Tag: legal

EPA Issues SNPRM Modifying and Supplementing 2021 Proposed TSCA Fees Rule

On November 16, 2022, the U.S. Environmental Protection Agency (EPA) published a much-anticipated supplemental notice of proposed rulemaking (SNPRM) to modify and supplement its 2021 proposed rule that would amend the 2018 Toxic Substances Control Act (TSCA) fees rule. 87 Fed. Reg. 68647. EPA states that “[w]ith over five years of experience administering the TSCA amendments of 2016, EPA is publishing this document to ensure that the fees charged accurately reflect the level of effort and resources needed to implement TSCA in the manner envisioned by Congress when it reformed the law.”

What Action Is EPA Taking?

After establishing fees under TSCA Section 26(b), TSCA requires EPA to review and, if necessary, adjust the fees every three years, after consultation with parties potentially subject to fees. The SNPRM describes proposed changes to 40 C.F.R. Part 700, Subpart C as promulgated in the 2018 Fee Rule (83 Fed. Reg. 52694) and explains the methodology by which EPA determined the proposed changes to TSCA fees. The SNPRM adds to and modifies the proposed rulemaking issued on January 11, 2021 (2021 Proposal) (86 Fed. Reg. 1890). EPA proposes to narrow certain proposed exemptions for entities subject to the EPA-initiated risk evaluation fees and proposes exemptions for test rule fee activities; to modify the self-identification and reporting requirements for EPA-initiated risk evaluation and test rule fees; to institute a partial refund of fees for premanufacture notices (PMN) withdrawn at any time after the first ten business days during the assessment period of the chemical; to modify EPA’s proposed methodology for the production volume-based fee allocation for EPA-initiated risk evaluation fees in any scenario where a consortium is not formed; to expand the fee requirements to companies required to submit information for test orders; to modify the fee payment obligations to require payment by processors subject to test orders and enforceable consent agreements (ECA); to extend the timeframe for test order and test rule payments; and to change the fee amounts and the estimate of EPA’s total costs for administering TSCA Sections 4, 5, 6, and 14. More information on the 2018 Fee Rule is available in our September 28, 2018, memorandum, and more information on the 2021 Proposal is available in our December 30, 2020, memorandum.

The SNPRM includes the following summary of proposed changes to TSCA fee amounts:

Fee Category 2018 Fee Rule Current Fees1 2022 SNPRM
Test order $9,8002 $11,650 $25,000
Test rule $29,500 $35,080 $50,000
ECA $22,800 $27,110 $50,000
PMN and consolidated PMN, significant new use notice (SNUN), microbial commercial activity notice (MCAN) and consolidated MCAN $16,000 $19,020 $45,000
Low exposure/low release exemption (LoREX), low volume exemption (LVE), test-marketing exemption (TME), Tier II exemption, TSCA experimental release application (TERA), film article $4,700 $5,590 $13,200
EPA-initiated risk evaluation $1,350,000 Two payments resulting in $2,560,000 Two payments resulting in $5,081,000
Manufacturer-requested risk evaluation on a chemical included in the 2014 TSCA Work Plan Initial payment of $1.25M, with final invoice to recover 50 percent of actual costs Two payments of $945,000, with final invoice to recover 50 percent of actual costs Two payments of $1,497,000, with final invoice to recover 50 percent of actual costs
Manufacturer-requested risk evaluation on a chemical not included in the 2014 TSCA Work Plan Initial payment of $2.5M, with final invoice to recover 100 percent of actual costs Two payments of $1.89M, with final invoice to recover 100 percent of actual costs Two payments of $2,993,000, with final invoice to recover 100 percent of actual costs
1 The current fees reflect an adjustment for inflation required by TSCA. The adjustment went into effect on January 1, 2022.
2 In the 2018 final rule, the fees for TSCA Section 4 test orders and test rules were incorrectly listed as $29,500 for test orders and $9,800 for test rules. The 2021 Proposal proposes to correct this error by changing the fees for TSCA Section 4 test orders to $9,800 and TSCA Section 4 test rules to $29,500.

Why EPA Is Taking the Action

EPA states that the fees collected under TSCA are intended to achieve the goals articulated by Congress by providing a sustainable source of funds for EPA to fulfill its legal obligations under TSCA Sections 4, 5, and 6 and with respect to information management under TSCA Section 14. According to EPA, information management includes collecting, processing, reviewing, and providing access to and protecting from disclosure as appropriate under Section 14 information on chemical substances under TSCA. In 2021, EPA proposed changes to the TSCA fee requirements established in the 2018 Fee Rule based upon TSCA fee implementation experience and proposed to adjust the fee amounts based on changes to program costs and inflation and to address certain issues related to implementation of the fee requirements. According to the SNPRM, EPA consulted and met with stakeholders that were potentially subject to fees, including several meetings with individual stakeholders and a public webinar in February 2021. EPA is hosting a December 6, 2022, webinar to hear from stakeholders on the proposed TSCA fees. This engagement and the previous stakeholder outreach will inform EPA’s final rule.

According to EPA, based on comments received in response to the 2021 Proposal, adjustments to EPA’s cost estimates, and experience implementing the 2018 Fee Rule, EPA is issuing this SNPRM and is requesting comments on the proposed provisions and primary alternative provisions described that would add to or modify the 2021 Proposal. EPA notes that TSCA allows it to collect approximately but not more than 25 percent of its costs for eligible TSCA activities via fees. EPA states that fee revenue has been roughly half of the estimated costs for eligible activities than EPA estimated in the 2018 Fee Rule, however. According to EPA, the shortfall was, in part, due to EPA’s use of cost estimates based on what it had historically spent on implementing TSCA prior to the 2016 amendments, not what it would cost to implement the Frank R. Lautenberg Chemical Safety for the 21st Century Act (Lautenberg Act). In the first four years following the 2016 Lautenberg Act’s enactment, EPA also did not conduct a comprehensive budget analysis designed to estimate the actual costs of implementing the amended law until spring 2021. In the SNPRM, EPA proposes to revise its cost estimate to account adequately for the anticipated costs of meeting its statutory mandates, which are based on the comprehensive analysis conducted in 2021. EPA states that these proposed revisions are designed to ensure fee amounts capture approximately but not more than 25 percent of the costs of administering certain TSCA activities, fees are distributed equitably among fee payers when multiple fee payers are identified by revising the fee allocation methodology for EPA-initiated risk evaluations, and fee payers are identified via a transparent process.

Estimated Incremental Impacts of the SNPRM

EPA evaluated the potential incremental economic impacts of the 2021 Proposal, as modified by this SNPRM for fiscal year (FY) 2023 through FY 2025. The SNPRM briefly summarizes EPA’s “Economic Analysis of the Supplemental Notice of Proposed Rule for Fees for the Administration of the Toxic Substances Control Act,” which will be available in the docket:

  • Benefits. The principal benefit of the 2021 Proposal, as modified by this SNPRM, is to provide EPA a sustainable source of funding necessary to administer certain provisions of TSCA.
  • Cost. The annualized fees collected from industry under the proposed cost estimate described in the SNPRM are approximately $45.47 million (at both three percent and seven percent discount rates (EPA notes that the annualized fee collection is independent of the discount rate)), excluding fees collected for manufacturer-requested risk evaluations. EPA calculated total annualized fee collection by multiplying the estimated number of fee-triggering events anticipated each year by the corresponding fees. EPA estimates that total annual fee collection for manufacturer-requested risk evaluations is $3.01 million for chemicals included in the 2014 TSCA Work Plan (based on the assumed potential for two requests over the three-year period) and approximately $2.99 million for chemicals not included in the 2014 TSCA Work Plan (based on the assumed potential for one request over the three-year period). EPA analyzed a three-year period because the statute requires EPA to reevaluate and adjust, as necessary, the fees every three years.
  • Small entity impact. EPA estimates that 29 percent of Section 5 submissions will be from small businesses that are eligible to pay the Section 5 small business fee because they meet the definition of “small business concern.” EPA estimates that the total annualized fee collection from small businesses submitting notices under Section 5 is $666,810. For Sections 4 and 6, reduced fees paid by eligible small businesses and fees paid by non-small businesses may differ because the fee paid by each entity would be dependent on the number of entities identified per fee-triggering event and production volume of that chemical substance. EPA estimates that average annual fee collection from small businesses for fee-triggering events under Section 4 and Section 6 would be approximately $103,574 and $2,896,351, respectively. For each of the three years covered by the SNPRM, EPA estimates that total fee revenue collected from small businesses will account for about six percent of the approximately $52 million total fee collection, for an annual average total of approximately $3 million.
  • Environmental justice. Although not directly impacting environmental justice-related concerns, EPA states that the fees will enable it to protect better human health and the environment, including in helping minority, low-income, Tribal, or indigenous populations in the United States that potentially experience disproportionate environmental harms and risks, and supporting the fair treatment and meaningful involvement of all people regardless of race, color, national origin, or income with respect to the development, implementation and enforcement of environmental laws, regulations, and policies involving TSCA. EPA notes that it “identifies and addresses environmental justice concerns by providing for fair treatment and meaningful involvement in the implementation of the TSCA program and addressing unreasonable risks from chemical substances.”
  • Effects on state, local, and Tribal governments. The SNPRM would not have any significant or unique effects on small governments, or federalism or Tribal implications.

Commentary

Bergeson & Campbell, P.C. (B&C®) has anticipated the public release of the SNPRM for some time and is not surprised by the proposed increases in fees. We recognize, however, that many readers may review these proposed fees and truly feel a sense of “sticker shock,” as Dr. Michal Freedhoff, the current Assistant Administrator of EPA’s Office of Chemical Safety and Pollution Prevention (OCSPP), cautioned regulated entities earlier this year. B&C has not evaluated the underlying budgetary analysis, so assumes that EPA’s estimate of its costs is accurate. Given that assumption and EPA’s authority to recover 25 percent of those costs, B&C focuses on other aspects of the proposal.

Taking an optimistic view, the increase may benefit regulated entities. EPA states in the SNPRM that “Collecting additional resources through TSCA fees will enable EPA to significantly improve on-time performance and quality.” The absence of these two metrics, as well as others, has mired EPA’s activities under TSCA Sections 4, 5, and 6 for years. The influx of funding, along with proper leadership, training, and management, will aid EPA with meeting its statutory deadlines under TSCA, and the transparency elements of its Scientific Integrity Policy and the scientific standards under TSCA Section 26. Below, we provide representative examples of how the fees increase will aid EPA with avoiding the repetitious shortcomings that have permeated its decision making under TSCA Sections 4, 5, and 6.

TSCA Section 4

B&C notes that EPA states the following about its intended use of its order authority under TSCA Section 4: “The Agency believes it is reasonable to assume that approximately 75 test orders per year will be initiated between FY 2023 and FY 2025. Approximately 45 of these test orders are expected to be associated with the Agency’s actions on PFAS.” In comparison, EPA has issued 20 TSCA Section 4 test orders on 11 existing chemical substances since March 2020. The issued test orders have, however, suffered from significant lapses in transparency. as well as outcomes that conflict with the scientific standards under TSCA Section 26 and the obligations under Section 4.

These concerns with transparency and EPA’s failure to meet the scientific standards under TSCA Section 26 are likely due in part to EPA’s resource and staffing limitations. Therefore, the increased cost of test orders from $11,650 to $25,000 will enable EPA to develop test orders that are focused on data needs, rather than data gaps, during its prioritization and risk evaluation activities. It will also provide EPA with the requisite funding to ensure that it responds timely to technical inquiries from test order recipients, rather than months and in some cases more than a year later.

TSCA Section 5

B&C has decades of experience reviewing EPA’s assessments on new chemical substances under TSCA Section 5. Of relevance here are our observations since TSCA was amended in 2016. Since this time, we have observed a decrease in transparency in EPA’s risk assessments on new chemical substances. For example, EPA routinely identifies analogs from which it reads across potential hazards for new chemical substances. It is not uncommon, however, for EPA to identify multiple analogs for doing so. What is common is that EPA selects an analog amongst many and does not state the scientific basis for the selected analog. This also applies to analogs identified by submitters that are often dismissed by EPA without a scientific basis for doing so. Furthermore, EPA routinely claims those analogs as confidential business information (CBI) without reviewing whether they are actually still confidential. It is important for EPA to protect legitimate CBI, but the statute also requires disclosure of information that is not actually CBI. Additional resources will allow EPA to update its databases to reflect the current state of CBI claims and to better evaluate whether old CBI claims are still justified.

We also hope that additional resources will enable EPA to rely on fewer “worst-case” shortcuts in its evaluations of PMNs. For example, EPA routinely uses the acute potential dose rate (PDR) as the exposure metric for assessing potential unreasonable risks, even when the hazard is a chronic effect. Evaluating against a PDR is a reasonable first pass calculation — if EPA does not identify risk using a PDR, no further evaluation is necessary. We do not, however, agree with EPA making unreasonable risk determinations on the screening-level assessments without further refinements — it is simply not justifiable scientifically to predict chronic risk using a PDR (as reflected in EPA’s assessments under Section 6). Performing the refined calculation requires additional effort, which the fee rule would help support.

We expect EPA will resolve the above issues with the increased funding that it intends on receiving for new chemical substance notifications (e.g., from $19,020 to $45,000 on PMNs). EPA states that the “Additional funding collected through TSCA section 5 fees will help EPA reduce the backlog of delayed reviews and support additional work for new cases.” These monies will also provide EPA the necessary budget to better justify the selection of analogs. Collectively, we hope these improvements will allow EPA’s risk assessors to exercise their inherently government function of evaluating and approving and/or modifying the contractor-generated work products as EPA-approved work products. This will provide more transparent and timely evaluations on novel chemistries notified to the Agency. This level of transparency will also ensure that EPA is satisfying its requirements under EPA’s Scientific Integrity Policy, which states “At the EPA, promoting a culture of scientific integrity is closely linked to transparency. The Agency remains committed to transparency in its interactions with all members of the public.” In doing so, EPA will additionally be providing risk assessments that clearly document its decision making and how those decisions satisfy the scientific standards under TSCA Section 26. These considerations are critical for submitters, not in the sense that they must agree with EPA’s determinations, but rather that they understand the bases for those determinations.

Unanswered questions about when the increased fees will improve the throughput of new chemicals reviews remain. Hiring and training staff takes time; EPA is currently working to fill open positions and train new staff. Submitters paying substantially higher fees would reasonably expect that EPA improve its performance or, if EPA cannot complete timely its reviews (absent suspensions by the submitter), expect that EPA would refund the submission fee.

TSCA Section 6

B&C views the fee increases for EPA’s administration of TSCA Section 6 as the most controversial, not necessarily because of the intended increased costs, which are substantial (e.g., EPA-initiated risk evaluation from two payments resulting in $2,560,000 to two payments resulting in $5,081,000), but rather because of EPA’s decision making in the risk evaluations and its incorporation of new policy directions into its revised risk determinations. EPA has stated that its revisions to the final risk evaluations on eight of the “first 10” chemical substances and accompanying revised risk determinations are “supported by science and the law.” EPA spent the last year revisiting its risk determinations, with little change other than EPA’s conclusion about the “whole chemical.” EPA has not addressed weakness in the risk evaluations identified by commenters; nor has EPA addressed the weaknesses in EPA’s systematic review process identified by the U.S. National Academies of Science, Engineering, and Medicine’s (NASEM) review of EPA’s “Application of Systematic Review in TSCA Risk Evaluations.” NASEM’s review concluded that “The OPPT approach to systematic review does not adequately meet the state-of-practice [and] OPPT should reevaluate its approach to systematic review methods, addressing the comments and recommendations in this report.” The foregoing issues are troubling and are expected to be contested by regulated entities when EPA proposes its draft risk management rules on the “first 10” chemical substances. EPA did, however, state in the SNPRM that:

Although section 6 cost estimates were informed by risk management and risk evaluation activities for the first 10 chemicals, EPA will not be recovering fees for those chemicals.

Though this may seem like a hollow victory for potentially regulated entities, given EPA’s risk determinations on these substances, the intended fees for the EPA-initiated risk evaluations at least provide a baseline of deferred costs that may be allocated for disputing scientific and legal shortcomings when EPA issues the draft and final risk management rules. Moving forward, we anticipate that EPA will use the intended increased funding from the various risk evaluation costs to ensure that the above issues are addressed in its future risk evaluations on high-priority substances.

Conclusions

B&C recognizes that its position on the proposed fees increase in the SNPRM may not be well received by regulated entities. We note that the increased fees will aid with decreasing uncertainty in EPA’s decision making and its timely completion of evaluations on new and existing chemical substances and improve transparency and documents that meet the scientific standards under TSCA Section 26. There is also no question that EPA has the statutory authority to raise fees to recover 25 percent of its costs. B&C’s view is that commenters should focus on the distribution of the fees among the categories, proposed exemptions, and other aspects of the rule, including when manufacture or import must cease to avoid paying fees, rather than focusing on the magnitude of the fee increase.

We also hope that regulated entities will welcome EPA’s use of the best available science and weight of scientific evidence in its risk evaluations. As we discussed above, these statutory requirements have not been met in the “first 10” risk evaluations. We recognize that the deadlines for risk evaluations are not necessarily the critical issue for regulated entities, rather it is EPA’s unreasonable risk determinations, which are based on risk evaluations that were developed in a manner inconsistent with TSCA Section 6 and the implementing regulations. The increased fees under TSCA Section 6 should aid with addressing these issues.

Finally, B&C is optimistic that the SNPRM will provide EPA with the requisite funding to ensure its successful oversight of activities under TSCA. Despite our optimism, we do recognize that increased funding alone will not improve EPA’s administration of TSCA. To ensure success, EPA’s leadership will have to manage and lead this program properly. These latter components are critical and if the SNPRM is promulgated as, or as close to as proposed, the expectation on this Administration to produce results will be sky high.

©2023 Bergeson & Campbell, P.C.

Consultant Time Tracking Apps: How to Make the Most of Them And What to Avoid

Legal time tracking software is great for law firms, but what about consultants and freelancers? Consultant time tracking apps should allow you to easily and accurately capture your time. If you find yourself guessing your time, you may be losing out on revenue.

Accurate and reliable time tracking is arguably the most important metric a consultant or freelancer can track. If not done properly, inaccurate time tracking can lead to billable leakage, poor utilization rates, decreased productivity, and poor performance in the long term. If you’re using a time tracking app and you have the following red flags, you may want to take note.

Time Tracking Habits to Avoid

Red Flag #1: You Must Enter Your Time Manually

A common issue with consultant time tracking apps is manual time entry. Many apps rely on users remembering to track their time accurately. This may seem like a reasonable expectation at first, but it doesn’t take into account the other tasks a legal professional needs to handle.

Multitasking is a frequent occurrence in the legal industry, but there is a point where it goes too far and ends up impacting performance. Manual timekeeping isn’t as easy as it seems.

To dive into the science of it, psychologists Daniel Kahneman and Amos Tversky coined the term planning fallacy in 1977. Planning fallacy, in short, is the psychological phenomenon where people are optimistic in guessing how long a task will take to complete, underestimating the true number.

Kahneman expands on this idea in his book, “Thinking Fast and Slow.” In the book, Kahneman states that we struggle with time estimation for two reasons:

  1. We don’t consider how long similar tasks have taken us in the past.
  2. We assume or fail to account for barriers, challenges, or complications that will delay our plans.

The planning fallacy affects individuals, groups, and entire organizations.

The trouble with this is the fact that consultants and their clients are often unaware of the problem. As optimism bias clouds our judgment, we fall into the trap of assuming that our tasks will go well.

Manual time tracking and entry forces consultants to make the mistakes discussed above. Consultants enter their projections ahead of time, ensuring that they neglect previous tasks and the amount of time taken to complete them. Or, they reconstruct their time from memory, losing a significant amount of revenue due to faulty judgment, errors in thinking, and inaccurate estimates.

In a perfect time tracking world, you should be able to start and stop your tracking, while the app measures the amount of time you’ve spent on a specific task or tasks automatically. You shouldn’t be forced to reconstruct or project time, which is a recipe for disaster.

Manual time entry has a direct impact on the amount of revenue you’re able to generate — even if you bill at a flat rate. This is why it’s so important to track time correctly.

You should be able to edit your time if you need to make changes, track meetings, and convert them to time entries automatically. Look for this in a mobile consultant time tracking app.

Red Flag #2: Uniform Time Tracking

Time tracking requires granularity.

In an ideal consultant time tracking app, you should be able to track billable vs. non-billable work automatically — track employees, contractors, and third-party time. You should be able to easily differentiate between the various types of timekeeping (e.g., tasks, projects, meetings, etc.).

Unfortunately, many consultant time tracking apps force users into a timekeeping model that may not be best for their business. This isn’t ideal, as it requires more time and attention when it’s time to analyze time entries for billing, invoicing, or internal analysis.

Red Flag #3: No reporting or analytics for consultant time tracking

There are lots of options for time tracking software consultants can use. However, many of these don’t provide management with the data and intel they need to make good decisions. Good legal time tracking software enables consultants to answer the following questions:

  1. Where are we losing the most time?
  2. Which employees are most productive, and why?
  3. Which employees are the least productive, and why?
  4. Which projects, clients, or tasks are most productive or profitable?
  5. Which projects, clients, or tasks are minimally productive and unprofitable?
  6. What is my profit per employee, partner, client, etc.?

Why are these questions important? They give your business the clarity you need to answer higher-level questions like:

  • How do we avoid unprofitable clients in the future?
  • How do we attract more of the clients we want and none of the clients we don’t like?
  • What 20 percent of projects produce 80 percent of our revenue?
  • What 20 percent of clients produce 80 percent of our headaches, conflict, or concerns?

These questions provide clarity.

However, a comprehensive look at your time entries isn’t enough. You’ll need to be able to break your reporting down into actionable, bite-sized chunks you can use to grow your consultancy.

Many time tracking apps are generalists in the sense that they provide you with a limited set of data on your team’s performance. They don’t provide you with the level of granularity and analysis your consultancy needs to grow.

Why Is Time Tracking Valuable for Consultants?

Time tracking is valuable for consultants because it can be easily translated to money. While many organizations feel they’re on top of their time tracking, this isn’t always the case. If your consultant time tracking app has any of the red flags I’ve mentioned, it may be time to switch.

These red flags lead to billable leakage, poor utilization rates, decreased productivity and poor performance over the long term.

Consultants need reliable time tracking software in order to run a productive business.

As a consultant, you’re busy. The software you use should simplify everyday tasks and keep your law firm running without the hassle.

©2006-2023, BILL4TIME. ALL RIGHTS RESERVED.
Article by Bill4Time
For more articles on legal marketing, visit the NLR Law Office Management section.

How to Confidentially Challenge a Women’s Business Enterprise (WBE) Certification

Women’s Business Enterprise (WBE) Certification is a valuable tool to help women-owned businesses secure additional contracts and business that they might not have otherwise secured. Despite a rigorous application process, occasionally someone discovers that a WBE is not legitimately women-owned and controlled.

If you suspect that a WBE certified through WBENC is not truly women owned and/or controlled, you can challenge the certification and maintain the confidentiality of your identity.

According to WBENC’s Standards and Procedures, a certification challenge must meet the following criteria to be considered:

1. Be in writing;
2. Be addressed to the Executive Director or President of the Regional Partner Organization (RPO) that certified the company; and
3. Include evidence challenging the WBE’s eligibility.

Next, the Executive Director or President of the RPO will determine, based on your submission, whether there is reason to evaluate the challenge further.

If they deem your challenge not credible, they will inform you in writing and the challenge will be closed. If you disagree, you can appeal that decision to the WBENC Board of Directors.

If your challenge is deemed credible, the RPO will notify the WBE that it is being challenged, with a summary of the reasons. The WBE then must provide information and/or documentation to refute the challenge, and the Executive Director or President will inform both the WBE and the challenging party, in writing, of the preliminary determination and provide the reasons. There may be an opportunity for hearing, and then a final determination will be made. Again, both parties are notified in writing of the decision, which may be appealed to WBENC.

From experience, the more detail your challenge provides and the more supporting evidence, the better your chances are of succeeding. It is not enough to simply say that you suspect the woman is not running the business. If such a challenge is important to you and/or your business, you may want to seek professional assistance in preparing your challenge materials.

©2023 Strassburger McKenna Gutnick & Gefsky
For more articles on business certifications, visit the NLR Corporate and Business Organizations section.

How to Solve Estate Planning Challenges: Q&A with Lindsey Paige Markus of Chuhak & Tecson, P.C.

In recognition of National Estate Planning Awareness Week, we sat down with Lindsey Paige Markus, a principal with Chuhak & Tecson law firm in Chicago to discuss the top estate planning challenges and considerations that her clients face. Markus oversees Chuhak & Tecson’s 24-attorney estate planning and asset protection group, and focuses her practice on counseling business owners and families in planning their estates, minimizing taxation and transferring wealth.

Read on to learn more about Markus’ key tips for successful estate planning, and how clients can tailor their estate plans for any stage of their lives.

The NLR: Estate planning needs can change throughout a person’s lifetime. How do you counsel clients to navigate these changes, whether it be marriage, having children or divorce?

Markus: Over time, assets and relationships may change. You might not have the same relationship with the individuals you selected to act as executor or trustee. You may also disagree on how the couple you identified to care for minor children have parented their own children at the last family gathering. Asset holdings, values and priorities change. When your children were young, you may have been very concerned with there being sufficient resources to provide for their everyday needs and help fund a college education. If they are now successful adults living on their own, you might wish to prioritize leaving a philanthropic legacy to your community. Similarly, laws and tax exemptions change over time. For these reasons, I often recommend that clients revisit their estate plan every three years to confirm that the individuals they have identified to carry out their wishes are still appropriate, in addition to the division of assets.

The following image from my book, “A Gift for the Future – Conversations About Estate Planning,” helps highlight life events impacting estate planning, including the following:

–         Engagement

–         Marriage

–         Buying a home or property

–         Starting and building a family

–         Welcoming grandchildren

–         Starting a business

–         Rapid estate growth

–         Charitable interests grow

–         Divorce

 

The NLR: How can clients prepare to handle probate and guardianship issues?

Markus: Ideally, clients will take the time to get documents in place so that their loved ones can avoid probate and guardianship proceedings. Often a revocable living trust is the most efficient vehicle to ensure that the court system is avoided during one’s life (guardianship proceedings) and upon death (probate). When properly drafted, the trust can also help to leverage estate tax savings, provide asset protection for beneficiaries and ensure that the maximum amount can pass estate-tax free from generation to generation. But it is not enough to simply have an estate plan with a revocable living trust. Rather, clients need to go through the process of funding their trust – retitling assets into the name of the trust, transferring real estate interests, business interests and making certain that beneficiary designations on life insurance and retirement plan assets comport with the overall plan.

The NLR: What do you think are some of the biggest or most common misconceptions people have about estate planning?

 

Markus: People think that “estate planning is for the rich and famous,” or comment, “I will make an estate plan…when I have an estate to plan!” In reality, everyone should have an estate plan in place to document their wishes and make the process more manageable for their loved ones. Estate tax savings are just one aspect. But anyone who has had the displeasure of going through the probate process appreciates the importance of avoiding it. Too often clients are overwhelmed by the process. In reality, like any project, actually engaging in the planning and getting it done is far easier than procrastinating. And once you find an estate planning attorney that you feel comfortable working with, the attorney should be able to help guide you seamlessly through the process. Clients are often surprised by how empowering the estate planning process can be.

The NLR: Estate taxes owed to federal and state governments can be difficult to deal with for many people. How can clients best navigate challenging estate tax situations?

Markus: Estate tax liabilities at the federal and state levels can easily reach a tax rate of 50%. FIFTY PERCENT! As challenging as it is to consider, those with taxable gross estates can’t afford to avoid planning. In contrast, by engaging in thoughtful estate planning, these estate tax liabilities can be minimized and sometimes completely eliminated. The best advice I have for clients is to engage in planning early. Once you see projections of your future net worth based on your life expectancy, you quickly appreciate the size of the potential tax liability. You will need to provide feedback on your goals of planning. And, from there, your estate planning attorney, working in tandem with your wealth advisor and CPA, can help advise you on proactive steps you can take now to help minimize or avoid those tax liabilities. Maybe it is through implementing an annual gifting program where you use the annual gift exclusion of $17,000 per person per year by making a gift outright or to a trust for the benefit of a loved one. Perhaps you are in a position to use your $12.92 million lifetime exemption before it cuts in half in 2026. The real benefit of gifting is that we can move the current value of the gift and all future appreciation outside of your taxable gross estate. Or, some clients elect to engage in life insurance as an estate tax replacement vehicle – they purchase life insurance to provide the family with liquidity to cover the estate tax in the future.

The NLR: What are some of the most common mistakes you see people make when it comes to estate planning, and how can they avoid them?

Markus: Start early! None of us know what the future has in store. Get your plan in place this year – and make modifications in the future. Fund your trust! Don’t just get an estate plan. Make sure you retitle assets into your trust and update beneficiary designations to leverage the benefits of the plan. Don’t forget about charitable intentions! It is so easy to leave a lasting legacy to a cause you are passionate about. In doing so, follow your estate planning attorney’s advice and consider leaving taxable retirement plan assets directly to the charity. That allows the funds to pass estate-tax free and income-tax free, sometimes saving more than 70% in estate and income tax consequences. Revisit your plan every three years. Review the summary of your plan, make certain your assets were properly moved into your trust and follow-up with your attorney to find out if any changes have taken place in the law which would warrant an update.

Article by  Rachel Popa of The National Law Review / The National Law Forum LLC
Copyright ©2023 National Law Forum, LLC
For more articles on estate planning, visit the NLR Estates & Trusts section.

Cryptocurrency Brings Disruption to Bankruptcy Courts—What Parties Can Expect and the Open Issues Still To Be Resolved (Part Two)

In this second part of our blog exploring the various issues courts need to address in applying the Bankruptcy Code to cryptocurrency, we expand upon our roadmap.  In part one, we addressed whether cryptocurrency constitutes property of the estate, the impacts of cryptocurrency’s fluctuating valuation, issues of perfection, and the effects of cryptocurrency on debtor-in-possession financing.  In this part two, we explore preferential transfers of cryptocurrency, whether self-executing smart contracts would violate the automatic stay, and how confusing regulatory guidelines negatively impact bankruptcy proceedings, including plan feasibility.

Preferential Transfers

Pursuant to section 547(a) of the Bankruptcy Code, a debtor-in-possession (or trustee) can avoid a transfer of the debtor’s property to a creditor made in the 90-days before filing the petition if, among other things, the creditor received more than it would have in a Chapter 7 liquidation proceeding.  Notably, such a transfer can only be avoided if the thing transferred was the debtor’s property.  When cryptocurrency is valued and whether cryptocurrency is considered to be property of the estate can impact preference liability.

Perhaps the first question to arise in cryptocurrency preference litigation is whether the transferred cryptocurrency is property of the estate.  If, as in the Chapter 11 bankruptcy case of Celsius Network LLC and its affiliates, the cryptocurrency withdrawn by the accountholder during the ninety days prior to the bankruptcy is determined to be property of the estate, and not the accountholder’s property, a preferential transfer claim could be asserted.  If, however, the cryptocurrency was property of the accountholder, for instance if it was held in a wallet to which only the accountholder had exclusive rights, no preference liability would attach to the withdrawal of the cryptocurrency.

Assuming that a preferential transfer claim lies, the court must decide how to value the preferential transfer.  Section 550 of the Bankruptcy Code allows a debtor-in-possession to recover “the property transferred, or, if the court so orders, the value of such property.”[1] This gives the debtor-in-possession wide latitude in asserting a preference claim.  For instance, the debtor-in-possession could take the position that the cryptocurrency is a commodity, in which case a claim could be asserted to recover the cryptocurrency itself, which, by the end of the case, may be worth a much more than it was at the time of the transfer, with any gain accruing to the estate’s benefit.[2]  In contrast, the party receiving the transferred cryptocurrency would likely take the position that the cryptocurrency is currency, in which case a claim would be limited to the value of the cryptocurrency at the time of the transfer.[3]

The proper valuation methodology has not to date been definitively addressed by the courts.  Perhaps the closest a court has come to deciding that issue was in Hashfast Techs. LLC v. Lowe,[4] where the trustee claimed that a payment of 3,000 bitcoins to a supplier was a preferential transfer.  The bitcoin was worth approximately $360,000 at the time of the transfer but was worth approximately $1.2 million when the trustee asserted the preferential transfer claim.  The trustee argued that the payment to the supplier was intended to be a transfer of bitcoins and not a payment of $360,000, and that the supplier was required to pay 3,000 bitcoins to the estate, notwithstanding the substantial increase in value (and the resulting windfall to the estate).  Ultimately, the court refused to decide whether bitcoin is either currency or commodities and held that “[i]f and when the [trustee] prevails and avoids the subject transfer of bitcoin to defendant, the court will decide whether, under 11 U.S.C. § 550(a), he may recover the bitcoin (property) transferred or their value, and if the latter, valued as of what date.”[5]

The changing value of cryptocurrency will also impact the question of whether the creditor received more than it would have in a Chapter 7 liquidation proceeding.[6]  While the value of preferential transfers are determined at the time of the transfer,[7] the analysis of whether such transfer made the creditor better off than in a Chapter 7 liquidation is determined at the time of a hypothetical distribution, which means, practically, at the time of the petition.[8]  Therefore, if a customer withdraws cryptocurrency from a platform during the 90-day preference period, and the cryptocurrency experiences a decrease in value during those 90 days, that customer could arguably be liable for a preferential transfer because the withdrawn cryptocurrency was worth more at the time of the transfer than at the time of the petition.

Presently unanswered is whether the safe-harbor provisions provided for in section 546(e) of the Bankruptcy Code shield cryptocurrency transfers from preferential transfer attack.  Pursuant to section 546(e), a debtor-in-possession cannot avoid as a preference a margin payment or settlement payment made to “financial participant . . . in connection with a securities contract . . . commodity contract . . . [or] forward contract . . . that is made before the commencement of the case.” If the court determines that cryptocurrency is a security or commodity, and that the transfers were made in connection with forward or commodities contracts, then section 546(e) may shield those transfers from attack as preferential.

Violations of the Automatic Stay and Smart Contracts

The self-executing nature of smart contracts may raise automatic stay concerns.  The automatic stay arises upon the filing of a bankruptcy petition, and in general, prevents creditors and other parties from continuing their collection efforts against the debtor.[9]  Of relevance to smart contracts, section 362(a)(3) of the Bankruptcy Code states that the stay applies to “any act” to obtain possession of or control of property of the estate.  Very recently, in Chicago v. Fulton, the United Stated Supreme Court held that section 362(a)(3) prevented any “affirmative act that would alter the status quo at the time of the bankruptcy petition.”[10]

Prior to Fulton, a bankruptcy court in Arkansas examined an analogous issue in Hampton v. Yam’s Choice Plus Autos, Inc. (In re Hampton).[11]  In Hampton, the court adjudicated whether a device that automatically locked the debtor out of her car violated the automatic stay when it disabled function of the car’s engine postpetition.  The device relied on a code—if the debtor paid, the creditor sent her a code, which she would then input, and this prevented the device from automatically disabling the car’s starter.  In this instance, the court found a violation of the automatic stay.[12]

Based on current case law, it remains unclear whether a smart contract, operating automatically, would violate the automatic stay.  For example, if a smart contract is based on a DeFi loan, and it automatically executes postpetition to transfer to the lender assets of the estate, a court may find a violation of the automatic stay.

Hampton would suggest that such actions would be a violation—but two issues caution against relying on Hampton as a clear bellwether.  First, Hampton was decided pre-Fulton and it remains unclear whether, and to what extent, the Supreme Court’s holding in Fulton would change the outcome of Hampton. Second, a potentially key factual distinction exists: the device in Hampton required the creditor to give the debtor a code to prevent the disabling of the car, but smart contracts can be programmed to automatically execute postpetition without any further action by the parties.  If a smart contract is found to violate the automatic stay, the next question is whether such a violation is willful, meaning that a court can impose monetary penalties, including potentially punitive damages.[13]

Note that even if a smart contract is found not to violate the automatic stay, it does not mean that a creditor can retain the property.  Section 542 of the Bankruptcy Code requires those in possession of estate property to turnover the property to the estate.  The estate is created at the time of the filing of the petition, and therefore, any smart contract that executes postpetition would theoretically concern estate property and be subject to turnover.  Unfortunately, ambiguities arise even in this statute, as section 542 contains a good-faith exemption to the turnover mandate if the recipient is not aware of bankruptcy filing and transfers the assets.[14]  Thus, the turnover mandate may be difficult to apply to non-debtor parties to smart contracts who program the contract ahead of time with the knowledge that such a contract may execute after a bankruptcy petition but with no actual knowledge of such petition having been filed.

Regulatory Confusion

The regulatory world has no uniform approach to cryptocurrency. Both the Securities and Exchange Commission (SEC) and the Commodities Future Trading Commission (CFTC), perhaps in part spurred by executive pressure, recently advanced heavier regulatory oversight of cryptocurrency.[15]  The two agencies also share jurisdiction; one agency asserting authority to regulate cryptocurrency does not preclude the other from doing so.[16]  Other agencies, such as the Department of the Treasury’s Office of Foreign Assets Control (OFAC) and Financial Crimes Enforcement Network (FinCen), have also asserted the jurisdiction to regulate cryptocurrency.[17]  The result is regulatory confusion for market participants, both because of the sheer number of agencies asserting jurisdiction and the fact that individual agencies can sometimes issue confusing and ill-defined guidelines.

For instance, the SEC applies the Howey test, developed in the 1940s, to determine whether a specific cryptocurrency is a security.[18]  Unfortunately, the SEC has stated that whether a specific cryptocurrency is a security can change overtime, and recently announced even more cryptocurrencies that they believe meet Howey’s definition of a security via their lawsuits with crypto exchanges Binance.US and Coinbase.[19]

The regulatory confusion clouding cryptocurrency has directly impacted bankruptcy proceedings. One recent case study offers a glimpse into that disconcerting influence. In 2022, crypto exchange Voyager Digital Holdings Ltd. filed for Chapter 11 bankruptcy. Another major crypto exchange, Binance.US, entered into an agreement with Voyager to acquire its assets—valued at around $1 billion. The SEC, the New York Department of Financial Services (NYDFS), and the New York Attorney General all filed sale objections in Voyager’s bankruptcy proceedings, arguing that if Voyager’s crypto assets constitute securities, then Binance.US’s rebalancing and redistribution of these assets to its account holders would be an “unregistered offer, sale or delivery after sale of securities” in violation of Section 5 of the Securities Act.[20]  The NYDFS also alleged that the agreement “unfairly discriminates” against New York citizens by subordinating their recovery of diminished assets in favor of Voyager’s creditors—as well as foreclosing the option to recover crypto rather than liquidated assets.[21]

SEC trial counsel noted that, “regulatory actions, whether involving Voyager, Binance.US or both, could render the transactions in the plan impossible to consummate, thus making the plan unfeasible.”[22]  In April 2023, Binance.US sent Voyager a legal notice canceling the prospective transaction, writing that “the hostile and uncertain regulatory climate in the United States has introduced an unpredictable operating environment impacting the entire American business community.”[23]

The SEC’s desire towards regulating cryptocurrency as securities appears to be growing.  On August 15, 2023, the SEC settled for $24 million its claims against Bittrex, which included violations of Section 5 of the Securities Act.[24] Upon the settlement, the director of the SEC stated that Bittrex “worked with token issuers . . . in an effort to evade the federal securities law.  They failed.”[25]  Uncertainty combined with aggressive enforcement leaves cryptocurrency entities in an uncertain and precarious position.

Plan Feasibility

The Voyager case also highlights issues with plan feasibility in Chapter 11.  In Voyager, the SEC objected to plan feasibility on the basis that one known digital asset of Voyager was a security, and therefore, the purchaser should register as a securities dealer.[26]  Although the court overruled the SEC’s objection, as noted above, Binance.US ultimately withdrew its purchase offer, placing blame on the overall regulatory climate.[27]  As regulations remain uncertain, and government authorities have shown a willingness to assert themselves into the process of reorganization, debtors who file for bankruptcy will have to brace for new or unforeseen objections to an otherwise confirmable plan.

Conclusion

Cryptocurrency has been seen by some as a disruptive force in finance.  As the above issues show, it also appears to be a disruptive force in bankruptcy cases.  Debtors and creditors alike will have to weather the disruption as best they can while the courts continue to grapple with the many open issues raised by cryptocurrencies.

See Cryptocurrency Brings Disruption to Bankruptcy Courts—What Parties Can Expect and the Open Issues Still To Be Resolved (Part One)

[1] See 11 U.S.C. § 550(a).

[2] This position would arguably be consistent with cases interpreting section 550(a) of the Bankruptcy Code that have held that the estate is entitled to recover the value of the property when value has appreciated subsequent to the transfer.  See, e.g., In re Am. Way Serv. Corp., 229 B.R. 496, 531 (Bankr. S.D. Fla. 1999) (noting that when the value of the transferred property has appreciated, “the trustee is entitled to recover the property itself, or the value of the property at the time of judgment.”).

[3] Mary E. Magginis, Money for Nothing: The Treatment of Bitcoin in Section 550 Recovery Actions, 20 U. Pa. J. Bus. L. 485, 516 (2017).

[4] No. 14-30725DM (Bankr. N.D. Cal. Feb. 22, 2016),

[5] Order on Motion for Partial Summary Judgment at 1-2, Hashfast Techs. LLC v. Lowe, Adv. No. 15-3011DM (Bankr. N.D. Cal. 2016) (ECF No. 49).

[6] See 11 U.S.C. § 547(b)(5) (requiring the transferee to have received more that it would have received in a Chapter 7 liquidation).

[7] Maginnis, supra note 3.

[8] See In re CIS Corp., 195 B.R. 251, 262 (Bankr. S.D.N.Y. 1996) (“Thus, the Code § 547(b)(5) analysis is to be made as of the time the Debtor filed its bankruptcy petition); Sloan v. Zions First Nat’l Bank (In re Casteltons, Inc.), 990 F.2d 551, 554 (9th Cir. 1993) (“When assessing an alleged preferential transfer, the relevant inquiry . . . [is] . . . the actual effect of the payment as determined when bankruptcy results.”).

[9] 11 U.S.C. § 362(a).

[10] 141 S.Ct. 585, 590 (2021).

[11] 319 B.R. 163 (Bankr. E.D. Ark. 2005).

[12] Hampton, 319 B.R. at 165-170.

[13] See 11 U.S.C. § 362(k) (providing that, subject to a good faith exception “an individual injured by any willful violation of [the automatic stay] shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”).

[14] See 11 U.S.C. § 542(c).

[15] David Gura, The White House calls for more regulations as cryptocurrencies grow more popular (Sept. 6, 2022, 6:00 AM), https://www.npr.org/2022/09/16/1123333428/crypto-cryptocurrencies-bitcoin-terra-luna-regulation-digital-currencies.

[16] See, e.g., CFTC v. McDonnell, 287 F. Supp. 3d 222, 228-29 (E.D.N.Y. 2018) (“The jurisdictional authority of CFTC to regulate virtual currencies as commodities does not preclude other agencies from exercising their regulatory power when virtual currencies function differently than derivative commodities.”).

[17] See Treasury Announces Two Enforcements Actions for over $24M and $29M Against Virtual Currency Exchange Bittrex, Inc., (October 11, 2022), https://home.treasury.gov/news/press-releases/jy1006.

[18] See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[19] Emily Mason, Coinbase Hit With SEC Suit That Identifies $37 Billion of Crypto Tokens As Securities, (June 6, 2023 5:08 pm), https://www.forbes.com/sites/emilymason/2023/06/06/coinbase-hit-with-sec-suit-that-identifies-37-billion-of-crypto-tokens-as-securities/?sh=3cc4c6d667a9; SEC Charges Crypto Asset Trading Platform Bittrex and its Former CEO for Operating an Unregistered Exchange, Broker, and Clearing Agency, https://www.sec.gov/news/press-release/2023-78 (last visited July 31, 2023).

[20] Jack Schickler, SEC Objects to Binance.US’ $1B Voyager Deal, Alleging Sale of Unregistered Securities, (last updated Feb. 23, 2023 at 2:32 p.m.), https://www.coindesk.com/policy/2023/02/23/sec-objects-to-binanceus-1b-voyager-deal-alleging-sale-of-unregistered-securities/.

[21] See NYDFS Objection to Plan, In re Voyager Digital Holdings, et al. at 9-10, No. 22-10943 (Bankr. S.D.N.Y. Feb. 22, 2023) [ECF No. 1051].

[22] Kari McMahon, SEC and New York Regulators Push Back on Binance.US’s Acquisition of Voyager, The Block (Feb. 23, 2023), https://www.theblock.co/post/214333/sec-and-new-york-regulators-push-back-on-binance-uss-acquisition-of-voyager.

[23] Yueqi Yang & Steven Church, Binance US Ends $1 Billion Deal to Buy Bankrupt Crypto Firm Voyager, Bloomberg (April 25, 2023), https://www.bloomberg.com/news/articles/2023-04-25/binance-us-terminates-deal-to-buy-bankrupt-crypto-firm-voyager.

[24] See Crypto Asset Trading Platform Bittrex and Former CEO to Settle SEC Charges for Operating an Unregistered Exchange, Broker, and Clearing Agency, https://www.sec.gov/news/press-release/2023-150 (last visited Sept. 18, 2023).

[25] Id.

[26] See Objection of the U.S. Securities Exchange Commission to Confirmation at 3 n.5, In re Voyager Digital Holdings, et al., No. 22-10943 (Bankr. S.D.N.Y. Feb. 22, 2023) (ECF No. 1047).

[27] See supra at n. 23.

© Copyright 2023 Squire Patton Boggs (US) LLP
Article by Mark A. Salzberg , Justin Cloyd of Squire Patton Boggs (US) LLP
For more articles on cryptocurrency, visit the NLR communications, media and internet section.

A Major Deal for the Minor League: California Bill Paves the Way for Historic Collective Bargaining Agreement for Minor League Baseball

Major changes are coming to the Minor League. In April, Major League Baseball (MLB) players and owners voted to ratify a historic collective bargaining agreement that, for the first time in history, covers Minor League players. MLB owners voted unanimously to ratify the agreement on April 3, following a March 31 vote in which more than 99 percent of Minor League players voted to ratify the agreement. The five-year agreement, which was negotiated by MLB and the MLB Players Association (MLBPA), more than doubles the salaries at all Minor League levels and provides that Minor League players will be paid almost year-round.

Equally significant, just seven months before the agreement’s ratification, MLB agreed to voluntarily recognize the MLBPA as the exclusive bargaining representative for Minor League players. MLB’s September 9, 2022 recognition decision marks the first time in history that all Minor League players have been represented by the MLBPA or any labor organization. Previously, the MLBPA only represented Minor League players on 40-man rosters, but the September 2022 recognition decision extended union coverage to all Minor League players. Integrating the 5,000-plus Minor League players into a union that had already represented 1,200 well-paid MLB players will no doubt pose a series of challenges to the MLBPA. But recognition as the exclusive union for Minor League players allows the MLBPA to negotiate bargaining agreements on behalf of the players, including the historic agreement ratified in April.

California Governor Signs Bill Paving the Way for Collective Bargaining Agreement

On September 11, 2023, the California Legislature unanimously passed SB 332, a bill designed to pave the way for the historic collective bargaining agreement ratified in April. SB 332 grants a narrow exemption from state labor laws for California-based Minor League players. The legislation was designed “to carry out the collective bargaining agreement” approved by MLB and the MLBPA. Specifically, SB 332 provides that certain provisions of Wage Order No. 10-2001—which covers the amusement and recreation industry—does not apply to Minor League Baseball players covered by the collective bargaining agreement ratified by MLB players and owners earlier this year. Additionally, the bill exempts these Minor League players from certain overtime and meal period laws, and it relaxes the requirements for the wage statements that must be provided to these players. Governor Newsom signed SB 332 into law on October 13.

The passage of SB 332 caps a major milestone for Minor League Baseball and ensures implementation of the collective bargaining agreement ratified earlier this year. With SB 332 signed into law, California’s Minor League Baseball players, owners, and fans can put contract negotiations in the rearview mirror – and play ball.

Copyright © 2023, Sheppard Mullin Richter & Hampton LLP.
For more articles on sports, visit the NLR entertainment, art and sports section.

Proposed Amendments to NY Film Production Tax Credit Would Disallow Costs for Artificial Intelligence

Since 2004, New York has provided tax credits to encourage film and television productions located in the state. In its adopted budget for fiscal year 2024, the tax credit program was extended to 2034, and the amount available for the tax credit increased to $700 million. The credit is 30% of “qualified costs” incurred in the production. This tax credit is one of the reasons that New York has remained one of the top filming locations in the United States notwithstanding stiff competition from other states to lure television and film projects.

Subsequently, legislation (S7422A) was introduced that would remove from “qualified costs” used to calculate the tax credit any production that “uses artificial intelligence in a manner which results in the displacement of employees whose salaries are qualified expenses, unless such replacement is permitted by a current collective bargaining agreement in force covering such employees.”

Given that the purpose of the tax credit is to incentivize production and creation of jobs in the state, with the increasing use of artificial intelligence (AI), there is scrutiny of how AI will impact/employment in film and television productions. The legislators were also aware that the use of AI was a major issue in the recent negotiations for contracts with the writers (now settled) and actors (still ongoing as of this date). Consequently, the idea to disincentivize the use of AI that supplants employment by removing the cost of AI from the calculation of the tax credit provides motivation to pursue the proposed legislation in New York’s Legislature.

The goal of removing AI costs from the credit is protecting employment from encroachment by AI, but how the disallowance would be implemented is unclear. For example, if instead of using costumed characters or extensive make-up, a production used computer generated images (CGI), would the cost of the CGI be disallowed? Or if AI were used to write or supplement dialogue, would that call into question those costs for computing the tax credit? How would an auditor reviewing the film credit know and understand where AI is used and whether it actually displaced a human employee? In addition, auditors would have to examine collective bargaining agreements to determine whether “such replacement is permitted by a current collective bargaining agreement in force covering such employees.”

Whether or not S. 7422-A is enacted, the proposal may pique the interest of the other 37 states that have some type of credit for film production. See Film Industry Tax Incentives: State-by-State (2023) | Wrapbook.

©2023 Greenberg Traurig, LLP. All rights reserved.
For more articles on artificial intelligence, visit the NLR Communications, Media and Internet section.

The Generative AI Revolution: Key Legal Considerations for the Fashion & Retail Industry

For better or worse, generative artificial intelligence (AI) is already transforming the way we live and work. Retail and fashion companies that fail to embrace AI likely risk losing their current market share or, worse, going out of business altogether. This paradigm shift is existential, and businesses that recognize and leverage AI will gain a significant competitive advantage.

For instance, some of our clients are using AI to streamline product design processes, reducing the costs and time necessary to generate designs, while others employ virtual models to circumvent issues related to adult and child modeling. Additionally, AI can provide valuable market intelligence to inform sales and distribution strategies. This alert will address these benefits, as well as other significant commercial advantages, and delve into the legal risks associated with utilizing AI in the fashion and retail industry.

There are significant commercial advantages to using AI for retail and fashion companies, including:

1. Product Design

From fast fashion to luxury brands, AI is set to revolutionize the fashion and retail industry. It enables the generation of innovative designs by drawing inspiration from a designer’s existing works and incorporating the designer’s unique style into new creations. For instance, in March 2023, G-Star Raw created its first denim couture piece designed by AI. We also worked with a client who utilized an AI tool to analyze its footwear designs from the previous two years and generate new designs for 2024. Remarkably, the AI tool produced 50 designs in just four minutes, with half of them being accepted by the company. Typically, this process would have required numerous designers and taken months to complete. While it is unlikely that AI tools will entirely replace human designers, the cost savings and efficiency gained from using such technology are undeniable and should not be overlooked.

2. Virtual Models

2023 marks a groundbreaking year with the world’s first AI Fashion Week and the launch of AI-generated campaigns, such as Valentino’s Maison Valentino Essentials collection, which combined AI-generated models with actual product photography. Fashion companies allocate a significant portion of their budget to model selection and hiring, necessitating entire departments and grappling with legal concerns such as royalties, SAG, moral issues, and child labor. By leveraging AI tools to create lifelike virtual models, these companies can eliminate the associated challenges and expenses, as AI models are not subject to labor laws — including child entertainment regulations — or collective bargaining agreements.

3. Advertising Campaigns

AI can also be used to create entire advertising campaigns from print copy to email blasts, blog posts, and social media. Companies traditionally invest substantial time and resources in these efforts, but AI can generate such content in mere moments. While human involvement remains essential, AI allows businesses to reduce the manpower required. Retailers can also benefit from AI-powered chatbots, which provide 24/7 customer support while reducing overhead expenses linked to in-person customer service. Moreover, AI’s predictive capabilities enable businesses to anticipate trends across various demographics in real-time, driving customer engagement. By processing and analyzing vast amounts of consumer data and preferences, brands can create hyper-personalized and bespoke content, enhancing customer acquisition, engagement, and retention. Furthermore, AI facilitates mass content creation at an impressively low cost, making it an invaluable tool in today’s competitive market.

4. ESG – Virtual Mirrors and Apps

From an environmental, social, and corporate governance (ESG) standpoint, the use of AI-powered technology can eliminate the need for retail stores to carry excess inventory, thereby reducing online returns and exchanges. AI smart mirrors can enhance in-store experiences for shoppers by enabling them to virtually try on outfits in various sizes and colors. Furthermore, customers can now enjoy the virtual try-on experience from the comfort of their homes, as demonstrated by Amazon’s “Virtual Try-On for Shoes,” which allows users to visualize how selected shoes will appear on their feet using their smartphone cameras.

5. Product Distribution and Logistics

Fashion companies rely on their C-level executives to make informed predictions about product quantities, potential sales in specific markets or stores, and the styles that will perform best in each market. In terms of logistics, AI models can be employed to forecast a business’s future sales by analyzing historical inventory and sales data. This ability to anticipate supply chain requirements can lead to increased profits and support the industry’s initiatives to reduce waste.

Legal and Ethical Risks

Although AI has some major advantages, it also comes with a number of legal and ethical risks that should be considered, including:

1. Accuracy and Reliability

For all their well-deserved accolades and hype, generative AI tools remain a work in progress. Users, especially commercial enterprises, should never assume that AI-created works are accurate, non-infringing, or fit for commercial use. In fact, there have been numerous recorded instances in which generative AI tools have created works that arguably infringe the copyrights of existing works, make up facts, or cite phantom sources. It is also important to note that works created by generative AI may incorporate or display third-party trademarks or celebrity likenesses, which generally cannot be used for commercial purposes without appropriate rights or permissions. Like anything else, companies should carefully vet any content produced by generative AI before using it for commercial purposes.

2. Data Security and Confidentiality

Before utilizing generative AI tools, companies should consider whether the specific tools adhere to internal data security and confidentiality standards. Like any third-party software, the security and data processing practices for these tools vary. Some tools may store and use prompts and other information submitted by users. Other tools offer assurances that prompts and other information will be deleted or anonymized. Enterprise AI solutions, such as Azure’s OpenAI Service, can also potentially help reduce privacy and data security risks by offering access to popular tools like ChatGPT, DALL-E, Codex, and more within the data security and confidentiality parameters required by the enterprise.

Before authorizing the use of generative AI tools, organizations and their legal counsel should (i) carefully review the applicable terms of use, (ii) inquire about access to tools or features that may offer enhanced privacy, security, or confidentiality, and (iii) consider whether to limit or restrict access on company networks to any tools that do not satisfy company data security or confidentiality requirements.

3. Software Development and Open-Source Software

One of the most popular use cases for generative AI has been computer coding and software development. But the proliferation of AI tools like GitHub Copilot, as well as a pending lawsuit against its developers, has raised a number of questions for legal counsel about whether use of such tools could expose companies to legal claims or license obligations.

These concerns stem in part from the use of open-source code libraries in the data sets for Copilot and similar tools. While open-source code is generally freely available for use, that does not mean that it may be used without condition or limitation. In fact, open-source code licenses typically impose a variety of obligations on individuals and entities that incorporate open-source code into their works. This may include requiring an attribution notice in the derivative work, providing access to source code, and/or requiring that the derivative work be made available on the same terms as the open-source code.

Many companies, particularly those that develop valuable software products, cannot risk having open-source code inadvertently included in their proprietary products or inadvertently disclosing proprietary code through insecure generative AI coding tools. That said, some AI developers are now providing tools that allow coders to exclude AI-generated code that matches code in large public repositories (in other words, making sure the AI assistant is not directly copying other public code), which would reduce the likelihood of an infringement claim or inclusion of open-source code. As with other AI generated content, users should proceed cautiously, while carefully reviewing and testing AI-contributed code.

4. Content Creation and Fair Compensation

In a recent interview, Billy Corgan, the lead singer of Smashing Pumpkins, predicted that “AI will change music forever” because once young artists figure out they can use generative AI tools to create new music, they won’t spend 10,000 hours in a basement the way he did. The same could be said for photography, visual art, writing, and other forms of creative expression.

This challenge to the notion of human authorship has ethical and legal implications. For example, generative AI tools have the potential to significantly undermine the IP royalty and licensing regimes that are intended to ensure human creators are fairly compensated for their work. Consider the recent example of the viral song, “Heart on My Sleeve,” which sounded like a collaboration between Drake and the Weeknd, but was in fact created entirely by AI. Before being removed from streaming services, the song racked up millions of plays — potentially depriving the real artists of royalties they would otherwise have earned from plays of their copyrighted songs. In response, some have suggested that human artists should be compensated when generative AI tools create works that mimic or are closely inspired by copyrighted works and/or that artists should be compensated if their works are used to train the large language models that make generative AI possible. Others have suggested that works should be clearly labeled if they are created by generative AI, so as to distinguish works created by humans from those created by machine.

5. Intellectual Property Protection and Enforcement

Content produced without significant human control and involvement is not protectable by US copyright or patent laws, creating a new orphan class of works with no human author and potentially no usage restrictions. That said, one key principle can go a long way to mitigating IP risk: generative AI tools should aid human creation, not replace it. Provided that generative AI tools are used merely to help with drafting or the creative process, then it is more likely that the resulting work product will be protectable under copyright or patent laws. In contrast, asking generative AI tools to create a finished work product, such as asking it to draft an entire legal brief, will likely deprive the final work product of protection under IP laws, not to mention the professional responsibility and ethical implications.

6. Labor and Employment

When Hollywood writers went on strike, one issue in particular generated headlines: a demand by the union to regulate the use of artificial intelligence on union projects, including prohibiting AI from writing or re-writing literary material; prohibiting its use as source material; and prohibiting the use of union content to train AI large language models. These demands are likely to presage future battles to maintain the primacy of human labor over cheaper or more efficient AI alternatives.

Employers are also utilizing automated systems to target job advertisements, recruit applicants, and make hiring decisions. Such systems expose employers to liability if they intentionally or unintentionally exclude or impact protected groups. According to the Equal Employment Opportunity Commission (EEOC), that’s precisely what happened with iTutorGroup, Inc.

7. Future Regulation

Earlier this year, Italy became the first Western country to ban ChatGPT, but it may not be the last. In the United States, legislators and prominent industry voices have called for proactive federal regulation, including the creation of a new federal agency that would be responsible for evaluating and licensing new AI technology. Others have suggested creating a federal private right of action that would make it easier for consumers to sue AI developers for harm they create. Whether US legislators and regulators can overcome partisan divisions and enact a comprehensive framework seems unlikely, but as is becoming increasingly clear, these are unprecedented times.

© 2023 ArentFox Schiff LLP
For more articles on AI, visit the NLR Communications, Media and Internet section.

The Supreme Court to Further Clarify “Transportation Worker” Exemption to the FAA

On September 29, 2023, the U.S. Supreme Court granted certiorari in Bissonnette v. LePage Bakeries Park St. LLC, a case from the Second Circuit Court of Appeals involving application of the Federal Arbitration Act’s (“FAA”) exemption for transportation workers.

Specifically, Section 1 of the FAA exempts from arbitration “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce”—the third category commonly referred to as the “transportation worker” exemption.

In the case below, the plaintiffs—a group of delivery drivers for a bakery—filed various wage and hour claims against the defendant, whom they claimed was their employer.  When the defendant moved to compel arbitration, the plaintiffs argued that, as bakery delivery drivers, they were exempt from arbitration as a “class of workers engaged in foreign or interstate commerce.”

The Second Circuit concluded that the plaintiffs were not exempt from arbitration because they were in the bakery industry, not in the transportation industry.  Therefore, the Second Circuit concluded that the plaintiffs were not transportation workers subject to exemption under Section 1 of the FAA. The Second Circuit’s decision turned, in part, on the interpretation of the U.S. Supreme Court’s decision in Saxon—a case that we previously reported on from last term.

In the Saxon case, the U.S. Supreme Court unanimously held that a ramp supervisor who frequently handled cargo for an interstate airline company was exempt under Section 1 of the FAA as a transportation worker.  In reaching that conclusion, the U.S. Supreme Court’s analysis focused on the “actual work” the worker performed, rather than the industry in which the employer operated—holding that “[the worker] is . . . a member of a ‘class of workers’ based on what she does at Southwest, not what Southwest does generally.”

Though the Second Circuit in Bissonnette acknowledged Saxon, the Second Circuit, in a split decision, held that Saxon did not come into play, stating that “those who work in the bakery industry are not transportation workers, even those who drive a truck from which they sell and deliver the breads and cakes”—essentially establishing a threshold requirement that the individual work in the “transportation industry” in order to be covered by the exemption.

In a pointed dissent, Judge Pooler wrote: “Of course these truckers are transportation workers,” and, “[b]y focusing on the nature of the defendants’ business, and not on the nature of the plaintiffs’ work, the majority offers the sort of industrywide approach Saxon proscribes.”

The U.S. Supreme Court’s forthcoming decision will likely clarify whether the FAA’s exemption contains an industry requirement or whether the analysis turns purely on the nature of the work the individual worker performs without regard to the underlying industry in which they work.  Regardless of the outcome, the U.S. Supreme Court’s decision will provide much-needed guidance at a time when more and more businesses are bringing transportation services in-house—opting to ship and deliver their own products as opposed to relying exclusively on traditional transportation companies.

Copyright © 2023, Hunton Andrews Kurth LLP. All Rights Reserved.
For more articles on employment, visit the NLR labor and employment section.

Navigating Data Ownership in the AI Age, Part 1: Types of Big Data and AI-Derived Data

The emergence of big data, artificial intelligence (AI), and the Internet of Things (IoT) has fundamentally transformed our understanding and utilization of data. While the value of big data is beyond dispute, its management introduces intricate legal questions, particularly concerning data ownership, licensing, and the protection of derived data. This article, the first installment in a two-part series, outlines challenges and opportunities presented by AI-processed and IoT-generated data. The second part, to be published Thursday, October 19, will discuss the complexities of the legal frameworks that govern data ownership.

Defining Big Data and Its Legal Implications

Big data serves as a comprehensive term for large, dynamically evolving collections of electronic data that often exceed the capabilities of traditional data management systems. This data is not merely voluminous but also possesses two key attributes with significant legal ramifications. First, big data is a valuable asset that can be leveraged for a multitude of applications, ranging from decoding consumer preferences to forecasting macroeconomic trends and identifying public health patterns. Second, the richness of big data often means it contains sensitive and confidential information, such as proprietary business intelligence and personally identifiable information (PII). As a result, the management and utilization of big data require stringent legal safeguards to ensure both the security and ethical handling of this information.

Legal Frameworks Governing Data Ownership

Navigating the intricate landscape of data ownership necessitates a multi-dimensional understanding that encompasses legal, ethical, and technological considerations. This complexity is further heightened by diverse intellectual property (IP) laws and trade secret statutes, each of which can confer exclusive rights over specific data sets. Additionally, jurisdictional variations in data protection laws, such as the European Union’s General Data Protection Regulation (GDPR) and the United States’ California Consumer Privacy Act (CCPA), introduce another layer of complexity. These laws empower individuals with greater control over their personal data, granting them the right to access, correct, delete, or port their information. However, the concept of “ownership” often varies depending on the jurisdiction and the type of data involved — be it personal or anonymized.

Machine-Generated Data and Ownership

The issue of data ownership extends beyond individual data to include machine-generated data, which introduces its own set of complexities. Whether it’s smart assistants generating data based on human interaction or autonomous vehicles operating independently of human input, ownership often resides with the entity that owns or operates the machine. This is typically defined by terms of service or end-user license agreements (EULAs). Moreover, IP laws, including patents and trade secrets, can also come into play, especially when the data undergoes specialized processing or analysis.

Derived Data and Algorithms

Derived and derivative algorithms refer to computational models or methods that evolve from, adapt, or draw inspiration from pre-existing algorithms. These new algorithms must introduce innovative functionalities, optimizations, or applications to be considered derived or derivative. Under U.S. copyright law, the creator of a derivative work generally holds the copyright for the new elements that did not exist in the original work. However, this does not extend to the foundational algorithm upon which the derivative algorithm is based. The ownership of the original algorithm remains with its initial creator unless explicitly transferred through legal means such as a licensing agreement.

In the field of patent law, derivative algorithms could potentially be patented if they meet the criteria of being new, non-obvious, and useful. However, the patent would only cover the novel aspects of the derivative algorithm, not the foundational algorithm from which it was derived. The original algorithm’s patent holder retains their rights, and any use of the derivative algorithm that employs the original algorithm’s patented aspects would require permission or licensing from the original patent holder.

Derived and derivative algorithms may also be subject to trade secret protection, which safeguards confidential information that provides a competitive advantage to its owner. Unlike patents, trade secrets do not require registration or public disclosure but do necessitate reasonable measures to maintain secrecy. For example, a company may employ non-disclosure agreements, encryption, or physical security measures to protect its proprietary algorithms.

AI-Processed and Derived Data

The advent of AI has ushered in a new era of data analytics, presenting both unique opportunities and challenges in the domain of IP rights. AI’s ability to generate “derived data” or “usage data” has far-reaching implications that intersect with multiple legal frameworks, including copyright, trade secrets, and potentially even patent law. This intersectionality adds a layer of complexity to the issue of data ownership, underscoring the critical need for explicit contractual clarity in licensing agreements and Data Use Agreements (DUAs).

AI-processed and derived data can manifest in various forms, each with unique characteristics. Extracted data refers to data culled from larger datasets for specific analyses. Restructured data has been reformatted or reorganized to facilitate more straightforward analysis. Augmented data is enriched with additional variables or parameters to provide a more comprehensive view. Inferred data involves the creation of new variables or insights based on the analysis of existing data. Lastly, modeled data has been transformed through ML models to predict future outcomes or trends. Importantly, these data types often contain new information or insights not present in the original dataset, thereby adding multiple layers of value and utility.

The benefits of using AI-processed and derived data can be encapsulated in three main points. First, AI algorithms can clean, sort, and enrich data, enhancing its quality. Second, the insights generated by AI can add significant value to the original data, rendering it more useful for various applications. Third, AI-processed data can catalyze new research, innovation, and product development avenues.

Conversely, the challenges in data ownership are multifaceted. First, AI-processed and derived data often involves a complex web of multiple stakeholders, including data providers, AI developers, and end users, which can complicate the determination of ownership rights. Second, the rapidly evolving landscape of AI and data science leads to a lack of clear definitions for terms like “derived data,” thereby introducing potential ambiguities in legal agreements. Third, given the involvement of multiple parties, it becomes imperative to establish clear and consistent definitions and agreements that meticulously outline the rights and responsibilities of each stakeholder.

© 2023 Bradley Arant Boult Cummings LLP
For more articles on AI, visit the NLR Communications, Media and Internet section.