D.C. Circuit Limits the DOT’s Authority to Regulate Air Charter Brokers

On April 1, 2011, the U.S. Court of Appeals for the D.C. Circuit issued an opinion in CSI Aviation Services, Inc. v. U.S. Department of Transportation,[1]in which it found that the Department of Transportation (DOT) violated the Administrative Procedure Act (APA) when the DOT failed to justify its authority to issue a cease-and-desist letter to CSI ordering CSI to terminate its business contractual relationships with various federal agencies.[2]

The CSI case is significant on many levels. First, the case is the first successful challenge of the scope of DOT’s consumer protection regulatory authority and it established the first precedent limiting DOT’s broad interpretation of what constitutes “common carrier” in the context of the definition of “air transportation”. Second, the case involved an inter-agency dispute involving the General Services Administration (GSA), which strongly disagreed with DOT’s position on having the authority to regulate CSI’s ability to enter into government contracts with various federal agencies. Finally, the case is significant because the court held that the DOT does not possess the authority to interfere with business relationships between the federal government and air charter brokers unless and until the DOT provides a reasonable explanation for its actions.

Background

Since 2003, CSI has been under contract with the GSA to broker air charter service for various federal agencies. On March 10, 2009, CSI won a competitive bid to renew its status as a GSA contractor through 2014. A few days prior, on March 6, the DOT sent CSI a letter requesting information to determine whether the company was engaging in “indirect air transportation” without the certificate of authority required by the Federal Aviation Act (FAvA). After the company provided the requested information, the DOT sent another letter, stating that based on the information CSI provided, CSI was acting as an unauthorized indirect air carrier in violation of the FAvA with respect to business transacted via its GSA schedule listing. The DOT also stressed that violations of the FAvA constitute unfair and deceptive practices and unfair methods of competition in violation of 49 U.S.C. § 41712.

Six other companies received similar letters. All six complied by terminating their status as contractors for GSA. Convinced that the DOT was exceeding its statutory authority, CSI alone chose to challenge DOT’s determination, asking the DOT to withdraw the cease-and-desist letter on the grounds that the Act requires a certificate of authority only for companies that operate “as a common carrier,”[3]and that CSI’s charter flights for the federal government are not common carriage.[4]

On November 25, 2009, seeking to avoid shutting down its business, CSI submitted a petition to DOT for an emergency exemption from the certification requirement. GSA supported CSI’s petition and in a letter to the DOT GSA explained at length why the Act’s certification requirements for common carriage should not apply to government contracts. “Acquisition [of air service] by the Federal Government . . . is distinct in several ways from acquisition in the private sector and does not present the consumer protection related concerns typically at issue in the private sector.”[5]GSA also added that Federal agencies which purchase air charter broker services are protected from unscrupulous contractors in a number of ways.[6]Although DOT granted CSI a temporary exemption, it indicated that it “remain[ed] of the view that . . . the provision of air services for U.S. Government agencies through the GSA contracting system constitutes an engagement in air transportation, necessitating that brokers conducting such business hold economic authority from the Department to act as indirect air carriers.”[7]

The Court’s Decision

The primary issue in the case was whether DOT properly concluded that air charter brokers that operate under GSA contract engage in indirect air transportation and therefore require certification from DOT despite the statutory provision that requires certification only for those who provide air transportation “as a common carrier.”

Initially, DOT argued that its letter was not a “final order” and that the court did not have jurisdiction. The court, however, rejected the DOT’s position and held that the letter was indeed an order because (1) it marked the consummation of the agency’s decision making process; (2) it  was not merely of a tentative or interlocutory nature; and (3) the order was an action in which “rights or obligations have been determined” or “from which legal consequences will flow.”[8]The court noted that CSI was faced with a choice between costly compliance and the risk of prosecution. The court also stressed that “an agency may not avoid judicial review merely by choosing the form of a letter to express its definitive position on a general question of statutory interpretation.”[9]

The court stressed that “at the very least, the DOT’s letter cast a cloud of uncertainty over the viability of CSI’s ongoing business. It also put the company to the painful choice between costly compliance and the risk of prosecution at an uncertain point in the future—a conundrum that we described in Ciba-Geigy as “the very dilemma [the Supreme Court has found] sufficient to warrant judicial review.”[10]The court reasoned that the DOT’s action was sufficiently burdensome to make six other GSA contractors terminate their air charter operations for fear of prosecution. The court stressed that “having thus flexed its regulatory muscle, DOT cannot now evade judicial review.”[11]

Next, the court explained why the DOT’s actions violate the Administrative Procedure Act. Specifically, the court explained that the fundamental question in reviewing an agency action is whether the agency has acted reasonably and within its statutory authority. The agency must not only adopt a permissible reading of the authorizing statute, but must also avoid acting arbitrarily or capriciously in implementing its interpretation,[12]which requires the agency to “take whatever steps it needs to provide an explanation that will enable the court to evaluate the agency’s rationale at the time of decision.”[13]In the CSI case, the DOT simply failed to explain why the Federal Aviation Act requires a certificate of authority for air charter brokers operating under GSA contract.

The court focused on the definition of air transportation under the Federal Aviation Act and stressed that the Act states that “an air carrier may provide air transportation only if the air carrier holds a certificate issued under this chapter […] The term “air carrier” means “a citizen of the United States undertaking by any means, directly or indirectly, to provide air transportation.”[14]The DOT’s position was that, as a broker of charter flights for the federal government, CSI was engaged in the indirect provision of “air transportation.” But the DOT’s reading failed to engage with the special statutory definition of that term. Under section 40102(a)(5), “‘air transportation’ is defined to include ‘interstate air transportation,’ which in turn means the interstate ‘transportation of passengers or property by aircraft as a common carrier for compensation,’ id. § 40102(a)(25) (emphasis added).”[15]“Common carrier” refers to a commercial transportation enterprise that “holds itself out to the public” and is willing to take all comers who are willing to pay the fare, “without refusal.”[16]Some type of holding out to the public is the essential requirementof the act of “provid[ing]” “transportation of passengers or property by aircraft as a common carrier.”[17]

The court relied heavily on the fact that CSI performs under its contract with the GSA as a dedicated service provider, not as a common carrier. Under the GSA contract, CSI provides charter service to government agencies only, not to all comers. Thus, within the scope of the contract, CSI does not appear to provide “transportation of passengers or property by aircraft as a common carrier.”[18]If CSI is not a common carrier under its GSA contract, then it does not engage in “air transportation” and its services for GSA do not fall within the certification requirement of the Federal Aviation Act.

The court chastised DOT for failing to address this critical issue both in its cease-and-desist order and in its brief to this court. “This failure is all the more baffling because CSI twice informed DOT that it does not believe it is covered by the “air transportation” portion of the Federal Aviation Act—once in CSI’s letter to DOT dated November 19, 2009, and again in CSI’s brief before this court.”[19]Yet DOT’s brief inexplicably claims, ‘It is undisputed that CSI’s service is indirect air transportation.’[20]The court emphasized that “not only is this a disputed point, it is at the very heart of the present controversy.”[21]

In conclusion, the court stressed that “given DOT’s complete failure to explain its reading of the statute, we find it impossible to conclude that the agency’s cease-and-desist order was anything other than arbitrary and capricious, and hence unlawful.  It appears to us that the law cannot support DOT’s interpretation, but we leave open the possibility that the government may reasonably conclude otherwise in the future, after demonstrating a more adequate understanding of the statute.”[22]

Impact of the CSI Decision

The immediate impact of the CSI decision is that CSI, along with other air charter brokers, will be able to continue to enter into contracts to arrange air transportation as a principal without the fear of a potential DOT enforcement action. Air charter brokers will continue to perform a valuable service for the federal government. The federal government spends several million dollars annually procuring air transportation services and the use of brokers enables the federal government to obtain the best possible prices and options for air transportation services from FAvA and DOT certificated air carriers.  For example, most of the nation’s Immigration and Customs Enforcement deportations and federal interstate prisoner movements are arranged by air charter brokers.

CSI’s position throughout the entire dispute was that DOT’s consumer protection regulations simply don’t apply because the federal government is not the “public,” and the court agreed. Indeed, the protections afforded the federal government under the Federal Acquisition Regulations are much more effective that DOT consumer protection regulations. Unscrupulous contractors may be prosecuted by the U.S. Department of Justice under a wide variety of civil and criminal fraud statutes.

New York’s Highest Court Reinstates $5 Billion Lawsuit By Big Banks Against MBIA

New York’s highest court yesterday reinstated a $5 billion lawsuit brought by a group of banks, including Bank of America and Wells Fargo, against insurance giant MBIA. ABN AMRO Bank, et al. v. MBIA Inc., et al., — N.E. 2d –, 2011 WL 2534059, slip op. (June 28, 2011). The Plaintiffs-banks sought to annul MBIA’s 2009 restructuring, which separated the insurer’s municipal bond business from its troubled structured finance unit, on the grounds that the transactions left the insurer incapable of paying insurance claims in violation of New York’s Debtor and Creditor Law. The Superintendent of Insurance in New York approved the transactions that effectuated the split of MBIA’s business in 2009.

The Court of Appeals’ decision represents a victory for Wall Street banks in one of the many battles being fought in connection with the collapse of the financial markets. Those banks saw their fraudulent transfer claims against MBIA dismissed earlier this year by the Appellate Division, First Department. The intermediate appellate court determined that the banks’ fraudulent transfer claims were a “collateral attack” on the Superintendent’s authorization of the restructuring and that an Article 78 proceeding challenging that authorization was the sole remedy available to the Plaintiffs. The banks’ remedies under Article 78 – a procedure entitling aggrieved parties to challenge agency decisions – would be limited compared to those remedies available in state or federal court under a fraudulent transfer theory.

At issue for the Court of Appeals was whether the Plaintiffs-banks had the right to challenge the restructuring plan in light of the Superintendent’s approval. Plaintiffs argued that the restructuring was a fraudulent conveyance because MBIA Insurance siphoned approximately $5 billion in cash and securities to a subsidiary for no consideration, thereby leaving the insurer undercapitalized, insolvent and incapable of meeting its obligations under the terms of the respective insurance policies. MBIA countered that, as held by the First Department, Plaintiffs’ claims were impermissible “collateral attacks” on the Superintendant’s approval of the restructuring.

In a 5-2 decision, the Court of Appeals modified the First Department’s decision and reinstated the Plaintiffs’ breach of contract, common law, and creditor claims. In an opinion authored by Judge Carmen Beauchamp Ciparick, the Court held that NY Insurance Law does not vest the Superintendent with “broad preemptive power” to block the banks’ claims. MBIA Inc., 2011 WL 2534059, slip op. at 16.

“If the Legislature actually intended the Superintendent to extinguish the historic rights of policyholders to attack fraudulent transactions under the Debtor and Creditor Law or the common law, we would expect to see evidence of such intent within the statute. Here, we find no such intent in the statute.” Id.

Critical to the Court’s holding was that Plaintiffs had no notice or input into the Insurance Department’s decision to approve MBIA’s restructuring. “That the Superintendent complied with lawful administrative procedure, in that the Insurance Law did not impose a requirement that he provide plaintiffs notice before issuing his determination, does not alter our analysis,” Judge Ciparick wrote. “To hold otherwise would infringe upon plaintiffs’ constitutional right to due process.” MBIA Inc., 2011 WL 2534059, slip op. at 21. Moreover, the Court noted that Plaintiffs’ claims could not be properly raised and adjudicated in an Article 78 proceeding. Id.

The Court’s decision re-opens claims by multiple financial institutions that MBIA instituted the restructuring in order to leave policyholders without financial recourse.

The case is ABN AMRO BANK NV. et al., v. MBIA Inc., et al, 601475-2009 (N.Y. State Supreme Court, New York County.)

Supreme Court Limits Bankruptcy Court Jurisdiction – Stern v. Marshall

In a decision that may create serious problems for bankruptcy case administration, the Supreme Court this morning invalidated part of the Bankruptcy Court jurisdictional scheme. Stern v. Marshall, No. 10-179, 564 U.S. ___ (June 23, 2011). Specifically, the Court held that the Bankruptcy Courts cannot issue final judgments on garden variety state law claims that are asserted as counterclaims by the debtor or trustee against creditors who have filed proofs of claim in the bankruptcy case.

Thus, while the Bankruptcy Court could issue a final order resolving the creditor’s claim against the estate, it could issue only a proposed ruling with respect to the counterclaim. Final judgment on the counterclaim could only be issued by the District Judge after de novo review of any matters to which a party objects. See 28 U.S.C. § 157(c).

In a five-to-four opinion by Chief Justice Roberts, the Court affirmed the Ninth Circuit Court of Appeals decision that had reversed an $88 million judgment in favor of Vickie Lynn Marshall (a/k/a Anna Nicole Smith) against E. Pierce Marshall for tortious interference with Vickie’s expectancy of a gift from her late husband J. Howard Marshall, Pierce’s father and one of the richest people in Texas.

The Court’s decision was based on constitutional principles defining the limits of Article III of the U.S. Constitution. Thus, it is likely to have implications that reach far beyond the narrow issue resolved in the instant case. The majority relies on the “public rights” doctrine to define the class of judicial matters that can be resolved by non-Article III tribunals like the Bankruptcy Courts. However, it adopts a narrower view of what constitutes “public rights” than was generally understood prior to this decision.

In addition, although earlier cases could be read to adopt a flexible pragmatic approach to Article III that focused only on significant threats to the Judiciary, Chief Justice Roberts takes a very firm approach, stating, “We cannot compromise the integrity of the system of separated powers and the role of the Judiciary in that system, even with respect to challenges that may seem innocuous at first blush.” Of particular interest, this case focuses on the nature of the Bankruptcy Judge as a non-Article III judge (i.e., no life tenure and no salary protection) and rejects the view that the Bankruptcy Courts are merely “adjuncts” of the Article III District Courts. Note that the “adjunct” construct was one of the foundations of the 1984 Act’s post-Northern Pipeline jurisdictional fix that created the core/non-core distinction. See Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).

The narrow holding is that Bankruptcy Judges, as non-Article III judges, lack constitutional authority to hear and “determine” counterclaims to proofs of claim if the counterclaim involves issues that are not essential to the allowance or disallowance of the claim. Here, although the counterclaim was a compulsory counterclaim, it was a garden variety state law tort claim and did not constitute a defense to the proof of claim. Contrast this with the preference claim involved in Langenkamp v. Culp, 498 U.S. 42 (1990). The receipt of such an unreturned preference is a bar to the allowance of the claim. See 11 U.S.C. 502(d). The opinion also distinguishes Langenkamp (and the earlier pre-Code case of Katchen v. Landy, 382 U.S. 323 (1966)) on the ground that the preference counterclaims in those cases were created by federal bankruptcy law. It is unclear whether that reference establishes a second condition to Bankruptcy Court resolution of counterclaims — i.e., that the counterclaim be based on bankruptcy law in addition to its resolution being essential to claim allowance.

The Court begins its opinion by interpreting the “core” jurisdictional grant of 28 U.S.C. 157(b)(1). The Court finds the provision ambiguous, but rejects the view of the Ninth Circuit that the Bankruptcy Court’s jurisdiction to determine matters involves a two-step process of deciding both whether the matter is “core” and whether it “arises under” the Bankruptcy Code or “arises in” the bankruptcy case. The Court states that such a view incorrectly assumes there are “core” matters that are merely “related to” the bankruptcy case (and which cannot be “determined” by the Bankruptcy Court). The Court states that core proceedings are those that arise in a bankruptcy case or arise under bankruptcy law and that noncore is synonymous with “related.” Thus, since counterclaims to proofs of claim are listed as core in the statute, the Bankruptcy Court has statutory authority to enter final judgment. (Note that the opinion does not explain how a tort claim that arose before the bankruptcy and that was based on non-bankruptcy state law could be a claim “arising in” the bankruptcy case or “arising under” bankruptcy law. Possibly the fact that procedurally it arises as a counterclaim is sufficient to convert a “related” claim into an “arising in” or “arising under” claim. Cf. Langenkamp.)

The Court also rejects the argument that the personal injury tort provision of 28 U.S.C. 157(b)(5) deprives the Bankruptcy Court of jurisdiction to resolve the counterclaim. The Court holds that section 157(b)(5) is not jurisdictional and thus the objection was waived.

Although the statute authorized the Bankruptcy Court to determine the counterclaim, the Court holds that grant violates Article III. The Court rejects the view that the Article III problem was resolved by placing the Bankruptcy Judges in the judicial branch as an “adjunct” to the District Court. The Court focuses on the liberty aspect of Article III and its requirement of judges who are protected by life tenure and salary guarantees. After outlining the extensive jurisdiction of Bankruptcy Judges over matters at law and in equity and their power to issue enforceable orders, the Court states “a court exercising such broad powers is no mere adjunct of anyone.”

The Court then uses the “public rights” doctrine as the test for which matters can be delegated to a non-Article III tribunal. Although Granfinanciera v. Nordberg, 492 U.S. 33 (1989), suggested a balancing test that considered both how closely a matter was related to a federal scheme and the degree of District Court supervision (a test that arguably supports the Bankruptcy Court’s entry of a judgment on a compulsory counterclaim), the Court settles on a new test for public rights limited to “cases in which resolution of the claim at issue derives from a federal regulatory scheme, or in which resolution of the claim by an expert government agency is deemed essential to a limited regulatory objective within the agency’s authority.” The state common law tort counterclaim asserted here does not meet that test. Instead, adjudication of this claim “involves the most prototypical exercise of judicial power.”

Interpreted in the most restrictive fashion, this ruling might create serious problems for case administration. In proof of claim matters, the Bankruptcy Court would be limited to proposed findings on most counterclaims, with the District Court entering the final order after de novo review. Query whether the majority’s limited view of “public rights” would prevent the Bankruptcy Judge from entering final judgment in other disputes that involve the non-bankruptcy rights of non-debtor parties. Bankruptcy Courts regularly resolve inter-creditor disputes and resolve disputes regarding the non-bankruptcy rights of parties to the bankruptcy case in contexts other than claim allowance. Whether the Bankruptcy Court’s exercise of this power is constitutional may turn on how broadly the courts interpret the “cases in which resolution of the claim at issue derives from a federal regulatory scheme” prong of the “public rights” test.

U.S. Supreme Court Rules Arbitration Clauses May Waive Class Action Rights

The Supreme Court of the United States ruled on April 27, 2011, that state laws and court decisions that prohibit arbitration clauses from containing class action waivers are preempted by the Federal Arbitration Act, and that such clauses are not necessarily unconscionable.

The Supreme Court of the United States recently handed down a decision in AT&T Mobility LLC v. Concepcion, 562 U.S. ___ (2011), which will have a major impact on the enforceability of class action waivers in arbitration clauses.  The court held that the Federal Arbitration Act (FAA) preempts state statutory and decisional authority that treats arbitral class action waivers as unconscionable, as a matter of law.  The Supreme Court also specifically disapproved of a California Supreme Court decision that had held that class action waivers in consumer contracts were unconscionable, and thus unenforceable.  The AT&T decision could provide a road map for companies desiring to avoid consumer class action claims.

Section 2 of the FAA makes agreements to arbitrate “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”  9 U.S.C. §2.  The California decision had held that class action waivers are, as a matter of law, unconscionable in consumer contracts of adhesion involving small amounts at issue.  Based on its finding that unconscionability may provide grounds to revoke any contract, the California court found the FAA did not prohibit it from refusing to enforce an arbitral class action waiver.

In AT&T, the Supreme Court held that this rule interferes with the clear intent of the FAA to promote arbitration, noting “[t]he ‘principal purpose’ of the FAA is to ‘ensur[e] that private arbitration agreements are enforced according to their terms.’”  AT&T slip op., at 9–10 (quoting Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 478 (1989)).  The court found that the California rule would disallow enforcement of any arbitration agreement that included a class action waiver in a consumer contract.  While the California court reasoned that its rule should only apply to adhesion contracts, the Supreme Court noted that “the times in which consumer contracts were anything other than adhesive are long past.”  AT&T slip op., at 12.  The Supreme Court also noted that the other requirements for the California rule to be applied—that the case involve small dollar amounts and involve schemes to cheat consumers—were too flexible and would only require basic allegations to be made to defeat the terms of an arbitration agreement.  The Supreme Court held that when a state law would impair the purpose of the FAA to the extent that the California rule would, the FAA must preempt the conflicting state law.

Importantly, the Supreme Court did not rule that all arbitral class action waivers are enforceable.  Rather, the Supreme Court held only that arbitral class action waivers are not, in and of themselves, unconscionable.  Courts still must evaluate the particular arbitration agreement at issue on a case-by-case basis to determine whether the terms are fair.  The arbitration agreement at issue in the AT&T decision, however, provides an example of an arbitration agreement that courts have held to be fair and enforceable.  The highlights of that arbitration agreement include the following:

  • Venue in the county where the consumer resides
  • Consumer election to have the arbitration be in-person, telephonic or decided based on written submissions
  • AT&T agreed to pay all costs for nonfrivolous claims
  • Arbitrators had the power to award any form of individual relief, including issuing injunctions and presumably awarding punitive damages
  • AT&T waived any right to seek reimbursement of its fees and costs
  • In the event that a consumer received an award greater than AT&T’s last written settlement offer, AT&T was to pay a $7,500 minimum recovery and double the amount of the consumer’s attorney’s fees

In finding AT&T’s terms fair, the Supreme Court relied on the District Court’s finding that consumers “were better off under their arbitration agreement with AT&T than they would have been as participants in a class action, which ‘could take months, if not years, and which may merely yield an opportunity to submit a claim for recovery of a small percentage of a few dollars.’”

Businesses at risk for consumer class actions should consider whether the cost of a generous arbitration provision like AT&T’s may outweigh the risk of consumer class actions.  The key to this analysis is the difference between the number of consumers who are likely to pursue individual claims to their conclusion and the likelihood that a plaintiff’s attorney will assert claims on behalf of a large number of consumers without their active participation.

Federal Judge Orders California Waste Hauling Firm to Reinstate Two Drivers and Cease Anti-Union Activity

At the request of the National Labor Relations Board, a U.S. District Judge this week ordered a San Jose area waste hauling company to offer reinstatement to two drivers and restore full assignments to other drivers who had expressed support for a union during an organizing campaign.

In issuing the temporary injunction May 17, Judge Jeremy Fogel of the U.S. District Court in San Jose said the NLRB’s Office of General Counsel was likely to win its case against the company, OS Transport LLC, and that the employees would experience irreparable harm if an order did not issue immediately.

The decision stated that the agency “has made a substantial showing that (the company) engaged in serious unfair labor practices, including the termination of a lead organizer and another Union supporter, retaliation against Union efforts in the form of unfavorable assignments, threats to Union supporters, and promises of improved treatment of employees who disavow the Union. These actions appear calculated to chill the employees’ rights to the point that the organizing campaign could be defeated before the Board issues its final determination.”

The dispute began in January 2010, when drivers were told they must incorporate as individual corporate entities in order to continue working. The drivers, who spoke primarily Spanish, were later told to sign incorporation applications filled out in English, or risk being fired. During this period, some drivers contacted the Teamsters Union, Local 350, and signed a joint letter of protest to the company. The union supporters were reassigned to less lucrative routes, and two were later fired.

The union filed charges with the NLRB Regional Office in Oakland and, following investigations, complaints were issued in December 2010 and February 2011 alleging multiple violations of federal labor law. The case was heard by an administrative law judge early this year, but a decision has not yet issued.

Under the injunction, the company owner must read the full order to employees in English and Spanish, or be present when the full order is read by an agent of the NLRB. In addition, the company must provide full names and addresses of employees to union representatives.

Prevailing Antitrust Defendants Recover $367,000 in e-Discovery Costs

Recently, prevailing antitrust defendants were awarded $367,000 in e-discovery costs incurred by their vendor. See Race Tires America v. Hoosier Racing Tire Corp., 2011 WL 1748620 (W.D. Pa. May 6, 2011). While the Court labeled the facts as “unique” and that its holding was limited, the Court’s opinion is very thorough and the facts may be familiar to many antitrust defendants.

In today’s age where the costs of e-discovery can run several hundred thousand dollars or more and outside vendors are routinely hired to help, this holding can be used as a shield and a sword. During discovery, a party can alert the other side that aggressive discovery requests and a demand for many electronic search terms is a major factor in awarding costs of e-discovery – if the responding party prevails. And, if a party should prevail, the potential for an award of the costs of e-discovery can be an additional bonus and/or leverage for any post-verdict resolution without appeal.

The facts are simple. Plaintiff Specialty Tires America (STA) brought antitrust claims against Hoosier Racing, its tire supplier competitor, and Dirt Motor Sports, Inc. d/b/a World Racing Group, a motorsports racing sanctioning body. STA claimed that a so-called “single tire rule” by various sanctioning bodies like Dirt Motor Sports, as well as the related exclusive supply contracts between some of these sanctioning bodies and Hoosier violated Section 1 and 2 of the Sherman Act and caused STA in excess of $80 million in damages. See Race Tires America v. Hoosier Racing Tire Corp., 614 F. 3d 57, 62-73 (3d Cir. 2010). The District Court granted summary judgment in favor of defendants finding that STA had failed to demonstrate antitrust injury, and the Third Circuit Court of Appeals affirmed. Id. at 83-84.

The normal rule that “costs — other than attorney’s fees — should be allowed to the prevailing party” (Fed. R. Civ. P. 54(d)(1)) creates a “strong presumption” that all costs authorized for payment will be awarded to the prevailing party, so long as the costs are enumerated in 28 U.S.C. § 1920, the general taxation-of-costs statute. As prevailing parties, the defendants each filed a Bill of Costs in which the majority of amounts requested were e-discovery costs. Plaintiff objected arguing that e-discovery costs were not taxable under 28 U.S.C. § 1920(4).
Section 1920(4) allows recovery of “[f]ees for exemplification and the costs of making copies … necessarily obtained for use in the case.” 28 U.S.C. § 1920(4). There are two statutory interpretation questions that have divided Courts. First, costs of electronic scanning of documents can be recoverable as “necessary” or unrecoverable as a mere “convenience.”

The other issue takes a few different forms, but focuses on whether the terms “exemplification” and “copying”, which originated in the world of paper, should be limited to physical preparation or rather updated to take into account changing technology and e-discovery. The Court discussed a litany of these cases. Some courts that have applied § 1920(4) to today’s e-discovery demands, have limited exemplification and copying to just the costs for scanning of documents, which is considered merely reproducing paper documents in electronic form, and refused to extend the statute to cover processing records, extracting data, and converting files. Courts are also divided on whether extracting, searching, and storing work by outside vendors are unrecoverable paralegal-like tasks, or whether such costs are recoverable because outside vendors provide highly technical and necessary services in the electronic age and which are not the type of services that paralegals are trained for or are capable of providing.

In this case, because the Court and the parties anticipated that discovery would be in the form of electronically stored information and because plaintiff aggressively pursued e-discovery (e.g., directing 273 discovery requests to one defendant and imposing over 442 search terms), defendants’ use of e-discovery vendors to retrieve and prepare e-discovery documents for production was recoverable as an indispensable part of the discovery process. The Court also found that the vendor’s fees were reasonable, especially because the costs were incurred by defendants when they did not know if they would prevail at trial.

The Court also denied the plaintiff’s request for a Special Master to assess the reasonableness of e-discovery costs incurred by the prevailing defendants as an unnecessary cost and delay.

Court Throws Out Antitrust Claims Against Netflix

In an April 29, 2011 opinion, the District Court for the Northern District of California granted defendant Netflix’s summary judgment motion against a putative class of plaintiffs comprising of individuals who subscribed to Blockbuster, Inc.’s online DVD rental services. See Order Granting Motion for Summary Judgment, No. M-09-2029 PJH, Dkt. No. 376 (“Order”).

Plaintiffs made no conspiracy allegations against Blockbuster, which was their subscription provider. Instead, the multidistrict litigation stemmed from a May 19, 2005 marketing/promotion agreement between Netflix and Walmart, pursuant to which Walmart allegedly exited the market allowing Netflix to enhance its dominant position in the market for DVD rentals, and to eventually raise its subscription prices. Plaintiffs claimed that the reduced competition in the online DVD rental market allowed Blockbuster, which now operated in a two-firm market, to also raise its subscription prices for DVD rentals to plaintiffs. Order at 2.

Plaintiffs’ key allegations were that (1) Blockbuster entered the market in late 2004; (2) Netflix dropped the price of its 3-out subscription plan from $21.99 to $17.99 in October 2004, in response to Blockbuster’s entry and never raised that price; (3) in May 2005, defendants entered into their allegedly illegal “promotional agreement” pursuant to which Walmart subsequently exited the market; (4) Blockbuster was charging $14.99 for its subscription plan prior to the challenged “promotional agreement”; (5) according to a Blockbuster executive, the $14.99 price was “not sustainable”; (6) Blockbuster had begun testing the $17.99 price in connection with certain of its subscription programs in advance of defendants’ announcement of their allegedly unlawful agreement; and (7) in August 2005, three months after the promotional agreement was announced, Blockbuster raised its subscription price from $14.99 to $17.99, the price being charged by Netflix.

The court initially had granted a motion to dismiss with prejudice based on the indirectness of the alleged injury, speculative nature of the harm and complexity of apportioning damages. Id. at 3 (relying on Assoc. Gen. Contractors of Cal. v. Cal. State Council of Carpenters, 459 U.S. 519 (1983)). Later, however, the court reconsidered its prior order and granted plaintiffs leave to amend to allege a direct and proximate causal injury.

In denying a second motion to dismiss, the court noted that plaintiffs’ revised theory of causation differed from their original theory in that “it now focused on Netflix’s ability to convert a competitive price into a supracompetitive price by refusing to compete in an unrestrained market, as well as Blockbuster’s ‘reliance’ on Netflix pricing in setting its own pricing.” Id. at 5 (emphasis in original). Combined with a number of new allegations, the court held that this new theory of causation was sufficient to get plaintiffs past the pleading stage. Nonetheless, the court continued to express concern about plaintiffs’ ability to satisfy the direct injury requirement and encouraged the parties to bring early summary judgment motions directed specifically to antitrust standing. Id. at 5-6.

At the summary judgment stage, and after discovery on the antitrust standing issue had been completed, plaintiffs no longer alleged that Blockbuster’s August 2005 price increase was a direct response to Walmart’s exit from the market. Instead, they argued that, in the but-for world, Netflix would have lowered its price to a true competitive level, and that because Blockbuster’s price derived from Netflix’s, Blockbuster would have followed suit by lowering its price, resulting in lower prices as of August 2005. The court determined that the only issue before it was, assuming Netflix would have lowered its price to the level alleged by plaintiffs, would Blockbuster “track” or “match” Netflix’s pricing.

Among other facts, evidence showed that Blockbuster believed that Netflix “defined” the maximum market price as early as 2003; that Blockbuster used Netflix’s then prevailing price as a baseline in setting its prices; that Blockbuster would not, and indeed did not, exceed Netflix’s pricing; and that each time Netflix cut prices, Blockbuster responded by cutting its price to undercut Netflix. Based on these facts, plaintiffs argued that had Netflix lowered its price below $17.99, Blockbuster would have followed and at least matched Netflix’s price. Id. at 9-10.

However, evidence also showed that Blockbuster considered a variety of factors in setting its prices, besides the price charged by Netflix, including its own financial condition, costs, price testing, product usage and research. Evidence also showed that, although Blockbuster had lowered its prices to compete with Netflix, its price of $14.99 was “temporary” and deemed “not sustainable”; that it believed it had “inferior services” compared to its rival; and that it had already begun a program of raising its prices to $17.99 for some subscriptions before defendants’ promotional agreement was announced. Id. at 10-11.

Concluding that there was no genuine issue of material fact present and that the only dispute was as to the legal effect to be given the undisputed facts, the court granted Netflix’s motion. Id. at 15. The court held that, even viewing all facts in the light most favorable to plaintiffs, they had failed to demonstrate that Netflix pricing truly set Blockbuster’s pricing “as a function of any interdependent market interaction, as opposed to simply a likely function of competitive dynamics of the market.” Id. at 14. At best, the court explained, “plaintiffs demonstrate only that Blockbuster pricing was set with reference to Netflix pricing. But, there is nothing to indicate that Blockbuster pricing – or its price increase in August 2005 – was in any way directly influenced or impacted by Netflix’s alleged anticompetitive conduct . . . .” Id. at 14-15 (emphasis in original).

Tax Court Disqualifies Plan for Not Adopting Required Amendments

Maintaining a retirement plan‘s qualified status comes with certain administrative burdens.  For employers, few burdens are more onerous than required plan amendments. Throughout the year, employers are informed that they need to adopt a plan amendment because of recent changes to the law.  Some amendments appear to lack a purpose.  After all, what is the worst that could happen if a plan’s compensation definition does not include the transportation fringe benefit, especially where participants are not offered transportation fringe benefits?  Recently, in Christy & Swan Profit Sharing Plan v. Commissioner of Internal Revenue, T.C. Memo 2001-62 (Mar. 15, 2011), the Tax Court explained the importance of adopting all required amendments.

In Christy & Swan Profit Sharing Plan, the Tax Court retroactively revoked a one-participant plan’s qualified status because it had not adopted timely amendments to comply with recent law changes.  In particular, the plan had not been amended to include qualified transportation fringe benefits in the definition of compensation, as required by the Community Renewal Tax Relief Act of 2000.  Additionally, the plan did not amend the definition of eligible retirement plan to include annuity contracts and eligible deferred compensation plans, as required by the Economic Growth and Tax Relief Reconciliation Act of 2001.  Instead of adopting these required amendments, the plan relied on a general “declaration” stating that the plan was amended by general reference to incorporate all statutory and regulatory amendments necessary to retain qualified status.  The Internal Revenue Service (IRS) notified the plan of its deficient terms and explained the options available under the audit closing agreement program under the Employee Plans Correction Resolution Program (EPCRS).  The plan’s sole participant, however, chose not to participate in EPCRS.

The arguments for and against plan disqualification, in this case, highlight the importance of maintaining a plan document that complies with all qualification requirements.  The argument against disqualification was that the plan did not need to be amended for statutory changes that would have no effect on its operation.  In other words, the plan claimed that the amendments had no meaningful purpose.  The argument in favor of disqualification was that the plan was required to satisfy the qualification requirements in form and in operation.  The plan’s failure to amend for statutory changes must be made in the context of what might have happened, not what actually happened, i.e., the employer may offer transportation fringe benefits in the future.

In granting summary judgment in favor of the IRS, the Tax Court unequivocally resolved the dispute by stating the following: “The requirements that a plan must satisfy for qualification under section 401(a) must be strictly met.  Vague, general references in plan correspondence to such requirements are insufficient.”

The Tax Court’s ruling reminds all plan sponsors of the importance of timely adopting required amendments.

Reinstatement of Debt: A Bankruptcy Court’s Strict Interpretation and Application of Change-in-Control Provisions to Protect Senior Secured Lenders

In In re Young Broadcasting, Inc., et al., 430 B.R. 99 (Bankr. S.D.N.Y. 2010), a bankruptcy court strictly construed the change-in-control provisions of a pre-petition credit agreement and refused to confirm an unsecured creditors’ committee’s plan of reorganization, which had been premised on the reinstatement of the debtors’ accelerated secured debt under Section 1124(2) of the Bankruptcy Code.

“Reinstatement” refers to a chapter 11 plan proponent’s ability to reinstate the pre-default terms of an accelerated debt by curing all defaults. This cure is typically accomplished by paying off all late payments and other arrearages and bringing the loan current. The bankruptcy court in Young Broadcasting rejected the committee’s attempt to reinstate the debtors’ senior secured debt because the committee’s plan resulted in a default under the change-in-control provisions of the pre-petition credit agreement. In so holding, the bankruptcy court rejected the committee’s arguments that certain provisions of the plan which “formalistically” complied with the change-in-control provisions were sufficient to avoid a default, finding the plan provisions to violate the plain terms and clearly expressed purpose of the change-in-control provisions.

Factual Background

Young Broadcasting, Inc. (“YBI“) and certain affiliates (collectively, the “Debtors“) owned and operated various television stations across the country and a national television sales representation firm. Prior to the bankruptcy filing, YBI had obtained senior secured financing of $350 million (the “Senior Secured Debt“). In addition, YBI had issued senior subordinated notes in the amount of $640 million.

After filing for chapter 11, competing plans of reorganization were filed in the Debtors’ jointly-administered cases by the Debtors and the Official Committee of Unsecured Creditors (the “Committee“). Under the Debtors’ proposed plan, holders of the Senior Secured Debt would receive equity in a new company formed to hold all of the common stock of the reorganized Debtors and the senior subordinated noteholders would receive equity warrants in the new company. As a result, the Debtors would be completely deleveraged.

By contrast, the Committee’s proposed plan would reinstate $338 million of the Senior Secured Debt. The Committee’s plan would also provide the senior subordinated noteholders with a pro rata share of 10% of the reorganized Debtors’ common stock and options to purchase preferred stock and additional common stock. In connection with the proposed reinstatement, and in an attempt to remain in compliance with the change-in-control provisions of the credit agreement (described below), the Committee’s plan provided that Vincent Young, one of the Debtors’ founders (“Mr. Young“), would receive all of the Class B shares of common stock of the reorganized Debtors and certain accompanying voting rights described further below. Upon full repayment of the Senior Secured Debt in November 2012 (the original maturity date), such stock would convert to 10% of the Class A common stock.

Holders of the Senior Secured Debt objected to confirmation of the Committee’s plan on the grounds that the proposed reinstatement was impermissible as it would violate certain change-in-control provisions in the credit agreement and that the plan was not feasible and violated the absolute priority rule.

Analysis

Section 1124 of the Bankruptcy Code defines when a creditor’s claim is deemed “impaired”, thereby entitling the creditor to vote on a plan of reorganization. A creditor whose claim is “unimpaired” is not entitled to vote. Pursuant to Section 1124(2), a plan of reorganization may render a claim unimpaired by providing for the reinstatement of the original terms of the prepetition obligation as it existed before default. This Section requires (i) that the plan provides for the cure of any payment or performance defaults (other than an ipso facto default), (ii) that the plan provides for compensation for any damages caused by the creditor’s reasonable reliance on the right of acceleration, (iii) that the plan provides for compensation for any actual pecuniary losses incurred as a result of a failure to perform a nonmonetary obligation, (iv) that the plan provides for the affirmation of the original terms, including maturity, and (v) that the plan not otherwise alter the legal, equitable or contractual rights of the creditor. Because an obligation that is so reinstated is deemed to be unimpaired, the reinstated creditor is deemed to have accepted the plan of reorganization and will have no right to vote. In effect, by meeting the requirements set forth under Section 1124(2), the plan proponent will have the ability to reverse a lender’s exercise of its contractual or legal right of acceleration and reinstate the original terms of the obligation. This can be a powerful tool for debtors and creditors when formulating plans under chapter 11 of the Bankruptcy Code. It is typically used with respect to obligations that had been accelerated pre-petition. Fully matured obligations must be paid in full in order to be reinstated.

In Young Broadcasting, the holders of the Senior Secured Debt argued that reinstatement was improper because the terms of the plan violated the change-in-control provisions in the credit agreement, resulting in uncured defaults. Both sides cited to In re Charter Communications, 419 B.R. 221 (Bankr. S.D.N.Y. 2009), where the bankruptcy court found no default under a change-in-control provision when a plan of reorganization provided the relevant principal with the necessary voting rights and voting power, but divorced those rights from the underlying economic interest in the company (i.e., the principal’s voting power was out of proportion to his underlying equity interest in the reorganized debtor).

The pertinent provisions of the Senior Secured Debt holder’s credit agreement provided that a change-in-control default would occur if Mr. Young, his immediate family members, certain persons controlled by Mr. Young and members of management ceased to hold over 40% of the Voting Stock (which stock granted the holder general voting power to elect the board of directors). The credit agreement also required that if any person or group were to own more than 30% of the total outstanding Voting Stock, then the Young group must own more than 30% or, alternatively, have the right or ability to elect a majority of the Debtors’ board of directors.

The Committee’s plan provided for two classes of directors and two classes of stock with different voting rights. There would be six Class A directors and one Class B director. The stock was likewise split between Classes A and B, with Mr. Young receiving all of the Class B shares of common stock of the reorganized Debtor. Each Class A share of common stock (5,000,000 of which were to be issued) would have 20 votes for Class A directors and 1 vote for the Class B director. Each Class B share of common stock (500,000 of which were to be issued) would have 1 vote for Class A directors and 1,000 votes for the Class B director. Under this structure, the Committee argued that the terms of its plan complied with the change-in-control provisions of the credit agreement because Mr. Young, who would be given all of the Class B stock, would have over 82% of the vote – far in excess of the 40% requirement. The Committee arrived at this figure by comparing the total number of votes Mr. Young would be entitled to vote (i.e. 500,500,000) to the total number of votes all Class A shareholders would be entitled to vote (i.e. 105,000,000). Thus, the Committee relied on the idea that Mr. Young’s retention of 82% of the absolute number of votes would suffice to avoid a default under the change-in-control provisions, even though, as a result of the two tiers of directors and stock, Mr. Young retained much less than the required 40% of the actual voting power.

Disagreeing with the Committee’s contentions, the bankruptcy court, applying New York law to interpret the credit agreement, found that the plain meaning of the change-in-control provisions required that the Young group retain the power to elect over 40% of the entire board of directors and not just over 40% of the votes. Under the Committee’s proposed terms, Mr. Young would have the ability to control less than 15% of the entire board. The bankruptcy court found that the clear intent of the change-in-control provisions was to preclude third parties from obtaining more control than the Young group and management. Accordingly, the bankruptcy court held that reinstatement of the Senior Secured Debt pursuant to the Committee’s plan was impermissible since the plan resulted in defaults under the change-in-control provisions of the pre-petition credit agreement that were not cured.

The bankruptcy court also denied confirmation of the Committee’s Plan for failure to meet the requirement under Bankruptcy Code Section 1129(a)(11) that the plan be feasible. Applying the “reasonable likelihood of success” standard for feasibility and looking at expert valuations and projections, the bankruptcy court found that the Committee’s plan was not feasible because the Committee failed to establish that the reorganized Debtors could satisfy the Senior Secured Debt upon maturity in November 2012 through either a sale or a refinancing.

Lastly, the bankruptcy court found that the Committee’s Plan violated the absolute priority rule because the Committee failed to produce sufficient evidence showing that the distribution of equity to Mr. Young, while general unsecured creditors were not paid in full, was outweighed by the value of the benefits conferred by reinstatement of the Senior Secured Debt. Thus, ultimately, the Committee in Young Broadcasting was unable to establish that reinstatement was a beneficial bargain for the estate.

Lessons Learned

Young Broadcasting has lessons for both lenders and debtors. For lenders, it highlights the importance of clearly drafted change-in-control provisions which can be used as a weapon to guard against an unfavorable reinstatement in a chapter 11 bankruptcy case. For debtors and other plan proponents, Young Broadcasting establishes some clear limits on the gamesmanship that can be played with change-in-control provisions in a reinstatement under Bankruptcy Code Section 1124(2). Though the Charter Communications case indicates that it may be possible to separate the economic interest from the voting interest, Young Broadcasting shows that it may not be possible to separate the actual number of votes from the underlying voting power and avoid a change-in-control default. The equitable considerations at play in Young Broadcasting also highlight the importance of clearly establishing the economic benefits to be obtained by the estate from the reinstatement.

Department of Labor Releases Timesheet Smartphone “App” for Employees

On May 9, the Wage and Hour Division (WHD) of the U.S. Department of Labor (DOL) launched its first application (or “app”) for smartphone platforms. The app (dubbed “DOL-Timesheet App”) is an electronic timesheet that allows employees to independently track the hours they work and determine the wages they believe they are owed.

The development and launch of the DOL-Timesheet App signals a continued and aggressive commitment by the WHD to enforce wage and hour laws across the country—but it also reflects a not-so-subtle shift in the WHD’s tactics. Aware that it has limited capacity for investigation and enforcement (especially in these times of budget cuts), the WHD is pushing measures, such as the DOL-Timesheet App, that essentially “deputize” employees, giving them the power and the know-how to determine whether their employers are complying with applicable wage and hour laws. In light of these measures, it is critical that employers take steps to ensure compliance with federal and state wage and hour laws and ensure the accuracy of their timekeeping systems.

The DOL-Timesheet app appears to be in line with the so-called “Right to Know” regulatory initiative the DOL unveiled in December 2010. Moreover, according to the DOL’s regulatory agenda, the DOL is considering a proposed rule that would require covered employers to notify workers of their rights under the Fair Labor Standards Act (FLSA), and to provide information regarding hours worked and wage computation.

The DOL-Timesheet App undoubtedly will add fuel to the wage and hour litigation fire sweeping across the country. Employers should not expect that this fire will die down in the near future.

About the Application

The application is a fairly simple time-tracking tool—with potentially dangerous consequences for employers that do not have reliable and accurate time-recording systems in place.

A user first enters his or her employment information, including the employer’s name, the employee’s hourly rate, and the day of the week on which the employee’s workweek begins. That information is saved, and moving forward the employee need only tap on that employer’s name to get to two prompts: “Start Work” or “Manual Time Entry.”

The “Start Work” function works like a stopwatch, and records the exact time that the icon is selected. Users will see the name of the employer and time information (e.g., “XYZ Corp., Started work on 5/12/11 9:36 am”). Tapping the employer’s name again allows the user to either “Stop Work,” presumably to signal the end of the workday, or “Start Break,” to record any break periods during the workday.

If “Start Break” is chosen, the user can select either “Meal” or “Other” as the type of break, and can add comments regarding that break. The timesheet will then show that information (e.g., “Break started at 9:44 am”). Users who are unfamiliar with rules relating to the compensability of break time under federal law can view a summary of the federal regulations on this topic.

Once “Stop Work” is selected, the DOL-Timesheet App gives the user a summary of his or her workday, which the user can email to anyone he or she chooses. The summary calculates gross pay for the week, based on the employee’s regular rate, and the app can calculate the number of overtime hours and wages due as a result.

The “Manual Time Entry” feature is similar in content, but simply allows the user to input historical data on start and stop times and breaks for any given date.

The DOL-Timesheet App also contains a very limited “Glossary” that defines common wage and hour terms. Only a few basic terms are included, such as “breaks,” “gross pay,” and “workweek.” The app also features a “Contact Us” section that gives telephone numbers and email and office addresses for the WHD.

Following is a screenshot of the DOL-Timesheet App:

The DOL-Timesheet App is not currently enabled to track more advanced pay mechanisms—such as tips, commissions, bonuses, deductions, holiday pay, pay for weekends, shift differentials, and pay for regular days of rest. According to the DOL, future releases or updates of the application may contain these features.

The free application is currently available only on the iPhone and iPod Touch, although the WHD is considering releasing it on other smartphone platforms, such as Android and BlackBerry. According to the DOL, workers without a smartphone can use the DOL’s printable work hours calendar in English or Spanish to track rate of pay, work start and stop times, and arrival and departure times.

Both the app and the calendar can be downloaded from the Wage and Hour Division’s homepage at http://www.dol.gov/whd/, or through traditional application servers, like iTunes.

Conclusion

The DOL’s new app makes it especially important for employers to ensure the consistency and the accuracy of their time-reporting mechanisms. In particular, employers should make sure that their employees understand that the company’s timekeeping mechanisms are the basis for their pay and the company’s compliance with applicable laws, and those records must be filled out completely and accurately regardless of whether the employees are using any other means for tracking their time. In addition, employers should not in any way discourage their employees from using the application lest they be charged with retaliation against their employees’ exercise of rights under the FLSA.

Employers defending wage and hour litigation also should consider this application as a potential source of relevant information. If the employee actually has maintained accurate, contemporaneous time records on the application, the information could be helpful to the employer’s defense as compared with an employee’s after-the-fact estimation of hours worked developed during litigation.

District Court Decision Reversed as Genuine Issue of Material Fact Remained: Zobmondo Entertainment LLC v Falls Media LLC

In an appeal from a decision of the Central District of California, Zobmondo Entertainment LLC v Falls Media LLC (Case 08-56831, April 26 2010), the US Court of Appeals for the Ninth Circuit has reversed a grant of summary judgment in favour of an accused trademark infringer, holding that questions of fact existed as to whether the trademark WOULD YOU RATHER…? as applied to board games was suggestive or merely descriptive.

Falls Media LLC and Zobmondo Entertainment LLC both incorporate the mark WOULD YOU RATHER…? on books and board games based around the idea of posing humorous, bizarre or undesirable choices. For example, one question from Zobmondo asks: “would you rather have your grandmother’s first name or her haircut?”.

Falls Media filed an ‘intent to use’ application for the WOULD YOU RATHER…? mark in July 1997 for books and board games. It released books incorporating the mark in 1997 and 1999, and a board game in 2004. The ‘intent to use’ application was allowed in 2002 and, following the submission of a statement of use in commerce, the US Patent and Trademark Office (USPTO) issued a registration for WOULD YOU RATHER…? in July 2005.

Zobmondo’s founder filed an ‘intent to use’ application for the mark WOULD YOU RATHER in September 1997. Falls Media’s mark was cited against Zobmondo and the application was subsequently abandoned. Regardless, beginning in 1998, Zobmondo went on to produce multiple games based around humorous ‘would you rather’-style questions, and in 2002 released its first game featuring the WOULD YOU RATHER…? mark.

In 2006, following the registration of Falls Media’s mark, Zobmondo filed suit against Falls Media in the Central District of California alleging among other things, trade dress infringement, copyright infringement and unfair competition. Falls Media responded by filing its own suit in the Southern District of New York claiming, among other things, trademark infringement and unfair competition. Zobmondo counterclaimed for cancellation of the WOULD YOU RATHER…? mark. The New York action was transferred to California and the two cases were consolidated.

Both parties filed motions for summary judgment. The court granted Zobmondo’s motion on several claims, including Zobmondo’s counterclaim for cancellation of Falls Media’s mark. In short, the court found, as a matter of law, that:

  • l the WOULD YOU RATHER…? mark was merely descriptive; and
  • l no rational juror could find that the mark had acquired secondary meaning by 2002, when Zobmondo first released a game prominently featuring the mark.

Falls Media appealed to the Ninth Circuit.

The district court had turned to several tests to determine that the WOULD YOU RATHER…? mark was merely descriptive. First, it applied the ‘imagination’ test, asking whether imagination or a mental leap was required in order to reach a conclusion as to the nature of the product referenced. Second, it applied the ‘competitors’ needs’ test to determine the extent to which the mark is needed by competitors for their goods and services. Finally, it utilized the ‘extent of use’ test, which evaluates the extent to which others have used the mark on similar merchandise. The court determined that both the ‘imagination’ and ‘extent of use’ tests indicated that the mark was descriptive, while the ‘competitors’ need’ test was difficult to apply. It buttressed its opinion with evidence in the form of statements by persons related to Falls Media suggesting that they believed that the mark was merely descriptive.

The Ninth Circuit found several flaws with the district court’s ruling. First, a proper application of the ‘imagination’ test would have found that, without comprehensive consumer surveys, there was no way to conclude that consumers necessarily viewed the mark as merely descriptive of a game involving bizarre or humorous choices. Second, the court found that the ‘competitors’ needs’ test indicated that the mark was suggestive, given that Zobmondo debated 135 possible names for its games during development, and successfully sold its games for several years without use of the WOULD YOU RATHER…? mark. The circuit court declined to apply the ‘extent of use’ test, which is not a controlling measure of trademark validity in the Ninth Circuit.

As to the additional evidence cited by the district court, the Ninth Circuit ruled that, while probative, the statements suggested only that Falls Media believed that the mark was descriptive, and did not indicate that consumers would reach the same conclusion. The Ninth Circuit also believed that the district court had improperly discounted expert testimony that the mark had never been used as the title of a board game before Zobmondo entered the market, as that suggested that competitors did not find the mark useful in describing their products. Finally, the Ninth Circuit noted that Zobmondo’s attempt to register a similar mark supports the inference that, at one time, it believed that the mark was inherently distinctive.

The core of the Ninth Circuit’s determinations was that the district court had misapplied the summary judgment standard as it relates to trademarks. A registered trademark enjoys a strong presumption of validity and where, as here, the USPTO does not require evidence of secondary meaning, the mark is entitled to a presumption that it is inherently distinctive as well. Trademark validity is also an intensely factual issue, and summary judgment is disfavoured in trademark claims generally. Given this, and the normal summary judgment standard requirement that all reasonable inference be drawn in favour of the nonmoving party, the Ninth Circuit simply could not conclude, based on incomplete and conflicting evidence, that there was no issue of fact as to whether WOULD YOU RATHER…? was suggestive or merely descriptive.

Supreme Court Affirms No “First Sale” Defense for Foreign-Made Copies

On December 13, 2010, the Supreme Court affirmed the Ninth Circuit’s decision in Omega S.A. v. Costco Wholesale Corp., upholding the Ninth Circuit’s interpretation of the first sale doctrine as inapplicable to foreign-made goods covered by U.S. copyrights.

Omega, a Swiss luxury watch manufacturer, sold its products internationally through various authorized dealers in the U.S. and abroad. One such product, a watch that included a design protected by a U.S. copyright, was made overseas and sold by Omega to one of its authorized foreign distributors. Following this sale, these copyrighted watches were imported into the U.S. without Omega’s approval by an unidentified third party. The watches were then purchased by ENE Limited, a NY company, which in turn sold the watches to Costco, which then began selling them in California.

Upon learning of Costco’s sales, Omega filed a copyright infringement action in the Central District of California. In its defense, Costco argued that the first sale doctrine under 17 U.S.C. § 109(a) barred Omega’s ability to bring the action, because the watches were the subject of an authorized sale to one of Omega’s foreign distributors. This, Costco argued, shielded it from liability despite the fact that its subsequent U.S. sale was unauthorized. The district court agreed, ruling in favor of Costco on summary judgment. Omega promptly appealed.

On appeal, Omega argued that § 109(a) applies only to the sale of goods “lawfully made under [U.S. copyright law]” and, therefore, the first sale doctrine did not apply because the goods were made outside the U.S. In response, Costco asserted that Omega’s reliance on earlier Ninth Circuit case law, specifically BMG Music v. Perez1, Parfums Givenchy, Inc. v. Drug Emporium, Inc.,2 and Denbicare U.S.A. Inc. v. Toys “R” Us, Inc.,3was misplaced because these cases had been overruled by the Supreme Court in Quality King Distribs., Inc. v. L’anza Res. Int’l, Inc.4

In its opinion, the Ninth Circuit first restated that an owner of a copy “lawfully made under [Title 17]” who imports and sells that copy does not infringe under the first sale doctrine. After reviewing BMG Music, Drug Emporium, and Denbicare, the court turned to the Supreme Court’s Quality King decision. In Quality King, the copyrighted goods had been “round trip” imported: they were first manufactured in the U.S., exported through an authorized distributor, sold to an unidentified third party abroad, and then shipped back to the U.S. where they were sold without the copyright holder’s permission. The Court in Quality King ruled that the first sale doctrine provided a defense against copyright infringement under these facts. However, the Court declined to address whether the same result would be warranted if the copyrighted products were first manufactured outside the U.S.5

Picking up where Quality King left off, the Ninth Circuit concluded that the first sale doctrine provides a defense against copyright infringement “only insofar as the claims involve domestically made copies of U.S.-copyrighted works” (emphasis added).6 Thus, under this decision, the first sale doctrine is available as a defense only if the copies were legally made in the U.S. Accordingly, the Ninth Circuit rejected Costco’s position and reversed the district court, finding no inconsistency between Quality King and the rule of law established by BMG, Drug Emporium, and Denbicare. Costco then sought certiorari to the Supreme Court.

In a per curium opinion released December 13, 2010, an equally-divided Supreme Court affirmed the Ninth Circuit’s decision.7 Justice Kagan recused herself and took no part in the decision, most likely due to her role as Solicitor General in preparing an amicus brief on behalf of the U.S. In this brief, the U.S. supported Omega’s assertion that “lawfully made under this title” as used in § 109(a) means made in accordance with U.S. copyright law, which does not apply extraterritorially.

On its face, the case appears to strike a blow to one of the remaining openings in the gray market, and may provide a powerful tool for international manufacturers who maintain separate marketing and pricing structures in separate international markets. A foreign DVD, camera, or electronics manufacturer, for example, would be able to charge less for its goods in the Asian market than it does in the U.S., and could enforce that marketing decision so long as the goods themselves are manufactured outside the territory of the United States. The Ninth Circuit’s holding that foreign-made goods are excluded from the first sale doctrine, combined with the increasing trend of manufacturing luxury goods abroad, may result in higher prices due to a reduced gray market.8

But this decision may be less a “victory” for international venders than it appears at first glance. After all, the 4-4 split merely earns Omega a win by default, not an express affirmation of its legal position. Indeed, the decision may also be viewed as a near miss on a Ninth Circuit reversal, rather than as an approval of that court’s interpretation of § 109(a). While one might assume that Justice Kagan—in light of the position taken by her, as Solicitor General, on behalf of the government—would have given Omega the final, precedent-setting vote it needed had she taken part, there is no guarantee of that. Nor can one assume that, had it come to a reasoned decision, the Court would not have created its own, different interpretation of the disputed provision.

The outcome of last week’s decision leaves the Ninth Circuit at least9 in support of a narrow interpretation of the “first sale” doctrine and market division programs based on control of copyrights in products.

Suburban Chicago Hilton to Pay $195,000 to Resolve EEOC National Origin Harassment Suit

Agency Says Exec Chef Subjected Hispanic Kitchen Employees to Slurs and Insults

CHICAGO – The Equal Employment Opportunity Commission (EEOC) announced today that a federal judge has entered a $195,000 consent decree to resolve a national origin harassment lawsuit brought by the agency against the Hilton Lisle/Naperville Hotel in Lisle, Ill.

In its lawsuit, EEOC charged that the Hilton Lisle/Naperville violated federal law by subjecting Hispanic employees in the hotel kitchen to offensive comments. Specifically, the EEOC charged that the hotel’s executive chef regularly referred to Hispanic employees as “s–cs” and “wetbacks.”

National origin discrimination violates Title VII of the Civil Rights Act of 1964. The EEOC filed suit, captioned EEOC v. Fireside West, LLC d/b/a Hilton Lisle/Naperville, No. 09 cv-5979, on Sept. 28, 2009 in U.S. District Court for the Northern District of Illinois in Chicago, after first attempting to reach a pre-litigation settlement through its conciliation process.

The three-year consent decree resolving the suit, approved by District Judge Edmund Chang yesterday, May 5, 2011, provides that $195,000 in monetary relief, which includes attorney’s fees, be distributed among two employees who filed charges of discrimination with EEOC and another additional employee.

The decree also requires the Hilton Lisle/Naperville to report any further complaints of retaliation or national origin harassment to the EEOC. The decree requires remedial training for all employees at the hotel, and mandates that the executive chef, who was alleged to have engaged in the harassment of Hispanic kitchen employees, receive personal anti-discrimination training. The decree includes an injunction prohibiting further discrimination on the basis of national origin and barring retaliation for reporting or complaining about discrimination.

“Federal law clearly requires employers to take prompt remedial action when they learn of harassment,” said John Hendrickson, regional attorney for the EEOC in Chicago. “In this case, the EEOC was prepared to show that not only did multiple employees report the harassment, but also that the executive chef himself acknowledged doing it. That’s not acceptable, and it’s not legal.”

EEOC trial attorney Aaron DeCamp added, “Over the next three years, EEOC will keep a close eye on how the Hilton Lisle/Naperville implements the consent decree to make certain these issues do not recur.”

In addition to Hendrickson and DeCamp, the case was litigated by Supervisory Trial Attorney Greg Gochanour and Trial Attorney Laurie Elkin. The EEOC Chicago District Office is responsible for processing charges of discrimination, administrative enforcement, and the conduct of agency litigation in Illinois, Wisconsin, Minnesota, Iowa and North and South Dakota, with Area Offices in Milwaukee and Minneapolis.