Announcing the FIDJ Mini-Blog

This week, Fuerst Ittleman David & Joseph is launching a Mini Blog, which will be submitted to its readers on a weekly basis. Unlike its usual Blog, which will continue to be updated here, the Mini Blog will allow FIDJ to communicate with its readers in a short and to-the-point style, delivering critical news updates with just enough commentary to explain why the updates are critical. We believe that this Mini Blog will be a valuable resource for our readers, and will allow subscribers to stay up to date on issues affecting all of our practice areas, including Tax & Tax Litigation, Food Drug & Cosmetic Law, Complex Litigation, Customs Import & Trade Law, White Collar Criminal Defense, Anti-Money Laundering, Healthcare Law, and Wealth & Estate Planning. Additionally, subscribers may sign up to receive only the content relevant to their interests on a subject-by-subject basis. As always, please feel free to reach out to us with comments regarding our content or suggestions regarding how we may better keep you up to date.

Click here to sign up.

Here is a sampling of what you can expect to receive in our Mini Blog:

Food and Drug:

On May 28, 2013, the Alcohol and Tobacco Tax and Trade Bureau (TTB) issued guidelines for voluntary “serving facts statements” that alcoholic beverage manufacturers may include on their packaging. A copy of TTB’s press release can be read here. The serving facts statements are similar to the nutrition panels currently found on non-alcoholic foods and beverages. According to the rule, serving facts statements will include: 1) the serving size; 2) the number of servings per container; 3) the number of calories; and 4) the number of grams of carbohydrates, protein, and fat preserving. In addition, serving fact statements may also include the percentage of alcohol by volume and a statement of the fluid ounces of pure ethyl alcohol per serving. TTB is providing the interim guidance on the use of voluntary serving facts statements on labels and in advertisements pending the completion of rulemaking on the matter. A copy of the TTB Ruling can be read here.

Healthcare:

A new bill in the U.S. House of Representatives, the Medicare Audit Improvement Act of 2013, seeks to amend title XVIII of the Social Security Act to improve operations of recovery auditors under the Medicare integrity program and to increase transparency and accuracy in audits conducted by contractors. A few proposals include limiting the amount of additional document requests, imposing financial penalties on auditors whose payment denials are overturned on appeal and publishing auditor denials and appeals outcomes.

In related news, the Department of Health and Human Services c/o the Centers for Medicare and Medicaid Services  (“CMS”) is proposing to increase the maximum reward for reporting Medicare fraud from “10 percent of the overpayments recovered in the case or $1,000, whichever is less, to 15 percent of the final amount collected applied to the first $66,000,000”¦” In case you don’t have a calculator handy, that’s a change from $1,000 to a potential maximum windfall of $9,900,000. It’s safe to assume that the number of whistleblower reports of alleged Medicare fraud are going to skyrocket. As the saying goes, you miss 100% of the shots you don’t take.

As decided by the United States Court of Appeals for the Eleventh Circuit, HIPAA preempts Florida’s broad medical records disclosure law pertaining to a decedent’s medical records. In Opis Management Resources, LLC v. Secretary of Florida Agency for Health Care Administration, No. 12-12593 (11th Cir. Apr. l 9, 2013), the 11th Circuit Court of Appeals ruled that Florida’s broad medical records disclosure law did not sufficiently protect the privacy of a decedent’s medical records. The Court noted that Florida allows for “sweeping disclosures, making a deceased resident’s protected health information available to a spouse or other enumerated party upon request, without any need for authorization, for any conceivable reason, and without regard to the authority of the individual making the request to act in a deceased resident’s stead.” In contrast, HIPAA only permits the disclosure of a decedent’s protected health information to a “personal representative” or other identified persons “who were involved in the individual’s care or payment for health care prior to the individual’s death” to the extent the disclosed information is “relevant to such person’s involvement”.

Tax:

On May 29, 2013, the New York Times reported that the Swiss Government will allow Swiss Banks to provide information to the U.S. Government in exchange for assurances that Swiss banks would only be subject to fines and not be indicted in an American criminal case. Per the New York Times,

The New York Times article reports that: But [Ms. Widemer-Schlumpf (Switzerland’s finance minister)] said the Swiss government would not make any payments as part of the agreement. Sources briefed on the matter say the total fines could eventually total $7 billion to $10 billion, and that to ease any financial pressure on the banks, the Swiss government might advance the sums and then seek reimbursement”¦. Ms. Widmer-Schlumpf said the government would work with Parliament to quickly pass a new law that would allow Swiss banks to accept the terms of the United States offer, but said the onus would be on individual banks to decide whether to participate.

This appears to be the beginning of the end of Swiss bank secrecy. If the Swiss relent to the U.S., the European Union will be next in line to obtain the same concession.

Anti-Money Laundering:

Our thoughts on the United States government’s attack on Mt. Gox can be read here, and Bitcoin continues to remain a hot topic all across the internet; see here, here, and here. Another virtual currency, Liberty Reserve, has also made a splash since being shut down by the Feds last week in what many have described as the largest money laundering scheme of all time; see here for details of the takedown, as well as the following articles describing the initial bits of fallout from the Liberty Reserve takedown: online anonymity, anti-money laundering compliance,Barclays Bank involvement, and the not guilty pleas entered by Liberty Reserve’s proprietors on Thursday. We will keep our eyes on these two cases as the fallout continues.

Florida Business Litigation Update: Florida Appeals Court Requires Insurer to Provide Separate Counsel for Multiple Insureds Under Single Policy

In Univ. of Miami v. Great Am. Assur. Co., 38 Fla. L. Weekly D392 (Fla. 3d DCA 2013), Florida’s Third District Court of Appeals announced a ruling in a case of first impression that will have a substantial impact in Florida’s legal community. Specifically, the court held that where multiple defendants are covered by the same policy of insurance, the insurer must provide independent and separate counsel for each defendant. This decision should be called the Lawyer’s Employment Opportunity Act of 2013. A copy of the decision is available here.

The Univ. of Miami decision was unique because one of the defendants, MagiCamp, contractually agreed to indemnify University of Miami (“The U”) for any damages arising from the activity. Because of that indemnification, the insurer took the position that there could be no conflict. The U disagreed, retained its own counsel, and later sued the insurer for reimbursement of its fees and costs. The Third District agreed with The U, and found that “where both the insured and the additional insured have been sued, and the allegations claim that each is directly negligent for the injuries sustained, a conflict between the insured and the additional named insured exists that would require the insurer to provide separate and independent counsel for each.”

Still, the decision raises more questions than it answers. Many policies are “wasting policies,” meaning that the total amount of coverage declines for every dollar expended on litigation costs. Thus, what happens when there a lawsuit claiming damages of $1,000,000 filed against an entire Board of Directors consisting of 6 directors, where the aggregate limits of total insurance coverage of their “wasting” policy is for $1,500,000? In this situation, there are (at least) two competing conflicts: (i) one for representation where there exists the possibility of finger pointing amongst the directors, and (ii) another where every available dollar of coverage is expended for every dollar spent on lawyers. To exacerbate the conflict, what should the insurer do when all but one of the insured-defendants agree amongst themselves that only one lawyer should represent them (in order to conserve available insurance dollars), yet there exists one dissenting director who wants his/her own counsel? The questions are endless.

It is expressly because of the endless array of “conflict questions” that Judge Shepherd dissented. Judge Shepherd rationalized that the issue of “conflict” is not and should not be decided on the basis of insurance law; rather, it is a question of professional ethics. Explaining that there was no conflict-in-fact because there was no adversity between the co-insureds, Judge Shepherd noted, “A conflict of interest between jointly represented clients occurs whenever their common lawyer’s representation is rendered less effective by reason of his representation of the other. Furthermore, the difference in the potential for liability [between] two insureds, standing alone, does not necessarily result in an actual conflict of interest between them so far as their joint defense is concerned.” In other words, a hypothetical “paper conflict” is insufficient to mandate the engagement of separate counsel.

Recognizing the logic of Judge Shepherd’s dissent, the majority noted that the Univ. Of Miami holding does not reach or address “[c]onflicts created by coverage or policy limit issues [which are] not the issue in this appeal.” Id. at fn 5. But that only begs the question of when the insurer must retain independent counsel for multiple insureds?

The answer, respectfully, lies not within the terms of the insurance policy, but within the confines of the professional responsibility of defense counsel. Rule 4-1.7(a)(1) provides that “a lawyer shall not represent a client if the representation of 1 client will be directly adverse to another client; or (2) there is a substantial risk that the representation … will be limited by the lawyer’s responsibility to another client.” Thus, the counsel retained to represent MagiCamp and The U was obliged to stand up to the carrier and explain that he/she was ethically barred from representing both parties. Unless, of course, said counsel was not ethically barred in fact, thus underscoring the point that the alleged “conflict” was nothing more than a “paper conflict.”

In any event, what remains clear is that skilled counsel is necessary to engineer the defense strategy at the inception of the case. Defense issues ranging from insurability and coverage, as well as counter-maneuvers and tactics designed to undermine the plaintiff’s case-in-chief need to be vetted at the earliest opportunities. Otherwise, parties remain entrenched in lawsuits even after the underlying case is over.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex litigation, including international and domestic business matters, contract disputes, and insurance issues. Please contact us by email at contact@fidjlaw.com or telephone at 305.350.5690 with any questions.

International Tax Compliance Update: Florida Couple Indicted for Failing to Report Offshore Bank Accounts as IRS Continues Enforcement Against Offshore Tax Evasion and FBAR Violations

In line with our recent coverage of the Internal Revenue Service’s initiatives to pursue illegal offshore tax havens, on May 16, 2013 a Florida couple – Drs. David Leon Fredrick and Patricia Lynn Hough – was indicted by a federal grand jury in Fort Myers, FL for conspiring to defraud the IRS. A U.S. Department of Justice press release on the indictment can be found here. Our recent coverage of the IRS’s recent efforts to pursue offshore tax evasion, including IRS’s John Doe Summons to Wells Fargo seeking information about the First Caribbean International Bank, may be reviewed here, here, here, and here.

According to the Department of Justice, the couple, both of whom work as physicians in the Sarasota area, conspired with a Swiss citizen currently under indictment in the Southern District of New York, and a banker from the United Bank of Switzerland (“UBS”) to defraud the IRS. The indictment goes on to describe that the couple used nominee entities and undeclared bank accounts in their names and the names of the nominee entities at several foreign banks, including UBS, for the purposes of illegal tax evasion. It is further alleged that the couples’ assets and income, including proceeds from real estate sales for more than $33 million, were deposited into undeclared foreign bank accounts. The Department of Justice claims the couple instructed Swiss bankers via email, telephone, and in-person meetings to make investments and funds transfers to undeclared accounts at UBS. Those undeclared funds were then allegedly used to purchase an airplane, several homes in North Carolina, a Florida condominium, and funds transfers of over $1 million to relatives.

The couple was additionally charged with falsifying tax returns between 2005 and 2008 by substantially underestimating their income and failing to report their foreign accounts. A trial date has yet to be set, but the charges carry the possibility of imprisonment for up to five years for the conspiracy charges and three years for each false tax return filing. The charges also carry penalties of $250,000 for each count.

This indictment offers a real world example of the severe consequences that U.S. taxpayers can face for the non-disclosure of foreign accounts to the IRS. Individuals who believe that they may be in violation of foreign account disclosure requirements under United States tax law should take a moment to read our discussion regarding the mitigation of possible criminal culpability, penalties, and fines under the IRS’s Offshore Voluntary Disclosure Program (“ODVP”) which can be found in Part II of our discussion of the IRS’s initiatives to curb offshore tax evasion in the Caribbean.

Furthermore, as noted in the Department of Justice’s press release, U.S. citizens, resident aliens, and legal permanent residents alike should be aware of their obligations to report their financial interest in, or signatory authority over, a foreign account in a particular year on Schedule B of the U.S. Individual Tax Return, Form 1040, when filing their tax returns.

This issue is a critical one for U.S. taxpayers holding foreign accounts, as well as the professionals advising them. The IRS is continuing to ensure that offshore tax evasion is eradicated and, based on recent history, it appears to have no intentions of leaving any stone unturned.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and have availed themselves of the IRS’s voluntary disclosure program. We also have considerable experience litigating against the Department of Justice and the IRS in civil and criminal tax matters. We will continue to monitor the development of this issue, and we will update this blog with relevant information as this issue continues to develop. You can reach an attorney by calling us at 305-350-5690 or emailing us at contact@fidjlaw.com.

Florida Complex Litigation Update: Raymond James Financial Services, Inc. v. Phillips: Florida Supreme Court rules that statute of limitations applies to arbitration

Resolving a matter of first impression in Florida, the Florida Supreme Court recently issued its decision in Raymond James Financial Services, Inc. v. Phillips, Case No. SC11-2513 (Fla. May 16, 2013), concluding that Florida’s statute of limitations applies to arbitration.

The landmark decision in Raymond James affects arbitration provisions in every type of agreement or business contract in Florida and elsewhere governed by Florida law.

Specifically, in Raymond James, a financial services investment firm, like Florida businesses in many other commercial contexts, required its clients to sign an agreement to arbitrate all disputes arising under the agreement. After the clients’ investments subsequently lost significant value, the disappointed investors filed a joint claim for arbitration against the investment firm, asserting numerous commercial-based claims, including breach of contract, negligence, breaches of fiduciary duty, and various state and federal violations. The investment firm moved to dismiss the claims, maintaining that all of the claims were time-barred by Florida’s statute of limitations.

An arbitration panel was appointed, and a hearing on the motion to dismiss was scheduled.

However, before the hearing, the investors filed a separate lawsuit in state trial court, seeking a declaratory judgment that, in relevant part, Florida’s statue of limitations does not apply to arbitrations, but applies only to judicial actions. See Fla. Stat. § 95.011 (limiting the applicability of Florida’s statute of limitations to a “civil action or proceeding”), available here.

The trial court agreed with the investors. On appeal, Florida’s Second District Court of Appeals disagreed with the trial court, but certified the question as to the applicability of Florida’s statute of limitations to arbitration agreements to be of great public importance.

The Florida Supreme Court in Raymond James began its substantive analysis with the actual language of Florida’s statute of limitations, noting that the statue is limited to a “civil action or proceeding.” The Court then turned to the “ordinary” definition of those terms and concluded that the “broad” terms do include an arbitration proceeding. The Court in Raymond James also noted as a matter of statutory construction that, while “civil actions” may be limited to court cases, the term “proceeding” in the statute is clearly broader in scope. Thus, the Court concluded that limiting the term “proceeding” to apply to only judicial proceedings would construe the term in a manner inconsistent to the language of the statute of limitations and the Florida Legislature’s intent in drafting such language.

The Florida Supreme Court in Raymond James also found that any contrary interpretation would defeat the purpose of a related statute, section 95.03, Florida Statutes, which renders void any contract provision attempting to shorten the applicable limitations period. See Fla. Stat. § 95.03, available here.

Further, the Court in Raymond James deemed its interpretation of Florida’s statute of limitations to be consistent with the interpretation of the term “arbitration” in other statutory provisions, including the Florida Arbitration Code, set forth in chapter 682, Florida Statutes, referring to arbitration in various provisions as an “arbitration proceeding.” The Court likewise observed that its broad interpretation of the terms “action or proceeding” to include arbitration was consistent with the history of the statute of limitations and the purpose behind its enactment, i.e., to discourage stale claims and to avoid parties waiting to bring claims until documents or witnesses are difficult to locate.

A slip copy of the Florida Supreme Court’s opinion in Raymond James Financial Services, Inc. v. Phillips is available here.

At bottom, the recent opinion affects the claims and defenses available to every individual or corporation in a Florida civil action or proceeding, including FINRA and other arbitration proceedings, that conducts business in Florida and/or enters into contracts governed by Florida law containing arbitration provisions. Accordingly, business owners and decision makers with commercial operations in Florida would be well advised to review the arbitration provisions in existing agreements so as to better understand rights and obligations in light of Raymond James, and to tailor all future agreements as necessary.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, including international and domestic business matters and contract disputes. Please contact us by email at contact@fidjlaw.com or telephone at 305.350.5690 with any questions.

Energy Drink Regulatory Update: Monster Sues City of San Francisco in Federal Court, City Fires Back in California State Court

As we reported here last week, the FDA announced that it is conducting an investigation into the use of caffeine in foods and beverages. Since the FDA’s announcement, the energy drink industry has continued to receive significant media attention. On May 6, 2013, the San Francisco City Attorney’s office announced that City Attorney Dennis Herrera, on behalf of the people of the state of California, filed a lawsuit in San Francisco Superior Court against Monster Beverage Corp. (“Monster”) for allegedly engaging in unfair, deceptive and unlawful business practices in violation of California laws. (To read the full press release, please click here.) This lawsuit comes just days after Monster filed a complaint against Dennis Herrera in the U.S. District Court for the Central District of California, alleging that Mr. Herrera’s attempts to regulate energy drinks are preempted by the federal Food, Drug, and Cosmetic Act (“FDCA”) and impinge on Monster’s constitutionally protected speech. By “singl[ing] out” Monster, despite the similarity between its advertising strategy and advertising for other energy drinks on the market, Monster argues that Mr. Herrera “appears to be motivated by publicity rather than science.” (To read the full text of the complaint filed in Monster Beverage Corporation v. Dennis Herrera, please click here.)

Mr. Herrera’s complaint alleges that Monster, the nation’s largest energy drink manufacturer, “promotes consumption of its drinks in an excessive and unsafe manner” and “has failed to adequately warn consumers of the dangers of consuming Monster Energy Drinks.” (To read the full complaint for People of the State of California ex rel. Dennis Herrera v. Monster Beverage Corporation, please click here.) The complaint states that Monster “promotes excessive consumption of its drinks” with statements such as: “bigger is always better,” “chug it down,” “throw [it] back,” a “smooth flavor you can really pound down,” and “the biggest chugger friendly wide mouth we could make.” Furthermore, in describing Monster’s “targeted advertising” toward children and adolescents, Mr. Herrera explicitly refers to Monster’s various social media pages, including Facebook, Twitter, YouTube, and a “Monster Army” social networking site. Mr. Herrera also alleges that Monster advertises to teenage boys by creating a “lifestyle” featuring “extreme sports, music, gaming, military themes, and the scantily-clad ”˜Monster Girls.'” (For more information regarding the litigation between Monster and San Francisco City Attorney Herrera, please read the Los Angeles Times article here.)

To support its allegations that Monster is unsafe for consumption by children and adolescents, Mr. Herrera relies heavily on scientific research that claims there is “a strong correlation between consumption of caffeine at levels found in Monster’s products and adverse health and safety consequences.” The scientific research Mr. Herrera refers to throughout the complaint is the same information contained in a letter from health law experts to the FDA sent in March of this year, which we discussed previously here. The complaint goes on to allege that the despite this scientific evidence, Monster “aggressively markets its products to children and teenagers,” and that its targeted advertising efforts are responsible for the product’s popularity with and frequent consumption by youth.

The complaint against Monster also alleges that Monster’s energy drink products are misbranded and adulterated foods under California law. Although Mr. Herrera acknowledges Monster’s move earlier this year to label its products as conventional beverages instead of dietary supplements, he nevertheless alleges that Monster’s products are misbranded because “Monster’s packaging, labeling, serving size, recommended conditions of use, and advertising statements demonstrate that Monster Energy Drinks are, and have long been, conventional beverages.” Further, the complaint states that Monster’s product are adulterated because they contain levels of added caffeine that “do not satisfy the GRAS [generally recognized as safe] standard because there is no scientific consensus concerning the safety of the caffeine levels in [its] products.”

If this lawsuit is successful, Monster Energy could be enjoined from continuing to engage in conduct the state deems harmful to consumers and competitors, and forced to pay significant civil penalties and restitution. The outcome of this lawsuit could have major repercussions for the energy drink industry, not only in California but across the country.

Fuerst Ittleman David & Joseph, PL will continue to track the progress of this lawsuit and any other developments in the regulation of energy drink products. For more information, please contact us via email at contact@fidjlaw.com or via telephone at (305) 350-5690.

Update: Banking Difficulties May Lead Marijuana Dispensaries to Commit Bank Fraud

As we have previously reported, despite the growing number of States that have sanctioned the use of marijuana in various forms, the federal government has continued its efforts to crack down on dispensaries. (Our recent articles discussing these efforts can be read here, here, and here.). In addition to criminal prosecution for drug trafficking, state sanctioned dispensaries face additional legal barriers which make operating difficult. As we previously reported, one such barrier is the inability of marijuana dispensaries to deduct business expenses. An additional barrier dispensaries face is finding banks, credit card companies, and payment processors to process the proceeds of marijuana sales.

The Colorado Task Force Report on the Implementation of Amendment 64 (which legalized marijuana use) summarized the problems associated with banking marijuana dispensaries as follows:

Financial institutions that are federally licensed or insured are required to comply with federal regulations. Since marijuana is a controlled substance under federal law, banks must either refuse to hold accounts for legal marijuana businesses…or risk prosecution.

The Task Force’s report can be read here.

As a result of marijuana remaining a Class I substance under the Federal Controlled Substances Act, banks face increased anti-money laundering (“AML”) risks when seeking to bank even those dispensaries which are fully compliant with state law. Pursuant to the Bank Secrecy Act, 31 U.S.C. §§ 5311-5330, as part of a bank’s anti-money laundering program, banks are required to create certain reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, 12 C.F.R. § 21.11 requires national banks to file Suspicious Activity Reports (“SAR”) when the bank knows, suspects, or has reason to suspect that a transaction involves funds from illegal activities or is intended or conducted in order to hide or disguise funds or assets derived from illegal activities as part of a plan to violate or evade any law or regulation or to avoid any transaction reporting requirement under Federal law. (More information on bank AML requirements under the BSA can be found on the Office of the Comptroller of the Currency’s website.)

Because the sale of marijuana remains prohibited under federal law, banks are placed in a position where they would be required to report any banking transactions involving proceeds from marijuana dispensaries. Moreover, banks face the realistic possibility of federal criminal penalties for assisting in money laundering should they knowingly accept and process funds from dispensaries. As a result of these risks and possible penalties, banks have simply refused to allow marijuana dispensaries to maintain accounts or conduct business with them.

Banks’ refusal to allow dispensaries to maintain accounts has made it extremely difficult for dispensaries to operate. As a result, many legal marijuana businesses have resorted to all cash operations. With the bank prohibition in place, dispensaries are looking for “creative” ways to engage in banking including: 1) establishing shell companies to disguise marijuana proceeds; 2) funneling marijuana derived profits into accounts of other legitimate businesses; and 3) placing marijuana derived profits into bank accounts of family members or personal accounts.

These alternative banking methods were the subject of a recent Bloomberg article, entitled “Pot Shops Can’t Take American Express or Deposit in Banks.” In the article, Bloomberg quotes Dale Gieringer, director of the California office of the National Organization for the Reform of Marijuana Laws, as saying “[a]s long as the bank doesn’t find out, you should be safe.” A copy of Bloomberg’s article can be read here. Despite Mr. Gieringer’s contentions, each of these methods could expose dispensary owners to criminal and civil liability.

Unfortunately, Bloomberg’s article never mentions the potential criminal and civil liabilities faced by dispensary owners should they use any of the above-referenced methods to open bank accounts. Generally speaking, the use of shell companies or other accounts to mask the profits derived from the sale of marijuana could subject the owner of a dispensary to a wide variety of federal criminal penalties, including bank fraud 18 U.S.C. § 1344, wire fraud 18 U.S.C. § 1343, and money laundering 18 U.S.C. § 1956. Additionally, those who assist in such actions, for example the friend or family member who allowed for money to be transferred through his or her account, would also face similar criminal charges. Moreover, should such fraud occur, the payment processors and banks who process this money can still be held liable for money laundering and face criminal and civil fines and penalties. Each of these penalties is available regardless of whether marijuana is legal under State law. Put simply, if a company lies for the purpose of opening a bank account, the consequences are severe.

The online poker industry has already experienced just how severe the consequences can be. There, several online poker companies, such as Full Tilt Poker and PokerStars, established shell companies in order to facilitate payment of gambling winnings to their members. The companies used third party payment processors to disguise financial transactions between the companies and U.S. players so that the transactions would appear to be unrelated to online gambling. The third party payment processors would then lie to U.S. financial institutions about the source of the funds, often facilitated by the creation of nonexistent online companies and phony websites. The ultimate conclusion of that case resulted in $731 million in civil monetary penalties as well as criminal convictions for executives of the payment processing companies that facilitated the fraud. (A full recount of the online poker saga can be read in our previous reports here, here, here, here, and here).

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Third Circuit Court of Appeals Issues Landmark Decision in Virgin Islands Economic Development Program Case

Disclosure: Joseph A. DiRuzzo, III of Fuerst Ittleman David & Joseph was part of the trial team that representedthe taxpayers in the June 2010 bench trial in the District Court of the Virgin Islands.

On April 17, 2013, the United States Court of Appeals for the Third Circuit overturned, in part, the ruling of the District Court of the Virgin Islands that the taxpayers were not bona fide U.S. Virgin Islands residents under I.R.C. section 932. The case is V.I. Derviates ex. rel. Vento v. Director of Virgin Islands Bureau of Internal Revenue, et al., case nos. 11-2318, 11-2319, 11-2320, 11-2321, 11-2322,11-2603, 11-2618, 11-2619, 11-2620, 11-2621, 11-2622, 11-2623,11-2624, 11-2625, 12-1416 and 12-1417. The Third Circuit’s precedential decision is available here.

The Vento case is a major win for taxpayers fighting the IRS over Virgin Islands residency and has major implications for those taxpayers who took tax credits for participating in the Virgin Islands Economic Development Program (EDP).

The facts of the case are as follows:

Richard and Lana Vento are married and filed a joint 2001 tax return with the VIBIR. In May 2001, the Ventos (through a limited liability company they controlled) contracted to buy Estate Frydendahl, a residential property on St. Thomas, for $7.2 million. Estate Frydendahl””which included a five-bedroom main house and several outlying buildings, including three two-bedroom cottages with kitchens””was sold furnished, and the transaction closed on August 1, 2001. At the time of purchase, the sellers were living in some of the outlying buildings, but the main house was vacant.

The Ventos hoped that renovations to Estate Frydendahl could be completed in time for them to move in by Christmas 2001. Progress was slow, however, and the Ventos grew frustrated. Consequently, in the late fall of 2001, Lana Vento brought in Dave Thomas, a construction manager whom she had previously hired to work in Hawaii, to supervise the project. In December 2001, Thomas travelled to the Virgin Islands and concluded that the main house at Estate Frydendahl was 50 percent livable, but the normal amenities, including water and electricity, did not work properly or consistently.

The Vento family (including Richard and Lana, as well as their daughters Nicole Mollison, Gail Vento, and Renee Vento) was on St. Thomas for the holiday season in December 2001. Nicole Mollison returned to Nevada with her husband and children on December 26, 2001, while the other Vento family members and guests stayed on St. Thomas through New Year’s Eve. Afterwards, the Ventos began to split their time between the Virgin Islands and the mainland. Lana visited the Virgin Islands most frequently because she was overseeing the construction efforts at Estate Frydendahl. She would spend between one and six weeks at a time there, then leave for another six weeks. During the first five months of 2002, Richard spent 35 days in St. Thomas, 23 days in San Francisco, and 41 days in Nevada. Richard also spent considerable time in Hawaii in 2002.

In addition to purchasing Estate Frydendahl, Richard became interested in participating in the Virgin Islands’ Economic Development Program (EDP), which offers very favorable tax treatment to certain approved Virgin Islands companies. Based on legal advice Richard received regarding the EDP between May 2001 and August 2001, he founded three companies in the Virgin Islands: (1) Virgin Islands Microsystems, which was to perform nanotechnology research; (2) Edge Access, which was to build internet access devices; and (3) VI Derivatives, LLC, which the VIBIR and IRS later deemed a sham partnership. Ultimately, only Virgin Islands Microsystems was approved to receive EDP benefits, and that approval did not occur until 2002.

In 2005, the Virgin Islands Bureau of Internal Revenue (VIBIR) issued Notices of Deficiency and Final Partnership Administrative Adjustments (FPAAs) to Richard Vento, Lana Vento, Nicole Mollison, Gail Vento, and Renee Vento and partnerships they controlled, assessing a deficiency and penalties of over $31 million against the Ventos and approximately $6.3 million against each of their three daughters (Nicole, Gail, and Renee). The VIBIR also concluded that two Vento-owned partnerships, VI Derivatives, LLC and VIFX, LLC were shams and disregarded them for tax purposes.

That same year, the IRS issued FPAAs that were nearly identical to those issued by the VIBIR. Significantly, however, the IRS also issued FPAAs to two other Vento-controlled partnerships. The Taxpayers challenged the VIBIR’s and IRS’s Notices of Deficiency and FPAAs in several separate proceedings in the District Court of the Virgin Islands.

The United States, on behalf of the IRS, intervened in the cases between the Taxpayers and the VIBIR, arguing that the Taxpayers should have filed and paid their 2001 taxes to the IRS instead of the VIBIR because they were not bona fide residents of the Virgin Islands.

In June 2010, the District Court in the Virgin Islands conducted a bench trial. The sole issue at trial was whether the Taxpayers were bona fide residents of the Virgin Islands as of December 31, 2001. The District Court held that they were not, and the Taxpayers, joined by the VIBIR, appealed.

The Virgin Islands taxation statutory scheme is known as the “Mirror Code,” under which the Internal Revenue Code is applied to the Virgin Islands merely by substituting “Virgin Islands” for “United Sates” throughout the Internal Revenue Code. However, Virgin Islands residents are subject to different tax filing requirements than other United States citizens. Under the version of 26 U.S.C. § 932(c) applicable in these appeals, taxpayers who are “bona fide resident[s] of the Virgin Islands at the close of the taxable year are required to” file an income tax return for the taxable year with the Virgin Islands. 26 U.S.C. § 932(c) (1986).

Thus, bona fide Virgin Islands residents who fully report their income and satisfy their obligations to the VIBIR do not pay taxes to the IRS. See Abramson Enters., Inc. v. Gov’t of Virgin Islands, 994 F.2d 140, 144 (3d Cir. 1993), available here. This is true even if the bona fide Virgin Islands resident is also a resident of the mainland United States. Slip op. at 19 (emphasis added).

As outlined by the Third Circuit, the meaning of “residency” may vary according to context. Martinez v. Bynum, 461 U.S. 321, 330 (1983). In the tax context, residency requires far less than domicile. Sochurek v. Comm’r, 300 F.2d 34, 38 (7th Cir. 1962); see also Croyle v. Comm’r, 41 T.C.M. (CCH) 339 (1980) (“[T]he citizen need not be domiciled in a foreign country”¦in order to be classed as a resident for Federal income tax purposes.”) Furthermore, while a person can have only one domicile, he can be a resident of multiple places at the same time.

As the Third Circuit explained, the intent to become a resident is not necessarily the intent to make a fixed and permanent home. Rather, it is the intent to remain indefinitely or at least for a substantial period in the new location. According to the Third Circuit, both Richard and Lana Vento intended to become Virgin Islands residents as of December 31, 2001. That intent was evidenced by their purchase of Estate Frydendahl and their ongoing business interests in the Virgin Islands. “And while the Ventos undoubtedly were motivated to live in the Virgin Islands because of its relatively favorable tax system, there is nothing unlawful or deceitful about choosing to reside in a state or territory because of its low taxes. Therefore, the District Court erred when it held that those motivations counseled against the Ventos‘ bona fide residency claims.” Slip op. at 31-32 (emphasis added).

The Ventos’ purchase and renovation of Estate Frydendahl showed that, by the end of 2001, they planned to remain in St. Thomas at least for a substantial period. Months before the end of 2001, the Ventos purchased Estate Frydendahl for $6.75 million, and began a renovation process that would eventually cost them another $20 million. This substantial outlay, approximately three times the size of the tax controversy in this case, was deemed by the Third Circuit to be strong evidence that the Ventos were not purchasing a sham property to avoid paying taxes, but rather that they had a bona fide intent to remain indefinitely or at least for a substantial period in the Virgin Islands. Richard Vento’s establishment of business interests in the Virgin Islands further supported his claim of bona fide residency.

Under Sochurek, a taxpayer’s unlawful tax evasion motives can clearly be considered evidence against bona fide residency. However, in this case, the Third Circuit held that the Ventos’ desire to take lawful advantage of more favorable tax treatment in the Virgin Islands did not undermine their claim of bona fide residency. Significantly for all pending Virgin Islands tax cases, the Third Circuit held as follows:

[A] taxpayer’s sincere desire to change his residency in order to take advantage of lawful tax incentives does not undermine his claim of bona fide residency. If anything, such a motivation would support the taxpayer’s intent to establish bona fide residency, which is a prerequisite for taking advantage of the lawful tax incentives.

Slip op. at 33-34; (emphasis added).

In refuting the IRS’ claim of improper motive in establishing a residency in the Virgin Islands, the Court acknowledged the well-settled proposition that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” citing Gregory v. Helvering, 293 U.S. 465, 469 (1935). Furthermore, the Court reiterated that “a taxpayer’s legitimate tax avoidance motives should not be held against him.” Slip op. at 37 citing Lerman v. Comm’r, 939 F.2d 44, 45 (3d Cir. 1991).

The Third Circuit faulted the District Court’s decision that the Ventos only moved to the Virgin Islands so they would be able to file tax returns with the VIBIR and not the IRS. The District Court’s decision was erroneous because that is precisely what Congress intended. The purpose of 26 U.S.C. § 932(c) is to “assist the [Virgin] Islands in becoming self-supporting” by “providing for local imposition upon the inhabitants of the Virgin Islands of a territorial income tax, payable directly into the Virgin Islands treasury. If a taxpayer decides to move to the Virgin Islands because he would prefer to file his taxes with the VIBIR rather than the IRS, that taxpayer is helping the Virgin Islands become self-supporting, so his move does not upon its face lie[] outside the plain intent of [§ 932(c)].”  Slip op. at 37. The Third Circuit concluded: “Using [the Ventos] desire to subject themselves to the mirror code as evidence that they did not intend to comply with it would be both incongruous and contrary to the Congressional scheme.”  Slip op. at 38.

Turning to physical presence, the Court viewed IRC § 932 as merely requiring that a taxpayer be a bona fide resident of the Virgin Islands at the close of the taxable year. Id. § 932(c)(1)(A) (1986). As stated by the Court:

Under the terms of § 932, a taxpayer can take advantage of its provisions even if he became a bona fide resident of the Virgin Islands only on the last day of the taxable year.

Slip op. at 40. Therefore, the Ventos’ presence or lack thereof in the Virgin Islands in the first part of 2001 sheds little light on their eligibility for § 932(c), which requires only that they be bona fide residents of the Virgin Islands at the end of 2001. Slip op. at 40.

In addition to being a huge win for the taxpayer and a huge loss for the IRS, this case is nothing short of a landmark in the longstanding dispute between the IRS and numerous individuals and entities which have attempted to participate in the Virgin Islands Economic Development Program. The IRS intervened in the District Court and essentially fought against the taxpayers and the Virgin Islands. The Third Circuit rebuffed the IRS and in doing so provided clear guidance regarding how participants in the Virgin Islands Economic Development Program are to be treated when faced with the claims of the IRS that they were not bona fide Virgin Islands residents and/or did not properly claim an EDP tax credit. Further, the fact that the taxpayers have multiple residences and moved to the Virgin Islands to participate in the Virgin Islands EDP will not be viewed against them, all of which strongly contradicts the IRS’s position that if a taxpayer has a residence in the 50 States he cannot be a bona fide Virgin Islands resident.

The attorneys at Fuerst Ittleman David & Joseph are actively litigating against the IRS, the United States, and the Virgin Islands Bureau of Internal Revenue in Virgin Islands residency cases in the District Court of the Virgin Islands, the U.S. Tax Court, the Third Circuit Court of Appeals, and the U.S. Court of Federal Claims. Additionally, Joseph A. DiRuzzo, III, is licensed to practice in the Virgin Islands and actually lived on St. Thomas for years before relocating to South Florida. Joseph A. DiRuzzo, III, is actively litigating federal tax cases (both civil and criminal) on St. Thomas and St. Croix.

You can contact us via email at: contact@fidjlaw.com, or by telephone at 305.350.5690.

Capital Records v. ReDigi, Inc.: New York District Court Determines that First Sale Doctrine does NOT apply to Digital Media. Did They Get it Right?

On March 30, 2013, only 11 days after the United States Supreme Court’s decision in Kirtsaeng v. Wiley to extend the first sale doctrine to foreign made goods, a United States District Court in the Southern District of New York decided in Capital Records, LLC v. ReDigi Inc., that the online re-sale of lawfully made and purchased digital media is excluded from the doctrine. A copy of the District Court’s opinion can be found here.

One of the integral issues in this case turned on whether or not the “first-sale doctrine” applied to pre-owned digital tracks. As we discussed in detail in previous blog entries on the Kirtsaeng case which can be found here and here, the first sale doctrine limits the copyright owner’s exclusive right of distribution after the original sale, allowing a secondary or re-sale market to effectively exist. It is well established that the first sale doctrine applies to tangible mediums such as books, dvds, and cds. However, ReDigi Inc.’s business model is the first that attempts to extend this doctrine to digital media.

ReDigi’s services, described in this video, allow users to upload and resell content purchased from online retailers like Apple’s iTunes. ReDigi’s system would verify its users’ purchased music, and allow users in turn to upload the tracks to ReDigi’s cloud.  The user’s access to the file would terminate and transfer to the new owner at the time of purchase. In essence, ReDigi was to function as the digital equivalent of a used record store. Capitol Records, however, was skeptical and believed that the product was directly infringing copyrights as well as enabling and inducing users to infringe copyright law. Back in January 2012, Capital Records filed a lawsuit against ReDigi, Inc. that raised these allegations.  The United States District Court for the Southern District of New York agreed with Capital Records, and as such, ReDigi, Inc. was unsuccessful in its effort to establish a “used” or “secondary” digital marketplace.

In its analysis, the Court found that ReDigi, Inc. violated copyright law by making unlawful reproductions of the content during the transfer process from a user’s hard drive to the cloud server.  The court stated:

[W]hen a user downloads a digital music file or “digital sequence” to his “hard disk,” the file is “reproduce[d]” on a new phonorecord within the meaning of the Copyright Act. Id.

This understanding is, of course, confirmed by the laws of physics. It is simply impossible that the same “material object” can be transferred over the Internet.  Because the reproduction right is necessarily implicated when a copyrighted work is embodied in a new material object, and because digital music files must be embodied in a new material object following their transfer over the Internet, the Court determines that the embodiment of a digital music file on a new hard disk is a reproduction within the meaning of the Copyright Act. [”¦]

Simply put, it is the creation of a new material object and not an additional material object that defines the reproduction right. The dictionary defines “reproduction” to mean, inter alia, “to produce again” or “to cause to exist again or anew.” See Merriam-Webster Collegiate Edition 994 (10th ed. 1998) (emphasis added). Significantly, it is not defined as “to produce again while the original exists.” Thus, the right “to reproduce the copyrighted work in . . . phonorecords” is implicated whenever a sound recording is fixed in a new material object, regardless of whether the sound recording remains fixed in the original material object.

Under this rationale and interpretation of the doctrine, the “transfer” of a digital file could never occur, only a “reproduction” under copyright law, thus wiping out the first sale doctrine for all digital goods.

In opposition, ReDigi, Inc. claimed that no unlawful copying occurred, but rather a permissible transfer of digital content. ReDigi, Inc. further argued that to the extent any copying did occur for the purposes of making the transfer, it constituted an allowable “fair use” and customary practice under the Copyright Act. ReDigi, Inc. argued that the transfer taking place represented space and format shifting that was no different than converting content to a different file type, moving content to a different location on a hard-drive, or syncing said content with another device – all of which are allowable actions under iTunes’ terms of use policy.

While the court’s premise is based in a valid and literal reading of the statute – which forbids the selling of a “copy” of an original work – it offers an limited analysis in its dismissal of very reasonable counterarguments that in the digital context the definition of what constitutes a “copy” is not the same as it has been traditionally. Arguably, a user that syncs content in the ReDigi, Inc. cloud and then subsequently forfeits access to that content is conceptually no different than selling a used CD to a record store. Rather than explore this analysis, to reconcile this tough decision, the Court noted that the first sale doctrine was enacted in a time where the ease, speed, and quality of data transfer could not have been imagined, and as such pushed for Congress to modify the provisions of the Copyright Act.

On the other hand, there are legitimate arguments that support the District Court’s decision. The first sale doctrine was established not only to open up the re-sale markets, but to also help preserve the tangible mediums on which content was stored. Presumably, without the first sale doctrine, the consumer who moved locations, ran out of storage room, or simply wanted to get rid of her copy, would discard it if she could not sell or give the used copy to another owner. Thus, with the assistance of this doctrine, a work that may otherwise disappear would remain accessible to the public. This historic rationale for imposition of the doctrine is much less applicable, however, to new age digital content. In a Digital Millennium Copyright Act (DMCA) Report dating back to 2001, the former Register of Copyrights, Marybeth Peters, explored this issue:

Physical copies degrade with time and use; digital information does not. Works in digital format can be reproduced flawlessly, and disseminated to nearly any point on the globe instantly and at negligible cost. Digital transmissions can adversely affect the market for the original to a much greater degree than transfers of physical copies [”¦]

The underlying policy of the first sale doctrine as adopted by the courts was to give effect to the common law rule against restraints on the alienation of tangible property. The tangible nature of a copy is a defining element of the first sale doctrine and critical to its rationale. The digital transmission of a work does not implicate the alienability of a physical artifact. When a work is transmitted, the sender is exercising control over the intangible work through its reproduction rather than common law dominion over an item of tangible personal property.

In the commercial context, ReDigi, Inc. is a relatively small player in the world of digital media, but the case’s outcome will have potentially huge and direct effects on digital media giants Apple and Amazon, both of which have pending patent applications for software that like ReDigi, Inc., opens up the secondary digital marketplace. As media continues to shift to the digital space the interplay of the consumer’s rights in their purchased data must be weighed against the protection of the copyright holder whose content can more easily be reproduced to almost identical quality. There is no obvious answer here, and it will be up to Congress to try to rework the Copyright Act and first sale doctrine to reflect the demands of modern technology.

It is not yet known how, or whether, ReDigi, Inc. will challenge the District Court’s decision. However, we expect that it will and hope that the Second Circuit Court of Appeals will examine the ReDigi, Inc. decision in light of the Supreme Court’s recent Kirtsaeng decision and broader policy considerations regarding this issue. We will keep you posted.

Real Estate Litigation Update: Statute of Frauds? It Had Better Be Written. Sort of.

Leave it to Don King to muddy the legal waters. Consistent with its recent pattern of strictly enforcing agreements, the Florida Supreme Court issued a decision that refused to expand exceptions to the Statute of Frauds. DK Arena, Inc. v. EB Acquisitions I, LLC, Case No. SC10-897, 38 Fla. L. Weekly S187a (March 28, 2013). A copy of the decision is available here.

The Statute of Frauds is codified at Fla. Stat. §725.01, and stands for the proposition that all contracts for the sale of land must be memorialized in a written document signed by the parties to the contract or their lawful representatives. Conversely, Promissory Estoppel is “[t]he principle that a promise made without consideration may nonetheless be enforced to prevent injustice if the promisor should have reasonably expected the promisee to rely on the promise and if the promisee did actually rely on the promise to his or her detriment.” The doctrine applies when there is (1) a promise which the promisor should reasonably expect to induce action or forbearance, (2) action or forbearance in reliance on the promise, and (3) injustice resulting if the promise is not enforced. W.R. Grace and Co. v. Geodata Serv., Inc., 547 So. 2d 919, 924 (Fla. 1989). Id. Principles of contract and estoppel frequently clash to form a quagmire of equity. Indeed, the question of whether promissory estoppel may be used to defeat a written contract is answered differently in jurisdictions across the country.

In DK Arena, EB Acquisitions agreed to purchase real estate from Don King, and the parties entered into a real estate sales agreement. The agreement had stringent due diligence periods, after which a $1 million deposit was to be disbursed to DK Arena. The agreement contained a standard provision which required all modifications to be in writing. However, as due diligence unfolded, EB Acquisitions saw the value of Don King and sought to capitalize on his promotional abilities. Accordingly, the parties discussed entering into a joint venture, wherein King would promote the project before the City Commission in an effort to change the subject property’s currently zoned use. According to EB Acquisitions, King verbally agreed to extend the due diligence period to enable the completion of negotiations over the parties’ joint venture agreement. Later, after the contractual due diligence period expired, the joint venture negotiations failed. King demanded the disbursement of the $1 million deposit. When EB Acquisitions refused, litigation ensued.

At trial, EB Acquisitions testified that although the agreement was not modified in writing, it detrimentally relied on King’s promises to extend the due diligence period in order to conclude the joint venture negotiations. The trial court agreed, finding that it would be inequitable and unjust to award DK Arena the deposit. The appellate court affirmed, but King is not one to sit silent when things don’t go his way, and appealed the matter to the Florida Supreme Court.

In DK Arena, the Court reviewed whether Florida would follow the Second Restatement’s view that promissory estoppel may be applied to enforce oral promises that would otherwise be unenforceable under the Statute of Frauds. The Court announced that unlike many jurisdictions, Florida will not. Instead, the Court held, “[t]he doctrine of promissory estoppel cannot be used to circumvent the statute of frauds.” Id. The Court reasoned that the doctrine of promissory estoppel should not be applied in derogation of “the legislative prerogative,” thus leaving exceptions to the statute of fraud squarely in the hands of the legislative branch.

Accordingly, Florida’s Supreme Court left us with a bright line rule that real estate agreements, and modifications thereto, must be reduced to writing or the verbal agreement will remain unenforceable. Well, sort of. In its decision, the Supreme Court tossed the lawyers of its Bar a bone. Specifically, the Court went on to explain that while promissory estoppel will not excuse performance of a written agreement, the doctrine of “waiver” remains very much alive.

The Court explained the difference between the two legal principles:

While waiver is sometimes viewed as related to estoppel, the two doctrines are founded on different principles and are considered distinct: Estoppel is designed to prevent fraud and injustice. In contrast, waiver is the intentional relinquishment, express or implied, of a known right. Although closely related, the doctrines of estoppel and waiver frequently are confused. Waiver operates to “estop” one from asserting that upon which he otherwise might have relied, but it is not a true estoppel. Waiver does not require detrimental reliance.

DK Arena, supra.  The Court went on to explain, “Waiver involves the act and conduct of only one of the parties, but equitable estoppel involves the conduct of both parties. Estoppel frequently carries the implication of fraud, but waiver never does.” Id.

Thus, while promissory estoppel cannot be used as a defense to performance of a contract, waiver survives. As long as a party is led to believe that a contractual provision will not be enforced, the law will not allow that provision to being enforced. In other words, the affirmative act of, “Gotcha sucker!” will not be strictly construed.

What does all of this mean? The obvious import of the Florida Supreme Court decision is the fact that nothing is obvious or decided. Real estate disputes, like all commercial matters, require skilled attorneys to navigate your interests through the most turbulent issues.

A Supreme Court Win for U.S. Consumers

The Economic Effect of the Supreme Court’s Ruling in Kirtsaeng v. Wiley

In a 6 to 3 decision handed down on March 19, 2013, the United States Supreme Court chalked up a rare victory for consumers over text book publishers, record labels, and others who sought to restrain the resale of copyrighted materials manufactured abroad.

Ruling in the landmark case Kirtsaeng v. John Wiley (568 U. S. ____ (2013)), the Supreme Court extended the “first sale doctrine” to foreign made goods. The Justices’ decision in the matter overturned the Second Circuit’s determination that the “first sale” doctrine did not apply to works made abroad without express consent of the copyright holder. The entire decision of the Court may be read here.

Back in a November 2012 blog post on this case, we discussed the first sale doctrine in detail. Simply put, the doctrine states that the owner of a lawfully purchased copy of copyrighted work may resell that work without limitations imposed by the copyright holder. For example, if you purchase a textbook, you may resell the book if you’d like. In this case, the Court was considering whether the doctrine applied to foreign-made copyrighted works. In a prior ruling that was potentially disastrous for worldwide markets, the resale (secondary) market and consumer pricing, the Second Circuit held that foreign-produced works could be restricted from resale by the copyright holder.

The U.S. Supreme Court did not agree. The majority decision, which did not follow traditional political patterns, was delivered by Justice Breyer and joined by Justices Thomas, Alito, Sotomayor, and Kagan. The liberal Justice Ginsberg wrote a rather lengthy and scathing dissent that was joined by Justice Kennedy and the normally conservative Justice Scalia.

In his opinion, Justice Breyer raised many of the same concerns we mentioned regarding the consequences of a restrictive reading of the first sale doctrines applicability to foreign goods. He stated, “[a]ssociations of libraries, used-book dealers, technology companies, consumer-goods retailers, and museums point to various ways in which a geographical interpretation would fail to further basic constitutional copyright objectives.” Justice Breyer went on to discuss the disruptive impact that a geographical interpretation of the first sale doctrine could have on imports of consumer products containing foreign-made component parts such as automobiles, microwaves, PCs, and calculators. He also warned that new litigation exposure to infringement suits could have a costly effect on the nearly $2.5 trillion retail import market.

The potential fallout had the Supreme Court not taken this position would have been enormous, not to mention economically unmanageable and horribly inefficient. Resale of all manner of consumer products would have dried up as individuals would be required to hire a lawyer before having a yard sale, selling a car, or even a house due to all of the copyrighted components contained therein.

The Majority opinion took a rather logical and real-world economic approach in its rationale in rendering its verdict in favor of consumers. As the court pointed out, Wiley (the publisher’s) ultimate interest was not to protect the copyright holder, but rather to be able to geographically price discriminate by protecting a publisher’s right to charge different prices in different countries. Laws still require the copyrighted products to be legally produced and legally purchased, so why rule in favor of protecting a copyright holder’s profits to the detriment of the domestic consumer? As Breyer noted in the opinion, the time-barred copyright monopoly afforded under US Copyright Law had the constitutional purpose of “promot[ing] the progress of science and useful arts[,]” not stifling that progress to maximize profits.

So what are the potentially negative consequences that could arise out of this decision? The American Association of Publishers or “AAP” – which understandably supported the limitation on resale of copyrighted works – argues that the inability to price discriminate could cut into copyright holders’ earnings, which in the short term would threaten the survival of small independent start-ups, non-profit publishers, and emerging content creators. At the same time, having a more equalized international pricing model could afford for a larger volume of product being sold. Ultimately, pricing and profit maximization would require a bit more economic intelligence, but this is not an insurmountable dilemma.

A greater, and more imminent negative outcome from the Court’s decision is that the economically prudent copyright holder most likely will no longer print “foreign edition” items or may be required to charge higher prices abroad. In fact, the plaintiff in this case, Supap Kirtsaeng, began this matter by importing the copyrighted textbooks from his native Thailand and selling them in the U.S. secondary market (e.g., eBay) for a profit. The fear now is that these “international edition” textbooks which are a mainstay of college and graduate school campuses may no longer be available at 50-75% discounts over the U.S. versions. Also, the AAP warns that less developed countries’ consumers would suffer due to higher costs or inability to purchase U.S. goods, and it could negatively effect those respective international markets. However, the U.S. Supreme Court seemed unswayed by these international arguments.

From the perspective of pure economic theory, allowing a more freely competitive global marketplace will force the publishers’ products to set their prices based on worldwide demand. Copyright holders may be forced to focus on a more uniform pricing model and attempt to ensure that they have a more universally appealing product. If such policies are implemented correctly, the copyright holder stands to gain a much larger consumer base for its product and still maximize profits. However, this macro-economic proposition that a copyright-protected work has one price – the lowest price that the copyright owner agrees to sell the work wherever in the world (plus shipping) – may also negatively effect domestic manufacturing as publishers of copyright-protected works may shift manufacture of works from the United States and other countries with high manufacturing costs to countries where such costs are much lower. This form of cost competition is always a possibility in a competitive market, however.

All tolled, the Supreme Court’s decision in Kirtsaeng is a win for the U.S. consumer, but not without some general shortcomings. The central problem with copyright law (and law in general at many times) is that the national laws and governing international treaties typically have not been revised for the present-day business environment. Legal disputes often flow from technology that didn’t exist at the time the laws were contemplated, reflecting the disconnect between technology and the law.

This fight is long from over, though. You can expect to see a strong lobbying effort by publishers, copyright holders, etc., for Congress to establish some additional copyright protections by narrowing this ruling and/or legislating some exceptions to it. No matter what the outcome, it will be good to see Congress giving a more focused look into U.S. copyright law and its effects on the American consumer and the copyright holders.