Michigan Employers Take Note: New Ruling Impacts Paid Leave and Minimum Wage

Today, July 31, 2024, the Michigan Supreme Court released a highly anticipated opinion in the case of Mothering Justice v. Nessel. This case assessed the constitutionality of the Michigan Legislature’s 2018 “adopt-and-amend” strategy under which the Legislature adopted, and then immediately changed, two ballot proposals that would otherwise have been included on the November 2018 ballot for decision by Michigan voters. The ballot proposals pertained to Michigan minimum wage and paid sick leave requirements, and were originally entitled the Earned Sick Time Act (ESTA) and Improved Workforce Opportunity and Wage Act (IWOWA). The Legislature’s “adopt-and-amend” action had narrowed the original ballot proposal language, and resulted instead in the enactment of the Michigan Paid Medical Leave Act (PMLA) and current minimum wage provisions in effect since early 2019.

After years of legal challenge, the Michigan Supreme Court reversed a 2023 decision of the Michigan Court of Appeals, and ruled that the “adopt-and-amend” approach utilized by the Michigan Legislature violated the Michigan Constitution. The Court determined both of the ballot initiatives as originally adopted by the Legislature should be reinstated in lieu of current, amended versions. In the interests of justice and equity, the Court ordered the reinstatement to occur, but only after a time period the same as that which employers would have been provided to prepare for the new laws absent their improper amendment.

Therefore, significant new legal requirements will become effective February 21, 2025. These include:

  1. The paid leave ballot proposal as initially adopted by the Legislature in 2018, in the form of the ESTA, is reinstated effective February 21, 2025, in place of the PMLA. All covered employers must amend existing paid leave policies or implement new leave policies as applicable that comply with the ESTA by February 21, 2025. Key elements of the ESTA include:
    • All Michigan employers, except for the U.S. government, are covered.
    • All employees of a covered employer, rather than only certain categories of employees as provided under the PMLA, are covered.
    • Covered employers must accrue sick time for covered employees, at a rate of at least one hour of earned sick time for every 30 hours worked.
    • Employers with 10 or more employees, as defined by the ESTA, must allow employees to use up to 72 hours of paid earned sick time per year.
    • Employers with fewer than 10 employees, as defined by the ESTA, must provide up to 40 hours of earned paid sick time, and are permitted to provide remaining earned sick leave up to the required 72 hours per year on an unpaid basis, rather than paid.
    • Employers may not prohibit the carryover or cap the accrual of unused earned sick time.
    • Employers may limit the use of earned sick time in any year to 72 hours.
  2. The minimum wage ballot proposal as originally adopted by the Legislature in 2018, in the form of the IWOWA, is also effective February 21, 2025, subject to a phase in of certain requirements that remains to be determined at this time. The IWOWA will replace the narrower amendments that previously were enacted and took effect in 2019. Key provisions effective February 21, 2025, include:
    • The state minimum wage rate will be $10.00 plus the state treasurer’s inflation adjustment, which has yet to be calculated and released.
    • Future increases will be calculated annually based on inflation as specified in the IWOWA.
    • The existing “tip credit” provisions employers of tipped employees currently utilize to calculate whether they have been paid minimum wage will be phased out over a period of years and eliminated entirely by February 21, 2029.
    • Employees will have expanded rights as to how they are compensated for overtime work, including “comp time” as an alternative to customary payment of overtime wages.

The above will be applicable absent further judicial, legislative, or voter-driven constitutional action that prescribes a different course. As to judicial action, opportunities for appeal or rehearing of a state Supreme Court decision are limited and discretionary. As to voter-driven constitutional action, such as a referendum, the timing of the Court’s decision may well not permit for such action to be included on the 2024 ballot, even if sufficient support for such action were shown.

In terms of any legislative action to amend, such action could only occur in a future legislative session, meaning January 2025 or later. As to the level of support required, because the ballot proposals were adopted by the Legislature rather than approved by a majority of Michigan voters in an election process, the normal requirements will apply. Had the ballot proposals been approved by a majority of Michigan voters in the election, a 75% supermajority of both houses of the Legislature would have been required for any amendment passage.

© 2024 Varnum LLP

by: Luis E. Avila, Maureen Rouse-Ayoub, Stephanie R. Setterington, Elizabeth Wells Skaggs, Hannah A. Cone, and Ashleigh E. Draft of Varnum LLP

For more news on Michigan Employment Laws, visit the NLR Labor & Employment law section.

Grantor Trusts Rules – Will the Loopholes be Closed in 2025?

While some may see the discovery and use of tax loopholes as a triumph of human ingenuity, others see their exploitation as an abuse of the tax code. The concepts developed here are complex but worth understanding if you want to use them for your clients or participate in the public discourse about related tax law reforms.

When anticipating significant appreciation of an asset, affluent taxpayers typically have two options: 1.  transfer the property now (as a gift) to avoid estate taxes on future appreciation, or 2. transfer the property upon death to avoid income taxes on the appreciation. For each of these options, there is good news and bad news:

If the taxpayer gifts the property today, its value is fixed for transfer tax purposes as of the gift date per IRC Sec. 2512. This avoids transfer taxes on any future appreciation. However, the donee inherits the donor’s basis, often low, under IRC Sec. 1015 and will pay income tax on the appreciation when selling the property.

If the property is transferred at death, its value is determined at the date of death under Sec. 2031, capturing all appreciation for transfer tax purposes. The donee receives a stepped-up basis under IRC Sec. 1014, eliminating income tax on the appreciation that occurred before the donor’s death. However, the property is subject to the estate tax at its current fair market value.

In addition to the above, we need to mention an intermediate situation, the incomplete gift. An incomplete gift occurs when the donor retains certain powers or interests over the transferred property, which prevents the gift from being considered complete for tax purposes. This can have various implications, including the deferral of gift tax liability and the potential inclusion of the property in the donor’s estate.

Tax Planning Conundrum: Wouldn’t it be nice if a taxpayer who has an estate large enough to be subject to estate taxes could do both: avoid capital gains taxes and avoid additions to the taxable estate due to appreciation? In other words, could one obtain a stepped-up basis for income tax purposes while also “freezing” the value of the wealth for transfer tax purposes?

Let’s hold that thought and review the Grantor Trust Rules. They determine when a trust is a grantor trust and when it is not, which in turn determines who pays income taxes. This will be important to solving the tax planning conundrum posed above.

Grantor Trust Rules

The distinction between a grantor trust and a non-grantor trust depends on whether the settlor (grantor) retains any incidents of ownership over the trust. If they do, it is a grantor trust; if they don’t, it’s a non-grantor trust. Incidents of ownership can be any number of things by which control over the trust is exerted, for example, the right to change beneficiaries (Table 1).

As stated, in a grantor trust, the grantor maintains a certain degree of control over the trust’s assets or income. In contrast, non-grantor trusts include irrevocable trusts in which the grantor has relinquished control over the trust assets and does not retain any powers that would cause the trust to be treated as a grantor trust.

Provision Description
Power to Revoke (§ 676) If the grantor has the power to revoke the trust and reclaim the trust assets, the trust is considered a grantor trust.
Power to Control Beneficial Enjoyment (§ 674) If the grantor retains certain powers to control the beneficial enjoyment of the trust’s income or principal, the trust may be treated as a grantor trust.
Administrative Powers (§ 675) If the grantor retains administrative powers that can affect the beneficial enjoyment of the trust, the trust may be considered a grantor trust.
Reversionary Interests (§ 673) If the grantor retains a reversionary interest in the trust that exceeds 5% of the trust’s value, the trust is considered a grantor trust.
Income for the Benefit of the Grantor (§ 677) If the trust income is or may be used to pay premiums on insurance policies on the life of the grantor or the grantor’s spouse, the trust is treated as a grantor trust.

If the trust income can be distributed to the grantor or the grantor’s spouse or held for future distribution to them, the trust is considered a grantor trust.

Table 1: The most important grantor trust rules

The distinction between grantor and non-grantor trusts was made to determine who has to pay income taxes on the trust’s income. In a grantor trust, it’s the grantor; in a non-grantor trust, it’s the trust.

The transfer tax and income tax regimes are closely aligned. When a grantor retains control over transferred property in a trust, they have a grantor trust.  This property is generally considered owned by the grantor at death for estate tax purposes. For instance, if a grantor has the power to revoke a trust, Section 676 treats the grantor as owning the property for income tax purposes, and Section 2038 treats it as owned by the grantor at death for estate tax purposes. However, there is a loophole.

The Loophole – The Intentionally Defective Grantor Trust

An Intentionally Defective Grantor Trust (IDGT) is a type of trust designed to be treated as owned by the grantor for income tax purposes but not for estate tax purposes. This means that the income generated by the trust is taxable to the grantor, but the trust’s assets are not included in the grantor’s estate for estate tax purposes. To draft an IDGT, certain provisions must be included to ensure that the trust is considered defective for income tax purposes. These provisions typically involve intentionally violating one of the above grantor rules so that the trust is taxed on the trust’s income.

A more descriptive name for an Intentionally Defective Grantor Trust (IDGT) could be “Swap Power Grantor Trust”. The swap power is a common feature in the drafting of an Intentionally Defective Grantor Trust (IDGT). It allows the grantor to reacquire trust property by substituting other property of equivalent value. This power is crucial because it helps ensure that the trust is considered a grantor trust for income tax purposes while not causing the trust property to be included in the grantor’s estate for estate tax purposes.

The “Swap Power” in Action:

  • Income Tax Implications:
    • Section 675: The swap power causes the grantor to be treated as owning the property for income tax purposes.
    • No Corresponding Estate Tax Rule: There is no rule that includes this property in the grantor’s estate for transfer tax purposes. Thus, the value of the property for transfer tax purposes is fixed at the time of the gift (Section 2512).

Transferring Property to the Trust:

  • Initial Transfer:
    • When the grantor transfers property to a trust with a swap power, the property is valued for gift and estate tax purposes as of the date of the gift, which freezes its value.
  • Appreciation:
    • Inside the trust, after the transfer, the property may enjoy unlimited appreciation; however, its value for estate tax purposes remains “frozen” at the time of the gift.

Income Tax Treatment of Transactions with the Trust:

  • Disregarded Transactions:
    • Under Section 675, transactions between the grantor and the trust (due to the swap power) are disregarded for income tax purposes.
    • Exercise of Swap Power:
      • When the grantor exercises the swap power (exchanging property within the trust), it is seen as moving assets between the grantor’s own “pockets,” so there are no income tax consequences.

Basis and Tax Implications:

  • Carryover Basis Rule (Section 1015):
    • Normally, the basis of the gifted property carries over to the donee, meaning any appreciation is subject to income tax when the property is sold.
  • Stepped-Up Basis (Section 1014):
    • By using the swap power, the grantor can transfer appreciated low-basis property out of the trust and high-basis property of the same value into the trust.
    • The appreciated property is back in the grantor’s hands. When the grantor dies, it gets a stepped-up basis to its fair market value at death.
    • This eliminates the capital gains tax on the appreciation of the property that occurred before the grantor’s death.
    • In addition, estate taxes are at a lower level because the valuation for estate tax purposes was frozen before appreciation in the trust.

This is all very well, but let’s see how this works out in practice.

Simplified Example

  • Grantor: John
  • Trust Beneficiary: Emily
  • Property: Real estate
  • Initial Value: $2 million
  • Appreciated Value: $6 million

Steps:

See Figure 1.

  1. Initial Transfer:
    • John transfers real estate valued at $2 million to a trust with a swap power. This value is fixed for gift and estate tax purposes.
  2. Appreciation:
    • The property appreciates to $6 million over several years, but its value for estate tax purposes remains “frozen” at $2 million.
  3. Using the Swap Power:
    • John uses the swap power to exchange the $6 million property in the trust for $6 million in cash or other assets.
    • This transaction has no income tax consequences because it is disregarded under Section 675.
  4. Basis Adjustment:
    • Normally, the property in the trust would retain John’s original basis, making any appreciation subject to income tax when sold.
    • By swapping the property out of the trust for $6 Million, John reclaims the house. Upon his death and transfer to beneficiaries, the property gets a stepped-up basis to its fair market value of $6 million.
    • This eliminates capital gains tax on the appreciation that occurred before John’s death.

avoid capital gains and estate taxes with a swap power

Figure 1: How to avoid capital gains and estate taxes with a swap power in a grantor trust (Intentionally Defective Grantor Trust)

John effectively avoids income tax on the property’s appreciation during his lifetime and ensures the property gets a stepped-up basis at his death, providing significant tax advantages for Emily. Our tax planning conundrum from above has been solved.

A number of other techniques have a similar effect, but their discussion goes beyond the scope of this article.

Biden’s Reform Plans

Historical Background

Until 1986, taxpayers aimed to avoid having their trusts classified as grantor trusts to escape the burden of personally paying income taxes on trust earnings. This was crucial in an era with a highly progressive income tax system, exemplified by 1954’s 24 tax brackets ranging from 20% to 91%. In 1954 Congress, codifying judicial decisions and wanting to prevent income shifting from higher to lower tax brackets, enacted the grantor trust rules. However, the 1986 Tax Reform Act and subsequent reforms compressed income tax rates, making grantor trusts more favorable. Today, classifying a trust as a grantor trust often results in better tax outcomes. Moreover, as explained above, careful drafting of grantor trusts can limit both estate and income taxes to an extent otherwise not possible (1).

The current situation subverts Congress’s original intent and is also perceived as societally unfair, as it benefits only the already very wealthy. Reforms are periodically suggested, most recently by the Biden administration in the Greenbook, the Tax Proposal for 2025 (2).

Several reform efforts are aimed at Grantor Retained Annuity Trusts, which we will discuss in a follow-up article but list here for context.

1. Grantor Retained Annuity Trusts (GRATs)

  • Minimum Value for Gift Tax: The remainder interest in a GRAT must have a minimum value for gift tax purposes equal to the greater of 25% of the value of the assets transferred or $500,000.
  • Annuity Payments: The annuity payments cannot decrease during the term of the GRAT.
  • Minimum and Maximum Terms: The GRAT must have a minimum term of ten years and a maximum term equal to the annuitant’s life expectancy plus ten years.
  • Prohibition on Tax-Free Exchanges: The grantor cannot exchange assets held in the trust without recognizing gain or loss for income tax purposes.
  • Impact: These changes aim to reduce the use of short-term and “zeroed-out” GRATs, which are often used for tax avoidance purposes.

2. Sales and Transfers Between Grantor Trusts and Deemed Owners

  • Taxable Events: Sales of appreciated assets between a grantor and a grantor trust will be recognized as taxable events, requiring the seller to pay capital gains tax on the appreciation.
  • Basis Adjustment: The buyer’s basis in the transferred asset will be the amount paid to the seller.
  • Purpose: This proposal aims to prevent tax-free transfers of appreciated assets and ensure that such transactions are treated similarly to sales between unrelated parties.

3. Income Tax Payments as Gifts

  • Gift Treatment: The grantor’s payment of income tax on the trust’s income will be treated as a taxable gift to the trust. This gift will occur on December 31 of the year the tax is paid unless the trust reimburses the grantor.
  • Impact: This change ensures that the grantor’s payment of the trust’s income tax liabilities is recognized as a transfer of value subject to gift tax.

4. Realization of Capital Gains

  • Realization Events: Unrealized capital gains on appreciated property will be taxed at the time of transfer by gift or upon death. This includes transfers to or from most types of trusts and distributions from revocable grantor trusts to persons other than the trust’s owner or their spouse.
  • Impact: This would treat transfers of appreciated assets as taxable events, departing from the current practice of realizing such gains only upon sale. It aims to ensure that high-income taxpayers do not benefit from deferred capital gains taxes indefinitely.

5. Intrafamily Asset Transfers

  • Valuation Discounts: Discounts for lack of marketability and control will be reduced or eliminated for intrafamily transfers of partial interests in assets if the family collectively owns at least 25% of the property.
  • Collective Valuation: The transferred interest’s value will be calculated as a pro-rata share of the total fair market value of the property held by the transferor and their family members, as if a single individual owned all interests.
  • Purpose: This proposal aims to curb the use of valuation discounts to reduce the taxable value of intrafamily transfers.

What if the Republicans Gain Control of Congress?

The Republican proposals regarding grantor trusts largely focus on maintaining the status quo established by the 2017 Tax Cuts and Jobs Act (TCJA). This includes making the increased estate, gift, and generation-skipping transfer (GST) tax exemptions permanent, thus avoiding the reduction scheduled for 2026. Additionally, Republicans are likely to oppose the Biden administration’s suggested reforms, such as treating sales between a grantor and a grantor trust as taxable events and recognizing the payment of income tax on trust income as a taxable gift.

Conclusion

As we anticipate potential changes to the grantor trust rules in 2025, it’s clear that the landscape of estate planning may undergo significant transformations. The Biden administration’s proposals, likely to be adopted in a similar form by Vice President Harris, aim to close loopholes that currently allow for substantial tax advantages through mechanisms like the swap power and GRATs. These reforms would impose stricter requirements and tax consequences, curbing the ability to avoid capital gains and transfer taxes. Conversely, Republican proposals focus on maintaining the current tax benefits established by the 2017 Tax Cuts and Jobs Act. Understanding these proposals and their potential impacts is crucial for tax professionals and affluent taxpayers. Staying informed and proactive will ensure the optimal structuring of trusts and asset transfers, aligning with the evolving tax regulations and maximizing the benefits within the legal framework.

 References:

1  Jesse Huber. The grantor trust rules: An exploited mismatch. The Tax Adviser. November 1, 2021

2  Department of the Treasury March 11, 2024. General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals. Green Book p.127

© 2024 wealthcarelawyer.com. All rights reserved.

In Trio of Decisions, Supreme Court Resolves Circuit Splits on Arbitration

Three recent Supreme Court Decisions—Coinbase v. Suski, Smith v. Spizzirri, and Bissonnette v. LePage Bakeries—based on consumer and employment disputes have resolved significant circuit splits over arbitration. These cases were all decided by a unanimous Court, with Justices Jackson, Sotomayor, and Roberts authoring the three opinions.

Supreme Court Considers Arbitrability Based on Conflicting Contracts

In Coinbase v. Suski (May 23, 2024), the Supreme Court held that where there is a conflict between one or more contracts between same parties regarding the arbitrability of a dispute, a court alone (and not the arbitrator) must decide which contract governs. The appeal arose from a sweepstakes dispute wherein the official rules of the sweepstakes conflicted with the defendant’s user agreement.

After the plaintiff consumers brought a class action in California federal court, the defendant sought a motion to dismiss based on an arbitration provision in the user agreement. The district court denied the defendant’s motion based on the forum selection clause in a contract detailing the sweepstakes’ rules. The Ninth Circuit affirmed, agreeing that the forum selection clause, which gave sole jurisdiction over sweepstakes-related disputes to California courts, superseded the arbitration provision in the user agreement.

In a unanimous decision, the Supreme Court agreed with the Ninth Circuit that courts, not arbitrators, must decide the threshold question of whether a subsequent agreement supersedes an arbitration provision, dismissing concerns that the holding would invite challenges to delegation clauses that empower arbitrators to decide disputes concerning arbitrability.

Prior to the decision in Suski, there was no precedent in the First Circuit addressing the question of who resolves conflicting dispute resolution clauses. However, the Court’s decision accords with the approach of the First Circuit to related questions.

In Biller v. S-H OpCo Greenwich Bay Manor, LLC (2020), the First Circuit held that for parties to agree to have an arbitrator decide gateway questions of arbitrability, they must do by “clear and unmistakable evidence,” safeguarding a court’s jurisdiction to decide questions of arbitrability. Similarly, in McKenzie v. Brennan (2021), the First Circuit held that the court holds the decision-making power to decide whether parties intend to arbitrate a dispute when a new contract between the parties does not contain a broad arbitration clause, but an earlier contract does.

District Courts May Not Dismiss Cases Referred to Arbitration Upon a Request to Stay

In Smith v. Spizzirri (May 16, 2024), the Supreme Court interpreted 9 U.S.C. § 3 to mean that when a district court finds that a contract compels arbitration and a party has requested a stay of court proceedings pending arbitration, the court lacks jurisdiction to dismiss the suit. Instead, the Supreme Court determined that a lower court must stay the proceedings until the dispute is resolved in arbitration or the dispute is brought back before the court.

The decision arose from a California class action alleging delivery drivers had been misclassified as independent contractors and denied required wages and paid leave. While the Ninth Circuit affirmed the lower court’s discretion to dismiss the action referred to arbitration on a motion by the defendant, the Supreme Court unanimously reversed and remanded. Spizzirri may be understood as the complement to an earlier decision also involving Coinbase, Coinbase v. Bielski (June 23, 2023) (see our prior alert here), which held that a district court must stay its proceedings while an interlocutory appeal on the question of arbitrability is ongoing.

The First Circuit (as well as the Fifth, Eighth, and Ninth Circuits) had previously held that a district court has discretion to either dismiss litigation without prejudice or stay the proceedings. Dismissal following a referral to arbitration provided plaintiffs with an opportunity to appeal that final, adverse ruling, with the Supreme Court’s decision now requiring plaintiffs to wait until the arbitration has been completed.

While the First Circuit has not yet passed a decision under following Spizzirri, a recent decision by the Rhode Island District Court may indicate how post-Spizzirri questions will be decided. In De Simone v. Citizens Bank (June 17, 2024) the court directly cited to Spizzirri to conclude that the proceedings in that case must be stayed pending arbitration. At the appellate level, the Ninth Circuit (which previously, like the First Circuit, held that courts have discretion to stay or dismiss) amended its opinion in Herrera v. Cathay Pacific Airways Ltd. (March 11, 2024; amended June, 24, 2024) to reflect the decision in Spizzirri, writing that “Spizzirri made clear that a district court does not have discretion to dismiss the action when granting a motion to compel arbitration under 9 U.S.C. § 3.”

Supreme Court Holds Workers in Any Industry May Benefit from Arbitration Exemption

In Bissonnette v. LePage Bakeries Park St. LLC (May 14, 2024), the Supreme Court unanimously held that the Federal Arbitration Act’s exemption for transportation workers at 9 U.S.C. § 1, which protects workers in foreign or interstate transportation from having their employment claims referred to mandatory arbitration, may apply to workers in any industry.

In LePage Bakeries, the defendant companies argued that baked goods delivery drivers were not protected from the exemption because they were not transportation industry employees. The district court and Second Circuit agreed, compelling arbitration of the parties’ dispute. The Supreme Court reversed, noting that the Second Circuit has created a transportation-industry requirement without any basis in the text of the statute.

The decision resolves a split among the First and Second Circuits in favor of workers seeking to bring class action claims. In two 2023 cases, Canales v. CK Sales Co. and Fraga v. Premium Retail Servs., Inc., the First Circuit explicitly rejected the Second Circuit’s reading of the Federal Arbitration Act that a worker must be employed in the transportation industry to benefit from the exemption to mandatory arbitration. Instead, the First Circuit focused on the worker’s role instead of the employer’s business, a test that the Supreme Court has now embraced. The Court’s decision follows New Prime, Inc. v. Oliveira (2019) and Southwest Airlines Co. v. Saxon (2023) wherein the Court held the exemption applies to independent contractors and airplane cargo loaders.

Recent Decisions Reflect Critical Questions on Jurisdiction Over Arbitration Disputes

The Supreme Court’s trio of unanimous arbitration decisions outline three areas in which district courts retain jurisdiction over arbitration disputes. The rulings reflect the outer limits of a multi-decade trend in which the Supreme Court has consistently issued arbitration-friendly decisions, encouraging the resolution of arbitrable matters without involving the courts.

It is likely that challenges to arbitrability based on conflicting contracts and transportation work will remain flashpoints in federal court litigation for years to come, with federal courts retaining jurisdiction over disputes referred to arbitration, hearing fewer appeals of orders compelling arbitration, and resolving matters that arise during those proceedings. The decisions serve as reminders to businesses that they should work with experienced counsel to draft and regularly review dispute resolution clauses in consumer and employment contracts to ensure that, if disputes do ultimately arise, they will be resolved via the intended procedure.

* * *

Thank you to firm summer associate Jonathan Tucker for his contribution to this post.

©2024 Pierce Atwood LLP. All rights reserved.
For more on Arbitration, visit the NLR ADR Arbitration Mediation section.

Top Competition Enforcers in the US, EU, and UK Release Joint Statement on AI Competition – AI: The Washington Report

On July 23, the top competition enforcers at the US Federal Trade Commission (FTC) and Department of Justice (DOJ), the UK Competition and Markets Authority (CMA), and the European Commission (EC) released a Joint Statement on Competition in Generative AI Foundation Models and AI products. The statement outlines risks in the AI ecosystem and shared principles for protecting and fostering competition.

While the statement does not lay out specific enforcement actions, the statement’s release suggests that the top competition enforcers in all three jurisdictions are focusing on AI’s effects on competition in general and competition within the AI ecosystem—and are likely to take concrete action in the near future.

A Shared Focus on AI

The competition enforcers did not just discover AI. In recent years, the top competition enforcers in the US, UK, and EU have all been examining both the effects AI may have on competition in various sectors as well as competition within the AI ecosystem. In September 2023, the CMA released a report on AI Foundation Models, which described the “significant impact” that AI technologies may have on competition and consumers, followed by an updated April 2024 report on AI. In June 2024, French competition authorities released a report on Generative AI, which focused on competition issues related to AI. At its January 2024 Tech Summit, the FTC examined the “real-world impacts of AI on consumers and competition.”

AI as a Technological Inflection Point

In the new joint statement, the top enforcers described the recent evolution of AI technologies, including foundational models and generative AI, as “a technological inflection point.” As “one of the most significant technological developments of the past couple decades,” AI has the potential to increase innovation and economic growth and benefit the lives of citizens around the world.

But with any technological inflection point, which may create “new means of competing” and catalyze innovation and growth, the enforcers must act “to ensure the public reaps the full benefits” of the AI evolution. The enforcers are concerned that several risks, described below, could undermine competition in the AI ecosystem. According to the enforcers, they are “committed to using our available powers to address any such risks before they become entrenched or irreversible harms.”

Risks to Competition in the AI Ecosystem

The top enforcers highlight three main risks to competition in the AI ecosystem.

  1. Concentrated control of key inputs – Because AI technologies rely on a few specific “critical ingredients,” including specialized chips and technical expertise, a number of firms may be “in a position to exploit existing or emerging bottlenecks across the AI stack and to have outside influence over the future development of these tools.” This concentration may stifle competition, disrupt innovation, or be exploited by certain firms.
  2. Entrenching or extending market power in AI-related markets – The recent advancements in AI technologies come “at a time when large incumbent digital firms already enjoy strong accumulated advantages.” The regulators are concerned that these firms, due to their power, may have “the ability to protect against AI-driven disruption, or harness it to their particular advantage,” potentially to extend or strengthen their positions.
  3. Arrangements involving key players could amplify risks – While arrangements between firms, including investments and partnerships, related to the development of AI may not necessarily harm competition, major firms may use these partnerships and investments to “undermine or coopt competitive threats and steer market outcomes” to their advantage.

Beyond these three main risks, the statement also acknowledges that other competition and consumer risks are also associated with AI. Algorithms may “allow competitors to share competitively sensitive information” and engage in price discrimination and fixing. Consumers may be harmed, too, by AI. As the CMA, DOJ, and the FTC have consumer protection authority, these authorities will “also be vigilant of any consumer protection threats that may derive from the use and application of AI.”

Sovereign Jurisdictions but Shared Concerns

While the enforcers share areas of concern, the joint statement recognizes that the EU, UK, and US’s “legal powers and jurisdictions contexts differ, and ultimately, our decisions will always remain sovereign and independent.” Nonetheless, the competition enforcers assert that “if the risks described [in the statement] materialize, they will likely do so in a way that does not respect international boundaries,” making it necessary for the different jurisdictions to “share an understanding of the issues” and be “committed to using our respective powers where appropriate.”

Three Unifying Principles

With the goal of acting together, the enforcers outline three shared principles that will “serve to enable competition and foster innovation.”

  1. Fair Dealing – Firms that engage in fair dealing will make the AI ecosystem as a whole better off. Exclusionary tactics often “discourage investments and innovation” and undermine competition.
  2. Interoperability – Interoperability, the ability of different systems to communicate and work together seamlessly, will increase competition and innovation around AI. The enforcers note that “any claims that interoperability requires sacrifice to privacy and security will be closely scrutinized.”
  3. Choice – Everyone in the AI ecosystem, from businesses to consumers, will benefit from having “choices among the diverse products and business models resulting from a competitive process.” Regulators may scrutinize three activities in particular: (1) company lock-in mechanisms that could limit choices for companies and individuals, (2) partnerships between incumbents and newcomers that could “sidestep merger enforcement” or provide “incumbents undue influence or control in ways that undermine competition,” and (3) for content creators, “choice among buyers,” which could be used to limit the “free flow of information in the marketplace of ideas.”

Conclusion: Potential Future Activity

While the statement does not address specific enforcement tools and actions the enforcers may take, the statement’s release suggests that the enforcers may all be gearing up to take action related to AI competition in the near future. Interested stakeholders, especially international ones, should closely track potential activity from these enforcers. We will continue to closely monitor and analyze activity by the DOJ and FTC on AI competition issues.

©1994-2024 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
For more on AI Competition, visit the NLR Communications Media Internet section.

PTAB MTA Pilot Program to the Rescue

On review of a final written decision from the Patent Trial & Appeal Board in an inter partes review (IPR), the US Court of Appeals for the Federal Circuit found that all challenged claims were obvious but left open the possibility of the patent owner amending the claims under the Motion to Amend (MTA) Pilot Program. ZyXEL Communications Corp. v. UNM Rainforest Innovations, Case Nos. 22-2220; -2250 (Fed. Cir. July 22, 2024) (Dyk, Prost, Stark, JJ.)

ZyXEL Communications petitioned for IPR challenging claims 1 – 4, 6, 7 and 8 of a patent owned by UNM Rainforest Innovation (UNMRI). The patent relates to methods for constructing frame structures in communication systems using orthogonal frequency-division multiple access (OFDMA) technologies. The patent describes a method for constructing a frame structure with two sections, each of which is configured for a different communication system, where the second communication system is used to support high mobility users (i.e., faster moving users).

Before the Board, ZyXEL argued that claims 1 – 4, 6 and 7 were unpatentable in light of two prior art references (Talukdar and Li), and that claim 8 was unpatentable in light of Talukdar and another prior art reference (Nystrom). During the Board proceedings, UNMRI filed a contingent motion to amend if any of the challenged claims were found to be unpatentable. As part of its motion, UNMRI requested preliminary guidance from the Board pursuant to the Board’s MTA Pilot Program. In its opposition to UNMRI’s motion to amend, ZyXEL argued that UNMRI’s amended claims lacked written description support, and in its preliminary guidance, the Board agreed. UNMRI attempted to file a revised motion to amend, but the Board rejected the revised motion and instead permitted UNMRI to file a reply in support of its original motion. It also allowed ZyXEL to file a sur-reply. The Board determined that claims 1 – 4, 6 and 7 were unpatentable, but that claim 8 was not. The Board also granted UNMRI’s motion to amend and determined that the new claims were nonobvious over the prior art of record. Both sides appealed.

With respect to the Board’s decision on the obviousness of claims 1 – 4, 6 and 7, the Federal Circuit found that substantial evidence supported the ruling. UNMRI’s primary argument was that a person of skill in the art (POSA) would not have been motivated to combine Talukdar and Li, but the Court credited the Board’s reliance on ZyXEL’s expert, who demonstrated sufficient motivation to combine the two references.

The Federal Circuit reversed the Board’s finding that claim 8 had not been shown to be obvious, however. The Court noted that while the Nystrom reference may not explicitly state the benefit of the missing limitations, “a prior art reference does not need to explicitly articulate or express why its teachings are beneficial so long as its teachings are beneficial and a POSA would recognize that their application was beneficial.”

Regarding UNMRI’s motion to amend, ZyXEL argued that the Board erred in granting the motion because UNMRI did not satisfy the requirement that the motion itself contain written description support for all of the claim limitations of the substitute claims. The parties agreed that UNMRI’s reply contained the missing written description, but ZyXEL argued that this could not cure the procedural defect. The Federal Circuit acknowledged the procedural error but determined that “the core purpose of the MTA Pilot Program is to allow for the correction of errors in the original motion [and is thus] designed to allow reply briefs to address and correct errors.” The Court noted that ZyXEL had opportunity to respond in its sur-reply brief. The Court upheld the Board’s decision to grant UNMRI’s motion to amend and remanded the IPR back to the Board to determine, in light of the Court’s rulings on claim 8 and the fair teachings of Nystrom, whether the substitute claims were nonetheless obvious.

The Federal Circuit also reminded the Board that it may sua sponte identify a patentability issue for the proposed substitute claims based on any prior art of record in the proceedings.

© 2024 McDermott Will & Emery
For more news on PTAB’s Motion-to-Amend Pilot Program, visit the NLR  Intellectual Property section.

The New Paradigm in Mexico for Damage Claims in Industrial Property.

The Federal Law for the Protection of Industrial Property, in force since the 5th of November of 2020, is distinguished from its predecessor, among other things, by the particularities in the claims of a compensation for damages caused by the infringement of industrial property rights.

Currently, individuals may claim a compensation for damages through the administrative venue, before the Mexican Institute of Industrial Property (IMPI), or through the civil venue before the corresponding Courts in the matter. This implies that the holder of infringed exclusive rights may opt for two procedures and authorities of different nature, which has its benefits and disadvantages.

Before the IMPI, the compensation action is exercised in an ancillary proceeding, provided that such authority has previously issued a declaration of administrative infringement that is enforceable. Alternatively, it is still possible for the action to be brought directly before the Civil Courts, once the resolution from IMPI is final.

Although the exercise of the action for compensation before the administrative authority implies that a specialized authority in the matter is to hear the case, it has the disadvantages that its ancillary proceeding requires the prior prosecution of an administrative infringement claim before the same administrative authority (IMPI) and the lack of experience to quantify damages and losses. Additionally, the time required for the enforcement of the resolution issued by the IMPI before the Federal Courts in Civil Matters must be added to the time required for the substantiation of the action.

Thanks to the entry into force of the new Law, individuals may also resort directly to the civil Courts to claim infringement of their industrial property rights and compensation for damages, without the need for a prior declaration of infringement by the IMPI. This implies that a Judge, an expert in civil law, will have to delve into complex, specialized and technical issues, specific to industrial property.

Additionally, it is provided that the proceeding of the civil action will be suspended if an invalidity claim is filed before the IMPI against the right basis the civil claim, as long as the administrative authority does not issue a final resolution to such nullity action. This counteracts the advantage of a civil proceeding whose resolution may be quicker than before IMPI.

The new landscape for the claim for damages requires a careful study of the particularities of each specific case to determine the suitability of each route, since this is influenced, among other factors, by the complexity, the sophistication of the counterparty, the causes and technical considerations of the violation caused, among others.

© 2005-2024 OLIVARES Y COMPAÑIA S.C.
For more news on Damage Claims in Industrial Property in Mexico, visit the NLR Real Estate section.

Biden Administration Changes Green Card Process for Mixed-Status Families

To improve immigration processes and provide additional support to immigrants, the Biden administration has announced several policy changes.

Starting Aug. 19, 2024, unauthorized spouses and children of U.S. citizens who have been in the United States for at least 10 years can apply for parole in place, allowing these individuals to obtain green cards without having to leave the country. If approved, eligible family members will have three years to apply for permanent residency while being granted work authorization. By enabling family members to adjust their immigration status from within the United States, rather than traveling abroad and potentially facing a 10-year reentry ban, this change may significantly simplify the permanent residency process for eligible individuals.

The U.S. Department of State has also revised its guidance to favor immigrants with U.S. college degrees and job offers. The updated guidelines clarify that it is in the public interest for these individuals, including those with work authorization from the Deferred Action for Childhood Arrivals (DACA) program, to utilize their degrees in the United States. Consular officers will now have the discretion to weigh an applicant’s college degree and job offer favorably when deciding whether to grant a waiver to a visa applicant who would otherwise be ineligible. These adjustments aim to expedite the work visa process for college graduates.

Additionally, the Biden administration announced plans to double the locations for the Executive Office Immigration Review (EOIR), a program that provides volunteer attorneys in immigration courts for those without legal representation. Currently operating in San Francisco, Chicago, and New Orleans, the EOIR will expand to Maryland, New York City, and Atlanta by the end of the fiscal year. This expansion seeks to ensure fair representation for immigrants during legal proceedings. The EOIR has issued a call for attorneys to provide pro bono support to the program.

To expand opportunities for Latino communities, the Biden administration also announced that the U.S. Department of Education will propose to expand federal outreach programs targeting beneficiaries of the DACA program. Known as the Trio Program, this initiative aims to assist individuals from disadvantaged backgrounds as they transition from high school to college. The Department of Education’s proposal would extend the Trio Program to reach an additional 50,000 individuals.

©2024 Greenberg Traurig, LLP. All rights reserved.
For more news on Biden Administration Green Card Processes, visit the NLR Immigration section.

15% Discount on Chinese Patent Annuities for Open Licensing

Per a slightly ambiguous notice from the Ministry of Finance and the National Development and Reform Commission released July 24, 2024 (财政部 国家发展改革委关于调整优化专利收费政策的通知), annuity fees will be reduced by 15% for Chinese patents for participating in China’s open licensing system. As of the time of writing, there were over 2,000 open licenses published on China’s Intellectual Property Administration’s (CNIPA) online publication system.

15% Discount on Chinese Patent

Specifically, section 2 reads:

A 15% reduction in annual patent fees during the implementation period of patent open licensing. If other patent fee reduction policies are also applicable, the most favorable policy can be selected, but it cannot be enjoyed repeatedly.

However, it is unclear if this requires an actual license or simply having an offer to license published on CNIPA’s open license system.

In addition, there appears to be an additional annuity fee due for patents that receive patent term compensation (presumably for both patent term extensions for pharmaceutical patents and patent term adjustment for CNIPA delay in patent examination). It is unclear if this additional annuity is due for the entire patent term or just for the added patent term.

Specifically, section 1 reads, in part:

A patent owner who files a request for patent term compensation shall pay a patent term compensation request fee.

If a request for patent term compensation is found to meet the conditions for term compensation upon review, an annual patent compensation fee shall be paid…

CNIPA earlier this month also released additional information about open licensing system including royalty rates.

The full text of the Notice if available here (Chinese only).

© 2024 Schwegman, Lundberg & Woessner, P.A. All Rights Reserved.
For more news on Chinese Patent Licensing, visit the NLR Intellectual Property section.

Opposing Decisions – Does the FTC Have the Authority to Ban Non-Compete Clauses?

In April, the Federal Trade Commission (FTC) promulgated a new rule banning non-competes (the Rule); the FTC adopted the Rule to prohibit employers from entering into or enforcing non-compete clauses with workers and senior executives. Several lawsuits were quickly filed challenging the rules. Separate parties filed in Texas (in which cases were consolidated), and ATS Tree Services, LLC, filed an action in Pennsylvania.

On July 23, 2024, the U.S. District Court for the Eastern District of Pennsylvania issued a ruling denying ATS Tree Services’ motion for a stay and a preliminary injunction against the Rule. ATS Tree Services, LLC v FTC, No: 2:24-cv-01743-KBH, at p.18 (E.D. Pa. July 23, 2024). The Court held that ATS had not demonstrated the irreparable harm necessary to justify the issuance of a preliminary injunction and also held that ATS failed to establish a reasonable likelihood of success on the merits of its action.

The ruling is diametrically opposed to the July 3, 2024, ruling from the U.S. District Court for the Northern District of Texas, which preliminarily enjoined the Rule and postponed its effective date in Ryan, LLC v. U.S., No. 3:24-CV-00986-E, 2024 (N.D. Tex. July 3, 2024). However, the district court declined to issue a universal injunction, making its ruling applicable only to the Ryan plaintiffs.

The Decisions

In ATS Tree Services, the court first held that nonrecoverable costs of compliance do not rise to the level of irreparable harm, in that “monetary loss and business expenses alone are insufficient bases for injunctive relief.” ATS Tree Services at p.18. Additionally, the court held that the claimed loss of contractual benefits was too speculative. Id. 20-21.

Even though the court found that ATS failed to establish irreparable harm, it added an analysis of ATS’s likelihood of success on the merits, spending the majority of its decision assessing (just as the Ryan Court had) whether “[s]ection 6(g) empowers the FTC with the authority to make substantive rules related to unfair methods of competition in or affecting commerce, or whether the rulemaking authority therein is limited to procedural rules relating to adjudications of unfair methods of competition in or affecting commerce.” ATS Tree Services, at p.8. Notably, the Court relied upon the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244, 2263 (2024) to “independently interpret the statute and effectuate the will of Congress subject to constitutional limits.” Id. at 25. In doing so, the Court harmonized sections 5 and 6 of the FTC Act, concluding:

When taken in the context of the goal of the Act and the FTC’s purpose, the Court finds it clear that the FTC is empowered to make both procedural and substantive rules as is necessary to prevent unfair methods of competition. Thus, the Court rejects ATS’s argument that it should read the word “procedural” but not the word “substantive” into the statutory text defining the FTC’s rulemaking authority. This argument is inherently inconsistent and therefore untenable. Id. at 26.

This was directly contrary to the Ryan decision where the court found under section 6(g) that the FTC lacks the authority to create substantive rules because the Act is only a “housekeeping statute” that allows the FTC to promulgate general “rules of agency organization procedure or practice,” not “substantive rules.” Ryan at *15 (citing Chrysler Corp. v. Brown, 441 U.S. 281, 310 (1979)).

The court in ATS Tree Services went on to address the FTC’s mandate to “prevent prohibited ‘unfair methods of competition’” under section 5, thereby acknowledging Congress’s terms were “intended to act prophylactically to stop ‘incipient’ threats of unfair methods of competition, not solely responsively through adjudications, as courts interpreting the statute have confirmed.” ATS Tree Services, at p. 28. In addition, the court found that the FTC’s rulemaking authority had been confirmed by other circuit courts. Finally, in the rest of the decision, the Court disposed of the other alternative challenges made by ATS. This was contrary to the Ryan decision, where the Texas court had held that the FTC acted arbitrarily and capriciously, because the Rule was “unreasonably broad without a reasonable explanation” and did not sufficiently address alternatives to issuing the Rule.

Key Takeaways

The two courts have issued opinions with conflicting analyses. While Texas has issued a preliminary injunction specific to the Ryan plaintiffs, the court did indicate it intends to make a final determination on the merits by August 30, 2024, prior to the Rule’s effective date. The Ryan Court will have the opportunity to vacate the Rule in its entirety as unlawful and issue a permanent injunction, with the scope of the relief ordered yet to be decided. This new ruling sets up the potential for an appeal to the U.S. Court of Appeals for the Fifth Circuit and possibly seek direct relief from the U.S. Supreme Court.

*This post was co-authored by Lily Denslow, legal intern at Robinson+Cole. Lily is not admitted to practice law.

Copyright © 2024 Robinson & Cole LLP. All rights reserved.
For more on Noncompetes, visit the NLR Antitrust Trade Regulation section

Triggers That Require Reporting Companies to File Updated Beneficial Ownership Interest Reports

On January 1, 2024, Congress enacted the Corporate Transparency Act (the “CTA”) as part of the Anti-Money Laundering Act of 2020 and its annual National Defense Authorization Act. Every entity that meets the definition of a “reporting company” under the CTA and does not qualify for an exemption must file a beneficial ownership information report (a “BOI Report”) with the US Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Reporting companies include any entity that is created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe (this includes corporations, LLCs, and limited partnerships).

In most circumstances, a reporting company only has to file an initial BOI Report to comply with the CTA’s reporting requirements. However, when the required information reported by an individual or reporting company changes after a BOI Report has been filed or when either discovers that the reported information is inaccurate, the individual or reporting company must update or correct the reporting information.

Deadline: If an updated BOI Report is required, the reporting company has 30 calendar days after the change to file an updated report.

What triggers an updated BOI Report? There is no materiality threshold as to what warrants an updated report. According to FinCEN, any change to the required information about the reporting company or its beneficial owners in its BOI Report triggers a responsibility to file an updated BOI Report.

Some examples that trigger an updated BOI Report:

  • Any change to the information reported for the reporting company, such as registering a new DBA, new principal place of business, or change in legal name.
  • A change in the beneficial owners exercising substantial control over the reporting company, such as a new CEO, a sale (whether as a result of a new equity issuance or transfer of equity) that changes who meets the ownership interest threshold of 25%, or the death of a beneficial owner listed in the BOI Report.
  • Any change to any listed beneficial owner’s name, address, or unique identifying number provided in a BOI report.
  • Any other change to existing ownership information that was previously listed in the BOI Report.

Below is a reminder of the information report on the BOI report:

  • (1) For a reporting company, any change to the following information triggers an updated report:
    • Full legal name;
    • Any trade or “doing business as” name;
    • A complete current address (cannot be a post office box);
    • The state, territory, possession, tribal or foreign jurisdiction of formation; and
      TIN.
  • (2) For the beneficial owners and company applicants, any change to the following information triggers an updated report:
    • Full legal name of the individual;
    • Date of the birth of the individual;
    • A complete current address;
    • A unique identifying number and the issuing jurisdiction from one of the following non-expired documents; and
    • An image of the document.

It is important to note that if a beneficial owner or company applicant has a FinCEN ID and any change is made to the required information for either individual, then such individuals are responsible for updating their information with FinCEN directly. This is not the responsibility of the reporting company

© 2024 Winstead PC.