Florida Litigation Update: Voluntarily Dismissal Trumps Arbitration Award

May 7th, 2015

Over the past few years, we have written about significant developments in the area of commercial arbitration proceedings here [Complex Commercial Litigation Update: New York’s Separate Entity Rule and the Reemergence of Florida as a Potential Gateway for Judgment Creditors to Seize Debtors’ Foreign Assets in Enforcement and Collection Proceedings], here [Florida Litigation Update: Arbitration Clauses are Not Always Enforceable], here [Litigation Update: Appellate Arbitration], here [Litigation Update: American Arbitration Association Announces Changes to Commercial Arbitration Rules] and here [Florida Complex Litigation Update: Raymond James Financial Services, Inc. v. Phillips: Florida Supreme Court rules that statute of limitations applies to arbitration].

We continue our coverage of this critically important issue today. Recently, the Florida Third District Court of Appeal, in Laquer v. Falcone, Case Nos. 3D14-1803, 3D14-1804, 40 Fla. L. Weekly D936b (Fla. 3d DCA Apr. 22, 2015), available here,  addressed whether the voluntary dismissal of a claim referred to arbitration divests the arbitrator of jurisdiction to enter an award even after maintenance of a final evidentiary hearing.  Under the facts in Laquer v. Falcone, the Third District found that the arbitrator did lack jurisdiction to enter an award.

The appellant in Laquer v. Falcone (Edie Laquer) filed a lawsuit against the appellants (Arthur Falcone and various companies) known as the “Joint Venture Lawsuit” involving a dispute over Laquer’s equity interest in a multi-million dollar real estate project in downtown Miami known as the “Miami WorldCenter” project.  In separate foreclosure actions, the bank(-mortgagee) sued Laquer.  Laquer, in the Joint Venture Lawsuit, then filed cross-claims against Falcone, alleging that Falcone breached a duty to defend in the foreclosure actions.  Falcone, based on a dispute resolution provision in the underlying corporate operating agreements between the parties, responded by moving to compel arbitration of the “duty-to-defend”/indemnification cross-claims.

The trial court denied the motion to compel, finding that the parties waived their right to compel arbitration by participating in the foreclosure lawsuits and the Joint Venture Lawsuit.  On appeal, in 13 Parcels LLC v. Laquer, 104 So. 3d (Fla. 3d DCA 2012), available here, the Third District reversed, holding that the arbitration provision in the operating agreements controlled the duty-to-defend cross-claims, which limited issue did not appear in the record to have been waived or raised in any other litigation matters between the parties.

On remand after the first appeal in 13 Parcels, Falcone subsequently moved to compel arbitration of the entire Joint Venture Lawsuit, as opposed to merely the duty-to-defend cross-claims.  The trial court denied this motion to compel, which the Third District affirmed in Falcone v. Laquer, 132 So. 3d 1171 (Fla. 3d DCA 2014), available here.  The appellate court in Falcone v. Laquer found that the Joint Venture Lawsuit was “a much larger case” than the duty-to-defend claim, and that the “larger” lawsuit included claims, parties and alleged agreements that were not governed by the arbitration provision.  Separately, the appellate court found that the parties seeking to compel arbitration had waived any limited right to arbitrate the Joint Venture Lawsuit by the filing of a motion to dismiss, discovery requests, discovery responses, a motion for summary judgment and counterclaims, all which were deemed by the court to be “consistent with the alleged right to compel arbitration.”

On remand again after the Falcone v. Laquer appeal, the trial court stayed the duty-to-defend cross-claims from the pending lawsuit pending arbitration, pursuant to the Florida Arbitration Code, Fla. Stat. § 682.03 (2010), available here, allowing a trial court to stay severable issues subject to arbitration, and the trial court referred the cross-claims to arbitration.

Before the start of arbitration, Laquer settled with the bank in the foreclosure actions.  Laquer, in the Joint Venture Lawsuit, then filed voluntary dismissals of the duty-to-defend cross-claims.  Notwithstanding, the arbitrator conducted an arbitration hearing, at which Laquer argued that the arbitrator lacked subject matter jurisdiction and the hearing was “futile” because there was no arbitrable dispute after Laquer had voluntarily dismissed the cross-claims.  After a three-day evidentiary hearing, at which Laquer did not participate while Falcone presented witnesses and exhibits, the arbitrator entered a final arbitration award against Laquer, concluding in the award that Laquer would take “nothing” in the duty-to-defend cross-claims.

Lacquer opposed confirmation of the arbitrator’s award, which opposition the trial court denied by confirming the award.  Lacquer thereafter moved for rehearing and reconsideration, and to vacate the award.  At a non-evidentiary hearing on those motions, Falcone argued that the stay of litigation pending arbitration rendered Laquer’s notices of voluntary dismissal ineffective.  The trial court agreed, finding that, because Laquer did not “come forward to lift the stay,” the voluntary dismissals were improper.

On appeal, now the third in the saga, the Third District in Laquer v. Falcone addressed two issues:  (1) whether the trial court’s stay rendered the voluntary dismissals “ineffective” such that the arbitrator retained jurisdiction to enter an award on the duty-to-defend cross-claims; and (2) if the stay did not render the voluntary dismissals ineffective, whether the voluntary dismissals deprived the arbitrator of jurisdiction to enter an award.  The appellate court answered the first issue in the negative, and the latter in the positive, and thus effectively vacated the arbitration award.

Specifically, as to the stay issue, the Third District found that the voluntary dismissals were consistent with the central purpose of a stay, i.e., “to prevent the taking of any further steps in the action during the period of the stay.”  In other words, Laquer “ceased to take any further steps in the action when she put an end to the action altogether.”  Thus, the stay on the cross-claims did not preclude the filing of voluntary dismissals or render them ineffective.

As to the arbitrator’s jurisdiction, the Third District agreed with Laquer’s position that the trial court erred when it confirmed the arbitration award because there was no dispute left to arbitrate.  Relying on Florida Rule of Civil Procedure 1.420(a)(1), available here, the court highlighted that this rule allows a plaintiff to dismiss an action, a claim or any part of an action or claim without court-order by filing a notice of dismissal at any time before a hearing on motion for summary judgment.  However, under the Second District’s decision in Soares Da Costa Construction Services, LLC v. Alta Mar Development LLC, 85 So. 3d 1172 (Fla. 2d DCA 2012), available here, the Third District noted in Laquer v. Falcone that the filing of voluntary dismissals under Rule 1.420(a)(1) is subject to an exception where a defendant demonstrates “serious prejudice” if the dismissal is allowed.  The court added that serious prejudice in this context includes situations where the defendant (1) is entitled to receive affirmative relief, or a hearing and disposition of the case on the merits, (2) has acquired substantial rights in the case or (3) where dismissal is inequitable, citing the Fifth District’s decision in Ormond Beach Associates Limited v. Citation Mortgage, Ltd., 835 So. 2d 292 (Fla. 5th DCA 2002), available here.

However, the appellate court found that the so-called “Ormond Beach exception” did not apply to the facts at issue in Laquer v. Falcone.  First, Falcone was not seeking any affirmative relief; and, regardless, the duty-to-defend cross-claims, which were the only claims compelled to arbitration, were dismissed.  Second, the Third District found that Falcone failed to demonstrate serious prejudice, rejecting Falcone’s argument that the final arbitration award empowered Falcone to obtain attorneys’ fees, costs and expenses incurred as a result of Laquer’s demand that Falcone defend the foreclosure actions and of Falcone’s subsequent efforts to avoid arbitration of the dispute.

Thus, the court in Laquer v. Falcone held that Falcone had not acquired substantial rights in the litigation for purposes of the Ormond Beach exception.

Preliminarily, the court distinguished Soares, noting that the parties in that case stipulated to a stay pending arbitration and expressly acknowledged that “the issues raised in the arbitration proceedings [in that case] were the same issues underlying the [Soares] Complaint.”  Additionally, in contrast to the timing of the voluntary dismissal in Laquer v. Falcone, the plaintiff in Soaresfiled the notice of voluntary dismissal after the arbitrator entered an award in favor of the defendant in that case.  Thus, in Soares, the Second District found that the defendant in that case had acquired substantial rights in the litigation after the defendant prevailed on his counterclaim in the arbitration because the defendant’s motion to confirm the arbitration award acted as a “counterclaim” in the main action once the motion to confirm was filed and served.  The appellate court in Soares further noted that, based on the stipulation between the parties in that case for arbitration, the parties each attached “some level of importance” to the arbitrator’s determination for purposes of the substantial-rights analysis.

The court in Laquer v. Falcone also found that the arbitrator exceeded his jurisdiction when it made findings of fact supporting the final arbitration award relative to the Joint Venture Lawsuit, because the only issue compelled to arbitration was the duty-to-defend issue and the Third District already had held that the Joint Venture Lawsuit was not subject to arbitration in Falcone v. Laquer(the second appeal).

Finding that Laquer’s voluntary dismissal deprived the arbitrator of subject matter jurisdiction over the arbitrable issue (the duty-to-defend cross-claims), and that the arbitrator thus exceeded his jurisdiction when entering a final arbitration award, the Third District in Laquer v. Falconereversed the trial court’s judgment affirming the award.

In sum, the foregoing appellate decisions reinforce the important strategic implications related to motions to compel arbitration for both sides of the ledger at all stages of litigation.  Among other considerations, litigants should carefully assess up-front how their conduct in the actual litigation and/or in other pending litigation might impact their subsequent ability to demand arbitration or, conversely, to resist it.  For example, in 13 Parcels, the court compelled arbitration of a limited claim when the parties had not waived the claim or raised it in any other litigation; whereas, inFalcone v. Laquer, based on waiver, the court refused to compel arbitration of the entire lawsuit when the party seeking to compel had affirmatively participated in the suit (by, among other things, moving to dismiss, engaging in discovery and moving for summary judgment).  Similarly, inSoares, the parties’ pre-arbitration stipulation helped support affirmance of the arbitration award in that case.  Further, plaintiffs should consider up-front the timing of voluntarily dismissals, given that the filing of a notice of voluntary dismissal before an arbitration hearing may deprive the arbitrator jurisdiction to entertain the arbitration (as in Laquer v. Falcone), while the filing of a notice of voluntary dismissal after the entry of an arbitration award may be too late to resist the arbitration (as in Soares, where the defendant there already had acquired substantial rights in the cause when the voluntary dismissal notice was filed).  As for defendants, they likewise should consider up-front whether or not to seek affirmative relief in any action for arbitration purposes, which the defendant did in Soares by filing a counterclaim in the arbitration and then moving to confirm the arbitrator’s award.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes.  The firm also specializes in wealth preservation and asset protection designed to preserve wealth, protect assets and form the foundation for continued, protected wealth-creation (whether domestically or offshore).  Please contact us by email at contact@fidjlaw.comor telephone at 305.350.5690 with any questions regarding this article or any other issues on which we might provide legal assistance.

Trade Based Money Laundering in the News: Miami-Area Electronics Exporters Targeted in FinCEN Anti-Money Laundering Initiative

April 22nd, 2015

On April 21, 2015, the Financial Crimes Enforcement Network (FinCEN) issued a Geographic Targeting Order (GTO) to approximately 700 businesses in the Miami, FL area which export electronics, including mobile phones.  The GTO implements several reporting requirements for these businesses when they are involved in currency transactions over $3,000, which is significantly lower than the usual $10,000 threshold.  The report to the government (typically referred to as an Form 8300) includes information about the transaction and the people involved.

According to the FinCEN press release, the purpose of the GTO is to “shed light on cash transactions that may be tied to trade-based money laundering schemes.”  Criminal organizations including drug cartels, crime syndicates, and terrorist-financing operations use trade-based money laundering to move and launder incredibly large sums of money just by buying and selling merchandise in international markets.

According to the Financial Action Task Force (FATF), an intergovernmental body formed in the late 1980s to combat money laundering and other financial crimes, anywhere from $590 billion to $1.5 trillion in illegally obtained money was laundered world-wide in 2012 through trade based money laundering.  There are four basic techniques for laundering money through trade:

  • over- and under-invoicing of goods and services;
  • multiple invoicing of goods and services;
  • over- and under-shipments of goods and services; and
  • falsely described goods and services.

A common method of  bringing “clean” money into a country, involves a company undervaluing its imports or overvaluing its exports.  To move money out of a country, the opposite would occur.  For example, a U.S. company could sell $2 million in products to a cartel-linked company or customer in Latin America.  The U.S. company then invoices these products upon export for only $1 million.  The foreign customer obtains the products – for which they paid only $1 million – and resells them in country for the full $2 million.  This creates $1 million in laundered money.  The problem of import-export invoice discrepancy is so large, that the Global Financial Integrity and the International Monetary Fund estimate that the difference between the declared value of Mexican exports to the United States in 2013 was almost $40 billion higher than the declared value of those same imports into the U.S. Of course, this is only one example of a trade based money laundering transaction. The list of other trade based money laundering transactions is seemingly endless, but FinCEN is clearly mobilizing to reign it in.

Under the GTO, select businesses operating in the area immediately around Miami International Airport, as well as their agents, subsidiaries, and franchisees, must now file FinCEN Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business,” anytime they receive currency, cashier’s checks, or money orders in an amount over $3,000 in an export transaction.  (As noted in the title of the Form, such reporting normally is required for transactions in excess of $10,000, not $3,000.)  The businesses must also obtain the customer’s telephone number, a copy of a valid photo identification, and written certification from the customer as to whether he or she is conducting the transaction on behalf of another person.  With respect to the transaction itself, the Form must also include a description of the goods involved in the transaction, the name and phone number of the person receiving the goods, and the final address to which such goods are being shipped.

FinCEN has been using GTOs to combat money laundering since August 1996, when certain licensed money transmitters in the New York metropolitan area were required by FinCEN to report information about the senders and recipients of all cash-purchased transmissions to Colombia of $750 or more.  Over the last two decades, other GTOs have targeted such areas as the Los Angeles Fashion District, armored car and money couriers in San Diego County, and wire transfer agents in Arizona.

In issuing the GTO, FinCEN Director Jennifer Shasky Calvery stated, “We are committed to shedding light on shady financial activity wherever we find it.  We will continue issuing GTOs, as necessary, as well as exercising FinCEN’s other unique anti-money laundering authorities, to ensure a transparent financial system that impedes money launderers and other criminals from masking their identity and illicit activity.”

And certainly GTOs can have an enormous impact on money-laundering operations.  In the aftermath of the first GTO involving New York area money transmitters, the U.S. Department of Treasury found that the targeted money transmitters’ business volume to Colombia dropped approximately 30%; the volume of transactions at other, non-targeted businesses fell at a similar level.  This would imply that in addition to the government-stated goals of collecting data and transparency, the practical effect of a GTO is to shift money laundering activity away from the targeted area.  Returning to the August 1996 New York GTO, U.S. Customs (now U.S. Customs and Border Protection) reported a marked increase in interdiction and seizure activity involving cash smuggling at the U.S.-Mexico border immediately after the GTO went into effect.

It will be interesting to see where the money laundering activities will shift as a result of the new Miami-area GTO.  According to Export-Import Bank figures, the top 10 electronics exporters operating in the GTO-targeted area accounted for over $212 Million in exports over the last seven years.  Therefore, if the historical effectiveness of GTOs in squeezing trade-based money laundering into other geographic areas is any indication, the Miami export trade community is in for a major hit.

Class Action Litigation Update: Who Should Decide Whether an Arbitration Clause Permits Classwide Arbitration: the Court or the Arbitrator?

April 2nd, 2015

Over the past two years, a series of court cases has renewed the debate over the availability of classwide arbitration in agreements that lack an express class waiver provision. Specifically, these cases raise the critical question of who—the court or an arbitrator—may construe whether an arbitration agreement permits class arbitration when the parties have not expressly agreed to a procedure.

The United States Supreme Court has yet to definitively address this issue and, this past month, declined to review a decision holding that a court, and not an arbitrator, determines the availability of classwide arbitration. Opalinski v. Robert Half International Inc., 761 F.3d 326 (3d Cir. 2014), cert. denied No. 14- 625, — S. Ct. —-, 2015 WL 998611 (U.S. Mar. 9, 2015). The Supreme Court’s decision to decline certiorari was surprising since there is a split of authorities in this gateway function among courts. Indeed, several district courts have relied on a plurality decision by the Supreme Court in holding that this issue is a procedural question, and not an arbitrability question. (Procedural questions are decided by arbitrator, whereas the core issue of arbitrability is reserved for the courts to decide.) On the other hand, two federal circuit courts held that this determination should be reserved for the court.

In light of the Supreme Court’s denial of certiorari in Opalinski, circuit courts are left without adequate direction, and continue to leave open this gateway issue. For example, if a circuit court rules that an arbitrator should determine the availability of classwide arbitration, the decision would create a circuit split on the issue and could present a better opportunity for the Supreme Court to address this specific question.

It remains to be seen whether any future circuit court cases will align with or contradict the decisions reached in the United States Courts of Appeals for the Third and Sixth Circuits. Until the Supreme Court offers guidance on this issue, companies using consumer arbitration agreements will need to defer to court decisions in the circuits where they operate to discern who should decide the availability of classwide arbitration.

Background

In Green Tree Financial Corporation v. Bazzle, 539 U.S. 444, 452-3 (2003), the Supreme Court evaluated whether the Federal Arbitration Act permits class-wide arbitration hearings, and concluded that an arbitrator should determine whether a contract forbids class arbitration. In support of this decision, the Court explained that the question of who should decide this issue “is a procedural one for arbitrators” because it concerns the procedure to be used in arbitrating the parties’ dispute, not whether they agreed to arbitration or whether the agreement applied to the underlying dispute. The opinion goes on to explain that this issue is not an arbitrability question because it “concerns neither the validity of the arbitration clause nor its applicability to the underlying dispute between the parties,” and does not ask “whether the parties wanted a judge or an arbitrator to decide whether they agreed to arbitrate a matter.” For these reasons, the Supreme Court determined that the matter of contract interpretation should be left for an arbitrator and not the courts.

Subsequent Supreme Court decisions, however, have cast doubt on Bazzle. In Stolt-Nielson, S.A. v. Animal Feeds International Corp., 559 U.S. 663, 680 (2010), the Supreme Court emphasized that “only a plurality” in Bazzle reached a conclusion on the issue. Thus, the Bazzle decision should be treated as non-binding. Then, in a note in the opinion for Oxford Health Plans LLC v. Sutter, 133 S. Ct. 2064, 2069 n.2 (2013), the Supreme Court expressly stated that “this Court has not yet decided whether the availability of class arbitration is a question of arbitrability.”

Court Decisions that Follow the Bazzle Rationale

Since its decision in Oxford, the Supreme Court has not addressed the issue of who should decide whether an arbitration clause permits classwide arbitration. Although no federal circuit courts of appeal have decided this question, some federal district courts have opted to follow Bazzle. See Guida v. Home Sav. of Am. Inc., 793 F. Supp. 2d 611, 615-19 (E.D.N.Y. 2011); Hesse v. Sprint Spectrum L.P., No. C06–0592JLR, 2012 WL 529419 (W.D. Wash. Feb. 17, 2012); Lee v. JPMorgan Chase & Co., 982 F. Supp. 2d 1109, 1112-14 (C.D. Cal. 2013); In re A2P SMS Antitrust Litig., No. 12-CV-2656 (S.D.N.Y. May 29, 2014); Sandquist v Lebo Auto. Inc., 228 Cal. App. 4th 65, 78-79 (2014).

These courts have concluded that the class arbitration question is for arbitrators to decide because it determines the procedures the parties will use to arbitrate their dispute. These courts have dismissed arguments pointing out the differences between individual and class arbitration, finding those differences to be insignificant because they are “more relevant to the issue of whether the parties agreed to class arbitration…than to the issue of whether the court or the arbitrator decides if an agreement contemplates class arbitration.” See Sandquist v. Lebo Automative, Inc. at 78-79. In Sandquist, the court reasoned that this issue is a procedural one because “a class action is a procedural device.” It is important to note that while these cases follow the Bazzle rationale, they do not provide an explanation or analysis to support this argument.

Court Decisions that Reject the Bazzle Rationale

            In the last two years, some courts have expressly rejected the Supreme Court’s rational in Bazzle. Most notably, the United States Courts of Appeals for the Third and Sixth Circuits have held that the issue of who should decide whether classwide arbitration applies is an arbitrability question for courts to decide because it determines whose claims the parties must arbitrate and, therefore, fundamentally affects both the nature and scope of the parties’ arbitrations.

In Reed Elsevier, Inc. ex rel. LexisNexis Div. v. Crockett, 734 F.3d 594, 597-99 (6th Cir. 2013), the Sixth Circuit held that the “question [of] whether an arbitration agreement permits classwide arbitration is a gateway matter, which is reserved ‘for judicial determination unless the parties clearly an unmistakably provide otherwise.’” Upon review, the Sixth Circuit determined that the agreement at issue in Reed Elsevier was at best “silent or ambiguous as to whether an arbitrator should determine the question of classwide arbitratability; and that is not enough to wrest that decision from the courts.” The Sixth Circuit made clear that the “principal reason to conclude that this arbitration clause does not authorize classwide arbitration is that the clause nowhere mentions it.”

In 2014, the Sixth Circuit again held that courts should decide the issue of classwide arbitration. In Huffman v. Hilltop Companies, LLC, 747 F.3d 391, 398-99 (6th Cir. 2014), the Sixth Circuit held that “[a]s was the case in Reed Elsevier, here the parties’ agreement is silent as to whether an aribtrator or a court should determine the question of classwide arbitrability.” In its opinion, the Sixth Circuit went on to reiterate that “the determination [of whether an arbitration agreement permits classwide arbitration] lies with this court” and not arbitrators.

Similarly, in Opalinski v. Robert Half Inc., 2014 U.S. App. LEXIS 14538 (3d Cir. July 30, 2014), the Third Circuit held that absent a clear agreement otherwise, a court and not an arbitrator, must decide if an agreement to arbitrate also authorizes classwide arbitration. The Third Circuit’s opinion explained that “questions of arbitrability” are limited to a narrow range of gateway issues. For example, they may include “whether the parties are bound by a given arbitration clause” or “whether an arbitration clause in a concededly binding contract applies to a particular type of controversy.” Id. at 84. On the other hand, however, questions that the parties would likely expect the arbitrator to decide are not “questions of arbitrability.” Questions that fall into the category of non-arbitrability include ‘“procedural’ questions that grow out of the dispute and bear on its final disposition” as well as allegations of waiver, delay, or similar defenses to arbitrability. In reaching this decision, the Third Circuit relied on the Supreme Court’s opinion in Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002), and explained that the crucial consideration in its analysis should be the contracting parties’ expectations because courts should not “forc[e] parties to arbitrate a matter they may well not have agreed to arbitrate.” On March 9, 2015, the Supreme Court denied the petition for certiorari.

Since the Third Circuit’s Opalinski decision in July 2014, there has not been much judicial activity on this issue. No other federal circuit courts have issued opinions regarding the question of who should decide issues of classwide arbitration. In the last few months, California appellate courts have also relied on the Third and Sixth Circuits’ reasoning in finding that this issue is an arbitrability question for the courts and not arbitrators.

For example, the California Court of Appeal for the Fourth District held that it was “not persuaded by Bazzle and its rationale for concluding the Class Arbitration Question is a procedural matter for arbitrators” and decline[d] to follow Bazzle, Sandquist, or similar cases adopting Bazzle’s rationale. Network Capital Funding Corporation v. Papke, 230 Cal.App.4th 503, 511-14 (2014). Instead, the court explicitly stated that “we agree with Opalinski, Huffman, and Reed Elsevier, and conclude the Class Arbitration Question is an arbitrability question for courts.” Id. The opinion further explained:

The Class Arbitration Question also is not analogous to issues the Supreme Court has found pose a procedural question for arbitrators to decide. For example, whether the parties agreed to arbitrate on an individual or class basis is not analogous to whether the claimant satisfied all prerequisites to arbitration established by the parties’ agreement. Similarly, the Class Arbitration Question is not analogous to whether the statute of limitations bars a party’s claims or ’allegation[s] of waiver, delay, or a like defense to arbitrability,’ all of which the Supreme Court has found to be procedural matters. Neither Bazzle nor any of the cases adopting its rational provides an explanation or analysis of how the Class Arbitration Question grows out of the parties’ underlying dispute or bears on the dispute’s final disposition.

Id.; see also Garden Fresh Restaurant Corp. v. Superior Court, 231 Cal.App.4th 678 (2014)(holding that, where an arbitration agreement does not “clearly and unmistakably” provide for class and/or representative arbitration, the issue of whether a collective arbitration is allowed is a “gateway issue” for the court to determine).

A Potential Circuit Split?

A recent case that could turn the tide in this debate was decided in the Southern District of New York earlier this month. In In re A2P SMS Antitrust Litig., No. 12-CV-2656 (AJN), 2015 WL 876456, at *2-7 (S.D.N.Y. Mar. 2, 2015), the Southern District of New York held that an arbitrator should decide the availability of classwide arbitration and certified the question for an interlocutory appeal to the Second Circuit. In its decision, the court relied on the Supreme Court’s opinion inBazzle and found that determining the availability of classwide arbitration is a procedural one for arbitrators. If the Second Circuit grants the petition for review, it will be in the position to decide whether to follow the Third and Sixth Circuits’ rationale or follow the Supreme Court’s opinion inBazzle and effectively create a circuit split on this issue.

Conclusion

With the exception of the recent California and New York cases, the law in this area appears to be at a standstill. It remains to be seen whether the circuit courts will adopt differing jurisprudential opinions and create a circuit split on this issue. Thus, in the absence of a clear decision by the Supreme Court, the question of whether the court, or the arbitrator,  determines the availability of classwide arbitration where an arbitration agreement lacks an express class waiver provision continues to be an unresolved issue.

In order to avoid the uncertainty posed by agreements that are silent on this issue, parties entering into arbitration agreements can insert a provision into the agreement that expressly allows or disallows class arbitration. Furthermore, in anticipation of a possible dispute over whether an agreement authorizes classwide arbitration, parties should include clear and unambiguous language specifying whether a court or an arbitrator should decide the question of arbitrability. By including these types of provisions into the agreement’s terms, parties can avoid the possibility of being forced to arbitrate a matter that they did not expressly agree to at the outset.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in all areas of complex litigation, including pre-litigation and arbitration. Should you have any questions or need further assistance, please contact us via email at contact@fidjlaw.com or via telephone at (305) 350-5690.

Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?

January 28th, 2015

Attorneys Andrew Ittleman and Jessika Tuazon of Fuerst Ittleman David & Joseph published their article, “Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?” in the December 2014 issue of the Food and Drug Law Institute’s Food and Drug Policy Forum. A copy of the article is available here.

In the article, Mr. Ittleman and Ms. Tuazon confront “the complex question of how the federal government should go about the process of ending its decades-old prohibition of cannabis and bring about a regulatory regime designed to address the wide array of risks and opportunities presented by legalization.” After describing the history of the federal government’s prohibition of marijuana, as well as the efforts of various states to legalize it in various forms, the article recommends that “rather than attempting to devise a statutory scheme for cannabis in an echo chamber, Congress should be carefully studying the successes and failures of the individual states’ efforts to regulate marijuana, as they are the perfect ‘social and economic experiments’ encouraged by traditional notions of federalism.” The article further suggests that instead of “starting from scratch in developing regulations for marijuana, the government could – and should – borrow elements from regulatory regimes already in place for analogous products.” The article also describes how existing federal agencies – including the FDA, the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), and

the Bureau of Alcohol, Tobacco, Firearms, and Explosives (“ATF”) – could all be delegated jurisdiction by Congress to regulate marijuana, as all three agencies

are well suited to handle the added task of regulating and enforcing laws overseeing the manufacture, distribution, and sale of marijuana.

Most importantly, Mr. Ittleman and Ms. Tuazon recommend that in undertaking the regulation of marijuana, the federal government should proceed flexibly, giving due regard to the marijuana industries already developing in numerous jurisdictions in the United States, as well as regulatory regimes already in place for analogous articles, including alcohol and tobacco. The article concludes with the following recommendations:

First, we respectfully submit that Congress should carefully study the marijuana industries already developing in numerous jurisdictions in the United States, and should likewise invite the individual states to participate in Congress’s legislative process. Additionally, because of the value of the data currently being developed

in states which have legalized marijuana in one way or another, the federal government should support the states in their efforts to regulate marijuana by providing regulatory guidance and law enforcement resources as requested by the states. The federal government should also continue to loosen restrictions on banks and other federally regulated financial institutions wishing to do business with licensed marijuana related companies, as the all-cash business model of the typical dispensary will only lead to security risks and the tainting of the information needed by Congress when considering how to govern the interstate market for cannabis.

Second, we respectfully submit that in evaluating its own regulation of medicinal and recreational cannabis, the federal government should look to regulatory regimes already in place for analogous articles, including alcohol and tobacco. By doing so, the process of writing regulations for the marijuana industry can be far more economical, and will give the regulated industry better notice and more opportunity to comply.

Third, we should all appreciate the scope of the task at hand, and understand that there is much more at issue than simply rescheduling or “legalizing” cannabis. Once prohibition has ended, marijuana may be available nationwide in the form of buds, edibles, drinks, tinctures and concentrates, potentially for medicinal and recreational purposes, and every possible variation on the manufacturing, distribution and use will be subject to regulation. It is therefore critical that Congress proceed deliberately so as to avoid a gap between the end of prohibition and the beginning of regulation, and flexibly so as to take all of the various forms and uses of cannabis into consideration.

Finally, everyone participating in the process of ending the federal government’s prohibition of cannabis should appreciate the magnitude of the black market and understand that it will not disappear overnight following a rescheduling. It is the black market, perhaps above all else, that mandates that Congress proceed deliberately when legalizing cannabis, to ensure that all possible voices are heard and seriously considered. Indeed, if federal regulation of cannabis is overly restrictive, leading to higher costs or elimination of choice for consumers, consumers will revert to the same black markets they have used for the past 40 years. A black market for cannabis – even following a federal rescheduling – will trigger all of the “Cole Memo Priorities” currently sought to be quelled by the Obama administration, including the diversion of profits to criminal enterprises, access to cannabis by children, and other adverse health consequences. Congress should thus take care to end prohibition deliberately, comprehensively, and with due regard for every interested party.

Fuerst Ittleman David & Joseph provides comprehensive representation to highly regulated businesses, including clients operating in the financial services, biotechnology, and international trade industries, and frequently lectures on these subjects for industry trade groups. The firm has more recently been called upon to combine its Food and Drug and Anti-Money Laundering practice areas in assisting marijuana-related businesses achieve financial compliance.

Complex Commercial Litigation Update: New York’s Separate Entity Rule and the Reemergence of Florida as a Potential Gateway for Judgment Creditors to Seize Debtors’ Foreign Assets in Enforcement and Collection Proceedings

January 13th, 2015

All too often a judgment-creditor hits a roadblock when a judgment-debtor attempts to evade enforcement of a money judgment by shielding the debtor’s assets located outside of the jurisdiction where the judgment was obtained, whether in other parts of the United States and/or throughout the world. The creditor then must chase the debtor’s foreign assets around the globe, where blocking statutes and bank secrecy regimes in other countries often significantly hinder, if not halt, the chase.

International banking cities in the United States with foreign bank branches have struggled with this issue for years, especially given recent globalization and advances in centralized operational technology, which now allow financial institutions to communicate with their branches and affiliates in a matter of seconds or a few keystrokes.

Litigants, lawyers, financial regulators and the courts likewise have struggled with this issue in the context of post-judgment enforcement proceedings, where international comity and foreign interests must be balanced with the rights of creditors to collect upon their final judgments.

Several legal decisions recently emanating out of New York have clarified various important issues in the matter, making the creditor’s chase for foreign assets more difficult in certain respects but easier in others. Specifically, for nearly a century, the courts in New York employed a common law rule—known as the separate entity rule—providing that, even when a bank-garnishee with a New York branch is subject to personal jurisdiction, the bank’s other branches are to be treated as separate entities for certain purposes, including pre-judgment attachments and post-judgment freezes and turnover orders. The separate entity rule thus required a creditor to track down and serve each and every bank branch where a debtor might be hiding assets and to successfully freeze (or enjoin) those assets before they were transferred or withdrawn by the debtor.

In 2009, the tides seemingly turned in favor of the creditors, when the New York Court of Appeals ruled that a creditor could reach beyond New York’s borders to seize assets held elsewhere. Specifically, in Koehler v. Bank of Bermuda, the highest court in New York held that a creditor could seek the turnover of stock certificates located outside the United States if the court had personal jurisdiction over the garnishee bank. The Koehler decision spawned a frenzy by judgment creditors viewing New York as a potential haven for collecting assets located worldwide from banks with branches in that state.

Years later in 2013, Motorola (the global telecommunications giant), after having obtained a judgment of more than $3 billion against various Turkish companies and their beneficial Turkish owners, obtained a post-judgment collection order restraining the debtors and anyone with notice of the order from transferring the debtors’ property. Motorola served the restraining order on, among other international banks with branches in the United States, the New York branch of Standard Chartered Bank (SCB), a foreign bank existing under the laws of the United Kingdom. SCB, which had no connection to the dispute between Motorola and the bank’s customers, did not locate any of the debtors’ assets at its New York branch, but, following a global search of its other branches, found $30 million worth of debtor-related assets in its branches located in the United Arab Emirates (UAE). SCB froze those assets in accordance with the restraining order, but the regulatory banking authorities in the UAE and Jordon quickly intervened and unilaterally debited the $30 million from SCB’s account with the UAE’s central bank. SCB then took the matter to court, arguing, in relevant part, that service of the restraining order on SCB’s New York branch was effective only as to assets located at that sole branch. In other words, relying on New York’s separate entity rule, the foreign bank garnishee (SCB) argued that the judgment creditor (Motorola) could not freeze the judgment debtors’ funds located in the bank’s foreign branches by merely serving its New York branch alone. In response, the creditor asserted that the separate entity rule was no longer valid law in light of Koehler.

The case identified above, Motorola Credit Corp. v. Standard Chartered Bank, garnered significant attention from the business and legal communities, including global financial and banking institutions, and was recently decided in October 2014.

Significantly, the same court that had previously allowed a judgment creditor to reach beyond the jurisdiction’s borders in Koehler prevented a creditor from doing this inStandard Chartered Bank. In a 5-2 decision, with a strong dissent, the majority expressly adopted the separate entity rule for post-judgment enforcement and collection proceedings, holding that the rule precludes a creditor from ordering a garnishee bank operating branches in New York to restrain a debtor’s assets held in foreign branches of the bank.

The majority in Standard Chartered Bank preliminarily found the separate entity rule to be “a firmly established principle of New York law.” The majority also distinguishedKoehler, noting that the rule was not expressly raised in that case; the case involved neither bank branches nor assets held in bank accounts (but stock certificates); and the foreign bank at issue there had conceded the court’s personal jurisdiction over the bank. The Standard Chartered Bank majority also relied on various policy reasons supporting adoption of the separate entity doctrine, including that “international banks have considered the doctrine’s benefits when deciding to open branches in New York,” and that the doctrine “promotes international comity and serves to avoid conflicts among competing legal systems.” Ultimately, the majority concluded “that abolition of the separate entity rule would result in serious consequences in the realm of international banking to the detriment of New York’s preeminence in global financial affairs.”

In sharp contrast, the dissent in Standard Chartered Bank deemed the separate entity rule to be “outmoded” and “a step in the wrong direction.” The dissent likewise maintained that “use of the separate entity rule to address potential comity issues is akin to using a cannon to kill a fly,” and that a bank’s concerns about double-liability (between responding to a US court-order and respecting a foreign country’s blocking statutes and banking privacy laws) and other potentially conflicting exposure could be addressed on a case-by-case basis. The Standard Chartered Bank dissent also viewed the majority’s opinion to conflict with the same court’s holding in Koehler. According to the dissent, the foreign bank simply “ha[d] aided its fugitive customers by erecting a monumental roadblock to [the judgment creditor]’s enforcement of a staggering judgment.”

As of the writing of this article, only two reported decisions have been decided in the wake of Standard Chartered Bank’s adoption of the separate entity rule.

In Lease Finance Group, LLC v. Fiske, a New York state trial court ruled that service in Pennsylvania of a non-domesticated New York judgment upon a domestic bank with branches throughout the United States, including in Georgia and New York, does not subject the debtor’s account in Georgia to the jurisdiction of New York courts for purposes of enforcing the New York judgment. However, the court in Fiske expressly noted that Standard Chartered Bank did not define the separate entity rule’s “scope in regard to domestic branches of banks located in foreign states.”

Additionally, in Motorola Credit Corp. v. Uzan, in post-judgment discovery proceedings related to Standard Chartered Bank, a New York federal district court addressed whether a New York judgment creditor (again, Motorola, in that case), through subpoenas issued on New York offices of international banks, could obtain discovery regarding accounts held by the judgment debtors or their agents in various foreign branches of those banks, including in France, Switzerland, Jordan and the UAE. Conducting a particularized analysis of the respective interests of those foreign jurisdictions and a “full consideration of international comity” as set forth in the United State Supreme Court’s seminal decision in Societe Nationale Industrielle Aerospatiale v. United States District Court for the Southern District of Iowa, the court in Uzan ordered the New York branches of banks in France, Jordan and the UAE to comply with the subject subpoenas and discovery requests. The court otherwise quashed (denied) enforcement of the subpoenas directed to the Swiss banks, concluding that the blocking statutes and bank privacy regime in Switzerland “is not merely protective of private interests, but expressive of public interest” and that Switzerland viewed its “bank secrecy as a positive social value and benefit.”

In sum, the foregoing decisions—Standard Chartered Bank, Fiske and Uzan—have provided creditors with new tools and strategies to chase and seize a debtor’s foreign assets, including the important discovery tools endorsed in Uzan. The decisions, while adopting the separate entity rule, also have left open numerous important legal questions, including the applicability of the rule to branches located outside of the jurisdiction of the judgment but within the United States and its territories; the extent that the corporate relationship between a bank and its affiliates distinguishes the rule’s application; and the degree to which a banking branch or affiliate conducts business within a jurisdiction for jurisdictional purposes, such as the foreign bank in Koehler, where the creditor was allowed to obtain foreign assets by serving a local branch over which the court had personal jurisdiction.

The analysis in this context is also subject to forum-specific considerations, as the policy interests underlying the separate entity rule as applied in New York City might differ from those in other important banking cities in the United States, such as Miami, Atlanta, Chicago, San Francisco, Boston, Philadelphia, Dallas, Los Angeles, Minneapolis and so forth. Those differences, of course, as well as the different laws in those respective jurisdictions, can lead to strategies that favor creditors’ enforcement efforts or, conversely, debtors’ asset-protection efforts.

For example, the separate entity rule is not the law in Florida, as affirmed in Tribie v. United Development Group International LLC. Notably, the court in Tribie rejected the bank’s (there, Wells Fargo’s) reliance on the separate entity rule to quash a writ of garnishment seeking discovery regarding the debtor’s assets at all of the bank’s branches, describing the rule as “a somewhat dated and seldom-cited legal doctrine.” The court thus required the bank to respond to the subject discovery by identifying, in relevant part, “whether Wells Fargo knows of other persons [or entities] indebted to [the debtor]” (emphasis added), including, presumably, the bank’s other branches holding the debtor’s assets. Similarly, in a case involving a judgment creditor’s request for an order directing a bank’s disbursement of a judgment debtor’s (there, the American Samoa Government’s) garnished funds under Hawaiian law, the court in Marisco, Ltd. v. American Samoa Government “predict[ed] that the Hawai’i Supreme Court would decline to adopt the separate entity rule” and directed the bank to disburse the debtor’s (a government entity’s) garnished funds.

Whether a creditor is attempting to seize foreign assets or a debtor is attempting to protect its assets in any jurisdiction, the individuated analyses in Tribie and Mariscounderscore the importance of the specific factual circumstances at issue and of the applicable authority where the dispute is focused and/or litigated.

The recent case law regarding financial institutions as a means of seizing foreign assets also underscores the reemergence of jurisdictions with important banking ties—such as Miami, Florida—as potential gateways for not only litigation in this area but the resolution of all types of global legal disputes, including international arbitrations. Indeed, Miami already promotes its relatively lower costs (as compared to other major banking cities, like New York, Los Angeles and San Francisco in the United States, and Paris and London abroad), multi-lingual professional force and central-location easily reachable from South America, Europe and Asia, among its unique benefits for handling international business and legal matters. Florida law regarding the separate entity rule, especially when compared to New York law as addressed in the recent cases cited in this article, now provides yet another feather in Miami’s cap as an ideal destination for litigation regarding the seizure of foreign assets, international arbitrations, the confirmation of arbitration awards and all garnishment and other collection proceedings related thereto.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes. The firm also provides wealth preservation and asset protection services designed to form the foundation for continued, protected wealth-creation (both domestically and offshore). Please contact us by email at contact@fidjlaw.com or telephone at 305.350.5690 with any questions.

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FDA Regulatory Update: Forecasting FDA Regulation of Laboratory Developed Tests (LDTs) in 2015

Wednesday, January 7th, 2015
2015 is proving to be a landmark year for FDA’s regulation of laboratory developed tests. As we have previously discussed (see our blog here), the U.S. Food and Drug Administration (FDA) has been expressing its intention to begin exercising regulatory authority over laboratory developed tests (LDTs) for years. In the Federal Register, FDA has defined LDTs as “a class of in vitro diagnostics that are manufactured, including being developed and validated, and offered, within a single laboratory.” Examples of these tests include genetic tests, emerging diagnostic tests, and tests for rare conditions. While FDA has claimed authority to regulate LDTs under the Food, Drug, and Cosmetics Act (FDCA), it has not drafted applicable regulations. Consequently, the primary federal regulation of laboratories and LDTs has been under the Clinical Laboratory Amendments of 1988 (“CLIA”).

While historically FDA has continued to claim authority to regulate LDTs, the agency consistently maintained the position that it would not enforce regulations regarding LDTs. FDA began departing from its “enforcement discretion” position on June 10, 2010, when it issued five Untitled Letters to companies stating that their tests did not qualify as LDTs as they were “not developed by and used in a single laboratory.” (To read the FDA’s Untitled Letters to Industry, please click here, here, here, here, and here.) In those instances, FDA determined that it would regulate those tests as medical devices and require premarket approval. In June 2010, FDA stated that increased regulation of LDTs may be necessary due to the changing nature of LDTs from “generally relatively simple, well-understood pathology tests” to tests that “are often used to assess high-risk but relatively common diseases and conditions and to inform critical treatment decisions.” (To read the full text of the Federal Register notice regarding federal oversight of LDTs, please click here.)

In 2012, the Food and Drug Administration Safety and Innovation Act (“FDASIA”) was signed into law requiring that FDA notify Congress if it intended to issue guidance on the regulation of LDTs. On July 31, 2014, in compliance with FDASIA, FDA notified Congress that it would issue two draft guidance documents pertaining to its regulation of LDTs. Shortly thereafter, FDA issued these guidance documents entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Framework Guidance”) and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Notification Guidance”). (For the full text of FDA’s notification and the two anticipated draft guidance documents, please click here.)

FDA’s Framework Guidance adopts the same definition of LDTs that FDA proposed in 2010, “an IVD that is intended for clinical use and designed, manufactured and used within a single lab.” It also identifies three groups of LDT: (1) LDTs that are subject to full enforcement discretion, (2) LDTs that are subject to partial enforcement discretion, and (3) LDTs that are subject to complete FDA regulation. Essentially, FDA explains how it will regulate these different types of LDTs under the current framework of medical devices. For example, low-risk LDTs are classified as class I medical devices and will be subject to partial enforcement discretion. FDA has grouped LDTs that are moderate- to high-risk into tests that FDA intends to fully regulate. Moderate-risk LDTs are those classified as class II devices, which will be required to gain clearance or approval through submissions to FDA. High-risk LDTs are those with the same intended use as a cleared or approved companion diagnostic, LDTs with the same intended use as a class III device approved by FDA, and LDTs for determining safety and effectives of blood or blood products.

The anticipated Notification Guidance describes how laboratories must notify FDA if they intend to “manufacture, prepare, propagate, compound or process” an LDT. FDA also plans to exercise enforcement discretion when it comes to establishment registration and devices listing for LDTs, as long as the laboratories notify FDA that they are manufacturing an LDT within six months after the final Framework Guidance is finalized by FDA. After notification, FDA will issue a notification confirmation number to the laboratory. The Notification Guidance also goes on to explain the types of record keeping, procedures, and reporting requirements the laboratories will need to incorporate into their procedures.

While the two guidance documents place a very high burden on the developers of LDTs, it is important to note that the guidance documents are themselves neither laws nor regulations. FDA specifically states that “[g]uidance documents represent FDA’s current thinking on a topic. They do not create or confer any rights for or on any person and do not operate to bind FDA or the public. You can use an alternative approach if the approach satisfies the requirements of the applicable statutes and regulations.” However, FDA does utilize such guidance documents regularly in its oversight of industry.

Most recently, the House Energy and Commerce Committee has issued a white paper regarding its 21st Century Cure Initiative in which it requests input related to FDA’s proposed LDT regulatory framework. This white paper sets forth eleven questions related to the proposed LDT guidance documents to which the committee seeks answers. These questions relate to a range of issues including: the clarification between the practice of medicine and developing these types of tests, the delineation between what constitutes a device and what constitutes a test not subject to device regulation, how will FDA determine the risk in its “risk-based” approach, the implementation of post-market processes to reduce hurdles to patient access to tests, and separation of CLIA and FDA regulation of LDTs, among others. The Committee requested that all comments be submitted by last week, so we should have a better idea of the reaction to these comments and FDA’s proposed guidance documents in the next few weeks.

Based on this timeline, we expect 2015 to be a remarkable year for LDT regulation as FDA’s policies and regulatory framework evolves and these types of tests are subjected to heightened scrutiny. It will be interesting to see how industry responds to this development in FDA’s LDT policies. In the past, various members of industry have submitted citizen petitions urging FDA not to regulate LDTs so there will likely be a strong reaction from industry to FDA’s notice to Congress and these two draft guidance documents. Fuerst, Ittleman, David, and Joseph, PL will continue to monitor the developments in FDA’s regulation of laboratory developed tests.

Complex Litigation Update: Bridging the Gap between Data on Causation of Lost Profits and the Admissibility of Expert Opinions

January 6th, 2015

The Eleventh Circuit recently held in Chapman v. Procter & Gamble Distributing, LLC that when determining the admissibility of medical expert causation testimony, the court, acting as the gatekeeper, must find that the expert’s opinion on novel issues of causation is based on generally accepted methodologies rather than untested hypotheses or collateral evidence.  Namely, there must be enough data, analytical evidence, and scientific literature upon which the expert can base an inference—not a hypothesis—of causation.  Here, we address the issue of how Chapman might impact expert causation testimony relating to non-scientific causation testimony, such as an expert’s valuation of a business’s alleged lost profits.

It is well settled that an expert’s testimony must be reliable and relevant to the issue at hand to be admissible.  Specifically, the court must determine that the expert’s methods in reaching his or her conclusion are sufficiently reliable.  The court cannot just take the expert’s word for it.  As set forth in a landmark case dealing with the admissibility of novel causation expert testimony, Daubert v. Merrell Dow Pharmaceuticals, Inc., when determining reliability, the court should look at: “(1) whether the expert’s methodology has been tested or is capable of being tested; (2) whether the theory or technique used by the expert has been subjected to peer review and publication; (3) whether there is a known or potential error rate of methodology; and (4) whether the technique has been generally accepted in the relevant scientific community.”  Although the law addressing the admissibility of expert testimony on causation initially developed in the medical and scientific fields, courts following theDaubert method have utilized the same analysis when dealing with the admissibility of expert testimony in commercial cases.

With the focus being on the expert’s methodology in reaching his or her ultimate conclusion, those seeking to have an expert opine on the lost profits of a business  should ensure the expert’s analysis comports with the Daubert factors.  But as we learned in Chapman, this would likely mean that the expert testifying as to the cause of the plaintiff’s lost profits would have to establish that analytical evidence, generally accepted in the relevant professional community, exists whereby this cause and effect may be inferred, not just hypothesized.  Because hypotheses can only be verified by testing, it would be improper to submit a mere hypothesis of causation to the jury for consideration.  It is not enough for the expert to say the defendant’s action or inaction may have caused the loss of profits, the expert would have to demonstrate that the method utilized in determining loss causation are generally accepted in the relevant community.  The key is to show general acceptance in the relevant professional community of the specific cause and effect, not just a generalized notion that certain acts or inactions can cause the damage.  Experts seeking to opine on the cause of a plaintiff’s alleged lost profits must be armed with evidence to demonstrate their primary methods for proving the cause and effect of the loss in that particular case.

Likewise, parties seeking to exclude an opposing expert’s testimony as to loss causation may look to Chapman for the proposition that expert testimony must establish that the lost profits were in fact cuased by the defendant and did not occur coincidentally.  Just as the court in Chapman determined that the expert seeking to establish that the plaintiff’s exposure to a particular substance was the cause of the injury was required to base his opinion on analytical evidence, an expert in a commercial case seeking to establish that a defendant caused a plaintiffs to suffer lost profits would likewise need analytical evidence to bridge the gap between the data relied upon and the lost profits alleged by the plaintiff.  Just as it was not enough for the experts in Chapman to provide plausible explanations as to the cause and effect that led to the plaintiff’s damage, it will not be enough for experts to simply speculate on untested theories of the cause of lost profits. Chapman may thus prove to be a powerful tool for those defending parties seeking to exclude speculative expert testimony.

Whether seeking to admit expert testimony on a novel issue of loss causation or seeking to have such testimony excluded, Chapman dictates that the expert’s testimony must close the analytical gap between the data and evidence of causation generally accepted in that relevant professional community with the specific opinion being offered.  Requiring experts to rely on more than just unverified methodologies reduces the speculative nature of such opinions and ensures that the jury is not misled by opinions of causation that are insufficient proof of causation.

The commercial litigation attorneys at Fuerst Ittleman David & Joseph are experienced in litigating complex matters involving expert witnesses in state and federal court. We would be happy to address any questions about these or similar legal issues. Please do not hesitate to contact us via email at contact@fidjlaw.com or by telephone at (305) 350-5690.

Same Surgical Procedure Exception under 21 CFR 1271.15(b): FDA Raises More Questions Than it Answers Regarding the Scope of the Exception

November 12th, 2014

The FDA has released a new draft guidance document for industry entitled “Same Surgical Procedure Exception under 21 CFR 1271.15(b): Questions and Answers Regarding the Scope of the Exception” (the Guidance Document), which can be read here. This Guidance Document is FDA’s attempt at clarifying the “same surgical procedure” exception set forth at 21 C.F.R. 1271.15. That exception allows for the use of autologous stem cell treatments without submitting to regulation under FDA’s drug or biologic regulations. As always, “FDA’s guidance documents, including this guidance, do not establish legally enforceable responsibilities.”

As background, FDA regulates human cells and tissues intended for use in transplantations, implantation, or transfer into human recipients as human cells, tissues, or cellular or tissue-based products. FDA defines “human cells, tissues, or cellular or tissue-based products” (HCT/Ps) to mean:

[A]rticles containing or consisting of human cells or tissues that are intended for implantation, transplantation, infusion, or transfer into a human recipient. Examples of HCT/Ps include, but are not limited to, bone, ligament, skin, dura mater, heart valve, cornea, hematopoietic stem/progenitor cells derived from peripheral and cord blood, manipulated autologous chondrocytes, epithelial cells on a synthetic matrix, and semen or other reproductive tissue. 21 CFR 1271.3(d).

FDA has set forth its regulations for HCT/Ps in 21 C.F.R. part 1271. In this part of the Code of Federal Regulations, FDA has divided HCT/Ps into two categories: (1) HCT/Ps regulated solely under part 1271 and section 361 of the Public Health Service Act (PHSA) (42 USC 264), and (2) HCT/Ps regulated under part 1271 and FDA’s regulations governing medical devices or drugs under the FDCA or biological products under section 351 of the PHSA (42 USC 262). However, practitioners can avoid regulation under Part 1271 if their treatment modalities fall within the “same surgical procedure” exception under 1271.15(b), which states “you are not required to comply with the requirements of this part if you are an establishment that removes HCT/Ps from an individual and implants such HCT/Ps into the same individual during the same surgical procedure.”

FDA’s new Guidance Document gives a brief overview of the history of the exception. In 1997, the FDA issued a document called “Proposed Approach to Regulation of Cellular and Tissue-Based Products” in which it stated “[t]he agency would not assert any regulatory control over cells or tissues that are removed form a patient and transplanted back into that patient during a single surgical procedure. The communicable disease risks, as well as the safety and effectiveness risks, would generally be no different than those typically associated with surgery.” After that, in 1998, FDA published a proposed rule in the Federal Register, 63 Fed Reg 26744, regulating the registration of HCT/P establishments followed by a final rule in 2001, 66 Fed Reg 5447. In the proposed rule, FDA stated that it received a comment assuming that a hospital retaining autologous tissue to be used in a subsequent application on the same patient, even if the use would occur in a future, not-yet-scheduled surgical procedure, would not be subject to registration and listing. In its final rule, FDA agreed that “so long as the hospital does not engage in any other activity encompassed with in [sic] the definition of “manufacture,” the hospital would not be required to register or comply with the other provisions to be codified in part 1271. For example, if the hospital expanded the cells or tissues, it would not meet the terms of the exception.”

After describing that historical background, FDA concludes in the new Guidance Document that “autologous cells or tissues that are removed from an individual and implanted into the same individual without intervening processing steps beyond rinsing, cleansing, or sizing, or certain manufacturing steps, raise no additional risks of contamination and communicable disease transmission beyond that typically associated with surgery.” FDA does not explain the leap from its 2001 explanation regarding hospital activities to its new decision that anyintervening steps outside of “rinsing, cleansing, or sizing” would bring a procedure outside of the “same surgical procedure” exception. What has happened between 2001 and now that has led FDA to determine that rinsing, cleansing, and sizing fit within the 1271.15 exception? This is only the first of many questions this new Guidance Document raises but does not answer. While attempting to provide some clarity to the regenerative medicine industry, FDA has, as it often does, raised additional questions and confusion as to how certain treatments and procedures will be regulated.

For instance, in addressing “[w]hen does the exception in 1271.15(b) apply?” (see Q4. of the Guidance Document), FDA states there are three criteria that must be met to fall under the exception. These criteria are that (1) the HCT/Ps must be removed and implanted into the same individual (autologous use), (2) the HCT/Ps must be implanted within the same surgical procedure, and (3) the HCT/Ps remain “‘such HCT/Ps;’ they are in their original form.” FDA has included a footnote to the third criterion stating:

Note that the criteria of “minimal manipulation” expressed in 21 CFR 1271.10 (a) is not the standard for establishing whether an HCT/P is “such HCT/P” under § 1271.15. Accordingly, even manufacturing steps considered minimal manipulation within § 1271.10(a), will typically cause the HCT/P to no longer be “such HCT/P” under §1271.15(b), unless the HCT/P is only rinsed, cleaned, sized, or shaped. (Emphasis added.)

This new narrower 1271.15 same surgical procedure exception leads to numerous other questions that our clients are asking in their medical practices. This footnote makes clear that the 1271 same surgical procedure exception is actually narrower than the “more than minimal manipulation” standard, which FDA has previously interpreted in guidance documents and regulatory preambles as being incredibly narrow. Would FDA consider centrifugation to be “rinsing, cleansing, sizing or shaping?” How does this Guidance Document affect the physicians in the United States who are utilizing centrifugation to work with stromal vascular fraction (SVF), many of whom using SVF in their practices under the auspices of the same surgical procedure exception? How does this interpretation affect cell separation procedures?

In attempting to clarify the types of procedures that fall within the same surgical procedure exception, FDA provides the following insights: “[P]rocedures that involve an incision or instrumentation (e.g., incision or surgical technique) during which an HCT/P is removed from and implanted into the same patient within a single operation performed at the same establishment, are considered to be the same surgical procedures. Examples include autologous skin grafting and coronary artery bypass surgery involving autologous vein or artery grafting.” (See Q3 of the Guidance Document.) As this statement seems to encompass a fairly broad range of procedures, it will be interesting to see exactly which procedures, other than those specifically mentioned, FDA will consider “surgical.”

FDA also attempts to address whether procedures that involve more than a single operation could fall under the same surgical procedure exception and whether autologous tissue can be shipped within the exception. In the Guidance Document, FDA writes that, in most situations, more than one procedure would not qualify under this exception. However, neither time nor the number of “procedures” involved is dispositive. Instead, there may be circumstances in which “removal and future implantation may be a number of days apart” and still fall within the exception (see A4 of the Guidance Document). HCT/Ps may only be rinsed, cleansed, and/or stored during the intervening time, according to FDA, and no other “manufacturing steps beyond labeling and storage may be performed.” Accordingly, it seems that procedures performed days apart can still be deemed to be the same surgical procedure. FDA also states that shipping of HCT/Ps cannot be done at any time during the procedure to fall under this exception, no matter what the purpose of the shipment (even for storage).

Despite the new questions raised, one of the few clear conclusions that can be drawn from this new draft Guidance Document is that FDA has decided to apply the same surgical procedure exception of part 1271 very narrowly. Practitioners and professionals in the regenerative medicine industry who believe that they are currently practicing within the same surgical procedure exception should closely scrutinize their practices in light of this Guidance Document to prepare and insulate themselves from potential enforcement action that may stem from violation of FDA’s newest interpretations. As this Guidance Document is a draft, FDA has chosen to accept comments, and comments must be submitted in writing by December 22, 2014. Fuerst, Ittleman, David, and Joseph, PL will continue to monitor this policy document and all other issues relating to FDA’s regulation of the regenerative medicine industry.

Money Laundering in the News: Los Angeles Fashion District Raid Puts Trade-Based Money Laundering and Black Market Peso Exchange in Spotlight

November 11th, 2014

On September 10, 2014, federal and local law enforcement officials raided the Los Angeles Fashion District in an effort to combat alleged money laundering for Mexican drug cartels which was occurring within the District. The raid, part of “Operation Fashion Police,” focused on the Fashion District due to the high potential for vendors to launder cartel money through a technique known as trade-based money laundering.

Law enforcement and financial institutions have seen an increase in trade-based money laundering since June of 2010 when the Mexican government announced regulations limiting deposits of U.S. cash in Mexican banks. (More information on Mexico’s deposit regulations can be found in the FinCEN Advisory entitled: “Newly Released Mexican Regulations Imposing Restrictions on Mexican Banks for Transactions in U.S. Currency” found here.)

A. Defining Trade-Based Money Laundering and understanding its common techniques.

Generally speaking, trade-based money laundering can be broadly defined as the process of disguising illicit proceeds and moving the value of such proceeds through a series of trade transactions in an attempt to disguise and legitimize their origin.

The basic premise of trade-based money laundering is as follows: Foreign drug traffickers who have an abundance of U.S. currency in the U.S. need a technique to move that money, the source of which is illicit drug profits, overseas. To accomplish this objective, traffickers, with the assistance of conspiring importers/exporters, arrange for the purchase of goods in U.S. dollars. Those goods are then shipped to foreign destinations, usually but not necessarily the home countries of the traffickers. Once these goods arrive, they are sold in the local currency. Thus, the traffickers have now moved their proceeds across the border, converted the U.S. dollars into local currency which traffickers use for day-to-day operations, and legitimized their income as the funds appear to be derived from legitimate trade and business transactions.

Trade-based money laundering can take several forms ranging from the very basic to the incredibly complex. While a complete list of trade-based money laundering techniques is beyond the scope of this article, some of the more common forms of trade-based money laundering include:

  • Over/Under invoicing goods and services: This technique involves the misrepresentation of the price of a good or service in order to transfer additional value between the importer and exporter. By invoicing the goods below fair market value, an exporter can transfer monetary value to an importer because the importer will be paying less for the good than the importer will receive when the good is sold. Alternatively, by invoicing at an amount above fair market value, the exporter receives added value as the goods have been purchased by the importer at a price higher than the value the importer will receive when they sell the goods.
  • Multiple invoicing of goods and services: This technique involves the issuance of more than one invoice for the same transaction. Through the issuance of multiple invoices, a money launderer can make multiple payments for the same goods, thus enabling more money to move in each transaction. Further, unlike over/under invoicing, these multiple payments can be made at fair market value. In order to increase difficulty in detection and avoid possible BSA reporting requirements, parties will often make payments for multiple invoices through different financial institutions.
  • Over/Under shipment of goods and services: This technique involves the misrepresentation of the amount of goods being shipped or services being provided. By shipping a greater quantity of goods than was paid for, an exporter can transfer addition value to an importer who will then sell these extra goods in the local market.
  • Falsely described goods and services: This technique involves the misrepresentation of the type or quality of the good being shipped or the service being provided. The false description creates a discrepancy between the listed invoice value and the actual market value of the good. For example, an exporter ships gold worth $3 per unit but falsely describes the shipment on its invoice as silver worth $2 per unit. The importer would pay the exporter $2 per unit for the goods shipped and then sell the higher valued product on the local market for $3 per unit and obtain the extra money as laundered profits.

The Financial Action Task Force, a 35 member inter-governmental policy-making body of which the U.S. is a member and whose purpose is to establish international standards to combat money laundering, has developed a comprehensive guide regarding the various trade-based money laundering techniques used to launder money. This informative guide can be read here.

B. The Black Market Peso Exchange

One advanced trade-based money laundering technique is known as the “Black Market Peso Exchange.” While the particular details of any Black Market Peso Exchange operation will vary on a case by case basis, the basic operation of any black market peso exchange arrangement usually follows the same steps.

To demonstrate, let’s use a hypothetical involving a Mexican drug cartel and apply their activities to the outline of trade-based money laundering provided by the Financial Action Task Force in its guide. In such a case, the black market exchange would operate as follows:

1) Drug traffickers smuggle drugs into the United States which are sold for U.S. dollars;

2) The drug cartel arranges to sell the U.S. dollars at a discount (i.e. a rate cheaper than that paid on the forex) in exchange for currency of the trafficker’s home country (in this example Mexican pesos) to a third party known as a “peso broker;”

3) The peso broker pays the cartel in pesos from his account located in Mexico;

4) The peso broker will then structure deposits of the U.S. dollars into the broker’s U.S. bank accounts, known to as “funnel accounts” in an effort to avoid triggering BSA reporting requirements;

5) The peso broker then locates Mexican importers who import goods from the U.S. and need to pay for these goods with U.S. Dollars;

6) Once located, the broker will arrange to pay the U.S. exporter on behalf of the Mexican importer in U.S. dollars from the broker’s U.S. bank account;

7) Goods are then shipped to the Mexican importer; and finally,

8) The importer sells the goods in Mexico, pays the broker his arranged discounted exchange fee in pesos deposited in the broker’s Mexican bank account, and thus replenishes the broker’s account with the pesos the broker needs to begin the cycle again with a new laundering transaction.

C. Trade-Based Money Laundering and Black Market Exchange Red Flags and Financial Institution Reporting Obligations

Pursuant to the Bank Secrecy Act (“BSA”), financial institutions are required to create reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, federal law requires that financial institutions file Suspicious Activity Reports (“SARs”) if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320; see also 12 C.F.R. § 21.11; (more information on BSA requirements can be found on the Office of the Comptroller of the Currency’s website here).

Due to the complexity of many black market peso exchange arrangements, FinCEN has issued several Advisories regarding potential “red flag” indicators of trade-based money laundering or black market peso exchange activities that financial institutions must be aware of. Such red flags include in part:

  • Third party payments for goods and services made by an intermediary apparently unrelated to the seller or purchaser of good;
  • Wires where no apparent business relationship appears to exist between the originator and the beneficiary;
  • Funds transferred into U.S. domestic accounts that are subsequently transferred out of the account in the same or nearly the same amounts, especially those originating from or destined to high risk jurisdictions;
  • A foreign import business with U.S. accounts receiving payments from locations outside the areas of their customer base;
  • In the case of a business account, the deposits take place in a different geographic region from where the business operates. For example, an account for a company operating locally in Florida receives numerous small deposits, all below the threshold reporting requirement, at bank branches in Texas, Virginia, and Tennessee;
  • In the case of a business account receiving out-of-state deposits, the debits do not appear to be related to the stated business activity of the account holder;
  • If questioned, the individuals opening or depositing funds into these “business accounts” have no detailed knowledge about the state business activity of the account holder or the source of the cash deposited.

Should any of the above red flags be spotted, FinCEN urges financial institutions to submit a Suspicious Activity Report indicating possible trade-based money laundering or black market peso exchange activity. A more complete list of trade-based money laundering red flags can be found in FinCEN’s Advisory FIN-2010-A001, entitled: “Advisory to Financial Institutions on Filing Suspicious Activity Reports regarding Trade-Based Money Laundering” found here. More detailed information regarding funnel account specific red flags can be read in FinCEN’s more recent Advisory, FIN-2014-A005, issued on May 28, 2014 here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, regulatory compliance, customs, import and trade law, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Florida Litigation Update: Appeals Court Clarifies Procedure to Execute Against Alcoholic Beverage License

October 21st, 2014

On September 23, 2014, Florida’s First District Court of Appeal issued its opinion in VMI Entertainment, LLC v. Westwood Plaza, LLC, et. al. clarifying the procedure to execute against a judgment debtor’s alcoholic beverage license.

But first, some background:  Westwood, as landlord, leased commercial property to VMI, as tenant.  Thereafter, VMI defaulted on the lease agreement and, as a result, became indebted to Westwood.  In execution proceedings, Westwood obtained a Writ of Attachment pursuant to Fla. Stat. § 76.01, which provides as follows: “Any creditor may have an attachment at law against the goods and chattels, lands, and tenements of his or her debtor under the circumstances and in the manner hereinafter provided.”  The Writ of Attachment specifically included reference to VMI’s alcoholic beverage license.  VMI moved to dissolve the Writ of Attachment; however, the trial court denied VMI’s request.  VMI appealed.

On appeal, Florida’s First District Court of Appeal considered the issue of whether an alcoholic beverage license may be the subject of a writ of attachment.  In ruling that the license could not be attached, the Court relied in part upon Fla. Stat. § 561.65(4), which sets forth the manner by which a lien or security interest in a “spirituous alcoholic beverage license” may be enforceable against the license. Fla. Stat. § 561.65(4) states that the party which holds the lien or security interest must, within ninety (90) days of the date of creation of the lien or security interest, record same with Florida’s Division of Alcoholic Beverages and Tobacco of the Department of Business and Professional Regulation using forms authorized by the division.  The Court also relied on Florida Supreme Court jurisprudence for two propositions:  First, Fla. Stat. 561.65(4) provides the exclusive means of perfecting a lien on an alcoholic beverage license, and second, a specific statute (Fla. Stat. §561.65(4)), controls over a general one (Fla. Stat. § 76.01).

Ultimately, the Court held that an alcoholic beverage license is not subject to attachment pursuant to Fla. Stat. § 76.01. Instead, the Court ruled, in order to attach an alcoholic beverage license, the creditor must follow the procedure set forth by Fla. Stat. § 561.65(4). Accordingly, the Court reversed the trial court’s order denying VMI’s motion to dissolve the writ (insofar as it encompassed VMI’s alcoholic beverage license) and remanded for entry of an order consistent with its opinion.

The attorneys at FIDJ have the experience necessary to perfect and liquidate an alcoholic beverage license lien.  If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling 305.350.5690.

Tax Litigation Update: Ninth Circuit Decision Provides Significant Support for Taxpayers Seeking to Discharge Tax Debt in Bankruptcy

October 20th, 2014

On September 15, 2014, the United States Court of Appeals for the Ninth Circuit issued a landmark decision strongly favoring debtors seeking to discharge tax debt in bankruptcy.

The case, Hawkins v. Franchise Tax Board (In Re Hawkins), involved a taxpayer, Trip Hawkins, seeking to discharge roughly 19 million dollars in a Chapter 11 bankruptcy.  The Government objected to the discharge under 11 U.S.C. § 523(a)(1)(C), which precludes the discharge of a tax debt “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”  The Government, which prevailed at the bankruptcy court and district court levels, argued that Hawkins’ level of spending while his tax debt remained outstanding constituted a willful attempt to evade or defeat his tax liability.

Overruling the bankruptcy court and district court decisions below, the Ninth Circuit held that in order for a tax debt to be precluded from discharge due to a willful attempt to evade or defeat the tax, the Government must establish that the debtor had the specific intent to evade payment of tax; mere overspending on other items while the tax debt remained outstanding, if the overspending did not occur with the specific intent of avoiding payment of tax, is insufficient to rise to requisite level of willfulness.

Background

Hawkins’ background created a less than sympathetic picture, which may have had some effect on the lower courts’ decisions to bar discharge.  Hawkins was a graduate of Harvard and Stanford who had been among the first employees of Apple Computers and later served as CEO (and significant stockholder) of Electronic Arts (EA), the noted video game manufacturer.  Hawkins’ wealth grew to about $100 million.  In 1990, EA created a wholly owned subsidiary called 3DO for the purpose of developing and marketing video games and game consoles, and Hawkins was put in charge of 3DO.  Thereafter, Hawkins sold a large amount of his EA stock and used the proceeds to invest in 3DO.  By selling his EA stock, Hawkins generated significant capital gains.  In order to offset his capital gains liability, Hawkins invested in several tax shelters offered by KPMG.  The IRS challenged the tax shelters in 2001 and disallowed the losses Hawkins had taken to offset his capital gains, resulting in millions of dollars of liability for Hawkins.  At the same time, 3DO’s business was stuttering, further compounding Hawkins’ financial situation.  In a 2003 state court filing seeking to reduce his child support obligations, Hawkins acknowledged that he owed $25 million to the United States in back federal income taxes.  All the while, even after recognizing the severity of his tax debt, Hawkins had enjoyed an expensive lifestyle, spending somewhere between $500,000 and $2.5 million more than what he earned on personal expenses in the 33 months between January 2004 and September 2006 when the bankruptcy petition was filed.

Hawkins did make some efforts to reduce his tax liability; he sold his house in July 2006 and paid all of the net proceeds, $6.5 million, toward his tax debt.  Hawkins also proposed an Offer in Compromise of $8 million in an effort settle the liability, but the IRS rejected the offer.  In September 2006, Hawkins filed for Chapter 11 protection, primarily in an attempt to rid himself of his tax debt.  Shortly after filing, Hawkins sold a vacation house for $3.5 million and paid the proceeds to the IRS.  The IRS also received a distribution of $3.4 million in Hawkins’ Chapter 11 plan.  Nevertheless, millions of dollars of tax debt remained outstanding and the United States objected to the discharge of the tax debt on the basis that Hawkins willfully attempted to evade or defeat his tax liability, again arguing that Hawkins’ extravagant spending evidenced his willfulness.

The United States prevailed on this argument at both the Bankruptcy Court and District Court levels, and Hawkins appealed to the Ninth Circuit.

Governing Law

The Bankruptcy Code generally permits a discharge of all pre-petition liabilities of a debtor, unless discharge is specifically precluded by the Bankruptcy Code.  Discharging income tax debt is possible, but doing so requires the debtor to overcome several hurdles.  In addition to meeting several timing requirements contained in § 523(a)(1)(A)-(B) (for instance, the tax at issue must have been based on a return due at least three years before the petition date and the return must have been timely filed and filed more than two years prior to the petition date), the debtor’s return must not be fraudulent and the debtor must not have willfully attempted to evade or defeat the tax at issue.

In many cases, the timing and non-fraudulent return requirements are clearly satisfied, and the outcome of the dischargeability determination hinges solely on whether the debtor willfully attempted to evade or defeat the tax at issue.  Courts are in near universal agreement that the phrase “willfully attempted in any manner to evade or defeat such tax” contains two elements the Government must prove: a conduct requirement and a mental state requirement.  The conduct requirement means that the Government must prove that the debtor engaged in some act or omission in an attempt to evade or defeat the tax.  The Government must also prove that the debtor committed the act or omission willfully.

The Hawkins case dealt solely with the mental state requirement, more specifically the mental state required by the statute’s use of the word “willfull” in order to preclude discharge.  A majority of Courts, including the Eleventh Circuit, have adopted a test which requires the Government to show that the debtor (1) had a duty to pay taxes under the law; (2) knew that he had such a duty; and (3) voluntarily and intentionally violated that duty.  These courts have not expressly required the Government to establish that a debtor had a specific, fraudulent intent to evade or defeat the tax.

In reversing the bankruptcy court and district court in Hawkins, the Ninth Circuit set forth a more restrictive, debtor-friendly interpretation of willfulness.  Specifically, the Court held that “we conclude that declaring a tax debt dischargeable under 11 U.S.C. § 523(a)(1)(C) on the basis that the debtor ‘willfully attempted in any manner to evade or defeat such tax’ requires showing of a specific intent to evade the tax.  Therefore, a mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took action the actions with the specific intent of evading taxes.”  In other words, to the Ninth Circuit, overspending alone will not rise to willfulness unless the debtor overspent with the specific intent of avoiding payment of his tax liability.

In reaching this conclusion, the Ninth Circuit focused on purpose of the Bankruptcy Code and the textual structure of § 523(a)(1)(C).  First, the Ninth Circuit emphasized the fact that federal bankruptcy law was designed to provide debtors with a fresh start, which in turn compels a strict, rather than expansive, interpretation of “willfulness.”  For support, the Ninth Circuit cited Kawaauhau v. Geiger, 523 U.S. 57 (1998), in which the Supreme Court held that, under § 523(a)(6) of the Bankruptcy Code, which precludes discharge of debts arising out of a willful and malicious injury, the party seeking to preclude discharge must establish an intent to injure, not just an intentional act that leads to injury.

The Ninth Circuit also relied on the text of § 523(a)(1)(C) in requiring a higher standard of willfulness.  The Ninth Circuit held that by grouping willfulness with the filing of a fraudulent return in a separate subsection, rather than the more banal timing requirements of § 523(a)(1)(A)-(B), Congress had evidenced its intent to require a showing of bad purpose on the part of the debtor for the Government to establish willfulness.

The Court also found support for its ruling in the Internal Revenue Code.  Specifically, the Court highlighted the fact that the language of § 523(a)(1)(C) is nearly identical to that found in IRC § 7201, which makes it a felony to “willfully attempt in any manner to evade or defeat any tax.”  Courts interpreting § 7201 have required the Government to prove that the taxpayer voluntarily and intentionally violated a known legal duty.  See Cheek v. United States, 498 U.S. 201 (1992).  This, “almost invariably,” will “involve deceit or fraud upon the Government, achieved by concealing tax liability or misleading the Government as to the extent of the liability.”  Kawashima v. Holder, 132 S. Ct. 1166, 1175, 1177 (2012).  In following this rationale, the Ninth Circuit rejected reasoning of other Circuit Courts facing this question which have relied upon portions of the Internal Revenue Code dealing with civil willfulness (such as IRC § 6672).  Generally speaking, civil willfulness requires the Government to establish intentional conduct, but not a bad faith purpose, while criminal willfulness requires a bad faith purpose.

The Ninth Circuit also focused on the consequences of imposing a rule providing that living beyond one’s means would lead to the preclusion of tax debt dischargeability.  “Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable.  Such a rule could create a large ripple effect throughout the bankruptcy system.”

In sum, the Ninth Circuit held that acts that detract from a debtor’s ability to pay the outstanding tax debt will not preclude discharge unless those acts are made with the specific intent of evading tax.  Intending to commit the act (or omission) that detracts from payment of the outstanding tax is not by itself sufficient.

Conflict with Other Circuits?

As stated above, several Circuit Courts of Appeal have read § 523(a)(1)(C) to require the Government to prove that the debtor (1) had a duty to pay taxes under the law; (2) knew he had that duty; and (3) voluntarily and intentionally violated that duty.  Under a broad interpretation, those elements are arguably satisfied if the act of overspending was committed intentionally, but without the specific purpose of avoiding taxation.

From a surface level it appears that the Ninth Circuit’s Hawkins decision creates a Circuit split, because the Ninth Circuit now requires the Government to prove specific intent to establish willfulness while a number of other Circuits have not expressly made that a requirement.  However, as the Court points out in Hawkins, in those other Circuits, living a lifestyle beyond one’s means has always been coupled with some other act or omission designed to evade taxes, such concealing assets, a failure to file returns and pay taxes, and structuring financial transactions to avoid currency reporting requirements.  Prior to Hawkins, no Circuit Court had directly answered the question of whether a taxpayer that files timely, accurate returns and does not engage in acts of deceit but spends beyond his means is willful under § 523(a)(1).  In that regard,Hawkins can be seen as a case of first impression and its reasoning is applicable across the country.

Moreover, it can be argued that the Ninth Circuit’s Hawkins decision expressly said what other Courts have said implicitly, or at least in a less forthright manner: where a bankruptcy debtor has lived beyond his means in the face of an existing tax debt, in order for discharge of the tax debt to be precluded, the Government cannot rely on overspending itself and must establish by a preponderance of the evidence some other act designed to evade taxes.

Effect on Eleventh Circuit Cases

The Eleventh Circuit is among the Circuit Courts that applies the three part test set forth above (the debtor had a legal duty to pay tax, knew of the legal duty, and voluntarily and intentionally violated that duty) in determining whether the mental state requirement of § 523(a)(1) has been satisfied.  Put more succinctly, “a debtor’s tax debts are non-dischargeable if the debtor acted knowingly and deliberately in his efforts to evade his tax liabilities.”  In Re Mitchell, 633 F.3d 1319 (11th Cir. 2011).  Additionally, the Court has stated that “fraudulent intent is not required” in determining willfulness.  In Re Fretz, 244 F.3d 1323 (11th Cir. 2001).

However, the Eleventh Circuit has never held that mere lavish spending in the face of a tax debt is sufficient to bar discharge.  Some evidence of a debtor’s deceit has always been present.  In both Mitchell (failure to file, titling assets in nominee names, reincorporating to avoid garnishment) and Fretz (failure to file), other factors contributed to the determination that the debtor satisfied the willfulness requirement.  Overspending alone was not determinative.  Therefore, Hawkins does not serve as directly contrary authority to the Eleventh Circuit’s approach to determining willfulness, but it does lend significant support to combat any argument the Government may raise in an attempt to establish willfulness based solely on overspending.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax and tax litigation in the Tax Court, the Federal District Courts, and Bankruptcy Courts.  They will continue to monitor developments in the Hawkins case and this area of the law generally. If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling 305.350.5690.