Ohio Supreme Court Issues Important Decision On Coverage for Intentional Acts

On December 30, 2010, the Ohio Supreme Court issued a significant decision which clarified the ever-changing law on coverage for intentional acts. In a key part of the ruling, the Court emphasized the importance of the doctrine of inferred intent, defining when it should apply to preclude coverage. Commenting on prior key cases, the Court explained that the doctrine is not limited to cases of sexual molestation or homicide. Rather, it can be applied whenever the insured’s intentional act and the harm caused by that act are intrinsically tied so that the act has necessarily caused the harm. Allstate Ins. Co. v. Campbell, 2010-Ohio-6312. In this ruling, the Court rejected the substantial certainty test which had been applied in certain prior opinions.

The strange facts involve an ill-fated teenage prank. A group of teenagers positioned a lightweight Styrofoam target deer, fastened to a piece of wood so that it could stand upright, just below the crest of a hill on a hilly and curvy two-lane, 55-mile-per-hour road. The teens placed the target on the road after dark in a position where drivers could not see it until they were 15 to 30 yards away. After placing the target, the teenagers remained nearby to watch the reaction of motorists. Shortly thereafter, Robert Roby drove over the hill, saw the target, took evasive action, but lost control of his vehicle, which left the road and overturned. Roby and his passenger, Dustin Zachariah, suffered serious injuries as a result.

Roby and Zachariah sued the teens, their parents, and their four insurance companies in the Franklin County Court of Common Pleas. The insurers filed declaratory judgment actions, seeking declarations that they were under no duty to defend or indemnify their insureds because their respective insurance policies contained intentional-act exclusions.

The trial court granted the insurers’ motions for summary judgment, inferring intent to injure as a matter of law, relying in part on the finding that the teens’ conduct was substantially certain to result in harm. The Tenth District Court of Appeals reversed, finding genuine issues of material fact regarding the teenagers’ intent. Allstate Ins. Co. v. Campbell, 2009-Ohio-6055 (10th Dt. 2009.) The Ohio Supreme Court affirmed the Tenth District’s decision that the trial court erred in granting the motions for summary judgment of three of the insurers (though it allowed summary judgment to stand for one insurer whose policy contained an “extremely broad” exclusion for “‘bodily injury’ or ‘property damage’ which results directly or indirectly from * * * an intentional act of any ‘insured’”). This split decision shows, as is often the case, that the precise language of the policy can be very important in determining the result.

Justice Lanzinger authored the opinion of the majority, which found summary judgment to be improper as to three of the insurers whose policies generally excluded coverage for injuries which were expected or intended by the insured. Describing the prior legal landscape in Ohio pertaining to inferred intent, the Court noted the two recognized examples of when inferred intent applies — sexual molestation and homicide. The Court stated that the inferred-intent doctrine is not limited to those two categories of cases.

To determine whether the inferred-intent doctrine applies, a court must determine whether the insured’s intentional act and the harm caused are intrinsically tied so that the act has necessarily resulted in the harm. Essentially, when the intentional act could not have been done without causing harm, the insured’s testimony regarding intent is irrelevant, and coverage is precluded. The Court warned, however, that Ohio courts must avoid applying the doctrine in cases where the insured’s intentional act will not necessarily result in the harm caused by the act.

Embracing this new test, the Court rejected the substantial certainty test (i.e., whether the act is substantially certain to result in the harm) in place in some other jurisdictions, like Massachusetts.

The Court held that the act of placing a target deer in the road, as the teens did here, did not trigger the application of the inferred-intent doctrine because the Court could not say, as a matter of law, that the act necessarily resulted in the harm. The Court pointed out that other cars drove by and avoided the target. As the Court declined to infer intent, it remanded the case for a factual inquiry as to whether the teens intended or expected harm and, in turn, whether the insurance agreements provided coverage under three of the policies. A question remains under this decision as to whether and how the insurers’ duty to defend should be determined in such cases where fact finding remains on the issue of inferred intent. Normally, if fact questions remain, a duty to defend applies. Here, the Court is not clear. Future clarification may be needed.

Three justices concurred in part and dissented in part. Justice Pfeifer stated that he would have held that the broader exclusionary language in the American Southern policy was not materially different from the exclusionary language in the other policies. Justice O’Donnell expressed his opinion that the Ohio Supreme Court adopted the substantial certainty test in Gearing v. Nationwide Ins. Co., 76 Ohio St.3d 34, 665 N.E.2d 1115 (1996), and that the new test departed from this law. Finally, Justice Cupp would have held that there was no coverage under the Allstate policy for similar reasons that the majority found no coverage under the American Southern policy.

Notwithstanding the dissenting opinions, in Ohio, the inferred-intent doctrine applies only in cases in which the insured’s intentional act and the harm caused by that act are intrinsically tied so that the harm necessarily results from the act.

Victory in New Mexico Voter Registration Case

New Mexico Settles Lawsuit, Agrees to Offer Voter Registration to Public Assistance Clients

Voter registration will be offered at public assistance offices following settlement  of lawsuit brought by coalition of voting rights groups

ALBUQUERQUE, NM – A federal judge on February 24, 2011 approved a consent order requiring New Mexico state officials to implement procedures to ensure that thousands of New Mexico citizens have the opportunity to register to vote at state public assistance offices, as provided by the National Voter Registration Act of 1993 (NVRA).  The consent order resolves a lawsuit brought against state officials by voting rights groups, including the Lawyers’ Committee for Civil Rights Under Law, Project Vote, and Dēmos; and by the Albuquerque law firm of Freedman Boyd Hollander Goldberg Ives & Duncan, and the law firm of DLA Piper.

The consent order details the specific procedures that New Mexico must follow to offer voter registration to public assistance clients who are applying for benefits, periodically recertifying their benefits eligibility, or submitting a change of address for receipt of benefits.  Congress required in the NVRA that these registration opportunities be provided to ensure that all citizens have a fair and equal ability to exercise the fundamental right to vote.  The consent order also mandates that New Mexico conduct voter registration training for public assistance employees and that state officials regularly monitor implementation of the order.

“We are pleased that New Mexico has worked with us to come to an agreement that will assure full implementation of the NVRA at public assistance offices,” said Robert Kengle, co-director of the Lawyers’ Committee’s Voting Rights Project.  “Because of this settlement, thousands of New Mexico’s citizens who have been traditionally disenfranchised now will have the opportunity to register to vote which Congress envisioned when it passed the NVRA in 1993.”

The consent order comes on the heels of a December 21, 2010 ruling in which U.S. District Judge Judith Herrera found that New Mexico was violating the NVRA by providing voter registration forms only to those public assistance clients who specifically request to register to vote.  The Judge ruled that the NVRA requires that registration forms be provided to clients as a matter of course, unless a client chooses to “opt out” by declining to register in writing.  Although the consent order allows the State to appeal this ruling, the order provides that an appellate ruling could only affect a narrow aspect of the procedures put in place by the order, and would not result in the order itself being reopened for further review.

“This agreement was a long time coming, and represents an important victory for the voting rights of low-income residents of New Mexico,” said Nicole Zeitler, director of Public Agency Voter Registration at Project Vote. “Public assistance agencies are a vital component of the voter registration system, and reach citizens who are less likely to register through other means.”

Prior to the filing of this lawsuit in July 2009, voter registration at public assistance offices in New Mexico had sharply declined from the level achieved shortly after the enactment of the NVRA, despite an increasing number of public assistance clients in the State.  In the 2007-2008 reporting period, the number of public assistance clients applying for voter registration had gone down by about 90 percent from the 1995-1996 period and, on average, each public assistance office was registering fewer than ten clients a month.  An investigation conducted by Plaintiff’s attorneys prior to filing suit revealed that none of the public assistance offices surveyed was regularly offering voter registration to its clients.

“For many years following the NVRA’s enactment, New Mexico’s Human Services Department failed to provide its clients with the voter registration services to which they are entitled,” said Allegra Chapman, counsel at Dēmos.  “We are pleased to see the state agency agree to do the right thing now, and hope to see other states follow suit.”

Cynthia Ricketts, Esq., of the Phoenix office of DLA Piper LLP (US) emphasized that “the consent order comes in time for New Mexico’s public assistance clients to register to vote in advance of the 2012 election year.”

“The consent order is an important step toward increasing the number of registered voters in New Mexico, especially the poor people in this State who historically have been left out of the electoral process,” added David Urias of the Albuquerque firm, Freedman Boyd Hollander Goldberg Ives & Duncan.  “It is unacceptable that there currently are over half a million unregistered eligible voters in New Mexico.”

The lawsuit originally included a claim that New Mexico also was violating the “motor voter” portion of the NVRA.  The NVRA requires that state motor vehicle offices provide clients the opportunity to register to vote simultaneous with applying for, or renewing, a driver’s license or state identification card.  This portion of the litigation was resolved in July 2010 in a settlement that includes similar provisions to those mandated by today’s consent order.

Fourth Circuit Offers Pyrrhic Victory On Corps Jurisdiction Over Developer’s Clean Water Act Permit

The Fourth Circuit Court of Appeal case, Precon Development Corporation, Inc. v. U.S. Army Corps of Engineers, 2011 WL 213052 (C.A.4 (Va.)), arises out of a determination by the Army Corps of Engineers (“Corps”) that it has jurisdiction, under the Clean Water Act (“CWA”), over 4.8 acres of wetlands located on the appellant owner’s property, approximately 7 miles from the nearest navigable water. The Corps denied the owner’s application for a CWA permit to develop the property, and the owner appealed to federal district court. The district court granted summary judgment to the Corps, upholding both its jurisdictional determination, and its permit denial. The owner appealed the district court’s jurisdictional determination, and the Fourth Circuit Court of Appeal reversed, holding that the Corps’ administrative record was inadequate to support its conclusion that it had jurisdiction over the wetlands. However, the court’s ruling will not likely have a large impact on future CWA permit applications given its limited holding.

Background Facts

The property owner is the developer of a 658-acre Planned Unit Development (“PUD”) in Virginia. The PUD is a mixed-use development with both residential and commercial elements. Previous to this case, the Corps granted the owner permission to fill 77 acres of wetlands for development, based in part on an understanding that this was to entirety of the development planned for the PUD. The Corps was not pleased that the owner planned to develop additional wetlands on the property and the owner agreed to reduce the wetlands to be filled from 10.7 acres to 4.8 acres (“Site Wetlands”).

The Site Wetlands are located adjacent to a man-made drainage ditch (the “Ditch”) but they do not abut the Ditch because a berm was created between the Site Wetlands and the Ditch. The Ditch, which flows seasonally, joins a larger perennial drainage ditch (the “Perennial Ditch”) downstream of the Site Wetlands. That ditch runs along the PUD boundary for approximately 3,000 feet before meeting up with a second perennial tributary 2.5 to 3 miles south of the PUD, before flowing into the Northwest River, approximately 3 to 4 miles downstream.

In 2007 the owner applied to the Corps for a jurisdictional determination whether the Site Wetlands were covered by the CWA, and a permit to fill the wetlands if the Corps decided a permit was required. The Corps determined it had jurisdiction over the Site Wetlands because they were adjacent to the Ditch that qualified as “waters of the United States” under the CWA, and denied the owner’s request for a permit.

The owner administratively appealed both determinations. A Corps appeals officer remanded the Corps’ jurisdictional decision for reconsideration under the new Corps “Rapanos Guidance” in light of the Supreme Court’s recent decision in Rapanos v. United States, 547 U.S. 715 (2006). The Rapanos Guidance instructs the Corps how to make jurisdictional determinations that comply with the new rules for CWA jurisdiction announced by the Supreme Court in Rapanos. UnderRapanos, wetlands like the Site Wetlands, which are adjacent to but not abutting a relatively permanent tributary, are not automatically subject to Corps jurisdiction. Rather, the Corps must evaluate the wetlands to determine whether there is a “significant nexus” with traditional navigable waters. Any such evaluation must include “similarly situated” wetlands in the area, which the Corps determined included 448 acres of wetlands that were separated from the Site Wetlands but were either on the owner’s property or located nearby.

The Corps upheld its jurisdictional determination under the Rapanos Guidance, finding that there was a significant nexus with both the Ditch and the Perennial Ditch and the downstream Northwest River.

The owner filed suit in federal district court and the court granted the Corps’ motion for summary judgment, finding that the Corps had properly defined the scope of its review area as including the entire 448 acres of similarly situated wetlands, and that the Corps’ determination that the wetlands had a significant nexus to the Northwest River was supported by substantial factual findings.

The owner appealed to the Fourth Circuit arguing two flaws in the Corps’ determination: (1) the Corps’ decision to aggregate 448 acres of surrounding wetlands was impermissible, and (2) even if all 448 acres were properly included in the jurisdictional determination, the Corps did not provide sufficient evidence that the connection between the wetlands and the Northwest River was a “significant nexus.”

Court’s Ruling

The court gave an overview of the Supreme Court’s prior rulings on CWA jurisdiction. It noted that the Supreme Court’s fractured Rapanosdecision resulted in two tests that could be applied when evaluating the Corps’ assertion of jurisdiction over wetlands lying alongside “remote and insubstantial” ditches and drains. However, the parties to the suit agreed that only Justice Kennedy‘s test governed their situation. Under Justice Kennedy’s test, when the Corps seeks jurisdiction over wetlands located adjacent to nonnavigable tributaries, it must establish that a “significant nexus” exists between the wetlands and navigable waters.

Drawing on the Supreme Court’s prior ruling in U.S. v. Riverside Bayview Homes, Inc., 474 U.S. 121, Justice Kennedy noted that wetlands possessing the “significant nexus” are those that “perform critical functions related to the integrity of other waters – functions such as pollutant trapping, flood control, and runoff storage.” (quoting Bayview Homes at p. 135.) Accordingly, Justice Kennedy found that a “significant nexus” exists if the wetlands, either alone or in combination with nearby similarly situated wetlands, significantly affect the chemical, physical, and biological integrity of more traditionally-defined “navigable” waters. When the wetlands’ effects on water quality were speculative or insubstantial, the required nexus did not exist and they were not considered “navigable waters” under the CWA.

Applying the “significant nexus” test to the Site Wetlands, the court first upheld the Corps’ labeling 448 acres of wetlands as “similarly situated” for purposes of its nexus determination. The court found that the Corps’ identification of the relevant tributary as both the Ditch and the Perennial Ditch was proper. It also found that the Corps’ use of all 448 acres in its analysis was proper as they were both abutting and adjacent to the tributary. The court rejected the owner’s claim that the berm between the Site Wetlands and the Ditch disconnected the Site Wetlands from the surrounding wetlands because the berm did not inhibit wildlife movement or wetland functions.

The court did question the Corps’ decision, after determining it would treat the Ditch and the Perennial Ditch together, to include adjacent wetlands stretching over three miles downstream as “similarly situated.” However, the court ultimately upheld the Corps’ finding and merely urged the Corps to consider ways to gather more concrete evidence of similarity in the future before using such a large area of wetlands.

As to the owner’s second argument, the court found that the record did not contain sufficient evidence to allow it to assess the Corps’ conclusion that the Site Wetlands had a “significant nexus” with the Northwest River located several miles away. The court stated that the record had no evidence of the actual flow of the adjacent tributaries to support its claim that the tributaries helped diminish downstream flooding and erosion. Moreover, even if there was sufficient evidence of flow in the record, the record did not support the Corps’ nexus determination in a case involving wetlands adjacent to two manmade ditches, flowing at unknown rates toward a river five to ten miles away, without any information on the river’s condition.

Based on its holding, the court reversed the district court’s grant of summary judgment and remanded the case to be sent back to the Corps for further consideration in light of the court’s opinion. The court also admonished the Corps in cases like the current one, involving wetlands running along a ditch miles from any navigable water, to pay attention to documenting why such wetlands significantly affect the integrity of navigable waters. The court stated that such documentation should include some comparative information that allows it to meaningfully review the significance of the wetlands’ impacts on downstream water quality.


The court’s ruling will likely have only minimal impact on future development or other projects seeking to fill in wetlands under a CWA permit. The court upheld the Corps’ decision to use a wide area in aggregating “similarly situated” wetlands, even though the Site Wetlands were separated from both the Ditch and the other wetlands. The court only reversed the grant of summary judgment because the Corps failed to adequately document the water quality impact the Site Wetlands and other wetlands would have on the Northwest River (the navigable water). In fact, the court gave the Corps a roadmap to meet its expectations on remand.

In sum, a developer seeking a CWA permit to fill wetlands should be aware that the court will require the Corps to adequately document its determination of a “significant nexus” between the wetlands and the navigable water. However, it appears the courts will still give significant deference to the Corps’ decision.

An interesting side note relates to the court’s use of only one of the twoRapanos tests. While the court did not address the issue of whether the other “continuous surface connection” test provides an alternate ground to establish Corps jurisdiction, it did hint that the berm separating the Site Wetlands from the Ditch could make the test’s application questionable. In any event, developers should be aware that the courts can also use this second test in finding Corps jurisdiction, leading to an even greater possibility that the Corps’ jurisdiction determination will be upheld.

A Federal District Court Rules That The Qui Tam Provision of the False Marking Statute is Unconstitutional

The Illinois Securities Law: The Remedy Is Rescission

When most people think securities regulation, they think federal jurisdiction. After all, the early 2000s saw several corporations thrust into the national spotlight as they dealt with securities improprieties and related investigations by the Securities and Exchange Commission. However, as a disgruntled holder of a security in Illinois, you may be able to find relief closer to home under a state act known as the Illinois Securities Law of 1953.

The purpose of this so-called blue sky law (a state regulation designed to protect investors against fraudulent sales practices and activities) is to “protect innocent persons who might be induced to invest their money in speculative enterprises over which they have little control.”

How Does the Act Protect Purchasers?

Among other actions, the Illinois Securities Law makes it a violation for any person to offer to sell any security except in accordance with the act, to sell securities when not registered, to make any false or misleading material statements in any reports filed under the act, to obtain money or property through the sale of securities by means of an untrue statement, and to circulate a prospectus while knowing that a material representation contained in the prospectus is untrue. In addition, Illinois’ blue sky law protects sellers of securities by making it a violation to “engage in any transaction, practice or course of business in connection with the sale or purchase of securities which tends to work a fraud or deceit upon the purchaser or seller thereof”or to “employ any device, scheme or artifice to defraud in connection with a sale or purchase of any security, directly or indirectly.”

How Can a Disgruntled Purchaser Obtain Relief under the Act?

Under the Illinois Securities Law, the only private remedy for a violation of the act by a disgruntled purchaser is rescission. In essence, the seller must take back the security and refund the purchaser what was originally paid for it. Therefore, a disgruntled purchaser may void the sale, at his or her election. First, however, the purchaser must provide notice of the election to void the sale within six months after he or she has knowledge that the sale is voidable (i.e., that the seller violated the Illinois Securities Law). The purchaser must give notice to each individual against whom recovery is sought, by registered or certified mail, addressed to the person to be notified at his or her last known address.

Each individual involved in the sale will be jointly and severally liable to the purchaser for the full amount paid for the security, with interest, minus any income or other amounts received by the purchaser on the security. If the purchaser no longer owns the security, he or she will be paid the difference between the cost of the security at the time of the original purchase minus the amount received when he or she subsequently sold the security.

Can the Act Also Help a Disgruntled Seller?

Under Section 13(G) of Illinois’ blue sky law, “a seller can conceivably seek a remedy. That section allows “any party in interest” to bring an action for prospective relief against any person who “has engaged or is about to engage in any act or practice constituting a violation” of the act. Therefore, if you are a disgruntled seller, and you are aware that a party has violated or is going to violate the Illinois Securities Law, you can ask the court to enjoin that party from violating the act in the future. However, the act does not provide disgruntled sellers with relief for harm that has already been done, only for prospective relief.Victory in New Mexico Voter Registration Case

Seeking CAFA Clarity: A Summary of Recent Case Law Addressing Challenges to Jurisdiction Under the Class Action Fairness Act

I.          The Class Action Fairness Act (“CAFA”)

In 2005, CAFA was enacted to assure fair and prompt recoveries for class members with legitimate claims, restore the intent of the framers of the United States Constitution by providing for Federal court consideration of interstate cases of national importance under diversity jurisdiction, and benefit society by encouraging innovation and lowering consumer prices.  Pub. L. No. 109-2, 119 Stat. 4 (2005), LEXSEE 109 PL 2.

To achieve these stated purposes, 28 U.S.C. §1332 was amended to expand diversity jurisdiction in class action litigation.  Subsection (d)(2) of §1332 provides that in class action cases involving 100 or more class members:

  (2)        The district courts shall have original jurisdiction of any civil action in which the matter in controversy exceeds the sum or value of $ 5,000,000, exclusive of interest and costs, and is a class action in which–

(A)        any member of a class of plaintiffs is a citizen of a State different from any defendant;

(B)        any member of a class of plaintiffs is a foreign state or a citizen or subject of a foreign state and any defendant is a citizen of a State; or

(C)       any member of a class of plaintiffs is a citizen of a State and any defendant is a foreign state or a citizen or subject of a foreign state.

CAFA eliminates some of the traditional procedural impediments to removal by no longer placing a 1 year limit on removal, allowing removal even if the defendant is a citizen of the state where the suit was initiated, and no longer requiring the removing defendant to obtain consent to removal from the co-defendants.  28 U.S.C. §1453(b).

Pursuant to 28 U.S.C. §1332(d)(11), mass actions also may be removed to federal court.  A mass action is a civil action in which monetary relief claims of 100 or more persons are proposed to be tried jointly on the ground that the plaintiffs’ claims involve common questions of law or fact.  Jurisdiction shall exist only over those plaintiffs whose claims in a mass action satisfy the $75,000 jurisdictional amount found in of §1332(a), and if the other requirements of CAFA removal are met, including minimal diversity and an aggregate amount in controversy in excess of $5 million.

Even thought CAFA expands diversity jurisdiction, the removing party still has the burden to establish the court’s jurisdiction by demonstrating that the requisite number of plaintiffs exist, that there is minimal diversity, and that the amount in controversy is sufficient to meet the statutory requirements.

II.        Exceptions to CAFA Jurisdiction

Certain class actions are specifically excluded from CAFA’s reach.  The exceptions to CAFA jurisdiction are fertile territory for plaintiffs trying to keep their class actions cases in state court.  CAFA’s exceptions are found in 28 U.S.C. §1332(d)(3) through (5) and include the following:


·       the discretionary/interests of justice exception,

·       the local controversy exception,

·       the home state exception, and

·       the state action exception.

A.  Discretionary/Interests of Justice Exception – 28 U.S.C. §1332(d)(3)

The discretionary/interests of justice exception allows a district court to decline jurisdiction in the interests of justice and looking a the totality of the circumstances if greater than one third but less than two-thirds of the members of all proposed plaintiff classes in the aggregate and the primary defendants are citizens of the State in which the action was originally filed.  In exercising this discretion the court must consider: whether the claims asserted involve matters of national or interstate interest; whether the claims asserted will be governed by laws of the State in which the action was originally filed or by the laws of other States; whether the class action has been pleaded in a manner that seeks to avoid Federal jurisdiction; whether the action was brought in a forum with a distinct nexus with the class members, the alleged harm, or the defendants; whether the number of citizens of the State in which the action was originally filed in all proposed plaintiff classes in the aggregate is substantially larger than the number of citizens from any other State, and the citizenship of the other members of the proposed class is dispersed among a substantial number of States; and whether, during the 3-year period preceding the filing of that class action, 1 or more other class actions asserting the same or similar claims on behalf of the same or other persons have been filed.

B.         Local Controversy Exception – 28 U.S.C. §1332(d)(4)(A)

Under the local controversy exception, a district court shall decline to exercise jurisdiction over a class action which meets the following three criteria.  First, greater than two-thirds of the members of all proposed plaintiff classes in the aggregate are citizens of the State in which the action was originally filed.  Second at least one defendant is a defendant from whom significant relief is sought by members of the plaintiff class; whose alleged conduct forms a significant basis for the claims asserted by the proposed plaintiff class; and who is a citizen of the State in which the action was originally filed; and principal injuries resulting from the alleged conduct or any related conduct of each defendant were incurred in the State in which the action was originally filed.  Third, during the 3-year period preceding the filing of that class action, no other class action has been filed asserting the same or similar factual allegations against any of the defendants on behalf of the same or other persons.

C.  Home State Exception – 28 U.S.C. §1332(d)(4)(B)

The home state exception applies when two-thirds or more of the members of all proposed plaintiff classes in the aggregate, and the primary defendants, are citizens of the State in which the action was originally filed.

 D. State Action Exception – 28 U.S.C. §1332(d)(5)(A)

If the primary defendants are States, State officials, or other governmental entities against whom the district court may be foreclosed from ordering relief then the case falls within the state action exception to CAFA jurisdiction.

  III.  Arguments raised to defeat CAFA jurisdiction

 A. Is this case a class action?

CAFA applies to class actions and  a class action is defined in 28 U.S.C. §1332 (d)(1) (B) as an civil action filed under Rule 23 of the Federal Rules of Civil Procedure or similar State statute or rule of judicial procedure authorizing action to be brought by 1 or more representative persons as a class action.  But does CAFA apply if the complaint does not specifically define a proposed class?

In College of Dental Surgeons of Puerto Rico v. Connecticut Gen. Life Ins. Co., 585 F. 3d 33 (1st Cir. 2009) the First Circuit grappled with this issue.  The plaintiff, the College of Dental Surgeons of Puerto Rico, brought suit on behalf of its members, consisting of licensed dentists in Puerto Rico, against multiple defendants claiming that the defendants’ claims handling practices were questionable, fraudulent and economically detrimental to the members.  Two defendants removed the case to federal court pursuant to CAFA.  The district court remanded the case on the basis that the complaint did not sufficiently define the plaintiff class.  On appeal, the remand order was vacated.  The First Circuit noted that the complaint plausibly alleged claims for class-wide relief and consistently alleged harm to the members as a professional group.  The appellate court rejected the argument that remand was appropriate because the case could never be certified since an association cannot be a member of a certifiable class.  The Court found that the association met the standing requirements to sue on behalf of its members because the members had standing to sue in their own right, the interests the association sought to protect were germane to its purposes; and neither the claim asserted nor the declaratory relief requested required the participation of individual members in the suit.  More importantly, the Court stated that class composition was not the issue at the inception of a class action.  Review of the complaint alone typically is insufficient for determining if the class can be certified, so the district court’s ruling on the inadequacy of the class definition was premature.

 B.  Is this case a mass action under 28 U.S.C. §1332(d)(11)?

In a series of cases brought in California, the plaintiffs were able to avoid CAFA jurisdiction by pleading around both the jurisdictional amount and the number of persons necessary to satisfy a mass action under §1332(d)(11).

In Tanoh v. Dow Chemical, Co, 561 F.3d 945 (9th Cir. 2009), cert. denied, 130 S. Ct. 187, 175 L. Ed. 2d 236 (2009) the defendant removed seven state court actions involving over 600 foreign nationals who claimed that they had been injured by exposure to the chemical DBCP while working on banana and pineapple plantations in the Ivory Coast.  In each case of the seven cases there were fewer than 100 plaintiffs.  The cases were removed to federal court on the basis of diversity jurisdiction and the mass action provisions of CAFA.  Dow Chemical argued that the seven actions, taken together, constituted a mass action and that the cases had been filed separately just to frustrate the purposes of CAFA jurisdiction.

The district court disagreed and remanded the actions.  Specifically, the court looked at the language in 28 U.S.C. §1332(d)(11) which specifically states that a mass action shall not include claims that are joined upon the motion of a defendant.  It found that Dow Chemical’s attempt to aggregate the actions for purposes of CAFA, was tantamount to doing an end-run around this limitation in the statute.  On appeal, the Ninth Circuit upheld remand of the actions to state court.  It rejected Dow Chemical’s argument that the plaintiffs should not be allowed to structure the complaints in order to defeat CAFA jurisdiction.  The appellate court did not consider cases decided under provisions other than CAFA’s mass action provision to be persuasive.    See also, Venegas v. Dole Food Co., Inc., 2009 U.S. Dist. LEXIS 22885 (C.D. Cal. Mar. 9, 2009), where approximately 2500 plaintiffs, banana plantation workers, filed multiple lawsuits against the same defendants alleging damages from exposure to a chemical used in banana farming operations in Costa Rica, Panama, Honduras and Guatemala. The plaintiffs were divided into groups alphabetically and by country so that each case had less than 100 plaintiffs. Defendants removed the cases to federal court on CAFA jurisdictional grounds asserting that all the actions should be considered one action because the plaintiffs divided their claims solely for purposes of avoiding federal court jurisdiction.  The motion for remand was granted.  Remand was granted, in part, because nothing in CAFA suggests that the plaintiffs, as the masters of their own complaint, may not file multiple actions each with fewer than 100 plaintiffs.  The court also held that the defendant had not met its burden of demonstrating that amount in controversy exceeded $75,000 individually or $5 million in the aggregate.

C.  Is there minimal diversity?

1.  For purposes of federal diversity jurisdiction, a corporation is considered a citizen of the state where it is incorporated and of the state where it has its principal place of business. 28 U.S.C. §1332(c)(1).  But what constitutes a corporation’s principal place of business?  

In Hertz Corp. v. Friend, 130 S. Ct. 1181, 175 L. Ed. 2d 1029 (2010), the U.S. Supreme Court addressed the meaning of principal place of business (“PPB”) for diversity jurisdiction purposes.  Plaintiffs, California citizens sued their employer, Hertz, in state court alleging California wage and hour law violations.  They brought the suit on behalf of themselves and a class of California citizens suffering similar harms.  Hertz removed the case to federal court on the basis of diversity jurisdiction, asserting that its PPB was in New Jersey.  The plaintiffs moved for remand alleging that Hertz’s PPB was in California.  Hertz submitted a declaration to establish that its PPB was in New Jersey.  In the declaration, Hertz stated that it had facilities in 44 states, that its corporate headquarters was in New Jersey, and that its core executive and administrative functions were carried out in New Jersey.  With respect to the state of California, Hertz stated that it had 273 of its 1606 car rental locations there, that about 2300 of its 11,230 full time employees were in California and that its business in California amounted to about $811 million of its $4.371 billion in annual revenue.  Based on these facts, the district court found that Hertz’s PPB was in California under the Ninth’s Circuit’s test which required the court to examine Hertz’s business on a state-by-state basis.  If the amount of activity in one state is significantly larger or substantially predominates, then that is the company’s PPB, but if there is no such state, then the PPB is the corporation’s nerve center, i.e., the place where the majority of its executive and administrative functions are performed.  After examining the plurality of Hertz’s business activity in various states, the district court found that its activity in California was significant and so Hertz’s PPB was in California.  The Ninth Circuit affirmed the remand order and Hertz appealed.

The United States Supreme Court reversed.  Noting that there were many different ways in which the various circuit courts over the years had determined what constitutes a company’s PPB, the Supreme Court thought it necessary to find a single, more uniform interpretation of this statutory phrase. The Court adopted the nerve center test, holding that PPB is best read as referring to the place where a corporation’s officers direct control, and coordinate the corporation’s activities.  In practice this should normally be the place where the corporation maintains its headquarters — provided that the headquarters is the actual center of direction, control, and coordination, i.e., the nerve center, and not simply an office where the corporation holds its board meetings.

2. What if the plaintiffs sue a limited liability company instead of a corporation.  What is the citizenship of an LLC under CAFA?

In Ferrell v. Express Check Advance of SC LLC, 591 F. 3d 698, (4th Cir. 2010), the plaintiffs filed a class action on behalf of South Carolina citizens against a payday lender for alleged violations of South Carolina law. The lender removed the case under CAFA.  Following a long line of case law holding that the citizenship of an unincorporated association is determined based upon the citizenship of each of the association’s members, the lender argued that there was diversity based on the citizenship of its sole member, a Missouri corporation with its PPB in Kansas.

Alternatively, the lender argued that if it was deemed an unincorporated association within the meaning of 28 U.S.C. §1332(d)(10), it was a citizen of Tennessee, under whose laws it was organized, and of Kansas where it had its PPB.

The plaintiff moved to remand, arguing that the defendant’s PPB really was South Carolina, the place where it made all its loans and where all of its employees, but for its top four officers were located. The district court held that the defendant, a limited liability company, was an unincorporated association under 28 U.S.C. §1332(d)(10).  Consequently, it was a citizen of the state under whose laws it is organized and of the state where it has its PPB.  The district court found that the lender’s PPB was in South Carolina, not Kansas, and therefore the case should be remanded.

On appeal, the Fourth Circuit affirmed.  It examined the citizenship language in 28 U.S.C. §1332.  Section 1332 (c)(1) provides that a corporation is a citizen of the state of its incorporation and the state of it PPB.  Section 1332(d)(10) provides that the citizenship of an unincorporated association is determined by the state under whose laws it is organized and the state where it has it PPB.  However, the court observed that the because the provisions relating to the citizenship of corporations and of unincorporated associations are found in different sections of the statute, the provision relating to unincorporated associations in §1332(d)(10) applies only to class actions covered by CAFA.  The court concluded that the term “unincorporated association” found in §1332(d)(10) refers to all non-corporate business entities.  The appellate court agreed with the district court’s analysis that the defendant’s PPB was in South Carolina so the case was remanded.

D.   Is the amount in controversy greater than $5 million?

1.    Has the plaintiff alleged any amount in controversy?

When a plaintiff does not allege an amount in controversy in the complaint, the defendant must prove by a preponderance of the evidence that CAFA’s in excess of $5 million amount in controversy has been met.  As the following cases demonstrate, this is not always an easy task.

 Berniard v. Dow Chemical Co., 2010 U.S. App. LEXIS 16515 (5th Cir. 2010), involved the remand of seven class actions stemming from a single incident, the sudden accidental release of ethyl acrylate, a potentially noxious chemical.  The release resulted in the evacuation of residents and businesses with a 2 mile area east of the facility where the release had occurred.  On the day of the release, two class actions were filed in state court.  Eventually, three more state court class actions were filed and two class actions were filed in federal court.

The district court examined the allegations in the pleadings to determine if it had jurisdiction under CAFA.  It examined the geographical reach of the chemicals, the number of persons affected, the seriousness and extent of the injuries suffered, and the potential monetary value of the damages, including punitive damages.  Upon removal, defendants had a choice to either sustain removal by: (1) adducing summary judgment evidence of the amount in controversy; or (2) demonstrating that it is facially apparent from the pleadings alone that the amount in controversy has been met.  The defendants chose the latter approach.

To meet the amount in controversy requirement, the defendants offered census data of the geographical areas at issue, and compared the quantum recovery in previously reported cases involving similar incidents and injuries. This was held to be insufficient. The court noted that the defendants had improperly equated the geographic areas in which potential plaintiffs might reside with the population of the class itself.  The comparison to damage recoveries in similar cases was found to be speculative.  It did not matter that the plaintiffs were claiming compensatory damages, pain and suffering, psychological and long term future damages, and even punitive or exemplary damages.

In Pretka v. Kolter City Plaza II, Inc., 608 F. 3d 744, (11th Cir. 2010), the court addressed what types of evidence the defendant could present to establish the jurisdictional amount in controversy.  The seven plaintiffs brought a putative class action on behalf of themselves and all other similarly situated depositors who had placed deposits on the purchase of luxury condominiums in the defendant’s development in West Palm Beach, Florida.  The complaint alleged breach of contract and violation of Florida’s Condominium Act, and sought rescission of the purchase contracts and return of the deposits, but did not state an amount in controversy.  Attached to the complaint were the plaintiffs purchase contracts showing an average deposit amount of roughly $105,000. The complaint stated that the class was believed to consist of over 300 members.

The defendant removed the case under CAFA.  In support of the removal, defendant attached a declaration of the CFO of its parent company indicating that the company had collected over $5 million in deposits from more than 100 prospective purchasers.  The plaintiffs moved for remand arguing that the court could not consider the CFO’s declaration because it was not a paper received from the plaintiffs. In its opposition brief, the defendant attached another declaration from its parent company’s closing manager who had reviewed the closing contracts.  She stated that those contracts showed that the defendant possessed purchase deposits totaling over $41 million.

The district court, relying on the 11th Circuit’s decision in a prior case, Lowery, held that it could not consider either the declaration evidence in support of the amount in controversy, or the contracts of other putative class members because such documents had not been supplied by the plaintiffs.  The district court also found that the first declaration impermissibly speculated as to the potential damage claim of all putative class members and the second declaration could not be considered because it had not been submitted with the notice of removal.  The district court remanded the case.

The defendant appealed, and the 11th Circuit held that district court had erred in rejecting the defendant’s evidence of the amount in controversy.  In reaching this conclusion, it distinguished its holding in Lowery, and disavowed any statements in the dicta of Lowery that could be considered contradictory to its holding in Pretka.  The Circuit Court held that when a case is removed under the first paragraph of 28 U.S.C. §1446(b), i.e., within 30 days of receipt of an initial pleading setting forth a claim for relief, that statutory language does not restrict the type of evidence that a defendant may use to satisfy the jurisdictional requirements for removal.  This is in contrast, however, to removal under the second paragraph of 28 U.S.C. §1446(b) i.e., within 30 days of receipt of an amended pleading, motion or other paper, upon which it may first be ascertained that the case is removable. In the latter instance, the evidence to be considered is limited to reliance on receipt of an “other paper” due to a voluntary act of the plaintiff.

Contrary to the district court’s ruling, the appellate court recognized that documents generated by a defendant do not necessarily involve impermissible speculation.  In the instant case, the CFO’s declaration contained non-speculative knowledge of the amount of every putative class member’s claim which could be considered, since the claims of the individual class members could be aggregated to determine the amount in controversy.  The court stated that evidence added post-removal also could be considered by the court.  Consequently, upon consideration of all of the defendant’s amount in controversy evidence, the remand order was rescinded.

In McGee v. Sentinel Offender Services LLC, 2010 U.S. Dist. LEXIS 126842 (S.D. Ga. Nov. 30, 2010), the plaintiff challenged the defendant’s CAFA removal on several grounds, including whether the amount in controversy requirement had been met. The Plaintiff filed a putative class action on behalf of all individuals previously convicted of a misdemeanor or ordinance violation in Georgia who were under probation supervised by Sentinel, a private probation company.  The plaintiff sued for alleged violation of Georgia’s RICO statute and sought reimbursement in an amount equal to times the amount paid to Sentinel for supervision of the class members in private probation.

Sentinel supported its CAFA removal with a declaration from its COO and Vice President, who stated that there were 35,753 individuals convicted of misdemeanors or ordinance violations in the State of Georgia under probation supervised by Sentinel, and that Sentinel had collected $5,675,639.20 from these individuals in supervision fees.  Plaintiff challenged the declaration because it did not specify when the fees were collected, whether they were collected within the statute of limitations period, or if they had been paid by persons who were class members.  The court rejected this challenge and retained jurisdiction.  The court noted that the declaration set forth an amount reflective of the damages sought by the plaintiff in the complaint.  The RICO claim sought the divestiture of any interest in the enterprise or personal property, including all fees collected by Sentinel. As for plaintiff’s statute of limitations argument, the court noted that when determining the amount in controversy for jurisdictional purposes, it could not look past the complaint to the merits of a defense that had not yet been established.

2. Has the plaintiff alleged an amount in controversy less than $5 million?

While some plaintiffs may allege no amount in controversy in the complaint, other plaintiffs may disavow an amount that meets the jurisdictional requisite.  For instance, in Freeman v. Blue Ridge Paper Products, Inc., 551 F. 3d 405 (6th Cir. 2008), the plaintiffs made every effort to avoid CAFA jurisdiction.

The claims involved 300 landowners who sued a paper mill for nuisance created by water pollution.  In their first class action suit filed in 2005 in Tennessee state court, the plaintiffs asserted claims covering a 6-year period from 6/1/99 to 8/17/05.  At trial in that case, they recovered an aggregate award of $2 million.

Thereafter, plaintiffs filed an additional class action lawsuit in state court, in which they sought damages accruing after 8/17/05 until the date of trial.  The name plaintiff disavowed individual damages above $74,000 or aggregate damages above $4.9 million.  The defendant removed the suit to federal court, but it was remanded for failure to satisfy the jurisdictional amount.

After remand, the plaintiffs amended the complaint to seek damages from 8/17/05 to 2/17/06.  The state court orally granted the motion to amend in December of 2007, but the written order was not entered until February of 2008.  In the interim, the plaintiffs filed four more lawsuits in state court , each suit covering a different six month time period.  Each complaint was essentially identical and pled the same damage limitations as the initial complaint. On February 4, 2008, the defendant removed all five cases to federal court where they were consolidated and subsequently remanded.  Defendant appealed.

On appeal, the Sixth Circuit found that the CAFA threshold had been met because the $4.9 million sought in each complaint had to be aggregated.  In so holding, the court noted that the complaints were identical, except for the artificially broken up time periods, and the plaintiffs offered no colorable reason for breaking up the lawsuits other than to avoid CAFA jurisdiction.  The court limited its holding to the situation where no colorable basis exists for dividing up the sought-for retrospective relief into separate time periods, other than to frustrate the purposes of CAFA. The Sixth Circuit recognized that generally a plaintiff could avoid CAFA jurisdiction by seeking amounts less than the threshold, “but where recovery is expanded, rather than limited, by virtue of splintering of lawsuits for no colorable reason, the total of such identical splintered lawsuits may be aggregated.”  Id. at 409.

E.  Arguments for exceptions to CAFA jurisdiction

While the party removing a case has the burden to establish that the federal court has jurisdiction under CAFA, once that burden has been met, the burden then shifts to the party seeking to remand the case to establish that a CAFA exception applies.

1.  The Home State Exception.

In Jackson v. Sprint Nextel Corp., 2011 U.S. Dist. LEXIS 7005, (N.D. Ill. Jan. 21, 2011) the plaintiffs sued Sprint, a Kansas Corporation alleging that Sprint conspired with other cell phone providers to impose artificially high prices for text messaging.  The action was brought on behalf of a putative class of all individuals who purchased texting from Sprint or an alleged co-conspirator from 1/1/05 to the present, had a Kansas cell phone number, received their cell phone bill at a Kansas mailing address, and paid a Kansas USF fee.  Sprint removed based on CAFA jurisdiction and the plaintiffs sought remand on the basis of the home state exception.

The lower court granted remand, finding that the plaintiffs had met their burden of establishing the existence of the home state exception because Sprint was a resident of Kansas and at least two thirds of the members of the proposed class were citizens of Kansas since the class only included members with Kansas billing addresses and cell phone numbers.  Sprint appealed.

On appeal the Seventh Circuit reversed, finding that the lower court could not draw conclusions about the citizenship of the class members based on information like the class members cell phone numbers and mailing addresses.  Instead, the district court could have relied on evidence of citizenship obtained through affidavits or survey responses in which putative class members revealed whether they intended to remain in Kansas or were a Kansas business. Using statistical principles, the plaintiffs could then establish the two thirds number required under the home state exception. Alternatively, the court noted that the plaintiffs could have defined their class as “all Kansas citizens who purchased text messaging from Sprint Nextel or an alleged co-conspirator. The case was remanded for further proceedings.

On remand, the parties conducted jurisdictional discovery.  Following the evidentiary roadmap set forth in the Seventh Circuit’s opinion, the plaintiffs obtained updated customer information from Sprint and its alleged co-conspirators.  The plaintiffs conducted a telephone survey of a random sample of putative class members.  They searched voter registration, driver license and secretary of state records and collected Internet information to determine the citizenship of those individuals and businesses who had not answered the survey. Using this new data, the Plaintiffs renewed their motion for remand.  While Sprint challenged the survey results on various grounds, in the end the court found that the plaintiffs had met their burden of establishing the elements of the home state exception. Hence the case was remanded.

 2.  The Local Controversy Exception. 

Under the local controversy exception, plaintiffs may name a local defendant from whom significant relief is sought and whose alleged conduct forms a significant basis for the claims asserted by the class, and who has not been sued in a class action in the previous three years.

Case in point, LaFalier v. State Farm Fire & Cas. Co., 2010 U.S. App. LEXIS 17588 (10th Cir. 2010), where the plaintiffs owned properties located in an environmentally contaminated town in Oklahoma.  The state established a Trust to purchase the properties and assist the homeowners in relocating.  During the purchase/relocation process, many homes were damaged by a tornado.  The Trust then offset any amounts the plaintiffs might receive from insurance against the amounts the plaintiffs would receive under the Trust.  The plaintiffs eventually brought suit against two individuals responsible for administering the Trust, and two appraisal companies, alleging that the defendants deliberately used appraisals that undervalued the properties, and conducted secret proceedings concerning the appraisals. The plaintiffs also sued ten insurance companies, three from Oklahoma and ten from out of state, alleging that the insurers paid only cash value for the tornado damage because they knew the properties would not be repaired or replaced, failed to reveal all coverage available, and improperly leveraged Trust offsets to urge the insureds to accept lower payments.

State Farm removed the case pursuant to CAFA.  The plaintiffs moved for remand under the local controversy exception and the case was remanded.  The insurers appealed, but remand was upheld.  The insurers argued that the claims against the Trust defendants had been misjoined with the claims against the insurers, consequently, the Trust defendant claims should have been ignored for purposes of analyzing the local controversy exception.  The district court disagreed.  Every plaintiff had a claim against the Trust defendants, but not every plaintiff had a claim against each named defendant insurer.  The Trust defendants were local defendants from whom significant relief was sought and whose conduct formed a significant basis for the claims asserted.  The doctrine of procedural misjoinder had not been adopted in the Tenth Circuit, and even if it had, it was not clear that the severed claims against the insurers would meet CAFA’s jurisdictional requirements of over 100 class members and in excess of $5,000,0000.

The lower court also rejected the insurers’ contention that an earlier lawsuit filed by these plaintiffs against the Trust itself, and not against the current named Trust defendants, meant that the plaintiffs could not satisfy the last prong of the local controversy exception.  On appeal the Tenth Circuit agreed with the district court, noting that the plain language of 28 U.S.C. §1332(d)(4)(A(ii) says there must be a prior action “against any of the defendants” and not “against any of the defendants or parties in privity with them” as the insurers would have had the court interpret the statute.  The Tenth Circuit also noted that State Farm had admitted that not every plaintiff had a claim against an insurer, and there was nothing before the court to demonstrate that at least 100 plaintiffs had claims against the insurers.

3.  The Discretionary/Interests of Justice exception

If greater than one third but less than two-thirds of the members of all proposed plaintiff classes in the aggregate and the primary defendants are citizens of the State in which the action was originally filed the discretionary exception may apply.  One of the difficulties in addressing this exception is that the term “primary defendant” is not defined in CAFA.  The definition is important because the statute requires that “all” of the primary defendants be residents of the state where the suit was filed.

In Powell v. Tosh, 40 Envtl. L. Rep. 20251, 2009 U.S. Dist. LEXIS 98564 (W.D. Ky. Oct. 21, 2009), the plaintiffs sought to remand their case to state court based, in part, on CAFA’s discretionary exception.  The plaintiffs, 28 Kentucky landowners, brought a class action nuisance lawsuit against nine defendants alleging that noxious fumes from the defendants’ hog farm operations were negatively impacting the value of the plaintiffs’ property and causing personal injuries.  Among the defendants were the local operators of the hog farms as well as some diverse defendants who were the owners of the hogs on those farms.

While it was undisputed that the CAFA’s jurisdictional requirements had been met, the plaintiffs argued that the case should be remanded pursuant to two of CAFA’s mandatory exceptions, the local controversy exception and the discretionary exception.  With respect to the discretionary exception, the plaintiffs argued that greater than one third but less than two-thirds of the members of the proposed class were citizens of Kentucky and the court agreed.  Next, the plaintiffs argued that the primary defendants were citizens of Kentucky.  The court disagreed.

The court looked at the language of the exception and determined that the requirement that the primary defendants be citizens of the state where the suit was filed, meant “all” of the primary defendants.  Next, the court examined the complaint and noted that all members of the plaintiff class had claims against the diverse defendants.  Accordingly, those defendants appeared to be the real targets of the class action.  Also indicative of their status as primary defendants was the fact that the diverse defendants had been sued directly and were the subject of a significant portion of the claims asserted by the plaintiffs.

 4.  The State Action Exception

One of the least argued exceptions to CAFA jurisdiction is the state action exception which applies if the primary defendants are States, State officials, or other governmental entities against whom the district court may be foreclosed from ordering relief.  Like the discretionary exception, the state action exception also contains the language “primary defendants” which has been interpreted to mean “all” the primary defendants must be state actors.

The question then turns on whether the defendants can be considered States, State officials or other governmental entities against whom the district court may be foreclosed from ordering relief.  The purpose behind the enactment of 28 U.S.C. §1332(d)(5)(A) was to prevent states, state officials or governmental entities from removing a case to federal court, and then arguing that due to immunity the federal court would be prohibited from ordering the relief requested by the plaintiff.

The issue was addressed in Frazier v. Pioneer Americas LLC, 455 F.3d 542 (5th Cir. 2006) where the plaintiffs brought a class action against the operator of hydrogen processing equipment and the Louisiana Department of Environmental Quality (“DEQ”) for damages allegedly caused by seeping mercury.  Pioneer removed the case pursuant to CAFA.  The plaintiffs moved for remand on multiple grounds including that CAFA’s state action exception applied.  The district court denied remand and the plaintiffs appealed.  On appeal, the plaintiffs argued that the DEQ was both a primary defendant and a state entity so remand was appropriate.  The Fifth Circuit disagreed because the statute requires “all” primary defendants to be States, State Officials or other governmental entities and Pioneer also was a primary defendant. The court rejected the plaintiffs’ argument that such a result violated the 11th Amendment and the principles of state sovereign immunity. The appellate court noted that unless the state joins in the removal, which it is not required to do so under CAFA, it does not waive its right to assert sovereign immunity.  Furthermore, the court may ignore sovereign immunity until the state asserts it.  The fact that absent waiver of the immunity, the court may not be able to order relief against the state, does not mean the court cannot assume jurisdiction over a case involving a state.


In the six years since CAFA’s enactment, the courts have seen many arguments against CAFA jurisdiction.  Several of these arguments could not have been foreseen by the drafters of the legislation.  In the coming year, we should expect to see more arguments relating to calculation of the amount in controversy, interpretation of the “mass action” provisions, and interpretation of CAFA exceptions containing undefined phrases such as “primary defendant” and “significant relief.”

Indirect Purchaser Plavix Class Actions Tossed for Lack of Antitrust Standing

On January 31, 2011, the District Court for Southern District of Ohio granted defendants’ Rule 12(b)(6) motion, dismissing indirect purchaser class actions that challenged proposed reverse payment agreements as anticompetitive under Sections 1 and 2 of the Sherman Act, 15 U.S.C. §§ 1-2. Plaintiffs alleged those agreements prevented the defendants from entering into an alternative competitive agreement that would have permitted the cheaper generic version of Plavix to enter the market sooner. In re Plavix Indirect Purchaser Antitrust Litig. (“Plavix“), Slip Op., No. 1:06-cv-226, 2011 WL 335034 (S.D. Ohio Jan. 31, 2011).

Background – Kroger Co. v. Sanofi-Avantis, 701 F.Supp.2d 938 (S.D. Ohio 2010) 

In an earlier opinion, which was incorporated by reference into the January 31 decision, the court dismissed the direct purchaser actions based on the same allegations. Accordingly, a brief description of the background of the case and the court’s prior decision is helpful in understanding the context of the court’s ruling dismissing the indirect purchaser claims.

The defendants in both sets of actions were Sanofi Aventis and Sanofi-Synthelabo, Inc., Bristol-Myers Squibb Company and Bristol-Myers Squibb Sanofi Pharmaceuticals Holding Partnership (collectively “Sanofi”) and Apotex Corporation (“Apotex”). Sanofi manufactures a patented clopidogrel bisulfate drug, known as Plavix, which is used to treat patients with a risk of heart attacks and strokes. Apotex was the first generic applicant to seek FDA approval to market a generic version of Plavix in the United States, alleging that Sanofi’s patent was invalid (called a Paragraph IV certification). Sanofi then initiated a patent infringement suit against Apotex. Kroger, 701 F.Supp.2d at 942.

The FDA grants the first generic applicant to file a Paragraph IV certification with a six-month exclusivity period during which the generic drug manufacturer may sell the drug free of competition from any other generic manufacturer. However, the filing of a patent infringement suit stays the FDA approval process for the generic drug for up to 30 months. 21 U.S.C. § 355(j)(5)(B)(iii); Kroger, 701 F.Supp.2d at 942.

The automatic 30-month stay that was triggered by Sanofi’s infringement suit pursuant to section 355(j)(5)(B)(iii) expired in May 2005, and the trial of the infringement action was scheduled for April 2006. Apotex received FDA approval in January 2006, which started the 6-month exclusivity period running before the patent issues were resolved. Apotex was, therefore, faced with either losing the lucrative 6-month exclusivity rights or launching its generic drug “at risk,” thus exposing itself to infringement damages if Sanofi’s patent was upheld. Apotex began preparing for an at risk launch based on a belief that it had a strong invalidity case. Meanwhile, Aventis had obtained independent professional advice that called into question the validity of the patent at issue. Kroger, 701 F.Supp.2d at 944.

Given the risks on both sides, negotiations ensued resulting in two sets of proposed settlement agreements, both of which required government approval to take effect. The first called for a series of “reverse payments” by Sanofi to Apotex, also guaranteeing that neither Apotex nor Sanofi would launch a generic during Apotex’s exclusivity period. When this agreement failed to gain government approval, the parties entered into a second proposed agreement that capped Apotex’s damages if the patent litigation was resolved in Sanofi’s favor and under which Sanofi would not be prohibited from launching its own generic during Apotex’s exclusivity period. Moreover, the effective date of the agreement was moved forward to June 1, 2011 from September 17, 2011. However, this agreement also failed to gain the required government approval. A later government investigation into the proposed settlement resulted in criminal charges against, and a guilty plea by, Bristol Meyers for making false statements to government officials in connection with the proposed settlement.Kroger, 701 F.Supp.2d at 945-46.

In August 2006, while the patent litigation was ongoing, Apotex launched its generic version of Plavix at risk and sold it a few weeks before Sanofi obtained an injunction against Apotex and halted the sale of the generic drug. Id. at 946. The infringement action was later resolved against Apotex and the patent was held valid and infringed. Apotex litigated the issue through the Federal Circuit which upheld the findings below. Id. at 962-63.
Plaintiffs, both direct and indirect purchasers, alleged that, but for the two proposed settlement agreements, defendants would have entered into another, procompetitive agreement either (1) licensing Apotex to market its generic brand, or (2) shortening the life of Sanofi’s patent rights in return for Apotex’s delayed entry into the generic market. They claimed that such alternative hypothetical agreement would have avoided the unsuccessful patent trial and would have resulted in plaintiffs receiving the benefits of lower-priced generic competition sooner. Id. at 946. They also raised a Section 2 claim premised on a Walker Process theory of monopolization through enforcement of a fraudulently-obtained patent based on misrepresentations made to the Patent and Trademark Office (“PTO”). Id. at 949.

The district court dismissed the direct purchasers’ Section 1 claims for lack of antitrust injury. The court concluded, “Plaintiffs’ allegations, taken as true and construed in their favor, preclude the possibility that their injury flowed from the anticompetitive effects of the [proposed] agreements ‘which make [D]efendants’ acts unlawful.'” Id. at 954 (internal citation omitted). The court distinguished the case from In re Cardizem CD Antitrust Litig., 332 F.3d 896, 906 (6th Cir. 2003) which similarly involved a reverse payment agreement, noting that the agreement involved in that case in fact kept the generic drug from entering the market.

In contrast, Apotex launched the generic drug at risk and sold it on the market for a few weeks before its sales were halted by valid injunctions. Accordingly, the injunctions, not the proposed agreements, caused plaintiffs’ alleged injury and were “impenetrable legal impediments to the sale of generic” Plavix. The court held, such “alleged injury, although related to an antitrust violation, nevertheless will not qualify as ‘antitrust injury.'” Kroger, 701 F.Supp.2d at 954. (internal quotation marks and citation omitted).

The court also rejected direct purchaser plaintiffs’ Section 2 Walker Process theory of monopolization. The court noted that such claims are typically brought as counterclaims in patent infringement suits, and that outside this context, “a patent’s validity can be challenged only by a party (1) producing or preparing to produce the patented product, and (2) being threatened or reasonably likely to be threatened with an infringement suit.” Id. at 960. Because the direct purchasers did not fall into either category, they could not directly challenge the validity of Sanofi’s patents. However, the court found that whether purchasers could nonetheless assert a Walker Process claim like plaintiffs’ was not a settled question.

Relying on In re DDAVP Direct Purchaser Antitrust Litigation, 585 F.3d 677 (2d Cir. 2009), the court opted for a narrow application of such a claim. InDDAVP, the Second Circuit held “that purchaser plaintiffs have standing to raise Walker Process claims for patents that are already unenforceable due to inequitable conduct.” 585 F.3d at 691-92 (emphasis added); Kroger, 701 F.Supp.2d at 961-62.

The court found DDAVP inapplicable, however, because Apotex litigated the validity of the patent at issue through the Federal Circuit and lost, thereby failing to establish “by clear and convincing evidence that Sanofi engaged in inequitable conduct” before the PTO. Kroger, 701 F.Supp.2d at 963. Accordingly, the court dismissed the direct purchasers’ claims.

The Indirect Purchaser Actions 

At the outset, and with the foregoing rulings in mind, the court noted that “a complaint’s ‘[f]actual allegations must be enough to raise a right to relief above the speculative level, on the assumption that all of the complaint’s allegations are true.'” Plavix, 2011 WL 335034, at *2 (quotingBell Atl. Corop. v. Twombly, 550 U.S. 544, 555-56 (2007)). The court also stressed that “something beyond the mere possibility of [relief] must be alleged, lest a plaintiff with a largely groundless claim be allowed to take up the time of a number of other people, with the right to do so representing an in terrorem increment of the settlement value.” Id.(internal quotation marks and citation omitted).

The court first turned to indirect purchaser plaintiffs’ injunctive relief claim under Section 16 the Clayton Act, 15 U.S.C. § 26. The court noted that plaintiffs sought to enjoin not just any future reverse payment agreements related to Plavix, but went “so far as to request to enjoin Defendants from the possibility of entering into a yet-to-be-determined reverse payment agreement on some yet unidentified drug.” Plavix, 2011 WL 335034, at *4 (emphasis added). In other words, indirect purchasers sought “an injunction preventing the practice of entering into reverse payment agreements.” Id. at *3 (emphasis in original). The court rejected the claim as “too speculative a basis for injunctive relief,” as plaintiffs “provide[d] no factual basis for their claims that there is any kind of threatened violation on the part of Defendants” and “merely speculate[d] that Defendants’ previous behavior and their status as the ‘world’s leading’ pharmaceutical or generic drug makers leads to the assumption that Defendants will engage in future collusive agreements.” Id. at *4.

The court next turned to the indirect purchasers’ claims under various states’ antitrust and consumer protection laws and rejected those claims based on the absence of antitrust injury as found in Kroger. See id. at *5 (indirect purchaser plaintiffs’ “alleged injury – paying ‘artificially inflated prices for Plavix’ – derives from the lack of access to a generic substitute caused by the court-ordered injunctions” and “is not of the type the antitrust laws were intended to prevent”). In reaching the same result as in Kroger, the court noted that indirect purchaser plaintiffs conceded that state courts are guided by federal decisions in interpreting similar state antitrust and consumer protection statutes. Id. The court also relied on a number of cases dismissing state law claims when similar federal claims based on the same allegations were dismissed. See, e.g., id. (citing and quoting, among others, Asahi Glass Co., Ltd. v. Pentech Pharms., Inc., 289 F.Supp.2d 986, 996 (N.D.III.2003) for proposition that “the state antitrust charge falls for the same reasons as the federal, since there is no difference material to this case between the state and federal statutes”).

Finally, the court also dismissed indirect purchasers’ unjust enrichment and restitution claims. Noting that an unjust enrichment claim “hinges on, inter alia, a benefit conferred by a plaintiff upon a defendant,” the court held that “[a]ny payment by Indirect Purchasers for Plavix was not a ‘benefit conferred’ but instead consideration for the patented drug.” Id. at *6.

Federal Court Refuses To Toss Out EEOC Claim That Chrysler Retaliated Against Employees

Hostile Warnings of Discipline and Termination After Complaint of Sex Discrimination Are Enough for Case to Go Forward, Judge Says

MILWAUKEE – Automobile giant Chrysler Group, LLC’s effort to have an U.S. Equal Employment Opportunity Commission (EEOC) claim of unlawful retaliation thrown out of court has failed, the agency announced today. The EEOC has received a February 17, 2011 Decision and Order from District Judge William F. Callahan, Jr., denying Chrysler’s motion for summary judgment. The judge held that the EEOC’s claims of retaliation on behalf of two women employed in the company’s national parts distribution center in Milwaukee should go forward. (EEOC v. Chrysler Group, LLC, E.D.Wis. No. 08-C-1067, Decision & Order, 2/17/2011, D.J. Callahan.)

The claims were brought by the EEOC under Title VII of the Civil Rights Act of 1964 in a lawsuit filed in December 2009. According to the EEOC, one of the women was taken off what the court described as a “coveted position” driving a power sweeper and assigned to more physically demanding work “picking” parts to satisfy a “hot order” in the “back order area” of the warehouse. The EEOC said that when the woman and a coworker complained that a male employee with less seniority should have been assigned to that job, they were accused of “disrupting the workforce” subjected to verbal harassment and threatened with discipline up to and including termination.

Chrysler urged the court to summarily reject EEOC’s claims because the women were neither discharged nor suffered any other tangible loss such as a loss of pay, benefits, or position. According to Chrysler, “the alleged verbal harassment and intimidation is simply not the kind of actionable harm which Title VII contemplates.”

The court rejected that line of reasoning. “An adverse employment action [necessary to sustain a claim for retaliation] need not be tangible,” Judge Callahan wrote. The court then reviewed the circumstances surrounding the statements to the women, finding that “the manner in which [the manager] delivered his message to each woman matters. If he were screaming and pounding his fists on the table while threatening termination, as [the women] testified, this scenario paints a much more hostile and intimidating atmosphere than if [the manager] delivered his message in a normal tone of voice, as he contends he did.”

Because of this controversy, the court concluded, the trial should go forward to determine whether Chrysler’s behavior “would have dissuaded a reasonable worker from making a charge of discrimination.”

The EEOC’s regional attorney in Chicago, John Hendrickson, said, “This is an important decision. It is a firm reminder that the concept of retaliation under the federal employment discrimination laws is a common-sense one. The Supreme Court has said that if an employer responds to a discrimination complaint in a way which would dissuade a reasonable worker from filing a charge, that’s retaliation. The EEOC will move swiftly to stem such actions.”

In addition to Hendrickson, the case is being litigated by Supervisory Trial Attorney Gregory Gochanour and Trial Attorneys Bradley Fiorito and Grayson Walker, all of EEOC’s Chicago District Office. The EEOC’s Chicago District Office is responsible for processing charges of discrimination, administrative enforcement, and the conduct of agency litigation in Illinois, Wisconsin, Minnesota, Iowa, and North and South Dakota, with Area Offices in Milwaukee and Minneapolis.

EPA Issues Final Boiler MACT Rules

On February 23, 2011, following ten years of litigation, the U.S. Environmental Protection Agency (“EPA”) released scaled-back air emission rules for industrial boilers and solid waste incinerators. EPA received over 4,800 public comments after it released proposed boiler and incinerator rules in April 2010, and EPA estimates that the cost to industry to implement the scaled-back rules will be approximately $1.8 billion – half the estimated $3.6 billion cost of complying with the originally proposed rules.

The recently released final rules address hazardous air pollutant (“HAP”) emission standards for industrial, commercial and institutional boilers and process heaters (the Boiler Maximum Achievable Control Techcnology or “Boiler MACT” rule) and commercial and industrial solid waste incineration units (the “CISWI” rule). Industrial boilers and process heaters burn fuels such as natural gas, biomass, coal and oil to produce heat or electricity; CISWIs burn solid waste.

EPA issued the final rules after a federal district court last month denied EPA’s request to further postpone their issuance for an additional fifteen months, and instead extended the court-imposed deadline (originally set at December 15, 2007 and subsequently extended multiple times) for one month – to February 21, 2011. The final Boiler MACT rule affects numerous industries, including paper mills, refineries, and chemical and manufacturing plants.

The Boiler MACT rules create emission limits for mercury, particulate matter and carbon monoxide for all new coal-fired boilers with heat input greater than 10 million Btu per hour and particulate matter emission limits for new biomass and oil-fired boilers. New boilers with heat input below 10 million Btu per hour will be required to undergo a boiler tune-up every two years. For existing boilers, the new rules create emission limits for mercury and carbon monoxide only for coal-fired boilers with input greater than 10 million Btu per hour. EPA did not establish emission limits for other existing boilers. Instead, those boilers must undergo a tune-up every two years.

Industrial boilers at major sources (those facilities that emit ten or more tons per year of a single air toxic or twenty-five or more tons per year of any combination of air toxics) are subject to emission limits for five different HAPs: mercury, dioxin, particulate matter, hydrogen chloride and carbon monoxide. The only exceptions for major source boilers are for natural gas and other “clean fuel” burning boilers and those boilers with heat input capacity below 10 million Btu per hour.

The new CISWI rule sets New Source Performance Standards and emission guidelines for 88 specific commercial and industrial solid waste incineration units. The CISWI rule establishes emission limits for mercury, lead, cadmium, hydrogen chloride, particulate matter, carbon monoxide, dioxin/furans, nitrogen oxides and sulfur dioxide. The affected incinerator units must come into compliance with the new limits by February 2016, at the latest.

The fate of this latest final rule package is uncertain, considering EPA expressed doubt that itcould issue defensible boiler and incinerator rules when it sought an additional fifteen month extension from the federal district court. However, EPA announced that it intends to begin the formal process of reconsidering these final rules, with additional details of the reconsideration process to be released in the near future.

Calculating Interest on Commercial Loans: Recent Legislation Expressly Permits Illinois Lenders to Use the “365/360” Method

Lenders throughout Illinois can breathe a sigh of relief now that Governor Pat Quinn has signed Public Act 96-1421, which amends the Illinois Interest Act to expressly permit use of the “365/360” method of calculating interest on commercial loans.

Leading up to this development, a flurry of class action lawsuits against financial institutions have called into question the legality of the well-established interest computation method, which has been routinely used by commercial lenders “since time immemorial,” according to one Cook County Circuit Court judge. Plaintiffs throughout the state have asserted that commercial promissory notes violate Illinois usury law when they specify that interest will be calculated according to a 360-day year and the actual number of days elapsed (i.e., 365). This claim is rooted in the Illinois Interest Act, which stipulates that interest must be calculated based on a year comprised of 12 calendar months (i.e., 365 days) whenever a promissory note specifies a “per annum” or “per year” interest rate—as virtually all commercial promissory notes do. Plaintiffs have also claimed that using the “365/360” method constitutes common law fraud and violates the Illinois Consumer Fraud Act. Making matters worse for lenders, defendants in mortgage foreclosure cases—lacking any other way to extricate themselves from failing business deals and save their properties—have raised the illegality of the interest calculation method as an affirmative defense.

The economic underpinning of the borrowers’ claims is that use of the “365/360” method results in a higher effective interest rate than the rate stated on the note. For example, if a promissory note establishes the interest rate at 5% per annum, with interest calculated according to a 360-day year and the actual number of days elapsed, then the effective interest rate will be 5.069444%, or 5% x (365/360). That means a borrower will pay an extra $694.44 a year in interest on a $1 million note. While trial court judges in Cook County have sided with the lenders in recent decisions, one downstate class action case resulted in a substantial settlement in favor of the plaintiffs.

Understandably, this rash of litigation put fear in the hearts of commercial lenders throughout Illinois and galvanized the industry to lobby for legislation. The result was Public Act 96-1421, which became law in August 2010 and amended the Illinois Interest Act to provide that “a rate of interest may be lawfully computed when applying the ratio of the annual interest rate over a year based on 360 days.” The act further states that the provisions of the amendment “are declarative of existing law.” Interestingly, however, the sponsor of the bill in the Illinois state senate remarked for the record that the “legislation will not dictate the outcome of any pending [litigation]. That will be up to the individual courts to apply the law.”

While it may be back to business as usual—at least with respect to calculating interest for commercial loans—lenders should take careful note that Public Act 96-1421 only applies to commercial loans and is silent with respect to consumer and residential mortgage loans. Lenders should also consider certain precautions to minimize the risk of future litigation. In addition to clearly setting forth in the loan documents that interest will be calculated on a “365/360” basis, lenders should require borrowers to acknowledge that use of this method will result in an effective interest rate that is higher than the stated interest rate.

Aspartame Class Action Dismissal Affirmed on Statute of Limitations Grounds

On January 28, 2011, the Third Circuit Court of Appeals in an unpublished opinion affirmed the 2008 decision of the District Court for the Eastern District of Pennsylvania to toss the Aspartame class action on statute of limitations grounds. The court of appeals agreed that the plaintiffs could not invoke the equitable doctrine of fraudulent concealment to toll the four-year statute of limitations for antitrust claims. In re Aspartame Antitrust Litig., Case No. 09-1487. Doc # 003110422286, filed 1/28/2011 (hereafter “Op.”).

The class plaintiffs asserted claims under Section 1 of the Sherman Act, 15 U.S.C. § 1, alleging that the defendants had conspired to fix the prices of and allocate the market for Aspartame, an artificial sweetener, since at least January 1, 1993. Op. at 2; see also In re Aspartame Antitrust Litig., No. 2:06-CV-1732-LDD, 2008 WL 4724094, at *1 (E.D. Pa. Aug. 11, 2008). The underlying class action was commenced in April, 2006, making the applicable statute of limitations, April 2002.

Neither of the two named plaintiffs – Nog, Inc. or Sorbee International, Ltd. – purchased any Aspartame product after 2001, with Nog’s last purchase occurring in 1995 and Sorbee’s in 2001. The district court initially had denied a motion to dismiss on statute of limitations grounds, finding that, although plaintiffs’ factual allegations relating to fraudulent concealment were “not robust,” the issue should be decided “on a developed factual record” and allowed the case to proceed to discovery. Op. at 2 (internal quotation marks omitted).

Discovery revealed, however, that neither plaintiff took any steps to investigate its claims. Nog’s president and Rule 30(b)(6) designee testified that Nog purchased roughly $454 worth of Aspartame from Defendant NutraSweet in 1994 and 1995. He further testified that, while Nog believed that “the price [of Aspartame] was out of sight” when it began purchasing the product, no one at Nog complained to NutraSweet, attempted to negotiate a price reduction, or investigated the existence of other suppliers because Nog believed that NutraSweet was the only Aspartame supplier. Op. at 3; see also Aspartame Antitrust Litig., 2008 WL 4724094, at *5 (Nog’s designee testified to belief that NutraSweet “was the only game in town”).

Sorbee’s vice president and Rule 30(b)(6) designee testified that the company purchased roughly $47,500 worth of Aspartame between 1997 and 2001 and similarly denied having undertaken any investigation of the Aspartame market. He disclaimed any knowledge as to whether the company had negotiated the price of the Aspartame it purchased or attempted to obtain Aspartame at a lower price from any other supplier. He was also unable to answer “the most basic questions concerning the Aspartame market; he admitted that he had no understanding of the balance of supply and demand, the fluctuation in the price of raw materials, or the prevailing price tendered by other direct purchasers.” Op. at 3-4; see also Aspartame Antitrust Litig., 2008 WL 4724094, at *5 (noting Sorbee’s designee had “no recollection about the ‘negotiation, price paid, bidding, or process of purchasing Aspartame'”).

Under these facts – and given that the named plaintiffs’ purchases were all outside the limitations period – the district court granted the defendants’ later summary judgment motion, finding that the “complete lack of any diligence by the Plaintiffs precludes them from invoking the equitable doctrine of fraudulent concealment.” Aspartame Antitrust Litig., 2008 WL 4724094, at *6. The district court pointed to “storm warnings” that as a whole put the plaintiffs on inquiry notice and triggered a duty to investigate. Id. at *6. These warnings included (1) plaintiffs’ belief that the price of Aspartame was “out of sight” and that NutraSweet was the sole supplier in the market, (2) the filing of several anti-competition suits in other jurisdictions naming some of the defendants, and (3) a 1993 Harvard study about the conditions of the Aspartame market, all of which “collectively revealed significant barriers to entry and lack of competition in the Aspartame market.” Aspartame Antitrust Litig., 2008 WL 4724094, at *6; Op. at 6-7.

The court of appeals affirmed, holding that, under the foregoing facts, “[e]ven if we assume that defendants fraudulently concealed their anticompetitive conduct, there is simply no evidence to show that plaintiffs exercised the level of due care necessary to toll the limitations period.” Id. at 6. The court also rejected plaintiffs’ argument that “their complete inactivity [was] justified by the sophistication of defendants’ concealment” and that “until there is some outward indication of a price-fixing conspiracy, plaintiffs cannot be expected to do anything at all.” Id.Pointing to the “storm warnings” noted by the district court, the court of appeals found this argument unpersuasive and held, “Although these warnings were not particularly ominous, they certainly required plaintiffs to do something. . . . Instead, both parties sat on their hands. Equity will not excuse such unjustified inactivity.” Id. at 7 (emphasis in original; internal citations omitted)

Employers Beware of Conducting Self-Evaluative Assessments of Compliance with Employment Laws: HR Tip of the Month

A recent case decided by a federal court in Pennsylvania serves as a reminder that a company intent on conducting an internal assessment of its compliance with applicable laws, including wage and hour laws, should carefully consider, in advance of performing that evaluation, its strategy to protect the results from potential disclosure in future litigation. In Craig v. Rite Aid Corporation, 2010 U.S. Dist. LEXIS 137773, a magistrate judge in the Middle District of Pennsylvania considered whether Rite Aid could restrict the plaintiffs’ ability to discover potentially relevant documents on the grounds that the documents were protected by the “self-critical analysis privilege,” a privilege recognized by some courts in limited circumstances “to protect evaluative materials created in accordance with governmental requirements, or for purposes of “‘self-improvement.’”

In Rite Aid, the documents sought to be protected related to the company’s voluntary internal assessment of its compliance with the FLSA, labor laws and existing bargaining agreements, initiated as part of a restructuring program led by a Human Resources executive under the direction of the company’s in-house counsel. The analysis included information-gathering, assessments, drafts, and recommended changes to store operations, all of which was shared with the in- house counsel for the purpose of obtaining legal advice and in anticipation of future FLSA litigation. Rite Aid asserted that the self-critical analysis privilege shielded the documents from production. The Court disagreed, expressing doubt as to the privilege’s validity in the Third Circuit. Even where the privilege had been recognized, the Court found it did not have widespread application where a company voluntarily undertook an internal review of its own practices and procedures. Although ruling that the defendants could not rely on the self-critical analysis privilege to protect from disclosure the challenged documents, the Court left open the possibility that other privileges, such as the attorney work product doctrine and attorney-client privilege, could offer additional protections.

As the number of wage and hour suits alleging failure to pay overtime continues to increase, it is certainly understandable why employers would want to review their payment and classification practices with an aim towards reducing litigation risk. Prior to undertaking such a review, companies should consider how to best protect the materials generated from such an internal assessment from disclosure in future litigation. The role that various individuals (Human Resources, in-house counsel, outside counsel) should play in the evaluative process, as well as the potential application of recognized privileges to the process, are factors which should be explored.

Caution: Discussions between Counsel and Client during a Deposition May Not Be Privileged

The morning session of the deposition could not have gone better. Defense counsel has not asked too many tough questions and both plaintiff and her counsel are pleased with her answers – except for one. During the lunch break, after discussing their respective plans for the upcoming holiday weekend, plaintiff asks her counsel about one of her answers. She is troubled that, upon reflection, her answer may not have been entirely accurate. Counsel’s immediate response is to assure plaintiff not to worry. His next instinct is to talk through the question and answer with his client to determine whether a clarification is necessary. But, should he? He sees no reason not to do so, as he firmly believes such discussion is within the attorney-client privilege. It is also necessary, not to coach the witness, but to ensure an accurate record. So, counsel and client discuss the answer in detail and determine that plaintiff’s response is, in fact, misleading. Following the lunch break, plaintiff’s counsel interrupts defense counsel’s first question and informs him that plaintiff wishes to amend one of her prior answers. Upon hearing the “new” answer, defense counsel asks plaintiff to describe, in detail, her discussions with her counsel during the lunch break. Plaintiff’s counsel jumps out of his seat, objects and directs his client not to answer on privilege grounds. Does plaintiff have to disclose the subject of her lunchtime conversation with her counsel or is it privileged? In the federal court in New Jersey, such conversations during a deposition break appear to be fair game for questioning and are not considered privileged.

This issue recently arose in Chassen v. Fidelity Nat’l Fin., Inc., Civ. Action No. 09-291 (D.N.J. July 21, 2010) (“Letter Order”). There, Magistrate Judge Salas determined that communications between client and counsel during a break in a deposition are not privileged and may be explored during the deposition, unless the discussion involves issues of privilege. According to Magistrate Judge Salas:

“Defendants have a right to explore whether the discussions counsel had with the Plaintiff during the recess may have influenced her testimony, thus interfering with the fact-finding goal of the deposition process.” Id. at 2. In a Memorandum and Order filed on January 13, 2011, Judge Sheridan agreed.

The Federal Rules of Civil Procedure do not directly address this issue. Fed. R. Civ. Pro. 30(c)(1) provides that deposition testimony should proceed as if it were trial testimony. Thus, the court in Hall v. Clifton Precision, 150 F.R.D. 525 (E.D. Pa. 1993), a case relied upon extensively by Magistrate Judge Salas, found that counsel may not consult with a client at any time after the start of the deposition. “‘During a civil trial, a witness and his … lawyer are not permitted to confer at their pleasure during the witness’s testimony … The same is true at deposition.’” Letter Order, at 1, quoting Hall, 150 F.R.D. at 528.

In Chassen, Deborah Hoffman, a proposed class representative, testified at deposition that she would not be available to attend the trial in the matter because of work. As a proposed class representative, Mrs. Hoffman’s availability to appear at the trial was relevant to her suitability to represent the class. A few moments later, the parties took a break so that the videographer could change tapes. When the deposition resumed, defense counsel asked Mrs. Hoffman, “[d]id you discuss your testimony you gave this morning with your lawyers during the break?” She responded, “Yes.” Defense counsel next asked Mrs. Hoffman to describe the discussion, which drew an objection from plaintiff’s counsel and a direction not to answer. During a brief colloquy, plaintiff’s counsel argued that, “[t]here was no question outstanding when we took the break, and counsel is allowed to consult with [a client] during a break in deposition,” under those circumstances. During another colloquy later in the deposition, plaintiff’s counsel admitted that, “I disclosed my mental impressions and opinions about her testimony” during the break. After defense counsel concluded his questioning, plaintiff’s counsel then asked several questions regarding Mrs. Hoffman’s availability to testify at trial. This time, under questioning by her counsel, Mrs. Hoffman testified that she could attend the trial as required.

Following the deposition, defense counsel filed an application with Magistrate Judge Salas seeking an order permitting defendants to question Mrs. Hoffman about her discussion with her counsel during the break in the deposition. Magistrate Judge Salas held that “counsel and witness are prohibited from engaging in private, off-the-record conferences during any breaks in a deposition, except for the purpose of deciding whether to assert a privilege.” Letter Order, at 1. If such conferences occur, the attorney taking the deposition is entitled to “inquire about the specific content of those communications to ascertain whether any witness-coaching has occurred.” Id. at 1-2; see also Hall, 150 F.R.D. at 532.

In plaintiff’s brief opposing defendants’ application, counsel argued that Hall is not controlling and, in fact, has been subject to much disagreement in other districts. Magistrate Judge Salas rejected plaintiff’s argument, finding that Hall was adopted by the District of New Jersey in Ngai v. Old Navy, Civil Action No. 07-5653, 2009 U.S. Dist. LEXIS 67117 (D.N.J. July 31, 2009). In Ngai, Magistrate Judge Shwartz, relying on Hall, found that text messages exchanged during a deposition between defense counsel and the deponent, who were in different locations, violated Fed. R. Civ. Pro. 30 and were not protected by the attorney-client privilege. Applying Hall, Magistrate Judge Salas held that “Defendants will be permitted to question Mrs. Hoffman about the communications between her and counsel during the break where Mrs. Hoffman admitted she spoke to counsel about her testimony.” Letter Order, at 2.

Plaintiff appealed the decision to Judge Sheridan who focused on two competing issues: (1) “whether the attorney impermissibly ‘coached’ Ms. Hoffman skewing the truthfulness of her testimony”; and (2) “whether such an attorney-client communication is privileged, and should remain confidential despite the coaching (if any).” Memorandum/Order at 1. In attempting to resolve these potentially conflicting positions, Judge Sheridan offered to hold an in camera hearing with plaintiff and her counsel to determine whether the discussions during the deposition were protected by the attorney-client privilege. After both parties rejected this suggestion, Judge Sheridan affirmed Magistrate Judge Salas’s decision and ordered Mrs. Hoffman to be deposed regarding her intra-deposition discussion with her counsel.

Unlike the Federal Rules of Civil Procedure, the New Jersey Court Rules directly address this issue, at least in part. The Court Rules expressly forbid a lawyer from consulting with a client “during the course of the deposition while testimony is being taken” except with regard to issues involving (a) privilege; (b) confidentiality; or (c) a limitation created by a previous order of the court. R. 4:14-3(f). There is some debate, however, as to the scope of the phrase “while testimony is being taken” and whether it is intended to extend the prohibition to breaks during the deposition. The comment to the Court Rule takes the position that the Rule applies only in the deposition room and “clearly does not address consultation during overnight, lunch, and other breaks.” Id., comment 6. However, in In re PSE&G Shareholder Lit., 320 N.J. Super. 112, 116-118 (Ch. Div. 1998), the court, after citing to the comment to the Rule, nevertheless imposed an order prohibiting consultation between lawyers and clients during deposition breaks.

In practice, an attorney defending a deposition needs to be aware that any discussions he/she has with a client during a break may not be privileged. Both the Chassen decision and R. 4:14-3(f) permit counsel to discuss with a client during a deposition issues pertaining to privilege (i.e., whether particular questions implicate privileged communications). However, a witness may be required to testify regarding any other substantive discussions with counsel during a break in the deposition. This is particularly true in cases pending in New Jersey federal court in light of the Chassen decision. Following Chassen, attorneys who discuss substantive matters with a client during a deposition break does so at their peril.

Third Party Retaliation Claims under Title VII, the Discovery Rule under the NJLAD, and the Self-Critical Analysis Privilege under the FLSA

Employers conducting business in the New Jersey / New York markets should take note of several recent employment-related decisions. In Thompson v. North American Stainless, LP, 2011 U.S. LEXIS 913 (Jan. 24, 2011), the United States Supreme Court ruled that an employee who claimed he was fired because his fiancée filed a sex discrimination charge against their mutual employer could pursue a retaliation claim under Title VII of the Civil Rights of 1964. In Henry v. New Jersey Department of Human Services, 2010 N.J. LEXIS 1260 (Dec. 10, 2010), the New Jersey Supreme Court held that a terminated employee should have the opportunity to avail herself of the “discovery rule” and demonstrate that she acted reasonably in pursuing her discrimination claim in order to avoid a dismissal on statute of limitations grounds. In Craig v. Rite Aid Corporation, 2010 U.S. Dist. LEXIS 137773 (M.D. Pa. Dec. 29, 2010), discussed in the HR Tip of the Month, the Middle District of Pennsylvania declined to recognize the “self-critical analysis” privilege to protect a company’s voluntary internal assessment of its compliance with the Fair Labor Standards Act (FLSA), labor laws and existing bargaining agreements.

Thompson v. North American Stainless, LP

Eric Thompson and his fiancée were both employed by North American Stainless (NAS). Three weeks after being notified by the Equal Employment Opportunity Commission (EEOC) that Thompson’s fiancée had filed a charge of discrimination, NAS fired him. Thompson then filed a charge with the EEOC and later filed suit in federal court claiming that NAS fired him in order to retaliate against his fiancée.

The district court granted summary judgment to NAS, holding that Title VII did not permit third party retaliation claims. An en banc panel of the Sixth Circuit affirmed, concluding that because Thompson did not engage in any statutorily protected conduct, he was not included in the class of persons for whom Congress created a retaliation cause of action. The United States Supreme Court granted certiorari, and in an 8-0 decision, reversed the appellate panel.

The Court considered two questions: first, whether NAS’s firing of Thompson constituted unlawful retaliation; and second, did Title VII grant him a cause of action. The Court had little difficulty answering the first question in the affirmative, finding that if the facts alleged by Thompson were true, then his termination violated Title VII. Relying on past precedent, Justice Scalia, writing for the Court, observed that Title VII’s anti-retaliation provision, unlike the substantive provision, was not limited to discriminatory acts that affected the terms and conditions of employment. Rather, it prohibited any employer action that might dissuade a reasonable worker from making or supporting a charge of discrimination. The Court thought it obvious that a reasonable worker might be dissuaded from engaging in protected activity if she knew that her fiancé would be fired.

Regarding the second question, the Court addressed whether “aggrieved” under Title VII should be construed in a matter consistent with Article III standing, which requires only injury in fact caused by the defendant and remediable by the court. Justice Scalia concluded that “aggrieved” must be construed more narrowly. He also rejected the position advanced by NAS – that a “person aggrieved” refers only to the employee who engaged in protected activity. The Court adopted the “zone of interests” test, holding that “aggrieved” under Title VII enabled a suit by any plaintiff with an interest “‘arguably [sought] to be protected by the statutes.’” Applying that test, the Court concluded that Thompson fell within the zone of interests protected by Title VII, as (i) he was an employee of NAS, (ii) the purpose of Title VII was to protect employees from unlawful actions, and (iii) he was not an accidental victim of retaliation (but rather injuring him was NAS’s way of punishing his fiancée).

Henry v. New Jersey Department of Human Services

In April 2004, Lula Henry (Henry), who held a Master’s degree, was hired by Trenton State Psychiatric Hospital at an entry-level nursing position. In late Spring/early Summer 2004, Henry developed initial concerns that racial discrimination explained why she was hired at an entry level position, though her concerns were uncorroborated by any firm evidence. In late Summer 2004, Henry questioned her classification and requested reclassification; in response she remained assigned to her entry-level position. In November 2004, Henry resigned from Trenton State in order to take a position with another entity.

In the Spring of 2006, Henry was informed by a union representative that a Nigerian nurse had contested the placement of a less qualified Caucasian nurse and that there were widespread claims of racism at Trenton State. Henry also learned that a Caucasian nurse with similar credentials to hers was immediately hired into a higher job classification, contrary to what she was told about her placement. Henry claimed that prior to learning this information she had no factual basis to substantiate her earlier suspicions of race-based discrimination.

On July 24, 2007, Henry filed a complaint alleging racial discrimination in defendants’ hiring practice and retaliation in violation of the New Jersey Law Against Discrimination (NJLAD). Defendants moved for summary judgment based on the two-year statute of limitations applicable to NJLAD claims. The trial judge granted the motion, determining that Henry’s action accrued in 2004 and was not tolled by the discovery rule. The Appellate Division affirmed, and the Supreme Court granted certification. At issue was the impact of the “discovery rule” on NJLAD claims. That rule “delays the accrual of the action until the plaintiff ‘discovers, or by exercise of reasonable diligence and intelligence should have discovered, facts which form the basis of a cause of action.’”

Henry argued that her NJLAD claims did not accrue until 2006 because that is when she had some measure of corroboration of her concerns. Defendants argued that the discovery rule should not apply to NJLAD cases, but that even if it did, the rule would not be appropriate under the facts of this particular case.

The Court explained that the discovery rule is a well-established equitable doctrine that is applied when the statute of limitations would cause unnecessary harm without advancing its purpose. However, the Court did not find that there was an equitable basis on which to extend the statute of limitations on Henry’s retaliation claim, because that claim must have accrued at or before the date of her resignation in November 2004. As a result, the Court affirmed the Appellate Division’s dismissal of the retaliation claim.

The Court reached a different result on Henry’s discrimination claim. Noting its approval of the use of the discovery rule in LAD cases “when and where appropriate,” the Court held that this case might present such a circumstance. Henry had initial concerns in 2004 about her hiring and classification, but the reason she was given in response had nothing to do with racial discrimination. That, according to the Court, may have led her not to pursue the issue, thereby requiring the tolling of her cause of action. The Court held Henry was entitled to assert that she did not have reasonable suspicion of racial discrimination, even by the exercise of reasonable diligence, until 2006 when, among other things, she learned that less qualified Caucasian nurses were hired into advanced positions and she was told by her union representative about other claims of racial discrimination. Under these circumstances, the Court decided that Henry should get a hearing at which she could show that she acted reasonably in pursuing her claim of discrimination.

Delaware Chancery Court Provides Further Clarification as to When the “Entire Fairness” Standard of Review is Appropriate and How It Will Be Applied

On January 14, 2011, the Delaware Chancery Court issued an opinion in In re John Q. Hammons Hotels Shareholder Litigation that a merger transaction in which a controlling stockholder received consideration different than that received by the minority stockholders met the “entire fairness” standard. This opinion followed the Court’s determination in October 2009 that “entire fairness,” was the appropriate standard of review in this case.

Factual Background

The lawsuit arose following a going private transaction involving the merger of John Q. Hammons Hotels, Inc., a publicly traded Delaware corporation, with and into an unaffiliated third party. In early 2004, Mr. Hammons (the Chairman, CEO and controlling stockholder of JQH) informed the Board that he had begun discussions with third-parties regarding a potential sale of JQH or his interest in JQH. The Board thereafter formed a special committee of the Board to evaluate and negotiate a proposed transaction on behalf of the minority stockholders and to make a recommendation to the Board regarding any such transaction.

After nine months of negotiations and deliberations between potential acquirors and the special committee, the Board (without the vote of Hammons who recused himself from the Board vote) approved an offer from an unaffiliated third party for $24 per share for shares of Class A common stock. JQH stock had been trading at $4 – $7 per share prior to the rumors of the merger. Pursuant to the terms of the merger agreement, the merger was conditioned on a waivable requirement that the merger agreement be adopted by the affirmative vote of a majority of the shares of Class A common stock held by unaffiliated holders. At a duly held stockholder meeting, more than 72% of the outstanding shares of Class A common stock voted to adopt the merger agreement.

After the consummation of the merger, a group of minority Class A stockholders brought a class action suit against Hammons for, among other things, allegedly breaching his fiduciary duties by negotiating an array of private benefits for himself that were not shared with the minority stockholders.

Standard of Review/Ruling

In an earlier ruling, the Court determined that “entire fairness” is the proper standard of review for this transaction, and not the less onerous business judgment rule favored by the defendants. The Court noted that the business judgment rule would have been appropriate but for certain procedural deficiencies in the approval of the transaction. The Court stated that in a case where the controlling stockholder and the majority are in a sense “competing” for portions of the consideration, there must be “robust procedural protections in place to ensure that the minority stockholders have sufficient bargaining power.”

The Court ruled that the business judgment rule would have applied if the merger was (1) recommended by a disinterested and independent special committee of the board and (2) approved by a majority of all minority stockholders by a vote that is not waivable. In Hammons, the transaction was approved by a majority of the minority of stockholders voting on the matter, but such vote could have been waived by the special committee.

On the first factor of the “entire fairness” analysis, i.e., “fair dealing”, the Court based its opinion on the following factors:

  1. the special committee that negotiated and approved the transaction satisfied the threshold requirements for independence (e.g., it retained independent and skilled legal and financial advisors, held dozens of meetings over the 9 month period leading up to the merger and negotiated with several interested parties, all resulting in a transaction in which the unaffiliated Class A stockholders ultimately received $24 per share, an 85% increase over the initial offer);
  2. members of the special committee were highly qualified and had extensive experience in the hotel industry;
  3. members of the special committee understood their authority and duty to reject any offer that was not fair to the unaffiliated stockholders as evidenced by their rejection of the initial offer from a separate third party;
  4. evidence at trial demonstrated that the members of the special committee were thorough, deliberate and negotiated at arm’s length with both competing potential acquirors over a nine month period to achieve the best deal for the minority stockholders.

Moreover, as to the plaintiffs’ claim that Hammons coerced or strong-armed the special committee, the Court noted that the plaintiffs provided no credible evidence at trial demonstrating any improper conduct on the part of Hammons and stated that “plaintiffs have not come close to showing the Merger resulted from an unfair process.”

On the second factor of the “entire fairness” review, i.e., “fair price”, the Court analyzed the testimony made by the valuation experts from both sides. Ultimately, the Court found the defendants’ valuation expert to be more credible, believable and well-reasoned.

Finally, as to the issue of whether Hammons breached a fiduciary duty to the minority stockholders, the Court found that because he did not participate in the approval of the merger as a director, he was not on both sides of the merger, he did not make an offer as a controlling stockholder and he did not engage in any conduct that adversely affected the merger consideration obtained by the unaffiliated minority stockholders, he did not breach any fiduciary duties to the minority stockholders.

For companies with controlling stockholders that engage in M&A transactions, this case illustrates the importance of establishing an independent and disinterested special committee of the board and giving the committee the power to negotiate the transaction.  In addition, potential targets should note the importance of procedural safeguards in approving transactions, such as a non-waivable vote of a majority of all of the minority stockholders. Such safeguards will help boards of directors preserve the protections afforded by the business judgment rule and help to avoid challenges to their decisions by disgruntled stockholders.

High Court Extends Retaliation Protection to Employee’s Family Members

On January 24, 2011 the Supreme Court reversed the Sixth Circuit in Thompson v. North American Stainless, LP and extended Title VII retaliation protection to family members of employees who engage in protected activities. The plaintiff in Thompson was fired within a matter of weeks after his employer received notice that his fiancée had filed a sex discrimination complaint with the EEOC. Mr. Thompson brought suit against the employer in Federal District Court claiming that he was fired in retaliation for his fiancée’s EEOC charge. The District Court dismissed the case on summary judgment on grounds that Title VII’s anti-retaliation provision does not cover “third party retaliation” claims. The District Court relied on well-established precedent requiring that a retaliation plaintiff first show that he or she engaged in protected activity. Since Mr. Thompson had not engaged in protected activity, the District Court concluded he was unable to establish a critical element of a retaliation claim. The Court of Appeals for the Sixth Circuit affirmed.

In a surprising decision, the United States Supreme Court unanimously reversed and held that while Mr. Thompson did not personally engage in a protected activity, he experienced the type of harm that Title VII’s anti-retaliation provision seeks to prevent. The Court fell back on its earlier reasoning in Burlington Northern and Santa Fe Railroad Company v. White, 548 U.S. 53 (2006), where it noted that Title VII’s anti-retaliation provision “must be construed to cover a broad range of employer conduct,” and held that the seminal test for retaliation is whether the employer’s action “might have dissuaded a reasonable employee from engaging in the protected activity.” Applying this logic, the Court concluded that a reasonable employee might be dissuaded from engaging in protected activity “if she knew her fiancée would be fired.” Although the Court stopped short of identifying a fixed class of relationships that will give rise to a retaliation claim, it attempted to narrow the reach of its decision by noting, “we expect that firing a close family member will almost always meet the Burlington standard, and inflicting a milder reprisal on a mere acquaintance will almost never do so…”

Despite the Court’s attempt to narrow its ruling, employers should be aware that the practical effect of Thompson is the creation of a new class of plaintiffs who will have standing to maintain a retaliation claim based on the protected activity of family members.

Developer Must Pay Prevailing Wages for Privately Financed Public Improvements

California Labor Code sections 1720 et seq. (the Prevailing Wage Law) (“PWL“) require employers engaged in public works projects to pay the prevailing wage to their employees if the project is “paid for in whole or in part out of public funds.” The Second Appellate District Court of Appeal recently ruled that private developers must pay prevailing wages for the construction of all public improvements in connection with a development project if public funds are used to finance any part of the public improvements, even if the remaining public improvements are paid for with private funds. The decision, if it stands, subjects developers to increased project costs not previously anticipated.

Background & Summary

In Azusa Land Partners v. Department of Industrial Relations, 191 Cal.App.4th 1 (2010), the developer proposed a master planned 500+ acre development that included up to 1,200 homes, 50,000 square feet of commercial, and public infrastructure and improvements. To obtain the City of Azusa’s approval, the developer agreed to public infrastructure and improvement work, including construction of a public school and park, freight under-crossings, sanitation district facilities, and street, bridge, storm drain, sewer, water, utilities, park and landscaping improvements. The public improvements were to be funded by Mello-Roos bonds which were approved for indebtedness of up to $120 million to be incurred by the Community Facilities District (“CFD”). The developer was required to construct the public improvements even if the actual costs exceeded the amount of bond funds sold by the CFD for the improvements. The total cost of the public improvements was approximately $146 million but the CFD only sold $71 million in bonds, leaving the developer on the hook for the remaining $75 million.

A third party requested an inquiry into whether the entire project was a “public work” subject to the PWL. “Public works” is broadly defined by the PWL and includes work “paid for in whole or in part out of public funds.” The Department of Industrial Relations (the “Department”), which was charged with the review, determined that even though the project was only partly funded with public funds, the entire project was nevertheless a public work and subject to the PWL. However, the Department also found prevailing wage did not have to be paid on the entire project because the project met an exemption in the PWL (Labor Code section 1720(c)(2)) that required prevailing wage only for those public infrastructure improvements in the project required as a condition of regulatory approval. Accordingly, the developer had to pay prevailing wage for all those public improvements even though some were in fact privately funded due to the shortfall in CFD funding. The developer appealed, but the Department upheld its initial determination, meaning prevailing wage had to be paid for all of the public improvements.

The developer filed a petition for writ of mandate in superior court and the trial court denied the petition. On appeal, the developer argued it should only be required to pay prevailing wage for the public improvements actually financed with the Mello-Roos bond proceeds and not for privately funded infrastructure improvements for which no bond proceeds were received – the developer was seeking a more narrow interpretation under section 1720(c)(2) of the PWL.

The Court of Appeal disagreed with the developer. First, the court held that under the PWL, the entire project was a “public work” because the project was funded in part through public funds. Second, the court held that under the PWL, the Mello-Roos bond proceeds constituted public funds. Finally, the court rejected the developer’s argument that even if the project was subject to the PWL, it should only be required to pay prevailing wage for the public improvements that were built with Mello-Roos bonds, and not any public improvements constructed at private expense. Instead, the Court of Appeal agreed with the Department and the trial court, interpreting the PWL to apply to all public improvements, regardless of whether or not they were paid for with Mello-Roos bonds.


Assuming the court’s holding stands (it will likely be appealed), the developer will be required to pay prevailing wage on the entire $146 million cost for the project’s public improvements, including the $75 million in public improvements which it privately financed.

Going forward, developers likely must pay prevailing wage on the entire build-out of public improvements, even if the development is mostly privately financed and privately owned. In this flagging economy, the decision is a further burden on an already stagnant development sector.

Civil Justice Reform – Law Firms An Inconvenient Forum – Reining In E-Discovery In The United States

The costs of litigation, particularly for large companies, has continued to skyrocket as electronic discovery moves from the fringe of litigation to center stage. Long, protracted e-discovery disputes have become more common, and occur in an environment where pitfalls are questionably defined and liability can be daunting. In fact, a recent survey of attorneys conducted by the ABA demonstrated that a substantial majority of the interviewed attorneys agreed that e-discovery is not only overly burdensome, but has also disproportionately increased the cost of litigation. Cases are settled because of anticipated cost rather than on the merits of the action, and many lawsuits are simply not brought from fear of the cost of litigation. To preserve the function of the civil justice system, something must be changed.

Cooperation is the cornerstone to discovery, and e-discovery is no exception. However, in many cases the parties cannot agree on all aspects of e-discovery, and courts have been forced to intervene. The results are not always consistent, and litigants may find themselves in trouble, despite their best efforts to meet their obligations. Worse still, litigants may find themselves targeted by unscrupulous e-discovery practices by an opponent that are designed solely to drive up costs or convince the court to issue sanctions.

Changes to the e-discovery practice in the U.S. are needed to discourage abuse of the discovery system, to keep the costs and liabilities of e-discovery reasonable, and to provide surer footing to parties as they navigate e-discovery in any given case. The source of ambiguity and uncertainty for litigants originates from the duty to preserve, though, more specifically, when that duty arises and what scope of preservation the duty requires. Litigants are often required to make these determinations when little is known about the nature of the actual claims that have not yet been filed. Add to this the threat of sanctions for failure to appropriately interpret one’s duties, and litigants find themselves in uncertain and perilous terrain. Even the grounds on which a court will issue game-changing sanctions vary in different jurisdictions, creating more uncertainty.

The field of e-discovery could be notably improved by providing clear and uniform guidance on the events that trigger a party’s duty to preserve documents as well as limiting and delineating the appropriate scope of that duty, and by explicitly proscribing the type and limits of sanctions that are available for specific types of conduct relating to e-discovery. Each of these subjects is addressed separately, below.

Triggering The Duty To Preserve

Scores of recent articles have been published to address issues relating to when a defendant’s duty arises to preserve documents for litigation. The sheer volume of literature that addresses the issue attests to the fact that the duty is neither clear nor intuitive. Business defendants can neither function nor thrive in such ambiguity; these entities can generate incredible volumes of electronically stored information (“ESI”) each day, and need specific guidance regarding what of this mass of information must be preserved, when that duty arises, and for how long the data must be kept. Currently, no bright-line rule exists that provides litigants clear guidance as to when their duty to preserve first arises.

Federal courts have generally agreed that the duty to preserve is triggered when litigation is initiated, is reasonably anticipated, or is reasonably foreseeable.1 Although there seems to be common acceptance of phrases such as “reasonable anticipation of litigation” or “reasonably foreseeable litigation,” litigants would find a clear, bright-line standard more useful – for example, triggering the duty when litigation is “reasonably certain,” or a similar phrase that provides litigants with a simpler cue for initiating their duty to preserve and issue litigation holds. Reducing the guesswork that is required by litigants in discerning the start of this duty would also reduce the frequency of lost documents and resulting sanctions. Generally, discovery would run smoother, and litigation could achieve the goals it was created to achieve.

When litigants are forced to interpret vague notions like “reasonably anticipated” litigation, they may well end up issuing holds far earlier than is necessary, or, as a complete waste, issuing them for a situation where litigation does not result. Conversely, months or years after issuing a hold, a court may determine that the hold was issued too late and issue sanctions for information that was not preserved. The shift to reasonable certainty provides a clearer articulation of the triggering of the duty to preserve and ensures that fewer complications will arise later, and discovery will proceed more smoothly.

Limiting The Scope Of E-Discovery

Even if a litigant has a clear understanding of when the duty to preserve is triggered, knowing what to include in a hold can be far more daunting and challenging. It is unlikely that the original drafters of the rules relating to discovery scope ever imagined the unparalleled volume of electronic documents that can be generated by a company. With only phrases like “reasonably related” and “likely to lead to discoverable information” as guidance to what should be preserved, litigants are left to issue these sweeping holds when they know very little about the “reasonably anticipated” lawsuit they are facing, particularly in jurisdictions that require only notice pleading. Include too much in a hold, and you must pay the potentially hefty price of reviewing and culling the additional irrelevant material; include too little or fail to include a single computer or custodian of records in your search, and sanctions may well follow. In fact, some litigants issue overly broad demands for preservation for the express purpose of later pursuing ancillary litigation against the preserving party for any perceived failures, regardless of how slender the relevance of the unpreserved information might be.

The scope of a litigation hold will vary in each case and is dependent on the specific claims raised in the case. However, baseline rules detailing a general framework of the minimum, reasonably expected scope of preservation would give initial guidance to parties and allow them to demonstrate their good-faith efforts to comply. This would allow the preserving party to meet its obligations in the early and unclear stages of litigation (or anticipation thereof) without fear of sanctions arising later. Furthermore, a minimum preservation standard would provide parties with a starting point from which to cooperatively build the scope of preservation for a specific case, and would place the onus of seeking a broader scope of preservation on the requesting party.

However, when attempting to negotiate an expansion of the minimum scope of preservation, litigants should not feel free to demand the stars and sky. Proportionality is key to efficient and effective discovery practice.2 As counsel for large corporations will attest, even a modest increase in the scope of preservation can cost hundreds of thousands of dollars, and the impact of requesting an expansive scope of preservation is not felt by the requesting party. The cost of e-discovery can quickly surpass the highest possible value of a judgment in a given case. The Seventh Circuit‘s Electronic Discovery Pilot Program3 acknowledges this problem in Principle 1.03 of its general principles, noting that “The proportionality standard set forth in Fed. R. Civ. P. 26(b)(2)(C) should be applied in each case when formulating a discovery plan. To further the application of the proportionality standard in discovery, requests for production of ESI and related responses should be reasonably targeted, clear, and as specific as practicable.”

Proportionality, however, is often difficult to ascertain in a given lawsuit. Therefore, the most reasonable way to provide a clear and uniform approach to the problem of proportionality would be to set a cost-threshold at which point the burden of paying for additional collection and preservation of ESI shifts to the requesting party. If a party meets the preservation guidelines described above, but the opposing party requests the preservation of more information, at some point, that party should be required to pay for the additional cost of searching for and preserving that information. A threshold of, for example, $15,000 before shifting the cost-burden would encourage parties to request preservation and production in a focused and calculated way, then determine whether the value of additional information would be worth the additional request. This would reduce the cost and burden to parties generally, while increasing the accuracy and use of strategy in discovery, without limiting a party’s access to justice. Proportional and well-defined discovery scope will go a long way to improving the current e-discovery problems in civil litigation.

Providing Clear Guidance On Sanctions In E-Discovery

In light of the ambiguity and uncertainty that currently pervades the e-discovery field, it is no surprise that sanctions related to e-discovery are on the rise. Sometimes years after a litigant issued its holds on shaky “anticipated litigation” and has preserved what it thought appropriate, a court will be asked to review the process employed by the litigant in preserving its documents. And, courts have not been consistent when deciding what types of conduct merit sanctions. When so little guidance exists on how to conduct e-discovery, adding additional threats of undefined sanctions for unspecified behavior can expose a party to liability they never imagined.

Typically, severe sanctions such as adverse inference instructions, default judgment, or striking pleadings are reserved for bad faith conduct. However, a recent federal opinion from the Southern District of New York sanctioned several parties for “gross negligence” stemming from their perceived failures to issue timely holds and preserve documents by issuing an adverse inference instruction regarding “missing” documents to the jury.4 In contrast, other courts have noted that negligence is simply not grounds for issuing such severe sanctions in most jurisdictions.5 Before issuing severe sanctions, courts should be required to find intent to prevent the use of ESI in litigation, rather than focusing on every possible inadvertent shortcoming in a party’s preservation efforts.6

Furthermore, courts must shift their focus away from the minutia of every step taken by a litigant to preserve data, and instead analyze the proportionality and sufficiency of the data that was preserved and produced, as well as the litigant’s overall good-faith effort to preserve. Otherwise, courts lose sight of what is truly at issue in the litigation. The court that sanctioned parties for “gross negligence” gave little regard to the fact that much of the “lost” data was duplicated in the documents produced by other parties, and penned only four paragraphs in an opinion that exceeds 40 pages to discuss the actual relevance of the allegedly lost documents.7 There was no suggestion that parties were unable to prepare their cases resulting from these shortcomings.

By ignoring the sufficiency of the preserved data and the overall good-faith efforts to preserve, courts seem to lose sight of the forest by focusing on the individual trees. The most important question should be whether a party has cooperated in a good-faith manner and made reasonable efforts to preserve and produce the material the opposing party requires to formulate and prepare their case, not whether every single quantum of data was preserved. Until courts shift their focus accordingly, the U.S. civil justice system will continue to creep closer to a Kafka-esque bureaucracy in which substance and utility are overshadowed by procedure.

Regulating electronic discovery on the issues surrounding preservation will provide certainty and predictability to litigants and ensure that good-faith efforts continue to be the key to functional discovery. A clear guide to the origin of the duty to preserve, the reasonable scope of preservation, and the repercussions for intentional failures is necessary to modernize the discovery process and encourage litigants to cooperate and focus their efforts to most efficiently resolve the disputes at issue.


Court Approves Disgorgement of Profits from Anticompetitive Behavior in Electricity Market

On February 2, 2011, the U.S. District Court for the Southern District of New York affirmed the right of the Department of Justice (“DOJ”) to seek disgorgement of profits for a violation of the Sherman Act. This case, involving the electric power industry, marks the first decision regarding a federal district court’s power to order disgorgement as a remedy for an antitrust violation under the Sherman Act. Click here to read the Court Order.

The case arose out of allegations that KeySpan Corporation (now part of National Grid USA), an electricity generator, manipulated electricity prices in the New York City area. According to the complaint filed by the DOJ’s Antitrust Division, KeySpan and a financial services company entered into a financial swap agreement in January 2006, giving KeySpan an indirect financial interest in the sale of generating capacity by its largest competitor in the New York City market. This financial interest had the anticompetitive effect of incentivizing KeySpan to withhold significant generating capacity from the retail auctions while profitably bidding capacity at the price cap, despite the addition of significant new third party generating capacity in New York City that otherwise likely would have caused prices to drop. According to the DOJ, this arrangement led to higher capacity prices in New York City and, in turn, higher electricity prices for consumers than would have prevailed otherwise, thereby violating Section 1 of the Sherman Act.1 The DOJ calculated that KeySpan earned approximately $49 million in net revenues under the swap.2 Interestingly, the Federal Energy Regulatory Commission (“FERC”) had previously investigated the same conduct and concluded that KeySpan’s actions did not violate its market manipulation rules.

In February 2010, the DOJ announced a settlement with KeySpan providing for disgorgement of profits and requiring KeySpan to pay $12 million to the U.S. Treasury. The DOJ filed a proposed consent decree with the federal district court, as required by the Antitrust Procedures and Penalties Act (the “Tunney Act”). This was the first time the DOJ had ever pursued disgorgement as a remedy for a Sherman Act antitrust violation. Subsequently, the New York State Public Service Commission (“PSC”) filed comments with the district court objecting to the DOJ settlement, arguing that $12 million was far too small an amount as it was not commensurate with KeySpan’s wrongful gains or the total harm to consumers, and that the settlement proceeds should be returned directly to consumers that were harmed by KeySpan’s anticompetitive behavior. Meanwhile, several private class action lawsuits were filed against KeySpan, alleging violations of the Sherman Act and New York state law.3

Judge William H. Pauley III, in granting the DOJ’s motion for entry of the consent decree, held that district courts have the authority, as part of their inherent equitable powers, to order disgorgement of profits to remedy a Sherman Act violation, and that disgorgement is consistent with the goals of remedies in antitrust cases, which include depriving defendants of the benefits of their anticompetitive conduct and deterring similar conduct in the future. The Court found disgorgement to be particularly appropriate in the present case because the anticompetitive conduct had ceased (the swap had expired) and, unlike in many other antitrust actions, there were no assets to be divested. Thus, absent disgorgement, the DOJ would be without recourse to remedy the antitrust violation.

Responding to the New York PSC’s concerns, the Court noted that the primary purpose of disgorgement is not to compensate victims but to deprive a wrongdoer of its ill-gotten gains, hence the disgorgement amount should be measured against KeySpan’s net revenues under the swap, not the estimated harm to New York City electricity consumers. Moreover, in the context of a settlement that avoids the need for a trial, it is unrealistic to expect a disgorgement figure equal to full damages, the Court explained, and the $12 million amount, representing 25% of KeySpan’s net revenues under the swap, was reasonable. Judge Pauley also noted that while direct payment of the disgorged proceeds to consumers might be optimal, this could violate the filed-rate doctrine,4 and payment to the U.S. Treasury was simpler and served the public interest.

This case demonstrates the U.S. antitrust authorities’ willingness to scrutinize and challenge potentially anticompetitive conduct arising out of complex commercial arrangements even where other federal or state regulators have looked at the same set of facts and found no violation of the laws and rules they administer. It also affirms disgorgement as part of the government’s broad arsenal of tools against such conduct and serves as a reminder that companies may face potential legal exposure not only to government agencies but to private plaintiffs. This has practical implications for electric power companies, other energy companies, and the broader business community. It reinforces the need for companies to be conscious of the antitrust laws when entering into business arrangements and to consult with experienced antitrust counsel whenever in doubt regarding the propriety of proposed conduct under the antitrust laws.