January/February 2007
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No, a paralegal is not a lawyer
Let's face it: A paralegal can definitely represent added value for your legal practice. But beware the
possibility of bumps in the road.
What paralegals can do
Sure, you have some business paralegals on staff. But have you really considered the universe of ways they
can help you out?
Getting legal with paralegals
Would regulating paralegals help your firm or legal department? Is regulation needed? Here's a look
what's happening now and what could happen in the future.
Are you ready for China?
Your client is considering investing in a Chinese company. Or your client may be a Chinese company
venturing overseas for the first time. What does that entail? Prepare for a lesson in the New World Order.
Before you grab that property . . .
The timing just wasn't right for Sarah and Robert Hudson.
Professionalism:
Lawyer jokes and cartoons have become a part of our culture. Most lawyers will laugh at them, even
though they may not be very funny and if targeted at a minority group would be abhorrent. But even those
that are funny and provoke a genuine laugh should give lawyers pause. Are we just misunderstood, or are
we doing something seriously wrong?
When a business begins a blog
Your new client calls with a question. She has heard that other businesses are operating "blogs" written by
employees or owners to promote and market their businesses, and she wants to launch a blog about her
business. She asks whether there are any legal issues of which she should be aware before she has her
employees start a blog. What do you tell her?
The 'agreement' that sparked a storm
At a recent legal presentation attended by prominent intellectual property lawyers and law professors, a
loaded question was posed to the audience: "By a show of hands — and be honest, now — how many of
you read the terms and conditions presented in an end-user license agreement?"
Is the future more secure?
Think you understand the newly enacted pension rules? Or at least that your business client does? Read
on.
Departments:
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Keeping Current: Canada
Canada has repealed the federal capital tax. The elimination of this tax will make easier the crossborder
securitization of various classes of Canadian leases and interest-bearing receivables on a tax-efficient
basis.
Nonbinding Opinion: Involuntary bankruptcy: The end has come
Editor's note: In the last issue of Business Law Today (Nov./Dec. 2006) we published an article suggesting
that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) revived a creditors'
remedy that had previously been seldom used—the involuntary petition against an individual debtor.
Snap Judgments
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Business Law Today
Volume 16, Number 3 January/February 2007
No, a paralegal is not a lawyer
A few things to keep in mind
By Frances P. Kao
Let's face it: A paralegal can definitely represent added value for your legal practice. But beware
the possibility of bumps in the road.
Many recent articles, books and seminars have used economic analyses to demonstrate the
financial benefits that paralegals can bring to a law practice. Less frequently discussed are the
ethical boundaries that lawyers working with paralegals must observe. These ethical rules are
ignored at a lawyer's peril since violating them can bring significant financial and reputational
harm to both the lawyer as well as the firm.
Potential pitfalls can arise starting from the hiring decision and throughout the duration of the
lawyer-paralegal relationship. However, a lawyer's ethical obligations when working with paralegals
are relatively straightforward and, with some care, need never be the cause of an unpleasant
discussion between the lawyer and his governing bar disciplinary committee.
So you're gonna hire a paralegal.
Jane Hendrick, a lawyer with a five-person firm, has just hired Bob Worth, a paralegal, to assist
with the firm's general nonlitigation work. Bob Worth is currently employed by Smith & Smith,
another small firm in the same city. Prior to being hired by Jane Hendrick, Bob Worth had been
supporting the lawyers at Smith & Smith in a small asset-purchase transaction on behalf of Atkins
Co. The seller, Baily Ltd., is represented by none other than Jane Hendrick. At the time she hired
Bob, Jane did not know that Bob had been working on the Atkins/Baily deal from the Smith &
Smith side.
On Bob's first day, he hears that Jane is representing Baily and he tells her that he was the one
that had been assisting the lawyers doing due diligence and had taken notes at several meetings
between Atkins and the lawyers from the Smith law firm. Jane likes it that Bob already knows
something about the transaction and tells him he can work on the deal with her. Having a general
understanding of the rules on ethical conflicts, Jane purposely assigns Bob to the task of finalizing
and preparing the closing documents because this does not require that Bob make use of or
otherwise disclose any privileged information that he received while working at Smith & Smith.
How's Jane doing so far?
Guideline 1 of the ABA Model Guidelines for the Utilization of Paralegal Services (Utilization
Guidelines) provides that "a lawyer is responsible for all of the professional activities of a paralegal
performing services at the lawyer's direction and should take reasonable measures to ensure that
the paralegal's conduct is consistent with the lawyer's obligations under the rule of professional
conduct . . . ." In turn, Rules 1.7 through 1.10 of the ABA Model Rules of Professional Conduct
(Model Rules) impose specific obligations on lawyers with respect to conflicts and imputations of
conflicts.
Given that conflicts rules would prohibit a lawyer from working on the opposite side of a
continuing matter, it is clear that a paralegal likewise may not do so. The paralegal also cannot
work on a matter adverse to a former client for whom he previously worked if the two matters are
substantially related and confidentiality may be jeopardized.
Most law firms would never take the risk of hiring a new lawyer without screening those lawyers
for conflicts because the principle of vicarious disqualification imputes the potential new lawyer's
conflicts to everyone in the firm — thereby, disqualifying the entire firm from a particular
transaction or representation. However, many lawyers and law firms do not screen paralegals or
other nonlawyers for conflicts even though the same principles of vicarious disqualification apply.
As a matter of good ethical practice, all potential new hires should be screened for conflicts at the
time the firm makes an offer of employment and that offer should be contingent on the results of
that conflict check. The paralegal should be asked to provide written detail of every individual or
entity for whom the paralegal provided services. This disclosure would then allow the hiring firm
to determine whether there are conflicts between the hiring firm's business and the paralegal's
prior work.
Moreover, irrespective of size, all firms should have, and should rigorously enforce, written policies
regarding avoidance of ethical conflicts, how to check for conflicts and, in the event of a potential
conflict, the importance of setting up ethical walls to prevent the disclosure of confidential
information.
Discovering potential conflicts early is critical because it gives the hiring firm several options. First,
the firm can decide if it wishes to obtain consents or conflict waivers from the affected clients.
Second, the firm can erect an ethical wall to protect against the communication of confidential
information from the new employee to others in the firm. Third, the firm can just decide not to
hire the paralegal with the conflict.
If no conflicts checks are ever made and the paralegal is hired, the lawyer or law firm runs the
risk of being entirely disqualified from representing the client on the particular transaction. In this
era of increasingly competitive law practice, this is certainly an unsettling prospect.
All in a day's work.
Jane wants to make good use of Bob's experience in drafting company bylaws, articles of
incorporation, board minutes and the ministerial aspects of incorporating a company. She thinks
that by giving Bob substantial responsibility and treating him as a full member of the legal team,
she can increase Bob's job satisfaction. Bob appreciates Jane's trust in him and always does his
best for all of Jane's clients.
Jack Jameson, the founder of Conrad Inc. and a potential new client, calls Jane's office to ask
about forming a new corporate entity as a Conrad Inc. subsidiary. Jane is out of town but Bob
invites Jack to talk things over. During the first in-person meeting between Jack and Bob, Bob is
asked whether the corporation should be formed in Delaware or New York; Jack also tells Bob that
speed is of the essence.
Bob tells Jack that the entity could be most quickly and efficiently formed in Delaware. Jack,
impressed with Bob's professionalism, says "great, let's get it done." Bob tells Jack that he has to
sign the form retention agreement for all new clients and Jack does so.
Once Jack leaves the office, Bob drafts standard articles of incorporation and also fills in the formbook company bylaws and sends them directly to Jack for his approval. A day later, after Jack
gives the nod to these documents, Bob electronically completes the necessary filings to
incorporate the new entity. Bob's provided terrific client service and Jane should be very pleased,
right?
Not exactly. All states prohibit the unauthorized practice of law and have an ethics rule like Rule
5.5 of the ABA Model Rules, which prohibits lawyers from aiding another person in the
unauthorized practice of law. Although what constitutes the unauthorized practice of law differs in
specifics from state to state, there are generally three things that every state — as well as
Guideline 3 of the Utilization Guidelines — prohibits a paralegal or other nonlawyer from doing.
First, a paralegal may not establish the attorney-client relationship. Second, a paralegal may not
give legal advice. Third, a paralegal may not appear in court on behalf of a client — and this
prohibition covers the taking and defending of depositions and the signing of pleadings or other
papers to be filed in court.
Limited exceptions to this third prohibition exist; for example, certain federal and state agencies,
certain tribal courts and certain state courts under local rules permit nonlawyers to make
appearance on behalf of clients.
In addition to these three hard and fast rules, it is incumbent on the lawyer, not the paralegal, to
determine what constitutes the practice of law in her jurisdiction. Lawyers should keep in mind
that, in some jurisdictions, any exercise of independent legal judgment constitutes the practice of
law.
A lawyer avoids running afoul of the prohibition against aiding in the unauthorized practice of law
through proper delegation and supervision of paralegals. Supervision is key because the lawyer is
responsible for the actions of any paralegal that she employs and proper supervision gives both
the lawyer and the client confidence that the paralegal is taking substantively and ethically proper
actions.
Proper delegation and supervision begins when selecting qualified persons as paralegals. A
paralegal can be qualified either by education (there are some several hundred paralegal
education programs that are approved by the American Bar Association) or by experience or a
combination of both.
Second, proper delegation and supervision means that a lawyer should match the paralegal's skill
set with the task that needs to be done. For example, one should not delegate real estate closing
tasks to a litigation paralegal unfamiliar with real estate transactions or assign inexperienced
paralegals to tasks without appropriate instruction. A lawyer can both ensure having qualified
paralegals and provide proper supervision by providing orientation and continuing training
programs, either formal or on-the-job, for the paralegal.
Third, a lawyer should properly guide the paralegals' work. This means that adequate instructions
should be given when assigning a new project to a paralegal. Moreover, the lawyer should also
monitor the progress of each assignment to ensure that the paralegal is proceeding on the right
track.
Most important, proper supervision requires that the lawyer review the paralegal's work product. It
is not enough that the paralegal has performed a particular task dozens of times and will likely
again perform the task properly. The lawyer must review the substantive work and be available to
the paralegal to provide guidance in even routine assignments. Permitting a paralegal to issue
work product on a substantive assignment without a lawyer's review can constitute aiding in the
paralegal's unauthorized practice of law.
As a general matter, lawyers should implement policies to avoid putting their paralegals into
difficult positions relative to client demands. For example, lawyers should implement a policy
requiring their paralegals to identify themselves to new callers or visitors as paralegals who are
not licensed to practice law. For small firms, the firm may want to use the standard engagement
letter to clearly identify the lawyers and the paralegals.
Paralegals should also be periodically reminded to defer all legal issues to the lawyers. These
procedures would comport with Guideline 4 of the Utilization Guidelines that requires lawyers to
take "reasonable measures" to ensure that clients, courts and other lawyers are aware that an
individual working with the lawyer is a paralegal and not licensed to practice law.
For both the lawyer and the paralegal, there are practical ramifications to engaging in and aiding
in the unauthorized practice of law. In most states, unauthorized practice of law is a misdemeanor
offense. Accordingly, the paralegal can be charged with a violation of law. That means that the
paralegal can be subject to an injunction against future conduct and, possibly, civil penalties.
For the lawyer, if the governing disciplinary organization determines that the lawyer failed to
properly supervise or otherwise aided the paralegal in the unauthorized practice of law, the lawyer
may be subject to penalties such as public censure, injunction, civil penalties, disgorgement of
fees and even suspension and disbarment. Also, because a paralegal's work merges into and
becomes the lawyer's work, a lawyer will be held liable for the malpractice of the paralegal
working under his supervision. Being charged with malpractice is one of the most severe
reputation blows that a lawyer can experience.
Silence is golden.
Bob is married and his wife, Carol, is also a paralegal. Carol has brought work home and has told
Bob about a particularly tricky research project she has been assigned. Bob has done this type of
research before in working with one of Jane Hendrick's clients and knows that the result is highly
fact dependent. He tells Carol the important underlying facts of the matter that he worked on and
also reveals the name of the client for whom he undertook the assignment.
He and Carol then share details of both his previous assignment and the areas of similarities with
her current assignment. Bob thinks nothing of telling his wife the details that the client shared
with him — he is confident that his wife will not share these discussions with anybody else.
The attorney-client privilege and the ethical obligation of client confidentiality extend to the
paralegal and all nonlawyers working with the lawyer. Rule 5.3 of the Model Rules provides that
lawyers who are partners in a firm, who have comparable managerial authority or who have
supervisory authority over nonlawyers "shall make reasonable efforts to ensure that the person's
conduct is compatible with the professional obligations of the lawyer." An analogous provision
exists in Guideline 6 of the Utilization Guidelines.
The effect of Model Rule 5.3 is that lawyers are responsible for nonlawyers' violations of the
ethical rules if they order or ratify the act, or are partners or supervisors of the nonlawyer and fail
to take timely remedial action on the conduct.
As a practical matter, lawyers must implement policies to protect client information and to train
their paralegals about the importance of client confidentiality. This obligation of confidentiality
extends to all types of client information including documents, files and computer security. As an
initial step in implementing confidentiality policies, the lawyer may want to ask that each paralegal
sign a confidentiality agreement that prohibits the paralegal from revealing any client information
and that sets forth penalties for breach of that commitment, including termination of employment.
Lawyers should also highlight issues arising from new technology including placing restrictions on
sending electronic materials directly to opposing counsel and the implementation of measures to
ensure that previous drafts of documents cannot be accessed. Key to this effort is the routine use
of built-in software features or custom programs that eliminate meta-data or lawyer notations
from electronic copies of documents.
Lawyers should further consider training paralegals on limiting the number of recipients of e-mail
communications sent to clients and others to avoid wide dissemination and inadvertent disclosure
of client information.
Further, it is important to inform paralegals and other nonlawyers that client confidentiality should
be a pervasive concept. For example, client matters should not be discussed on the elevator. After
all, who else is in the elevator and might be listening in? Information from or about the client
should not be discussed at home with a spouse or a significant other even if the person is
confident to a moral certainty that the information will go no further.
Lawyers also need to stress that, in the event of inadvertent disclosure, be it through erroneously
sent e-mail, mislaid documents or otherwise, the paralegal needs to immediately inform the
lawyer of the inadvertent disclosure rather than ignoring the disclosure and hoping that no ill
results follow. The earlier the lawyer learns of the inadvertent disclosure, the earlier that steps can
be taken to remedy the problem including informing the receiving party of the inadvertent
disclosure and requesting the return of the disclosed materials.
Finally, on termination of employment, lawyers should remind the departing paralegal of her
continuing obligation to maintain the client confidences learned during the course of the
paralegal's employment.
Time is money.
Bob Worth is a terrific paralegal but is not a particularly organized record keeper. He often forgets
to keep a detailed record of the matters he worked on and the amount of time that he spent on
specific matters. He routinely turns in a month's worth of time entries on the last day of the
month and "estimates" the amount of time he thinks was spent on each client's matter.
He believes he tends to underestimate the time for each client and when he cannot exactly recall
what task he performed, he writes in as a time description "attention to corporate transaction."
Since Bob's estimates are fair, there is no concern for Jane, right?
Paralegals and lawyers should follow the same rules when it comes to time keeping and billing.
Just like all professionals in the firm, a paralegal must follow careful procedures in keeping track
of work time including making accurate daily time entries with a detailed description of the task
undertaken.
Keeping track of working time is important for both the law firm and for the client. The law firm
should be fairly compensated for work performed on behalf of the client. Conversely, the client
should only have to pay for work actually performed and time actually expended — clients should
never be billed for duplicate time, excessive time or "guesstimated" time.
Accurate time keeping and proper task description are particularly important for those lawyers
who routinely file fee petitions. With respect to such petitions, courts mandate accurate and
detailed time records and, in case lawyers think appropriate delegation is unimportant, courts will
often disallow fees requested for paralegals for functions that are considered clerical or secretarial
in nature. Also, some courts will lower the rate of compensation if a lawyer performs work that
should have been delegated to a paralegal.
More rules about money.
At the end of the year, Bob approaches Jane and tells her he needs to be compensated more than
his agreed-on salary because he has worked a lot more hours than he originally anticipated when
he came to the firm. Also, during the course of the year, Bob had referred several new clients to
Jane. He asks Jane to give him either a referral fee a share of the fees earned from the clients he
referred to Jane.
Jane tells him she will think about it and indicates that she is in favor of such an arrangement.
After all, Jane gives referral fees to other lawyers who refer clients to her — what is different
about doing the same for Bob?
The fact that Bob is not a lawyer is critical to Jane's analysis. A lawyer may not split fees with
nonlawyers. Moreover, referral fees are strictly prohibited. What can be done, however, is for
lawyers to implement a compensation plan that includes bonuses or other amounts based on the
individual nonlawyer's productivity or based on the firm's profitability.
There is little doubt that a paralegal is a critical member of the legal team and helps to make a
lawyer's practice more efficient and profitable. To enjoy these benefits, however, lawyers must
focus on proper supervision. Supervision can result in early problem spotting, enhance the proper
training of nonlawyers, and give comfort to clients that proper attention is being paid to their
substantive work. Supervision is also central to avoiding malpractice and violating state law and
ethics rules.
After all, it is the lawyer's obligation to ensure that the paralegal is properly screened, adequately
trained, performs appropriate tasks, maintains high ethical standards and produces a competent
work product.
Resources
For more information about working with paralegals, visit the Web site of the American Bar
Association's Standing Committee on Paralegals (www.abaparalegals.org).
Or, consult the very informative book, Concise Guide to Paralegal Ethics, by Therese A.
Cannon (Aspen Publishers, 2006).
Also, virtually all state and local bar associations have programs or sections relating to the
use of paralegals.
Kao is a partner in the Chicago office of Skadden Arps Slate Meagher & Flom LLP. Her e-mail is
fkao@skadden.com. She was the chair of the ABA Standing Committee on Paralegals from 2004
to 2006.
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Business Law Today
Volume 16, Number 3 January/February 2007
What paralegals can do
And the list goes on
By R. Thomas Howell Jr. and Eric G. Orlinsky
Sure, you have some business paralegals on staff. But have you really considered the universe of
ways they can help you out?
Business lawyers, when asked, have dramatically divergent approaches to paralegal use. There is
some evidence that lawyers may misuse or under use them, and, on the other hand, evidence
that others are making far better, more cost-effective use of them.
To ascertain "best practices," to educate business lawyers about paralegals, and to improve the
satisfaction and quality of life of the paralegals who work with us, the Section formed an ad hoc
committee in 2004 to learn how business lawyers use paralegals and to point out better, more
efficient and effective ways to use business paralegals.
Among the first items of business the committee undertook was to engage the Section
membership in a comprehensive survey of a variety of issues relating to business paralegals.
Respondents included many firms, large and small, urban and rural, and nearly a third of them
practiced in-house. The purpose of this article is to detail the many responses to that survey.
According to the Business Law Section survey, one thing that is clear is that paralegals spend a
considerable amount of their time interacting with our clients. Of the respondents surveyed, 95
percent reported that their paralegals had written or e-mail correspondence with clients at least
weekly, and of those, 77 percent reported daily e-mail or written client communications. At least
weekly client telephone communications were reported by 93 percent of those surveyed, and 70
percent reported at least weekly face-to-face client contact. Similarly, respondents reported that
76 percent had at least weekly contact with government agencies.
We suspect, based on these results, that in many cases, the paralegals have more frequent
contact with firm clients than the lawyers for whom they work. Being able to communicate
effectively, both orally and in writing, is a critical skill for a paralegal. Lawyers and paralegal
managers should place significant emphasis on this skill when hiring new paralegals.
Paralegals also continue to do a significant amount of clerical-type work, with 83 percent
performing "clerical" work weekly, 88 percent performing filing and administrative work weekly,
and 83 percent photocopying weekly. Among the other fairly common tasks performed by
business paralegals on a weekly basis were entity formation, due diligence, factual investigation,
legal research and transactional document drafting. Each of these general categories will be
addressed with more specificity below.
Perhaps the one item identified by the survey that paralegals were reported not to be doing was
setting the fees to be charged for legal work. Fee setting is recognized in many states as such a
core function of being a lawyer, that paralegals would be engaged in the unauthorized practice of
law if they did it. This issue is discussed in more detail elsewhere in this issue of Business Law
Today — see Frances Kao's article just before this one.
In the Section survey, we asked members to identify those substantive areas of law in which the
paralegals in their firms most frequently practiced.
More respondents indicated that the paralegals in their firms practiced more frequently in litigation
than in any other substantive practice area. We suspect that since most firms surveyed also have
litigators (where paralegals are generally used much more frequently and effectively), most
respondents forgot that we were only asking about business paralegals. Another reason may be
that all paralegals in some firms are managed centrally. As a result, we have disregarded litigation
as a substantive area.
Of the remaining areas surveyed, members indicated that their paralegals practiced most
frequently in corporate/formations, corporate/acquisitions, real estate, intellectual property and
securities. Using a recent Legal Assistant Management Association (LAMA) survey, we can then
identify which specific tasks were performed most frequently by paralegals in those areas. These
tasks provide fertile ground for identifying new ways in which you might be able to put your
business paralegal to better use.
Corporate/formations and corporate/acquisitions. In the area of corporate law relating to both
formations and acquisitions, business paralegals frequently:
draft, prepare and file corporate charter documents, including amendments and merger documents, as well as
partnership and limited liability company certificates;
develop checklists for the proper formation and operation of each of the different forms of entities;
prepare minute books, stock certificates and stock ledgers and procure corporate seals;
prepare and file all documentation necessary to register or qualify an entity in one or more foreign jurisdictions;
prepare documentation for transfers of stock ownership;
draft minutes;
draft board resolutions;
draft and prepare the many documents required for shareholders' meetings; and
draft resolutions and other documents required to implement dividends and distributions as well as stock splits.
Business paralegals are also frequently called on to draft and prepare documents for corporate
and partnership dissolutions, noncompete agreements, loan documents and UCC filings, in addition
to ordering and administering UCC, lien and judgment searches on various businesses. Of course,
in the acquisition or loan context, business paralegals are also often called on to assist with due
diligence and to administer transaction closings.
Real estate. In real estate practices, paralegals are asked to:
draft deeds;
order title searches;
draft leases and lease assignments, amendments and exclusions;
prepare legal descriptions;
review plats and surveys;
coordinate escrow arrangements and prepare escrow instructions;
arrange for title insurance;
prepare mortgage releases;
calculate amortization tables;
prepare title abstracts; and
prepare, distribute and administer landlord consents and estoppel letters.
Intellectual property. In intellectual property practices, business paralegals:
correspond with the U.S. Patent and Trademark Office;
manage foreign patent and trademark applications and registrations;
docket IP deadlines;
perform trademark searches;
perform prior art patent searches;
assist with opposition and cancellation matters;
draft, prepare and file copyright filings and notices;
draft intellectual property licenses and assignments;
proofread technical documents; and
assist with IP due diligence for business transactions.
Securities. The securities areas saw some of the most sophisticated opportunities for business
paralegals. Securities paralegals were frequently delegated the responsibility to:
manage the EDGAR filing process, including the EDGARization of documents;
review filings for EDGAR coding and filing requirements;
draft and prepare SEC Forms 3, 4, 5, 8-K, 10-Q and 10-K;
less frequently, aid in the drafting of prospectuses and registration statements or assist in the preparation of
proxy statements;
obtain SEC ID numbers and CUSIP numbers;
assist with the printing and finalization of prospectuses and related documents at the financial printer;
prepare and administer securities compliance calendars;
draft form ADVs, Form U-4s, Form Ds; and
prepare and file other federal and state securities filings.
Our committee was interested in the effect of the increasing use of technology in law firms and
the effect it might have on business paralegals. We asked Section members whether or not they
believed that the growing use of technology was decreasing the use of paralegals. Only 11
percent of respondents thought that it was. It has been our experience that business paralegals
are among the first to adapt to the use of new technologies and, as a result, are often among the
best-trained staff when it comes to technology.
In many firms, the adaptability of the business paralegals in this regard actually may provide
them with greater responsibility for new projects that require the use of technology. So it does,
indeed, appear that the increasing use of technology, the automation of certain legal processes
and the concomitant desire to leverage on that technology and to push workflow down to lower
and more cost-efficient levels (not to mention the increasing commoditization of legal services)
may be increasing the use of business paralegals.
The LAMA survey seems to bear this out. According to LAMA, paralegals frequently used and were
facile with Microsoft Word; document management programs such as PC Docs, DocsOpen and
iManage; spreadsheets such as Lotus and Excel; data bases such as Access, Paradox and dBase
III; document assembly programs such as HotDocs; presentation software such as PowerPoint;
Lexis/Nexis and Westlaw; Dun & Bradstreet; LiveEdgar; EDGAR; PACER; and, more generally, the
Internet.
More great ideas were found in some of the anecdotal responses from some of the firms that
responded to the Section's survey.
One lawyer explained how he frequently used his business department paralegal to assist him with
client development and marketing. As a value-added service to his technology clients, this lawyer
helped circulate their business plans to potential funding sources such as venture capital firms.
The paralegal assisted with preparing a matrix of all of the venture capital firms with whom the
law firm had contact, the size and stage of deal the venture capital firm was interested in and the
industries in which the venture capital firm would consider investing.
Then, every time a client or prospective client of the firm was seeking capital, the paralegal
matched the client with all of the venture capital firms that might be interested in investing and
could send the client's business plan, along with a specifically tailored e-mail, to the law firm's
contact at the venture capital firm. In this way, the lawyer could provide a true value-added
service to the client or prospective client without spending too much time on implementation.
A lawyer at another firm described to us how her firm was carefully refining all of their audit
responses and opinion letters into highly standardized forms and using the HotDocs documentassembly program to allow their business paralegal to assemble drafts of audit response letters
and third-party opinion letters (together with back-up certificates) for transactions in everincreasing numbers with ever-increasing speed, efficiency and accuracy.
Several other firms have established subsidiaries that act as registered agents for their
incorporated clients. These registered agent operations are profit generators for their firms and
are run by the business paralegals.
Great ideas for more effectively filling the plates of our business paralegals are all around us. We
hope that some of these ideas, and many others in the other articles in this mini-theme issue, will
help you to rethink how you or your firm uses your business paralegals. Effectively using them will
lead to greater personal and professional satisfaction for you (the business lawyer) and greater
professional responsibility and satisfaction for your business paralegal.
And we assure you: It can be a profitable experience!
Howell is of counsel with Seyfarth Shaw LLP in Chicago. His e-mail is rhowell@seyfarth.com.
Orlinsky is a partner in the Baltimore office of Saul Ewing LLP. His e-mail is eorlinsky@saul.com.
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Business Law Today
Volume 16, Number 3 January/February 2007
Getting legal with paralegals
A look at state regulations
By Catherine R. Durgin
Would regulating paralegals help your firm or legal department? Is regulation needed? Here's a
look what's happening now and what could happen in the future.
Paralegals are an inextricable part of American legal practice and are often closely tied to the
supervising lawyer's efficiency and even competence. However, regulation of paralegals has largely
been scant and inconsistent, though the topic continues to find its way into courtrooms and state
legislatures. Across the country, paralegals urge bar associations, state legislatures and courts to
consider regulatory programs that go beyond merely defining the term "paralegal."
Emerging regulatory programs vary in context and substance, from merely establishing voluntary
qualification criteria to requiring minimum educational standards and mandating continuing legal
education for paralegals. While many legal professionals support voluntary regulation, there is a
lack of consensus on the need for mandatory paralegal regulation. This article describes and
compares paralegal regulatory developments in several states.
The debate about the need for paralegal regulation is as old as the profession. The arguments
often parallel a person's view on the role of paralegals in the delivery of legal services. Are
paralegals merely assistants to lawyers, or do they represent an independent profession that
requires separate regulation and supervision? While some are content letting the supervising
lawyer decide the qualifications of the paralegals he or she hires, others call for increased
supervision and regulation.
Even the advocates for increased regulation have differing opinions on what needs to be done:
Some want to raise the profile of the profession by establishing standards for paralegals, while
others call for mandatory regulation that expands the role of paralegals in the delivery of legal
services and simultaneously protects the public from the unauthorized practice of law. Proposals at
the state and national levels recommend various regulatory schemes as solutions. Some have
been successful, others not so successful.
In California, the desire to increase standards has resulted in legislation that sets out a higher
standard of education and mandatory continuing education for paralegals. Sponsored by the
California Alliance of Paralegal Associations, California Business & Professions Code Sections 64506456 became effective on Jan. 1, 2001. Under the California statute, it is unlawful for a person to
identify himself or herself as a paralegal unless he or she has met the qualifications of the statute
and performs all services under the direction of a qualified lawyer. Further, the terms "paralegal,"
"legal assistant", "lawyer assistant," "freelance paralegal," "independent paralegal," and "contract
paralegal" are synonymous under Section 6454.
The California statute does not establish a governing body, mandatory competency testing, or
mandatory registration for the paralegal profession. It does not provide for moral character checks
or a disciplinary system. However, it creates a crime enforceable by the courts and allows
consumers to bring a cause of action against an individual who violates the law.
In other jurisdictions, such as Texas and North Carolina, courts have approved voluntary
certification programs to set higher paralegal standards and raise the profile of the paralegal
profession. The Texas Board of Legal Specialization administers a voluntary certification program
for paralegals who wish to be board certified in a specialty area of law. The certification process is
governed by the Texas Plan for Recognition and Regulation of Legal Assistants, as amended in
June of 1999.
Unlike in California, the Texas Plan does not restrict the use of the term "legal assistant." Any
legal assistant has the right to work under the supervision of a licensed lawyer in any area of law
even though the legal assistant is not certified.
To become board certified under the Texas Plan, a legal assistant must meet several eligibility
requirements, including a satisfactory showing of substantial involvement in the particular area of
law for which certification is sought. In addition, the legal assistant must have at least five years
experience, have peer reviews by professionals associated with the specialty area, pass a fourhour written examination — and in some circumstances — undergo an oral interview as part of the
certification process. Currently, there are 320 board certified legal assistants in Texas.
The North Carolina State Supreme Court also recently adopted a program called the Plan for
Certification of Paralegals. Approved and administered by the North Carolina State Bar, the North
Carolina Plan is a self-funded voluntary certification program.
As in the Texas Plan, the North Carolina Plan does not restrict the use of the term "paralegal" nor
does it differentiate between the services that can be performed by a certified or noncertified
paralegal. Thus, a paralegal in North Carolina can choose not to be certified and still perform
substantive legal work under the supervision of a lawyer using the titles "paralegal" or "legal
assistant." North Carolina Certified Paralegals must meet a minimum level of education to be
eligible for certification and must have a minimum level of continuing education to remain certified
under the plan.
The Florida State Bar Board of Governors is currently reviewing a two-tier plan recommended by
the State Bar Special Committee to Study Paralegal Regulation. Tier one would include those
paralegals who meet the requirements of Florida State Bar Rule 10-2.1, which defines a paralegal
as a person who performs delegated substantive work for which a lawyer is responsible. Tier two
paralegals would have to meet more stringent experience, educational and continuing education
criteria to hold themselves out as a "Florida Registered Paralegal." If approved by the State Bar
Board of Governors, the plan will be submitted to the Florida Supreme Court for final action.
California, Florida, and Louisiana also have voluntary paralegal certification programs administered
through their statewide paralegal associations. To be eligible for these state certifications, the
paralegal typically must first get a national credential. The Certified Legal Assistant/Paralegal
program established by the National Association of Legal Assistants (NALA) and the Paralegal
Advanced Competency Exam offered by the National Federation of Paralegal Associations (NFPA)
are well recognized national professional certification programs.
Established in 1976, NALA's Certified Legal Assistant/Paralegal (CLA/CP) program is a voluntary
self-regulatory program that encourages the growth of the paralegal profession and a high level of
achievement. The CLA/CP examination is a two-day comprehensive exam with more than 1,000
questions based on federal law and procedure. More than 13,000 paralegals have obtained the
CLA/CP credential. Continuing education is required to maintain the credential.
NFPA's Paralegal Advanced Competency Exam (PACE), established in 1994, provides a competency
evaluation of paralegals. PACE is a four-hour computer-generated exam. An applicant successfully
passing the exam is entitled to the "Registered Paralegal" credential but must obtain continuing
education to maintain it.
Some in the legal profession endorse paralegal regulation that expands the role and activities of
paralegals in order to improve public access to affordable legal services while protecting the
public. NFPA strongly supports this view. In its Statement on Issues Affecting the Paralegal
Profession, NFPA states that public protection and professional accountability are integral to any
regulatory plan, but first, it is necessary to do the following:
Identify traditional and nontraditional areas in which paralegal roles and responsibilities can be expanded;
revise the applicable Rules of Professional Conduct or Code of Professional Responsibility to allow for expanded
roles and responsibilities for paralegals, including: (1) revision to the references concerning ultimate
responsibility and accountability of a lawyer for paralegal work, rather than under direct supervision and (2)
revision to references concerning nonlawyer partnerships with lawyers and fee-sharing arrangements with
nonlawyers;
provide a model for revisions to court rules that would permit expanded roles and responsibilities for paralegals;
and
provide a model for expanded rules of practice in state administrative agencies for representation by paralegals
and other qualified nonlawyers.
In line with this expanded role of paralegals, NFPA endorses regulations that recommend
mandatory licensing and proposes a two-tier program, including standards for education,
standards to measure competency, ethical rules and a disciplinary process. NFPA also believes that
any licensure plan should define those tasks that may be performed by paralegals in numerous
specialty areas of law. While recognizing that the regulation of nonlawyer activity is best
addressed at the state level, NFPA urges the legal community to recognize its responsibility to
provide the public with various levels of services at different levels of expertise and costs.
Currently, some voluntary registration programs allow for the expanded role of paralegals. In
various counties in Washington, including King County, Pierce County and Spokane County, the
bar associations have established voluntary registration programs that allow qualified nonlawyers
to perform certain direct services. For instance, a paralegal in these counties can register with the
bar or the court to present ex parte orders.
A mandatory registration is required for certain nonlawyer direct service providers in states such
as California. For instance, "legal document assistants" and "unlawful detainee assistants" in
California are subject to registration and bonding under Business & Professions Code Sections
6402 and 6405 respectively. To be eligible to register, the applicant must meet minimum
educational or experience requirements according to Section 6402.1.
Arizona has a similar provision in its Code of Judicial Administration. Section 7-208 requires legal
document preparers in Arizona to meet certain minimum education requirements, experience
requirements, and pass a written examination.
The Wisconsin Supreme Court is currently considering a proposed form of paralegal licensure.
Endorsed by the Wisconsin State Bar, the proposed licensure program was drafted by State Bar's
Paralegal Task Force. It is intended both to establish professional standards for paralegals and to
improve the use of paralegals in an effort to meet some of the legal needs that currently go
unserved. If enacted, it would be unlawful for a person in Wisconsin to use the title "paralegal"
unless licensed. To be eligible for a paralegal license in the proposed system, the person must
meet certain post-secondary education, training requirements, and continuing education standards.
Not everyone agrees on the need for mandatory regulation of paralegals. Certain courts and
paralegal organizations believe that consumers of legal services are adequately protected by the
license of the lawyer for whom the paralegal works, and that regulation may hinder the growth of
the profession.
In 1999, the New Jersey Supreme Court declined to adopt a paralegal licensing system and
concluded that paralegal oversight is best conducted by the lawyers who supervise the paralegals
and are accountable for their work. The court recommended that the New Jersey Bar Association
work with the paralegal community to create a certification program as a means to recognize and
identify qualified paralegals.
The Washington State Bar Association Board of Governors also turned down a paralegal licensing
proposal by the Washington State Practice of Law Board, which would have established a process
to license certain nonlawyers to render assistance or advice in defined areas of law.
Several paralegal organizations have published statements against licensing paralegals. NALA, with
a membership composed of more than 18,000 paralegals, through individual membership and its
90 state and local affiliated associations, opposes any mandatory regulation. In its statement to
the New Jersey Supreme Court, NALA argued that there is no demonstrated public need to
regulate paralegals who work under the supervision of a lawyer. NALA instead supports voluntary
self regulation through its national professional certification program.
Likewise, the International Paralegal Management Association (IPMA), an international association
of paralegal managers, opposes any type of mandatory regulation of paralegals. In its Position
Paper on Paralegal Regulation, IPMA argues that regulation will not increase the standards of the
profession nor expand the role of paralegals.
It is the job of the consumer to determine the value of legal services. Clients will continue to
protest fees for inadequate or overpriced legal services, and the courts will also play a role by
awarding fees for substantive paralegal work and refusing to award fees for clerical work whether
performed by a lawyer or a paralegal.
Like NALA, IPMA believes that mandatory regulatory programs may hinder the growth of the
profession. It argues that such programs are costly to implement and may be translated into
higher salaries and higher billing rates, which in turn will increase the cost of paralegal services.
Regulatory requirements, IPMA argues, may deter college graduates considering law school from
first working as paralegals and may deter those in other industries from considering the paralegal
field as a second career. This may deprive firms from hiring other types of otherwise qualified
candidates. Regulation may also prevent firms from collecting court-approved fees for paralegals
who do not meet regulatory requirements.
Whether the paralegal regulation is voluntary or mandatory, lawyers are ultimately accountable
for the work done by a paralegal under their supervision. Needless to say, lawyers must verify
academic credentials and prior work history when considering a paralegal and must ensure that
their paralegals are informed of changing laws and ethical concerns.
An established certification or licensure system will be helpful for lawyers to ascertain paralegals'
qualifications and their continuing education. As employers and consumers of paralegal services,
lawyers have a strong voice in making changes in paralegal regulation.
Defining regulation
The requirements of regulatory programs vary from state to state. In general, regulation
comes in several forms, including registration, certification and licensure.
Registration involves the process by which individuals or institutions list their names with
an association or agency. It may be voluntary or mandatory. Education, training or bonding
requirements are sometimes associated with registration.
Certification programs are designed to validate an individual's specific skill and knowledge
at or above an established performance level. Elements of professional certification
programs include established standards, consistent and relevant testing, and regular
updating and renewal. Certification programs can be administered through private
organizations or public agencies. Certification is typically not a legal precedent to gain
employment in a particular field.
Licensure is the process by which an agency or branch of government grants permission to
persons meeting predetermined qualifications to engage in a given occupation or use a
particular title. Licensure is a mandatory legal condition for employment and is generally
enacted by legislation. The impetus behind a legislature to license a profession is the
health, welfare and safety of the public.
— Catherine R. Durgin
Durgin is a paralegal with Loeb & Loeb LLP, in Los Angeles. Her e-mail is cdurgin@loeb.com.
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Business Law Today
Volume 16, Number 3 January/February 2007
Are you ready for China?
The world economy has a new player
By Paul W. Boltz Jr.
Your client is considering investing in a Chinese company. Or your client may be a Chinese
company venturing overseas for the first time. What does that entail? Prepare for a lesson in the
New World Order.
In its 11th Five-Year Plan, announced in 2006, the Chinese government said that it intends to
pursue a variety of policies designed to achieve a balance in five areas of Chinese society:
growth in domestic consumption and exports to international markets,
development of inland and coastal areas,
development of rural and urban areas,
promotion of a harmonious society and economic growth, and
the needs of both the environment and man.
This shift in focus from "growth at any cost" to a balance of economic and noneconomic interests
signals an important shift in the leadership's thinking and will likely have long-lasting ramifications
for China. The promotion of a harmonious society as a national goal also signals, at least in part,
the government's concern over the widely reported uprisings by local citizenry throughout China
over unjust treatment by companies or governmental authorities.
If this directive can be implemented in a meaningful way (an admittedly big "if" in an environment
as complex as today's China), it could represent the first major revision to the late Deng
Xiaoping's famous words "to get rich is glorious," which ignited China's economic opening to the
world more than 25 years ago. It appears that the new aphorism may soon become "to get rich is
glorious as long as society doesn't unravel."
While the 11th Five-Year Plan will undoubtedly affect China's economic and social development for
the foreseeable future, it masks numerous other, more subtle, tensions in the Chinese capitalist
system. These tensions — encompassing an array of competing government interests, as well as
economic and social trends — directly shape the way Chinese companies operate, affecting
everything from their corporate structure to their day-to-day operations and long-term planning.
These various tensions are felt all the more acutely by China-based companies, including both
companies incorporated in China and offshore holding companies of Chinese businesses, when
they list overseas. Following listing, they are often subject to much more rigorous regulations and
governmental supervision than those within China. But, one might ask whether enough companies
are in this situation to make this topic particularly relevant. Well, consider the following:
Hong Kong, which maintains and enforces its own securities regulatory regime separate and apart from Mainland
China, is the most popular destination for overseas listings by China-based companies because of a number of
factors, including physical proximity, investor support and Hong Kong's sophisticated financial infrastructure. On
Oct. 31, 2006, the Main Board of the Hong Kong Stock Exchange had a total market capitalization of
approximately U.S. $1.46 trillion, making it the world's 7th largest stock exchange. China-based companies
accounted for 43 percent of this amount.
Although compliance costs and litigation risk have increasingly become deterrents to going public in the United
States in recent years, the U.S. markets remain a highly desirable destination for many China-based companies
due in large part to potential higher valuations, larger investor base and deeper liquidity than is available in
many other countries, as well as a prestige factor that remains strong in China. There are now more than 40
China-based companies trading on the New York Stock Exchange and Nasdaq, with dozens more companies
trading on the American Stock Exchange, over-the-counter or on the "pink sheets." This is more than the total
number of companies from France, Germany and Italy that are public in the United States.
The London Stock Exchange's AIM market, which was started in 1995 and caters to small, growing companies,
has become an important market for China-based companies. Currently, more than 30 China-based companies
trade on AIM.
The proliferation of offshore listings by China-based companies heightens the importance of understanding the
various tensions in China, which each in its own way has the potential to profoundly affect such companies'
businesses and financial results at any time.
For example, one of the most fundamental tensions arises from the conflict between the Chinese government's
periodic policy initiatives and the realities of China's hyper-capitalism. The Chinese government's continued use
of the term "five-year plan" conjures up Cold War era images of millions of workers being mobilized to build
massive factories and other grandiose government projects.
The fact that China still uses such plans as broad policy blueprints suggests that China remains a commandand-control economy and is continuing its experiment with "socialism with Chinese characteristics," which is the
Communist Party's way of explaining how Marxism is not incompatible with the adoption of certain free market
principles.
The reality is far different. Estimates as to the relative size of the private sector in China vary
widely, but a quick stroll through any major Chinese city will confirm that the private sector is a
big and growing part of the Chinese economy. In fact, a major portion of China has already
entered a phase of "hyper-capitalism" where almost every type of compliance issue from worker
safety to accurate labeling of products can, to varying degrees, take a back seat to profit growth.
While the breadth of China's economy makes generalizing about corporate behavior difficult, it is
fair to say that many China-based companies operate on a day-to-day basis with a lot fewer
restrictions than companies in the United States despite the existence of numerous laws and
regulations in China.
The result of this hyper-capitalist environment is that no one can predict if the Chinese leadership
will actually implement the objectives stated in their five-year plan if, in turn, that means reining
in the free-wheeling, high-growth portion of the economy. China's recent experience in attacking
official corruption, which is an oft-stated goal of the government but has produced sporadic
results, suggests that the leadership can no longer assume its edicts will produce tangible results.
For lawyers advising China-based companies that are listed overseas, this tension can create a
range of problems that often have no clear solution. One typical scenario would arise if, for
example, in order to promote a harmonious society as called for by the 11th Five-Year Plan, the
government were to adopt new rules requiring companies to accrue a percentage of their profits
to make minimum disability payments to workers injured on the job, who often now receive little
or no compensation even for life-threatening injuries.
Let's further assume that you discover from your China-based overseas listed client that it has no
intention of making any accruals or payments for disabled workers. Your client explains that it is
an open secret that most companies are ignoring this directive, and your client does not want its
profitability affected.
What should international legal counsel do in this entirely plausible situation? If the noncompliance
could have a material effect on your client's business and your client fails to publicly disclose this
risk, it could be subject to investigations and various forms of punishment by the applicable
overseas securities regulator, as well as lawsuits from shareholders. On the other hand, full
disclosure could make your client a target for government investigation and punishment in China.
Laws in China are sometimes drafted in a vague manner. Consulting with the local governmental
authority that has responsibility for enforcing the law in the client's province or locality to clarify
whether the company's inaction is punishable under the new law is one option. Many government
offices are accustomed to being consulted about specific corporate questions.
Yet, as with other countries, asking three different officials will often yield three different answers.
Moreover, in China, local governmental authorities can easily reverse their positions, even when
the prior position was provided in writing.
As a practical matter, the fact that Chinese laws are not entirely clear in their meaning can justify
a middle approach where the noncompliance is publicly disclosed, along with an explanation that it
could possibly expose the company to various forms of punishment although the company cannot
be certain because of the law's ambiguity. Nonetheless, even with such an approach, the company
is operating in a gray area.
Another important tension springs from the Chinese government's sometimes inconsistent attitude
toward foreign investment. Ever since the government opened its economy in 1978, it has allowed
— and in many cases actively encouraged — foreign capital into China through venture capital,
private equity and foreign direct investment. Yet, this cross-border investment activity creates
considerable tension with the Chinese government's general preoccupation with understanding and
controlling capital flows in and out of the country for macroeconomic and tax purposes.
Venture capital is one area of foreign investment that has been particularly problematic for the
Chinese government. Foreign venture capitalists are often resistant to investing in companies
incorporated in China for a variety of reasons.
These include the fact that China's Company Law makes it difficult for domestically incorporated
companies to issue stock options — which is commonly used to retain and motivate key
employees as in the United States — and that investors' "exits" from investments in such
companies through an M&A transaction or IPO can be more complicated for a domestic company.
Accordingly, venture capitalists, as well as private equity investors, will usually require that the
domestic company form an offshore holding company (typically in an offshore haven such as the
Cayman Islands or the British Virgin Islands), into which the investors will place their money and
receive shares. This offshoring activity has, in many respects, moved the funding and control of
domestic assets out of reach of the Chinese government.
The government historically could not see the shareholding structures of the offshore companies
or when or how they engaged in significant corporate transactions such as offshore IPOs. It also
allowed Chinese shareholders to move their equity ownership outside of China and China's tax
laws, which like the United States taxes its citizens on worldwide income but unlike the United
States has limited means to enforce tax laws extra-territorially.
The resulting tension culminated in China's foreign exchange regulators in the first half of 2005
requiring approval of the establishment of offshore holding companies by persons in China and of
previously established offshore holding companies. With approvals difficult to obtain, the practical
effect of this requirement was to nearly halt foreign venture capital activity in China until the
government realized it had perhaps overshot the mark.
In October 2005, the government announced that it would only require informational filings, rather
than substantive approvals, when offshore structures are implemented and with updated filings to
be provided when there are changes to the company's shareholding structure or other specified
corporate events.
More recently, a group of Chinese ministries, including the powerful Ministry of Commerce —
which is one of the principal ministries that regulates foreign investment in China — have jointly
introduced new regulations that give government officials substantial leeway to block, among
other things, offshore restructuring activities initiated to facilitate an overseas listing.
The new rules also apparently reintroduce the requirement that had been eliminated five years
ago that Chinese companies, as well as the offshore listing vehicles of Chinese companies, may
need to obtain approval of the Chinese Securities Regulatory Commission before listing overseas.
Because these regulations are so new and their meaning is unclear, it is too soon to tell their
long-term effect on Chinese companies seeking to list outside of China.
While there are hopes that the Chinese government will reduce capital controls and other legal
restrictions over time, these recent developments show that the Chinese regulatory environment is
subject to extreme and abrupt changes. Accordingly, local Chinese and international legal counsel
must devote significant time to devise investment structures that comply with the ever-changing
foreign exchange and investment laws.
In turn, China-based companies listed overseas must continually educate and update their
shareholders on these risks, which are quite distinct from the typical risks facing companies
operating in the United States and many other developed countries.
The Chinese government also faces a similar dilemma with its high-tech industry, the promotion of
which has been a long-term economic priority for China. By most measures, this focus has worked
extremely well, with Chinese manufacturers becoming increasingly competitive in a variety of
high-tech industries, including semiconductor design and manufacturing, medical device production
as well as software development.
Along with the boom in high-tech manufacturing, however, there has been tremendous growth in
high-tech industries that facilitate the exchange of information, particularly wireless and Internet
services. According to China's Ministry of Information Industry, as of Sept. 30, 2006, there were
more than 443 million cell phone users in China, making it the largest cell phone market in the
world. There were also more than 123 million Internet users in China as of June 30, 2006,
according to the China Internet Network Information Center.
People's interconnections through e-mails, instant messaging, wireless text messaging and other
technologies pose a direct challenge to the Chinese government's ability to control information.
One well-known response to this challenge was official pressure on U.S. Internet companies such
as Yahoo! and Google to screen their content for Chinese users.
The Chinese government also takes numerous other steps on the ground to maintain control
including shutting down Web sites and banning wireless services for improper content. Many of
China's overseas listed companies operate in these industries, including portals NetEase, Sohu and
Sina and wireless service providers Linktone, Hurray!, KongZhong and Tom Online (all of which
are listed on Nasdaq), and have been affected in various ways by these government actions.
Some investment bankers and legal counsel will, in the course of due diligence for an IPO or other
transaction, attempt to audit the content of a service provider to determine if it is permissible.
There are inherent limitations to the effectiveness of this type of diligence given that "improper
content" is an amorphous concept. Moreover, many of these companies offer an enormous
amount of content, some of which is prepared and distributed on a continuing basis by the users
themselves.
As a result, due diligence is often better devoted to discussing with company management what
guidance they have received from governmental authorities regarding the meaning of improper
content and what systems they have put in place to ensure that content is adequately supervised.
In turn, to effectively deal with securities regulators and shareholders of overseas listed
companies, international legal counsel has a key role in developing a comprehensive understanding
of the tensions that affect information-based, high-tech industries to create robust public
disclosure.
While diligent lawyers and robust public disclosure can go a long way to addressing a number of
the major tensions in China, some require a more comprehensive review of the way companies
operate there. For example, perhaps the most common complaint of China-based companies that
are listed overseas is that it is impossible to effectively compete in China while strictly observing
all domestic and foreign anti-corruption laws. Subsidiaries and joint ventures of U.S.-based
companies that operate in China often make this complaint as well.
Corruption in China is a significant issue, and it can take every form imaginable. China has
adopted extensive anti-corruption laws that carry significant penalties, including potentially death
for people convicted of accepting bribes or mishandling state-owned assets. But, enforcement of
these laws is uneven and perceived to be driven more by political concerns than a genuine effort
to cleanse the system.
In this environment, many China-based companies simply conclude that a certain amount of
corruption is necessary to remain competitive, and they are willing to live with the risk of possible
government action against them.
China-based companies that are listed overseas, particularly in U.S. markets, have a heightened
burden of complying with foreign anti-corruption laws such as the U.S. Foreign Corrupt Practices
Act (FCPA) which applies to any company whose shares are publicly traded in the United States.
For these companies, corrupt conduct not only exposes the company to the risk of punishment by
the Chinese authorities, but also to FCPA enforcement actions by the Securities and Exchange
Commission (SEC) and Department of Justice (DOJ) as well as class-action litigation.
Companies in this situation face difficult choices. If a company's management and board of
directors decide not to probe too deeply into, for example, how their sales managers in the field
in China spend large discretionary expense accounts in a kind of "don't ask, don't tell" policy, then
the company can never fully assess the nature or size of its risk exposure.
On the other hand, companies may become aware of questionable conduct within their
organization, but stopping it may render the company uncompetitive. The argument that
shareholders are better served by continuing the conduct rather than causing the company's
business to fall apart can be very compelling to management and directors in this situation,
although courts and regulators such as the SEC and DOJ are unlikely to be impressed with this
logic.
The problem is exacerbated by the fact that even if the management and board of directors want
to eliminate corrupt activity within their company, some corrupt practices may be so pervasive in
their region or industry or in China generally that company staff may not realize that the practices
are impermissible. Accordingly, the staff may not make a connection between the specific conduct
at hand and the company's corporate policies on observing anti-corruption laws and reporting
questionable conduct up-the-ladder within the company.
International legal counsel obviously cannot change the way business is conducted in China.
Nonetheless, a focus on practical preventive measures can go a long way to avoiding future
problems, particularly with respect to conduct that staff may not be aware is corrupt. Specifically,
preparation of clear, easy-to-understand codes of conduct and other corporate policies and
continuous training of management and staff, with specific examples that address the day-to-day
situations that staff commonly face in China, can be cost-effective tools for promoting compliance.
Of course, this is just a small sampling of the numerous tensions at work in China. Many more
words could be written on other tensions, including the government using state-controlled
companies to affect public policies vs. the interests of overseas shareholders and rapid
modernization and expansion of legal framework vs. arbitrary interpretation and enforcement.
Moreover, all of these issues are subject to such rapid change that it is impossible to predict what
companies' biggest concerns will be even just a few weeks or months from now.
The intersection of these numerous tensions with overseas securities and anti-corruption laws is
an interesting area of practice for a lawyer as I have discovered first hand. Is China's unique
brand of capitalism heading in the right direction from a legal compliance perspective?
I am cautiously optimistic that as China's economy and legal system continue to mature, coupled
with China's integration with the world economy, the tensions will gradually lessen. Investors need
to bear in mind, however, that an investment in a China-based company is in effect an
investment in the entire Chinese system.
Boltz is a partner at Morrison & Foerster in Hong Kong. His e-mail is pboltz@mofo.com.
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Business Law Today
Volume 16, Number 3 January/February 2007
Before you grab that property . . .
States take a close look at eminent domain
By Francesca Jarosz
The timing just wasn't right for Sarah and Robert Hudson.
In November 2003, village officials from Lake Zurich, Ill., met with the Hudsons to tell them the
town was interested in purchasing their gray stucco house with a scenic view of the lake and
sunset.
The home had been in Sarah Hudson's family for three generations. In 1979, she purchased it
from her dad, who had grown up there. She and Robert lived in the house right after they were
married. Though at the time they were renting its two apartments, the Hudsons had given thought
to retiring there.
"It had been in the family and we wanted to keep it in the family," Sarah Hudson said. "Price was
not an issue."
The Hudsons told the village they weren't interested in selling. In response, village officials
mentioned their power to file a condemnation for the property under eminent domain, but they
didn't think it would come to that.
More than two years later, it did. Today, the lot is only an expanse of light brown dirt covered in
rocks and rubble and a sign depicting what will be built there: A five-story retail and condominium
complex. After a 15-month legal battle, the Hudsons began to crumble under the costs, which
amounted to about $75,000 out of their own pockets. They became the last of the five property
owners in the area to give in and settled with the village for $390,000.
"It was like a slow death," Hudson said. "I'd wake up in the middle of the night and I'd just be
thinking about this stuff."
The village took possession of their property this past May. It had to be evacuated by the end of
June, a month before Illinois Gov. Rod Blagojevich signed a bill enacting legislation to reform the
state's eminent domain laws.
Prior to the new legislation, Illinois dealt with eminent domain by case law since there were no
statutes in place to regulate it. State Sen. Susan Garrett, who helped sponsor the legislation, said
that under the previous system, eminent domain laws were lopsided in favor of condemning
authorities.
The new statutes, which go into effect in January, give property owners greater rights by
measures such as requiring that land be proven blighted before it is condemned and compensating
owners for relocation.
Garrett said the decision to take action came after hearing stories like that of the Hudsons. "For a
lot of people, it's just too late," Garrett said. "We acted as fast as we could."
Illinois politicians aren't alone in their haste to act. Since the U.S. Supreme Court issued its
decision in the June 2005 eminent domain case Kelo v. New London, legislatures in 31 states
have passed bills that range from organizing committees to study their states' eminent domain
practices to banning eminent domain for economic development. The legislation has been enacted
in 26 states, according to the National Conference of State Legislatures (NCSL). In two states,
legislation was vetoed by the governor.
"It's a remarkable response so quickly," said Larry Morandi, director of state policy research for
the NCSL.
In Kelo, the court ruled 5-4 that New London, Conn., could use eminent domain to condemn five
nonblighted investment properties and 10 nonblighted homes for a waterfront development project
designed to bring jobs and revenue to the distressed town.
The Fifth Amendment states that land condemned by eminent domain must be for public use.
Under a strict interpretation, that means projects such as parks, roads and hospitals. In Kelo, it
means private economic development intended to financially boost a community.
More than a year later, as the gush of legislative action calms to a trickle, activists and more
neutral experts on both sides of the eminent domain battle are stepping back to assess how the
new measures are affecting each side's chance for victory. Many are calling what's happened
post-Kelo a gain for property rights advocates. Others say that despite the tighter restrictions,
landowners remain susceptible to eminent domain abuse.
What's clear at this point is that states have taken the Supreme Court up on the invitation issued
in the decision to examine and, in many cases, change their eminent domain policies.
"The Kelo court suggested that states could have power as they saw fit. That's what's happening,"
said Dwight Merriam, a Hartford, Conn.-based land use lawyer who co-edited the ABA publication
Eminent Domain Use and Abuse: Kelo in Context.
Many say the measures taking place are an outpouring of the post-Kelo backlash. Alan Weinstein,
associate professor of law and urban studies at Cleveland State University in Cleveland, compared
the negative response to Kelo to that of Roe v. Wade in 1973.
Cincinnati lawyer Timothy Burke said he's experienced it firsthand. He represented the city of
Norwood, Ohio, in Norwood v. Horney, the first major eminent domain case in a state supreme
court since Kelo. In the June 2006 decision, the Ohio Supreme Court unanimously ruled that the
municipality could not take property for an economic development project. The court also specified
that classifying an area as "deteriorating" does not justify condemnation.
Burke said that without the attention Kelo drew to eminent domain, he doubts that Norwood even
would have made it to Ohio's Supreme Court. "Kelo hit and the political firestorm erupted," he
said. "Norwood's timing couldn't have been worse."
After Kelo was issued, media outlets posted nonscientific online polls allowing readers to share
their opinions on eminent domain. One conducted by MSNBC showed 97 percent of about 130,000
respondents said cities should not be allowed to seize homes and buildings for private economic
development projects designed to benefit the public. A similar CNN poll showed 66 percent of
about 180,000 respondents said the government should never be able to seize private land;
another 33 percent said it should only be able to do so for traditional public use.
"Eminent domain is a gut issue that affects everybody," said Morandi of the NCSL. "You're
concerned if you think local government can take your property to put up a big box."
Such concern runs high among property rights advocates, who say the Supreme Court went
further in its interpretation of Kelo than it had before. Steven Anderson, a lawyer at the Institute
for Justice, which represented property owner Susette Kelo in the Kelo decision, said the court
had never justified eminent domain use on the basis of "pure, naked economic development"
without the condition of blight.
"Everyone's homes and businesses are up for grabs," Anderson said.
But others say the anti-Kelo frenzy is unwarranted in light of the decision's effect. Michael Allan
Wolf, who teaches local government and land-use planning at the University of Florida's Levin
College of Law in Gainesville, Fla., said the court began expanding its definition of public use 100
years before Kelo.
Wolf and others who argue that Kelo followed precedent point to two decisions in which public use
was broadly interpreted.
In the 1954 Berman v. Parker, the Supreme Court ruled against Washington, D.C., department
store owners who argued that their store, which wasn't considered blighted, should not be
overtaken by a government-commissioned redevelopment project designed to improve the rundown area where the store was located. The court upheld the redevelopment on the basis that it
served a public purpose.
In a 1984 case, Hawaii Housing Authority v. Midkiff, the court ruled that it could use eminent
domain to take away land from the 72 people who owned 47 percent of the land and redistribute
it to other private owners. Through the decision, the court defined public purpose as bringing
overall benefit to the market by breaking up an oligopoly.
Merriam, who represents both condemners and the condemned in land use cases, said Kelo
caused a stir because of its emotional effect, which was amplified by several well-publicized
accounts of eminent domain abuse leading up to the decision. Among them was the Lancaster,
Calif., City Council's decision in 2000 to expand the local Costco by ousting a smaller retailer, a 99
Cents Only store.
When Kelo came around, it was the first Supreme Court eminent domain case in which "little
people were getting displaced from their little houses so that the government could do a project
that was a little selfish," as Merriam put it.
"Because it drew the attention of the average citizen to the eminent domain power of
government, it did draw some measurable change," Merriam said.
The change is particularly striking in states like South Dakota, where eminent domain use is now
limited to traditional public use projects. No economic development venture will qualify.
The new legislation's sponsors, Rep. Larry Rhoden, majority leader in the South Dakota House,
and state Sen. Jim Lintz, said it passed unanimously with support from the state's municipal
leagues.
Rhoden said Kelo struck a nerve in South Dakota, where property rights are closely held. "There
were a lot of people that were pretty upset," he said. "Legislation was a reassurance to citizens
that the same thing wouldn't be allowed to happen in South Dakota that happened in
Connecticut."
Other states also are seeking reassurance, though few go as far as South Dakota. Most legislation
tackles issues such as limiting eminent domain to "blighted" areas, which, in the strictest sense,
are zones that pose a detriment to public health or safety. Other states deal with matters not
addressed in Kelo, such as how much a property owner is compensated and how much public
notice is given when a property is to be condemned.
Experts on both sides of the eminent domain debate say the legislation will bring about some
positive change.
In Connecticut, where Kelo happened, legislation was enacted this past spring to establish a
system where landowners have a means of mediating with local governments and can avoid facing
the expenses of litigation.
Utah, the only state to use the system currently, has had it in place since 1997, and Craig Call,
lead lawyer at the state's Office of Property Rights Ombudsmen, said it's been successful. The
Utah Department of Transportation, which acquires more property than any single agency in the
state, has seen the percentage of property it has to acquire through court drop from 23 percent in
2002 to 7 percent this year, Call said
David Parkhurst, principal legislative counsel for the National League of Cities, which represents
18,000 municipalities across the country, said it's good that Kelo has brought eminent domain
under the light of state examination.
"As a state-derived power, eminent domain is best handled at the state and local level," Parkhurst
said. The projected benefits of change are accompanied by more concerns, though.
Merriam said one issue that's been neglected in legislative discussions is the social equity effect of
eminent domain. Low-income tenants often suffer serious blows when where they live is taken,
since landlords are the ones compensated. "The people most likely to lose their homes are the
ones that can't afford it," Merriam said.
Compensation for small businesses also has been neglected. Call said the federal government caps
the amount that businesses can be compensated at $10,000, plus moving expenses. That's often
not enough to cover hidden costs of relocation, such as re-establishing business reputation.
At the same time, some say states have acted too quickly in their haste to ease constituents'
concerns about Kelo. Patricia Salkin, associate dean and director of the Government Law Center at
Albany Law School in Albany, N.Y., is heading up the New York State Bar Association's task force
on eminent domain. The group examined the definition of public use under New York's constitution
as well as bills proposed in New York's state legislature before suggesting policies that should be
adopted in the state.
Salkin said legislators need to carefully examine their states' practices before creating new laws.
No comprehensive, scientific research has been done to determine how eminent domain is used
state by state, Salkin said. These quick reactions can lead to ineffective policy.
"Most (legislators) throw the baby out with the bathwater, and I don't think most of them know
exactly what they've done," Salkin said. "They just want to be able to tell voters on Election Day,
'I did something.'"
A big fear even among those who express neutrality on the eminent domain question is that fastenacted legislation will be overly restrictive.
Merriam said that the most successful redevelopment happens under partnerships between the
government and a private developer. Laws that prohibit private development leave the
government as the sole developer, which might not be the most effective method. "It's a matter of
expertise," he said. "The government may be very good at policing and fire protection but may not
be good at providing a development project."
Banning eminent domain for economic development has other damaging effects, some say.
David Barron, a professor at Harvard Law School, who has researched local government and
property law, believes that without the ability to use eminent domain for economic development,
cities would be forced to pay buyers exorbitant amounts to acquire property.
Economic development projects are necessary, he said, citing the success of ventures such as
Baltimore's Inner Harbor and the Dudley Street Neighborhood Initiative in Roxbury, Mass. "Cities
don't want to build a lot of highways that lead only to post offices," Barron said.
Burke said the power is particularly important for revitalizing urban centers and inner-ring
suburbs. If governments don't have the power to take chunks of land for redevelopment,
development projects will take place on tracts of land further from the city, which leads to urban
sprawl.
"Developers are not going to look at putting together a lot of different lots," Burke said. "They're
going to look up the Interstate at the next vacant farm."
David Snyder, a Philadelphia-based litigator for Fox Rothschild who represents both those
condemning property and those whose property is condemned in eminent domain cases, said that,
since Kelo, he's seen a general reluctance among federal, state and local governments to use
eminent domain unless it's as a last resort. Even a transportation agency, which uses eminent
domain for traditional public uses, told Snyder they were concerned about the reaction to Kelo
inhibiting their ability to use it.
But experts say that the extent of change that will come as a result of legislation remains to be
seen. Morandi of the NCSL said that even in states like Georgia, where some of the toughest
legislation has been passed, the statutes might not make much of a difference because eminent
domain hasn't been used for economic development to a great extent there.
"Some of the legislation looks very sweeping," Morandi said. "But until you know how eminent
domain has been used in that state, you don't know if you're going to get up to that threshold."
Other legislation leaves room for flexibility in dealing with eminent domain, and that has some
property rights advocates concerned.
In Oklahoma, a bill written by Rep. Mark Liotta to tighten ambiguity about eminent domain use in
the constitution's language failed to pass the legislature. The final vote came after the state's
Supreme Court ruled in May 2006 in Board of County Commissioners of Muskogee County v.
Lowery that economic development is not a valid reason to use eminent domain in Oklahoma. As
a result, many of Liotta's fellow legislators thought stronger constitutional language was
unnecessary.
Liotta disagrees. "They closed the door but they didn't lock it — the amendment would have
locked it," he said. "There will always be folks that want to take advantage of broadening the
public use definition even further. You're always going to have someone pushing the envelope."
Anderson, of the Institute for Justice, said his main concern with much of the legislation is that
the definition of "blighted" will be interpreted loosely to justify economic development.
Since Kelo, the Institute's grassroots advocacy group, the Castle Coalition, has tracked both the
number of eminent domain condemnations filed for private use and the number of preliminary
actions taken to file condemnations for private use. These include steps such as examining an
area for blight or stating that eminent domain can be used in an area.
The group gathered information from news stories, public documents and court decisions. Their
report, which was released in June 2006, shows that local governments filed 354 condemnations
for private use in the year after Kelo, compared with about 3,700 filed between 1998 and 2002,
the last period in which they conducted such a study. In the same year, about 5,400 preliminary
actions were taken, compared with about 6,600 from 1998 to 2002.
Another survey of about 1,600 local officials drawn from the National League of Cities' database,
conducted in March 2006, showed that 76 percent of about 500 respondents reported that they
have not used eminent domain in the past three years in connection with an economic
redevelopment project. However, 87 percent of the same group said they would not delay an
eminent domain project because of the Kelo outcry.
For property-rights advocates, that 87 percent helps drive home a fear of what they consider
misuse of eminent domain. Regardless of legislation, they say that fear has been amplified since
Kelo.
"As a rule, governments tend to look out for themselves," said Rhoden, the South Dakota
representative. "If it's in the best interest of governments to use eminent domain for economic
development, then I'm afraid they might use it to the abuse of citizens."
That's a big concern in Lake Zurich, where Illinois' new legislation has done little to curb some
residents' fears that the Hudsons' property may not be the last one condemned under eminent
domain. In house after house on the two streets near the sparkling waterfront, residents display
signs in their windows that say, "Eminent domain abuse," with the words circled and slashed
through.
These homes are in the three-block area that the town in 2002 made into a Tax Increment
Financing (TIF) district, in which redevelopment is funded by the future tax revenues it will
generate. In Illinois, an area must have a set of blight factors, which range from excessive
vacancies to inadequate utilities — such as storm sewers — to become a TIF district. The Hudsons'
home, also part of the TIF district, was eligible because of concerns with the structure of a
stairway, blocked exits and its use for two apartments even though it was a single-family home,
said John Dixon, Lake Zurich's village administrator.
Dixon said because the three-block area qualifies as a TIF district, village officials believe it would
meet the new blight standards required to use eminent domain under Illinois legislation. And the
village might need to use that power to carry out its redevelopment plan expanding the number of
retail outlets and condos in the area, though Dixon said he doesn't anticipate it. He added that the
village board decided it will not use eminent domain to take property occupied by its owners.
But that decision didn't help Sarah Hudson, who compared the July 9 demolition of her rental
property to an "execution in the public square." She owns another property on a stretch of
lakefront land that the village has agreed not to condemn, but she's still fearful. She's been
distrustful of the village since her first struggle.
"Eminent domain was a threat, but I never thought it would come down to that," Hudson said. "I
was wrong."
Francesca Jarosz is a senior at Northwestern University's Medill School of Journalism in Evanston,
Ill.
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Business Law Today
Volume 16, Number 3 January/February 2007
Professionalism:
It's no joke
By Charles E. McCallum
Lawyer jokes and cartoons have become a part of our culture. Most lawyers will laugh at them,
even though they may not be very funny and if targeted at a minority group would be abhorrent.
But even those that are funny and provoke a genuine laugh should give lawyers pause. Are we
just misunderstood, or are we doing something seriously wrong?
Many lawyer jokes and cartoons make one or more of the following points:
Lawyers care only about making money. These jokes and cartoons suggest that lawyers care more about their
fees than about their clients. (Such as: Lawyer discovers that a client paying fees inadvertently gave the lawyer
two $100 bills stuck together. The lawyer recognized that he faced an ethical dilemma: "Should I tell my
partner?" or cartoon: Lawyer sitting across desk from worried client says: "Well, Mr. Jones, how much justice
can you afford?")
Lawyers care only about themselves. Jokes and cartoons of this category imply that lawyers care only for
themselves — they have no compassion for others. (Such as: Devil offers lawyer wealth and fame in exchange
for the souls of the lawyer's wife and children. After thinking for a minute, the lawyer says, "What's the catch?")
Lawyers are deceitful. These jokes and cartoons characterize lawyers as dishonest. (Q: How can you tell if a
lawyer is lying? A: His lips are moving.)
Why are we so poorly regarded? Partly, I think, because we have strayed from our professional
ideals. How can we get back to them? To answer that question we first need to define what we
mean by a "profession," a term I use here to refer to what have historically been called the
"learned professions" — law, health care and the clergy.
These days, the words "profession" and "professional" are sometimes used more loosely to refer
to individuals engaged in a wide variety of other trades and occupations. While such individuals
may share similar training (and, in some cases, licensure), the primary focus of their associations
is, like medieval guilds, to advance the interests of their members. They are more trade
associations than professional organizations.
What, then, defines a "profession," as I use the term? I will suggest seven attributes that
characterize professionals. I preface my suggestions as to what characterizes a professional with
two general observations:
First, there is an ethical/moral dimension to what it means to be a professional. This is recognized
in the Preamble to the Model Rules of Professional Conduct, which acknowledges that lawyers
must be guided by "personal conscience" and the exercise of "moral judgment." A sound moral
compass is essential.
Second, as David Maister observes in True Professionalism, "Professionalism is predominantly an
attitude, not a set of competencies." Great professionals are distinguished, he says, not by their
abilities but by the pride they take in their work, their commitment to quality, and their devotion
to the interests of the client. To that I would add the notion of passion. The true professional is
passionately committed to quality, passionately devoted to the interests of the client, and
passionately devoted to the public interest and the administration of justice.
To be of value to the client, of course, that passion cannot be blind, but must be joined with and
energize the lawyer's exercise of independent professional judgment. The professional thus has
the difficult task of being passionately committed to the client's interest and at the same time
professionally detached.
Against that background of moral dimension and passionate commitment, I suggest that the
following are the principal attributes of the learned professions (including the law). While
consistent with what has been written on the subject, these suggestions are based primarily on
my experience of more than 40 years in the practice of law, and on what I was taught in law
school and learned from mentors and role models in the profession.
1. Dedication to serving clients before self. A lawyer puts the interests of her clients before her
own interests. The lawyer has an intense, fiduciary-like relationship with her clients, and accepts
responsibility for advancing their interests. This relationship and responsibility underlie the ethical
rules (confidentiality, avoidance of conflict of interest, zealous advocacy) that flow out of the
lawyer's overriding duty of loyalty to the client.
The very best lawyers have a fanatic, almost compulsive, dedication to client service. They learn
as much as they can about their clients' business, listen closely to those clients' needs, and try to
think like those clients in order better to serve them. If a single Latin word were to be the motto
for the legal profession, it would be servimus ("we serve"). This zealous dedication to service is
founded on a deeply caring attitude.
Some part of what has gone wrong in the practice of law arises out of misplaced priorities, with
some lawyers allowing accumulation of wealth to be placed ahead of dedication to service. I do
not mean by this to suggest that lawyers should not be businesslike in the conduct of their
profession. To the contrary, efficiencies and specialization should result in services being delivered
"better, faster and cheaper," a benefit to clients. Nor do I mean to suggest that a lawyer is not
entitled to earn a very good living.
But, as Maister observes in True Professionalism, "Being a professional is neither about money nor
about professional fulfillment. Both of these are consequences of an unqualified dedication to
excellence in serving clients and their needs." Maister says that one of his favorite questions is to
ask lawyers, "Why do you do what you do?" The answer he always listens for is "I like helping
people." If that one is missing, he says he knows that he is dealing with a professional in trouble.
2. Dedication to serving the public interest. The lawyer as professional has duties, as a "public
citizen," to work to improve the law, to assist the courts in the administration of the system of
justice, and to assure access to justice by all, including those who cannot afford to pay for
adequate legal assistance. Also, lawyers have a duty of public service as volunteers in nonprofit
organizations or in unpaid appointed or elected governmental positions. It is to a large extent in
consideration of their public service obligation that lawyers have been granted substantial
privileges, including professional independence and self-governance.
The professional responsibility of every lawyer to provide voluntary pro bono publico legal services
to those unable to pay is set forth in the Model Rules of Professional Conduct. Another equally
important professional public service obligation is law reform, and in particular reforming the law
and government processes so as to reduce the public's need for legal services.
We should take care to avoid the criticism that has been leveled at the medical profession — that
it has focused on remedial services (requiring more professionals) rather than on preventive
services (reducing the need for professionals). Our role model might be dentists, who endorsed
fluoridation of water supplies and fluoridated toothpaste because they reduced the incidence of
tooth decay, despite the fact that this would over time reduce the need for dental care.
3. Honesty and integrity. The Model Rules of Professional Conduct unambiguously require
uncompromising honesty and integrity. A lawyer may not engage in conduct involving "dishonesty,
fraud, deceit or misrepresentation," even when in a specific instance honesty works to the client's
disadvantage. Thus in representing a client a lawyer may not make a false statement of material
fact or law to a third person, nor may she fail to disclose a material fact when necessary to avoid
assisting a client's criminal or fraudulent act. And a lawyer may not knowingly mislead a tribunal
or offer evidence that the lawyer knows to be false.
Integrity means strict adherence to a code of ethical values. Recent developments in the world of
business law underscore the importance of strict adherence to ethical values. For example, a
lawyer may not misrepresent his identity in the course of conducting a corporate internal
investigation or, as is alleged to have occurred in the Hewlett-Packard scandal, knowingly engage
a nonlawyer to do so, even if the misrepresentation does not violate applicable law. That is, a
lawyer may not behave dishonestly simply because it is not criminal to do so.
Nor may a lawyer turn a blind eye when it is obvious that her services are assisting the client in
the commission of a fraud or a crime, as is alleged to have occurred in the Enron debacle, or give
a legal opinion to be relied on by third parties that is based on factual assumptions that the
lawyer cannot reasonably believe to be true.
Honesty and integrity go together with loyalty, reliability, fairness and compassion to make up
"character," which is sometimes defined simply as moral excellence. That good character is
essential to professionalism is evident from the fact that processes for admission to the bar
include an investigation of the applicant's character and fitness.
4. Dedication to excellence. The professional has high standards for professional services, and
none higher than those he demands of himself. However many times a professional may have
done a particular task, he will seek each time to do it better than before. And even though the
client may impose a cap on the fees for the project, the professional will do what it takes to do
the job right, regardless of the fact that he may not be paid for all of his work. The phrases "good
enough" and "this will do" are anathema to the professional.
5. Practice in context. The professional serves his client with knowledge and awareness of the "big
picture" — the overall setting and context in which services are rendered. A doctor, for example,
cannot fulfill his professional duty to his patient by prescribing for one condition while ignoring the
patient's overall health and the potential interactions of the medication with the patient's other
conditions.
In the same way, a lawyer cannot fulfill his professional duty to the client simply by delivering an
excellent real estate deed if he fails to at least raise with the client other potential issues in the
acquisition of real estate, such as environmental risks. For this reason the lawyer, as a
professional, seeks to know and understand the context in which the client operates and in which
the lawyer's services are being used.
6. A specialized body of knowledge and skills freely shared with other professionals.Lawyers must
learn, and bar exams test, a specialized body of knowledge and skills. After admission to practice,
the lawyer — as a professional — has a continuing obligation (even if not required by her state's
rules of professional conduct) to update, renew and expand such knowledge and skills through
continuing legal education. And, as professionals, lawyers who develop or acquire new knowledge
or techniques freely share it with the profession generally, in furtherance of the public interest,
just as doctors readily share with one another new treatments that may alleviate suffering or save
lives.
7. Adherence to ethical rules and participation in self-regulation.The Model Rules of Professional
Conduct are disciplinary rules of professional ethics designed to serve the interests of clients and
the public. In addition to the obligation to abide by the letter and the spirit of those rules, lawyers
also have the duty to work for the improvement of the profession and to assist in its selfregulation.
As a first step toward restoring professionalism, we must be mindful of and guided by those seven
essential professional attributes. Understanding what it means to be a professional is not enough,
however. We must articulate the message of professionalism to young lawyers and law students.
This must be done in our law schools, and in our law firms, and by judges and leaders of the bar.
Even more important, we must live by those professional standards in our own lives at the bar.
Ultimately, it is up to the profession to re-assert professionalism.
Even if all lawyers were to "talk the talk, and walk the walk," however, we should not expect
lawyer jokes and cartoons to fade from the scene. Cultural stereotypes die hard. But if we can reground ourselves in professionalism, we will feel better about ourselves, individually and as a
profession, and less embarrassed by those jokes and cartoons. We are embarrassed by them
because they are too close for comfort. We will feel better when we can be confident that they are
wide of the mark.
Model Rules and the profession
Support for the suggestions set forth in this article can be found in the Preamble to the
ABA Model Rules of Professional Conduct:
"A lawyer, as a member of the legal profession, is a representative of clients, an officer of
the legal system and a public citizen having special responsibility for the quality of justice."
Preamble [1]
"As advisor, a lawyer provides a client with an informed understanding of the client's legal
rights and obligations . . . As advocate, a lawyer zealously asserts the client's position
under the rules of the adversary system. . . . As negotiator, a lawyer seeks a result
advantageous to the client but consistent with requirements of honest dealings with others."
Preamble [2]
"A lawyer's conduct should conform to the requirements of the law, both in professional
services to clients and in the lawyer's business and personal affairs. A lawyer should use
the law's procedures only for legitimate purposes and not to harass or intimidate others. . .
. While it is a lawyer's duty, when necessary, to challenge the rectitude of official action, it
is also a lawyer's duty to uphold legal process." Preamble [5]
"As a public citizen, a lawyer should seek improvement of the law, access to the legal
system, the administration of justice and the quality of services rendered by the legal
profession. As a member of a learned profession, a lawyer should cultivate knowledge of the
law beyond its use for clients, employ that knowledge in reform of the law and work to
strengthen legal education. . . . [A]ll lawyers should devote professional time and resources
and use civic influence to ensure equal access to our system of justice . . . A lawyer should
aid the legal profession in pursuing these objectives and should help the bar regulate itself
in the public interest." Preamble [6]
"A lawyer should strive to attain the highest level of skill, to improve the law and the legal
profession and to exemplify the legal profession's ideals of public service." Preamble [7]
"The legal profession's relative autonomy carries with it special responsibilities of selfgovernment. The profession has a responsibility to assure that its regulations are conceived
in the public interest and not in furtherance of parochial or self interested concerns of the
bar." Preamble [12]
McCallum is a partner at Warner Norcross & Judd LLP, in Grand Rapids, Mich. His e-mail is
cmccallum@wnj.com. This article is based on a paper presented at a program entitled "Lawyer
Jokes and Bashing — A Bum Rap or Painfully on Target?" at the 2006 Annual Meeting of the ABA
Section of Business Law.
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Business Law Today
Volume 16, Number 3 January/February 2007
When a business begins a blog
It's easy, but is it safe?
By By John E. Ottaviani, John W. Bagby and Kristie D. Prinz
Your new client calls with a question. She has heard that other businesses are operating "blogs"
written by employees or owners to promote and market their businesses, and she wants to launch
a blog about her business. She asks whether there are any legal issues of which she should be
aware before she has her employees start a blog. What do you tell her?
Blogs are being used by businesses of all sizes, from General Motors to one-person consulting
firms. In many cases, the same principles that have been applied to traditional forms of
communication by businesses are now also being applied to blogs — such as intellectual property,
employment and securities law.
The major difference between other types of business communications and business blogging that
businesses and counsel need to consider is the speed and ease of publication to a broadcast
market. Where before publication required a printing press, radio or TV broadcast or Web site
developer to reach a wide audience, now anybody with Internet access can create a blog that has
the potential to be read by millions. This article highlights some of the more important legal
concerns raised when employees or owners of a business engage in blogging about the business.
Given the fact that a blog typically contains text, images, hyperlinks and even music or video files,
your client needs to be aware of the intellectual property matters applicable to blogs. Issues
include: (1) who owns the content; (2) who is liable for infringing material; (3) trademark issues;
and (4) the potential disclosure of trade secrets by employees or third parties.
First of all, you should advise your client that, with respect to the issue of the ownership of the
rights to blog content, the same content ownership rules that apply to forms of traditional paperbased communications about a business also apply to blogs.
As a general rule, the person creating the content and posting to the blog will own the copyright
for that content and have the right to control its use in the future. Work-made-for-hire rules
apply: The company owns the content posted by an employee when blogging in the scope of his
or her employment. The employer has the right to redistribute the content or reuse it for other
purposes. The company may also acquire the copyright by written assignment if the content is not
a work made for hire.
If, however, the person writing the content is not a regular full time employee (such as an
independent contractor or a freelancer), the work made for hire rules generally do not apply. The
person submitting the content owns the copyright in the post or other content unless there is a
written assignment of the copyright to the company. If more than one person is contributing to
the blog, the contributions from each person must be analyzed separately.
If a blog posting contains content (for example, photographs or music) that has been created by a
third party, the company generally will not have rights to the third-party content unless there is
an express agreement assigning the rights to the company or granting the company permission to
use the content for specific purposes.
Of course, if the employee is posting to a personal blog on her own time, her posting would not
be owned by the employer, even if it pertains to the employer or the employer's business. The
employee will still own the copyright and the content, provided there is no written agreement
assigning her rights to the employer. The business generally does not have any rights to revise
this content.
It should be noted that obtaining a written agreement signed in advance does not always result in
the assignment of blog rights to an employer. Some states inhibit or constrain an employer's
ability to demand in advance an automatic assignment of personal works created outside of
company time or not using company resources. Counsel should consult the applicable local law on
this issue.
Next, you should advise your client as to who will be liable in the event that infringing content is
posted to a corporate blog.
If the infringing content is posted to a corporate blog that is operated by an employee of the
business or by someone else under the authority of the business, then both the business and the
person posting the offending content could be held liable in an infringement action. To avoid this
result, a company should make certain that its policies governing the posting of infringing content
to the corporate Web site are modified to apply to the posting of infringing content on a blog.
Of course, if content infringing another's copyright is posted by either of these people on a
personal blog, then the risk to the company should be minimal, provided that ownership of the
intellectual property rights in the blog was never transferred by assignment agreement to the
company, and the company is not otherwise sponsoring the personal blog.
What happens if employees from two or more companies contribute to a blog? Who is liable if one
of them posts infringing content? This is a fact-specific determination. Potentially, the employers
of all of the contributors could be liable if the employees are considered partners. This risk may be
avoided or at least minimized by the use of contracts that contain exculpation and indemnification
clauses that work to allocate responsibility among the contributors and place any onus on the
person who actually committed the infringement.
Third, you should advise your client as to what trademark issues exist with respect to blogs.
The name or title of the blog may be a cause for concern if it is similar to another's trademark or
it may be a trademark the company sponsoring the blog would choose to register. In addition, the
use of the company's trademarks or the trademarks of other companies in blog posts could also
give rise to liability.
If the blog is marketed under a particular name, whether the name of the person responsible for
the blog or a title (such as the "The Trademark Blog"), traditional trademark rules apply.
As a general rule, anyone starting a blog should usually undertake a clearance search to make
sure that someone else's trademark rights are not going to be infringed by the proposed blog
name. That is true even where someone is using his own name in the title of a blog. For example,
a lawyer named William Blass probably may have difficulty using "Bill Blass' Blog" as the title of a
blog to promote his law practice, as "Bill Blass" is a registered trademark of the world-famous
fashion designer. The courts would show greater deference to the use of Blass' full name.
With respect to the use of a company's trademarks and third-party trademarks in a blog, a
business should follow the same policies that it uses for its written corporate communications and
for its Web site. The company's trademarks should be used in such a way as to preserve quality
control, and the marks always should be designated as trademarks. Third-party marks should be
used with caution and only consistent with "fair use" guidelines or with permission of the
trademark owner.
Finally, your client needs to know how to protect the business against the potential disclosure of
trade secrets by employees or third parties in blogs.
Confidential information and trade secret policies should be drafted to make specific reference to
blogs, just as in the case of any other employee communication. Given the popularity of blogging,
your client should remind employees of confidentiality restrictions in connection with any blogging,
whether for the company or otherwise. If a third party discloses the company's trade secrets, the
response should be little different from what might happen in any other form of communication.
Once a secret has been publicly disclosed, should the client undertake to "get the cat back into
the bag"? Whether that is wise, or if it would help, are matters beyond the scope of this article.
Having said this, some after-the-fact efforts to recover confidential information may be possible.
Indeed, many blogs are "hosted" on free services — such as blogspot.com — and those free
services can be very easy to find for purposes of restraining orders or other injunctive action.
If your client's business is a publicly traded company, then not only does she need to be aware of
intellectual property issues relating to blogs, she also needs to know about securities law issues
relating to blogs.
You should advise your client that blog postings by a publicly traded company's officers are likely
to be attributable to the company. In fact, even the postings of lower level employees may create
liability for the issuer, particularly if the blogger identifies himself or herself as an employee. To
address this potential issue, public companies should develop company policies to guide any
employees or officers posting content. Lessons learned from company e-mail policies, Web site
content and other forms of publications should be useful to apply to drafting policies to govern
blogging.
On the other hand, third-party blogs should not create liability concerns unless the public
company's officers somehow get involved in approving or correcting postings. If such an
association is created in the public mind, then the public company could become responsible for
blog postings, even on third parties' sites.
You should advise your client of the need for careful planning for corporate blogs sponsored by
offering participants, particularly given the SEC's recent reforms to the 1933 Securities Act rules.
The new rules attempt to encourage the use of the Internet in securities disclosure, but "gun
jumping," or making illicit offers to sell securities before the rules allow, even through a blog
posting, remains a very real liability risk. Even when companies are allowed to precondition the
market in ways that they were not before securities offering reform, blog postings could constitute
free writing prospectuses (FWP) that must be filed with the SEC.
Moreover, a blog posting by an publicly traded company's employee, even if the blog is not
sponsored by the issuer of the stock, may also constitute an FWP.
In addition to advising your client about the intellectual property and securities implications of
blogs, your client should also be aware of the advertising and commercial laws that could be
applied to blogs.
The same rules that apply to statements a business makes about its products or a competitor's
products in traditional forms of media will likely apply to statements made on a corporate blog.
While there are no definitive cases yet, it seems safe to conclude that a business could be liable
for false advertising, deceptive trade practices, misrepresentation or breach of warranty based on
statements made on a corporate blog.
You should advise your client that the Federal Trade Commission may apply the same consumer
protection laws that apply to other media online to corporate blogs. The FTC seeks to ensure that
products and services are described truthfully in online ads and that consumers get what they pay
for, and this policy could potentially be extended to corporate blogs. This means that rules
concerning "truth in advertising," "unfair and deceptive practices," and required disclosures should
be followed in blogs just as they would for online Web sites or in printed materials.
The commission is already enforcing its rules against deceptive domain names, such as where a
domain name is similar to the domain name of a Web site that provides free credit reports, and it
leads consumers to other Web sites that require payments for credit reports. It is not much of a
leap to extend these enforcement practices from online Web sites and domain names to corporate
blogs.
In addition, your client should be advised to be careful about making statements about its own
products or services in a blog. These statements could be construed as warranties or guarantees
about the product and its performance, which could give rise to liability if the product or service
does not live up to the warranty. A company that does make statements or permits its employees
to post statements about its products or services in a blog should make certain that company
policies concerning product statements made on the corporate Web site or in printed materials are
adhered to in the posts.
Now that you and your client have discussed the intellectual property, securities, advertising and
commercial law concerns raised by business blogs, what other issues should you raise? The
following may be relevant:
Employment law — In addition to the securities and intellectual property concerns that are raised when
employees post on blogs, there are also questions as to how a company can control what is said about it by its
own employees, and whether employees can be terminated for blog postings. [Note the article in Business Law
Today in May/June 2006, "Welcome to the blogosphere: A primer for business lawyers."].
Liability defenses — Section 230 of the Communications Decency Act (47 U.S.C. Section 230) and Section 512 of
the Digital Millennium Copyright Act (17 U.S.C. Section 512) provide defenses to Internet service providers, Web
site hosting services and others for liability claims for content provided by third parties. These laws should be
analyzed to see if they apply to your client's company blog.
Acceptable conduct policies — If the blog accepts comments or postings from third parties, the business should
consider incorporating an "acceptable use policy." This can be a stand-alone policy located through a link on the
home page, or can be part of the "terms and conditions" towhich the third parties agree before posting content
or comments. Typically, these terms would regulate the content of the postings (for example, no profanity) and
permit the business to delete or edit postings that do not comply with the terms.
Vicarious liability — If a business sponsors a blog, it will be responsible for the postings made by its employees.
Businesses need to consider carefully who will be allowed to make posts on behalf of the company or moderate
discussions or blog postings.
Blogs are a new and exciting form of communication. While it is true that blogs raise new issues
for businesses to consider, in many cases the same legal principles that have applied to traditional
forms of communication by businesses are now also being applied to blogs.
When advising clients, lawyers should emphasize the use of common sense and the application of
existing legal rules and corporate policies to business and employee blogs. This strategy should go
a long way toward protecting the business that ventures into this new medium.
What is a blog?
A blog (short for Web-log) is essentially a journal, maintained on an Internet Web site, that
is periodically updated and is meant for public consumption. Typically consisting of short
posts arranged in reverse chronological order, blogs enable people to publish comments and
ideas instantly for others to read.
In common parlance, the activity of updating a blog is called blogging, and someone who
maintains a blog is a blogger. Individual articles on a blog are called posts or entries. Blogs
can be written by one individual, a group of contributors, or the public at large.
Posts to a blog generally consist of a title and a brief commentary, and often include
excerpts or summaries of relevant news, a link to the specific information discussed, and a
comment section allowing viewers to respond. The scope of topics on which blogs focus is
endless, ranging from political commentary, to industry-specific news, to baseball and other
sports, to general commentary on daily life, to one's own personal life and views.
For example, there are many law-related blogs. The Business Law Section's Cyberspace Law
Committee sponsors a blog that follows committee meetings and activities.
The origin of blogs dates back roughly to 1997, when blogs evolved from prior technologies
such as e-mail lists, news feeds, electronic bulletin boards and personal Web pages.
Blogging reached the mainstream when automated technologies eventually allowed authors
to blog with little technical background and generally at no cost, and attained new heights
of popularity during the 2004 U.S. presidential campaign.
By some estimates, tens of millions of blogs may now be found on the Internet. Blogs have
become so widely recognized that Merriam-Webster listed blog as its Word of the Year in
2004.
Although blogs started as personal journals, many lawyers and law firms now maintain legal
blogs (sometimes referred to as blawgs) to provide a personal viewpoint on important
current issues, to create an easily accessible community of firm-relevant information, or as
a general marketing tool. A quality legal blog can establish the blogger as an authority in a
specific practice area, thus augmenting business and professional development.
Technology has evolved to permit enhanced distribution of blogs. Rather than use the
traditional "bookmarks" to view individual blogs, many people now use RSS (short for "rich
site summary" or "really simple syndication"), a technology that automatically sends to the
reader posts that meet pre-selected criteria. Using RSS files, one can create a data stream
that supplies headlines, links and article summaries from a blog. Users can have updated
content from blogs delivered to them by a news aggregator, a piece of software specifically
designed to receive these data streams. The reader likes this for the simplicity and speed.
Many bloggers encourage the use of RSS technology by having a button right on the blog.
Others dislike this technology because it will frequently miss certain content or formatting
of the original site (including advertising the blogger may be counting on having viewed by
her readers).
— Contributed by Michael Andrews, an associate at Petrie Schwartz, LLP, in Boston, and a
member of the Cyberspace Law Committee.
Ottaviani is a partner at Edwards Angell Palmer & Dodge LLP, in Providence, R.I. His e-mail is
jottaviani@eapdlaw.com. Bagby is a professor of information sciences and technology at
Pennsylvania State University, in University Park, Pa. His e-mail is jbagby@ist.psu.edu. Prinz is
the founder and principal of the Prinz Law Office, in Los Gatos, Calif. Her e-mail is
kprinz@prinzlawoffice.com. The authors gratefully acknowledge the contributions of Paul Arne,
Michael Andrews, Michael Fleming and Candace Jones to this article. All are members of the
Business Law Section's Cyberspace Law Committee.
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Business Law Today
Volume 16, Number 3 January/February 2007
The 'agreement' that sparked a storm
A 'click-through' goes bad
By Elizabeth Bowles and Eran Kahana
At a recent legal presentation attended by prominent intellectual property lawyers and law
professors, a loaded question was posed to the audience: "By a show of hands — and be honest,
now — how many of you read the terms and conditions presented in an end-user license
agreement?" Of the nearly 100 people in the auditorium, not a single hand was raised. Shocking?
Only if such an admission is unexpected. It really isn't.
Why does it matter that even those who should know better don't read their end-user license
agreements (EULA)? The answer can be found in the Sony "rootkit" public relations nightmare. We
define "rootkit" later in this article, but for the time being simply accept that what happened to
Sony, or (more accurately) what it did to itself, goes beyond the confines of the Sony digital rights
management case itself and should be analyzed within the contractual framework of EULAs and
the tension between the freedom to contract and (arguably) overreaching terms/abuse of license.
The ultimate question is: Does it matter if people know what they are installing on their
computers?
Our story deals with Sony BMG's (Sony) recent controversial experience in dealing with digital
rights management software. But before we continue with that story, we should briefly introduce
some technical definitions: "rootkit" and "DRM."
First, let's take a look at a "rootkit." A rootkit is a set of software tools installed on a computer
that is intended to conceal processes, files or system data currently running on the computer. The
purpose of a rootkit is to help an intruder maintain access to a computer's system while protecting
that intruder from detection. While rootkits can be used for legitimate purposes, they often modify
parts of the operating system or install themselves as drivers or kernel modules.
The rootkit's cloaking is specifically designed to make it difficult for a user to find the rootkit and
to disable or otherwise "hack" its processes. When used in the context of digital rights protection,
the purpose of a rootkit is to make it difficult for end users to hack into and defeat content
protection. How difficult it is to defeat content protection or, put another way, how well the rootkit
is designed, may also affect the user's ability to remove the rootkit from his or her computer
system.
The second technical term is digital rights management, popularly known as DRM. DRM refers to
the technologies used by publishers or copyright owners to control end-user access to and use of
digital data like music, movies and software. DRM is used by many brand-name copyright holders
and distributors, one of the most notable being Apple's iTunes, which uses DRM to ensure that
music files are only played on so-called "authorized computers."
Although the use of DRM is strongly supported by those interested in protecting digital rights,
DRM is highly unpopular with many end-users, such as large peer-to-peer networks that depend
on restriction-free sharing of intellectual property for their existence. These groups claim that
"digital rights management" is a misnomer and that "DRM" should stand for "digital restrictions
management."
So we now return to Sony and how their DRM scheme went wrong. The Sony DRM story dates
back to mid-2004. That year, Sony began using two pieces of DRM software on its CDs. The first
was Extended Copy Protection (XCP), developed by a company called First4Internet (F4I), and the
second was MediaMax, developed by SunnComm. The purpose of these two programs was to
protect the CD content of 52 titles featuring popular artists such as Frank Sinatra, Celine Dion and
Louis Armstrong.
Sony allegedly used a rootkit to mask the installation of the XCP DRM software, which was cloaked
by the installation of a file called Aries.sys. To make matters worse, according to several media
reports, the Aries.sys file not only cloaked installation of the rootkit, it also transmitted user
information back to Sony. The Sony DRM software was also alleged to interfere with the way both
Microsoft Windows and Mac OS X operating systems normally play CDs and perhaps inadvertently
opened security holes that allowed viruses to infect computers running the software. It was also
alleged that this rootkit could not be removed without damaging the Windows operating system.
It wasn't until more than a year later that computer security experts, most notably Mark
Russinovich, discovered the Sony rootkits on their systems. Being the techies that they are, and
— to put it mildly — being that they were "disturbed" by their finding, they began blogging about
it. The net result for Sony? Public and consumer outrage, three class-action lawsuits (two in
California, one in New York), an investigation by Florida's attorney general, two investigations in
Canada, and numerous bloggers more than willing to take Sony to task for its "bad" behavior.
The media frenzy that ensued over the next year and a half fanned the proverbial fires, causing
Sony to suffer a number of "black eyes" as it scrambled to contain the damage.
Initially this damage control was arguably not well thought out. Sony's public position was
reported as, "Most people don't even know what a rootkit is, so why should they care about it?"
(Arguably, most people don't know what a EULA provides, but is it fair to argue that they should
not care about it?) Other media reports detailed how Sony subsequently argued that the
installation of the rootkit, and indeed that everything it did was all included in its EULA, and that,
therefore, it was contractually allowed to do as it did, including cloaking the software and
monitoring end user behavior.
The public relations nightmare notwithstanding, the ultimate question here concerns Sony's EULA.
From a legal perspective, EULAs have a role to play in managing copyright holders' rights. How
they are used and enforced is something that should concern every lawyer.
Let's begin with establishing a few important points pertaining to EULAs. Most users typically see
them in the form of click-through agreements, which require acceptance of the terms and
conditions prior to allowing installation of software. True to their purpose, EULAs, for the most
part, play a valuable role in protecting the software developer's work. It is also fair to say that a
few rancorous EULAs create a whole lot of bad press for the legitimate majority.
At the most basic level, click-through agreements are enforceable, provided they comply with the
normal rules of contract formation, such as offer and acceptance. Because of the medium in which
they appear, it is generally the case that when properly presented — the EULA must be legible,
timely and complete — there is usually very little controversy about them.
It is also equally well established that when these factors are in place, a user need not have read
nor even understood a EULA to be bound to it; it only matters that he or she had an opportunity
to read it. In the Sony DRM case, one of the $60-million questions is whether the opportunity to
read the EULA was legally meaningful or, put another way, whether the user's consent was valid.
This question is key in light of the clearly unanticipated actions taken by the Sony rootkit and its
DRM software.
Ultimately, the Sony rootkit experience illustrates how EULAs should not be used. Why? EULAs
should never serve as a vehicle for developers to "sneak" in terms and conditions that they know,
or should know, would be offensive to public policy or, for that matter, to the general public. Also,
it can make the developer look really bad even though, legally speaking, the developer is in the
right — all the "i"s dotted, all the "t"s crossed and "voila": A valid contract was formed.
But really now, who cares about legal technicalities when the developer's customers are mounting
the consumer equivalent of a mutiny? It should be common sense for any company that if
consumers stop purchasing its goods, the EULA has no value regardless of how carefully it was
constructed.
It must be noted that Sony has an unquestionable right to protect its copyright. The only question
is how far does this right extend? In other words, did Sony have the right to take the steps it did
to protect those rights even if those actions would be tantamount to an abuse of license? Part of
the outrage over Sony's conduct was because no other copyright holder in Sony's industry has
tried to take their license rights this far.
Also, when the DRM software spies on end users without their knowledge, is impossible to
uninstall, and is hidden from view, can it still be valid despite ostensible consumer "consent"? In
the Sony DRM case, the critical variable was whether there was valid consent. If there was no
valid consent, then no contract was formed, which means that Sony failed to get the user's
consent to install the program. If so, it is in a world of hurt.
It is also possible that the Sony rootkit, put simply, is "malware" (malicious software) as many
have argued. In fact, Microsoft reportedly added the Sony rootkit to its list of worms, Trojans and
viruses that its Windows Malicious Software Removal Tool detects and deletes. Proponents of the
idea that Sony's behavior was malicious point to the allegation that the Sony rootkit developers
cooperated with antivirus companies to ensure that anti-virus software would not detect the
rootkit.
Then, of course, there are those who wholeheartedly disagree that the rootkit is malware. Period.
Sony, for example, posted on its Web site's FAQ that the rootkit was not malware because "[t]he
protection software simply acts to prevent unlimited copying and ripping from discs featuring this
protection solution. It is otherwise inactive. The software does not collect any personal information
nor is it designed to be intrusive to your computer system."
Ultimately, regardless of whether the software was deliberately malicious or just inept, the key
question we keep returning to is whether there was legally valid consent.
This exercise reveals at least two things: First, it is alleged that the only notice that the rootkit
even existed was contained in a click-through EULA visible only after removal of the shrink wrap
and after the first steps of installation were initiated. If the user clicked on "Disagree," they could
only use the CD as a coaster — since the CD had been opened, it was not returnable, only
exchangeable for the same title. Add to this the allegations that the CD package did not alert
consumers to the fact that an application would be installed, let alone the specifics of what it
would do once on the hard drive.
Many courts that have enforced click-through EULAs in the past have done so in part precisely
because the software in question was returnable. The fact that the CDs purchased from Sony
could not be returned and that there was no notice on the outside of the package meant that the
Sony DRM EULA was more likely to be found a contract of adhesion rather than a garden-variety
click-through agreement.
Second, this exercise leads us to examine the text of the EULA itself, which is alleged to include
the following terms:
Restrictions on the user's ability to use the digital content on the CD in the event that that consumer chooses to
leave the United States;
Restrictions on user's ability to use the digital content on the CDs at work;
Restrictions on user's ability to use and retain lawfully made copies of the digital content on the CDs in the
event that the original CD is stolen or lost;
Restrictions on user's ability to use the digital content on the CDs following a bankruptcy;
Conditioning the user's continued use of the digital content on the CDs on acceptance of all Sony BMG software
updates;
A purported $5 limit on Sony BMG's entire liability to the purchaser of the CDs;
Restrictions on user's ability to examine and test his or her computer to understand and attempt to prevent the
damage cause by the rootkit;
A reservation of rights by Sony to use technological "self-help" measures against the computers of users who
want to make use of the digital content on the CDs "at any time, without notice."
What the EULA notably does not say is that the CD will install a potentially harmful rootkit and
will transmit information back to Sony.
At the same legal presentation mentioned at the beginning of this article, the presenter read
through each one of the EULA's terms. The audience's reaction was one of initial amusement
coupled with an utter lack of understanding of the rationale for any of them.
Granted, this does not amount to an empirical analysis of the issue. However, when so many legal
experts bewilderingly shake their heads when asked "why are these provisions necessary?" that
raises a very serious question. If the terms are unnecessary, then even assuming for the sake of
argument that Sony successfully obtained valid user consent to its EULA, do they amount to an
abuse of license?
Eventually, Sony realized that its behavior was not what its consumers wanted, expected, or
would be willing to put up with. In a salvage attempt, it proposed one settlement in which Sony
would provide the following:
A replacement CD.
A cash benefit of $7.50.
Free downloads of the music on the CD.
Up to three additional free album downloads.
Software updates to fix known security vulnerabilities.
Disclose security vulnerabilities discovered in the future.
Ensure that, "until 2008, any future content protection software will be fully and accurately disclosed,
independently tested, and readily uninstalled."
Whether or not this compensation package is acceptable to those "injured" by Sony's behavior or,
for that matter, appropriate as a deterrent to others is open to debate, and the cases against
Sony for their allegedly overreaching use of DRM software are still going forward.
That said, lawyers should take note of the practical lessons offered by this saga:
(1) Provide clear and conspicuous disclosure on the outside packaging so that users know the
DRM software is included before they open the CD. The strength of the notice on the outside of
the package will doubtless be the subject of debate, with copyright holders arguing that the notice
should be minimal so as not to scare off consumers needlessly. That notwithstanding, it is
doubtless that any copyright holder would be covered if a consumer purchases a CD that clearly
contains the following notice:
Attention: This CD will install a software application on your computer that will monitor the contents on your
hard drive and alert [name of copyright owner] to any infringing use;
(2) repeat in the EULA a full and simply worded disclosure of the operation of the DRM software,
specify that it includes a rootkit, and an explanation of what the rootkit and software will do; and
(3) provide an easy and workable detection and removal process that will not damage the
operating system even if the program destroys the CD content on its way out.
Following these simple steps should avert any similar future controversy, which is no small thing
considering the significant expenses Sony has incurred in dealing with the issues raised by its DRM
software. Taking appropriate measures to avoid future controversy is an excellent way to ensure
that the legal tools available are in sync with the business needs of clients.
Other resources
The Section's Cyberspace Committee considers the following items its "e-contracting
trilogy":
"Click-Through Agreements: Strategies for Avoiding Disputes on Validity of Assent," Christina L. Kunz et
al., 57 Business Lawyer 401 (Nov. 2001)
"Browse-Wrap Agreements: Validity of Implied Assent in Electronic Form Agreements," Christina L. Kunz
et al. (a different et al.), 59 Business Lawyer 279 (Nov. 2003)
"Strategies For Modifying Electronic Agreements and Policies," a CLE program presented by the Business
Law Section's Cyberspace Committee at the Spring 2005 meeting.
Bowles is president of Artistotle.net Inc., in Little Rock, Ark. Her e-mail is ebowles@aristotle.net.
Kahana is a corporate lawyer with DataCard Corp., in Minnetonka, Minn. His e-mail is
eran_kahana@datacard.com. Opinions expressed here are his own.
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Business Law Today
Volume 16, Number 3 January/February 2007
Is the future more secure?
A look at pensions, retirement and changes in the law
By Donald J. Myers, Michael B. Richman and Sonia A. Chung
Think you understand the newly enacted pension rules? Or at least that your business client does?
Read on.
The Pension Protection Act of 2006 (the PPA), which President Bush signed into law on Aug. 17,
2006, is being described as the most significant pension legislation since the Employee Retirement
Income Security Act of 1974 (ERISA). This is no small statement, as Congress has passed pension
legislation almost every other year since ERISA was enacted.
While the principal impetus for the PPA was to reform the rules for funding defined benefit
pension plans, the law makes significant changes in many other areas as well. In this article, we
focus on a few highlights of the pension law changes that are intended to create new
opportunities for increasing participation in defined contribution plans, stabilizing defined benefit
plans, and providing added investment flexibility, to help assure that Americans have sufficient
income in retirement.
The first part examines the changes to the rules for 401(k) plans and other qualified retirement
plans to encourage better levels of plan participation and funding and describes some of the
practical implications for plan sponsors and their counsel to consider with regard to plan design.
The second part examines significant changes to the ERISA fiduciary responsibility rules and some
of the implications of those changes for pension plan asset management, affecting not only those
who manage plan assets but also firms that sponsor funds in which ERISA plans invest.
For 401(k) plans, the PPA contains new guidance on automatic enrollment — enrolling employees
in the plan automatically, without requiring them to submit an enrollment form and to select
investments and contribution levels — with the goal of offering employees a painless opportunity
to take that first step toward saving for retirement. While the basic concept of automatic
enrollment is certainly nothing new, Congress has now provided added incentives.
First, the PPA dispels any lingering concern plan sponsors may have had about state laws
impeding their ability to offer automatic enrollment, by clarifying that ERISA preempts any such
state laws. Second, beginning in 2008, 401(k) and 403(b) plan sponsors who implement specific
guidelines for automatic enrollment will receive favorable plan treatment from the Internal
Revenue Service, in the form of deemed satisfaction of certain annual nondiscrimination tests.
Finally, the PPA offers fiduciary protections for default investments resulting from automatic
enrollment. The latter two points merit additional discussion.
Under the PPA's requirements, plan sponsors interested in establishing a so-called "safe harbor
automatic enrollment plan" must first set a uniformly applicable initial default contribution limit of
no less than 3 percent, rising to at least 6 percent by the fourth year of participation. In addition,
the sponsors will be required to provide a matching contribution equal to at least 100 percent of
the first 1 percent deferred and at least 50 percent of the next 5 percent deferred, not to exceed
6 percent of compensation. Employer matching contributions may be subject to a maximum twoyear vesting schedule.
In providing this safe harbor, the PPA offers a practical incentive for plan sponsors who would
have been inclined to use, or are using, a traditional, nonautomatic enrollment safe harbor plan
(which also provides nondiscrimination testing relief). Under a traditional safe harbor plan, a plan
sponsor is required to contribute a minimum total employer match equal to 4 percent of
compensation, which must be fully vested from day one.
Under this new type of safe harbor automatic enrollment plan, however, a plan sponsor's required
matching contribution is a half percent lower, at just 3.5 percent, and includes the increased
flexibility of the maximum two-year vesting schedule. This combination of the lower required
employer contribution and a vesting schedule may translate into savings for plan sponsors.
A significant concern in the area of automatic enrollment plans has been how to appropriately
invest the automatic contributions of participants who do not elect an investment vehicle, and
whose accounts are therefore invested by default in an option selected by the plan sponsor. To
address this issue, the PPA amends Section 404(c) of ERISA, the exception to the ERISA fiduciary
rules for participant-directed individual account plans, to cover these default investments.
Under the new rule, participants are to be provided with a notice within a reasonable period of
time before each plan year, explaining their right to designate the investment of contributions and
how, in the absence of an investment election, their contributions will be invested. They must
then have a reasonable period of time after receiving the notice and before the plan year begins
to make an affirmative investment election.
In the absence of an affirmative election, the participant is nevertheless treated, for purposes of
the ERISA fiduciary rules, as having exercised control over assets that are placed in the
designated default investment. This means that the plan fiduciaries are not liable for any losses or
other adverse results from that investment (unless the losses result from the imprudent selection
of the default investment).
Although Congress' message on the importance of strengthening defined contribution plans could
not be clearer, it did not stop there. The PPA also contains stringent defined benefit funding rules
(although some argue they may actually hasten the demise of defined benefit pension plans
altogether, rather than stabilize them for the good of future retirees).
Under the PPA's new defined benefit plan funding rules, which begin to be phased in for the 2008
plan year, a plan's annual funding target must now be 100 percent of its liability obligations
(rather than 90 percent as under prior law). Further, instead of the current 30-year amortization
period, unfunded amounts related to past service liabilities must now be amortized over a sevenyear period.
If, in a preceding year, a plan has more than 500 participants and plan assets valued at less than
specified percentages of the plan's funding target (80 percent when determined without regard to
the PPA's special "at-risk" assumptions, and 70 percent when determined with regard to those
assumptions), the plan will be deemed to be "at risk." At-risk plans are required to use special,
less-favorable actuarial assumptions that will, in turn, effectively increase an employer's required
minimum contributions.
In addition to the greater minimum contributions required of at-risk plans, the PPA contains
several other provisions aimed at ensuring that plan sponsors have little incentive to underfund
their plans.
For example, if a plan is at-risk, and the employer also sponsors a nonqualified deferred
compensation plan (as defined by Internal Revenue Code Section 409A — generally, special plans
for high-ranking company officers and senior management), the plan sponsor must ensure that it
does not "fund" the deferred compensation plan by way of a grantor trust or other similar vehicle
during this at-risk period. If the employer does "fund" through such a vehicle, it will likely be
subjecting the company's highest officers to the severe penalties applicable to 409A violations, not
the least of which is a 20 percent penalty tax.
Further, plan sponsors of underfunded plans who miss a required quarterly contribution will be
charged interest at the plan's effective rate, plus 5 percent. Also, if the plan's funding level falls
below 60 percent, benefit accruals must stop until the plan's funding exceeds that level.
Turning now to the ERISA fiduciary responsibility rules, the PPA represents the first major change
to these rules since ERISA was enacted 32 years ago.
The principal purpose of the PPA's changes is to "modernize" the fiduciary rules, alleviating the
effect of its restrictions on nonabusive transactions. To do so, the PPA provides a number of new
exemptions and loosens the rules that apply to private investment funds. These changes have a
number of ramifications for plan sponsors, plan participants, investment firms and their counsel.
One of ERISA's major changes to pre-1975 law was to impose a series of "prohibited transaction"
rules on the management and administration of plans. Some of the rules were based on trust law
concepts against fiduciary self-dealing. ERISA went beyond trust law to strictly prohibit
transactions with "parties in interest" to plans, because of concerns that such parties could abuse
their relationships with the plans for their own benefit. These included plan fiduciaries, plan
sponsors, persons providing services to plans and their affiliates.
Under these rules, for example, the plan sponsor could not sell securities or real estate to the
plan, or make a loan in the event the plan were to run short of money to pay benefits. Plan
service providers were prohibited from engaging in purchases or sales with the plan, or even from
providing services to the plan.
This absolute prohibition on transactions with parties in interest has raised many problems, such
as how plans were to secure the services necessary for their operation if not from their service
providers. For this reason, ERISA included a number of exemptions from the prohibited transaction
rules (including for plan service providers to provide services to the plan, thereby removing that
dilemma), and provided a mechanism to create additional exemptions that is administered by the
U.S. Department of Labor (DOL).
Over the years, DOL has granted a large number of class and individual exemptions. Many of
these recognize that transactions with persons whose only relationship with the plan is to provide
nonfiduciary services, such as broker-dealers or record keepers, have limited potential for abuse.
Congress has now established a broad exemption for transactions with service providers to plans
and their affiliates, covering purchases, sales and extensions of credit. This will provide relief for
many technical prohibited transactions that were difficult to monitor, eliminating the need to seek
individual exemptions or rely on class exemptions with their own sets of restrictions.
There are two conditions. First, the service provider (or affiliate) may not be a "fiduciary" to the
assets involved in the transaction. That means that the service provider may not be the manager
of the assets, or provide "investment advice" with respect to those assets. It is unclear whether
the exemption is available for a transaction with a service provider who acts as a "manager of
managers" and appoints the actual manager of the assets.
Second, the transaction must be for "adequate consideration." This term is defined for publicly
traded securities, but its meaning for other types of assets is left to DOL regulations. ERISA
already contains a similar definition, and while DOL proposed regulations under that definition in
1988, they were never made final. Depending on the assets involved, it is conceivable that until
DOL issues further guidance, parties may be reluctant to rely on the service provider exemption
and instead continue to use DOL class exemptions.
Eventually, the new service provider exemption will likely supersede the need to comply with
some of the DOL class exemptions, which often have detailed conditions and requirements.
Lawyers will want to review arrangements operated under those class exemptions to determine
whether compliance with those exemptions continues to be necessary.
The ERISA fiduciary responsibility rules apply to transactions involving "plan assets." Under a DOL
regulation, plan asset treatment is not limited to assets held by ERISA plans themselves, but can
extend to the assets of funds in which ERISA plans invest.
The general rule is that a private investment fund, such as a hedge fund, is subject to ERISA if at
least 25 percent of any class of its equity interests comes from "benefit plan investors." The
regulation defines "benefit plan investors" to cover not only ERISA plans but also nonERISA
employee benefit plans, which can include state and local government as well as foreign plans.
The result has been to discourage private investment funds from accepting ERISA plan
investments because of the restrictions that come from being subject to the ERISA prohibited
transaction rules.
The PPA makes two changes to the plan assets rule. First, it requires that the only plans counted
for purposes of the 25-percent test be limited to those that are either (1) subject to ERISA or (2)
covered by the parallel Internal Revenue Code prohibited transaction rules (for example, individual
retirement accounts (IRAs)) (collectively, ERISA investors). Second, it provides that in the event
that a fund treated as holding plan assets invests in a second fund, only the percentage of its
assets that come from ERISA investors is counted in applying the 25 percent test to the second
fund.
The result is a significant narrowing of the plan assets test. The expected consequence is that
private investment funds should be more willing to accept ERISA investors.
Private fund counsel should revise the ERISA discussion in funds' offering materials to reflect the
change. They also should confirm that the private fund document provisions on the ability to
redeem out ERISA investors to stay under the 25 percent threshold conform to the new manner
for running the test.
There is a clear trend away from "defined benefit" pension plans, which place investment risk on
the employer, in favor of 401(k) and other "defined contribution" pension plans, which place such
risk on the employee. While many defined contribution plans require investments to be directed by
the employees, employees may lack the knowledge to manage their own investments and require
professional investment advice.
However, a person who provides investment advice to plan participants can become a fiduciary,
subject to the ERISA fiduciary rules. There have been two consequences: (1) Companies that
provide the investment options under the plan, which are the most likely source for advice, may
be unable to provide that advice because of conflicts of interest that may violate ERISA; and (2)
plan sponsors are concerned about fiduciary liability if they hire advice providers.
Over the years, DOL has identified categories of "investment education" that can be provided
without making the provider an ERISA fiduciary, and also has described advice structures that
avoid conflicts of interest that could violate the ERISA prohibited transaction rules. Independent
advice firms also have sprung up to fill the void. Nevertheless, many have felt that there were
still too many barriers preventing participants from receiving the advice they need to be able to
effectively manage their retirement savings.
The advice exemption added by the PPA covers investment advice provided to participants by a
"fiduciary adviser," defined as a registered investment adviser, bank trust department or registered
broker-dealer or their affiliates, employees or agents. The principal condition is that the advice
arrangement must follow one of two structures.
Under the first structure, the fiduciary adviser's fees or other compensation must not be affected
by the investments selected by the participant as a result of the advice. Under the second, the
advice must arise solely from the use of a computer model that meets a series of requirements,
including that it be based on objective criteria and independently certified as meeting the
conditions of the exemption. Either structure must be independently approved and subject to
annual independent review to assure compliance with the exemption.
Regulatory action is required before the computer model portion of the exemption can become
available. The certification process, which must be in place before a model can be used, is to be
defined by DOL. Also, the computer model approach is not available to IRAs pending a DOL study
on whether the approach is feasible for IRAs.
Here is an issue for IRAs because the computer model approach was developed for 401(k) and
similar plans that provide a limited menu of investment options that a model can use, while IRAs
typically have no limits on available investments. If DOL does not determine that there is a
computer model investment advice program feasible for IRAs, then it is to grant an administrative
exemption based on the new statutory exemption. So it may be at least a year, and likely longer,
before IRAs can benefit from the computer model approach.
The effect of this new exemption is unclear. The limitations may considerably restrict the flexibility
of firms in structuring advice programs. Some firms are moving forward to develop computer
models that meet the requirements of the exemption (subject to expected DOL guidance), while
others — particularly those with large IRA clienteles — are taking a "wait and see" approach.
In sum, the PPA makes a number of significant revisions to the rules for retirement plans. The
open questions are whether these changes will be effective at promoting plan participation,
increasing retirement savings and improving defined benefit plan funding. If not, more will need to
be done to address concerns as to whether Americans will have sufficient income to provide for
their retirement.
Myers is a partner, Richman is counsel and Chung is an associate at Reed Smith LLP. Myers and
Richman are in the Washington office and Chung is in the Pittsburgh office. Their e-mails are:
dmyers@reedsmith.com; mrichman@reedsmith.com; schung@reedsmith.com.
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Business Law Today
Volume 16, Number 3 January/February 2007
Keeping Current: Canada
By Martin Fingerhut
Federal capital tax is eliminated north of the border
Canada has repealed the federal capital tax. The elimination of this tax will make easier the
crossborder securitization of various classes of Canadian leases and interest-bearing receivables
on a tax-efficient basis. This results from the interplay between the Canadian withholding tax on
the one hand, and provincial capital taxes on the other.
Canada's withholding tax regime creates a significant hurdle to securitizing leases or interestbearing receivables in foreign capital markets. Subject to several exceptions, a 25 percent
withholding tax applies to interest or rent paid to nonresidents. Although this rate is often
reduced by treaty, it rarely falls below 10 percent, and generally renders an off-shore
securitization less than desirable.
Notwithstanding the current withholding tax regime, it has been possible to structure crossborder securitizations of interest-bearing Canadian loans free of withholding tax if the loans
satisfy the three criteria of a statutory withholding tax exemption:
The borrower is a corporation resident in Canada (or a partnership having only such corporations as partners);
with some exceptions (including acceptable events of default), mandatory repayments in the first five years do
not exceed 25 percent of the amount of each loan;
the parties are unrelated and deal at arms-length.
It has also been possible to adapt this long-term corporate debt exemption to structure offshore securitizations for trusts and short-term loans without attracting withholding tax:
In one transaction, a Canadian special purpose corporation (SPV) purchased a revolving pool of floor-plan
loans, and issued five-year notes to U.S. investors.
In another, a Canadian SPV borrowed five-year funds from a UK commercial paper conduit and on-lent the
proceeds to a Canadian securitization trust.
These structures faced a number of complex issues, including the Canadian tax authority's
policies with respect to back-to-back loans, tax minimization at the Canadian SPV level, and the
desire to achieve off-balance sheet funding.
While these structures allow corporateloans to be securitized cross-border without withholding
tax, they have not been used for leases or consumer assets. This stems from a "capital tax"
imposed by certain provinces and, until recently, the federal government.
This capital tax applies to the liabilities and equity of most Canadian corporations, but is offset
by an allowance for a corporation's holdings of loans made to other corporations. It is for this
reason that capital tax applies when a Canadian SPV obtains off-shore funding to finance leases
or consumer loans, but not where the securitized assets comprise solely corporate loans.
With the elimination of the federal capital tax, only provincial capital tax need be considered.
Some provinces do not impose this tax; in others it ranges from .3 percent to .525 percent.
However, a corporation will only be subject to a provincial capital tax if it has a "permanent
establishment' in that province, which will generally depend on (1) the location of its head office
and other places of business, (2) the residency of its employees and (3) the residency of certain
types of agents that have "general authority to contract" on behalf of the corporation.
Except for Manitoba, an agent having general authority to contract will not constitute a
"permanent establishment" if the agent is "independent" and acting in the ordinary course of its
own business (such as, if the agent is not related to the corporation and performs services for a
number of different entities).
Depending on the facts of a particular securitization, it should be possible to design an SPV so
that its only permanent establishment is in a province that does not impose capital tax. By doing
so, it would be possible to structure a cross-border securitization of pools of leases or
noncorporate loans (such as auto loans, residential mortgages, credit card receivables and loans
to REITS) on a basis that avoids both withholding tax and capital tax.
The securitization of more Canadian loans and leases off-shore will enable Canadian originators
to obtain increased and lower-cost financing, while at the same time providing U.S. and other
foreign investors with a diversified portfolio of well-underwritten Canadian receivables.
Fingerhut is a partner at Blake, Cassels & Graydon LLP, in Toronto. His e-mail is
martin.fingerhut@blakes.com.
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Business Law Today
Volume 16, Number 3 January/February 2007
Nonbinding Opinion
By Maria Ann Milano
Involuntary bankruptcy: The end has come
Editor's note: In the last issue of Business Law Today (Nov./Dec. 2006) we published an article
suggesting that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
(BAPCPA) revived a creditors' remedy that had previously been seldom used—the involuntary
petition against an individual debtor. Samole and Keyfetz, "New law, new tools for creditors: A
fresh look at the involuntary bankruptcy petition." On this page is a short article noting that
when Congress imposed credit-counseling as a prerequisite for an individual to be a debtor in a
bankruptcy case, it may have inadvertently eliminated involuntary bankruptcy petitions as a
creditor's remedy against an individual.
Congress should be wary of unintended consequences. The recently enacted Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005 (BAPCPA) contains numerous provisions that
make it more difficult for debtors to discharge their debts to creditors. What Congress did not
intend was to enact a statute that would enable individual debtors to evade their creditors. The
proponents of BAPCPA will surely be surprised to learn that they enacted a statute that removes
a weapon from the creditors' arsenal — the petition for an involuntary bankruptcy of an
individual.
The involuntary bankruptcy petition has long been available to creditors who want to subject
their debtors to the jurisdiction of the bankruptcy court. Involuntary bankruptcies can require
debtors to disclose assets, can prevent the dissipation of assets, and can remedy fraudulent
transfers and preferences. In the BLT article in the last issue, "New law, new tools for creditors:
A fresh look at the involuntary bankruptcy petition," David A. Samole and Lisa B. Keyfetz
suggest that involuntary bankruptcy can subject an individual debtor to the federal homestead
exemption limit, rather than the much more generous homestead exemption granted by some
states (Florida and Texas being the most notorious.).
Samole and Keyfetz (like Congress before them) fail to appreciate how a change to the debtor
eligibility provisions in Section 109(h) of the Bankruptcy Code makes an involuntary petition as
useless as a rubber sword.
BAPCPA left untouched Section 303(a), which states that an involuntary case may be
commenced only against a person "that may be a debtor under the chapter under which such
case is commenced." However, BAPCPA rigidly restricts who may be a debtor. Section 109(h)
states "an individual may not be a debtor" unless he has had credit counseling from an approved
nonprofit agency within the "180 day period preceding the filing of the petition by such
individual." Since BAPCPA became effective on Oct. 17, 2005, there have been numerous
reported decisions striking petitions and dismissing voluntary bankruptcies filed by debtors who
did not have credit counseling before the bankruptcy petition was filed.
Congress surely did not intend the credit counseling requirement to be an impediment to
involuntary bankruptcies. Nevertheless, Section 109(h) provides an individual with a shield
against an involuntary bankruptcy petition. Section 303(a) says that involuntary cases may only
be commenced against eligible debtors, and Section 109(h) says that an individual is an eligible
debtor only if he has taken a credit counseling course in the 180 days before the petition date.
To protect oneself against a creditor's involuntary bankruptcy petition, an individual debtor need
only stay away from credit counselors!
Milano is a principal at Riddell Williams P.S. in Seattle. Her e-mail is mmilano@riddellwilliams.com
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Business Law Today
Volume 16, Number 3 January/February 2007
Snap Judgments
By Francesca Jarosz
It ain't easy being global
If you're a law firm, that is. According to the Chicago Tribune, there are differences between the
U.S. system and that of London, where firms have heavy central management and lawyers
advance through a regimented, 10-year process. Another trick is making the firm's image
universally appealing and managing the multinational enterprises.
But these challenges haven't stopped some of the top U.S. firms from trying to take their vast
practices overseas. In Chicago, for example, the firm Kirkland & Ellis has established outposts in
London and Munich and is looking to venture into Hong Kong. Others have acquired foreign firms
as a way of expansion, and many are making it a top priority.
Investigating the investigators
It's a bit ironic that the federal body responsible for keeping an eye on potential foul play in the
investment market is getting the once-over itself. The Securities and Exchange Commission,
which has taken some heat for its handling of a recent insider-trading case, will be reviewed by
Congress' investigative branch, the Governmental Accountability Office, the New York Times
reports.
In late October, the GAO accepted the request of Senate Finance Committee Chair Charles
Grassley, a Republican from Iowa, to look into the SEC's enforcement unit, which investigates
violations of securities laws, and its office of compliance, inspection and examination, which
handles a slew of regulated companies.
It will do that by analyzing things such as seeing how many referrals the SEC gets that actually
trigger regulatory action. The accountability office will also look at the types of cases the SEC
brings and how it tracks them, with a focus on policing insider trading.
As of August this year, the SEC had opened 838 investigations.
Reviews of the SEC aren't rare. The GAO has examined the commission in 2004 and 2005. John
Heine, an SEC spokesman, said the group welcomes the review and looks forward to receiving
recommendations.
Critics, rev up your engines.
And speaking of the SEC ...
One of the bigger challenges of complying with the agency's recently expanded guidelines for
executive pay disclosure will be the requirement that proxy statements have a discussion and
analysis section on compensation that is written in everyday language. In the analysis,
companies have to answer questions about the objectives of the compensation program and
what it's designed to reward. In other words, get away from vague euphemisms, such as "pay is
based on performance," and cut to the chase.
HR Magazine offers some tips on how to do just that: Start work early to make sure you
understand the objectives and get professional help if you don't. Setting up a mock analysis is
helpful to prepare for the real thing, and get the compensation committee involved.
After all, it's important that everyone speaks the same language, especially when that language
can be difficult to understand.
Business travel hotels: No room for kids
Travelers thinking of bringing the kids along might receive a less-than-cheerful greeting at the
Holiday Inn or Omni. Hotels like these, which once aimed at attracting families, have traded that
approach for loyalty to their standard customer: the business traveler.
Sure, crayons and activity books are nice, but they don't necessarily fit in with the hotels' classy
surroundings. "It's inauthentic for a hotel to try to be something that it's not," Mark Snyder, a
brand-management executive, told the New York Times.
It's also difficult to cater to both the business guests, who want peace and quiet, and
youngsters, who just want to splash in the pool. And for hotels, the former seems to be more
promising.
What's in it for the little ones? Well, there's always the complimentary soap.
Smooth operators
Callers, beware: Your records aren't as confidential as you might think. There's a controversial
and, by some definitions, illegal practice called "pretexting" out there, and detectives,
information brokers and even some companies use it to track down phone records. According to
Newsweek, pretexters call phone companies pretending to be someone else to get their hands
on the records, which can be used for everything from tracking information on job candidates to
finding car owners who are late on making payments.
Some companies, such as Verizon, have used security codes and other measures to protect
callers from getting their records swiped. Others, such as AT&T, don't think the problem is big
enough for such a fuss. In fact, the extent of pretexting is a tough call to make. One complaint
to the Federal Trade Commission on the issue listed 40 Web sites promoting the service.
Federal and state bills to illegalize the practice are pending. In the meantime, you might want to
call with care.
The law of the bottom line
Talk about growing pains. At firms trying to climb for the ranks among the top 100, lawyers
who aren't making the dollar are likely to be replaced, the Chicago Tribune reports. With today's
pressure on not only growing, but growing profitably, a concept known as revenue per lawyer
(RPL) is becoming the law firm equivalent of the corporate earnings per share. And increasing
RPL is a big priority, especially at mid-level firms itching to become one of the big dogs.
"You subtract lawyers who don't meet the market criteria you're trying to achieve," said Chicago
legal consultant Joel Henning.
So much for a pep talk.
Who's the boss?
It's hard to tell at some companies these days. In the first eight months of 2006, 960 corporate
head honchos were replaced at various companies, according to U.S. News & World Report. It's
happening at firms from Ford Motor to Viacom, and in some cases, the turnover time is less
than nine months.
At companies like the pharmaceutical giant Bristol-Myers Squibb, the move is an attempt at
redemption from financial woes and a shot at a PR boost. And Bristol-Myers has scored success
in both. Since the New York-based company replaced its CEO in September, its stock has
jumped 6 percent.
That's good news for everyone. Except, of course, the CEO.
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