By R. Lee Vail, P.E., Ph.D., J.D.

Up-to-date Process Safety Information

When originally adopted in 1996, the Environmental Protection Agency (EPA) adopted

“the requirements of the OSHA PSM Standard, 29 CFR 1910.119(c) through (m) and (o), with minor changes to address statutory differences. This makes clear that one accident prevention program to protect workers, the general public, and the environment will satisfy both OSHA and EPA.” [1]

But do they?

On January 13, 2017, the EPA amended the Risk Management Program (RMP) requirements including changes to the incident investigation report requirement (located in §1910.119(m) of PSM) and other provisions previously aligned with OSHA PSM. Whereas the contents of the incident investigation report may be a minor change, one change was flatly contradicted by an Occupational Safety and Health Review Commission (OSHRC) decision in September of last year: whether documentation of process safety information (PSI) was a continuous obligation.

When revising the requirement for PSI (located in §1910.119(d) of PSM) the EPA said:

EPA is revising § 68.65(a) in order to remove irrelevant text regarding the timeframe for initial development of PSI and to more clearly demonstrate that PSI must be kept up-to-date. EPA is revising § 68.65(a) to remove the phrase “In accordance with the schedule set forth in § 68.67” and is adding the phrase: “and shall keep PSI up-to-date.” EPA expects that revising § 68.65(a) in this manner will help Program 3 facilities to better comply with PSI requirements and further clarifies the requirement that PSI must be completed prior to conducting a PHA.[2]

Apparent from this discussion, EPA intended merely to “clarify” that the obligation to update PSI was continuous. It is important that EPA did not discuss this change as a change in substance. It was EPA’s interpretation of an OSHA rule.

However, the OSHRC came to a different decision when it said

the obligation to document RAGAGEP compliance is not continual.” Paragraph (d)(3)(ii), using the verb form of “document,” directs the employer to take an action that naturally takes place at a particular point in time. That point in time is specified in paragraph (d), which contains the cited requirement as a subsidiary provision, specifically stating that written process safety information is to be completed “[i]n accordance with the schedule set forth in paragraph (e)(1)”— that is, every five years.17 29 C.F.R. § 1910.119(d), (e)(1), (e)(6). Therefore, on its face, the requirement to document compliance with RAGAGEP applies only every five years.[3]

Further, the OSHRC decision (which came after the EPA rule change), potentially has further implications. The OSHRC further opined, “because the duty imposed by the standard to discover non-RAGAGEP conditions is not continual, the duty to ensure RAGAGEP compliance must also not be continual.” Id. The OSHRC concluded that OSHA’s interpretation was unreasonable based on the regulatory history and would make another provision (§1910.119(j)(4)(iii)) superfluous.

This conclusion influenced another ORHRC opinion, that the “interim measures” provision of §1910.119(j)(5) effectively suspends the “comply with RAGAGEP” provisions of §1910.119(d)(3)(ii):

In sum, the only reasonable interpretation of (d)(3)(ii) is that (j)(5)’s interim measures option dictates the timing for when non-RAGAGEP equipment must be documented as RAGAGEP-compliant. In other words, if interim measures have been implemented and the deficiency is corrected “in a safe and timely manner,” an employer need not document that such equipment conforms to RAGAGEP until the deficiency has been corrected. Id.

It is highly possible, based on the statements made during the rulemaking process, that the OSHRC would have concluded anyway that “interim measures” would suspend the need to “document RAGAGEP.” But one thing is certain; OSHA’s opinion and EPA’s 2017 “clarification” of the OSHA rule (that PSI must be kept current) were rejected by the OSHRC in the BP Products/BP Husky case.

Now what?

________________________________

[1] 61 Fed. Reg. 31668, 31672 (June 20, 1996) [Emphasis Added].

[2] 82 Fed. Reg. 4594, 4675 (January 13, 2017) [Emphasis Added].

[3] Bp Prod. N. Am., Inc., 2018 O.S.H. Dec. (CCH) ¶ 33688 (04 National/Federal Sept. 27, 2018). [Emphasis Added.]

By the Kean Miller Tax Team

The 2019 Regular Session of the Louisiana Legislature ended on June 6, 2019. Important new tax provisions include several legislative acts signed into law by the Governor along with several proposed constitutional amendments that will appear on the ballot this October. In addition to substantive law changes, important remedial legislation was also passed that addressed the ability to appeal a state tax refund denial but left a possible trap for the unwary with respect to local refund claims.  The following are some notable legislative enactments that made it out of the 2019 Session.

Income and Franchise Tax Legislation

Act 442 (SB 223), enacted June 22, 2019.

New Pass-Through Rules Impacting the Federal SALT Deduction Cap

Act 442 allows an S corporation or any entity taxed as a partnership for federal income tax purposes to elect to be taxed as a C corporation for Louisiana income tax. The modification allows pass-through owners to pay state and local taxes at the entity level, bypassing the $10,000 SALT cap introduced in the Tax Cut and Jobs Act which only applies to individuals.

Reports emerged on July 23, 2019 that Treasury and the IRS have stepped up meetings with tax practitioners concerning this and similar SALT cap workarounds passed by state legislatures. The IRS included guidance on applying the SALT deduction cap to pass-through entities on its April 2019 Priority Guidance Plan update, and it is likely that new regulations are on the horizon that may limit the usefulness of this type of “workaround.”

Act 442 became effective on June 22, 2019.

Act 304 (HB 263), enacted June 11, 2019.

Net Operating Loss (“NOL”) Carryfowards Revert Back to First-In, First-Out

Act 304 amends R.S. 47:287.86(C)(2) to provide that the net operating loss carryforwards are applied starting with the earliest taxable year of NOLs when calculating taxable income for taxable periods beginning in 2020. This legislation reinstates the pre-2016 NOL carryforward rules (before the unpopular and problematic legislative changes creating the “last-in, first-out” ordering rules introduced during the 2016 budget crisis).  Louisiana NOL tracking has now become even more complicated (although this is a welcome change to the law).

Act 304 became effective on June 11, 2019.

Economic Development and Incentive Legislation

Act 203 (SB 237), enacted June 11, 2019.

Authorizes New Tax Increment Financing Projects in Economically Deprived Areas

 Act 203 authorizes the creation of new tax increment financing districts in areas with high unemployment. New public entities covering the districts will have the authority to borrow against future increases in sales and property tax collections in order to fund new economic development projects.

Act 203 became effective on June 11, 2019.

Act 251 (HB 585), enacted June 11, 2019.

 Property Located Within New Federal Opportunity Zones to Qualify for Restoration Tax Abatement Program

 Act 251 amends R.S. 47:4312(3) to add structures located in new federally designated Opportunity Zones to the property eligible to participate in the Restoration Tax Abatement Program. Qualifying property owners renovating or restoring buildings within Opportunity Zones are now eligible to contract with local governing authorities to temporarily freeze property tax assessments for 5 years at the pre-improvement level.

Act 251 became effective on June 11, 2019.

Sales and Use Tax Developments

Act 360 (HB 547), enacted June 17, 2019.

Reenactment of Remote Seller Law

Act 360 amends and reenacts Louisiana’s remote vendor law to more effectively implement a post-Wayfair “remote seller” sales tax registration system through the creation and establishment of the Louisiana Sales and Use Tax Commission for Remote Sellers. A loophole in the drafting of last year’s legislation made its application (including the Commission’s service as the central collector for sales/use taxes on remote sales) contingent on a ruling of the Supreme Court of the United States that the South Dakota sales tax law at issue in Wayfair was constitutional. However, the Supreme Court never technically ruled on the constitutionality of the South Dakota sales tax law, holding only that physical presence was no longer a requirement for “substantial nexus” (under Complete Auto Transit) and remanding to the South Dakota Supreme Court to determine whether the rest of the law was constitutional.

The new legislation sets a hard deadline of July 1, 2020 for the new Commission to start collecting tax. Out-of state sellers with more than $100,000 in sales or 200 transactions in Louisiana are required to file Direct Marketer Returns under R.S. 47:302(K) until the new system is ready.

The Act contains several drafting issues Louisiana courts will undoubtedly be called upon to address, and as a result, its practical scope may be much more limited than anticipated. For example, the definition of “remote seller” under Act 360 is limited to sellers that both lack physical presence in Louisiana and which are not considered “dealers” under R.S. 47:301(4)(a)-(l), greatly restricting the impact of the law. In addition, the Act does not address whether online marketplace facilitators qualify as dealers, an issue currently pending before the Louisiana Supreme Court under Normand v. Wal-Mart.com USA, LLC, 2019-0263 (La. 5/6/19).

Act 360 becomes effective on August 1, 2019.

Act 359 (HB 494), enacted June 17, 2019.

Specifies Sales and Use Taxes for Asphalt

Act 359 provides sourcing rules for sales and use tax on raw materials to be converted into road asphalt.

Act 359 became effective on June 11, 2019.

Property Tax Relief

Act 432 (HB 301), enacted June 22, 2019.  

Proposed Constitutional Amendment to Exempt Goods Destined for Outer Continental Shelf From Property Tax

Act 432 would amend R.S. 47:1951.2 and 1951.3 to exempts raw materials, goods, commodities and other property stored in Louisiana and destined for the Outer Continental Shelf from ad valorem tax.

The exemption will take effect subject to approval by the voters of a constitutional amendment on the ballot this October.

Act 385 (HB 493), enacted June 20, 2019.

Authorization for a Homestead Exemption Audit Program in New Orleans

Act 385 allows the city of New Orleans to establish a homestead exemption audit program for Orleans Parish property. The city is authorized to impose a fee up to ten percent on the total amount of taxes, penalties, and interest owed by a taxpayer.

Act 385 becomes effective on August 1, 2019.

Board of Tax Appeals

Act 365 (HB 583), enacted June 19, 2019.

Proposed Constitutional Amendment to Expand Board Jurisdiction 

Act 365 would expand the jurisdiction of the Board of Tax Appeals to include challenges to taxes under Federal law or the Constitution of Louisiana.   

The change will take effect subject to approval of a constitutional amendment to be set before voters on the ballot this October.

Act 367 (SB 198), enacted June 18, 2019.

Allows State (but not Local) Refund Claims for Illegal Tax Overpayments Without Payment Under Protest

Act 367 legislatively overrules last year’s Louisiana First Circuit Court of Appeal decision in Bannister Properties which held that R.S. 47:1621(F) prohibits refunds arising from the Department of Revenue’s misinterpretation of a law or regulation without a payment under protest. Bannister Properties concerned several taxpayers who had voluntarily paid franchise tax under a Department regulation later ruled invalid. The new legislation repeals R.S. 47:1621(F) in its entirety and allows refund claims for all overpayments due to any unconstitutional law, illegal regulation, or misinterpretation of a law or regulation by the Department of Revenue.  The new legislation does not appear, however, to address the appeal of a denial of a local refund tax claim.  This means there may be no effective remedy for taxpayers to recover local taxes not paid under protest even if the tax is later determined to be illegal.       

Act 385 became effective on June 18, 2019.

Local Taxes

Act 169 (HB 43), enacted June 7, 2019.

Authorizes Occupancy Tax on Short-Term Rentals in New Orleans

Act 169 authorizes the City of New Orleans to levy and collect a tax upon the paid occupancy of short-term rentals located within the city. The tax may not exceed six and three-quarters (6.75%) percent of the rent or fee charged for occupancy. The City Council may impose the occupancy tax by ordinance after voter approval.

Act 169 became effective on July 1, 2019.

If you have questions, please contact Kean Miller tax attorneys, Jaye Calhoun (504.293.5936), Jason Brown (225.389.3733), Angela Adolph (225.382.3437), Phyllis Sims (225.389.3717), Willie Kolarik (225.382.3441) or Sanders Colbert (504.585.3021).

By Jessica C. Engler & Michael deBarros[1]

Policyholders are often disappointed in the amount of time their insurers take to investigate and pay claims.  In 2003, the Texas Legislature enacted the Texas Prompt Payment of Claims Act (“TPPCA”) to facilitate the prompt investigation and payment of Texas insurance claims.[2] Codified at Section 542 of the Texas Insurance Code, the TPPCA imposes an affirmative duty on insurers to promptly pay claims as soon as it becomes “reasonably clear” that they are obligated to do so under the policy.

The TPPCA outlines requirements and deadlines that insurance carriers must meet to avoid paying penalties to an insured.[3] In short, the TPPCA generally requires insurers to accept or reject claims within 15 business days of receiving of the insured’s written notice of claim, or within 30 days for surplus line insurers. If the insurer rejects the claim, it must state its reasons for rejection. If an insurer accepts a claim, it must pay the claim within 5 business days. If the insurer fails to pay the claim within 60 days, the insured is entitled to payment of the claim, statutory damages of 18 percent interest per year, and attorney’s fees.

Texas courts have continuously held that to prevail under a claim for TPPCA damages under section 542.060, the insured must establish: (1) the insurer’s liability under the insurance policy, and (2) that the insurer failed to comply with one or more sections of the TPPCA in processing or paying the claim.[4] Although this test is easily applied to insureds who do not receive acceptance or rejection of their claim within the 15 day time period, or payment within 5 business days after acceptance of their claim, the procedure is less clear when the insured submits to the appraisal process after the insurer has rejected the claim.

Many property insurance policies have appraisal clauses. A typical appraisal clause provides that if the insured or the insurer disagrees on the valuation of property or the amount of loss, either party may make a written demand for appraisal of the loss. After the demand is made, the insured and insurer each select an appraiser and the two appraisers value the property and set the amount of the loss as to each item. If the appraisers fail to agree on a valuation or the amount of loss, the dispute is submitted to an “umpire” who determines a valuation and amount of loss that is binding on the parties.

In Barbara Technologies v. State Farm Lloyds[5]  and Ortiz v. State Farm Lloyds,[6] the Texas Supreme Court recently decided whether an insurer may be liable for damages and fees under the TPPCA after it pays an insured, in full, within five business days of an appraisal award. The cases are factually similar. In both cases, the insureds filed claims for wind and hail damage and State Farm denied the claims, alleging that the damages sustained were less than the policy deductibles. The insureds filed suit to recover damages for the underpayment, and State Farm invoked the appraisal clauses. The appraisers found State Farm had undervalued the loss, and State Farm issued payments to the policyholders within the five business days of the appraisal award. The trial court in both cases concluded that State Farm’s prompt payment of the appraised amount at the conclusion of the appraisals foreclosed all TPPCA claims against the insurers.

On appeal, the Texas Supreme Court held that the TPPCA’s requirements and deadlines—including the 60 day payment deadline—continue to apply, even during appraisal. Consequently, an insurer’s payment of an appraisal award within five business days of the award does not immunize it from TPPCA claims. The Court did note, however, that an appraisal award does not establish liability under an insurance policy as a matter of law.  Therefore, an insured must still prove that the loss is covered under the policy to succeed in its TPPCA claim.

These cases are important because insurers can no longer avoid TPPCA liability by rejecting a claim, invoking appraisal, and delaying payment until the appraisal concludes. In his dissent, Justice Nathan Hecht cautioned that the holding could have a chilling effect on the appraisal process:

The result of today’s decision is this: If an appraisal is requested, either by the insurer or the insured, after a claim has been rejected in whole or in part, and the insurer immediately pays the award, it is nevertheless liable for 18 percent interest and attorney fees if the claim is later adjudicated to be covered by the policy. Unless the insured gives up, litigation is unavoidable, either over the rejection or over the penalty. If that does not make appraisal requests unlikely, it certainly makes them less likely. The Court renders the appraisal process it praises of little use.

Time will tell whether these opinions materially affect the way insurers handle claims in Texas.  For now, insurers are on notice that the appraisal process will not, by itself, suspend or eliminate TPPCA delay damages.

*********************************************************

[1] Special thanks to Gabriella Leonovicz, Tulane University Law School Class of 2021, for her assistance with this article.

[2] See Mike Geeslin, Texas Dep’t of Insurance, Technical Advisory Committee on Claims Processing Report on Activities, Sept. 2010, at 2-4 (2010).

[3] See Tex. Ins. Code §§ 542.055(a)(1)-(3), .056(a), .057(a) .058(a), .060.

[4] Barbara Technologies Corp. v. State Farm Lloyds, No. 17-0640, p. 10, June 28, 2019 (https://www.txcourts.gov/media/1444300/170640.pdf)

[5] Id.

[6] Ortiz v. State Farm Lloyds, No. 17-1048, June 28, 2019 (https://www.txcourts.gov/media/1444305/171048.pdf)

 

By Ed Hardin

As reported by national and local media outlets, two Gretna, Louisiana, police officers were fired for social media activity that targeted Congresswoman Alexandria Ocasio-Cortez.  In the case of one of the officers, he posted a message on his personal Facebook page regarding the Congresswoman that allegedly included threatening remarks directed toward her.  The second officer then gave a “like” to the post.  Media outlets quickly picked up the story. The Gretna Police Department then fired both officers for violating the Department’s social media policy.  The situation is a vivid illustration of how social media activity can intersect with employment issues with serious consequences.  For employees, it shows that employees can be held responsible for their social media activities.  For employers, it shows the value of social media policies and how those policies can serve as reminders to employees to be mindful of their social media activities.  For more about the story see the recent articles from NOLA.com and CBS news.

 

 

 

By Max B. Kallenberger

A potential purchaser of a business and a corresponding seller often disagree on the value of the business, particularly in regard to sales projections.  The purchaser may attempt to entice the seller with what it believes is a fair compromise – accepting the perceived over-inflated price asked for by the seller, but paying only a portion at closing, with the balance payable a few years later if the projected sales forecast is in fact achieved.  The seller readily agrees, confident the business will absolutely grow and this so-called “earnout” will net the additional proceeds without fail.  Sounds like a win for both parties – but is it too good to be true?

Earnout provisions allow a purchaser to condition a portion of the purchase price on the future performance of the purchased business.  If the buyer does not have the cash available for full payment of the asking price, an earnout provision can be used to delay payment of the purchase price with certain conditions and parameters placed on paying the additional amount, such as meeting specified financial goals after the sale.  While earnout provisions sound fairly reasonable and easy to apply in theory, in practice these provisions often result in hardships for both the purchaser and seller, who may have very different objectives post-closing. Once the seller has sold its business, it no longer has control of operations and can no longer make important decisions. Because earnout provisions are typically contingent on the business performing well after the sale, the seller has a strong interest in ensuring the business operates in a progressive manner; however, the buyer often wants to implement new or different strategies that will be beneficial in the long term, but that could result in revenue declining over the earnout period.  Even though a seller may continue in a limited role after the sale, with the loss of control, the seller will be hard pressed to argue for strategies that would result in maximizing the earnout.

Earnout provisions can also be a problem for the buyer, who will need to be careful not to purposefully limit or minimize the earnout, which could result in litigation between the parties.  Buyers typically do not have any duty to ensure or maximize an earnout.  To counteract this potential problem, sellers may argue that an implied covenant of good faith and fair dealing exists on the part of purchaser which precludes the purchaser from engaging in conduct depriving the seller of the earnout benefit.  However, proving that a purchaser has in fact breached this covenant also presents its own problems.  Suits over a breach of earnout provisions can be expensive and can be difficult to prove on the part of a seller.  One solution is to state that the purchaser will use its “best efforts” to maximize the chances that the earnout is attained.  Again, however, this only provides minimal assurances to the seller as lawsuits can devolve into whose expert is more credible as to whether “best efforts” were in fact used by the purchaser.

Because courts have generally refused to fill gaps or provide additional terms in earnout provisions, such provisions should be drafted with as much clarity as possible and contextualized to fit the specific type of business at issue.  An earnout provision should include which party is responsible for preparing relevant financial statements the earnout may be calculated from and what review and objection rights the remaining party has to such statements.  The provision should also specify the accounting principles and procedures to be used in preparing the statements, and if necessary, be business or industry specific.  A dispute resolution process should also be included to cover situations where the buyer and seller cannot resolve a disagreement over the earnout calculation.  Without covering these specifics in detail, a seller runs the risk of not receiving any earnout compensation.  Thus, it is important that earnout provisions and dispute resolution procedures be specified in detail in the purchase agreement – or, not used at all.  From the seller’s vantage point, the best solution is to receive as much  of the purchase price as possible at the time the purchase is closed.

By Jill A. Gautreaux

Effective June 6, 2019, Act 164 of the 2019 regular session of the Louisiana legislature legalized the use of Cannabidol (CBD) for certain applications.  The Act permits the use of industrial hemp, which was declassified from being a Schedule 1 controlled dangerous substance by the US Congress last year in the 2018 Farm Bill.  Industrial hemp is derived from the Cannabis Sativa L species of plant, exclusive of the plants of Genus Cannabis that meet the definition of marijuana, as defined by La. R.S. 40:961.

The Louisiana Legislature recognizes industrial hemp as an agricultural commodity and has authorized its cultivation.  Industrial hemp growers must be either a USDA-licensed hemp grower or licensed by the Louisiana Department of Agriculture and Forestry and registered with the Louisiana Department of Health and Human Services in accordance with Louisiana’s Food, Drug and Cosmetic law.  The rules and regulations governing the cultivation of industrial hemp will be promulgated once the USDA rules on the subject are promulgated. The CBD product cannot be used as an inhalant or in alcoholic beverages and food products (unless and until approved by the FDA), or claim to be a dietary supplement.  The CBD product is subject to specific labeling requirements, including having a disclaimer that the product has not been evaluated by the FDA and having a scannable bar code that links the product with its certificate of analysis.  CBD must have a concentration of not more than 0.3% of delta-9 tetrahydrocannabidol (THC) by dry weight basis.  Lab analysis of the CBD product must be performed to insure compliance with regulations and a certificate of analysis must be filed with the Louisiana Department of Health and Human Services.

The Louisiana Office of Alcohol and Tobacco Control (ATC) has been charged with the licensing of wholesalers and retailers of CBD products.  A list of the wholesalers’ and retailers’ registered products must be provided to the ATC.  The application to become a CBD wholesaler or retailer is now available from the ATC, but formal rules and regulations to govern such licensees are not yet promulgated.  The application/annual licensing fee is $175.00.

Sales of CBD products will be subject to a three (3%) percent tax rate, in addition to applicable State and local sales taxes.  The additional taxes have been earmarked for the Early Childhood Education Fund.

By Tod J. Everage

Today, the U.S. Supreme Court resolved a Circuit Split, holding that punitive damages are not recoverable to a seaman under an unseaworthiness claim. The Court, in a 6-3 ruling, sided with the U.S. Fifth Circuit’s analysis under McBride and reversed the U.S. Ninth Circuit’s decision in Dutra v. Batterton. The Court followed Townsend, in which the Court previously allowed punitive damages for failure to pay maintenance and cure under General Maritime Law, but recognized the distinction between such a claim and the historical prohibition of punitive damages for unseaworthiness claims. The Court reasoned that unseaworthiness in its current form was purely the Court’s own invention, which came after the passage of the Jones Act. In what is sure to be good news for vessel owners and Jones Act employers, the Supreme Court re-enforced the governance of the Miles uniformity principle between maritime statutory law and maritime common law.

The Court’s full decision can be read here.

 

By: Katie M. HollowellDevin Ricci, and Eric Lockridge

A recent United States Supreme Court decision handed down in May addressed what occurred when contract, bankruptcy, and intellectual property laws intersected.[1] In Mission Products Holdings, Inc. v. Tempnology, LLC nka Old Cold, LLC, the Supreme Court was presented with the question of whether a debtor’s rejection of an executory contract rescinded the rights conveyed with that contract. Holding that a rejection of the contract is a breach, the Supreme Court found, using traditional contract principles, that the rights at issue survive the debtor’s breach.

The rights at issue were Mission Products Holdings, Inc.’s (“Mission”) non-exclusive rights to use Tempnology, LLC’s (“Tempnology”) trademarks. As part of an exclusive distribution licensing agreement in 2012, Tempnology granted Mission a non-exclusive trademark license to use in distributing Tempnology’s products. The parties’ agreement was set to expire in July 2016, but in 2015 Tempnology filed a Chapter 11 Petition for Relief. Chapter 11 of the United States Code (the “Bankruptcy Code”) allows a debtor or its trustee to “reject” an executory contract, meaning the debtor can cease performing under the contract.[2] Tempnology took advantage of this provision and requested the Bankruptcy Court’s approval to reject its contract with Mission.

An executory contract, according to the Supreme Court, is one in which “performance remains due to some extent on both sides.” When a debtor rejects the executory contract, it will repudiate any further performance. The Supreme Court held, according to 11 U.S.C. § 365(g), that rejection of the contract constituted a breach.

The parties agreed on two consequences of Tempnology’s rejection: (1) Tempnology could cease its performance and (2) Mission could assert a pre-petition claim in Tempnology’s bankruptcy for damages. Mission’s claim would be pre-petition because upon rejection, the breach is deemed to occur immediately before the Petition for Relief was filed.[3] But, Tempnology contended one more consequence flowed from its rejection – Mission’s rights to use its trademark terminated. The Bankruptcy Court agreed, and terminated Mission’s trademark license. The Bankruptcy Court Appellate Panel disagreed and reversed, which in turn was reversed and the Bankruptcy Court’s decision reinstated by the First Circuit. The First Circuit agreed with the Bankruptcy Court that Mission’s license had terminated upon rejection.

The Supreme Court, however, held that 11 U.S.C. § 365(g) states rejection constitutes a breach and “breach” is not a specialized bankruptcy term. Thus, the consequences of rejection are those that occur upon breach in normal contract law – a contract granting a license that is breached does not revoke the license or prevent the licensee from doing what the license allows. Interestingly, the Supreme Court qualified this holding, stating that the license continues subject to any special contractual term or applicable state law.

Furthermore, the Supreme Court found Tempnology’s argument that special considerations of trademark law meant the license should terminate to be unavailing. The Supreme Court looked to 11 U.S.C. § 365’s illustrative provisions, such as the one in 11 U.S.C. § 365(n), applicable to patent law.[4] The Supreme Court noted that these provisions were enacted in response to special situations and were Congress’s response to particular cases. Their enactment did not erase the general rule in 11 U.S.C. § 365(g) that rejection constitutes breach. The Supreme Court reversed the First Circuit’s decision, holding Mission’s trademark licensing right survived Tempnology’s rejection of the contract.

The Supreme Court’s holding could have interesting implications for contract drafting techniques involving trademark and other intellectual property rights in the event the licensor ends up in bankruptcy. How the Supreme Court would rule when faced with a particular contract provision governing such a situation remains to be seen. But the case serves as a lesson to practitioners to consider carefully the ramifications of rejection of an executory contract in bankruptcy.

************************************************

[1] Mission Products Holdings, Inc. v. Tempnology, LLC nka Old Cold, LLC, 587 U.S. ___ (2019).

[2] See 11 U.S.C. § 365(a).

[3] 11 U.S.C. § 365(g)(1).

[4] See, e.g., 11 U.S.C. §§ 365(h), (i), and (n).

By: Jessica C. Engler

Outsourcing of basic business functions is increasingly popular. While businesses would once perform data management in-house and rely on their on-site server infrastructure to store data, businesses today are frequently turning to cloud storage providers and other third-parties to hold and manage data. These third party vendors are frequently charged with holding sensitive personal information, such as protected health information, social security numbers, and payment card information, supplied to them by their customers.

In a breach involving multiple entities in the data-supply chain, companies rely on their contracts to avoid liability—regardless of whether the breach originated with the consumer-facing company, a third party processor, a third party cloud storage provider, or another entity. Yet, in some cases, indemnity clauses inside the vendor agreements aren’t as comprehensive as believed at the time they were negotiated. A recent opinion from the Sixth Circuit, on appeal from the U.S. District Court for the Western District of Tennessee, Spec’s Family Partners Ltd. v. First Data Merchant Services, LLC, highlights the importance of indemnity agreements and consequential damage waivers in the data breach context.[1]

Spec’s Family Partners, Ltd. (“Spec’s”) operates a chain of liquor stores that allow customers to purchase goods using payment cards backed by payment networks like MasterCard and Visa. These payment networks contract with issuing banks, which issue payment cards to consumers, and acquiring banks, which sponsor merchants in the system and process the transactions. Intermediary companies like First Data Merchant Services, LLC (“First Data”) frequently contract with acquiring banks to facilitate transaction processing from merchants.

In 2012 and 2013, Spec’s payment card network was compromised; the attackers installed malware and accessed customer payment data. After the issuing banks reimbursed the affected consumers for the fraudulent charges and replaced cards, Visa and MasterCard issued assessments on the acquiring bank, Citicorp Payment Services, Inc. (“Citicorp”). Citicorp then demanded payment from First Data, which then sought reimbursement from Spec’s. Spec’s refused to pay, relying on the consequential damages waiver in its Merchant Agreement with First Data (“MSA”). In response, First Data began withholding the proceeds of routine payment card transactions from Spec’s, placing them in a reserve account. At the time suit was filed, First Data had withheld approximately $2.2 million, and the total would ultimately reach $6.2 million.

The district court sided with Spec’s, holding that card brand assessments constituted consequential damages (and not “third-party fees and charges”), recovery for which was waived under the MSA. The district court later granted summary judgment in favor of Spec’s, holding that First Data materially breached the MSA when it held funds to reimburse itself for the breach assessments. First Data appealed the grant of summary judgment, and the Sixth Circuit undertook a de novo review of both the contract interpretation and summary judgment decision.[2]

On appeal, First Data claimed that the contract’s indemnification clause assigns responsibility to Spec’s as it stated that Spec’s must indemnify First Data, Visa, and MasterCard, and hold them harmless from and against:

any and all claims, demands, losses, costs, liabilities, damages, judgments, or expenses arising out of or relating to (i) any material breach by [Spec’s] of its representations, warranties or agreements under this Agreement; [or] (ii) any act or omission by [Spec’s] that violates . . . any operating rules or regulations of Visa or MasterCard . . .

Investigation of the data incidents revealed that Spec’s had failed to comply with the Payment Card Industry Data Security Standard[3] (“PCI DSS”) prior to the attacks, which had left it vulnerable to breaches. First Data argued that Spec’s failure to comply plus this contractual clause obligate Spec’s for the third party assessments. However, the MSA also contained the following limitation of liability:

IN NO EVENT SHALL EITHER PARTY’S LIABILITY OF ANY KIND TO THE OTHER HEREUNDER INCLUDE ANY SPECIAL, INDIRECT, INCIDENTAL, OR CONSEQUENTIAL LOSSES OR DAMAGES, EVEN IF SUCH PARTY SHALL HAVE BEEN ADVISED OF THE POSSIBILITY OF SUCH POTENTIAL LOSS OR DAMAGE.

The ultimate question before the Sixth Circuit was whether the card brand assessments passed on by First Data constituted “consequential damages.” Applying classic constructs of contract interpretation, the Sixth Circuit observed that Tennessee law defines consequential damages (or “special damages”) to be damages that “are the natural consequences of the act complained of, though not the necessary results.”). The Sixth Circuit found the data breaches, which resulted in assessments were a natural result of Spec’s PCI DSS non-compliance, but did not necessarily follow from that non-compliance. Citing Spec’s argument, the Sixth Circuit observed that a non-compliant merchant might never suffer a data breach: “Though certainly a foreseeable consequence of a weak data security, the issuance of assessments nevertheless constitutes consequential damages because it did not necessarily follow from Spec’s Family’s non-compliance.”[4] Therefore, the Sixth Circuit confirmed that First Data retained liability for the assessments under the MSA and, consequently, that First Data materially breached the MSA by withholding payment to Spec’s.

First Data countered before the district court and on appeal that Spec’s first breached through its PCI non-compliance. The courts were not persuaded by this argument because, after the first breach in 2012, Spec’s began focusing becoming more PCI compliant.[5] Spec’s hired a PCI consultant, and Spec’s paid a $10,000 non-compliance fine levied by Visa without contest.[6] After the 2012 breach, First Data and Spec’s continued to perform under the MSA, so the district court—and subsequently the Sixth Circuit—determined that the PCI non-compliance could be considered cured and/or did not rise to the level of a breach “vital to the existence of the contract.”

This case highlights the importance of indemnity clauses and consequential damage waivers in data vendor contracts. While a company may be successful in negotiating a favorable indemnity agreement, that indemnity can be undercut by a general consequential damages waiver. Particularly in data breach claims as seen in Spec’s Family Partners, that waiver of consequential damages can result in millions of dollars in liability. Rather than generic waivers and indemnification clauses, parties negotiating contracts that will require sensitive data sharing may want to consider carve-outs specific to data breaches or cyber liability. Parties may also consider breaking out the limitations into categories, based upon the type, cause, or amount of the damages. The parties may also look to cyber insurance to provide coverage. None of these approaches are mutually exclusive nor comprehensive, and parties should discuss all of these with concepts with data counsel when negotiating vendor contracts.

*******************************************************

[1] Case No. 17-5884/5950 (Before J. Batchelder, J. Cook, and J. Kethledge) (available at http://www.opn.ca6.uscourts.gov/opinions.pdf/19a0294n-06.pdf).

[2] Spec’s also appealed the district court’s reduction of prejudgment interest from Tennessee’s standard 6.25% to 1.79% under federal law. The Sixth Circuit ultimately affirmed the 1.79% interest rate.

[3] The PCI DSS is a security standard for organizations that handle branded credit cards from major credit card providers (i.e., Visa, MasterCard, Discover Financial Services, American Express, and JCB International)

[4] The Sixth Circuit noted that their interpretation was consistent with the “only other federal appeals court” to address this precise issue—the Eighth Circuit in Schnuck Markets, Inc. v. First Data Mech. Servs. Corp., 852 F.3d 732 (8th Cir. 2017).

[5] See Spec’s Family Partners Ltd. v. First Data Merch. Serv. Corp., 2017 WL 4547168 (W.D. Tenn. Jul. 7, 2017).

[6] Id. at 8.


By David Nelson and Beau Bourgeois

In humanity’s never ending quest for perfection, being close to perfect is still failure. If you grew up playing sports you undoubtedly heard a grizzled coach disgustedly say, “[c]lose only counts in horseshoes, hand grenades and atomic warfare.” However, under the Doctrine of Substantial Performance (and the related “Economic Waste” theory), construction projects may be another example of when close is good enough.

At its core a construction contract contains the agreement between the owner and contractor specifying what the contractor agrees to build in exchange for the amount the owner agrees to pay. In many cases owners hire an architect or engineer to develop plans and specifications to specify exactly what the contractor must build. Logically, it would seem that an owner should not be required to pay if the contractor did not build exactly what it agreed to build. Isn’t a party entitled to exactly that for which it bargained? The answer is– not always.

For example, assume that the owner specified that all lumber used must be manufactured by company A, but the contractor actually used lumber manufactured by company B. If the error was not discovered until after the project was nearing completion, and the wood was of similar quality, consider the potential inequity that would result if the contractor was required to completely tear down and rebuild using company A’s lumber just to be paid. The Doctrine of Substantial Performance is designed to address this potential inequity, by limiting an owner’s damage to the loss in value as opposed to the cost of repair when a contractor has substantially performed and the cost of full performance far outweighs the value to the owner.

Under Louisiana law, where a contractor substantially performs a building contract, he is entitled to the contract price less the damages that the owner can prove are attributable to the contractor’s breach by failing to strictly to comply with the plans and specifications.[1] The contractor bears the initial burden of proving substantial performance (that the thing is fit for its intended purpose), but then the burden of proof shifts to the owner to prove that a deficiency in the work exists, that the deficiency was the result of faulty material or improper workmanship or failure to comply with the plans and specifications, and the damages sustained as a result.[2]

Thus, to be entitled to payment the contractor must only prove that it substantially performed the contract. This is a question of fact to be decided by the trial court.[3] Substantial performance occurs when a building is fit for its intended purpose even if certain deficiencies or omissions in construction exist.[4] The factors to consider in determining whether substantial performance is reached include “[1] the extent of the defect or non-performance, [2] the degree to which the purpose of the contract is defeated, [3] the ease of correction, and [4] the use or benefit to the owner of the work already performed.”[5] The jurisprudence on this issue indicates that “substantial performance by a contractor is readily found, despite the existence of a large number of defects in both material and workmanship, unless the structure is Totally [sic] unfit for the purpose for which it was originally intended.”[6]

The Doctrine of Substantial Performance does not unfairly deprive the owner of that to which it bargained, but does shift the burden of proof to the owner. Once the contractor proves that it substantially performed the contract, the burden shifts to the owner to prove:

  1. the existence and nature of the defects;
  2. that the defects were the result of faulty materials, improper workmanship, or the failure to follow the plans and specifications; and,
  3. the cost of repair or completion.

An owner seeking to obtain specific performance or a reduction in the contract price in the amount required to “perfect” or fully complete the work must prove both the necessity of such “perfection” and that the benefit of full performance outweighs the costs.[7] Following the above example, if the owner could prove that the lumber used by the contractor was structurally unsound he/she would likely be entitled to require the complete demolition and rebuild of the structure. In that case the benefit to the owner (a structural sound structure) would outweigh the considerable cost to the contractor. On the other hand, if the lumber used by the contractor was only proven to have a shorter useful life than that of lumber from manufacturer A, the owner’s remedy may be limited to the diminished value of the structure.

The Doctrine of Substantial Performance recognizes that there is no such creature as a perfect construction project and purports to balance the respective rights of the parties to achieve a fair and equitable result.

________________________________________________

[1]  Airco Refrigeration Serv., Inc. v. Fink, 134 So. 2d 880, 882 (La. 1961).

[2]  Superior Derrick Servs., L.L.C. v. LONESTAR 203, 547 F. App’x 432, 439 (5th Cir. 2013) (citing Neel v. O’Quinn, 313 So. 2d 286, 290 (La. App. 3d Cir. 1975)).

[3] Id. (citing Rice v. Mesa General Contractor, LLC, 986 So. 2d 122, 129 (La. App. 5th Cir. 2008); Neel, 313 So. 2d at 290).

[4] Rice, 986 So. 2d at 219 (citing Mount Mariah Baptist Church, Inc. v. Pannell’s Associated Electric, Inc., 835 So. 2d 880 (La. App. 2d Cir. 2002)); Neel, 313 So. 2d at 290 (citing Master Maintenance Engineering, Inc. v. McManus, 292 So. 2d 284 (La. App.1st Cir. 1974); Jerrie Ice Co. v. Col-Flake Corporation, 174 F. Supp. 21 (E.D. La. 1959), affirmed 278 F.2d 508 (5th Cir. 1960)).

[5] Cosman v. Cabrera, 28 So. 3d 1075, 1080–81 (La. App. 1st Cir. 2009) (citing Mayeux v. McInnis, 809 So.2d 310, 313 (La. App. 1st Cir. 2001). See also Neel, 313 So. 2d at 290 (citing Airco, 134 So. 2d 880).

[6] Neel, 313 So. 2d at 291 (citing Clark v. Whitener, 296 So. 2d 393 (La. App. 2d Cir. 1974)).

[7] Id. at 290 (citing Nichols Ford Co., Inc. v. Hughes, 292 So. 2d 345 (La. App. 2d Cir. 1974); U-Finish Homes, Inc. v. Michel, 183 So. 2d 101 (La. App. 1st Cir. 1965)). See also Superior Derrick Servs., 547 F. App’x at 439–40; Cosman, 28 So. 3d at 1080.