in Sesco suggests, without any further discussion, that the IRS agreed with the Taxpayer’s position that these electricity derivatives qualified as “regulated futures contracts” under Code Section 1256 except for satisfying the QBE requirement.

During the examination process, the Taxpayer apparently requested a private letter ruling from the IRS that the relevant ISOs were Category 3 Exchanges.   According to the district court, “The IRS refused, asserting that the request for a QBE determination must be made by the exchange itself.”  The Taxpayer then asked one of the ISOs to request Category 3 Exchange status, but the ISO declined to do so.  Taxpayer then filed suit challenging the IRS’s adjustments and asserted that the IRS “acted arbitrarily and capriciously and abused its discretion when it refused to make a QBE determination except upon request from the ISO.”  In essence, the Taxpayer was attempting to force the IRS to designate the ISOs at issue as QBEs.

The IRS defended its decision not to designate the ISOs as QBEs principally on the grounds that, as a matter of law, it is not required to designate any exchanges as QBEs under Category 3.   After briefly considering the wording of Code Section 1256 and the relevant legislative history, the court agreed with the IRS position and dismissed the case on procedural grounds (lack of jurisdiction).

Observations

Although the District Court’s decision in Sesco may be of little or no precedential value due to the procedural aspects of the case, the decision nevertheless is important in that it reflects what has long been understood to be the IRS’ position regarding Category 3 Exchange status, which is that Category 3 Exchange status is not automatic and requires a formal determination by the IRS.  Sesco also confirms that the IRS believes QBE classification can only be requested by the exchange at issue, not by exchange participants.

Unfortunately, Sesco does not address the separate question of whether the IRS could have unilaterally designated the ISOs at issue as QBEs without the participation of the exchanges.  Sesco also raises, but does not address, the issue of whether derivatives traded on exchanges that are not “futures” exchange can be considered “regulated futures contracts” for purposes of Code Section 1256.  These are critical questions that will become more relevant in the near future as the exchange-trading and exchange-clearing requirements imposed by the Dodd-Frank derivatives reform legislation begin to take effect.

© 2011 McDermott Will & Emery

Entrepreneur’s Guide to Litigation – Blog Series: Complaints and Answers

Recently posted at the  National Law Review  by John C. Scheller of Michael Best & Friedrich LLP an entrepreneur’s guide to the litigation process.

A.  The Complaint

Litigation begins with a Complaint. “Complaint” is capitalized because it is a specific legal document, rather than a garden-variety complaint about something. The Complaint lays out the plaintiff’s specific legal claims against the defendant. It needs to contain enough facts that, if everything stated is true and there are no extenuating circumstances, a judge and jury could find in favor of the plaintiff.

As an example, Paul Plaintiff is suing Diana Defendant for violating a contract. Paul files a Complaint with a court claiming several facts: 1) Diana signed a contract to buy widgets; 2) Paul delivered the widgets; and 3) Diana did not pay the agreed-upon amount. If the court finds that these facts are true, then, unless there were extenuating circumstances, Diana probably breached a contract with Paul and should pay damages.

Paul’s Complaint also needs to allege facts showing that he has a right to be in that court. For example, if Paul wants to sue Diana inTexas, he has to show that the case and the parties have some connection toTexas. If he wants to sue her in a federal court, he has to meet a number of other criteria. (Federal court is generally only available if the parties are based in different states and the damages are relatively substantial or if the legal question is one of federal law.)

B.  Response to a Complaint

Once the defendant officially learns of the Complaint, she has a certain limited time to file some sort of response with the court. The time to respond, however, does not run from when the plaintiff filed the lawsuit, but generally when he officially delivered notice of the Complaint to the defendant. (There is a timeline that starts ticking when the defendant becomes aware of a state court lawsuit she wants to “remove” to federal court.) The amount of time for the defendant to respond varies by what court the case is in, but is generally a short period of time.

After receiving the complaint, the defendant has three options: 1) Ignore the Complaint and have the court grant judgment in favor of the plaintiff; 2) Tell the court that the Complaint is defective and ask for dismissal; or 3) Answer the Complaint. Option one is usually not a good plan; courts do not look favorably on defendants who ignore the legal process, and this option prevents a defendant from fighting the plaintiff’s claims.

Option two does not deal with the merits of the plaintiff’s issue. It is simply telling the court that the Complaint is defective for a variety of reasons including, for instance, how it was served, who the parties are (or are not), which court the case is in, or simply that, even if everything is true, the plaintiff cannot win. For example, if Paul sues Diana, but never tells Diana about the suit, Diana can then ask the court to dismiss the case. Also, if Diana works for DefendCo and Paul’s contract was actually with DefendCo and not with Diana, personally, she may be able to have the case dismissed because Paul sued the wrong party. If Paul sued Diana in a federal court inTexaswhen both parties are residents ofCaliforniaand neither has ever been to or done business in Texas, then Diana may be able to get the case dismissed, at least from theTexascourt.

Finally, there is the “So, what?” defense. If the Complaint doesn’t actually allege a cause of action, the defendant can ask the court to dismiss it. This usually happens because the plaintiff simply assumes a fact, but does not include it in the Complaint. If, for example, Paul alleges only that Diana failed to pay him a certain amount of money, but does not allege that a contract existed between them, then Diana can essentially say “So, what?” and ask the court to dismiss the case. She would ask the court to dismiss the case because, even if true (she really did not pay him any money), he did not plead any facts showing that she was supposed to pay him money. The defendant is not admitting the truth of the allegation; she is just saying that even if true, the plaintiff cannot win.

Finally, a defendant can file an Answer. Again, “Answer” is capitalized because it is a specific legal document. In an Answer, the defendant responds, paragraph by paragraph, to each of the plaintiff’s allegations. The defendant must admit, deny, or say that she does not know the answer to each specific allegation. Saying “I don’t know” functions as a denial.

For example, Paul’s Complaint probably alleges that Diana lives at a certain address. Assuming Diana actually lives there, she has to admit that fact. Paul may allege that he delivered the correct number of working widgets to Diana. If the widgets were not what she actually ordered or did not work, Diana would deny that allegation. Finally, Paul may claim that those widgets cost him a certain amount of money. Diana likely has no way to know how much Paul paid for the widgets, so she would say she does not know – thus leaving Paul to prove that allegation.

Also in the Answer, the defendant can claim affirmative defenses. Those tell the court that there were extenuating circumstances so that, even if everything the plaintiff says is true, the court should not find in favor of the plaintiff.

For example, if Paul told Diana not to worry about paying him for the widgets for six months but then turned around and immediately sued her, she would claim that as an affirmative defense.

Finally, the Answer may contain counterclaims. These claims are the defendant counter-suing the plaintiff for something. The counterclaims may be related to the original suit or not. Usually they are related, but they do not have to be. This section follows the same rules as if the defendant were filing a complaint.

For example, Diana may counterclaim against Paul because he sent her the wrong widgets and, perhaps, add a claim that when Paul delivered the widgets to her warehouse, he backed his truck into her building and caused damage. She would then counterclaim for breach of contract and property damage. The court would then sort out the whole mess to decide who owed whom how much.

Click Here: to view the previous post in the Entrepreneur’s Guide to Litigation – Blog Series: Introduction

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Department of State Releases August 2011 Visa Bulletin

Recently posted at the National Law Review  by Eleanor Pelta, A. James Vázquez-Azpiri and Lance Director Nagel of  Morgan, Lewis & Bockius LLP details regarding The U.S. Department of State’s August 2011 Visa Bulletin.

The U.S. Department of State (DOS) has released its August 2011 Visa Bulletin. The Visa Bulletin sets out per country priority date cutoffs that regulate the flow of adjustment of status (AOS) and consular immigrant visa applications.  Foreign nationals may file applications to adjust their status to that of permanent resident, or to obtain approval of an immigrant visa application at an American embassy or consulate abroad, provided that their priority dates are prior to the cutoff dates specified by the DOS.

What Does the August 2011 Bulletin Say?

EB-1: All EB-1 categories remain current.

EB-2: Priority dates remain current for foreign nationals in the EB-2 category from all countries except China and India.

The relevant priority date cutoffs for Indian and Chinese nationals are as follows:

China: April 15, 2007 (forward movement of five weeks)

India: April 15, 2007 (forward movement of five weeks)

EB-3: There is continued backlog in the EB-3 category.

The relevant priority date cutoffs for foreign nationals in the EB-3 category are as follows:

China: July 8, 2004 (forward movement of one week)

India: June 1, 2002 (forward movement of one month)

Mexico: November 1, 2005 (forward movement of four months)

Philippines: November 1, 2005 (forward movement of three weeks)

Rest of the World: November 1, 2005 (forward movement of three weeks)

How This Affects You

Priority date cutoffs are assessed on a monthly basis by the DOS, based on anticipated demand. Cutoff dates can move forward or backward, or remain static and unchanged. Employers and employees should take the immigrant visa backlogs into account in their long-term planning, and take measures to mitigate their effects. To see the August 2011 Visa Bulletin in its entirety, please visit the DOS website at http://www.travel.state.gov/visa/bulletin/bulletin_5518.html.

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