Today's General Counsel, V10 N3, June/July 2013

june/july 2013 VOluMe 1 0 / nuMBeR 3 todaysgener alcounsel.com

TIME FOR A

CARBON tAx? +

Debarment From Government Contracts Trends In State Attorney General Litigation A GC Charged With Obstructing Justice Satisfied Clients Could Signal An Inefficient Law Department

INTELLECTUAL PROPERTY

HUmAN RESOURCES

Trolls Eye Design Patents

Arbitration for Non-Competes

E-DISCOVERY

CANADA/ CROSS–BORDER

Lessons from Apple v. Samsung

Oil Sands Acquisitions

GOVERNANCE

Risk Management in the Legal Department

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Offshore Accounts Subject to New Tax Protocols Why Settlements Can Be Expensive Knowing When It’s Time To Leave

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june/july 2013 toDay’s gEnEr al counsEl

Editor’s Desk

Times are tough for non-practicing entities, AKA patent trolls. They don’t hide under bridges like their namesakes, but they do prefer to keep a low profile and that is getting harder. The America Invents Act of 2011 took direct aim at one of their fundamental tactics by making it illegal to file a single lawsuit claiming multiple defendants had infringed a patent in the same way. NPEs (and all other patent holders) must file individual lawsuits against each company. Predictably, NPEs began doing just that, which caused the number of infringement suits filed annually to rise to 4000, more than half them filed by NPEs. That, along with their colorful nom de guerre, has garnered NPEs lots of publicity and placed them squarely in the public consciousness. On June 3 President Obama announced several executive orders “to protect innovators from frivolous litigation.”

Normally, NPE’s assert claims against business method or software patents, but they are adaptable, and in this issue of Today’s General Counsel, David W. Long and Matt Rizzolo describe what may be their next strategy – asserting claims against design patents. They cite the vague “ordinary observer test” for design patent infringement and the statutory right to recover not just a reasonable royalty, but the infringer’s total profit. The incentive is huge. Long and Rizzolo show that most of $1 billion jurors awarded to Apple in its litigation against Samsung was disgorged profits from infringed design patents.

Heather Hubbard, Mark Bell, and Tera Rica Murdock cite the Apple-Samsung litigation in a different context, as an object lesson in e-discovery protocol, especially the duty to preserve potentially important documents. They note that the court found Samsung had acted in conscious disregard of its obligations, because it had been cited for failure to preserve

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seven years before and hadn’t corrected its system. They advise addressing systemic flaws that lead to failure-to-preserve, and creating a system for ensuring preservation.

Before you sign off, check out our newly designed website. It includes features from current and past issues of Today’s General Counsel, as well as links to some of the most interesting and useful articles and blogs from around the web, curated with today’s general counsel in mind. We’re at http://www.todaysgeneralcounsel.com.

Bob Nienhouse, Editor-In-Chief bnienhouse@TodaysGC.com

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Features

40

IS IT TIME FOR A CARBON TAX?

44

DEBARMENT FROM GOVERNMENT CONTRACTS

46

TRENDS IN STATE ATTORNEY GENERAL LITIGATION

50

GENERAL COUNSEL CHARGED WITH OBSTRUCTING JUSTICE

54

SATISFIED CLIENTS COULD SIGNAL AN INEFFICIENT LAW DEPARTMENT

56

OFFSHORE ACCOUNTS SUBJECT TO NEW TAX PROTOCOLS

60

WHY SETTLEMENTS CAN BE EXPENSIVE

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KNOWING WHEN IT’S TIME TO LEAVE

4

Charles Komanoff and Scott Segal Two policy analysts square off on a crucial issue.

Steven A. Shaw A severe penalty, but dispute and mitigation are possible.

Saul P. Morgenstern, Sam Lonergan and Danelco Moxey Shrinking budgets, growing incentives.

Laina Lopez Recent decision turns the tables on the DOJ.

Kevin Blodgett and Bill Young A data point, not a destination.

James Duggan Own up or face consequences.

Michael H. Bierman and John S. Caragozian It’s not war, even if it seems that way.

Glenn W. Young Look within for an exit strategy.

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Departments Editor’s Desk Executive Summaries

2 10

6 Page 20 INTELLEC TUAL PROPERT Y

16 | Design Patents May Be Next Target David W. Long and Matt Rizzolo Uncertain scope, low barriers for asserting claims.

E-DISCOVERY

HUMAN RESOURCES

GOVERNANCE

18 | Tips For Managing E-Discovery

24 | Use Arbitration To Protect Non-Competes

28 | General Counsel As Risk Manager

Jasmine Juteau Maximum compliance at minimum cost.

Steve Safranski and Heather McElroy A well-crafted clause prevents a race to the courthouse.

Mary E. McCutcheon and Erica Villanueva Insurance contract review belongs in the legal department.

20 | Some Pointed E-Discovery Lessons From A Battle Of Giants Heather Hubbard, Mark Bell and Tera Rica Murdock Apple v. Samsung provides a roadmap.

30 | “Reliance” In Class Actions Clarified By Supreme Court Thomas Rohback Scalia tips the balance.

34 | Compliance Clampdown On Bribery Laura Martino Checking the boxes won’t work.

CANADA / CROSS-BORDER

36 | Trends In Canadian Energy M&A Jamie Koumanakos and Micah Wood Strong Asian demand, and a new “net benefit” test.

eDitor-in-chief Robert Nienhouse chief operating officer Stephen Lincoln Managing eDitor David Rubenstein

executive eDitor Bruce Rubenstein

senior vice presiDent & Managing Director, toDay’s general counsel institute Neil Signore art Direction & photo illustration MPower Ideation, LLC vice presiDent of Business DevelopMent Sasha Hefler Business Manager Amy Ceisel contriButing eDitors anD Writers

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Mark Bell Michael Bierman Kevin Blodgett Jim Duggan Heather Hubbard Jasmine Juteau Charles Komanoff Jamie Koumanakos Sam Lonergan David Long Laina C. Lopez Laura Martino Mary E. McCutcheon

Heather McElroy Saul P. Morgenstern Danelco Moxey Tera Rica Murdock Tom Rohback Steve Safranski Scott H. Segal Steven Shaw Erica Villanueva Micah Wood Bill Young Glenn W. Young Matt Rizzolo

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Executive Summaries INTELLEC TUAL PROPERT Y

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E-DISCOVERY

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Design Patents May Be Next Troll Target

Practical Tips For Managing E-Discovery

Some Pointed E-Discovery Lessons from a Battle of Giants

By David W. Long and Matt Rizzolo Dow Lohnes PLLC

By Jasmine Juteau Morvillo Abramowitz Grand Iason & Anello PC

By Heather Hubbard, Mark Bell and Tera Rica Murdock Waller Lansden Dortch & Davis LLP

Non-practicing entities currently focus on asserting business method or software patents, but soon they may turn to design patents. The potentially vague and inconsistently applied “ordinary observer test” for design patent infringement and the statutory right to recover not just a reasonable royalty, but the infringer’s total profit from the infringing device, make them attractive targets for litigation.

The ordinary observer test compares the accused design to the claimed design “as a whole.” Unlike the mythical PHOSITA (person having ordinary skill in the art) used in utility patent cases, the ordinary observer is not skilled in the design art. It is someone who gives normal attention to purchasing the product and is also assumed to have knowledge of the prior art designs. The ordinary observer test only requires that the accused design be substantially the same as the patented design.

Developers and manufacturers should consider applying for design patents as part of their intellectual property strategy.

Design patents are relatively inexpensive to procure, and unlike utility patents, they require no maintenance fees. A patent serves not only to protect the ornamental design of a product, but it could be used as evidence to defend against a third party claim of infringement. Even if the design patent is not granted, the examination process may uncover prior art.

Finally, it is important to keep in mind that design patents may be obtained both on the overall design of a product and its constituent parts.

This article addresses current topics in the preservation, collection and review of electronically stored information.

The first step after receiving a demand for ESI is to initiate a hold procedure that preserves relevant materials. Don’t assume the company server houses all relevant ESI. As the number of devices used by employees has multiplied, it is imperative to be aware of ESI stored on devices outside the office. Even information that is outside the office may be within the company’s “custody or control.”

Storage devices are another source of ESI. Most of the data will be largely duplicative of the ESI on the “live” network, but it is important to understand the relationship between them. Archive systems, for example, may capture only portions of documents or alter metadata.

To issue an effective litigation hold and a complete collection, IT professionals should be consulted about the relevant differences.

While new technologies such as predictive coding are gaining ground, they remain cost prohibitive for most standard e-discovery needs. The traditional method of designing and applying search terms continues to be the preferred method for reducing a large collection of ESI to a manageable review set.

Designing an effective search to achieve responsive ESI is a crucial task.

The terms must be broad enough to capture all potentially relevant materials without pulling in too many irrelevant documents. As ESI multiplies, crafting precise terms is an important component of cost-saving efforts.

Before trial in the litigation between Samsung and Apple, the court focused on the e-discovery efforts of the parties. Apple alleged that Samsung failed to preserve documents, as it had done in prior litigation, and asked for an adverse inference sanction. Samsung alleged that Apple had failed to meet the preservation obligations to which it was holding Samsung.

The court held that the duty to preserve was triggered when Apple made a presentation to Samsung about Samsung’s possible infringement. While Samsung argued that it could not have known litigation would commence then, the court noted that the standard is not whether a party in fact reasonably foresaw litigation, but whether a reasonable party would reasonably foresee it.

Apple v. Samsung also demonstrated that if a plaintiff asserts a trigger date, the plaintiff itself should make sure it was in compliance by that date. When Apple asserted that litigation was foreseeable to Samsung as of the date of the presentation, it was not able to persuasively argue that its own duty to preserve did not arise until litigation was filed.

The court determined that despite issuing a litigation hold, both parties failed to properly implement it. It found that by failing to end policies that had previously thwarted the failure to preserve, Samsung acted in conscious disregard of its obligations and imposed an adverse inference. The authors provide a “roadmap” for document preservation based on examples from the case.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2013

Executive Summaries

HUMAN RESOURCES

GOVERNANCE

PAGE 24

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Use Arbitration to Protect Non-Competes

General Counsel as Risk Manager

“Reliance” in Class Actions Clarified by Supreme Court

By Steve Safranski and Heather McElroy Robins, Kaplan, Miller & Ciresi L.L.P.

By Mary E. McCutcheon and Erica Villanueva Farella Braun + Martel LLP

By Thomas Rohback Axinn Veltrop & Harkrider LLP

Employers have traditionally used choice-of-law or forum-selection clauses to secure a favorable venue in which to litigate validity and scope of a non-competition provision and avoid unfriendly state law. In certain jurisdictions these clauses have not been effective. Most problematic are those – like North Dakota, Montana, Oklahoma, and California – with a stated “fundamental public policy” against non-competes.

The Supreme Court’s recent decision in Nitro-Lift Technologies LLC v.

Howard suggests a solution: a properly drafted arbitration provision in the employment agreement would allow for efficient low-cost enforcement, and offer multi-state employers greater confidence in the enforceability of their agreements.

An effective arbitration clause must be mandatory. It should contain a choice-of-law provision and an exclusive forum-selection clause, providing that the arbitration take place in a particular state under that state’s law. It should explicitly state that the arbitrator has authority to grant injunctive and provisional relief to enforce the terms of the agreement. To address the need for speed, the parties should agree that the arbitrator apply the AAA Optional Rules for Emergency Measures of Protection.

To deter a challenge, the parties may include a provision providing for attorney fees in enforcing the arbitration clause.

It should be drafted in clear and simple terms, flagged with individual headings.

According to Nitro-Lift, public policy will not prevent enforcement of an arbitration clause. While in some jurisdictions “fundamental public policy” may trump choice-of-law and forum selection clauses, they cannot trump arbitration under the FAA.

One of the functions migrating into corporate law departments is risk management, including assessing the company’s insurance requirements and purchasing adequate insurance coverage. While companies may purchase a variety of insurance policies, the ones most likely to benefit from legal department review include commercial general liability, data privacy and cyber-risks liability, errors and omissions liability, director and officer liability and, in some cases, fiduciary liability and/or employment practices liability.

The types of companies that need professional risk managers are those which face major physical exposures, either on the first-property or the thirdparty liability side. A typical small- to medium-size company rarely needs to hire a risk manager. What makes sense for virtually any law department is to appoint a specific attorney, an insurance point person, to take responsibility for insurance issues.

This article explains the various tasks relating to insurance, and which should be handled by the insurance point person, the broker and outside insurance counsel respectively. The authors suggest initiating a broker selection process.

Even if a company ends up remaining with its existing broker, it will have learned a lot through the process.

Insurance policies are contracts. Getting to know your insurance contracts is a worthwhile effort. The risks which can be mitigated or even eliminated by proper attention to these contracts make it worth the time it takes to learn about them and about how to purchase the best possible contract for the company.

The Supreme Court’s March 27 decision in Comcast v. Behrend settled an ongoing dispute between Justice Scalia and Justice Ginsburg. A month before the Court had affirmed certification of the securities class in Amgen, Inc. v Connecticut Retirement Plans and Trust Funds. In Amgen, the putative class sued for allegedly false and misleading statements and omissions concerning the safety, efficacy, and marketing of two drugs. The Amgen Court, with Ginsburg in the majority, applied the precedent of Basic, Inc. v. Levinson (1988), and found classwide reliance in a fraud-on-the-market case, according to which a securities plaintiff who purports to represent a class can satisfy its burden of proving reliance without delving into the decision process of each purchaser.

The fraud-on-the-market theory recognizes a rebuttable presumption of reliance on a material representation made to the general public. As the Court explained, an efficient market presumes that individuals will rely on material misrepresentations in buying and selling securities. Scalia’s dissent called the fraud-on-the-market rule a court invention.

Amgen raised questions as to the showing required at the class certification stage beyond securities cases.

Were it not for the Comcast decision, it is likely that aggressive class action plaintiffs would have seized on Justice Ginsburg’s language that the issue of certification is not a “license to engage in free-ranging merits inquiries ...” With Comcast, Scalia’s view has prevailed, and the securities law implications of Amgen will not be a benefit to plaintiffs.

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Executive Summaries GOVERNANCE

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CANADA /CROSS–BORDER

POINT-COUNTERPOINT

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Compliance Clampdown On Bribery

Trends In Canadian Energy M&A

Is It Time For A Carbon Tax?

By Laura Martino CPA Global

By Jamie Koumanakos and Micah Wood Blake Cassells & Graydon LLP

Charles Komanoff (Yes) The Carbon Tax Center and Scott Segal (No) Bracewell & Giuliani LLP

Critics have called the Foreign Corrupt Practices Act ambiguous, and they claim it lacks judicial oversight. In November, 2012, the Department of Justice and the SEC jointly published 130 pages of long-awaited guidance, informing stakeholders of how the FCPA would be interpreted for prosecution. Shortly after those guides were issued, Eli Lilly was hit with an unprecedented fine of more than $20 million for making improper payments through foreign subsidiaries to government officials.

The Eli Lilly case illustrates that operating in foreign markets requires detailed due diligence in order to avoid exposure to the FCPA. Organizations with particular vulnerability are those with overseas operations that embrace global supply chains and networks of intermediaries, including agents, distributors or brokers. The FCPA prohibits companies from paying an agent or intermediary, knowing that money would likely be transferred to a foreign official to gain an improper advantage.

The author provides a due diligence checklist to address DOJ and SEC concerns about how companies are vetting potential business partners, putting riskbased protocols in place and scrutinizing agents or intermediaries based in locations with a high degree of corruption.

The checklist items include initial vetting, risk assessment, contract processes and clauses, and continuous monitoring on either a scheduled or ad hoc basis. No two companies have the same systems, the author notes, and there is no uniform approach codified by law. It is up to companies to take measures to fit their business structures.

Energy industries remain at the core of Canadian M&A activity. Approximately 25 percent of the largest 50 friendly public transactions reviewed in a survey by the authors’ firm occurred in the energy sector, notably in oil and gas. There were several high profile transactions, including the $19-billion acquisition of Nexen

by China’s CNOOC. Asian demand for commodities remains strong, and Asian companies, including state owned enterprises, have turned to Canada and other resource-rich countries to secure supply. In addition, Asian companies continue to see value in investing in commodities, even where those commodities cannot presently be exported to Asian markets. Synthetic crude oil from the Canadian oil sands is an example.

Canada continues to develop its liquefied natural gas infrastructure, which bodes well for investment in Canada’s shale gas reserves. In recent years, technological advances have solidified the economic viability of shale gas investment.

All large investments by non-Canadians in Canadian businesses must meet the “net benefit” standard: They must be of net benefit to Canada. In a speech following government approval of the CNOOC/Nexen and Petronas/Progress Energy transactions, Canada’s prime minister stated that in respect to oil sands investments in particular, foreign state control “has reached the point at which further such foreign state control would not be of net benefit to Canada,” and going forward, acquisitions of control of Canadian oil sands businesses

by SOEs will satisfy the test only under “exceptional circumstances.”

There is no way to tackle climate change without taxing carbon pollution, according to Charles Komanoff. No other policies can do the job as effectively and broadly. Hoping the problem of climate change will fix itself isn’t tenable, not with the news that atmospheric concentrations of CO2 have passed 400 parts per million, a level not reached in at least three million years.

Segal counters that the case for a carbon tax seems more to do with hidden sources of revenue needed as chips for some grand bargain in tax reform than it does with any commitment to reducing greenhouse gases. Reducing greenhouse gases, he says, will prove difficult when the tax is imposed in the United States while the manufacturing industries and the energy upon which they depend can simply cross international borders. No unilateral policy that fails to include conforming behavior by China and India, he argues, will produce real reductions.

Komanoff says that our trading partners will follow our lead because WTO regulations empower carbon-taxing countries to neutralize unfair trading disadvantages by levying “border tax adjustments” on imports.

Segal maintains that a carbon tax is highly regressive, imposing a larger burden on low than on high-income households, as lower-income households spend a disproportionate amount of income on energy and energy-intensive necessities.

One report estimates households in the lowest quintile would have a burden 1.4 to 4 times higher than those at the top quintile.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2013

Executive Summaries

FEATURES PAGE 44

PAGE 46

Debarment From Government Contracts

Trends In State Attorney General Litigation

By Steven A. Shaw Covington & Burling LLP

By Saul P. Morgenstern, Sam Lonergan and Danelco Moxey Kaye Scholer LLP

The government may suspend a contractor based upon “adequate evidence” that it has engaged in certain misconduct. The suspension continues for 12-18 months, or until the completion of any investigation or legal proceeding.

An indictment constitutes “adequate evidence” as a matter of law, but is not required. A conviction or civil judgment is not a necessary prerequisite to debarment. The government can also debar a contractor for poor or negligent performance, and for any other misconduct so serious as to affect the contractor’s “present responsibility.” Debarments generally may not exceed three years.

If a contractor disputes the facts, it will typically set forth its version in a written submission and, frequently, in a meeting with the suspension debarment offical (SDO). Rather than contest the facts alleged in the notice of suspension or proposed debarment, many contractors focus their submissions on their present responsibility. Such an approach, based upon changed circumstances, can be effective. This is precisely because the issue in a suspension/debarment action is not whether the alleged misconduct actually occurred, but whether the contractor is presently responsible.

Contractors may contest the findings and decisions of SDOs internally within the agency imposing the action, in federal district court, or both, depending on the individual agency’s regulations.

The EPA, for example, has a procedure allowing contractors to seek review of debarment decisions with an EPA official senior to the SDO. There is no such internal remedy within the Department of Defense.

State attorneys general have become increasingly aggressive in bringing multifaceted, multi-state lawsuits against a broad array of companies and industries, resulting in multimillion dollar verdicts and settlements. Reasons for that aggressiveness include expansions of their powers to enforce federal law and recent Supreme Court rulings limiting federal preemption.

In almost every state, the attorney general is an elected position. Therefore, politics is a contributing factor to every decision. Legislative compromises that leave ambiguities in regulatory schemes are another factor, with the AG attempting to fill gaps through litigation and settlements that govern future conduct.

Such agreements are often reflective of the particular AG’s political views, not that of Congress or the state legislature.

This phenomenon, often referred to as “legislation through litigation,” is facilitated in part by the attorney general’s unique ability to prosecute claims on behalf of its citizens under each state’s parens patriae doctrine. This doctrine allows the attorney general to bring representative claims, similar to class actions, on behalf of a group of citizens (including individuals and corporations), while avoiding many of the procedural hurdles associated with a class action.

The tobacco litigations of the 1990s provide a model for these litigations.

Every investigation or litigation spearheaded by a state AG’s office is unique, and has the potential to grow in both the number and type of plaintiffs and claims.

The authors provide a list of tactical considerations and issues to be addressed when confronting such suits.

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Executive Summaries FEATURES

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A General Counsel Charged With Obstructing Justice

Satisfied Clients Could Signal An Inefficient Law Department

Offshore Accounts Subject to New Tax Protocols

By Laina Lopez Berliner, Corcoran & Rowe LLP

By Kevin Blodgett Rockwater Energy Solutions and Bill Young Bridgeway Software

By James Duggan Duggan Bertsch LLC

The author defended the general counsel of the company formerly known as Blackwater, who was indicted on two counts of obstruction of justice. She and her legal team argued that he was providing bona fide legal advice to his client when he committed the predicate acts, and should not have been indicted in the first place. They relied on 18 U.S.C. §1515©, which states that legitimate representation of a client shouldn’t be a basis for an obstruction offense.

In a 2001 case, the Eleventh Circuit ruled that §1515(c) was an affirmative defense that had to be raised by the attorney-defendant. The author’s team argued that the case had been wrongly decided. In their view, the statute required the government to plead in the indictment the inapplicability of §1515(c). They also noted that felony charges must be presented to a grand jury, and that an accused criminal defendant must “be informed of the nature and cause of the accusation.”

In this case, had the grand jury been aware of §1515(c) when it was considering whether the charged conduct was criminal, it well might have decided not to indict.

A judge in the U.S. District Court, Eastern District of North Carolina, agreed that the government must allege in any indictment charging an attorney with obstruction of justice that the attorney was not providing bona fide, lawful legal representation services at the time. The author’s client was spared a trial.

Client satisfaction with legal departments is often measured by annual surveys, in which clients rate the service they are receiving. But giving individuals or even specific divisions within a company “good service” may not be best for the business as a whole. The goal should be supporting the business strategy, while protecting against and managing risk.

The most effective method of understanding expectations and priorities is “management by walking around.” This should include conversations that are designed to garner feedback on what legal needs to be doing to support the client and how the client views the relationship.

Attending client meetings is another good way of learning and facilitating dialogue. Once a strong mutual understanding of how legal should (and perhaps should not) support the client is established, annual surveys then can be used to diagnose how well the department is executing.

In depth understanding of business priorities, coupled with existing operational mandates – for example cost reduction targets – can be used to drive informed, strategic decision making on matters such as staffing, resource allocation and selection of outside counsel.

Communicating the plan through the legal department should be done with an eye toward getting all who are involved to understand the ultimate purpose and enabling the company to achieve its goals. Satisfying the enterprise becomes the primary motivator, rather than doing what is necessary at the moment to satisfy an individual client.

For many years, American taxpayers were able to avoid taxes by placing assets in offshore accounts. Rules regarding disclosure were ambiguous and easily circumvented, and enforcement by the IRS was weak. As a result, offshore planning became synonymous with taxfree planning, and most advisors were conditioned to equate offshore with tax avoidance. In fact, U.S. taxpayers are taxed on their worldwide income, from whatever source, and under the new Foreign Account Tax Compliance Act the U.S. has imposed reporting obligations on foreign financial institutions that have accounts for U.S. taxpayers.

The penalties for not paying are severe. For example, the maximum civil penalty for failing to file can be up to 50 percent of the account value, and criminal penalties can be up to $500,000 and 10 years in prison. Each form and corresponding failure to file has its own set of draconian penalties, and they can be stacked on one another. The longer one waits to come clean, the greater the penalties.

Amnesty is possible. Due to the success of the offshore amnesty programs of 2010 and 2011, the IRS launched its third amnesty program in 2012, and it is still available in 2013. Provided that the taxpayer is not under investigation or audit already, the taxpayer may come forward and avoid criminal prosecution.

Given the opportunities the IRS has provided for U.S. taxpayers to gain amnesty, it is becoming less tolerant and forgiving of those who don’t.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2013

Executive Summaries

FEATURES PAGE 60

PAGE 64

Why Settlements Can Be Expensive

Knowing When It’s Time To Leave

By Michael H. Bierman McKenna Long & Aldridge and John S. Caragozian Sunkist Growers, Inc.

Litigation is more like a settlement negotiation than a war, even while the company is acting tough to demonstrate that a compromise is in the plaintiff’s interest.

Keeping that perspective can help control litigation costs. This article discusses some specific steps that can be useful.

How the company and the law firm determine what the firm will do to defend the case will determine the costs of the litigation. Other things being equal, the law firm is more likely to do too much than too little. In-house counsel can control the tendencies of outside counsel to be too thorough and produce too much by having a close working relationship with the lead lawyer.

A thorough initial investigation – whether by in-house counsel or the law firm – is likely to be a wise investment, even if it’s expensive. The primary goal is to develop a feel for the settlement value of the case.

How much a company should spend is best determined through budgeting.

The law firm is best positioned to develop detailed estimates of the cost of litigation.

Over the course of the case, the attitude usually evolves from “millions for defense but not one penny for tribute” to “we need to settle this case.”

Ongoing mediation can help focus the parties on the goal of settlement. By telling the parties to take specific steps after failure, the mediator can guide and facilitate the information exchange process necessary for eventual settlement.

By Glenn W. Young Henkel Group

This list of good reasons to leave your job as in-house attorney is comprehensive, if not exhaustive. Among the more interesting: If you like finding problems more than solving problems, leave. The author quotes a maxim in support of that proposition: “A fool can ask more questions than a wise man can answer” and observes that if attorneys take more pride in pointing out the flaws in a client’s preliminary plans than in the solutions they help develop, they are indeed foolish.

Some of the suggestions may be selfevident: If you do not like the company you work for, leave. In-house lawyers have one client. Find one you like and serve it well; If you do not like, or at least respect, the people you serve, leave.

The author exhorts in house attorneys to recognize and have respect for the extremely hard job their clients have, and calls attention the difficult task of selling more and more products and services at increasingly greater margins in a prudent, responsible way.

He advocates being grateful that there are talented people who have the skills to execute the strategies that attorneys help develop. He states that “we all became lawyers hoping we could help people,” and notes that in-house lawyers get to do that every day, as the products and services that their clients provide play an important role in the economy and in the well-being of the users of the clients’ products and services.

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Intellectual Property

Design Patents May Be Next Troll Target

By David W. Long and Matt Rizzolo

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here is much ado these days about non-practicing entities (NPEs), sometimes known as patent assertion entities (PAEs), and known pejoratively as “patent trolls.” Technology companies decry them, federal agencies have held workshops and hearings on the effects they may be having on the economy, members of Congress have proposed laws to curtail their activities, and President Obama has weighed in with executive actions and more proposals for Congress. Currently PAEs focus on asserting business method or software patents, bur for a variety of reasons they may soon begin to assert design patents.

At first, this seems counterintuitive. Most PAEs tend to assert patents whose claims can be read quite broadly or are over-complicated, obscuring clear definition. Design patents, on the other hand, specifically protect “new, original, and ornamental design for an article of manufacture.” Each patent includes a single claim, for example “The ornamental design for a [certain type of device], as shown and described.”

Depending on the details included, the patent may include several figures showing the patented design from different perspectives and, potentially, multiple embodiments of the claim. For example, an Apple design patent covering the iPad includes a single claim to “an ornamental design for an electronic device,” but it also includes nine different figures showing various views of the claimed design.

Why might PAEs be attracted to design patents? Two reasons: the potentially vague and inconsistently-applied “ordinary observer test” for design patent infringement, and the statutory right to recover not just a reasonable royalty, but the infringer’s total profit from the infringing device.

Below, we look at how these and other design-patent related issues may attract PAE activity.

THE ORDINARY OBSERVER

The Federal Circuit held, in Egyptian Goddess v. Swisa, that the ordinary observer test is “the sole test” for design patent infringement. As articulated by the Supreme Court back in 1871, the ordinary observer test is: “[I]f, in the eye of an ordinary observer, giving such attention as a purchaser usually gives, two designs are substantially the same, if the resemblance is such as to deceive such an observer, inducing him to purchase one supposing it to be the other, the first one patented is infringed by the other.”

The ordinary observer compares the accused design to the claimed design “as a whole.” Unlike the mythical “PHOSITA” (person having ordinary

skill in the art) used in utility patent cases, the ordinary observer is not skilled in the design art. Rather, it is someone who gives normal attention to purchasing the product, and is also assumed to have knowledge of the prior art designs.

Thus, infringement is more likely to be found where a patented design represents a great departure from the prior art than where the patented design is closer to the prior art designs, yet still not obvious.

The ordinary observer test requires only that the accused design be substantially the same as the patented design.

The two designs need not be identical.

And, unlike with utility patents, the courts generally do not provide a jury with a claim construction.

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Intellectual Property

This confluence of factors – the ordinary observer test, the focus on the design as a whole, and the requirement for only a substantial similarity for infringement – increases the potential for a design patent holder to argue a broad scope of the claimed design, in the same way that PAEs often argue a broad scope of computerimplemented systems and methods.

As with computer-implemented patents, the potential for broad assertions and uncertainty related to design patents could lead accused infringers to settle questionable claims of infringement.

LOST PROFITS

Traditional patent remedies of reasonable royalties and lost profits, along with injunctions, are available to design patent holders. However, 35 U.S.C. § 289 provides an additional remedy specific to design patents: disgorgement of profits made by the infringer from sales of the covered device, up to the infringer’s total profits.

Design patent holders are prevented from recovery of both reasonable royalty damages and disgorgement of profits, and the infringer’s profit recovered cannot be trebled in the event of willful infringement. But trebling is not common in patent litigation anyway.

The real motivation for PAEs may lie in the potential to recover the total profits of any device. This can create massive leverage in favor of PAEs in licensing negotiations. This is particularly true given the Federal Circuit’s recent damages-related decisions that have forced patentees to more clearly link the value of their patents to the damages sought. But with a design patent, a PAE could potentially receive an infringer’s total profits on a device (such as a smartphone) based on the infringement of a patent that covers only a portion of the device’s visual appearance – an end run around these recent Federal Circuit cases.

For a quick example of the difference between reasonable royalties and disgorgement of profits, consider the jury’s verdict in last year’s high-profile AppleSamsung case. The jury found Samsung infringed several utility and design patents, and it awarded general damages over $1 billion, including upwards of

$80M per each of several of Samsung’s smartphone models. Although the jury award was not broken down by patent, based on a comparison of the award to the reasonable royalty damages and Apple’s lost profits that were alternatively sought by Apple, it is apparent that the profits Samsung was ordered to disgorge from these devices comprise by far the largest part of the award.

While the judge later vacated a portion of the damages award for certain products and ordered a new trial, she did not overturn the majority of the damages based on disgorgement of Samsung’s profits.

The Patent Office broadly interprets “articles of manufacture” to cover not just physical products, but also the design of web sites and graphical user interfaces (GUIs). One of the patents Apple asserted against Samsung was directed to the iPhone’s home screen layout, and Google has many design patents covering its search page design. Experience has already shown that many PAEs target web sites and GUIs with their system and method patent claims, which may be attractive targets for design patents as well.

Design patents are relatively inexpensive to procure. Prosecution costs and filing fees are substantially lower than they are for utility patents, and unlike utility patents, they require no maintenance fees.

Because design patents may be thought of as less valuable than utility patents, design patents may be cheaper on the secondary market for PAEs to purchase from patent owners who focus on utility patents. And finally, filing a complaint does not require any sophisticated pre-suit infringement analysis. As the Federal Circuit recently found in Hall v. Bed Bath & Beyond, there is no special pleading requirement for a claim of design patent infringement.

As with utility patents, the bare “notice pleading” standard applies.

PRUDENT STEPS

Developers and manufacturers should consider applying for design patents as part of their intellectual property strategy. Design patents are granted for “new, original and ornamental design[s] for an article of manufacture….”

As with utility patents, if the design is obvious in view of the prior art, the

patent will not be granted. Also like utility patents, design patents are subject to examination at the U.S. Patent and Trademark Office (design patents are searchable), but the grant of a design patent is evidence of the originality and non-obviousness of the design.

Thus, applications for design patents for the appearance of user interfaces, other user layouts, product appearance, etc., should be considered.

A patent serves not only to protect the ornamental design of a product, but it could be used as evidence to defend against a third party claim of infringement. Even if the design patent is not granted, the examination process may uncover prior art.

Finally, it is important to keep in mind that design patents may be obtained both on the overall design of a product and its constituent parts.

The groundwork may already be laid for a wave of PAE design patent activity.

Learning from past experience, companies in virtually all industries should be wary of this perfect storm of uncertain patent scope, increased leverage, availability of statutory remedies for infringement, low barriers and low expense of asserting claims. ■

David W. Long is a Member in the Intellectual Property and Litigation practice groups at Dow Lohnes PLLC., with more than twenty-five years experience in telecommunications. dlong@dowlohnes.com

Matt Rizzolo is an associate in Dow Lohnes PLLC’s Litigation practice group. He concentrates his practice on intellectual property matters, with a focus on patent litigation. mrizzolo@dowlohnes.com

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june/july 20 13 toDay’s gEnEr al counsEl

E-Discovery

Practical Tips For Managing E-Discovery

By Jasmine Juteau

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s companies attempt to reign in legal fees, many are considering tackling more e-discovery tasks in-house, and corporate counsel are finding they need to have greater insight into the e-discovery process. This article is a practical guide to various e-discovery issues facing companies today, written with corporate counsel in mind. It addresses current topics in the preservation, collection and review of electronically stored information (ESI). Careful thought and

advance planning in these areas can help counsel achieve maximum compliance with minimum risk, cost and interference in business operations.

THE LITIGATION HOLD

After receiving a demand for ESI, the first step is to initiate a procedure for preserving relevant materials. To prepare appropriate litigation hold instructions for custodians and IT employees, there are several questions to ask:

• Who are the custodians?

• What are the dates for requested information?

• What is the relevant ESI (e.g., email, databases, or other electronic files)?

• Where is ESI stored?

• How is it backed up or archived?

• Does the company have data retention policies or other practices, and if so should they be altered to accommodate preservation?

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Detailed responses to these questions will form the backbone of instructions provided with respect to ESI retention.

Don’t assume the company server houses all relevant ESI. For example, counsel often overlook local storage. Files saved to a computer desktop may not be saved to the network, in which case “images” of the hard drives may be required.

The number of devices used by employees has multiplied, so it has become necessary to be aware of ESI stored on devices outside the office.

Ask whether custodians work remotely and have laptops, home computers or personal data archives with relevant information. Ask if they use smart phones or other personal devices (like tablets or e-readers) for work purposes.

Consider whether they use third-party providers which host ESI (e.g. on-line email accounts, instant messaging or file sharing services).

Even information that is outside the office may be within the company’s “custody or control.” Several courts have determined that companies have a legal right to company information saved on an employee’s personal computer or in a personal account, and the company can require the employee to furnish that information in response to a document demand.

Similarly, several decisions have established that where the terms and conditions of a third-party service establishes the company’s authority over the relevant data, the company is responsible for requesting and producing such data in response to a document demand.

BACK-UPS AND RETENTION

Back-up and archiving practices are changing rapidly. As the volume of data expands, back-up tapes are being replaced with back-up servers and cloud-based storage, including vault systems. These systems offer far greater capacity and provide easier access to stored information if needed – and they present yet another source of ESI. Most of this data will duplicate the ESI on the “live” network, but it is important to understand the precise relationship between them. For example, archive systems may capture only certain portions of documents,

so the live network version is more complete. To issue an effective litigation hold and ensure a complete collection, IT professionals should be consulted about the relevant differences, if any, between the archived information and the live network.

IT professionals and the custodians should also be consulted about policies or practices employed to limit data storage.

Any “auto-delete” function, whether system-wide or applied on an individual basis, should be immediately disabled for relevant custodians. Similarly, the company should know the deletion practices of its third-party providers and take immediate steps to gather information in danger of being purged. For instance, some services maintain client messages for five years. If a subpoena was served today regarding activities that took place in 2008, potentially relevant communications would disappear daily without intervention.

A further consideration for companies with international offices is the geographic location of ESI. Global data networks allow employees in one country to run email or access files on servers in another country. Meanwhile, countries are promulgating data privacy laws that limit the ability of local offices to transfer personal data such as employee email abroad, even to corporate affiliates or company attorneys.

In a recent example, the Macau Office for Personal Data Protection penalized the Macau unit of the Las Vegas Sands Corp. for the unauthorized transfer of customer data to the U.S. parent company. If relevant ESI resides abroad companies must carefully consider the potential impact of data privacy laws.

Once ESI has been identified and secured, the next step is organizing the collection of data for review and, ultimately, production. There are several compelling reasons for ensuring that all relevant ESI is collected and reviewed in a sound and orderly fashion. An insufficient collection effort can quickly escalate into a series of problems. Counsel’s ability to conduct an early case assessment and consider the company’s position may be hampered without timely identification of key documents.

Failure to conduct a complete collection also will mean more collection work in the future, with more delay and disruption to the company. In addition, metadata, the background electronic file data that is generally required in response to the document demand and could be important evidence, may be corrupted or lost without a forensically sound collection. By saving and exporting data without the proper software or training, in-house IT professionals can permanently alter this critical information.

Lastly, insufficient or incomplete collection can lead to costly discovery disputes and, in the worst cases, sanctions for spoliation.

VAULT SYSTEMS

Many companies use so-called “vault” systems for data storage and archiving, and these systems are also marketed for ediscovery, particularly to facilitate inhouse collection and review. There are several benefits to vault systems, such as the capacity to maintain a complete set of all network data, the capacity to safeguard metadata, and advanced search functions.

However, it is important to understand their limitations for e-discovery purposes.

There are several technical issues for counsel to consider before authorizing ESI collection using any in-house resources, including a vault system: • Will the in-house personnel design and input search instructions appropriate to the system and sufficient to capture the desired results?

• Will the searches include documents in their most complete form, such as emails plus their attachments, or databases plus underlying data sources?

• How will the company address ESI that is not stored on the network or vault system?

• When extracting data, what impact if any will there be on the files’ metadata?

Counsel should also consider whether a vault system offers a viable alternative as a document review platform. Features such as de-duplication of identical emails, the ability to review related emails as a group, continued on page 23

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Some Pointed E-Discovery Lessons from a Battle of Giants

By Heather Hubbard, Mark Bell and Tera Rica Murdock

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lmost everyone knows of Apple’s patent infringement lawsuit against Samsung. What you may not know is that leading up to trial, the attention of the court focused largely on the e-discovery efforts of the parties.

Apple alleged that Samsung had failed timely to preserve documents, as it had in prior litigation, and asked the court for the sanction of an adverse inference.

Samsung, in turn, alleged that Apple had failed to meet the preservation obligations to which it was holding Samsung.

The opinions of the Northern District of California in this case provide a good roadmap for evaluating your corporation’s own preservation policies,

with regard to these basic issues: 1. Triggers for Issuing a Litigation Hold.

Both motions for sanctions were based on the theory that Apple and Samsung failed to preserve information by the date the duty to preserve was triggered.

The court granted both motions because litigation holds were not timely issued by either party.

An obligation to identify, locate, and preserve data arises when litigation or government inquiry is reasonably anticipated, threatened, or pending.

This “duty to preserve” stems from the common law duty to avoid spoliation of relevant evidence for use at trial.

The most common events for corporations that may give rise to the duty to preserve are: • Pre-litigation discussions with an opposing party or their counsel regarding potential claims.

• Receipt of a demand letter, subpoena, complaint, or civil investigative demand.

• Contemplation of or inquiry from a state or federal government or regulatory agency.

• Seeking advice of counsel about commencing litigation.

In each of these events, a reasonable

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party would have notice of a credible probability that it would become involved in litigation.

In Apple v. Samsung, the court held that the duty to preserve was triggered when Apple made a presentation to Samsung about Apple’s patents and Samsung’s possible infringement. While Samsung argued that it could not have known litigation would commence then, the court noted that setting the trigger date is an objective analysis. The standard is not whether a party in fact reasonably foresaw litigation, but whether a reasonable party would reasonably foresee it.

This case also demonstrated that if a plaintiff is asserting a certain trigger date, it should make sure that it was in compliance by that date itself. Plaintiffs may be held to a higher standard with regard to the trigger date for a duty to preserve, because it is more reasonable for a plaintiff to foresee when litigation may commence.

When Apple asserted that litigation was reasonably foreseeable to Samsung

as of the date of the presentation, it was not able to persuasively argue that its own duty to preserve did not arise until litigation was filed.

Once a party determines that the duty to preserve has arisen, that party must suspend its routine document retention or destruction policy and put in place a litigation hold to ensure the preservation of documents relevant to the specific and identifiable litigation. A litigation hold is notice, written or oral, to custodians of potentially relevant documents or data to preserve those documents or data.

2. Proportionality in Preservation.

Not only must the litigation hold be issued timely, it must be applied broadly to potential custodians and relative to the information at issue. When Samsung issued its first hold, it was limited to a small group. Almost eight months later, when the lawsuit was filed, it then widened the hold to thousands of employees.

The court essentially held that there is no

“proportionality” in preservation and the litigation hold must be issued broadly at the moment the obligation arises.

Generally, the duty to preserve applies to anyone who reasonably could anticipate being a party to a lawsuit.

While this duty does not require a party to preserve every document in its possession, it does require a party to preserve all information that could be relevant to a potential lawsuit. This means that any individual with potentially relevant information should be put on notice of the litigation hold. Indeed, in light of Apple v. Samsung, companies are well-advised to issue the notice to all employees so there is no chance of an oversight or potential spoliation.

A company is relieved of this burden only if a court grants a protective order limiting the preservation requirements. It is rare to get such protection, but if it is sought, it should be at the outset of the litigation. The more detailed and substantiated the information a company has to

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support the contention that the preservation is burdensome, the more likely the company is to succeed in seeking help from the court in alleviating the burden.

Without the court’s assistance, however, companies should not assume that the expense of preservation outweighs its benefit. This is one area where it is much better to ask for permission than to beg for forgiveness, as forgiveness could be in the form of a significant sanction.

To put it bluntly, there is no principle of proportionality in preservation without a court order. As courts have noted, “prudence favors retaining all relevant materials.” In practice, this means that companies need to be proactive in ensuring that potentially relevant material remains preserved by putting all employees on notice of the preservation obligations.

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3. Taking Necessary Steps to Preserve Evidence.

Not only must a company immediately issue a litigation hold to all persons with potentially relevant materials as soon as its duty to preserve is triggered, it must also be detailed and thoughtful in its approach. In Apple v. Samsung, the court determined that despite issuing a litigation hold (albeit untimely), both parties failed to properly implement it.

Issuing a hold to just a handful of the most obvious custodians and then waiting until a lawsuit is filed to circulate the hold to a more expansive set of employees may actually be used as evidence of “conscious disregard” of the company’s obligations to preserve. Not only should the litigation hold be sent to all potentially affected employees (not just key managers), it should be specific in the categories of documents that should be preserved. Requiring employees to check an electronic box or sign a document verifying that they have reviewed the hold is not sufficient if documents are nevertheless destroyed and the company cannot cite to any further attempts to obtain compliance.

To avoid sanctions due to destruction of evidence, which may include dismissal or an adverse inference instruction, more stringent standards must be employed.

Any automatic deletion or destruction policies should be suspended. In-house

and outside legal teams should meet with the recipients of the litigation hold (as well as the information systems employees assigned to assist with collection and preservation) to educate them on the importance of preserving evidence, the scope of the hold, and the technical requirements of the company’s system to preserve data and prevent destruction. Periodic audits should also be conducted to ensure that employees are preserving information as they were instructed in the litigation hold and training meetings. Failure to take each of these steps may result in sanctions, as they did in Apple v. Samsung.

To ensure preservation is a priority and prevent potential sanctions, a company should prepare well in advance of an actual dispute. A written policy and procedure manual for collection and preservation should be adopted and consistently applied in all circumstances.

The manual should identify each step that must be taken, when it must be completed and the persons responsible.

Additionally, the legal and business managers, and the information systems personnel responsible for implementing these procedures, should be trained and the process validated prior to putting it into practice.

If a corporation is ever subject to sanctions for failure to properly preserve evidence, it should avoid getting the painful lesson twice, because sanctions may be cumulative in their effect. As an example, the court began its opinion on Apple’s Motion for an Adverse Inference against Samsung by noting that Samsung had been subject to sanctions seven years earlier, when it had failed to preserve evidence by not turning off an auto-delete e-mail function. It then found that although Samsung had altered this auto-delete function to allow a user to save documents, it had not actually ended auto-deletion.

As a result, documents were destroyed after litigation with Apple was reasonably foreseeable. The court found that by failing to end the policies that had previously thwarted the failure to preserve, Samsung acted in conscious disregard of its obligations and imposed an adverse inference.

That may be one of the biggest lessons about prioritizing preservation from Apple v. Samsung: Corporations should first address systemic flaws that led to prior failures to preserve documents and data. Then they should create a system for evaluating a trigger, preserving broadly, and ensuring preservation. ■

Heather Hubbard is a partner at the Nashvillebased law firm Waller and deputy practice group leader of the firm’s litigation and dispute resolution group. Her practice includes IP litigation, e-discovery and data management, healthcare litigation, copyrights and trademarks.

She serves clients in media, entertainment, franchise and information technology. heather.hubbard@wallerlaw.com

Mark Bell, associate and litigation and dispute resolution attorney at Waller, focuses his practice on healthcare litigation, and e-discovery and data management. He works with clients across the design and construction, healthcare, automotive and manufacturing and home health industries. mark.bell@wallerlaw.com Tera Rica Murdock is an associate at Waller and part of the firm’s litigation and dispute resolution group, where she focuses on labor and employment, financial services litigation, e-discovery and data management and healthcare litigation. Murdock serves clients in the automotive, manufacturing, healthcare and banking and financial services industries. terarica.murdock@wallerlaw.com

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Practical Tips For Managing E-Discovery continued from page 19 capacity for multiple reviewers and retention of document review history are all relevant to that assessment. It is essential to have a complete understanding of the benefits and limits of vault systems before utilizing one for purposes of e-discovery.

While new technologies such as predictive coding are gaining ground, they remain cost-prohibitive for most standard e-discovery needs. The traditional method of designing and applying search terms continues to be the preferred method of reducing a large collection of ESI to a manageable review set. Designing a search that will achieve a well-tailored set of potentially responsive ESI is a crucial task. The terms must be broad enough to capture all potentially relevant materials without pulling in an abundance of false positives and irrelevant documents.

As ESI multiplies, crafting precise and

accurate terms is an important aspect of cost-saving. Moreover, judges routinely criticize discovery efforts based on poorly-selected search terms, and they have recommended that attorneys consult with professionals qualified to design an effective search methodology.

Identifying and drafting relevant search parameters involves several steps.

• Understand the search function of the relevant software.

• Speak with key custodians to assess the subject matter and identify key terms, including common abbreviations and short-hand references.

• Review key documents to identify core terms and concepts.

• Control quality to judge initial search results and adjust search terms as needed.

• When possible, cooperate with

opposing counsel on the search to avoid later disputes.

Failure to follow these steps can result not only in an overly costly and burdensome review project. It can also lead to deficient production that is subject to sanctions. ■

Jasmine Juteau is Counsel to Morvillo Abramowitz Grand Iason & Anello PC. Her practice is focused on white collar defense, regulatory enforcement and corporate compliance. jjuteau@maglaw.com

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Human Resources

Use Arbitration to Protect Non-Competes

By Steve Safranski and Heather McElroy

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t’s a familiar story: an employee bound by a non-competition covenant is recruited by a competitor in a jurisdiction that refuses to enforce the covenant, and a race to the courthouse ensues.

The employee files a declaratory-judgment action in the unfriendly jurisdiction to invalidate the non-compete, and the former employer files a competing enforcement action in its home state. With two parallel lawsuits, the results are far from ideal. At best, it’s a costly jurisdictional fight with competing motions in different courts. At worst, the non-compete is invalidated.

Traditionally, employers have used choice-of-law or forum-selection clauses to try to secure a favorable venue in which to litigate the validity and scope of a non-competition provision and avoid unfriendly state law. But in certain jurisdictions, these clauses have not been effective.

The United States Supreme Court’s recent decision in Nitro-Lift Technologies LLC v. Howard suggests a solution: a properly drafted arbitration provision in the employment agreement would allow for efficient, low-cost enforcement, and offer multi-state employers greater confidence in the enforceability of their agreements.

DECLARATORY JUDGMENT ATTACK

Multi-state employers seeking to protect their goodwill and confidential information with non-compete provisions have faced a longstanding conundrum due to inconsistent state laws regarding enforcement. Most problematic, however, are jurisdictions, like North Dakota, Montana, Oklahoma, and California, with a stated “fundamental public policy” against non-competes.

California has become the finish line for many races to the courthouse to challenge post-employment covenants, because California courts almost universally refuse to enforce such provisions.

Section 16600 of California’s Business

and Professions Code outright prohibits non-competes: “Every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind, is to that extent void.”

For years, California courts have used Section 16600 to invalidate agreements that restrain an employee from engaging in competitive employment after leaving a former employer, no matter where the former employer resides or where the non-competition agreement was signed.

In Application Group, Inc. v. Hunter,

decided in 1998, the California Court of Appeals expanded Section 16600 into a statute of national scope. AGI, a California employer, recruited one of Hunter’s Maryland employees who had signed a non-compete in Maryland and promptly filed a declaratory-relief action in California to void the non-compete. Affirming the trial court, the First District invalidated the non-compete even though the former employee still worked for AGI in Maryland and never intended to move to California, reason-

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Human Resources

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ing that Section 16600 was intended to ensure that “California employers will be able to compete effectively for the most talented, skilled employees in their industries, wherever they reside.”

This decision paved the way for an onslaught of lawsuits by California employers to invalidate restrictive employment covenants. One of the favored tactics of former employees and their California employers has been to file a declaratoryjudgment action to void the non-competition covenant, often before the former

employer can even get an action filed in its home state. These preemptive declaratoryjudgment suits are often successful.

Employers have attempted to save their non-competes by inserting choice-of-law provisions into their employment agreements. This has not always been effective, as they can be trumped by a fundamental policy against post-employment restrictive covenants. For example, California courts will typically not enforce choice-of-law provisions in non-compete cases on the grounds that any state’s law that would

uphold the provision is considered antithetical to California’s strong public policy against them.

A specific forum-selection clause may fare better, but again, it is not a sure bet.

For example, in Bunker Hill International, Ltd. v. Nationsbuilder Insurance Services (2011), the Georgia Court of Appeals reversed the enforcement of a forum selection clause in a non-compete agreement, holding that it “is void because its application would likely result in the enforcement by an Illinois court of at least one covenant in

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violation of Georgia public policy.”

This means that, in the context of litigating non-competition covenants, races to the courthouse continue. These cases have inconsistent results, and nearly always involve protracted litigation and expensive motion practice.

Advanced Bionics Corp. v. Medtronic, Inc. provides a prime example of a prolonged jurisdictional fight over a noncompetition covenant. When a Medtronic employee with a two-year post-employment non-compete was recruited by California company Advanced Bionics, both the Minnesota and California state courts asserted jurisdiction and enjoined proceedings in the other court. Even though the employment agreement selected Minnesota law, the California Court of Appeals (2001) held that California law would apply and enjoined the Minnesota case.

Meanwhile, the Minnesota courts enforced the non-compete and upheld the Minnesota courts’ exercise of jurisdiction. Ultimately, the California Supreme Court (2002) reversed the order enjoining Medtronic from proceeding in Minnesota, but the action to invalidate the non-compete could still proceed simultaneously in California. The end result? Two parallel proceedings were permitted to continue in tandem, in a “race to judgment.”

The United States Supreme Court’s Nitro-Lift decision suggests a solution to the litigation marathon. The dispute in Nitro-Lift arose from a contract between employer Nitro-Lift Technologies LLC and two of its former employees who had entered into confidentiality and noncompetition covenants. The contract also contained an arbitration clause, which provided that any dispute between NitroLift and the employee “shall be settled by arbitration ... in an arbitration proceeding conducted in Houston, Texas...”

After the two Nitro-Lift employees left for a competitor, Nitro-Lift instituted an arbitration action alleging breach of the non-competes. The employees turned around and filed suit in Oklahoma state court (a state that prohibits non-competes), asking the court to void the noncompetition agreements. After several appeals, the Oklahoma Supreme Court agreed and declared the non-competition clauses “void and unenforceable as

against Oklahoma’s public policy.”

On further appeal to the U.S. Supreme Court, the high court vacated the Oklahoma Supreme Court’s decision, concluding that it had disregarded Supreme Court precedent on the Federal Arbitration Act when it declared the non-competition covenants null and void. The FAA “declares a national policy favoring arbitration,” and provides that a written arbitration clause in a contract “is valid, irrevocable, and enforceable.” And, it says, when parties commit to arbitrate contractual disputes, “attacks on the validity of the contract ... are to be resolved by the arbitrator in the first instance, not by a federal or state court.”

According to Nitro-Lift, public policy, no matter how significant, will not prevent enforcement of an arbitration clause.

While in some jurisdictions “fundamental public policy” may trump choice-of-law and forum selection clauses, they cannot trump arbitration under the FAA. the ARBItRAtION CLAUSe

So what does such an effective arbitration clause look like? First, it must be mandatory.

Second, it should contain a choiceof-law provision, and an exclusive forum-selection clause providing that the arbitration take place in a particular state, with that state’s law to apply. To ensure enforceability, the designated forum should have a significant connection to the underlying employment relationship.

Third, the arbitration clause should explicitly state that the arbitrator has authority to grant injunctive and provisional relief in order to enforce the terms of the agreement, i.e., “Upon application of any Party, the arbitrator may require specific performance of any provision of this Agreement, including the award of emergency, temporary, or preliminary injunctive relief.”

Fourth, to address the need for speed, the parties should agree that the arbitrator apply the AAA Optional Rules for Emergency Measures of Protection, which provide a protocol for seeking immediate, emergency relief. To avoid later challenges to the arbitration clause based on procedural unconscionability, attach a copy of these rules (and any other arbitration rules to be

invoked) to the employment agreement.

Fifth, to deter a race to the courthouse to challenge the arbitration agreement, the parties may include a provision providing for attorney fees in enforcing the arbitration clause. But do not overreach.

Make the obligations reciprocal.

Lastly, draft the arbitration clause, as well as the rest of the employment agreement, in clear, simple terms, flagged with individual headings. Do not bury it in a lengthy, single-spaced 20-page contract.

Consider asking the employee to initial the arbitration provision separately to ensure that he or she consented to its terms.

An effective arbitration clause, although a welcome alternative to a costly jurisdictional courtroom battle, will not guarantee enforcement of the non-competition covenants. To be enforceable, the non-compete must still meet the substantive requirements of the chosen jurisdiction. All told, however, a carefully drafted arbitration clause with defensible choice-of- law and venue provisions and a protocol for seeking emergency relief will undoubtedly provide a more efficient and lower-cost alternative to the race to the courthouse. ■

Stephen P. Safranski is a partner at Robins, Kaplan, Miller & Ciresi LLP. His practice focuses on complex business litigation, with emphasis on competition law. He represents clients in the food and grocery, hospitality, cable, telecommunications and health care industries. spsafranski@rkmc.com

Heather M. McElroy is at attorney at Robins, Kaplan, Miller & Ciresi LLP, practicing in complex business litigation, with an emphasis on competition law and financial litigation. hmmcelroy@rkmc.com

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june/july 2013 today’s Gener al counsel

Governance

General Counsel as Risk Manager

By Mary Mary E. E. McCutcheon McCutcheon and and Erica Erica Villanueva Villanueva By

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s companies restructure or streamline operations, general counsel must manage a broadening array of tasks. One function migrating into corporate law departments is risk management, including assessing the company’s insurance requirements and purchasing adequate coverage.

This may seem like an odd fit, but good risk management is often intertwined with tasks that clearly belong to the legal department. While companies may purchase a variety of insurance policies, the ones most likely to benefit from legal department review include commercial general liability, data privacy and cyber-risk liability, errors and omissions liability, director and officer liability (D&O), and in some cases fiduciary liability and/or employment practices liability policies.

sive equipment (first-property), or companies in the transportation or construction sector, where the company could face major liability due to accidents (third-party liability).

What makes sense for virtually any law department is to appoint a specific attorney to take responsibility for insurance issues. Allow this person the time to become familiar with the company’s insurance policies and what they do and don’t cover. By doing this, you can confidently delegate many of the key insurance tasks to an “insurance point person” and know that nothing is falling through the cracks.

The insurance point person should: • Handle the nuts and bolts of annual policy renewals. This involves working with an insurance broker,

An effective risk management strategy will also depend on strong external support from insurance brokers and insurance coverage counsel.

An effective risk management strategy will also depend on strong external support from insurance brokers and insurance coverage counsel. For general counsel, the challenge is to delegate various tasks to the correct internal or external service provider.

General counsel taking over risk management (usually from the company’s finance department) may wonder if they need to hire a risk manager. For a typical small to medium-size company, the answer is probably no. The types of companies that need professional risk managers are usually those which face major physical exposures, either on the first-property or the third-party liability side. For example, companies that have multiple research or manufacturing facilities with expen-

who would actually solicit quotes and place the insurance coverage, and the internal finance department, which will be responsible for premium payments and logistics.

• Handle the insurance application process, particularly for D&O insurance. Insurance policy applications are important legal documents, and failure to properly disclose information requested in them can have serious consequences. In the case of D&O coverage, the initial application will often require the applicant to poll its officers and board members regarding pending or potential claims.

For these reasons, it is best to have insurance applications reviewed by continued on page 33

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Governance

“Reliance” in Class Actions Clarified by Supreme Court

By Thomas Rohback

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class action ping pong match has been going on in the Supreme Court between Justice Scalia and Justice Ginsburg.

The Court’s otherwise unremarkable decision on March 27 in Comcast v. Behrend, reaffirming the Court’s holding in Wal-Mart v. Dukes, may have signaled the end of the match.

On February 27, 2013, the Supreme Court had affirmed certification of the securities class in Amgen, Inc. v Connecticut Retirement Plans and Trust Funds. The decision in Amgen suggested two dramatic effects: one in the area of securities law, and the other in the area of class action law.

In Amgen, the putative class sued a

biotechnology company, Amgen, Inc., and several of its officers, for allegedly making false and misleading statements or omissions concerning the safety, efficacy, and marketing of two of Amgen’s top drugs.

The complaint alleged private causes

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Governance

of action under Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission Rule 10b-5. To recover under such a claim, a private plaintiff or a class of private plaintiffs must prove: (1) a material misrepresentation or omission by the defendant, (2) scienter, (3) a connection between the misrepresentation or omission and the purchase or sale of a security, (4) reliance upon the misrepresentation or omission, (5) economic loss and (6) loss causation.

Unlike in many areas of the law, a securities plaintiff who purports to represent a class can satisfy its burden of proving reliance when securities

tion of materiality will result in individual questions predominating ... Instead, the failure of proof on the element of materiality would end the case for one and for all; no claim would remain in which individual reliance issues could potentially predominate.”

In other words, given the assumption that this is an efficient market, the claims of all purchasers would rise or fall together based on an eventual determination of whether the misrepresentation was material. Therefore, the case was appropriate for class certification under Rule 23(b)(3).

While the Amgen Court continued to apply the precedent of Basic, Inc.

presumption of “reliance,” plaintiffs should still have to prove the essential elements of the efficient market and materiality that would justify using the fraud-on-the-market method of satisfying the element of reliance before certifying the class.

For his part, Justice Scalia, writing in dissent, sharply criticized the fraudon-the-market rule: “This rule is to be found nowhere in the United States Code or in the common law of fraud or deception; it was invented by the Court in Basic, Inc. v. Levinson.”

In closing, Justice Scalia left no doubt as to his views on the subject: “Today’s holding does not merely

As the Court explained, an efficient market presumes that individuals will rely on material misrepresentations in buying and selling securities on a public exchange.

31 are purchased on a public stock exchange without delving into the decision process of each purchaser. The fraud-on-the-market theory endorsed by the Supreme Court in Basic, Inc. v. Levinson, in 1988, recognizes a rebuttable presumption of reliance on a material representation made to the general public. As the Court explained, an efficient market presumes that individuals will rely on material misrepresentations in buying and selling securities on a public exchange.

For the element of “reliance” to be proved on a class-wide basis under a fraud-on-the-market theory, the alleged misrepresentation or omission must be “material.” The Amgen Court, however, held that it was not necessary to prove materiality at the certification stage.

Rather, the Court noted that the question of materiality would be common to all class members, and explained that the eventual answer to the common question of materiality would be common for the class: “[T]here is no risk whatever that a failure of proof on the common ques-

v. Levinson in finding class-wide reliance in a fraud-on-the-market case, the Court expressly recognized that the fraud-on-the-market presumption of reliance may be in jeopardy. The Court noted that the decision in Basic was issued by only four justices. (The Court was sitting as a quorum with only six justices for that decision.)

In his concurring opinion, Justice Alito expressly stated that “more recent evidence suggests that the presumption rests on a faulty economic premise.” Nevertheless, Justice Alito joined with the Court because the petitioners had not asked the Court to revisit Basic’s fraud-on-the-market presumption. In Amgen, the Court held that the defendants could not challenge whether the NASDAQ stock exchange was an efficient market because they had conceded this in their pleadings. (“Amgen conceded in its answer that the market for its securities is ‘efficient’….”)

In dissent, Justice Thomas explained that even if the questionable fraudon-the-market theory could allow a

accept what some consider the regrettable consequences of the four-Justice opinion in Basic; it expands those consequences from the arguably regrettable to the unquestionably disastrous.”

It can only be assumed that every defendant sued under a fraud-on-themarket theory from this point forward will challenge the continued vitality of fraud-on-the-market.

More broadly, Amgen raised questions as to the showing required at the class certification stage beyond securities cases. Two years ago, when the Supreme Court issued its decision in Wal-Mart Stores, Inc.v. Dukes, many were quick to herald this decision as the death knell of large class actions. But Wal-Mart was never really a decision about the size of the class (although the massive size certainly was a consideration). Rather, the Court in Wal-Mart properly rejected the certification of a purported class where individual issues of fact predominated. Although the size of the class in Wal-Mart drew headlines, the Court’s decision did not bar any class

june/july 2013 today’s Gener al counsel

Governance

from being certified simply because of its massive size.

In his Amgen dissent, Justice Thomas argued that the rebuttable presumption underlying the fraud-on-the-market theory should be allowed to be rebutted at the class certification stage. As he reasoned, if the theory is unfounded, then reliance cannot be proved on a classwide basis. But the Amgen Court reasoned that certification could be granted even on a suspect theory because the claims of all class members would rise or fall on the strength of that theory.

In Wal-Mart, however, the Court

class, the Court in Wal-Mart took a very different approach than the Court in Amgen as to whether the vitality and viability of the unifying theory should be challenged at the certification stage.

Even before Wal-Mart, courts recognized the Daubert gatekeeping function as having vital importance to the issue of class certification. In American Honda Motor Co., v. Allen, the Seventh Circuit Court of Appeals held that “when an expert’s report or testimony is critical to class certification ... a district court must conclusively rule on any challenge to the

Arguably, much of the Amgen decision may have been dicta because the defendant in that case was estopped by its own pleadings from challenging the efficient market premise. Nevertheless, the Court’s language certainly did not seem to suggest that the Court’s opinion was just a casual observation.

On the issue of testing the soundness of the theory by which common questions can be susceptible to common answers, the opposing opinions and dissents of Justice Ginsburg and Justice Scalia in Amgen and Wal-Mart suggested that we were heading for

Justice Scalia, writing in dissent, sharply criticized the fraud-on-the-market rule.

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stressed the need to have a rigorous analysis where an expert’s opinion would be essential for a putative class’s ability to address key issues, such as reliance, on a class-wide basis: “Respondents have not identified a common mode of exercising discretion that pervades the entire company – aside from their reliance on Dr. Bielby’s social frameworks analysis that we have rejected ... Respondents attempt to make that showing by means of statistical and anecdotal evidence, but their evidence falls well short ... The statistical evidence consists primarily of regression analyses performed by Dr. Richard Drogin, a statistician, and Dr. Marc Bendick, a labor economist ... Drogin concluded that “there are statistically significant disparities between men and women at Wal-Mart ... [and] these disparities ... can be explained only by gender discrimination ... Even if they are taken at face value, these studies are insufficient to establish that respondents’ theory can be proved on a classwide basis.”

So by rejecting the expert testimony that would have allowed the common question to be answered as to the entire

expert’s qualifications or submissions prior to meeting on a class certification motion.”

In American Honda, the expert’s testimony was “necessary to show that Plaintiffs’ claims are capable of resolution on a class-wide basis and that the common defect in the motorcycle predominates over the class members’ individual issues.” If the fraud-onthe-market theory at the center of the Amgen decision is little more than a judicially-recognized expert opinion, then it should be scrutinized in a Daubert type hearing if certification depends on that theory. Nevertheless, that is not the holding of Amgen.

The Amgen decision had language that would surely be quoted by plaintiffs’ attorneys seeking class certification in a wide variety of contexts that seemed to reject the rigorous inquiry urged by the Court in Wal-Mart: “Rule 23 grants courts no license to engage in free-ranging merits inquiries at the certification stage. Merits questions may be considered to the extent – but only to the extent – that they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied.”

a tie-breaker. Comcast seems to have resolved the debate.

Were it not for the Comcast decision, it is likely that aggressive class action plaintiffs would have seized on Justice Ginsburg’s language that the issue of certification is not a “license to engage in free-ranging merits inquiries ...”

With Comcast, however, it is more likely that the significance of Amgen will be confined to securities class actions, and the securities law implications of Amgen will not be a benefit to plaintiffs. ■

Thomas G. Rohback is a partner at Axinn Veltrop & Harkrider LLP. His cases have involved diverse areas of the law ranging from antitrust to anti-terrorism litigation, in industries including manufacturing, financial services, insurance, utilities and telecommunications. tgr@avhlaw.com

today’s Gener al counsel june/july 2013

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General Counsel as Risk Manager continued from page 29 someone in the legal department.

• Review all claims, demands, investigations and inquiries that target the company. The legal department’s insurance point person will be able to spot claims that are potentially covered and make sure they are promptly reported.

• Prepare presentations to the board regarding the company’s coverage.

tell you what those companies are doing. The broker can give you a realistic appraisal of what is achievable in terms of coverage and pricing, given current market conditions and your company’s risk profile.

For routine claims, your broker is also the best person to notify the proper insurance companies. The broker will have access to all the insurers’

Appoint a specific in-house attorney to take responsibility for insurance issues.

• Work with a broker to ensure compliance with the insurance requirements in company contracts. At a minimum, your insurance point person should be familiar with the insurance, indemnity and waiver of claims language in the contracts that the company enters into, to ensure that adequate coverage is purchased. The insurance point person can work to standardize the company’s contractual insurance and indemnity obligations. Often these are considered “boilerplate” and are ignored, but in fact they can vary widely. Lack of standardization makes it very difficult to purchase insurance coverage that complies with all requirements.

Failure to do so could result in serious coverage gaps.

Your broker is the person best positioned provide advice regarding which insurance to buy, the liability limits you should carry and how much risk you should retain in the form of deductibles or self-insured retentions. The broker will be able to compare your company to other companies in the industry and

contact information and know which policy periods are implicated by a claim. You may also want to involve law firm insurance coverage counsel at this stage.

Don’t be afraid to ask questions.

This will be easier if you’ve assigned an insurance point person who has developed some familiarity with your company’s risks and the coverage you have obtained. That person can be an active participant in the renewal process, rather than simply approving the broker’s recommendations.

If you aren’t totally satisfied with your broker, you may want to initiate a broker selection process. When brokers compete, you will get detailed analyses of your current risk profile, insurance program, and areas for potential change and improvement. Even if you end up remaining with your existing broker, the process will be instructive.

However, if you’re not ready to take this step, you can ask outside consultants for a second opinion.

Outside coverage counsel can be helpful in many situations, from answering application questions to selecting among carriers when the language

on their policies seems similar. You also may wish to consult with insurance coverage counsel to evaluate whether a particular claim is covered, or at the stage when a claim is being filed. In cases involving complex issues or novel insurance coverage arguments, the initial notice letter can articulate the legal basis for the company’s position.

At times it may make sense for the coverage counsel to report the claim to the insurer. In other circumstances, for strategic reasons, coverage counsel may just advise on how best to posture the claim.

Insurance policies are contracts.

The risks that can be mitigated or eliminated by proper attention to these contracts make it worth the time it takes to learn about them, and how to purchase the best possible contract for your company. ■

Mary McCutcheon is a partner at Farella Braun + Martel LLP and chair of the firm’s Construction and Insurance Department. She represents corporations, public entities and individuals in a wide variety of insurance coverage disputes. mmccutcheon@fbm.com

Erica Villanueva is a partner at Farella Braun + Martel. She represents policyholders seeking coverage under a variety of insurance policies, including general liability, directors’ and officers’ liability, professional liability, employers’ liability, property and business interruption policies. evillanueva@fbm.com

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Compliance Clampdown On Bribery

By Laura Martino

C

orporate lawyers world-wide have recently received potent reminders about the force of the U.S. Foreign Corrupt Practices Act. The FCPA is landmark legislation from 1977, designed to combat bribery of overseas officials.

In November 2012, the Department of Justice and the SEC published 130 pages of long-awaited guidance, informing stakeholders of how the FCPA would be interpreted for prosecution in an ever-more complex corporate landscape. This prompted a high profile rebuke from the Manhattan Institute for Policy research, which argued that the law itself was ambiguous and required reform. A more likely culprit for the FCPA’s ambiguity, one might argue, is lack of judicial oversight.

Aside from those interpretive releases, corporate leaders could not have failed to notice a powerful example of the FCPA in practice. In December, the SEC charged the pharmaceutical firm Eli Lilly with making improper payments through foreign subsidiaries to government officials in Brazil, Poland, Russia and China, in efforts to win business.

Those inducements totaled just over $8.4 million, but Eli Lilly was hit with a fine of about three times that amount.

Kara Novaco Brockmeyer, head of the SEC Enforcement Division’s FCPA Unit, said that Eli Lilly and its subsidiaries had a “check the box mentality” when it came to thirdparty due

diligence, and he warned: “Companies can’t simply rely on paper-thin assurances by employees, distributors or customers. They need to look at the surrounding circumstances of any payment to adequately assess whether it could wind up in a government official’s pocket.”

Enforcement Division associate director Antonia Chion added: “When a parent company learns tell-tale signs of a bribery scheme involving a subsidiary, it must take immediate action to ensure that the FCPA is not being violated. We strongly caution company officials against averting their eyes from what they do not wish to see.”

The Eli Lilly case brought home the stark reality that, for global companies with U.S. ties, operating in foreign markets requires detailed due diligence in order to avoid risk exposure and maintain compliance. It can be a daunting task. That’s why companies are increasingly seeking assistance in this area from legal support services providers.

While some may regard anti-bribery legislation as a bureaucratic hindrance, most companies understand that these laws aim to create a level playing field, in which equal standards are set across the board, and prevent undesirable conduct that can hinder free trade and diminish public confidence. The reality, however, is that certain countries experience more corruption than others, as seen by their placement in Transparency International’s “Corruption Perceptions Index.”

Organizations with particular vulnerability to non-compliance are those with overseas operations that embrace global supply chains and networks of intermediaries, including agents, distributors or brokers. The FCPA prohibits companies from paying an agent or intermediary if they know that money would likely be transferred to a foreign official to gain an improper advantage.

Importantly, knowledge that an agent would do so can be inferred. A com-

pany cannot simply look the other way when it comes to the acts of its intermediaries. A company’s declaration that it wasn’t aware of what its agents were doing would not necessarily shield it from civil or criminal liability. The onus is on the company to know about its intermediaries and business partners.

Why has guidance emerged now, more than 35 years after the FCPA was passed? And what has happened to sharpen corporate awareness of the law’s potential effects? Essentially, because of the increased number of enforcement actions. The DOJ and SEC are concurrently pursuing investigations more aggressively than ever, levying large fines and putting executives at risk of imprisonment. There also has been an effect from the Dodd-Frank Act, which offers financial incentives for information that alerts the authorities to cases of non-compliance.

This climate of increased enforcement is expected to continue in the United States, and globally as well, as demonstrated, for example, by the UK Bribery Act and the tightened policies recently released. This, together with the FCPA clampdown, underscores the critical importance of compliance, a complicated enough issue so that it often requires the assistance of a legal support provider.

“For a responsible company with worldwide reach, there is a constant balancing act between meeting business objectives and fulfilling compliance obligations,” says Suzanne Bullitt, Trade Compliance Director (Americas) at Invensys, a global technology business. “Legal support services take a deeper dive into the regulations and flag potential concerns.”

On the contract side, she notes, legal support services providers help to vet terms and conditions while managing deals before, during and after the inking of continued on page 39

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JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

Canada/Cross–Border

Trends In Canadian Energy M&A

By Jamie Koumanakos and Micah Wood

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Canada/Cross–Border

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mid recent global economic turbulence, Canada has had a strong record of financial stability. This appears likely to continue, even with anemic economic performance in North America and Europe. Much of Canada’s stability and economic success in recent years has resulted from the country’s wealth of natural resources (along with fossil fuel prices that remain well above prices that prevailed a decade ago), its well-capitalized financial institutions which were largely shielded from the financial collapse in 2008 and a relatively predictable political landscape.

As a result of this stability and strong natural resource base, Canada remains a top destination for foreign investment, including in the energy sector.

Below we look at some of the trends that we see in Canadian mergers and acquisitions activity in the energy sector, and we canvass recent regulatory developments of interest to both foreign and domestic buyers and sellers.

STRONG ASIAN DEMAND

Energy remains at the core of Canadian mergers and acquisitions activity.

In the fifth annual Blakes Canadian Public M&A Deal Study, we found that approximately 25 percent of the largest 50 friendly public transactions reviewed occurred in the energy sector, most notably oil and gas. Indeed, transactions involving the Canadian oil and gas sector have continued to increase.

According to published reports, the number of announced Canadian oil and gas deals valued at $1 billion or more increased by 115 percent in 2012 as compared to 2011 (from 6 to 13), while the value of all announced transactions in the sector increased by 112 percent year over year. In fact, in 2012, there were a total of 337 announced oil and gas sector transactions, valued at over $66.2 billion. The highest-profile of these transactions included the $19-billion acquisition of Nexen by China’s CNOOC, the $5.5-billion acquisition of Progress Energy Resources by Malaysia’s Petronas and the $3.8-billion acquisition of Provident Energy by Pembina Pipeline.

Asian demand for commodities has

continued strong, and Asian companies, including state owned enterprises (SOEs), have increasingly turned to Canada and other resource-rich countries to secure supply. In addition, Asian companies continue to see good value in investing in commodities, even where those commodities cannot presently be exported to Asian markets (for example, synthetic crude oil from the Canadian oil sands).

Asian interest in Canadian energy resources was evident in the highprofile Nexen and Progress Energy deals, as well as Mitsubishi’s recently

ment in Canada’s shale gas reserves. In recent years, technological advances have solidified the economic viability of shale gas investment. At the same time, U.S. shale gas reserves have increased substantially, depressing local commodity prices, while continued longterm forecasts show strong natural gas demand in Asian markets.

These trends present an opportunity for continued investment in Canada’s unconventional production sources, and the development of LNG facilities to increase export capabilities of Canadian natural gas to major markets, including Asia.

Energy remains a core of Canadian mergers and acquisitions activity.

announced $2.9-billion acquisition of a 40 per cent interest in Encana’s Cutback Ridge natural gas development.

This demand for commodities includes the purchase of non-Canadian energy assets from Canadian companies, with Sinopec’s $1.5-billion acquisition of a 49 percent equity stake in Talisman Energy’s U.K. North Sea assets, and Toyota Tsusho’s $602-million acquisition of a royalty interest in Encana’s U.K. coal bed methane resource asset.

Despite the Canadian federal government’s position in respect to foreign SOEs controlling Canadian businesses in the energy sector (as discussed below), we expect Asian investment in Canadian resource companies to remain brisk.

Asian companies that are not SOEs will continue to benefit from Canada’s open investment environment, while SOEs will be able to make minority investments in Canadian energy companies, and invest in expanding existing Canadian businesses or establishing new ones.

SHALE GAS

Canada continues to develop its liquefied natural gas (LNG) infrastructure, which bodes well for continued invest-

Interestingly, amid the debate over oil pipelines throughout North America (including the Keystone Pipeline), there has been little public backlash against the development of LNG facilities in Prince Rupert and Kitimat, British Columbia, and significant support from government and aboriginal groups for the facilities. There are currently at least eight major projects planned for the region, with Petronas, Shell and Chevron taking key roles in advanced projects.

Moreover, the prospect of significant LNG exports by the end of the decade has prompted significant Canadian and foreign investment in gas-rich northeast B.C. In particular, Asian investors have shown continued interest in acquiring rights to the natural gas that is increasingly being used by that region as a source of energy.

The Canadian oil industry in Western Canada appears to be at a major crossroads. Western Canadian producers of bitumen and synthetic crude oil need access to new markets and increased access to existing markets. These producers have run into significant difficulty in gaining access to new and expanded markets because of limited pipeline

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June/July 2013 today’s gener al Counsel

Canada/Cross–Border capacity. Oil pipeline expansion will challenge the long-term growth of the oil industry within Western Canada.

The Canadian federal government passed the Jobs, Growth and Longterm Prosperity Act in 2012 to help curtail misuse of the regulatory review process to delay development. With respect to federally regulated pipelines, this law includes enhanced powers to ensure that reviews are conducted in a timely manner and gives the Governor in Council (in essence, the federal cabinet), as opposed to the National Energy Board, the power to approve pipeline construction and operation.

remains supportive of investment in Canadian energy projects, including by non-Canadian investors, there is increasing concern about investments by foreign SOEs in Canadian businesses, particularly in the Western Canadian energy sector. As noted, last year saw major acquisitions of established Canadian energy companies by foreign SOEs. In response to these investments, the Canadian Federal government released a policy and updated its guidelines detailing how investments by foreign SOEs would be reviewed under the nation’s foreign investment laws.

We expect to see continued foreign investment in oil and gas transportation infrastructure in 2013, in spite of controversy in Canada and the U.S. 38 Similarly, the Alberta government passed the Responsible Energy Development Act, which contemplates the formation of a new single regulator that will integrate the powers previously held by various agencies and is expected to be operational by June 2013. While there may be short-term growing pains, it is expected that the new federal and provincial regulatory regimes will result in reviews that are more streamlined and timely than has been the case in the past.

We anticipate continued strong support for transportation infrastructure development by the governments of both Canada and Alberta. It is unclear at this stage whether the U.S. government will support the Keystone Pipeline. The U.S. State Department’s draft environmental assessment may be a step toward approval.

Ultimately, we expect to see continued foreign investment in oil and gas transportation infrastructure in 2013, in spite of controversy in Canada and the United States.

FOREIGN INVESTMENT

While the Canadian Federal government

At the core of the policy is the substantive test that must be met by all large investments by nonCanadians in Canadian businesses: that the investment must be of “net benefit” to Canada. In a televised speech that followed the Canadian federal government’s approval of the CNOOC/Nexen and Petronas/Progress Energy transactions, Canada’s Prime Minister stated that in respect to oil sands investments in particular, “foreign state control of oil sands development has reached the point at which further such foreign state control would not be of net benefit to Canada,” and going forward, acquisitions of control of Canadian oil sands businesses by SOEs will satisfy the test only under “exceptional circumstances.”

The government did not provide any detail as to what might constitute an exceptional circumstance, leaving open the possibility that even an acquisition of control of a Canadian oil sands business could be approved if circumstances warrant.

Outside of the oil sands, all reviewable investments by SOEs will be scrutinized closely, but should be expected to more easily satisfy the “net benefit” test than a similar investment in Canada’s oil sands.

In addition, there has been no change in how minority investments, joint ventures, or greenfield investments by or involving SOEs, in the oil sands or otherwise, will be treated. Such investments that do not involve an acquisition of control of a Canadian business are not subject to the foreign investment laws, except to the extent they raise national security issues. As a result, foreign SOEs will continue to have wide latitude to participate as minority, noncontrolling investors in Canadian oil sands projects. ■

Jamie Koumanakos, a partner at Blake, Cassels & Graydon, practises Canadian corporate and securities law with a focus on domestic and crossborder mergers and acquisitions and private equity transactions. He represents private equity funds, corporations, hedge funds and investment banks with respect to private and public acquisition and investment transactions in Canada. jamie.koumanakos@blakes.com

Micah Wood, a partner at Blake, Cassels & Graydon, advises Canadian and multinational clients on all aspects of competition law, including mergers and acquisitions, strategic alliances, unilateral conduct and commercial practices, criminal and civil investigations, and compliance matters. He also provides advice regarding foreign investment reviews and regulatory law. micah.wood@blakes.com

today’s Gener al counsel june/july 2013

Governance

Compliance Clampdown On Bribery continued from page 35 signatures. “They help determine whether you can make and/or accept payments. It’s not about looking at individual companies, but evaluating the relationships between them for areas of risk.”

Bullitt also stresses the need to monitor policies in every relevant territory: “Trade compliance is a challenge, not just because of everchanging regulations, but because of how those regulations are interpreted and enforced by different regimes.

For example, when the UN issues sanctions on a specific individual or country, different jurisdictions around the world will interpret the terms of that sanction in different ways.”

• Does it have comprehensive vetting procedures?

• Is it carrying out ongoing screening?

• Has it developed appropriate accounting procedures?

• Does it have a process in place for responding to suspicious conduct?

In light of this focus, companies are increasingly recognizing the importance of implementing due-diligence programs. An effective due diligence program should incorporate a number of measures, including: • Initial vetting: This encompasses agents, consultants, suppliers, distributors, salespersons and other intermedi-

The DOJ and SEC will want to see whether or not companies are vetting their potential business partners.

She cites two countries that demonstrate the sweeping effects of sanctions: Myanmar, “which is prone to fluctuating market conditions,” and Libya.

Libya, she says, “is a prime example of a political climate that changed in a matter of weeks, but not necessarily in the way you’d expect. It was a riskier market to deal with after the revolution than before, and became subject to a number of sanctions. Six months later, most of them were lifted. For organizations doing business there, it was vital that they were kept up to date.”

The DOJ and SEC will want to see whether or not companies are vetting their potential business partners, putting in place risk-based protocols, and undertaking greater scrutiny with respect to agents or intermediaries based in locations with a high degree of corruption. Accordingly, government authorities may evaluate a company based on the following:

aries working on a company’s behalf, and it’s usually done in stages over a 90-day period. Companies also need to determine who in the business is responsible for the relationship with any particular intermediary.

• Risk assessment: This is a much more time-consuming step. It involves putting together a legal or compliance group with the specific aim of determining the risk factors that could stem from the intended country or region where the business partner is located; the volume and type of work that the company intends to carry out; and whether, for example, there would be exposure to government contacts. The group would also examine the results of the initial vetting.

• Creation of a due-diligence path.

Starting with basic- to-medium-level risk, this would include watch-list screening to assess whether a potential business partner has been flagged as a cause for concern. Then, a deeper reputation search of

corporate registers would be conducted to cover high-level risk. Some companies may conduct site visits of potential business partners’ headquarters, so they can see for themselves whether there are any risks inherent in their facilities and practices. In other cases a company may decide to sever the relationship after an initial risk assessment.

• The contract process. A company may include specific compliance clauses in its contracts that will alert business partners to its anti-bribery policy. Some companies may also require affirmative certifications from those partners, expressing that they will assist with compliance matters.

• Continuous monitoring. This could be done on both a regular – annual, for example – or on an ad hoc basis (for example when a red flag comes up with regard to an agent, and a company then subjects the agent to an ad hoc screening process).

Broader FCPA compliance could include other key components, including: Publishing a company policy on compliance that incorporates clear and objective standards, and training intermediaries and employees to follow that policy; training employees to identify red flags; creating a company hotline to enable employees to warn about potential red flags; and setting scrupulous accounting procedures – for example, ensuring that payments can go only to business entities, not individuals.

No two companies have the same systems, and there is no uniform approach codified by law. It is up to each company to tailor measures that fit its business structure. ■

Laura Martino is Head of Global Operations, Legal Services, and a regulatory compliance officer, at CPA Global. lmartino@cpaglobal.com

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Point-Counterpoint

Is it Time for a Carbon Tax? 40

Yes

No

By Charles Komanoff

By Scott Segal

It’s the Least Costly and Most Efficient Climate Insurance

T

Any Policy That Fails to Include China and India Will Not Produce Real Reductions

W

here is no way to tackle climate change without taxing carbon pollution. No other policies – not cap-and-trade, not Clean Air Act regulations, not subsidizing “clean energy” – can do the job as effectively and broadly. Hoping climate change will go away by itself isn’t tenable, not with the news that atmospheric concentrations of CO2 have passed 400 parts per million, a level not reached in at least three million years.

Only a carbon tax can influence the billions of decisions here and across the globe that determine how much energy is used and whether low or highcarbon sources provide it. Those decisions range from the immediate and mundane – drive or ride transit, take the high-mileage car or the guzzler – to corporate and far-reaching: aluminum or composites for next-generation airframes, build in town or on the outskirts, sign a power contract with a coal generator or a wind farm.

hen Apple CEO Tim Cook took the stand recently before the Senate Subcommittee on Investigations, he was clear and unapologetic about the use of foreign subsidiaries and other tactics to minimize the corporation’s tax obligations.

His solution for simplification of the tax code was just as clear: a corporate income tax rate of about 20 percent, as opposed to the current 35 percent, with fewer deductions. For repatriation of funds back to the United States, he called for an even lower rate of 5 percent to10 percent.

There is little doubt that proposals like Cook’s make sense and are straightforward justifications for tax reform, the whiff of which in Washington may be stronger than any time since 1986.

Tax reform is easy. All it requires are sources of revenue to replace unfavorable current ones, and the political will to collect them. One of the many

continued on page 42

continued on page 43

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2013

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june/july 2013 today’s gener al counsel

Time for a Carbon Tax? (Yes) continued from page 40

Climate damage won’t figure in those decisions until the price of fossil fuels reflects the damage carbon does.

Fortunately, the remedy is simple. Wherever a fuel is extracted and put into a pipeline or rail car, or imported to a domestic dock, its receiver would be charged for the fuel’s carbon content, which represents its eventual contribution to atmospheric carbon pollution. Since the entire United States has only a few thousand such

What about China, whose emissions have rocketed past ours?

WTO regulations empower carbon-taxing countries to neutralize unfair trading disadvantages by levying “border tax adjustments” on imports.

(Nations may similarly exempt exporters so their carbon content isn’t taxed twice.) Then watch our trading partners follow our lead. After all, if they won’t tax their carbon pollution, we’ll do it for them and pocket the revenue.

Only a carbon tax can influence the billions of decisions that determine how much energy is used and whether low or high-carbon sources provide it.

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Charles Komanoff, an economist and policy analyst, cofounded the Carbon Tax Center in 2007.

His work includes books – Power Plant Cost Escalation, Killed

By Automobile, and The Bicycle Blueprint – computer models, scholarly articles and journalism. kea@igc.org

points and the carbon content is known in each case, any new paperwork will be minimal.

The fuel seller is free to pass the cost down the chain, subject only to market competition.

That is why the tax works. To retain market share, electricity distribution companies will lean away from high-carbon coal and toward zero-carbon renewables or nuclear.

To maximize returns, real estate developers will lean toward erecting “green buildings” in transit-served areas. Likewise, quicker paybacks will steer consumers toward L.E.D. lamps and high-efficiency appliances and autos, and will induce entrepreneurs to provide them. This multitude of carbon-informed choices will shrink U.S. carbon emissions.

The steeper and longer the tax on carbon pollution ramps up, the deeper the shrinkage. My modeling for the Carbon Tax Center suggests that a carbon tax starting in 2014 at a modest $15 per ton of carbon dioxide but rising briskly by $12.50 each year – similar to a bill proposed by Representative John B. Larson (D-CT) several years ago – would, in its tenth year (2023), reduce U.S. CO2 emissions from 2005 levels by one third. The deepest cuts would come initially in power generation, where clean-energy technology has advanced the furthest, but emissions from passenger travel and freight movement also would fall. Our petroleum requirements would drop by one fifth.

Speaking of revenue, opponents often ignore it, either to cast carbon taxing in a poor light or out of disdain for bigger government. But the tax could be made revenue-neutral as well as incomeprogressive, either by distributing each month’s or year’s revenues to all U.S. households as pro rata electronic payments (“dividends”), or by slashing payroll and corporate income taxes that discourage hiring and investment (“tax shifting or swapping”). British Columbia’s carbon tax owes its popularity to a combination of these approaches.

A carbon tax could be part of a bipartisan deal to eliminate costly energy subsidies and tax preferences for both clean and dirty energy, as noted in major reports on energy tax policy options prepared recently for the House Ways & Means Committee and the Senate Finance Committee. It could also render superfluous proposed Clean Air Act regulation of carbon emissions. The Act continues to do wonders for air quality, but it lacks the breadth, flexibility and transparency of a price mechanism for driving low-carbon investment and innovation.

Risk management is central to modern life, and the consequences of climate instability are too dire to forswear insurance. No climate insurance is less costly or more efficient than a carbon tax.

Fossil fuels provide nearly boundless energy, but their unfettered use is in the process of making the planet uninhabitable by many species, possibly including humans. A carbon tax can lead us back from the brink. n

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2013

Time for a Carbon Tax? (No) continued from page 40

sources of revenue currently under discussion is the carbon tax, a tax on emissions of greenhouse gases (GHGs) with particular emphasis on carbon dioxide.

It is easy to see how a carbon tax could fit into the tax reform mosaic. Say, in exchange for lower corporate rates, progressives demand a carbon tax that its proponents proclaim is “politically advantageous,” because as analysts such as Ike Brannon of the R Street Institute

Such a policy is highly regressive, imposing a larger burden on low-income households compared to those with higher incomes. The reason for this is simple: lower income households spend a disproportionate amount of their income on energy and energy-intensive necessities, and the amount they spend is a larger percentage of their total income. One report estimates that under a carbon tax, households in the lowest quintile of income distribution would have

A carbon tax seems to have more to do with revenue needed as chips for some grand bargain in tax reform than it does to any meaningful commitment to reducing GHGs. point out, it is a tax that is relatively hidden, particularly if phased in with sufficient time to mask its impact on electric rates, manufacturing and gasoline prices.

The case for a carbon tax seems more to do with hidden sources of revenue needed as chips for some grand bargain in tax reform than it does with any meaningful commitment to reducing GHGs. While Chief Justice John Marshall’s famous dictum that “the power to tax is the power to destroy” is as true today as it was in 1819, GHGs prove difficult to destroy when the tax is imposed on a unilateral basis, and the manufacturing industries and the power upon which they depend can and do cross international borders.

Global climate change is just that, global. No unilateral policy that fails to include conforming behavior by China and India will produce real reductions. Indeed, by incentivizing the flow of manufacturing industry from relatively energy-efficient economies like the United States to China and India, a carbon tax may have the perverse effect of making climate change worse (see James V. DeLong, “A Skeptical Look at the Carbon Tax,” George Marshall Institute publication, April 2013).

A carbon tax is designed to increase the price of goods and services in proportion to the amount of CO2 emissions that result from the production and use of that product. By its very nature, it will therefore raise prices for consumers.

a relative burden 1.4 to 4 times higher than the top quintile of households.

In addition to imposing the direct costs of higher energy prices, a carbon tax would hit individuals a second time, indirectly, through higher priced goods and services. This indirect effect is difficult to quantify but easy to understand. Companies would have to choose between reducing carbon emissions, finding ways to use less energy, or cutting expenses elsewhere – all costly alternatives. The end result is those costs would likely get passed onto consumers, workers or shareholders, through changes in consumer prices, stock returns, wages or by other means.

So, if carbon taxes make for dubious environmental and tax policy, what can be done to address the issue of carbon taxes on behalf of corporations and allied interests?

First, keep in mind that adopting a carbon tax remains a difficult political endeavor in light of the limited popularity of both new taxes and aggressive climate policy. Second, as with many concepts with surface appeal, corporations are well advised to join the policy discussions on carbon taxes with the same directness they bring to more familiar energy-tax topics like depreciation, interest deductions, and partnership status. Contrary to popular belief, the most important currency on tax reform (and other policy issues) in Washington comes in the form of research, message development and message discipline. n

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Scott Segal is a partner at the Bracewell Giuliani law firm.

He is founding partner of the Policy Resolution Group, the firm’s government relations and strategic communications practice. He has written and taught extensively on energy and environmental topics and been interviewed frequently by national media.

Scott.Segal@ bgllp.com

Debarment From Government

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ContraCts t

By Steven A. Shaw

he number of suspensions and debarments imposed by executive branch agencies has more than doubled in recent years. Recent legislation and various proposals that would impose debarments automatically make this a good time to better understand what debarment means, and how it is intended to work.

Suspension and debarment are not intended to punish, but rather to protect the government from doing business with contractors that are not “presently responsible.” Each agency has an official suspension debarment official (SDO) with authority to suspend or debar. Those sanctions have the immediate effect of making the contractor ineligible for new contracts or federal assistance programs throughout the government.

The government may suspend a contractor based upon “adequate evidence” that it has engaged in certain misconduct. The suspension continues for 12-18 months, or until the completion of any investigation or legal proceeding.

An indictment constitutes “adequate evidence” as a matter of law, but is not required. An SDO may debar a contractor if a civil or criminal judgment is entered against it for any offense related to business integrity, whether or not the conduct was related to a government contract.

A conviction or civil judgment is not a necessary prerequisite to debarment, however. The government can also debar a contractor for poor (even negligent) performance of a government contract, and for any other misconduct that is so serious that it affects the contractor’s “present responsibility.” Debarments generally may not exceed three years.

sCoPe oF Debarment

A suspension or debarment action may be taken against any “contractor,” defined as any individual or entity that (a) submits offers for or is awarded Government contracts or subcontracts, or (b) reasonably may be expected to do so, and (c) agents of contractors.

Debarment actions need not, therefore, be limited to persons having contracts with the government or with the agency that is imposing the debarment. The government can suspend or debar not only contractors, but also those affiliated with and employed by contractors.

Following a determination that a contractor has engaged in actionable misconduct, an affiliate of that contractor may also be debarred, if the affiliate is given notice and an opportunity to respond. Generally, persons and entities are affiliates if either has the power to control the other, or a third party has the power to control both. Debarments may be extended to include persons or entities holding sufficient ownership interest.

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The government can suspend or debar a person or entity that has not directly committed any misconduct, based on imputation to them of actionable misconduct by others. If Joe Jones, a Widget Company inspector, signed false test certifications for widgets to be shipped to the Army, then Jones’ misconduct may be “imputed” to the Widget Company because he was acting within the scope of his employment.

The Widget Company debarment could be extended further to include anyone associated with the Widget Company that participated in, knew of, or had reason to know of the misconduct. Thus, the Widget’s VP of Operations could be debarred, for example, upon a finding that he directed the company’s shipments to the Army, and that he knew that Inspector Jones was the company’s only inspector. This could support a finding that the VP had reason to know of the false testing certifications.

Once it has been determined that there is evidence of misconduct sufficient to require action, the SDO is required to notify the contractor of the action and its implications and to advise the contractor of its rights. The contractor’s name is then posted on a public website (www.sam.gov), signifying the contractor’s immediate ineligibility for new contracts.

Before making a submission in opposition to the suspension/debarment, the contractor may request and receive a copy of the administrative record which contains the information relied upon by the SDO in reaching the decision. There is no right to discovery beyond the right to a copy of the administrative record. The contractor in its submission generally either disputes the facts alleged in the notice or concedes the facts. Where the facts are not contested, the contractor will usually set forth information to demonstrate its present responsibility.

DISPUTING DEBARMENT

If a contractor disputes the facts asserted in the debarment or suspension notice, it will typically set forth its version of the facts in a written submission and, frequently, in a meeting with the SDO. The program attorney, contracting officer and/or investigator familiar with the proposed action often attend these meetings and provide information in response to the contractor’s submission.

After the administrative record is closed, a determination is made as to whether the facts initially alleged in the notice of suspension or continued on page 53

Trends In State Attorney General Litigation

46

By Saul P. MorgenStern, SaM lonergan and danelco Moxey

S

tate attorneys general (SAGs) have become increasingly aggressive in bringing multifaceted, multi-state

lawsuits against a broad array of companies and industries. Often brought in their home state courts, SAG lawsuits have resulted in multimillion dollar verdicts and settlements. In recent years, SAGs have secured victories against a growing list of industries, including the pharmaceutical industry, the insurance industry, the online socialmedia industry, the financial service industry, consumer product manufacturers and others.

Given current trends, it is safe to assume these lawsuits will continue to target a diverse group of industries. It is therefore imperative to understand the underlying drivers of the SAG actions and to develop coherent plans for avoiding these lawsuits, or defending against them should they arise.

State attorneys general are the chief lawyers for their respective states. While the specific scope of their authority varies, each is charged with protecting the interests and safety of the

to class actions, on behalf of a group of citizens (including individuals and corporations), while avoiding many of the procedural hurdles associated with a class action.

The potential exposure for a company facing such a suit is often enough to force settlement without even considering the merits of the claims. This is particularly true when individual harms are recast into broad harm to the public through various statutory and common law applications, such as the public nuisance doctrine, which typically contain significant civil penalty Suing an industry garners significant press, and fine provisions.

The tobacco litigawhich is often dominated by state attorney tions of the 1990s provide a good case study general press releases. illustrating the tactical mind set that drives many of these litigations. state and its citizens. There are many reasons After decades of successfully defending against for the increased aggressiveness of SAGs, includ- claims in numerous states, the tobacco industry ing recent expansions of their powers to enforce was humbled by litigation brought by 46 state federal law and recent pronouncements of the attorneys general who, through the use of their Supreme Court limiting federal preemption. As state laws, unique positions, and effective coordian initial matter, however, it is important to rec- nation, were able to avoid many of the proceognize that in almost every state, the attorney dural and substantive obstacles private litigants general is an elected position. Therefore, politics face. The cases led to the 1998 Master Tobacco is a significant contributing factor to every deci- Settlement Agreement, which forced the industry sion. Suing an industry garners significant press, to pay more than $200 billion to the states. which is often dominated by SAG press releases.

This SAG success resulted from some relaGiven the outlook for most state and local tively new tactics. First, increased communicabudgets, any effort to pull money into state tion turned what started as a single suit brought coffers from alleged wrongdoers is likely to be by the Mississippi attorney general into a lawsuit warmly embraced by most voters. This dynamic, combined with the fact the SAG may employ private counsel on a contingent fee basis to prosecute the claims, often makes these litiga- After settling fraud and antitrust claims with the tions irresistible opportunities to boost name recognition without appearing to spend state New York State Attorney General for $850 million, resources until the lawsuit is resolved on terms favorable to the state.

Marsh Insurance found itself defending against Legislative compromises that leave gaps or ambiguities in regulatory schemes are another factor, with state attorneys general attempting an onslaught of other state regulatory claims and to fill these gaps through litigation and settlement agreements that govern future conduct. private class action suits.

Such agreements often reflect the attorney general’s political views, not that of Congress or the state legislature. This phenomenon – often referred to as “legislation through litigation” – is facilitated comprising 46 states and several U.S. territories. in part by the SAG’s unique ability to prosecute Second, the SAGs retained private counsel on claims on behalf of its citizens under each state’s a contingency fee basis, essentially outsourcing parens patriae doctrine. This doctrine allows their law enforcement function to lawyers with SAGs to bring representative claims, similar financial incentive to obtain money from the to-

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june/july 2013 today’s gener al counsel

Saul P. Morgenstern

48

is a member of Kaye Scholer LLP and CoChair of the firm’s Antitrust Practice Group. He has defended multi-state and multi-jurisdictional litigation brought by state attorneys general and private litigants in state and federal courts. saul.morgenstern@ kayescholer.com

Sam Lonergan is Counsel at Kaye Scholer LLP. He represents members of the pharmaceutical, telecommunication and lending industries, and has defended against litigations brought by state attorneys general throughout the country. samuel.longergan@ kayescholer.com

bacco industry. Third, by raising both consumer protection and Medicaid subrogation claims against the tobacco industry, SAGs employed a multifaceted approach instead of a more traditional single claim approach.

Last but not least, the SAGs were permitted to aggregate individual damages into a single claim for harm to the general welfare, overcoming the obstacle of having to prove specific causation. Many, if not all of these tactics are still being employed by SAGs today.

Coordination among state attorneys general has been driven, in part, by the National Association of Attorneys General. NAAG is dedicated to fostering increased cooperation among the states on all legal and law enforcement issues and serves as their central communication hub. Among other things, NAAG

The lawfulness of outsourcing law enforcement judgments to private counsel with financial interests in the outcome is open to question.

Several states limit the SAG’s ability to enter into contingency fee agreements by requiring a bidding process, capping hourly wages and/or requiring extensive documentation. Additionally, where a state’s constitution or statutes vest the power to spend state money in the legislature, a SAG’s decision to enter into a contingency fee agreement with private counsel may violate the separation of powers doctrine. The Louisiana Supreme Court has invalidated such a contingency fee agreement on that basis.

Similar arguments are currently working through other state courts.

These agreements may be similarly susceptible to due process arguments, and also may

The tobacco litigations of the 1990s provide a good case study illustrating the tactical mind set that drives many of these litigations.

organizes meetings to discuss potential claims and notifies members when investigations are initiated. For example, a collaboration fostered

by NAAG enabled a small coalition of states investigating DISH Network, LLC, to evolve into a 46-state litigation.

Under the authority of state and federal laws, SAGs arguably now have the power to bring suit and launch investigations concerning virtually any industry. Every investigation or litigation spearheaded by a state attorney general is replete with unique legal, political and tactical considerations that must be identified and evaluated from the outset of the matter.

The following are some practical issues to consider when faced with such a situation:

Appropriateness of Outside Counsel Fee Agreement: As noted above, SAGs increasingly rely on private counsel to prosecute claims on a contingent fee basis. Depending on one’s perspective, this is a course that avoids budget-driven enforcement choices or facilitates the filing of cases lacking merit because there is no direct cost for bringing them. With more than $290 billion in cuts to state budgets over the past five years, this tactic has been used frequently.

give rise to ethical considerations in the context of agreements to pay the state’s counsel fees directly. These issues should be examined and possibly addressed early in a case.

The Scope of the Conduct at Issue: Because SAGs routinely meet and are in constant communication, it is important to determine whether the conduct at issue is limited to one state or extends to multiple states. If the conduct extends beyond a single state, multiple state legal regimes are likely to apply, and it is critical to identify their similarities and differences. The outcome of that analysis will likely affect both defense and settlement strategy.

Any settlement consideration must also involve analysis of whether a settlement may expose the settling defendant to future lawsuits. Indeed, these cases are often instigated by private counsel who pitch potential lawsuits to SAGs, and the pitch is more persuasive if the potential defendants have shown

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2013

a propensity for settling similar claims. For example, after settling fraud and antitrust claims with the New York State attorney general for $850 million, Marsh Insurance found itself defending against an onslaught of other state regulatory claims and private class action suits.

If the claims at issue implicate other industry members, it may present an opportunity to share legal costs, contribute to advancing settlement terms and present a host of other practical benefits to the defense group.

Local State Politics: Understanding local state politics is crucial to gaining a better understanding of the SAG’s concerns and motivations. Each state is unique. For example, in some states the law is clear that the governor has no authority to interfere with the attorney general’s litigation strategy. In such states, barring the governor’s ability to enforce his or her will politically, the attorney general enjoys a great deal of autonomy to direct litigation strategy and tactics. In such states, the legislature is the more influential institutional check on the state attorney general.

In other states, it may be the governor.

Statute of Limitations and Other Initial Issues: Depending on the state and the posture of the suit, a statute of limitations may be operative. Because application of the statute of limitations often limits liability or, in some instances, precludes a claim altogether, analyzing applicability is a critical early case assessment task.

An often-related question is whether the lawsuit has been brought on behalf of the proper party. In certain instances, SAGs may attempt to circumvent the application of the statute of limitations by filing suit on behalf of the state, which may be immune to the statute, rather than on behalf of the state agency or citizens who “own” the claim and to whom the statute may apply. This is another issue that should be analyzed and addressed early.

Every investigation or litigation spearheaded by a state attorney general’s office is unique and has the potential to grow in both the number and type of plaintiffs and claims, and any party that is the object of a SAG investigation or lawsuit should retain counsel experienced in defending against such actions. ■

Danelco Moxey is an associate at Kaye Scholer LLP. He has represented international financial institutions, assetmanagement firms, broker-dealers and other companies in connection with civil securities actions, regulatory investigations, and adversary proceedings. danelco.moxey@ kayescholer.com

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A GenerAl Counsel

ChArGed With obstruCtinG JustiCe

By Laina Lopez

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A

s general counsel you have to concern yourselves with a range of issues. Is the company exposed to liability under that contract? Will that employee sue? How will those new regulations affect the company?

One concern that is not likely to be on your radar screen is the possibility of being indicted personally on criminal charges for performing your job.

It could happen and in fact did happen a few years ago in North Carolina. In April, 2010, a federal grand jury returned an indictment against five former employees of the company previously known as Blackwater Worldwide, Inc. (now Academi), a “federal firearms licensee.”

All of the charges related to weapons and alleged violations of federal firearms regulations.

One such regulation required all weapons with barrels of less than 16 inches to be registered with the Bureau of Alcohol, Tobacco, Firearms and Explosives, because such “short-barrel” weapons are considered inherently more dangerous than standard-length weapons.

government could prove that our client intended to obstruct a federal investigation by ordering the short-barrel conversion and then covering it up, he would potentially face several years in jail. But our trial team identified an enormous problem with the government’s case: Because he was providing bona fide legal advice to his client (Blackwater), the defendant had committed no crime.

Pursuant to 18 U.S.C. §1515(c), the federal obstruction of justice statute “does not prohibit or punish the providing of lawful, bona fide, legal representation services in connection with or anticipation of an official proceeding.” Thus, because the defendant was providing lawful, bona fide legal advice to his client (and the indictment did not allege otherwise), he lacked the specific intent necessary to commit a crime. In fact, he should not have been indicted in the first place.

Although it may seem obvious that lawyers should not be indicted for providing bona fide legal advice, it plainly was not obvious to the prosecutors in the Blackwater case, and it was not obvious historically.

Before §1515(c) was enacted, prosecutors were, according to congressional findings, harassing defense attorneys for giving advice to their

The federAl obsTrucTion of jusTice sTATuTe “does noT prohibiT or punish The providing of lAwful, bonA fide, legAl represenTATion services.”

One of those indicted was Blackwater’s former general counsel, who called on our law firm to represent him. He was indicted on three counts, one count of conspiracy to commit various weapons violations and two counts of obstruction of justice. Summarizing, the indictment charged that, in March 2009, our client, while serving as general counsel, instructed certain Blackwater employees to move a few short-barrel rifles from one location to another on Blackwater’s campus. The indictment further charged that he ordered the replacement of the short barrels with standard-length barrels, and that he later attempted to cover up his conduct by trying to create the impression that Blackwater’s then-president had instead ordered the barrel conversion.

These charges involved serious felonies. If the

clients in situations where it seemed to prosecutors to be obstruction of justice. To correct this problem, in 1986, Congress added §1515(c) to the obstruction statute, noting that legitimate, zealous representation of a client never should be a basis for charging a lawyer with an obstruction offense.

Since its enactment, §1515(c) has been invoked only a few times. The most prominent decision addressing the provision was United States v. Kloess, a 2001 case decided by the U.S. Court of Appeals for the Eleventh Circuit. In Kloess, the court ruled that §1515(c) was an affirmative defense that had to be raised by the attorney-defendant.

In other words, under Kloess, when charging a lawyer with obstruction of an official proceeding, the government does not have to allege in the indictment that he was providing non-bona fide, unlawful legal representation services.

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Rather the lawyer-defendant had to point out to a jury that he or she wasn’t committing a crime, but was lawfully representing a client.

After reviewing the statute’s plain language, certain case law, and the admittedly sparse legislative history, our team became convinced that Kloess had been wrongly decided. In our view, the statute’s plain language required the

Our client clearly was acting as an attOrney prOviding legal representatiOn services at all relevant times.

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Laina Lopez is a litigator at Berliner, Corcoran & Rowe, LLP. She focuses on complex litigation, international law, and appellate law. lcl@bcr-dc.com

government to plead in the indictment the inapplicability of §1515(c). The presumed-innocent lawyer-defendant should not bear the burden to raise its application.

We forcefully advocated this position because, if our client had been providing bona fide, legal representation services, he had committed no crime,and there was no basis for charging the offense in the first place.

Moreover, if we were correct that the Government and not the general counsel bore the burden of raising §1515(c)’s inapplicability, then the indictment would be dismissed as constitutionally defective, potentially permitting our client to go free before having to endure a high-profile trial.

As a result, we decided to challenge Kloess. In June 2012, we filed a motion to dismiss the indictment before U.S. District Court Judge Louise Flanagan in the Eastern District of North Carolina.

Among other things, we argued that the indictment was fundamentally defective for failure to plead an essential element – the inapplicability of §1515(c) – of an obstruction offense against an attorney. We further argued that, under binding Fourth Circuit law, as distinguished from non-binding Eleventh Circuit law, the inapplicability of §1515(c) had to be raised in the first instance by the government in the indictment submitted to the grand jury.

Under the Sixth and Fifth Amendments to the U.S. Constitution, we noted, felony charges must be presented to a grand jury, and an accused criminal defendant must “be informed of the nature and cause of the accusation” against him. An

indictment that does not allege all essential elements fails to give the grand jury the full context and fails to provide the defendant with adequate notice of the crimes he allegedly committed.

Indeed, in this case, had the grand jury been aware of §1515(c) when it was considering whether the charged conduct was criminal, it very well might have decided not to indict.

We knew, however, that persuading the court to adopt our legal position would be an uphill battle. Motions to dismiss indictments are frequently made but rarely granted. Furthermore, it is a lot to ask a district court to disagree with a circuit court decision (albeit a non-binding one) on an important principle of federal law.

Nevertheless, on February 4, 2013, Judge Flanagan granted our motion and dismissed the indictment on all counts.

The judge agreed with us that the inapplicability of §1515(c) was an essential element of the offense of obstruction when charged against an attorney. Under Fourth Circuit jurisprudence, the court noted, an affirmative defense excuses punishment for a crime already established and admitted. (For example, the insanity defense is a classic affirmative defense because a defendant admits to having committed the crime but asks that his behavior be excused and not punished due to insanity.)

Section 1515(c), the court held, did not (like an insanity defense) seek to excuse punishment for a committed crime, but mandated that providing bona fide, lawful legal representation services is not a crime in the first place. Thus, the government must allege in any indictment charging an attorney with obstruction of justice that he was not providing bona fide, lawful legal representation services at the time.

In this case, our client clearly was acting as an attorney providing legal representation services at all relevant times. Specifically, after appropriate research and analysis of the law, he gave his client legal advice relating to the configuration of certain weapons in his client’s possession. Because the indictment nowhere alleged how these actions were anything other than bona fide, lawful legal representation services, the indictment was defective and had to be dismissed. Although Judge Flanagan dismissed the indictment without prejudice, the government elected not to file a superceding indictment, and our client is now free of all criminal charges.

We hope you never have to suffer the horrific cloud of a criminal prosecution for doing your job. But, if you do, now you know about Judge Flanagan’s decision regarding §1515(c) and how an essential element can make all the difference. n

june/july 2013 TOdAy’S GENER AL COUNSEL

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2013

Debarment From Government Contracts continued from page 45

proposed debarment continue to meet the relevant standard. If the facts no longer provide “adequate evidence” for a suspension, or establish a basis for debarment by a preponderance of the evidence, the suspension or proposed debarment is terminated.

In fact-based actions not based on indictments, convictions or judgments, if the SDO decides that the contractor has raised a genuine dispute of material fact as to each basis for a suspension or proposed debarment, then the SDO must refer the matter to an official to conduct a fact-finding proceeding and to make findings of fact. The SDO will then reach a decision based upon those findings.

Rather than contest the facts alleged in the notice of suspension or proposed debarment, many contractors choose to focus their submissions on their present responsibility. Such an approach, based upon changed circumstances, can be effective. This is because the issue in a suspension/debarment action is not whether the alleged misconduct actually occurred, but whether the contractor is presently responsible. It is the contractor’s burden to demonstrate present responsibility.

If the contractor admits the alleged misconduct or if it has been otherwise established, the contractor’s presentation of evidence demonstrating present responsibility will have context.

Only then will it be able to demonstrate the effectiveness of remedial measures designed to insure such violations would not reoccur. The SDO may decline to debar a contractor, even where the misconduct is clear, upon consideration of, among other things, several mitigating factors set forth in the regulations.

MITIGATING FACTORS

The mitigating factors are examples of circumstances that credit the contractor for efforts to prevent misconduct, for responding in a positive manner after learning of the misconduct, and for transparent dealings with the government. The most significant question tends to be whether senior management recognizes the seriousness of the misconduct and accepts responsibility.

Evidence of an effective business conduct program is critical to any effort to demonstrate present responsibility. Agencies are increasingly rejecting mere rules-based programs in favor of effective “values-based” ethics programs that focus as much on improving the ethical culture of the organization as they do on enforcing its rules.

Responsible contractors will not only have taken the appropriate steps internally after learning of the misconduct, but will also have fully cooperated with the government in resolving liability by disclosing the details of the matter to the SDO and accepting responsibility by appropriately resolving civil and criminal liability.

If the SDO determines that actionable misconduct did occur and that the contractor failed to meet its burden of demonstrating its present responsibility, the contractor likely will be debarred or suspended. If the contractor proves it is presently responsible, then the SDO should determine that debarment is not necessary to protect the government’s interests and terminate the action.

If the SDO determines that the contractor has not fully met its burden of demonstrating its present responsibility, the SDO may offer the contractor the opportunity to enter into an administrative agreement in lieu of debarment.

ADMINISTRATIVE AGREEMENTS

Administrative agreements, signed by the agency and the contractor, describe the misconduct that formed the basis for the action, document the remedial measures taken by the contractor, and require audits and periodic reporting to verify compliance. They generally last for three years.

Many agreements contain provisions requiring the contractor to engage outside consultants and/or monitors to review and verify the contractor’s business conduct programs and other internal processes.

The contractor is frequently required to provide the agency with copies of relevant internal audit reports.

Contractors also are frequently required to submit periodic reports in which extensive information is provided about the operation of the contractor’s business. The contractor may also be required to report all known fraud-related litigation and investigations, as well as all known “misconduct,” regardless of whether it is the subject of litigation or investigation.

Contractors may contest the findings and decisions of SDOs internally within the agency imposing the action, in federal district court or both, depending upon the individual agency’s regulations. The EPA, for example, has a procedure allowing contractors to seek review of debarment decisions with an EPA official senior to the SDO. There is no such internal remedy within the Department of Defense.

In all cases, SDOs’ debarment and suspension decisions may be challenged in federal district court, by establishing an abuse of discretion in accordance with the Administrative Procedures Act. n

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Steven Shaw is senior of counsel at Covington & Burling, in the Washington DC office and a member of the Government Contracts Practice Group. He is the former Deputy General Counsel (contractor responsibility), Department of the Air Force, where he served as the Air Force debarment and suspension official and managed the Air Force Coordination of Fraud Remedies Program. sshaw@cov.com

al n ig S d l u o C S t n ie l C d ie f iS Sat

an IneffIcIent

Law Department

By Kevin Blodgett and Bill Young

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C

lient satisfaction is a term often used in legal department circles, but one that seldom receives a great deal of strategic thought. In-house legal leadership often thinks of client satisfaction as a destination. They approach it by conducting an annual satisfaction survey and reacting to the results, then hoping for better scores next year. The aim of this article is to explore what the concept of in-house client satisfaction truly means, and how satisfying your internal clients can be used as a data point to validate whether the legal department is fulfilling its true mission: aligning with and supporting business goals and objectives.

In the broader world, client satisfaction is generally thought of as how satisfied a client or customer is with a product or service. It is used to help set oneself apart from the competition. From an in-house legal department perspective, however, the clients are a captive market. The alternatives at their disposal for legal services are limited.

Therefore, many think of in-house client satisfaction as analogous to a doctor’s “bedside manner.” Is the legal department responsive and user-friendly? Is it delivering advice with expertise and cooperation? Is it practical, responsive, and does it advocate zealously when a case arises? Using criteria such as these to measure client satisfaction is fine, up to a point. Legal does need to provide a reasonably pleasant, knowledgeable and productive experience for the business partners.

Taking a step back, though, we don’t think that simply addressing the traditional measures of client satisfaction ought to be the goal. Rather, it should be satisfying internal partners by providing the business what it needs, when it needs it, based upon a mutually agreed set of priorities.

Working with the business clients to establish the most appropriate levels of support that legal can and should provide lays the foundation for truly satisfying clients. Adding some “bedside manner” then becomes the icing on the cake.

ALIGNING PRIORITIES In-house legal departments support many groups and individuals, from the executive suite to front-line personnel. Each of these has its own priorities and needs. With so many conflicting demands on its time and an increasing need to do more with less, one of the biggest issues facing a legal department becomes how to prioritize work so that it supports business

goals while not alienating individual clients.

It is almost axiomatic that having satisfied clients is better than having unsatisfied clients, since it seems to be an indication that the legal department is doing things right. This is not necessarily the case, however, since doing things the client wants does not necessarily equate to providing the support the business needs.

Take, for example, the advertising manager who continuously calls her favorite in-house attorney to review each line of a standard piece of copy. Short on resources and backlogged with other case work, the attorney takes the time to complete the request at the expense of other pressing initiatives. The advertising manager – the client – may be satisfied, but is this really in the best interest of the company?

Chances are reviewing ads is a low priority for the organization’s board, executive team and shareholders. Legal departments must be aligned with the company’s business objectives and prioritize their efforts accordingly, in order to bridge the gap between traditional client satisfaction and true, value-added partnership.

Crafting successful legal/business partnerships begins with understanding the goals of the enterprise and aligning expectations at the highest level. Legal leadership should be working with senior enterprise leadership to understand the near and long-term goals of the business in order to establish priorities for how to allocate its resources.

Once legal is in alignment at the highest levels, it can drive that alignment down through the department so that all legal resources, internal and external, are spending their time on the work that brings the highest value relative to their individual roles and responsibilities.

TRUE CLIENT SATISFACTION Although we advocate taking a different view of client satisfaction, achieving it is still important.

Providing valuable services to the organization, in a manner that best meets the priorities of the business, ensures that legal is fulfilling its true mission. It helps avoid the pitfalls associated with dissatisfaction.

In our experience, clients that are dissatisfied can react in a variety of ways. Sometimes they “forum shop” for the individual within the department whom they know will provide the level of service they are looking for, whether or not it is that individual’s responsibility. While this might lead the lawyer to believe he or she is achieving client satisfaction, it risks creating an imbalanced workload that is not in sync with business objectives. continued on page 59

55

Kevin Blodgett is Senior Vice President and General Counsel, Rockwater Energy Solutions, Inc. and former General Counsel and Executive Vice President, Administration, Dynegy Inc. kblodgett@ rockwaterenergy.com

JUNE/JULY 2013 TODAY’S GENER AL COUNSEL

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Offshore Accounts Subject to New Tax Protocols

By James Duggan

F

or many years, American taxpayers have been able to avoid taxes by placing assets in offshore accounts. In the past, rules regarding reporting and disclosure were ambiguous and easily circumvented, and enforcement by the IRS was weak. As a result, offshore planning became synonymous with tax-free planning. No wonder thousands of Americans turned to offshore accounts as a way to protect their wealth.

In fact, offshore structures and assets must be fully disclosed to the IRS, and enforcement by the government is at an all-time high.

Penalties for failing to comply are significant, and they include large civil penalties as well as criminal prosecution. The time has come for all U.S. taxpayers with foreign structures to become tax-compliant.

While the tax code is complex and the terminology can be befuddling, the rules pertaining to offshore planning can be simplified and are actually quite clear. The most important things to know are: • U.S. taxpayers are taxed on their worldwide income, from whatever source. This applies to all individuals carrying a U.S. passport, regardless of where in the world they reside, and to all residents of the United States, regardless of where they hold a passport. While certain structures may afford better tax treatment than others, they are all subject to tax rules under the Internal Revenue Code.

Do not be fooled by foreign advisors who declare that the foreign account is not subject

to taxation because it is located in a tax-free jurisdiction. While this may be accurate as pertains to the tax-free jurisdiction, it is not true with respect to the United States, and unless you relinquish your U.S. passport, you will always be taxed on worldwide income.

• You must disclose your offshore assets.

There is no shortage of IRS Forms for U.S. taxpayers with foreign components in their structure. The most commonly discussed forms are the “FBAR” (Form TDF 90-22.1) and the “Shadow FBAR” (Form 8938).

DO NOT BE FOOLED BY FOREIGN ADVISORS WHO DECLARE THAT THE FOREIGN ACCOUNT IS NOT SUBJECT TO TAXATION. The FBAR is required when you have a financial interest in or signature authority over a foreign account in excess of $10,000 in aggregate at any time during the year. This form must be received by the Department of Treasury

by June 30 each year.

The Shadow FBAR is required when you have “foreign financial assets” in excess of a stated threshold amount, regardless of your signature authority over them. The threshold amounts vary

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june/july 2013 today’s gener al counsel

based on the nature of the taxpayer, but for individuals it is an amount in excess of $50,000 on the last day of the tax year, or more than $75,000 at any time during the year. The Form 8938 gets attached to your annual return.

In addition to these, you must also ensure that you check the box on your annual 1040 where it asks if you have any offshore accounts.

There are other potential forms for international structures as well.

The IRS launched ITS ThIRd amneSTy pRogRam In 2012, and IT IS STIll avaIlable In 2013.

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James M. Duggan is a principal of Duggan Bertsch, LLC, a Chicago-based business, tax, estate and wealth planning firm comprised of attorneys and accountants. His practice concentrates principally on business and corporate law, and on estate and wealth planning as they relate to closely held business interests and high net worth families. jduggan@ dugganbertsch.com

• If you don’t disclose, your foreign institution will probably do it for you. Under the new Foreign Account Tax Compliance Act (FATCA), the United States broadened its reach and imposed reporting obligations on foreign financial institutions that have accounts for U.S. taxpayers. After some initial resistance, the foreign financial community has for the most part resigned itself to the fact that it must comply.

Given the choice between keeping a taxpayer’s account secret or avoiding the wrath of the U.S. government, most institutions quickly buckle to the threats of the U.S. government.

In addition, a multitude of countries are entering into Tax Information Exchange Agreements (TIEAs), which require the participating countries to share information on their taxpayers if they have assets or income in the other country. This is not just a U.S. Issue. Countries around the globe are adopting a cooperative effort to stop tax evasion, and increase their revenues.

• The penalties are severe. Once upon a time, the IRS seemed content just collecting the taxes that were owed on foreign accounts, with a reasonable amount of interest that oftentimes could be negotiated. Not anymore. Non-compliant taxpayers can expect penalties, and severe ones at that.

For example, the maximum penalties for failing to file the FBAR can be up to 50 percent of the account value for civil penalties, and there are criminal penalties of up to $500,000 and 10 years in prison. In addition, with respect to FATCA, the understatement penalties under IRC 6662 increased from 20 percent to 40 percent, and the statute of limitations can run up to 12 years. Each form and corresponding failure to file has its own set of draconian penalties, which can be stacked on one another. The longer one waits to come clean, the more the penalties.

• Amnesty is possible. Due to the success of the offshore amnesty programs of 2010 and 2011, the IRS launched its third amnesty program in 2012, and it is still available in 2013. Provided that the taxpayer is not under investigation or audit already, the taxpayer may come forward and report all years from 2003 on and avoid criminal prosecution.

However, in addition to paying the tax that should have originally been paid, the taxpayer must pay the following: interest, a penalty of 27.5 percent of the highest aggregate balance during the unreported years, and a penalty of 20 percent of the income tax owed. While the penalties do add up, liberty has some value. The sooner you act, the sooner you can remove the threat of prison.

In summary, if you have offshore assets, entities, trusts, accounts, or income in a foreign structure, you must report and pay applicable taxes or suffer severe consequences. Given all the opportunities the IRS has provided for U.S. taxpayers to come forward, it is becoming less tolerant and forgiving of those who don’t. Based on experience, becoming compliant is a much easier and affordable proposition for those taxpayers who hire counsel and get to the IRS before the IRS gets to them. Ignoring offshore accounts and hoping for the best if you are caught is not an option. It’s time to comply. n

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2013

Doing what the client wants may not equate to proviDing the support the business neeDs.

An Inefficient Law Departmentt continued from page 55

When clients believe they are under-served by the legal department, they may be motivated to take shortcuts or alternate approaches. Worst case, they may circumvent the legal department altogether or seek outside counsel assistance, driving up costs and potentially creating other negative consequences.

The traditional method for determining how a legal department is satisfying clients is to conduct a formal (typically annual) survey, then use the results to make adjustments. Surveys such as these can be valuable, but they don’t tell the whole story. The true value of conducting formal surveys comes when they are used at the culmination of a process of information and feedback-gathering, not when they serve as the primary method for gathering feedback.

The most effective method for understanding client expectations and priorities is “management by walking around.” Conversations with clients, designed to garner feedback on what legal should be doing to support them and how clients view the state of the relationship, are fundamental.

Attending client meetings is another good way to learn. It enables a two-way dialogue between legal and clients. Once a strong mutual understanding of when and how legal should (and perhaps should not) support the clients is established, the surveys can be used to diagnose how well the department is executing.

TURNING ALIGNMENT INTO SATISFACTION Having achieved an understanding with clients regarding how work should be prioritized and the support levels clients should expect, the legal department is now equipped to build a busi-

ness plan to ensure things get done right. In our experience, the best legal department business plans typically look two to three years out, with heightened focus on the next 12 to 18 months.

We believe that it is important to establish a point person to coordinate these efforts. Ideally, a dedicated operational resource such as a “Legal Department Operations Manager” can serve as coordinator and facilitator for all legal operational matters.

Detailed understanding of business priorities coupled with existing operational mandates – for example cost reduction targets – can be used to drive informed, strategic decisions on matters such as staffing, resource allocation and selection of outside counsel. Communicating the plan through the legal department should be done with an eye toward getting everyone to understand the ultimate purpose, enabling the company to achieve its goals. With the whole team in alignment, satisfying the enterprise becomes a primary motivator and goal, rather than doing what is necessary at the moment to satisfy an individual client.

Communication and feedback is required.

Since the business partners were involved in establishing priorities, they should be involved in year-round measurement and course correction.

One method we have found particularly effective for this is establishing Service Level Agreements with the clients. “SLAs” do not cover the legal department’s concrete goals and metrics, such as spending levels and headcount targets.

They are focused on tangibly demonstrating to the clients that legal fully understands what it is expected to do and how legal is going to interface with the business on a daily basis.

It is our belief that client satisfaction can best be thought of as a data point, rather than a destination. While in-house legal departments have many different objectives, we view the ultimate goal as supporting the business strategy while protecting against and practically managing risk. This should start with senior-level alignment on organizational priorities and carry forward into a legal department business plan that closely aligns people, process and technology based on “highest value work” and bottom-line impact to the business.

Ongoing dialogue with business clients can help legal department leadership determine whether it is accomplishing mutually agreedupon organizational objectives. When the business clients’ ultimate priorities are reflected in the legal department’s allocation of resources and delivered with a healthy dose of “bedside manner,” clients are truly satisfied. n

Bill Young is former Senior Director Legal & Corporate Administration, Dynegy Inc. and former Director, Huron Legal Consulting. He is currently Product Line and Law Department Operations Executive, Bridgeway Software Inc. and President of the Institute for Law Department Excellence. bill@ildeonline.com

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Why Settlements Can Be Expensive How to Make Them Cheaper

By Michael H. Bierman and John S. Caragozian

W

hen the time comes to settle a case brought against a company, the options facing in-house counsel are limited. Even though the claims against the company may not be particularly strong, the company should not be exposed to a material risk of a potentially large adverse verdict. As a practical matter, therefore, the company has little choice but to agree to the settlement that outside counsel says is the best available. At this unhappy point it frequently seems that the company has spent more than it should have in legal fees and settlement.

What could in-house counsel have done to manage the litigation differently?

By nature, litigation is adversarial. Like war, it tends to get out of control. It is driven largely by the actions of the adversary. The allegations against the company often can make the company look incompetent or dishonest, and its executives and employees will often want to fight. It’s important for all involved parties not to “lose,” and litigation tends to become hard-fought. Each battle becomes invested with the egos of the lawyers and perhaps the parties.

And the company’s defense is largely in

the hands of an outside law firm over whom in-house counsel has limited control.

Each of these factors tends to increase the cost of litigation, make it resistant to cost-control, and to justify large non-routine legal bills.

Still, almost all civil cases settle over time.

Therefore, litigation is functionally more like a settlement negotiation than a war, even while the company is acting tough to demonstrate that a compromise settlement is in the plaintiff’s interest.

Keeping that perspective can help to control litigation costs. Specifically, keep the following important factors in mind.

• The Right Law Firm. Most non-routine litigation is defended by an outside law firm charging by the hour. How the company and the law firm determine what the law firm will do to defend the case, more than anything else, will determine the costs of the litigation.

Other things being equal, the law firm is more likely to do too much than too little. The firm has an incentive to be thorough to avoid liability. The individual lawyers have an incentive to be “productive.”

In-house counsel can control this tendency to some degree by having a close working relationship with the lead law firm lawyer handling the case. But be aware that, while in-house counsel might be able to dictate particular staffing or strategy by fiat, that can be dangerous without a full understanding of the consequences.

The lead lawyer should be willing to discuss the benefits and costs of each task and be open to customizing the litigation process to fit the case. That lawyer should also have enough experience to know how the case is likely to turn out and be personally invested in the case.

A company does not benefit from an experienced but busy lead lawyer who merely fronts the litigation – or, alternatively, from an inexperienced lead lawyer who is invested but unfamiliar with the component costs and benefits of litigation activities.

• The Initial Investigation. Meaningful control over litigation requires knowledge of the facts. A thorough initial investigation, whether by in-house counsel or the law firm, is likely to be a wise investment, even if it’s expensive. The primary goal is to develop a feel for the settlement value of the case. A basic understanding of the applicable law is necessary, but settlement value is usually driven more by the facts than by the details of the law.

A company does not benefit from an experienced but busy lead lawyer who merely fronts the litigation.

The initial investigation by nature cannot be complete. For example, some evidence will be in the sole possession of the plaintiff, and a complete review of all the company’s own documents is usually not feasible. Nonetheless, careful interviews of the key available witnesses and gathering and review of the company’s readily available relevant documents will increase the quality of both budgets and initial strategy.

• Budget. To impose control on litigation costs, in-house counsel should make an early estimate of how much the case is worth and how much the company should spend defending it. A strong initial investigation will usually allow a surprisingly accurate estimate of total exposure. How much a company should spend is best determined through budgeting.

The law firm is best positioned to develop detailed estimates of the likely cost of the litigation. However, the law firm’s initial “realistic” budget may be higher than necessary. A discussion of each line of the budget will aid in-house counsel in deciding how much should be spent.

The natural control on legal fees is the relationship between the cumulative defense costs and the defendant’s exposure. That ratio should be a fraction, but what fraction depends on many factors. However, everybody understands that spending more than a case is worth – having a ratio of one or more – is usually a mistake.

• Avoid War. When a company is sued for alleged misdeeds of important employees and exposure is potentially significant, the natural reaction is to fight back. However, over the course of the case, the attitude usually evolves from “millions for defense but not one penny for tribute” to “we need to settle this case.”

By the end, the same people who insisted on fighting will often be wondering why the

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Michael Bierman is a partner in the Los Angeles office of McKenna Long & Aldridge. He handles business litigation, intellectual property litigation and corporate investigations. mbierman@ mckennalong.com

june/july 2013 today’s gener al counsel

John S. Caragozian

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is Corporate Secretary and Senior Counsel at Sunkist Growers, Inc. He chairs UCLA’s annual Bollens-RiesHoffenberg lecture, and has been an adjunct professor at Loyola of Los Angeles Law School. He was previously a business litigator in Washington D. C. and Los Angeles.

Jcaragozian@ Sunkistgrowers.com

company spent so much and apparently received so little.

In-house counsel can limit the costs of the war phase by steadfastly maintaining a negotiation mentality. A focus on the relationship between each litigation action and settlement will allow identification of those actions that are unlikely to be costeffective for settlement, even though they are commonly taken and expected of defendants.

A prime example is the attack on the pleadings. Although motions to dismiss are common, they rarely end up affecting the settlement of the case. Pleading allegations that are clearly defective are generally not weighed heavily in settlement negotiations, whether or not they are attacked by a motion. Conversely, courts are frequently reluctant at the pleading stage to decide the important but unclear legal issues that could affect settlement.

The embodiment of lawsuit as war is “scorched-earth” litigation – a strategy of trying to weaken the plaintiff by making the litigation expensive. The arsenal of weapons used to make the plaintiff work includes motions to dismiss, protracted fights over document production and other discovery, extensive depositions and multiple summary judgment motions.

Scorched-earth litigation is rarely costeffective. A good plaintiff’s lawyer will usually litigate less expensively than the defense, and often can thwart scorched-earth tactics relatively cheaply. The work product may not look pretty.

It may not comply with all the rules, but when the disparity in resources is clear to the judge, plaintiff’s counsel can be surprisingly effective.

• Early Mediation. At the point when both sides start treating a case like a settlement negotiation, litigation costs frequently decrease markedly. The parties become increasingly reluctant to spend money on litigation if the case is “about to settle.” The earlier that point comes in the litigation, the less the litigation is likely to cost.

Some litigation is usually necessary before the parties can realistically begin discussing settlement. The company decision makers will

Some litigation is usually necessary before the parties can realistically begin discussing settlement. frequently start out with a directive to fight, and the plaintiff’s lawyer will frequently be reluctant to abandon a rosy view of the case until its weaknesses are demonstrated. Both sides will act tough to avoid signaling that they lack resolve. Some information exchange is usually necessary for the parties to come to terms with the actual facts.

Nevertheless, starting the mediation process early may lower the cost of the litigation. Even though cases rarely settle after an initial mediation session, having an ongoing mediation can help focus the parties on the goal of settlement.

It is important to choose a mediator who is willing to direct the case toward settlement after an initial fruitless session. By telling the parties to take specific steps after failure, the mediator can guide and facilitate the information exchange process necessary for eventual settlement, allowing it to proceed more cheaply and efficiently than traditional discovery. By directing the parties’ activities, the mediator can discourage the kind of aggressive “attack” actions that will tend to embitter and prolong the litigation.

Even if full-blown litigation resumes because the parties are not yet ready to settle, an early failed mediation will frequently create some understandings between counsel that will help with settlement later.

Not all of these suggestions will be helpful in every case. Some cases need to be litigated to conclusion – either summary judgment or trial. Insurance, multiple defendants and other factors may alter the parties’ strategies.

Nonetheless, taking these steps whenever applicable will tend to reduce litigation costs over time. n

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Knowing When It’s Time to Leave

By Glenn W. Young

n in-house lawyer has good days and bad days, even good weeks and bad weeks. Sometimes it’s necessary to step back and reflect on why we do it, and whether we should continue to do it.

The following are one in-house attorney’s brief reflections and conclusions on the subject.

A

• If you do not like the company you work for (i.e. your client), leave. In-house lawyers have one client. Find one you like and serve it well. If you cannot do that or are no longer able to do that, you are doing yourself, your client and your profession a disservice.

• If you do not like, or at least respect, the people you serve (i.e. your in-house customers), leave.

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If we do not recognize and have respect for the tremendously difficult job our in-house customers have, and if we are not committed to helping them succeed in their jobs, we are not going to be successful in our own jobs. If you think it is easy, for example, to sell more and more products and services at increasingly greater margins and do it in a prudent, responsible way, try it sometime. If you do, I think you will very quickly be glad there are talented people who have the skills to execute the strategies that you had the skills to help them develop.

Glenn W. Young is Assistant General Counsel with the Henkel Group, a Fortune Global 500 organization. glenn.young@ henkel.com

• If you think leading your customers to successfully do their jobs means you are smarter or more important than those people, you should leave.

Leaders know that they serve the people they lead. Business journals, history books and scriptures are filled with examples of

great leader-servants. If it has become more important to be perceived as superior in intellect, prudence and morality than your customers, it will be very difficult to properly serve those customers.

• If you like finding problems more than solving problems, leave. “A fool can ask more questions than a wise man can answer.” Or, “a fool can ask more questions in a day than a wise man can answer in a lifetime.” Choose the maxim you want.

Obviously, it is an important part of our job to play the fool. If we stop there, however, we are not fully using our talent. If we are bragging more about pointing out the flaws in our customers’ preliminary plans than we are about the solutions we helped them develop, we really have become foolish.

We all became lawyers hoping we could help people. In-house lawyers get to do that everyday. The products and services that our clients provide play a very important role in our economy and in the well-being of the users of our clients’ products and services. (If they do not, that may be an additional but unrelated reason for reflection on the future.)

If the macro economic benefits and pride in your company’s mission are not enough, do not underestimate how much we help our in-house customers and their families when we help our customers to be successful. They become successful by doing the prudent thing in a prudent way.

We have many sources of satisfaction when a transaction or a conflict or a strategy works out. The success of the people to whom we give advice and the ability of those people to share that success with their families is a very good reason to do what we do. ■

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