Tag: Corporate Security

Are Restrictive Covenants Enforceable in California? It Depends.

Recently posted in the National Law Review an article by attorneys Alice Y. Chu and Kurt A. Kappes of Greenberg Traurig, LLP regarding the enforeceability of non-competes in California:

 

GT Law

 

In California, it is well established that non-compete provisions are unenforceable, subject to certain statutory exceptions. Nevertheless, some courts have also recognized that non-compete provisions are enforceable if necessary to protect confidential information or trade secrets.

But what about non-compete provisions that are ambiguous as to their protection of confidential information or trade secrets? Recently, when faced with such a provision, one California federal court narrowly construed the provision to find it enforceable.

The Facts in Richmond

In Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D. Cal. July 1, 2011), a California federal district court evaluated the following provisions included in the parties’ Confidentiality and Non-Disclosure Agreement (“NDA”):1

Non–Solicitation. During the Term of this Employment (a[s] hereinafter defined), and for a period of one year thereafter, [defendant] [shall not] directly or indirectly, initiate any contact or communication with, solicit or attempt to solicit the employee of, or enter into any agreement with any employee, consultant, sales representative, or account manager of [plaintiff] unless such person has ceased its relationship with [plaintiff] for a period of not less than six months. Similarly [plaintiff] shall not solicit the employment of, or enter into any agreement with any employee, consultant or representative of [defendant].

Non–Interference. During the Term of this Employment, and for a period of one year thereafter, [defendant] will not initiate any contact or communication with, solicit or attempt to solicit, or enter into any agreement with, any account, acquiring bank, merchant, customer, client, or vendor of [plaintiff] in the products created and serviced by [plaintiff], unless (a) such person has ceased its relationship with [plaintiff] for a period of not less than six months, or (b) [defendant]’s relationship and association with such person both (i) pre-existed the date of this Agreement and (ii) does not directly or indirectly conflict with any of the current or reasonably anticipated future business of [plaintiff].

Non Compete and Non Circumvent. [Defendant] will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter. [Defendant] will not use any of the [plaintiff]’s technical knowhow or Source Code for the personal benefit other than the employment and to meet the customer needs defined by [plaintiff].2

The NDA also contained a provision that barred the defendant from disclosing or using confidential information used in plaintiff’s business.3 Confidential information was defined to include “Proprietary Data,” such as “know-how,” contract terms and conditions with merchants, technical data, and source code; “Business and Financial Data;” “Marketing and Developing Operations;” and “Customers, Vendors, Contractors, and Employees,” including their names and identities, data provided by customers, and information on the products and services purchased by customers.4

The Richmond Court’s Analysis

In evaluating plaintiff’s motion for a temporary restraining order, the court assessed plaintiff’s claim that, by teaming up with plaintiff’s former employee to form a competing venture, the defendant had breached the non-compete provisions of the NDA.5 Defendants argued that the plaintiff was not likely to prevail on its contract claims because the non-compete provisions in the NDA are unenforceable under California Business and Professions Code § 16600.6

Within this context, the court first noted that the California Supreme Court had recently confirmed that “‘[t]oday in California, covenants not to compete are void, subject to several exceptions,” and that the California Supreme Court “‘generally condemns noncompetition agreements.’”7

Second, the court also observed that the California Supreme Court had rejected the “narrow-restraints” exception to Section 16600 applied in several Ninth Circuit cases, finding that “‘California courts have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.’”8 As the court stated, “Section 16600 stands as a broad prohibition on ‘every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.’”9

Third, the court rejected plaintiff’s argument that Section 16600 applies only to restrictions on employees, concluding that Section 16600 did apply to the facts of the case.10

Fourth, the court acknowledged that, even though Section 16600 applied, a number of California courts have also held that former employees may not misappropriate a former employer’s trade secrets to compete unfairly with the former employer.11

Applying these principles, the court held that the non-solicitation and non-interference provisions of the NDA were likely unenforceable under California law because the provisions were more broadly drafted than necessary to protect plaintiff’s trade secrets and “would have the effect of restraining Defendants from pursuing their chosen business and professions if enforced.”12

In regards to the non-compete provision, the court reasoned that “the scope of the prohibitions on ‘compet[ing] with [plaintiff] with similar product and or Service using its technology” and using ‘technical knowhow’ is not entirely clear.”13 However, the court then concluded that “if the clause is construed to bar only the use of confidential source code, software, or techniques developed for [plaintiff’s] products or clients, it is likely enforceable as necessary to protect [plaintiff]’s trade secrets.”14

To support this construction, the court specifically cited the California Uniform Trade Secrets Act (“UTSA”)’s definition of a “trade secret,” even though plaintiff had not alleged a UTSA claim against the defendants and the UTSA was not briefed.15 The court also found that the provision prohibiting use of confidential information was likely enforceable to the extent that the claimed confidential information is protectable as a trade secret.16

Based on these conclusions regarding the enforceability of the provisions, and facts showing that plaintiff had established at least serious questions going to the merits of its claims, the court issued a narrow temporary restraining order.17

IMPLICATIONS

Richmond demonstrates that at least one California federal court may be willing to narrowly construe an ambiguous non-compete provision and find it enforceable to the extent necessary to protect a party’s trade secrets. In so doing, however, the court invites comparisons to California cases where courts have refused to narrowly construe broad non-compete provisions to be protections of trade secrets.18 For example, in D’sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000), a Court of Appeals refused to reform a non-compete provision that broadly prohibited employees from working in connection with a competing product.19 But D’sa was strictly in the employment context, where courts are more likely to look for over-reaching. Arguably, moreover, the provision at issue in D’Sa was broader than the provision considered inRichmond, which expressly referenced “technology,” “technical knowhow,” and “Source Code” in its language. Nevertheless, even with these references, the Richmond court conceded that the scope of the provision was “not entirely clear,” yet was willing to reform it to find it enforceable.

Furthermore, in enforcing the non-compete provision, the Richmond court also relied on the so-called “trade secret exception” to Section 1660020 — an exception that the California Supreme Court noted but declined to address in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008). This is an exception that other courts, particularly state courts, have questioned.21 This reliance suggests that, in the absence of conclusive guidance from the California Supreme Court on the viability of this exception, federal courts may remain willing to apply this exception to non-compete provisions perhaps as a way to harmonize the two statutes. In doing so, it is possible that the same collision between federal jurisprudence and state jurisprudence that gave rise to the Edwards decision may lie ahead. The California Supreme Court will then have an opportunity to address a key issue that the Supreme Court left unaddressed in a footnote in Edwards.

Finally, even with the uncertainty over the viability of the “trade secret exception” and whether courts will narrowly construe a non-compete provision to find it enforceable, companies should ensure non-compete provisions are drafted to clearly and specifically protect trade secrets, thereby increasing the likelihood that such a provision will be enforced.

1Plaintiff is a company that provides enterprise resource planning software for financial service companies that provide credit card terminals to merchants. Id. at *1. One of the defendants developed and maintained enterprise resource planning software for the plaintiff and, pursuant to this relationship, entered into this NDA with plaintiff’s predecessor-in-interest. Id. at *1-2.

2Id. at *16.
3Id. at *16.
4Id. at *16.
5Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *15-22 (N.D. Cal. July 1, 2011).
6Id. at *16.
7Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *16 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 945-46 (2008)).
8Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 949 (2008)).
9Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Cal. Bus. & Profs. Code § 16600).
10Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011).
11Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011)(quoting Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1237 (2009)(citing Morlife Inc. v. Perry, 56 Cal. App. 4th 1514, 1519-20 (1997); American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989); Southern Cal. Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431, 442–448 (1960); Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. 1980); Gordon v. Landau, 49 Cal. 2d 690 (1958); Gordon v. Schwartz, 147 Cal. App. 2d 213 (1956); Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957)).
12Id. at *18.
13Id. at *19.
14Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443, 1456 (2002)). Interestingly, there is theoretically no temporal limit to a trade secret, so the one year limit of the non-compete provision actually undercut the plaintiff’s protection!
15See Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Cal. Civ.Code § 3426.1(defining “trade secret” to include programs, methods, and techniques that derive independent economic value from not being generally known to the public, provided they are subject to reasonable efforts to maintain their secrecy)).
16Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)
17Id. at *23.
18Perhaps this decision also signals a willingness among California federal courts to protect employer’s interests by reforming or severing provisions that may not comply with Section 16600. See also Thomas Weisel Partners LLC v. BNP Paribas, No. C 07–6198 MHP, 2010 WL 1267744 (N.D. Cal. Feb. 10, 2010)(holding that a former employee’s non-solicitation provision was void to the extent it restricted the former employee’s ability to hire the employer’s employees after the former employee transitioned to another company, but upholding the rest of the employment agreement). These decisions may renew forum shopping, the ill that the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) was implicitly designed to address.
19The provision stated: “Employee will not render services, directly or indirectly, for a period of one year after separation of employment with Playhut, Inc. to any person or entity in connection with any Competing Product. A ‘Competing Product’ shall mean any products, processes or services of any person or entity other than Playhut, Inc. in existence or under development, which are substantially the same, may be substituted for, or applied to substantially that same end use as the products, processes or services with which I work during the time of my employment with Playhut, Inc. or about which I work during the time of my employment with Playhut Inc. or about which I acquire Confidential Information through my work with Playhut, Inc. Employee agrees that, upon accepting employment with any organization in competition with the Company or its affiliates during a period of five year(s) following employment separation, Employee shall notify the Company in writing within thirty days of the name and address of such new employer.” D’sa v. Playhut, Inc., 85 Cal. App. 4th 927, 930 -31(2000).
20Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011).
21As an example of the trend, see, e.g., Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 577 (2009)(“Although we doubt the continued viability of the common law trade secret exception to covenants not to compete, we need not resolve the issue here.”); Robinson v. U-Haul Co. of California, Nos. A124070, A124097, A124096, 2010 WL 4113578, at *10 (Cal. Ct. App. Oct. 20, 2010)(“the so-called ‘trade secrets’ exception to Business and Professions Code section 16600 . . .rests on shaky legal grounds”)(citing Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008); Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 578 (2009);Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1238 (2009)). When the apparent conflict in this area is addressed, perhaps the California Supreme Court will defuse it entirely, by agreeing with the way the court in Retirement Group v. Galante, 176 Cal. App. 4th 1226 (2009) reconciled it: “the conduct is enjoinable not because it falls within a judicially-created ‘exception’ to section 16600’s ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.” Retirement Group v. Galante, 176 Cal. App. 4th at 1238.

©2011 Greenberg Traurig, LLP. All rights reserved.

Physician Separation Issues

Posted in the National Law Review an article by attorney David Schick of Baker Hostetler physician Separation Agreements:

Physician Separation Issues are best dealt with upfront in the documents the physician enters into with the practice, when the physician joins the practice as an employee and/or when the physician becomes an owner of the practice.  Obtaining a Separation Agreement at the time a physician departs, while ideal, is often not possible, especially if the departure is not amicable; which is generally the case when the practice has terminated the physician’s employment.  The best way to avoid costly and time consuming litigation at the time of separation is to have carefully drafted documents prepared up front.  Think of these documents as a prenuptial agreement of sorts designed to govern post practice relationship issues, rather than post marital relationship issues.

For example, a well drafted Employment Agreement will specify the manner in which the physician’s employment may be terminated whether for cause (i.e. a specific set of reasons the practice may terminate the physician’s employment immediately); or for no cause (i.e. by the practice or by the physician voluntarily with a required period of notice).  This Agreement also will specify the parties’ rights and obligations to each other following termination.  These rights and/or obligations can vary depending upon whether the physician terminated his employment, whether the practice terminated the physician’s employment for cause, or whether the practice terminated the physician’s employment without cause.

For example, the practice usually will pay for the physician’s malpractice insurance during the physician’s employment.  However, the physician is usually responsible for the cost of “tail” coverage upon termination of employment, which can be very expensive. A common compromise, however, is for the physician to be responsible for the cost of “tail” coverage if the physician terminates his own employment (i.e. quits), or if the practice terminates the physician’s employment for cause (i.e. because the physician committed one of the wrongful acts specified in the Employment Agreement); however, the practice may be obligated to purchase the “tail” coverage if the practice terminates the physician’s employment without cause.

The well drafted Employment Agreement also will specify that all patients treated by the physician are the practice’s patients, not the physician’s patients; and upon termination, the patients’ medical records remain the property of the practice.  However, the Employment Agreement should grant the physician the right to make copies of such records for any legitimate (non-competitive) purpose including defense of a malpractice action or a third party audit at the physician’s expense.

These Employment Agreements also will specify the parties’ obligations to each other regarding the non-disclosure of confidential information, the non-solicitation of the practice’s patients and employees, and non-competition, both during employment and following termination.  The non-competition provisions will typically specify a certain geographic service area within (and a time period during which) the physician may not practice or establish an office.  These provisions are of particular importance to both the physician and the practice; and if not properly drafted can be rendered unenforceable.  A non-competition provision that turns out to be unenforceable will come as a pleasant surprise for the departing physician and as a bitter pill for the practice to swallow.  This area of the law is currently in a state of flux, and legal expertise is critical to draft critical to draft contractual language that stands the best chance of meeting the parties’ expectations during and following the parties’ relationship with each other.

Carefully drafted buy in and entity governing documents also are necessary to deal with the issues pertaining to the practice’s and the physician’s relationship with each other during the period of ownership, and upon termination of such ownership.  The physician owner’s Employment Agreement will not only deal with the issues described above, but also will deal with the payment of any earned, but unpaid compensation payable upon the physician’s termination of employment.  This earned, but unpaid compensation typically represents the physician’s share of the practice’s accounts receivables based on a formula set forth in the Employment Agreement.  The amount payable can sometimes vary depending upon whether the practice terminated the physician’s employment for cause or without cause; or whether the physician terminated his employment.

The buy-in documents (i.e. shareholder buy-sell, operating and/or partnership agreements) depending on the nature of the entity involved, also will deal with the amount of money, if any, the physician is entitled to be paid for the physician’s ownership interest in the practice.  These Agreements, if properly drafted, spell out how the value of such ownership interest will be determined, and the manner in which payment for such interest will be made (i.e. immediately, via insurance proceeds in the event of death, and/or via a promissory note over time).  Once again, the purchase price and/or the manner of payment can vary depending upon the reason for the separation and/or on whether the physician’s separation occurs close to (or coincidently with) another owner’s separation.  Simultaneous withdrawal provisions are critical to prevent the practice from having to pay out multiple physicians at the same time, when those physicians leave together or within a relatively short period of time of each other.  Otherwise, these “simultaneous” withdrawals can create a financial burden on the practice (or a “run on the bank”) that the practice may not be able to satisfy; a disappointing result for both the practice and the departing physician.

Similar documents govern the parties’ relationship with each other, during (and upon termination of) the parties’ relationship with each other, in connection with other business entities connected with the practice.  Typically, the practice owners also own interests in the building within which the practice is located; as well as other joint ventures or entities such as ambulatory surgical or imaging centers.  Properly draft shareholder buy-sell, operating and/or partnership agreements governing these ancillary entities, also will define the parties’ rights, duties and obligations to each other in the event the physician’s relationship with the practice is terminated, and will dictate whether the departing physician also is to be bought out or otherwise removed from these entities.

In summary, not all physician departures are amicable; and in fact, many are not.  Further, the practice might not even be dealing with the physician at the time of separation; which is the case in the event of a physician’s death.  Emotions typically run high at this juncture, and carefully drafted documents will give the parties’ the security of knowing what will be expected of them at the time of separation.  The time and expense spent up front also will be significantly less than the time and expense associated with the litigation that is almost certain to ensue in the absence of pre-existing definitive agreements that govern the separation.

© 2011 Baker & Hostetler LLP

White Collar Crime

The National Law Review would like to advise you of the upcoming White Collar Crime conference sponsored by the ABA Center for CLE and Criminal Justice Section, General Practice,  &   Solo and Small Firm Division:

 

 

Event Information

When

February 29 – March 02, 2012

Where

  • Eden Roc Renaissance Miami Beach
  • 4525 Collins Ave
  • Miami Beach, FL, 33140-3226
  • United States of America
Primary Sponsors

  • Highlight

The faculty includes some of the leading white collar lawyers in the United States.  The keynote panels for the 2012 program will continue to focus on the role of ethics and corporate compliance in today’s business environment.

  • Program Description

Each year the National Institute brings together judges, federal, state, and local prosecutors, law enforcement officials, defense attorneys, corporate in-house counsel, and members of the academic community.  The attendees include experienced litigators, as well as attorneys new to the white collar area.  Attendees have consistently given the Institute high ratings for the exceptional quality of the Institute’s publication, its valuable updates on new developments and strategies, as well as the rare opportunity it provides to meet colleagues in this field, renew acquaintances and exchange ideas.

The faculty includes some of the leading white collar lawyers in the United States.  The keynote panels for the 2012 program will continue to focus on the role of ethics and corporate compliance in today’s business environment.  Once again, we expect excellent representation from the corporate sector.

  • CLE Information

ABA programs ordinarily receive Continuing Legal Education (CLE) credit in AK, AL, AR, AZ, CA, CO, DE, FL, GA, GU, HI, IA, ID, IL, IN, KS, KY, LA, ME, MN, MS, MO, MT, NH, NM, NV, NY, NC, ND, OH, OK, OR, PA, RI, SC, TN, TX, UT, VT, VA, VI, WA, WI, WV, and WY. These states sometimes do not approve a program for credit before the program occurs. This course is expected to qualify for 11.0 CLE credit hours (including TBD ethics hours) in 60-minute-hour states, and 13.2 credit hours (including TBD ethics hours) in 50-minute-hour states. This transitional program is approved for both newly admitted and experienced attorneys in NY. Click here for more details on CLE credit for this program.

Second Circuit's Citigroup Decision Endorses Presumption of Prudence, Upholds Dismissal of Disclosure Claims

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP regarding the decision that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach:

 

 

 

In a much-anticipated decision, the U.S. Court of Appeals for the Second Circuit joined five other circuits in ruling that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach can overcome only upon a showing that the employer was facing a “dire situation” that was objectively unforeseeable by the plan sponsor. In re Citigroup ERISA Litigation, No. 09-3804, 2011 WL 4950368 (2d Cir. Oct. 19, 2011). The appellate court found the plaintiffs had not rebutted the presumption of prudence and so upheld the dismissal of their “stock drop” claims.

BACKGROUND

The Citigroup plaintiffs were participants in two 401(k) plans that specifically required the offering of Citigroup stock as an investment option. The plaintiffs alleged that Citigroup’s large subprime mortgage exposure caused the share price of Citigroup stock to decline sharply between January 2007 and January 2008, and that plan fiduciaries breached their duties of prudence and loyalty by not divesting the plans of the stock in the face of the declines. The plaintiffs further alleged that the defendants breached their duty of disclosure by not providing complete and accurate information to plan participants regarding the risks associated with investing in Citigroup stock in light of the company’s exposure to the subprime market. On a motion to dismiss, the district court found no fiduciary breach because the defendants had “no discretion whatsoever” to eliminate Citigroup stock as an investment option (sometimes referred to as “hardwiring”). Alternatively, the lower court ruled that Citigroup stock was a presumptively prudent investment and the plaintiffs had not alleged sufficient facts to overcome the presumption.

SECOND CIRCUIT DECISION

Oral argument in the Citigroup case occurred nearly a year ago, and legal observers have been anxiously awaiting the court’s ruling. In a 2-1 decision, with Judge Chester J. Straub issuing a lengthy dissent, the Second Circuit rejected the “hardwiring” rationale but confirmed the application of the presumption of prudence, which was first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The court also rejected claims that the defendants violated ERISA’s disclosure obligations by failing to provide plan participants with information about the expected future performance of Citigroup stock.

Prudence

Joining the Third, Fifth, Sixth, Seventh, and Ninth Circuits,[1] the court adopted the presumption of prudence as the “best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Under the presumption of prudence, a fiduciary’s decision to continue to offer participants the opportunity to invest in employer stock is reviewed under an abuse of discretion standard of review, which provides that a fiduciary’s conduct will not be second-guessed so long as it is reasonable. The court also ruled that the presumption of prudence applies at the earliest stages of the litigation and is relevant to all defined contribution plans that offer employer stock (not just ESOPs, which are designed to invest primarily in employer securities).

Having announced the relevant legal standard, the court of appeals dispatched the plaintiffs’ prudence claim in relatively short order. The plaintiffs alleged that Citigroup made ill-advised investments in the subprime market and hid the extent of its exposure from plan participants and the public; consequently, Citigroup’s stock price was artificially inflated. These facts alone, the court held, were not enough to plead a breach of fiduciary duty: “[T]hat Citigroup made a bad business decision is insufficient to show that the company was in a ‘dire situation,’ much less that the Investment Committee or the Administrative Committee knew or should have known that the situation was dire.” Nor could the plaintiffs carry their burden by alleging in conclusory fashion that individual fiduciaries “knew or should have known” about Citigroup’s subprime exposure but failed to act. Relying on the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court of appeals held these bald assertions were insufficient at the pleadings stage to suggest knowledge of imprudence or to support the inference that the fiduciaries could have foreseen Citigroup’s subprime losses.

Disclosure

The court’s treatment of the disclosure claims was equally instructive. Plaintiffs’ allegations rested on two theories of liability under ERISA: (1) failing to provide complete and accurate information to participants (the “nondisclosure” theory), and (2) conveying materially inaccurate information about Citigroup stock to participants (the “misrepresentation” theory).

As to the nondisclosure theory, the court found that Citigroup adequately disclosed in plan documents made available to participants the risks of investing in Citigroup stock, including the undiversified nature of the investment, its volatility, and the importance of diversification. The court also emphasized that ERISA does not impose an obligation on employers to disclose nonpublic information to participants regarding a specific plan investment option.

Turning to the misrepresentation theory, the court found plaintiffs’ allegations that the fiduciaries “knew or should have known” about Citigroup’s subprime losses, or that they failed to investigate the prudence of the stock, were too threadbare to support a claim for relief. Though plaintiffs claimed that false statements in SEC filings were incorporated by reference into summary plan descriptions (SPDs), the court found no basis to infer that the individual defendants knew the statements were false. It also concluded there were no facts which, if proved, would show (without the benefit of hindsight) that an investigation of Citigroup’s financial condition would have revealed the stock was no longer a prudent investment.

IMPLICATIONS

Coming from the influential Second Circuit, the Citigroup decision represents something of a tipping point in stock-drop jurisprudence, especially with respect to the dozens of companies (including many financial services companies) that have been sued in stock-drop cases based on events surrounding the 2007-08 global financial crisis. The Second Circuit opinion gives the presumption of prudence critical mass among appellate courts and signals a potential shift in how stock-drop claims will be evaluated, including at the motion to dismiss stage.[2]

Under the Citigroup analysis, fiduciaries should not override the plan terms regarding employer stock unless maintaining the stock investment would frustrate the purpose of the plan, such as when the company is facing imminent collapse or some other “dire situation” that threatens its viability. Like other circuits that have adopted the prudence presumption, the Citigroup court emphasized the long-term nature of retirement investing and the need to refrain from acting in response to “mere stock fluctuations, even those that trend downhill significantly.” It also sided with other courts in holding that the presumption of prudence should be applied at the motion to dismiss stage (i.e., not allowing plaintiffs to gather evidence through discovery to show the imprudence of the stock). Taken together, these rulings may make it harder for plaintiffs to survive a motion to dismiss, especially where their allegations of imprudence are based on relatively short-lived declines in stock price.

Some had predicted the Second Circuit would endorse the “hardwiring” argument and allow employers to remove fiduciary discretion by designating stock as a mandatory investment in the plan document. The Citigroup court was unwilling to go that far, but it did adopt a “sliding scale” under which judicial scrutiny will increase with the degree of discretion a plan gives its fiduciaries to offer company stock as an investment. This is similar to the approach taken by the Ninth Circuit inQuan and consistent with the heightened deference that courts generally give to fiduciaries when employer stock is hardwired into the plan. Thus, through careful plan drafting, employers should be able to secure the desired standard of review. Language in the plan document and trust agreement (as well as other documents) confirming that employer stock is a required investment option should result in the most deferential standard and provide fiduciaries the greatest protection.

Also noteworthy was the court’s treatment of the disclosure claims. Many stock-drop complaints piggyback on allegations of securities fraud, creating an inevitable tension between disclosure obligations under the federal securities laws and disclosure obligations under ERISA. The Second Circuit did not resolve this tension, but it construed ERISA fiduciary disclosure requirements narrowly and rejected the notion that fiduciaries have a general duty to tell participants about adverse corporate developments. The court made this ruling in the context of SPD disclosures under the 401(k) plan that identified specific risks of investing in Citigroup stock. Plan sponsors should review their SPDs and other participant communications to make sure company stock descriptions are sufficiently explicit about issues such as the volatility of a single-stock investment and the importance of diversification. These disclosures may go beyond what is already required under Department of Labor regulations.

[1]. See Howell v. Motorola, Inc., 633 F.3d 552, 568 (7th Cir.), cert.denied, ­­­2011 WL 4530151 (2011); Quan v. Computer Sciences Corp., 623 F.3d 870, 881 (9th Cir. 2010); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008); Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995).

[2]. That said, plan sponsors and fiduciaries should continue to monitor future developments in Citigroup in light of Judge Straub’s dissenting opinion and the likelihood of a petition for rehearing (or rehearing en banc), which the Citigroup plaintiffs have indicated they intend to seek. In his dissent, Judge Straub rejected the Moench presumption in favor of plenary review of fiduciary decisions regarding employer stock. He also disagreed with the majority’s interpretation of ERISA disclosure duties.

Copyright © 2011 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

Protecting Your Brand in the New .XXX Top-Level Domain

Recently posted in the National Law Review an article written by atttorneys  Lee J. Eulgen, Antony J. McShane and Katherine Dennis Nye of Neal, Gerber & Eisenberg LLP regarding  ICANN’s established procedures for the use of .XXX as a new top-level domain :

 

The Internet Corporation for Assigned Names and Numbers (ICANN) recently established procedures for the use of .XXX as a new top-level domain (TLD) like .COM, .NET, and .ORG. However, unlike those other TLDs, .XXX has been designed to clearly signal adult content on the Internet. Given the connection between .XXX and adult content, many brand owners outside the adult industry have reasonable concerns about protecting their name and brand from use with the .XXX TLD.

In part to allay some of these fears, the company behind .XXX, ICM Registry, has created a sunrise period, which has just opened, to help protect brand owners from the use of their trademarks with the .XXX TLD. Between Sept. 7 and Oct. 28, 2011, trademark owners that are not in the adult industry can “reserve” their trademark for a one-time fee of approximately $250. For example, if the fictional ABC Company owns a U.S. federal trademark registration covering the mark ABC, it could reserve www.abc.xxx so that no one else can register or use that domain name for at least the next 10 years.

One important exception to the reservation process is that if two trademark owners both own the same mark, the one that wants to actually register and use the .XXX domain will prevail over the one that simply wants to reserve the same domain. For example, assume the fictional Acme Adult Magazine and Acme Family Restaurant both own U.S. federal trademark registrations for the mark ACME. If the restaurant applies to reserve www.acme.xxx and the magazine applies to register the same domain, ICM Registry will permit the magazine to register and use the domain, and the restaurant will lose its reservation fee.

Failure to reserve important trademarks during this sunrise period could have serious consequences. Most fundamentally, failure to reserve .XXX domain names corresponding to your trademarks could of course lead to undesirable usage of your marks in connection with domain names corresponding to adult web sites. Although brand owners may be able to recover .XXX domain names from others who register and use those domains in bad faith – just as brand owners can in domain name disputes over .COM or .ORG domains – the damage to a brand may be greater from misuse of a trademark in connection with the .XXX TLD by an adult content site than from misuse with another TLD. Furthermore, regardless of what TLD is at issue, the process of forcibly obtaining a domain name through legal means can be expensive. Thus, trademark owners should consider carefully whether reserving their marks during the .XXX sunrise period makes sense for their brands. 

© 2011 Neal, Gerber & Eisenberg LLP.

The U.S. Has a New Patent Law

Posted in the National Law Review on October 27, 2011 an article regarding the Patent Reform Act of 2011 by Taylor P. Evans of Andrews Kurth LLP:

President Obama signed the Patent Reform Act of 2011 into law on September 16, 2011. Below is a summary of selected provisions of the Act.

First to File

Effective March 2013, the U.S. patent system will change from a first-to-invent to a first-to-file system. This means that if two people make the same invention and there has been no public disclosure of the invention, and both describe and claim that invention in separate patent applications, the inventor that filed his patent application first gets the patent. Thus, filing early will be more critical than ever before. Companies should consider filing a provisional application for an invention as early as possible, possibly followed by additional provisional applications as the technology of an invention develops, with a non-provisional application within a year of the first provisional application. The first-to-file provision will have no effect on existing patents or applications filed before March 2013.

Post-Grant Challenges

Effective September 2012, third parties will be able to challenge the validity of patents within nine months of issuance in the Patent Office in a Post-Grant Opposition Review proceeding. Any basis for a validity challenge will be entertained, including questions of novelty and obviousness, as well as challenges based on non-patentable subject matter or an improper written description or other formalities. After nine months, third parties may challenge patents through Inter Partes Review, which will replace existing Inter Partes Reexamination proceedings. In an Inter Partes Review, invalidity challenges must be based only on prior patents and printed publications.

In view of these changes, companies planning to initiate Inter Partes Reexamination proceedings should do so prior to September 2012. In addition, companies should arrange a monitoring program to identify patents that relate to the company’s product line for possible challenge in a Post-Grant Opposition Review proceeding upon issuance. Similarly, patentees should be aware that a significant challenge against their patents in the patent office may develop, and they should be prepared to defend against challenges from competitors when their own patents issue.

False Marking

The new Act severely limits false marking lawsuits. Only the federal government and direct competitors that have been damaged can sue for false marking. Furthermore, non-government litigants will no longer be able to collect five hundred dollars in damages per item. In addition, it is no longer actionable not to remove expired patent numbers from products. The new law also provides for “virtual marking,” by which a company marks its product with “Patent” or “Pat.,” followed by a web address. The corresponding website displays the patent marking information and must be available to the public at no charge. These changes apply retroactively to existing cases.

Disjoinder

The new law bars plaintiffs from suing multiple defendants in the same suit if the only thing that the defendants have in common is that they are alleged to infringe the same patent(s). Courts will also be barred from consolidating cases involving different defendants according to the same criteria, except that unrelated parties may still be joined for purposes of discovery. This provision applies to all suits filed on or after September 16, 2011.

Supplemental Examination

Supplemental examination is a new post-grant procedure that will allow a patentee to cure possible inequitable conduct by presenting previously withheld information to the Patent Office after issuance of a patent. After the previously withheld information is presented, and if the claims are allowed again, that information cannot be used in later court proceedings. Supplemental examination proceedings cannot be commenced or continue once an infringement action has been brought.

Assignee Filing

Under the new Act, a company can file a patent application on behalf of an inventor where the inventor is under obligation to assign its rights to the company and refuses to sign the oath or declaration. This provision will become effective in September 2012.

Fees

Effective September 26, 2011, all Patent Office fees will be subject to a 15% surcharge.

Other Changes

There are numerous other changes to the patent system under the Patent Reform Act of 2011, including, for example, elimination of the “best mode” requirement, and changes unique to specific types of inventions, such as business methods or computers. For additional information or to discuss all the new changes in more detail, please call us.

© 2011 Andrews Kurth LLP

How September 11 Changed Insurance

Recently posted in the National Law Review an article by Jared Wade of Risk and Insurance Management Society, Inc. (RIMS) regarding the impact on the entire insurance industry  after  September 11:

We are now more than 10 years removed from the worst terrorist attack in history. In the days and months following September 11, terrorism insurance weighed so heavily on the mind of both policyholders and insurers that the federal government was forced to add backstop capacity to the market.

But Jeff Beauman, vice president of all-risk underwriting for FM Global, explains that 9/11 affected much more than just one line of coverage. It arguably had a bigger impact on the entire insurance industry than even the vast losses suggest. Contract certainty was something that few talked about — and even fewer expected — prior to the attack.

Most insurance buyers will still tell you that they want their policies quicker, but improvement has been made. Furthermore, the number of lines involved in the claims made every insurer rethink its risk appetite. The industry, like the world, will never be the same.

RM: How did September 11 change insurance?

Jeff Beauman: Probably the biggest change I’ve seen has been a much higher interest in contract certainty. If you remember, in the months following 9/11, the concern that so many clients had, particularly those affected by the event, was that the policies they had purchased had not yet been issued. The industry as a whole had not been very good at getting policies issued quickly. Since that time, the industry has been working very hard to do so.

RM: Are clients still very concerned about contract certainty? How far along has the industry come?

Beauman: It’s always going to vary from one carrier to the next, but I do think that customers are much more appreciative of companies that are able to get policies issued on time-and [those] issuing policies where the language is very well understood by both parties. In terms of FM Global, we’re now issuing about two-thirds of our master policies before the effective date and 90% within 30 days.

What that means is that our clients have the written documentation very quickly after they decide to purchase coverage with us. Generally, I think, whether you talk to policyholders or underwriters, you will find that this emphasis on contract certainty has probably been a good thing for us as an industry.

RM: How so?

Beauman: It caused us to raise our game. Beforehand, you had a process by which policies would be issued “at some point,” and people came to accept it as normal because every [insurer] was equally bad. There was no good way for a client to compare one carrier to the next.

Now, you do have an expectation on the part of clients because, after big disasters, they have seen the importance of having that policy language issued. It’s something they now ask for. It gives the client a greater sense of confidence that they know what they have as part of their overall risk management strategy.

And the terrorism event of 9/11 helped to highlight the weakness the industry had in this area because there were so many claims being made without adequate policy documentation. There were disputes that received a lot of notoriety in the courts. So September 11 helped the industry improve.

RM: Was this because dealing with terrorism claims was so new and the specific policy language was so unfamiliar to everyone? Hurricane Andrew had many claims of its own, but did the particulars of the contract language matter less in that instance because hurricane claims had been dealt with before?

Beauman: Yes, that’s right. Part of what allowed the industry to not focus on contract certainty [in the past] was that they had some personal, first-hand experience to fall back on. Terrorism was so new to everybody and the event itself was so unusual, that it did cause a wake up. When you don’t have that personal experience to fall back on, you have to rely on policy language.

RM: There must have been a lot of people after 9/11 who believed that they had coverage for terrorism but weren’t sure what it consisted of.

Beauman: Exactly. In terms of the World Trade Center, limits were purchased under the presumption that the two buildings would never be damaged in the same event. And further complicating things was that it was what is considered a “clash event” because there were a lot of lines all involved in the same event, something no one had anticipated.

You had hull coverage for aviation because you had three airplanes involved. You had a lot of automobile policies that were affected. You had life insurance, obviously. You had property insurance. You had fine arts coverage. You had a lot of types of cargo insurance. You just had a lot of smaller lines that are not typically involved in the same occurrence. That forced insurers to re-evaluate their risk appetite and how they go about establishing their maximum lines.

RM: Has there ever been a “clash event” as broad as 9/11?

Beauman: No — and I would hope that none of us ever see an event like it again. It was the worst type of clash event because it was something that had never been imagined beforehand by anyone aside from the people who perpetrated it.

Take a typical event like Hurricane Irene that just happened. Underwriters understand that there is going to be wind damage. They understand there is going to be flood damage. They understand that there is going to be some damage to automobiles and buildings. They understand that there may be some people who lose their lives. Because they can visualize it, they can establish what their risk exposure might be, and they can operate their business comfortably depending on their risk appetite. 9/11 caused all underwriters to reconsider their risk appetite to make sure they weren’t over-extended.

———-

Jared Wade is senior editor of Risk Management.

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

The Financial Toll of the Arab Spring

Recently posted in the National Law Review an article by Jared Wade of Risk and Insurance Management Society, Inc. (RIMS) regarding political and social turmoil often disrupt business operations:

Political and social turmoil often disrupt business operations. And when we’re talking about revolutions like those seen throughout the Middle East in 2011, those disruptions — and the associated costs — amplify.

The Financial Times is here to provide some examples of just how much damage some companies have suffered. The start by noting a Grant Thornton survey from June that claims a whopping 22% of the world’s companies were affected by the Arab Spring. Globalization indeed.

International companies in sectors such as retail, travel and construction have unsurprisingly been early losers.

In July, Thomas Cook, the tour operator, said it expected operating profits this year of just £320m – compared with analysts’ estimates of £380m – because of declining business in Egypt, Tunisia and Morocco.

Cyril Sweett, a British consultancy and property company, warned last month that its next financial results would be hit because Middle Eastern turmoil had led to a number of projects being scrapped.

Other companies are struggling to collect payment for bills for projects disrupted by protest, armed conflict or regime change.

Dana Gas, a fuel producer heavily dependent on Egypt, is owed $200m by the country for invoices related to natural gas sales, according to Ahmed Al-Arbeed, chief executive, adding that some will be repaid this year.

Rentokil Initial, the pest-control to cleaning services company, said it would be “nice to get back” £4.8m it says it is owed for a rat-catching contract signed while Colonel Muammer Gaddafi was still in power in Libya, although it is as yet undecided on whether to revive its operations in the country.

Great anecdotes to help show the depth of the problem. And on the macro-level, here’s an infographic from Grant Thornton listing what percentage of companies in different regions have been negatively affected by the uprisings.



 

 

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

Anti-Money Laundering Compliance Costs

Recently posted in the National Law Review an article by Emily Holbrook of Risk and Insurance Management Society, Inc. (RIMS) regarding anti-money laundering  initiatives take more precedence in the corporate world:

 

Each year, anti-money laundering (AML) initiatives take more precedence in the corporate world, particularly within the financial industry. According to Celent, global spending on AML compliance, including operations and technology, will reach a staggering $5.8 billion within the financial sector by 2013.

Overall, the AML compliance burden is expected to expand at a rate of 7.8% annually while global spending on AML software is projected to expand at a rate of 10.4% per year. But what is the motivation behind such a drive? The research firm found that 42% of respondents cited regulatory requirements, and 25% pointed to reputational risk and brand protection as the main driver for AML compliance spending. And in further findings, financial institutions cited the integration of their AML and anti-fraud operations and technologies as a long-term goal.

“Although intuitively attractive, many institutions may find it difficult to build a business case for integrating AML with anti-fraud,” said Neil Katkov, senior vice president for Celent. “Fortunately, the compliance-driven development of modern AML software, analytics and case management has created a new generation technology that can often deliver better results than legacy anti-fraud systems.”

It seems it’s out with the old and in with the new — and expensive — AML

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

Troubled Loan Workouts: Qualified Professionals Can Help Maximize Recovery for All Parties

Posted in the National Law Review an article by Norman B. Newman of Much Shelist Denenberg Ament & Rubenstein P.C. regarding workout of a financially troubled loans:

The workout of a financially troubled loan requires the participants—typically the lender, the borrower and the guarantors—to be well versed in legal and business principals, coupled with an ability to understand the emotional aspects of the situation. The primary goal of a troubled loan workout is to maximize the recovery to all parties involved. That end result is best achieved when each party is represented by qualified professionals, including a loan officer who is familiar with the situation, as well as experienced attorneys and workout consultants. Collectively, these resources offer a vast network of appraisers, real estate and business brokers, buyers, prospective lenders and other contacts—all of whom are familiar with financially troubled business matters.

From the lender’s side, a loan workout officer will bring to the table a thorough understanding of the loan documents and know what collateral has been pledged, as well as the extent of the perfection of the security interests granted to the lender. The loan officer will be able to communicate with the borrower and the guarantors with respect to the existing defaults under the loan documents. This individual will also know the lender’s rights in light of the default and whether the lender is choosing to presently exercise its rights under the loan documents or reserve exercising them until a future date.

From a legal prospective, it is essential that all parties involved in a troubled loan workout be represented by attorneys experienced in handling financial distress matters. The lender’s attorney will review the loan documents, examine collateral perfection issues and assist in providing updated UCC, tax lien and judgment lien searches. This attorney will also be able to advise the lender as to the various remedies available in the exercise of its rights against the borrower and the guarantors, including in-court and out-of-court options.

The other parties should also turn to legal counsel for advice regarding their rights, remedies and obligations under the operative documents. Attorneys for the borrower and guarantors will advise their clients how best to cooperate with the lender in a consensual workout scenario or what defenses might be available in an adversarial situation. This advice will also cover in-court and out-of-court options, including the availability of bankruptcy relief as part of a consensual loan workout.

Assuming the lender does not need to take immediate action to get control over or liquidate its collateral, most troubled loan workouts involve some period of forbearance that affords the borrower additional time to resolve its financial problems. Under a limited forbearance arrangement, the lender gives up little, while both the borrower and the lender have an opportunity to pursue various benefits. At this stage, the parties should involve experienced workout consultants who, for example, will help analyze the borrower’s business and provide advice regarding the profitability and viability of the enterprise. They often help prepare short-term and long-term cash flow projections and budgets or test such projections and budgets when they are prepared by the borrower. Additionally, they typically play a role in determining the best way to maximize the recovery to all parties, whether it be a reorganization of the borrower, a sale or an orderly liquidation of the borrower’s assets. If a restructure or reorganization is the chosen solution, workout consultants will help determine what additional funds might be necessary to accomplish the desired result.

The workout of a financially troubled loan involves complex legal and business issues, as well as the emotions of the business owners or the guarantors of the borrower’s indebtedness. Partnering with experienced attorneys and other workout professionals is an essential step towards navigating these difficult waters and ensuring a successful outcome for all of the parties involved.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.