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

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

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

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

The facts of the case are as follows:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Federal Court Orders FDA to Approve OTC Sales of “Morning-After Pill,” Finds Current Age and Point-of-Sale Restrictions to be Arbitrary and Capricious

On April 5, 2013, Judge Edward R. Korman of the United States District Court for the Eastern District of New York found that the Secretary of Health and Human Service’s (“HHS”) decision to limit over-the-counter (“OTC”) purchases of the emergency contraceptive levonorgestrel (marketed under the name PLAN B and commonly referred to as the “morning-after pill”) to women 17 and older, and thereby requiring girls 16 and under to have a prescription for the pill, to be arbitrary and capricious. In so holding, Judge Korman ordered the FDA to make the pill available OTC to women and girls of all ages free of the numerous point-of-sale restrictions that currently exist. A copy of the Court’s Opinion in Tummino v. Hamburg can be read here.

I. Procedural Posture

The Court’s decision is the culmination of a twelve year battle between family planning organizations and the FDA regarding the OTC sales of levonorgestrel.

A. The approval of PLAN B for prescription use, the subsequent Citizen Petition and the manufacturer’s supplemental new drug applications

In 1999, the FDA first approved leveonorgestrel for prescription use. Two years later, in 2001, the plaintiffs in this case filed a Citizen Petition with the FDA seeking the agency to switch leveonorgestrel from prescription to OTC status for all ages. A copy of the 2001 Citizen Petition can be read here. The FDA denied the Citizen Petition in 2006. The FDA’s denial can be read here.

Concurrent with the consideration of Citizen Petition, the FDA considered several supplemental new drug applications (“SNDA”) submitted by the drug’s manufacturer. The first SNDA sought OTC access to the drug for all ages. This SNDA was denied by the FDA. Subsequent to this denial, the manufacturer filed a second SNDA seeking OTC access for women 16 and older. However, “despite nearly uniform agreement among FDA scientific review staff that women of all ages could use Plan B without a prescription safely and effectively” the FDA rejected this application. See Tummino v. Torti, 603 F. Supp. 2d 519, 523 (E.D.N.Y. 2009).

The manufacturer then submitted a third SNDA, which proposed making Plan B available without a prescription to women 17 and older. “While FDA scientists and senior officials found that 17 year olds could use Plan B safely without a prescription, the FDA Commissioner determined that, because of ”˜enforcement’ concerns, Plan B would be  available  without  a  prescription  only  to women 18 and older.” Thus, the FDA approved the product’s OTC sale for women 18 or older while requiring the product be available to women 17 and younger by prescription only. In addition, despite the OTC approval for women over 18, the FDA placed several point-of-sale restrictions on the sale of the product including: 1) the drug could only be sold in pharmacies; and 2) the drug could only be sold to consumers who presented government-issued identification establishing proof of age. The petitioners sought judicial review of the FDA’s decision.

B. Tummino v. Torti (Tummino I): Plaintiffs’ first challenge to the FDA’s ruling on emergency contraception.

Subsequent to the FDA’ denial of the Citizen Petition, the plaintiffs sought judicial review in Tummino v. Torti, 603 F. Supp. 2d 519 (E.D.N.Y. 2009). In its complaint, the plaintiffs alleged that the FDA’s denial of its Citizen Petition, in light of the scientific evidence presented in the concurrent SNDAs, was arbitrary and capricious because it was not the result of reasoned and good faith agency decision-making.

In 2009, the Court agreed and vacated the FDA denial of plaintiffs’ Citizen Petition. In vacating the FDA’s denial, the Court found that the denial was the product of improper political influence and was arbitrary and capricious because the rationale for the agency’s decision departed from its own policies.

“To support a claim of improper political influence on a federal administrative agency, there must be some showing that the political pressure was intended to and did cause the agency’s action to be influenced by factors not relevant under the controlling statute.” Id. at 544 (quoting Town of Orangetown v. Ruckelshaus, 740 F.2d 185, 188 (2d Cir. 1984)). In holding that the decision was the by-product of political influence, the Court found that despite Advisory Committee and FDA scientists strongly recommending the drug for OTC without age restriction, the FDA Commissioner decided against unrestricted OTC access because of pressure from the White House. Thus, the Commissioner’s decision was influenced by outside political pressure and not factors relevant under the controlling statute. (It should be noted that a drug is considered suitable for OTC use when it is found to be safe and effective for self-administration and when its label clearly provides directions for safe use and warning regarding unsafe uses, side effects, and adverse reactions. See generally, 21 C.F.R. § 330.10(a)(4).)

In finding that the agency’s decision was arbitrary and capricious, the Court noted several departures by the FDA from its established policies and procedures. “The most glaring procedural departure was the decision to act against the Advisory Committee’s recommendation to approve the Plan B OTC switch without age restriction.” Tummino I, 603 F. Supp. 2d at 547. The Court went on to note that in every application in the last decade, the FDA has followed committee recommendations.

The Court noted that the FDA’s denial of the Citizen Petition departed from the agency’s general policies and procedures in at least four other respects. First, the FDA departed from policy when it placed additional members on its Advisory Committee for the purpose of achieving ideological balance. The Court noted that the “goal of ideological diversity does not aid the FDA in its obligation to examine the safety and effectiveness of a drug’s use in self-medication.” Secord, the Court found that the unusual amount of White House involvement in the decision was not the norm in the FDA’s OTC reclassification decision-making process. The third departure involved the timing of the agency’s decision to deny the Citizen Petition. The Court found that the decision regarding OTC status was made before the scientific review staff had completed its review of the manufacturer’s SNDA and without consultation with FDA scientists. The fourth departure was the agency’s refusal to extrapolate actual use study data from older age groups to the 16 and younger age group. The Court noted that the FDA routinely extrapolated such data when reviewing the safety and effectiveness of other forms of contraception.

However, the Court did not grant the plaintiff’s request to require the drug to be available OTC without restrictions for all age groups. Instead, the Court remanded to the FDA to reconsider its decision free from political influence and to “conduct a fair assessment of the scientific evidence.” The Court also ordered that the FDA make the drug available to 17 year olds OTC under the same point of sale restrictions that were currently in place for those 18 and over because scientific data was sufficient to support the safe use of the drug as an OTC for women 17 and older.

C. The reconsidered Citizen Petition, the 2011 SNDA, the FDA’s approval of OTC use and the subsequent reversal by the Secretary of HHS

Following the Court’s 2009 remand in Tummino I, the FDA once again undertook consideration of the plaintiff’s Citizen Petition for reclassification of leveonorgestrel from prescription to OTC status for all ages without point-of-sale restrictions. While the agency was reconsidering the plaintiff’s Citizen Petition, the drug’s manufacturer submitted a fourth SNDA seeking to allow OTC access to a single dose version of levonorgestrel for all ages.

On December 7, 2011, the FDA announced that “[b]ased on the information submitted to the agency, CDER [the Center for Drug Evaluation and Research] determined that the product was safe and effective in adolescent females, that adolescent females understood the product was not for routine use, and that the product would not protect them against sexually transmitted diseases. Additionally, the data supported a finding that adolescent females could use Plan B One-Step properly without the intervention of a healthcare provider.” Thus, the FDA announced that “there is adequate and reasonable, well-supported, and science-based evidence that Plan B One-Step is safe and effective and should be approved for nonprescription use for all females of child-bearing potential.” A copy of FDA Commissioner Hamburg’s statement can be read here.

However, that same day, HHS Secretary Sebelius overruled FDA Commissioner Hamburg and ordered the FDA to deny the SNDA. In her December 7, 2011 Memorandum to FDA Commissioner Hamburg, Secretary Sebelius concluded “that the data submitted for this product do not establish that prescription dispensing requirements should be eliminated for all ages.” More specifically, the Secretary noted “[t]he label comprehension and actual use studies submitted to FDA do not include data on all ages for which the drug would be approved and available over-the-counter. Yet, it is commonly understood that there are significant cognitive and behavioral differences between older adolescent girls and the youngest girls of reproductive age, which I believe relevant to making this determination as to non-prescription availability of this product for all ages.” A copy of the Secretary’s Memorandum can be read here.

While the Secretary’s denial of the SNDA did not directly apply to the plaintiff’s Citizen Petition, because the Secretary’s rationale for denying the SNDA was based on a lack of comprehension and actual use studies which were also lacking from the Citizen Petition, the practical effect of the Secretary’s decision was to force the FDA to once again reject the Citizen Petition. As a result, on December 12, 2011, the FDA again denied the Citizen Petition requesting OTC access to levonorgestrel for all ages without point-of-sale restrictions. A copy of the FDA’s 2011 denial can be read here. The petitioners sought judicial review of the FDA’s 2011 decision.

D. Tummino v. Hamburg (Tummino II)

Subsequent to the FDA’ denial of its Citizen Petition, the plaintiffs again sought judicial review. As in its original complaint, the plaintiffs again alleged that the FDA’s denial of its Citizen Petition, in light of the scientific evidence presented in the concurrent SNDAs, was arbitrary and capricious because it was not the result of reasoned and good faith agency decision-making. The plaintiffs further sought an order from the Court requiring the FDA to grant its Citizen Petition and make levonorgestrel-based emergency contraception available for all ages without point-of-sale restrictions. The Court agreed.

The Court reasoned as follows: “Though the agency’s decision is unfettered at the outset, if it announces and follows””by rule or by settled course of adjudication””a general policy by which its exercise of discretion will be governed, an irrational departure from that policy (as opposed to an avowed alteration of it) could constitute action that must be overturned as ”˜arbitrary, capricious, [or] an abuse of discretion’ within the meaning of the Administrative Procedure Act.” (citing INS v. Yang, 519 U.S. 26 (1996)). Such was the case here.

In its biting opinion, the Court found that the Secretary’s decision in reversing the FDA Commissioner and denying the Citizen Petition was arbitrary and capricious for several reasons. The Court noted the unprecedented intervention of the Secretary in “overrul[ing] the FDA in an area which Congress entrusted primarily to the FDA, 21 U.S.C. § 393(d)(2), and which fell within the scope of the authority that the Secretary expressly delegated to the Commissioner.” See also FDA Staff Manual Guides, Vol.II – Delegations of Authority.

With respect to the Secretary’s determination that the studies submitted were insufficient because they did not include data on women of all ages, the Court found that the Secretary ignored the FDA’s previous waiver of such a requirement.  Moreover, the Court found that even if this could form an adequate basis for prohibiting OTC access for girls of all ages, the Secretary could not justify prohibiting non-prescription access for the age groups [14 and older] for which studies were presented.

The Court was even more critical with respect to the Secretary’s insistence on point-of-sale restrictions for OTC access. First, the Court noted that the Secretary could “not define any harm that could come from the use of levonorgestrel-based emergency contraceptives” by girls younger than 17. Second, the Court noted that even if such risks exist for an OTC product, “the policy of the FDA is to rely on labeling” and providing warnings and directions for use in at risk populations as opposed to implementing point-of-sale restrictions to address safety concerns. The Court went on to find that the “FDA’s authority over nonprescription drugs does not extend to restricting the point-of-sale distribution of drugs that have been found to be safe ”˜when used in the manner intended.’” (quoting American Pharmaceutical Ass’n v. Weinberger, 377 F. Supp. 824, 828 (D.D.C. 1974)). Thus the Court found that “[t]he Secretary’s edict to the FDA simply reflects the fact of her lack of familiarity with, or her willingness to ignore, the policy of the FDA in dealing with these concerns.”

Moreover, the Count found that the rationale and evidence upon which the Secretary relied in forming her decision was so weak that the agency could not adequately explain it in the administrative record itself. Thus, the Court found that FDA had to supplement the administrative record by considering the extra-record material and evidence, namely the studies and evidence submitted by the manufacturer in its 2011 SNDA. This evidence further supported the Court’s conclusion that the Secretary’s reversal of the FDA’s determination that levonorgestrel-based emergency contraceptives should be available OTC without point-of-sale restrictions was arbitrary and politically motivated.

In finding that the Secretary’s actions were arbitrary and capricious, the Court took the bold action of ordering the FDA to approve levonorgestrel as an OTC emergency contraceptive without any age or point-of-sale restrictions. In so ordering, the Court rejected the FDA’s request for remand to the agency so that the agency could initiate rulemaking. In a process the Court described as an “administrative agency filibuster,” the Court found that the “FDA has engaged in intolerable delays in processing the petition.” The Court noted that “one of the devices the FDA has employed to stall proceedings was to seek public comment on whether or not it needed to engage in rulemaking in order to adopt an age-restricted marketing regime. After eating up eleven months, 47,000 public comments, and hundreds of thousands, if not millions, of dollars, it decided that it did not need rulemaking after all.” The Count went on to state that “plaintiffs should not be forced to endure, nor should the agency’s misconduct be rewarded by, an exercise that permits the FDA to engage in further delay and obstruction.”

It is not yet known how, or whether, the FDA will appeal Judge Korman’s landmark decision.

The Court’s decision in this case highlights the importance that the judicial branch can and does play in allowing parties to engage in meaningful, and not mere perfunctory, judicial review of agency decisions. The attorneys of Fuerst, Ittleman, David,& Joseph, PL have extensive experience in the fields of food, drug, and cosmetic law and administrative litigation. For more information, please contact Fuerst Ittleman David & Joseph, PL at contact@fidjlaw.com.

CMS To Post Additional Nursing Home Deficiency Data Online

On March 22, 2013, the Centers for Medicare and Medicaid Services (“CMS”) announced that it would increase the amount of information available online by posting a nursing home’s three (3) preceding standard health surveys and three (3) years of prior complaint surveys. A link to the CMS memorandum may be found here. Previously, searchable data only included statements of deficiencies (Form CMS-2567) for the most recent standard health surveys and the past fifteen (15) months of complaint surveys. In addition to the expanded time frames, CMS also plans to include indicators as to the scope and severity of each cited deficiency.

Interestingly, CMS decided not to gather and publish corresponding plans of correction (PoCs) submitted by nursing homes. Generally, when a nursing home receives a deficiency citation via CMS Form-2567, it is required to draft and submit a plan of correction identifying how and when the cited deficiency will be resolved. This information may, however, be requested directly from the nursing home or the state survey agency (in Florida, the Agency for Health Care Administration).

With this recent move toward the publication of expanded deficiency information and ease of access to that information, the importance of drafting plans of correction has become more important than ever. On the one hand, nursing homes must draft a plan of correction in such a way as to adequately address any and all concerns expressed by CMS. However, on the other, nursing homes must carefully draft plans of correction so as to prevent third parties from taking statements of deficiency out of context and using them against the nursing home in subsequent proceedings.

For more information about how your nursing home should respond to a statement of deficiency or prepare a plan of correction, please contact Fuerst Ittleman David & Joseph, PL by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

FDA Energy Drink Regulation in the News: Health Experts Push for Regulatory Changes and Monster Moves to Market as a Beverage Instead of as a Dietary Supplement

On March 19, 2013, a group of doctors, researchers, and public health experts sent a joint letter to the Commissioner of the U.S. Food and Drug Administration (“FDA”) urging the FDA to make changes to the regulation of energy drinks. In its letter, the group concluded that there is a “robust correlation between the caffeine levels in energy drinks and adverse health and safety consequences,” especially where children, adolescents and young adults are concerned. Furthermore, the group claims that “there is neither sufficient evidence of safety nor a consensus of scientific opinion to conclude that the high levels of added caffeine in energy drinks are safe under the conditions of their intended use.” As a result of these findings, the group is pushing the FDA to require manufacturers to label energy drinks with the product’s caffeine content and demonstrate that the levels of caffeine in those products are generally recognized as safe (“GRAS”) and comport with existing GRAS standards for beverages.

The FDA has previously dismissed public concerns about the safety of caffeine levels in energy drinks. In an unpublished response to Senator Dick Durbin’s 2012 investigation of dietary supplements, which included energy drinks, the FDA explained that the amount of caffeine in energy drinks is not significantly different from the levels of caffeine in commonly consumed beverages like coffee or carbonated soda. (For more information, please see Natural Insider’s article here.) Furthermore, the FDA noted that most caffeine consumed by Americans comes from what is naturally present in coffee and tea and that a review of the available studies does not indicate any new, previously unknown risks associated with caffeine consumption.

Monster to Market Energy Drinks as Beverage Instead of Dietary Supplement

In a move unrelated to the letter described above, Monster Beverage, the largest seller of energy drinks, recently announced its plan to discontinue marketing its energy drink products as dietary supplements. Instead, Monster will market its products as conventional beverages. In addition to implementing required changes to its product labeling to reflect nutrition facts instead of supplement facts, Monster disclosed that its energy drink products will now specify caffeine content. (For more information about the change in the marketing of Monster energy drinks, please click here.) Monster’s announcement of its plan to shift the marketing of its energy drinks comes just a few months after another energy drink brand, Rockstar, made a similar move.

According to Joseph Cannata, an executive vice president at Rockstar, Rockstar made its decision to market energy drinks as beverages because consumers found food labels easier to read than dietary supplement labels. A spokesperson for Monster, Michael Sitrick, explained that Monster’s decision was influenced by several factors. Specifically, Mr. Sitrick stated that a major reason for the change was to stop the “misguided criticism” that Monster was selling its energy drinks as dietary supplements because dietary supplements are more lightly regulated than beverages. Additionally, Mr. Sitrick explained that “Monster Energy drinks could equally satisfy the regulatory requirements” for either dietary supplements or beverages. (For more information, please read the New York Times article here.)

These announcements from Rockstar and Monster Beverage come after a year of close public scrutiny over energy drinks. In July 2012, the parents of a 14-year-old girl filed a lawsuit against Monster after their daughter died following the consumption of two Monster Energy products. (For more information about this incident, please read CBS’s coverage here.) In November 2012, the FDA received several voluntary adverse health reports listing the dietary supplement 5-hour Energy as contributing to an illness or death. Subsequently, the FDA began a routine investigation to determine whether a possible link exists between the hospitalizations and 5-hour Energy. (For more information about this investigation, please read CBS’s coverage here.) In spite of these recent investigations, the FDA has not officially changed its position regarding the safety of consuming energy drinks.

FDA Regulation of Energy Drinks

The FDA does not have a specific category or specific regulations for energy drinks. Typically, energy drinks have been marketed as either dietary supplements or conventional beverages, depending on the product’s ingredient, intended use, and labeling. For manufacturers, determining the appropriate regulatory framework for a product has important implications on a product’s development, as it can help guide product formulation and establish the limitations on product labeling and marketing, any requirements for pre- or post-market reporting or mandatory adverse event disclosures to the FDA. As we previously explained here, categorizing products as either conventional foods or dietary supplements can be difficult.

The FDA defines conventional foods as “articles used for food or drink for man or other animals, chewing gum, and articles used for components of any such article.” All ingredients in conventional foods must be pre-approved by the FDA as a food additive or meet the requirements of the GRAS provisions. Dietary supplements, on the other hand, are defined as products “intended for ingestion that contain a dietary ingredient intended to add further nutritional value to (supplement) the diet.” Dietary supplements may be in forms such as tablets, capsules, softgels, gelcaps, liquids, or powder, and may be one, or a combination, of the following substances: vitamins, minerals, herbs or botanicals, amino acids, concentrates, metabolites, constituents, or extracts. Based on these definitions, it may be more difficult to classify certain liquid products where the product is intended to supplement the diet with vitamins or nutrients but resembles a conventional beverage in serving size and taste.

In an attempt to assist manufacturers in properly classifying their products as either liquid dietary supplements or conventional beverages, the FDA issued a draft guidance document in 2009. (The FDA’s Guidance document can be accessed here.) This 2009 draft guidance states that the FDA considers a product’s name, packaging, serving size, recommended conditions of use, and other representations about the product, to be determinants of whether the product is a conventional food or dietary supplement. This guidance has not been finalized; however, the U.S. Government Accountability Office released a report in March 2012 indicating that the FDA is in the process of developing and reviewing a final guidance document that clarifies when a liquid product should be marketed as a dietary supplement or conventional beverage. (The U.S. Government Accountability Office’s report can be accessed here.)

If a product is a conventional food or dietary supplement but improperly marketed as the other type of product, the product could be deemed by the FDA to be misbranded or adulterated in violation of 21 U.S.C. § 331(a) and 21 U.S.C. 342(a)(2)(C). Failure to comply with the appropriate labeling regulations could subject manufacturers to enforcement action. The FDA has issued Warning Letters against manufacturers for mislabeling conventional beverages as dietary supplements. (For more information about the FDA’s past enforcement action regarding the labeling of dietary supplements, please read our previous post here.)

Uncertainty Regarding the Future Regulation of Energy Drinks

Despite the FDA’s current position that the elevated caffeine levels in energy drinks do not pose a significant health risk, the public continues to pressure Congress and the FDA to address its concerns about the safety of consuming energy drinks. Now, with the release of this joint letter to the FDA, doctors, researchers, and public health experts seem to support the push for tighter regulation and increased oversight of these products. At this time, it remains to be seen what steps Congress and the FDA will take to address any gaps in the present regulatory scheme.

Fuerst Ittleman David & Joseph, PL will continue to monitor any developments in the regulation of compounding pharmacies. For more information, please feel free to contact our offices by email at contact@fidjlaw.com or by phone at (305) 350-5690.

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

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

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

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

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

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

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

The Court explained the difference between the two legal principles:

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

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

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

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

A Supreme Court Win for U.S. Consumers

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

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

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

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

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

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

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

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

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

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

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

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

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

POM Appeals FTC Final Order Regarding Deceptive Claims

As we previously reported, on May 17, 2012, an FTC Administrative Law Judge (“ALJ”) held in an Initial Decision that POM Wonderful LLC’s (“POM“) claims that its products can treat, prevent, or reduce the risk of heart disease, prostate cancer, and erectile dysfunction (“ED”) were deceptive and inadequately substantiated because the claims were not supported by sufficient “competent and reliable scientific evidence.” FTC case law defines “competent and reliable scientific evidence” as “tests, analysis, research, or studies that have been conducted and evaluated in an objective manner by qualified persons and are generally accepted in the profession to yield accurate and reliable results.” Seee.g. In re Novartis Corp., 127 F.T.C. 580, 725 (1999). Although the Initial Decision rejected the FTCs theory that competent and reliable scientific evidence for the disputed claims could only be satisfied with two double-blind, randomized placebo-controlled clinical trials (RCTs), the ALJ found that competent and reliable scientific evidence could be established without RCTs in order to adequately substantiate disease claims. Subsequently, both POM and the FTC appealed the Initial Decision to the FTC Commissioners.

On January 10, 2013, the FTC Commissioners issued a Final Order approving the Initial Decision 5-0 that POM made deceptive claims about treating, preventing or reducing the risk of heart disease, prostate cancer and ED. The Commissioners also issued a cease and desist order restraining POM’s future advertising.

On March 8, 2013, POM appealed the Commission’s Final Order to the United States Court of Appeals for the District of Columbia Circuit. POM’s petition for review can be found here. Significantly, POM’s petition did not request a stay from the D.C. Circuit. Thus, the cease and desist order restraining POM’s advertising has become effective and will remain so at least until the DC Circuit issues a ruling on this case.

Fuerst Ittleman David & Joseph, PL will continue to monitor the development of the POM case. For more information about food and dietary supplement claims or to have Fuerst Ittleman David & Joseph, PL complete a label and website review for your products, please contact us at (305) 350-5690 or contact@fidjlaw.com.

Business Litigation Update: Suddenly, Contracting Parties Face Tort Risks in Florida

A recent Florida Supreme Court ruling could open the door to unforeseen liabilities for individuals and companies entering into contracts governed by Florida law.

On March 7, 2013, in Tierra Condominium Ass’n vs. Marsh & McLennan Cos., SC10-1022, 38 Fla. L. Weekly S151a (March 7, 2013), the Court limited the application of the “economic loss doctrine” (or, the “Rule”) to product liability cases. This ruling went largely unreported – except for our blog entry that you can read here – and was probably ignored by anyone who wasn’t a builder or a lawyer. Yet this ruling actually has a profound impact on anybody who has entered into a contract in which Florida law applies.

In usual circumstances when a party is the victim of a contract breach, the offended party sues under the contract seeking damages. Now enter the economic loss doctrine. Generally speaking, the Rule provides that someone suffering only economic damages in the breach of a contract may recover for those damages based only upon the provisions of the contract, such as warranties. Other “tort theories,” such as negligence or strict liability that seek to circumvent mundane and defined contractual remedies, were not. This was to prevent – as the U.S. Supreme Court said in one seminal case – “contract law . . . drown[ing] in a sea of tort.” East River Steamship Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 873 (1986). Therefore, as a result of the economic loss doctrine, an aggrieved contract party cannot recover for things like personal injury or property damage.

Not so fast, says the Florida Supreme Court. In its March 7, 2013 ruling, the court held, “[T]he application of the economic loss rule is limited to products liability cases. Therefore, we recede from prior case law to the extent that it is inconsistent with this holding.” What the Florida court was “reced[ing] from” was 25 years of jurisprudence in which the court expanded the application of the Rule well beyond its humble beginnings in product liability law. With the ruling in Tierra, however, the court has gone back to the roots of the Rule. The Tierra decision can be read in full here.

Implication for Florida Contracts

So let’s say that you have a supply/distribution contract governed under Florida law, and that contract provides that a party cannot seek damages for the supplier failing to deliver a product in a timely fashion. When the merchandise shows up late at the distributor’s warehouse, the Miami court house doors are opened. Before Tierra, the court would have said that the distributor cannot sue under the contract for damages because of the applicable provision. Now, with the Tierra ruling, the distributor may be able seek damages from the supplier alleging that the supplier was negligent in not properly delivering the merchandise. While it is unclear whether other long standing doctrines from which the economic loss rule expanded will continue to bar such remedies, a wave of new litigation is fully expected to test Tierra ramifications.

It is precisely because of this “wave of uncertainty” businesses should consult with their counsel to revisit existing contractual language. From a drafting standpoint, business lawyers for years have worked clauses into contracts to limit their clients’ liability. Accommodating the ruling in Tierra is no exception. Now, in addition to specifically disclaiming certain warranties and waiving liability for indirect, consequential, incidental and special damages, the contract will have to contain waivers for damages under tort theories as well. The inclusion of certain provisions should be able to provide an effective breakwater against the sea of tort litigation that is expected after Tierra.

This ruling has other implications of which companies should be aware. For example, it is sound business practice that when risks cannot be managed through contracts, private insurance is employed to mitigate the exposure. The question now arises whether a company’s commercial general liability (“CGL”) policy covers these new tort liabilities. The commonly used Insurance Services Office’s CGL policy (2007 form) lists 16 specific exclusions from coverage, including a “Contractual Liability” exclusion, which excludes coverage for a contractual breach. So even though a CGL policy typically covers tort claims such as personal injury and property damage claims directly against the insured, such a policy may not cover these claims when they arise out of a contract. It is incumbent upon businesses to review their respective policies to discern whether the policies exclude tort claims arising from contractual duties. And if that is the case for the insurance in your business, you may want to see if you can obtain specific “Contractual Liability Insurance.”

It is certain that the ripple effects of the Florida Supreme Court’s ruling in Tierra will be felt in the business and legal communities for years to come. The important message here is to be prepared. Whether seeking to mitigate your risks of tort damages through effective contractual drafting, or through insurance, or a combination thereof, effective legal guidance on this critical issue is essential.

Even an older, executed contract can be amended to accommodate the changes brought about by the Florida Supreme Court’s ruling. To perform a check–up, contact one our experienced business attorneys today.

The Latest Zpic Target: Medicare Cost Reports

(For additional information concerning ZPICs, please refer to our January 11, 2013 blog entry, “ZPICs and Skilled Nursing Facilities: Medicare’s Wild Wild West”).

A. Cost Reports, Generally

When Medicare was created in 1966, Medicare paid participating providers (e.g. hospitals and skilled nursing facilities) based on a portion of their costs. Medicare’s portion of costs was determined by multiplying total costs by the ratio of Medicare charges to all charges. Providers were paid an estimated amount on an interim basis; however, providers filed a “cost report” at the end of each year in order to compute a final settlement. Generally, the cost report aggregated a providers’ detailed financial data. If Medicare overpaid the provider from the interim payments, a payable was generated from the provider. If Medicare underpaid the provider from the interim payments, a receivable was generated to the provider. Medicare discontinued this payment system in 1983 (for hospitals) and 1998 (for nursing homes).

Medicare now utilizes a prospective-based reimbursement system which has no relation to a providers’ actual cost report. While providers are still required to file cost reports as a condition of participation in the Medicare program, the cost report no longer impacts the settlement process. Rather, the Centers for Medicare and Medicaid Services (“CMS”) utilizes the data to compute national reimbursement rates. In other words, a providers’ Medicare cost report is used by CMS for informational purposes only.

B. ZPIC Requests for Provider Business and Financial Data

As briefly referenced in our January 11, 2013 blog entry, “ZPICs and Skilled Nursing Facilities: Medicare’s Wild Wild West,” ZPIC auditors are demanding that skilled nursing facilities produce, in addition to patient/resident medical records, confidential and proprietary business and financial records. Generally, these demands include requests for the following: (a) detailed general ledgers; (b) audited financial statements; (c) organization charts; (d) journal entry descriptions; (e) chart of accounts; (f) board meeting minutes; (g) facility check register; (h) list of facility credit card holders and bills; (i) facility grouping schedule; (j) working trial balance; (k) balance sheets; (l) profit and loss statements; (m) floor plans; (n) facility and corporate policy and procedures manuals.

These requests not only appear to exceed the scope of a ZPIC’s authority, but also appear duplicative. When the ZPIC is questioned as to its authority to request such information, the ZPIC frequently responds citing generally to the Social Security Act. When pressed for specific citations to legal authority, the ZPIC may cite to 42 CFR §§420.301-304. Interestingly, 42 CFR 420.301-304 falls under Subpart D, “Access to Books, Documents, and Records of Subcontractors” (Emphasis added). A skilled nursing facility, however, does not fall under the definition of a “subcontractor” as defined in 42 CFR §420, Subpart D. Despite advising the ZPIC of this flaw, the ZPIC is generally unwilling to engage in any further discussion relative to the scope of its authority.

Further, the requested financial information is duplicative given CMS already obtained the financial data in the normal course of business via the provider’s Medicare cost reports. Of course, if CMS, c/o its Fiscal Intermediary/Medicare Administrative Contractor (“FI/MAC”), had an issue with the information contain in the provider’s cost report, the issue would have been addressed at that time. Yet, a request for a provider’s financial data from several years prior appears to be a means of harassing a provider into noncompliance following an endless barrage of detailed and dated financial document requests.

C. Are Medicare Cost Reports “Fair Game” for ZPICs? 

When a nursing home fails (or is otherwise unable) to produce such business and financial data, the ZPIC may instruct the FI/MAC to a issue “Notice of Change of Amount of Program Reimbursement” for each corresponding fiscal year end period. The result may be as severe as a reopening of each corresponding fiscal year end period and denying some or all of the provider’s Medicare costs referenced therein.

Interestingly, the regulations clearly state that the FI/MAC is the only entity with the authority to reopen provider cost reports and make determinations relative to same. See 42 C.F.R. §405.1801, et. seq. Further, while Section 4.7.1 of the Medicare Program Integrity Manual permits a ZPIC to compile and review cost reports, the ZPIC Zone 7 Statement of Workexpressly excludes cost report action from the scope of a ZPIC’s authority (e.g. reopening and denials).

However, the FI/MAC typically accepts the ZPICs directives without question or analysis. More importantly, the FI/MAC generally has no knowledge concerning the underlying basis for the ZPIC’s cost report action. In other words, the ZPIC and FI/MAC make it clear that the ZPIC is the sole entity making all decisions and determination relative to the providers cost reports. Thus, the FI/MAC is simply issuing correspondence based on ZPIC directives.

D. A Lack of Provider Business and Financial Data Cannot be the Basis of a ZPIC’s Adverse Cost Report Determination

ZPICs have asserted, in no uncertain terms, that the failure (or inability) to produceall of the demanded financial documentation will lead to the reopening and denial of all Medicare costs contained in the corresponding fiscal year end cost reports.

However, a provider’s failure (or inability) to produce all of the demanded financial and business records has no relation to the actual ZPIC cost report determinations. In addition to aggregating a provider’s financial data (for informational purposes only), a Medicare cost report also includes RUG scores (a/k/a the rate CMS will pay the provider for a given resident). These RUG scores are multiplied by a skilled nursing facility’s census to identify Medicare days paid. Despite requesting business and financial data, ZPICs are reopening cost reports relative to Medicare days paid and making their determinations accordingly. The ZPICs’ conduct is the equivalent of stating that no skilled nursing facility resident during the same periods qualified for Medicare and any payments received by the skilled nursing facility for those Medicare residents must be returned. Yet, whether a resident qualified for Medicare and whether that information was accurately included in the provider’s cost report has no relation to, for instance, a provider’s failure or inability to produce unrelated credit card statements and/or building floor plans. Instead, a determination relative to the accuracy of a provider’s resident Medicare costs would require an analysis of the actual facility residents during the corresponding periods. Even still (and as previously noted), a provider’s Medicare cost reports are merely informational.

E. Does a Provider Have Appeal Rights?

While providers are given the opportunity to appeal cost report reopenings/denials (whether before the Provider Reimbursement Review Board or the MAC, depending upon the amount at issue), appeals may be futile given regulations which permit CMS, c/o the U.S. Department of the Treasury, to begin recouping and/or offsetting Federal and certain eligible state funds due the provider. In essence, the provider is at risk of being choked out of business with millions of dollars earmarked by the ZPIC for recoupment/offset before the provider can assert its appeal rights, even in an action arguably void at its inception. Whether a provider should exercise its appellate rights or seek some other type of relief from a cost report reopening/denial is ultimately a fact-intensive analysis which should be made in light of all of the circumstances affecting the provider’s business.

Fuerst Ittleman David & Joseph, PL will continue to monitor the ZPIC landscape. For more information concerning the foregoing, please contact our firm’s litigation department by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.