Florida Litigation Update: Certified Conflict Regarding Enforcement of Restrictive Covenants in Employment Agreements

August 25th, 2015

The Florida Fourth District Court of Appeal, in Infinity Home Care, L.L.C. v. Amedisys Holding, LLC, Case No. 4D14-3872, 40 Fla. L. Weekly D19229a (Fla. 4th DCA Aug. 19, 2015), available here, has clouded an already uncertain arena with its recent interpretation of restrictive covenants found in employment agreements-a business issue that, as the Chief Justice of the Florida Supreme Court acknowledges, “is critical not only to medical doctors but to those in all walks of life, because [it] applies to all types of restrictive convents” across a wide range of commercial dealings and relationships.

Generally, under Florida law, restrictive covenants that restrain one’s right to work in a certain field will be upheld if the proscription is reasonable in time, scope, geography, and necessary to protect the legitimate business interests of the employer. Infinity Homes analyzed the recurring debate over the scope of the term, “legitimate business interests,” as codified in section 542.335, Florida Statutes, available here. Section 542.335 defines a legitimate business interest to include trade secrets; valuable confidential business or professional information; substantial relationships with specific prospective or existing customers, patients, or clients; customer, patient, or client goodwill; and extraordinary or specialized training. Fla. Stat. § 542.335(1)(b). The statute also expressly notes that protection of restrictive covenants “is not limited to” the foregoing examples of legitimate business interests.

In practice, restrictive covenants are used in all types of commercial agreements, including by firms and businesses who contractually require their employees and/or agents not to, among other things: divert business; disclose trade secrets or confidential information; or compete against the firm or business within a defined period and/or geographic location. These “non-compete” and “non-solicitation” agreements are crucial to a company’s success by ensuring continuity with business relations.

Infinity Home addressed the non-compete and non-solicitation provisions of an employment agreement between a provider of home health care services and a former employee who was primarily responsible for handling the company’s relationships with case managers at health care facilities that referred their patients to the company. When the employee was hired, the employee signed a “Protective Covenants Agreement,” which precluded the employee from competing against the company within the same county in which the company operated for a period of one year after the employee’s termination, and from soliciting any business from the company for a period of one year after termination. The company was particularly interested in protecting its referral sources.

Immediately following the employee’s termination, the employee in Infinity Homes went to work for a direct competitor and began soliciting referral sources that had previously referred business to the company. The company sued both the former employee, for breach of the restrictive covenants in the employment agreement, and the competitor, for tortious interference with the company’s business relationships.

In relevant part, the Fourth District in Infinity Home considered whether referral sources for home health services constitute a legitimate business interest entitled to protection under section 542.335. The trial court ruled in favor of the company, enforcing the restrictive covenants in the employment agreement and granting a temporary injunction in the company’s favor. On appeal, the Fourth District in Infinity Home affirmed, upholding the enforceability of the restrictive covenants for the business interests at issue in that case.

While at first blush it may appear to be a rather straightforward decision, the Fourth District was confronted with separate decisions from other Districts reaching diametrically opposite conclusions on the identical issue: the Third District, in Southernmost Foot & Ankle Specialists, P.A. v. Torregrosa, 891 So. 2d 591 (Fla. 3d DCA 2004), available here; and the Fifth District, in Florida Hematology & Oncology v. Tummala, 927 So. 2d 135 (Fla. 5th DCA 2006), available here.

In Tummala, the Fifth District acknowledged that the company (a group of medical specialists) seeking enforcement of a non-compete provision in an employment agreement (with a doctor who was formally employed in the specialty group) made a “compelling argument” that the referral relationships in that case should be recognized as a protectable, legitimate business interest. However, the Fifth District felt constrained by the express language of section 542.335, concluding that a legitimate business interest relating to medical patients includes only those “specific prospective or existing” patients with whom the party has a “substantial relationship.” Tummala, 927 So. 2d at 138-39 (quoting Fla. Stat. § 542.335(1)(b)3., and citing University of Florida, Board of Trustees v. Sanal, 837 So. 2d 512 (Fla. 1st DCA 2003), available here). Because referring physicians supply only a stream of “unidentified prospective” patients with whom the company seeking to enforce the restrictive covenant has no “prior relationship,” the Fifth District in Tummala concluded that the employment agreement in that case could not be enforced under a plain reading of the statute.

In direct contrast, in a case involving similar contractually-based business interests between a medical specialty group and a former doctor within the group, the Third District’s Torregrosa opinion concluded that non-compete and non-solicitation provisions in an employment contract could be enforced, finding those restrictive covenants were reasonably necessary to protect the company’s “legitimate business interests in its patient base, referral doctors, specific prospective and existing patients, and patient goodwill.”

Having the benefit of the reasoning from each of the two sister District Courts on the same issue, the Fourth District in Infinity Home agreed with the Third District, finding that section 542.335 should not be so narrowly construed as to exclude “referral sources” as a legitimate business interest. Rather, the Fourth District observed:

Th[e statute] allows the court to examine the particular business plans, strategies, and relationships of a company in determining whether they qualify as a business interest worthy of protection. Relationships with specific referral sources, which are not mentioned in the statute, are not the same as relationships with unidentified prospective patients [which are mentioned in the statute].

Still, acknowledging a split of authority by the appellate courts, the Fourth District certified an express and direct conflict between the District Courts to the Florida Supreme Court.

Ultimately, given the certified conflict between the appellate courts, it will be interesting to see how the Florida Supreme Court will resolve the conflict. Although the Florida Supreme Court originally accepted jurisdiction to review the Fifth District’s decision in Tummala, the Court subsequently discharged jurisdiction before any resolution on the merits. However, in a dissenting opinion regarding the jurisdictional issue in Florida Hematology & Oncology Specialists v. Tummala, 969 So. 2d 316 (Fla. 2007), available here, the Chief Justice stated that, “[o]n a daily basis, economic futures are placed at risk through the use of [all types of restrictive] covenants,” adding that “clarification of what the law is with regard to restrictive covenants is imperative.”

It therefore appears that either the Florida Legislature or the Florida Supreme Court will weigh in the matter soon and likely provide needed clarification to the legal and business communities. It also appears that the Third and Fourth Districts’ decisions in Torregrosa and Infinity Home, respectively, provide a more reasoned and balanced analysis of the issues in dispute. The protection of referral sources-for the business world in general, and for the medical services field in particular-is a legitimate business interest worthy of protection, especially where a company or industry cultivates referral relationships over a material period of time, dedicates resources to maintain and grow those relationships, and depends upon them as a significant and predictable source of business, as the Fourth District noted in Infinity Home.

We will continue to monitor these issues and will report any meaningful developments.

Regardless, the case law in jurisdictions throughout the United States, including in Florida, confirms that enforcement of restrictive covenants heavily depends on the specific facts and circumstances involved, as well as the specific laws of the jurisdiction at issue. Likewise, the current conflict under Florida law offers many lessons for businesses seeking to enforce these covenants, including that employment agreements should be carefully tailored to the nature of the business at issue by spelling out exactly what is so important about the information, relationships, goodwill or training for which protection is sought. Similarly, if/when a company or firm seeks to enforce its commercial agreements containing restrictive covenants, careful attention should be given to developing a factual predicate that establishes exactly how a business interest has been or will be negatively impacted such that enforcement of the agreements is necessary.

The attorneys at Fuerst Ittleman David & Joseph specialize in the complexities of commercialized globalization and have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes, as well as wealth preservation and asset protection (whether domestically or offshore). Please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690 with any questions regarding this article or any other issues on which we might provide legal assistance.

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Food Safety in the News: FDA Creates an Accelerated Path for Food Importers

August 21st, 2015

The U.S. Food and Drug Administration (“FDA”) has established the Voluntary Qualified Importer Program (“VQIP”), which will allow participating importers to expedite review and importation of foods. The VQIP is in the draft guidance stage of implementation, meaning that the program is not binding on the FDA or the public until all public comments are received and the FDA finalizes the program. (To read the VQIP Draft Guidance please click here.) This program has been created as a result of the recently enacted Food Safety Modernization Act (“FSMA“), which “enables the [FDA] to better protect public health by helping to ensure the safety and security of the food supply.” Guidance at 3. The FSMA was signed into law to amend the Federal Food, Drug, and Cosmetic Act (“FD&C Act“) with the goal of protecting the United States food supply.
The FSMA implements safety standards importers must meet to import food into the United States. Pursuant to the FSMA, FDA is required to create a system through which food importers who have a proven food safety track record can expedite imports, and FDA created the VQIP to comply with that mandate. The VQIP is a voluntary, fee-based system allowing expedited review and importation of food for importers who have proven food safety track records and high levels of control over the supply chain.
The draft guidance lists the benefits of the program and the criteria importers must meet to become and remain eligible. Here are a few points of emphasis:
Benefits:

* Expedited entry into the United States for foods included and approved in the VQIP application. Therefore, qualified importers will enjoy the immediate release of their foods being imported into the United States.
* Examination limited to “for cause” situations, such as risks to public health or to audit the importer, instead of random, at will examinations.
* The VQIP importer can determine the location of the FDA examination mentioned immediately above.

Eligibility:
* Food importers must have at least a three-year history of importing food into the United States;
* The importer, or any entity associated with the food, cannot be subject to an ongoing FDA investigation or action, or have a history of noncompliance.
* Importers must develop and implement food safety procedures -VQIP written policies –

for the entire supply chain, which ensures adequate safety and security over the entire chain.
Importers must be cognizant that they will experience a period of heighted FDA scrutiny prior to initial approval. However, once accepted, the importers will enjoy all the benefits of the VQIP program.
FDA expects this fee-based system to begin accepting importer applications on January 2018 and following the importers being accepted into the program, begin offering the benefits on October 1. FDA is accepting public comments until August 19, 2015 to allow the public to provide input on the draft guidance document, including the proposed $16,400 fee.
The attorneys in the Food, Drug, and Life Sciences practice group at Fuerst Ittleman David & Joseph, PL will continue to keep abreast of the developments with the new VQIP guidance. If you are an importer or within the industry and have questions or legal issues stemming from this guidance document, feel free to contact us at (305) 350-5690 or contact@fuerstlaw.com.

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OFAC Publishes New Venezuelan Sanctions Regulations

August 18th, 2015

On July 10, 2015, the Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) published the new Venezuela Sanctions Regulations that expand the reach of existing sanctions against that country. As a result of these new regulations, both individuals and companies doing business in Venezuela are now required to conduct enhanced diligence of their Venezuelan counterparties to ensure compliance with the sanctions.

The new Venezuela Sanctions Regulations, which are codified in 31 CFR Part 591, implement the Venezuela Defense of Human Rights and Civil Society Act of 2014 (Pub. L. 113-278) (the “Act”) and Executive Order 13692, Blocking Property and Suspending Entry of Certain Persons Contributing to the Situation in Venezuela, which was signed by President Obama on March 8, 2015. The Venezuela Sanctions Regulations were published by OFAC in abbreviated form with the intention of supplementing 31 C.F.R. Part 591 with a more comprehensive set of regulations at a later date. When finalized, supplemental regulations may include additional interpretive and definitional guidance and additional general licenses and statements of licensing policy with respect to Venezuelan sanctions.

Pursuant to the Act, the President is required:

to impose targeted sanctions on persons he determines to be responsible for significant acts of violence or serious human rights abuses against antigovernment protesters in Venezuela and to have ordered or otherwise directed the arrest or prosecution of persons in Venezuela primarily because of the person’s legitimate exercise of freedom of expression or assembly.

As a result, the President identified designated individuals in the Annex to the Executive Order whose property and interests in property are effectively blocked pursuant to 31 C.F.R. § 591.201, and who are now blocked from entry into the United States. The list of such blocked parties currently includes several officers of the Venezuelan military, national guard, national police, and intelligence service as well as one “national level” prosecutor. In addition to blocking transfers by individuals or companies with these blocked parties, the Venezuela Sanctions Regulations also block transfers to the property and interests of any entity owned 50% or more by any of the blocked parties (alone or in the aggregate).

Transfers to Blocked Parties

The “Effective Date” of the applicable sanctions is March 9, 2015, for the blocked parties listed in the Annex to the Executive Order and the earlier of the date of actual or constructive notice that property and interests in property are blocked for persons whose property and interests are otherwise blocked. 31 C.F.R. § 591.302. Under the Venezuela Sanctions Regulations, all transfers after the Effective Date in violation of the sanctions, or of any regulation, order, directive, ruling, instruction, or license issued pursuant to the Venezuela Sanctions Regulations, involving any property or interest in property blocked under the new regulations, are null and void and shall not serve as the basis for the assertion or recognition of any interest or right, remedy, power, or privilege in the blocked property. 31 C.F.R. § 591.202 (a). In effect, the Venezuela Sanctions Regulations create a ban on transfers to blocked parties. Attempts to transfer property to blocked parties shall not be recognized.

Despite this apparent absolute ban on transactions with blocked parties, the Venezuela Sanctions Regulations carve out exemptions for transfers with blocked parties in limited circumstances which establish to the satisfaction of OFAC each the following:

1. Such transfer did not represent a willful violation of the Venezuela Sanctions Regulations; and

2. The individual who held or maintained the property transferred to the blocked party did not have reasonable cause to know or suspect that the transfer required a license or authorization (from OFAC), or if they acquired a license or authorization from OFAC for the transfer, that the individual was the victim of lies, deceit or fraud by a third party (so the individual was unaware of the true nature of the transfer; and

3. The individual who held or maintained the property transferred to the blocked party files a report with OFAC setting forth in full the circumstances relating to the transfer as soon as such individual discovers that the transfer is in violation of the Venezuela Sanctions Regulations.

31 C.F.R. § 591.202 (d).

In addition to the above-mentioned transfer exemptions, OFAC regulations also provide that individuals who believe that funds have been blocked due to mistaken identity may request a release of funds. Such individuals should mail a written request addressed to the Office of Foreign Assets Control, Compliance Programs Division, 1500 Pennsylvania Avenue, NW.–Annex, Washington, DC 20220, or send a facsimile transmission to the Compliance Programs Division at (202) 622’1657. 31 C.F.R. § 501.806.

Financial Institutions

The Venezuela Sanctions Regulations affect not only individuals and companies making transfers to Venezuela, but U.S. financial institutions as well. For instance, under the new regulations, U.S. financial institutions are restricted from transferring funds to accounts belonging to the blocked parties or accounts of entities that are owned 50% or more by a blocked party. U.S. financial institutions are only authorized to transfer funds or credit between blocked accounts in its branches or offices; provided that no transfer is made from an account in the United States to an account held outside the United States, and further provided that a transfer from a blocked account may be made only to another blocked account held in the same name. 31 C.F.R. § 591.504. The only exceptions to these strict transfer restrictions are for legal services and emergency medical services so long as such professional fees and reimbursements are specifically licensed in advance by OFAC. Additionally, payments for legal services from funds originating outside the United States are authorized.

Reporting Requirements

In addition to expanding compliance requirements, the Reports on Blocked Property found in Part 501 of Title 31 of the Code of Federal Regulations are also applicable to the Venezuela Sanctions Regulations. 31 C.F.R. § 501.606. As a consequence, any person, including a financial institution, holding property blocked pursuant to the Venezuela Sanctions Regulations must file initial, ongoing, and annual reports with OFAC as follows:

1) Initial reports are required to be filed such property holders within 10 business days from the date that the property becomes blocked. Initial reports shall describe the owner or account party, the property, its location, and any references necessary to identify the property and its actual or estimated value.

2) Reports of Blocked Transactions are required to be filed on an ongoing basis for all payments or transfers that are received and blocked by financial institutions. Such reports shall include a photocopy of the payment or transfer instructions received and shall confirm that the payment has been deposited into a new or existing blocked account.

3) Annual comprehensive reports on all blocked property held as of June 30 of the current year shall be filed annually by September 30. Annual reports shall be filed using Form TD-F 90-22.50, Annual Report of Blocked Property.

31 C.F.R. § 501.603.

The requirements to furnish information or maintain records are enforced by OFAC by imposing the following civil penalties for non-compliance:

1) The failure to comply with a requirement to furnish information pursuant to 31 CFR 501.602 may result in a penalty in an amount up to $20,000, or up to $50,000 where a transaction(s) is valued at greater than $500,000 in addition to judicial enforcement of the requirement to furnish information.

2) Failure to timely file a required report, whether set forth in regulations or in a specific license, may result in a penalty up to $2,500, if filed within the first 30 days after the report is due, and a penalty up to $5,000 if filed more than 30 days after the report is due. If the report relates to blocked assets, the penalty may include an additional $1,000 for every 30 days that the report is overdue, up to five years.

3) Failure to maintain records in conformance with the requirements of OFAC’s regulations or of a specific license may result in a penalty in an amount up to $50,000.

31 C.F.R. § 501, Appendix A (IV).

Given that civil penalties for violations and failure to maintain and report information can be very severe, individuals, business entities and financial institutions who have recently entered or facilitated business transactions involving Venezuela should have their records reviewed to ensure compliance with the new regulations.

Penalties

Penalties for transfers in violation of the rules and failure to report can be severe. While willfulness and awareness are factors used in determining and mitigating the amount of the penalty, failure to self-disclose upon realization of a violation of the regulations can result in an increased penalty. OFAC’s civil penalty determination is based on an analysis of the “egregiousness” of a violation, giving substantial weight to the following factors: “willful or reckless violation of law,” “awareness of conduct at issue,” “harm to sanctions program objectives” and “individual characteristics.” As demonstrated below, egregious violations coupled with failure to self-disclose are penalized most harshly.

1) Non-egregious violations disclosed through voluntary self-disclosure will be assessed a proposed civil penalty of one-half of the transaction value, capped at a maximum base amount of $125,000 per violation.

2) Non-egregious violations which come to OFAC’s attention by means other than a voluntary self-disclosure shall be assessed a proposed civil penalty based on the applicable schedule amount found in Appendix A to Part 501 of Title 31 of the Code of Federal Regulations (capped at a maximum base amount of $250,000 per violation).

3) Egregious violations disclosed through voluntary self-disclosure shall be assessed a proposed civil penalty of one-half of the applicable statutory maximum penalty applicable to the violation.

4) Egregious violations which come to OFAC’s attention by means other than a voluntary self-disclosure shall be assessed a proposed civil penalty equal to the applicable statutory maximum penalty amount applicable to the violation.

31 C.F.R. § 501, Appendix A (V)(B)(a).

In addition to the above penalties, OFAC may also refer matters to law enforcement agencies for criminal investigation and/or prosecution. 31 C.F.R. § 501, Appendix A (II)(F).

Conclusion

The Venezuela Sanctions Regulations add a significant new layer of controls onto import and export transactions involving Venezuela. The new regulations create additional compliance and due diligence responsibilities for individuals and/or entities doing business in Venezuela. Prior to entering into any business transaction, the Venezuela Sanctions Regulations require due diligence to be conducted to confirm that participating parties are not owned or controlled by any person that is subject to sanctions under said regulations. Unfortunately, this due diligence may be complicated by the fact that many corporate ownership documents which could establish a lack of nexus between the Venezuelan company or customer and the blocked parties are either unavailable or very difficult to obtain by the U.S. individual or company seeking to do business in Venezuela.

The attorneys at Fuerst Ittleman David & Joseph have made it a priority to assist individuals navigate the complex world of administrative law and regulatory compliance, including trade sanctions such as the Venezuela Sanctions Regulations. If your business or personal affairs requires you to make transfers to Venezuela, we encourage you to contact us by email at contact@fuerstlaw.com or telephone at (305) 350-5690 so that we might provide you with effective legal assistance.

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Appellate Litigation Update: Eleventh Circuit Overturns Precedent, Permits Supplemental Briefing on Issues Not Initially Raised in Briefs

August 7th, 2015

On August 5, 2015, the United States Court of Appeals for the Eleventh Circuit, sitting en banc, issued its ruling in United States v. Durham, overturning the Circuit’s previous precedent on the issue of whether an appellant may raise an issue not raised in his or her opening brief by way of supplemental briefing where the issue arises from an intervening decision of the United States Supreme Court. In finding that such supplemental briefing is permitted, the Eleventh Circuit’s position is now consistent with other circuit courts that have addressed the issue. A copy of the opinion can be read here.

While the facts underlying Durham’s conviction are not relevant to the ultimate decision of the Eleventh Circuit, for context it is important to note that during Durham’s sentencing, he was found to be an Armed Career Criminal under 18 U.S.C. § 924(e) (hereinafter referred to as “ACCA”). When submitting his initial brief on the merits on appeal, Durham did not raise a challenge to the application of the ACCA to his case. However, during the briefing of Durham’s appeal, the U.S. Supreme Court ordered reargument and supplemental briefing in United States v. Johnson, 135 S. Ct. 939 (2015), on the issue of whether the residual clause of the ACCA is unconstitutionally vague.

As a result of the Supreme Court’s order of supplemental briefing in Johnson, Durham sought a stay in his appeal and permission to file a supplemental brief once a decision in Johnson was rendered. In his proposed supplemental brief, Durham argued that should the residual clause of the ACCA be found unconstitutional, only two of his previous felony convictions would qualify as violent felonies under the ACCA and, as such, the ACCA would not apply to him. Ultimately, the U.S. Supreme Court found the residual clause to be unconstitutionally vague. However, the Supreme Court’s decision was issued before the panel hearing Durham’s case had issued its decision. Thus, in Durham’s case, the Eleventh Circuit was faced with the situation where it had not yet ruled on the merits of Durham’s appeal but the Supreme Court’s decision in Johnson presented Durham with a new and meritorious issue which was not briefed.

In granting a hearing en banc, the Eleventh Circuit addressed the narrow issue of whether the Court should overturn its precedent barring an appellant from asserting an issue not raised in his opening brief where the issue is based on an intervening Supreme Court decision that changes the law. Phrased differently, the issue was whether the failure to raise a claim or theory in the opening brief that a party files, where that claim or theory is based on an intervening Supreme Court decision, bars the party from raising the issue in his or her reply brief or through the filing of a supplemental or substitute brief.

In its short and pointed opinion overruling its prior precedent and finding that such supplemental briefing is allowed, the Eleventh Circuit noted that of all the circuit courts which have previously addressed this issue, it was the only one which maintained a strict categorical rule against raising new issues which were not raised in an initial brief, even in the case where such an issue is based solely on an intervening decision of the Supreme Court. The Eleventh Circuit held:

[W]here there is an intervening decision of the Supreme Court on an issue that overrules either a decision of that Court or a published decision of this Court that was on the books when the appellant’s opening brief was filed, and that provides the appellant with a new claim or theory, the appellant will be allowed to raise the new claim or theory in a supplemental or substitute brief provided that he files a motion to do so in a timely fashion after (or, as in this case, before) the new decision is issued.

The new rule applies to both future cases and those direct appeals currently pending before the Court that involve an intervening Supreme Court decision. However, the Court did not define what “a timely fashion” is. Thus, it is possible that further clarification through subsequent cases will be needed.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of complex civil and administrative litigation, criminal defense, and appellate practice at both the state and federal levels. Should you have any questions or need further assistance, please contact us by email atcontact@fuerstlaw.com<mailto:contact@fuerstlaw.com> or telephone at 305.350.5690.

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FTC Litigation Update: FTC v. Bayer Litigation: What Type of Evidence Is Needed to Substantiate Probiotic Claims?

August 4th, 2015

Monday, June 15, 2015 marked the beginning of the newest chapter of litigation between Bayer Corporation (“Bayer”) and the U.S. Justice Department, arguing on behalf of the Federal Trade Commission (“FTC“), regarding Bayer’s potential violation of a 2007 consent decree. FTC, the agency that oversees and regulates dietary supplement advertisements, has filed suit alleging that Bayer violated a 2007 consent decree when it made unsubstantiated claims about one of its probiotic dietary supplements.

In 1994, Congress amended the Food, Drug, and Cosmetic Act to include the Dietary Supplement Health and Education Act (“DSHEA“). DSHEA defines what a dietary supplement is and sets forth the legal framework for the dietary supplement industry. The Food and Drug Administration (“FDA“) has regulatory authority over the labeling and manufacturing of food, drugs, and medical devices, and it shares jurisdiction with FTC over the advertising of those same products.

While FTC and FDA share authority over dietary supplement marketing, each agency has a different regulatory focus with a different standard. Per FDA, manufacturers of dietary supplements are not required to obtain approval from the FDA, while prescription drugs and medical devices advertisers are. On the other hand, FTC requires dietary supplement advertisements to meet the same substantiation threshold as drug and medical devices: competent and reliable scientific evidence. FTC defines “competent and reliable scientific evidence” in its policy guide entitled “Dietary Supplements: An Advertising Guide for Industry” as:

tests, analyses, research, studies, or other evidence based on the expertise of professionals in the relevant area, that have been conducted in an objective manner by persons qualified to do so, using procedures generally accepted in the profession to yield accurate and reliable results.

FTC further states there “is no fixed formula for the number or type of studies required or for more specific parameters like sample size and study duration.” See FTC Policy Guide. However, FTC has been attempting to narrow “competent and reliable scientific evidence” through consent decrees (settlements with private parties that are not developed via the Administrative Procedure Act’s notice-and-comment rulemaking process) to exclusively be defined as two randomized, well-controlled, double-blind clinical trials (“RCTs”). As we have previously reported (here, here, and here), this re-defined standard has created confusion among the dietary supplement industry as to the definition of “competent and reliable scientific evidence.”

The current litigation between FTC and Bayer is a battle over what type of substantiation is required to meet FTC’s standards for dietary supplements. The issue before the Court is whether Bayer satisfied FTC’s “competent and reliable” scientific standard without the use of clinical testing. Both the Government and Bayer concede the appropriate standard was one for dietary supplements, but Bayer argues that FTC’s substantiation standard for dietary supplements should not include multiple RCTs since FDA limits requiring RCTs to prescription drugs and devices.

Background-The 2007 Consent Decree

FTC brought suit against Bayer in 2007 to “cease and desist certain advertising practices with respect to One-A-Day brand vitamin and mineral supplements.” See Consent Decree. Bayer subsequently entered into a consent decree with FTC, which requires Bayer to “possess[ ] and rely upon competent and reliable scientific evidence” before any representations regarding “the manufacturing, labeling, advertising, promotion, offering for sale, sale, or distribution of any dietary supplement, [or] multivitamin.” Id. Therefore, before Bayer can make claims about any dietary supplement, the claims must be backed by competent and reliable scientific evidence.

The U.S. Government is now accusing Bayer of advertising a probiotic-Phillips Colon Health Supplement-without possessing “competent and reliable scientific evidence.” Per Bayer’s advertisements, the probiotic helps “defend against occasional constipation, diarrhea, and gas and bloating.” In 2014, the Department of Justice (representing FTC), “filed a motion to show cause why Bayer should not be held in civil contempt for violating” the court order. (To read the Department of Justice News Release, please click here.) The government “alleges that consumers have paid hundreds of millions of dollars for Phillips’ Colon Health, even though Bayer lacks the evidence to support the claims of the purported benefits.” Id.

The Government’s Argument

The government contends that Bayer violated the consent decree by not possessing sufficient evidence to support the probiotic claims advertised. To convince the Court of its position, the government enlisted an expert gastroenterologist and an expert microbiologist “to review[ ] the materials produced by Bayer’s counsel” and “concluded the totality of evidence shows Bayer lacks competent and reliable scientific evidence to substantiate the specific claims.” Government’s Trial Brief at 7.

The government argues that Bayer’s claims are not backed by competent and reliable scientific evidence because the claims about the supplement’s probiotic bacteria were not supported by “any materials, such as studies or papers, when making the specific claims at issue.” Id. at 5. Rather, Bayer only “produced to the FTC approximately 100 papers and several cover letters as purposed substantiation.” Id. at 5. The government asserts that substantiating probiotic claims “requires an RCT of a daily dose of the actual, three-bacteria strain formula . . . to which Bayer asserts its claims are addressed: healthy people.” Id. at 8. According to the Government, the papers and cover letters submitted by Bayer to FTC failed to accomplish that task.

Bayer’s Argument

Bayer insists that it has not violated the consent decree because the company has provided sufficient evidence to substantiate its probiotic claims. Bayer argues that the consent decree does not delineate the specific type of evidence that satisfies the competent and reliable substantiation standard. Therefore, to comply with the competent and reliable standard, Bayer conducted a literature review which included a dozen human studies to support its claims and comply with the consent decree. Further, “Bayer produced almost 100 studies to the government.” However, the government was not satisfied with Bayer’s literature and pushed the contempt order forward.

Bayer now argues that FTC is attempting to implement a new standard for dietary supplements by requiring the same type of substantiation for dietary supplements as it does drugs. (To read Bayer’s trial brief, please click here.) This new standard would force “all dietary supplement claims . . . [to] be supported with the same product-specific RCTs required to prove safety and efficacy in order to obtain FDA approval to market a drug.” Bayer’s Brief page 3. This “drug-like substantiation,” as Bayer calls it, “is wholly inconsistent with DSHEA” and allowing a new standard “would undo exactly what Congress enacted DSHEA to accomplish.” Id. at 6. According to Bayer, this new standard of competent and reliable evidence to be redefined as RCTs “would transform the product [dietary supplements], as a matter of law, from a food into a drug.” Id. at 7.

What Does This Mean For the Dietary Supplement Industry?

Ultimately, a judge will decide if Bayer’s substantiation is sufficient, or if FTC’s requirement for RCTs will prevail. Nevertheless, the dietary supplement industry is monitoring the ongoing saga between Bayer and FTC closely. If the judge rules that RCTs are required for dietary supplement substantiation, the resulting standard of substantiation would impact the entire industry.

Fuerst Ittleman David & Joseph, PL is monitoring the litigation between the Department of Justice and Bayer. The attorneys in our Food, Drug, and Life Sciences practice group are experienced in assisting regulated industry to ensure that products are marketed and advertised in compliance with all applicable federal laws and regulations. For more information, please call us at (305) 350-5690 or email us at contact@fuerstlaw.com

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Complex Litigation Update: Eleventh Circuit Targets “Shotgun Pleadings,” Clarifies Definition

July 28th, 2015

Each court may have its own definition of what constitutes a “shotgun pleading,” but the United States Court of Appeals for the Eleventh Circuit attempted to clarify that term in Christopher J. Weiland v. Palm Beach Co. Sheriff’s Office et al., available here. In doing so, the Court reversed the District Court’s decision, holding that two counts alleged in the pleading were not shotgun pleadings, but instead were informative enough to permit a court to readily determine if they stated a claim upon which relief can be granted. After all, the Court wrote, dismissal under Rule 8(a)(2) and Rule 10(b) is only appropriate when it is “virtually impossible to know which allegations of fact are intended to support which claims for relief,” and this case presented no such impossibility.

Background

Christopher Weiland’s original complaint told a story about two Palm Beach County Sheriff’s Office deputies shooting, tasering, and beating him in his bedroom without warning or provocation. Weiland’s father had called the police and told the 911 dispatcher that his son, who suffered from bipolar disorder, was “acting up,” “on drugs,” and “probably had a gun.” Deputies Christopher Fleming and Michael Johnson were dispatched to the residence. What happened after is disputed by the deputies, but Weiland claims that while sitting on a bed motionless with a shotgun idle in his lap, Johnson fired two rounds at Weiland, knocking him off the bed. Weiland claims Fleming then tasered him when he was immobile and critically injured.

Weiland was charged with two counts of aggravated assault on a law enforcement officer and incarcerated for two years awaiting trial. When trial came around, the officers’ stories fell apart, and Weiland was acquitted.

Weiland filed a lawsuit in state court in January 12, 2011, but then added multiple claims under 42 U.S.C. § 1983 on December 17, 2012 and removed to federal court. In May 2013, the District Court dismissed without prejudice all of Weiland’s § 1983 claims. It concluded that four counts asserting those claims violated Rule 8(a)(2) and Rule 10(b) of the Federal Rules of Civil Procedure. However, even though it dismissed Weiland’s claims, the District Court observed that “viewing the alleged facts in the light most favorable to Weiland … Defendants violated Weiland’s fourth amendment constitutional rights when they shot him.” The District Court gave Weiland time to amend his complaint, and he submitted a third amended complaint, which was the subject of the Eleventh Circuit’s review.

In the third amended complaint, the four counts at issue were presented as follows:

  • Count One claims that Fleming, Johnson, and the deputies, acting under color of state law, violated Weiland’s constitutional rights by “using excessive and unreasonable force.”
  • Count Two claims that the Sheriff’s Office “did not adequately train or supervise its Sheriff Deputies in … [the use of] appropriate and proportioned force” in detaining mentally ill citizens
  • Count Three claims that Fleming, Johnson, and the Sheriff’s Office conspired to cover up their violations of Weiland’s constitutional rights
  • Count Four claims that the Sheriff’s Office had a custom or policy of using its internal affairs investigations to “perpetrate a coverup of any misconduct by Deputies.”

The District Court again dismissed all four of the § 1983 claims, this time with prejudice, because  pleading them “duplicated the violations of Rule 8(a)(2) and 10(b), which formed the basis of the court’s [earlier] dismissal of th[o]se counts.” It concluded that the claims failed to prove any factual support for his allegations beyond referring to alleged practices and policies in the Sheriff’s Office. However, following a similar pattern to the first dismissal, the District Court conceded that the complaint did in fact state a conspiracy claim, even though it was dismissed.

Defining Shotgun Pleadings

The Eleventh Circuit first considered under what authority the District Court relied on in dismissing Weiland’s claims. The Court’s best guess was that the District Court relied on its inherent authority to control its docket and ensure prompt resolution of lawsuits, which in some circumstances includes the power to dismiss a complaint for failure to comply with Rule 8(a)(2) and Rule 10(b). The Court therefore reviewed the dismissal under an abuse of discretion standard of review.

The Court began by explaining that Rule 8(a)(2) required a complaint to include “a short and plain statement of the claim showing that the pleader is entitled to relief.” It also noted that Rule 10(b) provides that

A party must state its claims or defenses in numbered paragraphs, each limited as far as practicable to a single set of circumstances. A later pleading may refer by number to a paragraph in an earlier pleading. If doing so would promote clarity, each claim founded on a separate transaction or occurrence – and each defense other than a denial – must be stated in a separate count or defense.

If a complaint does not meet these standards, the Court wrote that it is commonly referred to as a “shotgun pleading.” But what is a shotgun pleading? The Eleventh Circuit asked the same question.

The Court discussed a “thirty-year salvo of criticism aimed at shotgun pleadings,” writing that “there is no ceasefire in sight.” After sifting through its past opinions, the Court identified four rough types or categories of shotgun pleadings, writing:

The most common type – by a long shot – is a complaint containing multiple counts where each adopts the allegations of all preceding counts, causing each successive count to carry all that came before and the last count to be a combination of the entire complaint.

The next most common type … is a complaint that does not commit the mortal sin of re-alleging all preceding counts, but is guilty of the venial sin of being replete with conclusory, vague and immaterial facts not obviously connected to any particular cause of action.

The third type… is one that commits the sin of not separating into a different count each cause of action or claim for relief.

Fourth and finally, there is the relatively rare sin of asserting multiple claims against multiple defendants without specifying which defendant(s) are responsible for which acts or omissions, or which of the defendant(s) the claim is brought against.

The Court wrote that the unifying characteristics of these four types is that they all fail in some aspect to give the defendants adequate notice of the claims against them and the grounds upon which each claim rests.

Applying Characteristics of Shotgun Pleadings

While the Court did not tackle all four of the counts dismissed by the District Court, it held that the District Court abused its discretion when it dismissed Weiland’s Count One and Count Three claims against Fleming and Johnson on the grounds they did not comply with Rule 8(a)(2) and 10(b). While the Court admitted those two counts might have some faults, it concluded that they were informative enough to permit a court to readily determine if they state a claim upon which relief can be granted. After all, the District Court already recognized Counts One and Three as stating claims upon which relief can be granted by holding that Weiland made valid fourth amendment and conspiracy claims.

The District Court dismissed Weiland’s § 1983 claims in Count One and Three because the counts incorporated “all of the factual allegations contained in paragraphs 1 through 49 inclusive,” and also failed to identify “which allegations are relevant to the elements of which legal theories” and “which constitutional amendment governs which counts.” The Eleventh Circuit wrote that at first glance these counts might appear to have made common mistakes of shotgun pleading, but that is not the case.

The Court wrote that in Weiland’s case, the allegations of each count were not rolled into every successive count on down the line. Furthermore, the Court determined that this was not a situation where a failure to more precisely parcel out and identify the facts relevant to each claim materially increased the burden of understanding the factual allegations in each count. Therefore, the Court held that Count One did adequately put Fleming and Johnson on notice of the specific claims against them because Weiland organized the 49 paragraphs into three clear subsections. As to Count Three, even though only one of Weiland’s alleged deprivations of constitutional rights yields a cognizable claim, the Court held that the count also gave Fleming and Johnson adequate notice.

Finally, the Court disagreed with the District Court’s characterization of Weiland’s complaint as “failing to identify … which constitutional amendments govern which counts.” The Court held that the complaint did identify specific amendments, and just because the count included constitutional amendments under which Weiland is not entitled to relief, that is not dispositive of a Rule 8(a)(2) and 10(b) dismissal. Rather, a dismissal under those two rules is appropriate only where it is “virtually impossible to know which allegations of fact are intended to support which claim(s) for relief.”

The takeaway from this case is in the Court’s clarification of what constitutes a shotgun pleading. The Court accepted two counts from Weiland’s amended complaint, even though not perfectly composed, due to the viability of the claims. This means that when courts have conceded that a case has been made for a certain claim, the courts cannot simply dismiss based on the format of the pleading so long as the pleading gives adequate notice to the other party.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in the areas of complex civil and administrative litigation at both the state and federal levels. Should you have any questions or need further assistance, please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690.

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Criminal Tax Litigation Update: Seventh Circuit Affirms District Court’s Sentence of Probation for Beanie Babies Creator

July 27th, 2015

On July 10, 2015, the United States Court of Appeals for the Seventh Circuit affirmed the sentence of Ty Warner, the billionaire creator of Beanie Babies who pleaded guilty to evading $5.6 million in taxes by hiding assets in a Swiss bank account. The decision can be found here.

In 1996, Warner traveled to Switzerland and opened an account at UBS, which ultimately held as much as $93 million. In 2002, Warner moved his account from UBS to Zuercher Kantonalbank (ZKB), and placed his assets in the name of a Liechtenstein shell company. By that time, the account had grown to $107 million. Warner, a U.S. taxpayer, failed to report and pay taxes to the IRS on the interest income generated by his Swiss account, which amounted to $24.4 million through 2007. Consequently, Warner underpaid his taxes by $5.5 million.

The U.S. Department of Justice began to investigate UBS in 2008, and in March 2009, the IRS started its Offshore Voluntary Disclosure Program (OVDP)(Please see our prior blogs on the OVDP: available here, here, here, here, here, here, here, and here).

Warner never accessed the funds in his Swiss bank account, and in 2009 Warner applied to the OVDP. However, Warner was rejected from the OVDP because he was already under investigation. In 2011, Warner received a grand jury subpoena requiring him to turn over his Swiss bank records. Warner fought the subpoena, see In re Special Feb. 2011-1 Grand Jury Subpoena Dated Sept. 12, 2011, 691 F.3d 903, 909 (7th Cir. 2012), but ultimately was forced to comply with the subpoena.

Ty Warner was charged in 2013 in the U.S. District Court for the Northern District of Illinois for tax evasion in violation of 26 U.S.C. section 7201, available here.

The information alleged that Warner evaded $885,300 in taxes in 2002 by failing to report income from his Swiss account.  According to the information, Warner fraudulently reported he did not have a foreign bank account on his income tax return, see Schedule B (line 7b), available here, and failed to file a Report of Foreign Bank and Financial Account (FBAR), available (the former version) here, in violation of the Bank Secrecy Act, available here.

Warner pleaded guilty, agreeing to pay full restitution and a civil FBAR penalty in the amount of $53.5 million (equal to 50% of the highest balance in 2008). The plea agreement had the following U.S. Sentencing Guideline (USSG) calculation:

  • Base offense level 24 (based on $5.6 million tax loss (see USSG 2T1.1, available here)
  • a two-level enhancement for sophisticated means (see USSG 2T1.1(b)(2), available here)
  • a two-level reduction for acceptance of responsibility (see USSG 3E1.1(b), available here)
  • and a one-level reduction because the plea relieved the Government of having to prepare for trial (see USSG 3E1.1(b))
  • for a total offense level of 23.

A level 23 offense level, with no prior criminal history, results in a guideline sentence of 46-57 months, see USSG Sentencing table, available here.

Warner’s sentencing occurred in January 2014, and the District Court judge, evidently moved by Warner’s unique characteristics, sentenced Warner to probation (the Government wanted at least one year of incarceration). The Government appealed.

On appeal, the U.S. Court of Appeals for the Seventh Circuit engaged in the standard two-step process.  First, it reviewed the Guidelines calculation to ensure it was properly calculated (procedural reasonableness).  Second, it reviewed the trial judge’s analysis of the 18 U.S.C. section 3553(a) factors, available here (substantive reasonableness). See generally Gall v. United States, 552 U.S. 38 (2007), available here, and Rita v. United States, 551 U.S. 387 (2007), available here.

The 7th Circuit focused on the substantive reasonableness of the sentence and noted that the trial judge properly focused on Warner’s characteristics as an individual, which demonstrated a benevolence that was unique.  For instance, the Court cited to various instances of charitable giving that were extraordinary. As to the seriousness of the offense, the Court noted that the Government sought a sentence well below the guidelines, which was mitigated because

His crime was isolated and uncharacteristic: he had kept only one offshore account containing “a small fraction” (about 6%) of his total wealth. He was 69 years old, had no prior criminal history, and posed no danger to society. In particular, the court found, there was “no question of him violating the tax laws in the future.” Moreover, he cooperated by pleading guilty and promptly paying both full restitution and the FBAR penalty, although, it is true, his cooperation was incomplete (e.g., he resisted the government’s subpoena and did not dis-close the source of his offshore assets). The district court also appropriately took into account Warner’s attempt to enter the OVDP in September 2009.

Slip op. at 21. The Court further noted that Warner paid full restitution and a $53.6 million FBAR penalty.

The Court also recognized that a $53.6 million penalty provided an acceptable level of deterrence for Warner and anyone else considering a similar attempt to evade the payment of a tax. In particular, the Court noted that “Warner’s FBAR penalty was nearly ten times the size of the tax loss he caused (not accounting for interest).”  Slip op. at 25.

And, interestingly, in addressing sentencing disparities, the Court noted that:

probation is a common sentence in offshore tax evasion cases. The evidence introduced below shows that roughly half of the defendants convicted since 2008 have received terms of probation rather than imprisonment. And, of course, thousands more have avoided criminal prosecution altogether by entering the OVDP.

Slip op at 27 (emphasis added). Ultimately the Court affirmed the sentence of probation.

What is the impact of the Warner case? While it remains to be seen how district courts around the country will apply the Warner case, one thing is clear – “roughly half of the defendants convicted since 2008 have received terms of probation rather than imprisonment.”  In other words, district courts appear to be departing downward from the sentencing guidelines (where a sentence of incarceration is presumptively reasonable) and imposing sentences of probation.

What does this mean for taxpayers who have been, or may be, prosecuted for tax evasion and failing to disclosure foreign accounts?  It would appear that if a taxpayer can demonstrate the he is similarly situated with other defendants who have received sentences of probation, he would likewise receive a term of probation instead of incarceration.  Accordingly, it is incumbent upon the taxpayer and his attorneys to develop the facts which will demonstrate a basis to mitigate the sentence and depart from the sentencing guidelines, similar to what occurred in the Warner case. Of course, in order to demonstrate the facts necessary to receive a downward departure, the taxpayer would be wise to engage counsel and avail himself of the IRS’s Offshore Voluntary Disclosure Program.

The attorneys at Fuerst Ittleman David & Joseph have extensive criminal and civil tax litigation experience before the district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. Courts of Appeal, including representing those with unreported offshore accounts.  You can contact us by email at contact@fuerstlaw.com or by telephone at 305.350.5690.

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Third Circuit Clarifies Mental State Required for Hobbs Act Extortion Conviction

July 23rd, 2015

The United States Court of Appeals for the Third Circuit (“Third Circuit”) in United States v. Fountain, clarified the mental states required of the payor and payee to uphold a conviction for extortion under the Hobbs Act. In its decision, the Third Circuit affirmed the conviction and sentences handed down by the United States District Court for the Eastern District of Pennsylvania. In doing so, the Third Circuit synthesized prior extortion case law and articulated that the evidence must indicate that the payor had a reasonable belief that the payee would perform official acts in return for the money, and the payee knew the payor made the payment because of that belief. In order to fully understand the implications of United States v. Fountain, a brief primer on the classic official right extortion jurisprudence is necessary.

Elements of Hobbs Act Extortion Under Color of Official Right 

Coercion

The Hobbs Act, found at 18 U.S.C. § 1951 et. seq., a federal statute penalizing extortion – often used in cases involving corrupt government officials – provides that “[w]hoever in any way . . . affects commerce or the movement of any article or commodity in commerce, by robbery or extortion . . . shall be fined under this title or imprisoned not more than twenty years, or both.” 18 U.S.C. § 1951.

“Extortion,” in turn, is defined as “the obtaining of property from another, with his consent, induced by wrongful use of actual or threated force, violence, or fear, or under color of official right.” As explained in United States v. Manzo, 636 F.3d 56, 65 (3d Cir. 2011), “a person can only commit extortion in one of two ways: (1) through threatened force, violence or fear or (2) under color of official right. Both of these types of extortion are inherently coercive.”

Generally, “when proceeding under a color of official right theory, the misuse of public office is said to supply the element of coercion.” Id. The “importance of a defendant’s public office or official act to a Hobbs Act charge is its coercive effect on the payor.” United States v. Fountain at 7; see also Evans v. United States, 504 U.S. 255, 268 (1992). The Supreme Court in Evans stated, “the Government need only show that a public official has obtained a payment to which he was not entitled, knowing that the payment was made in return for official acts.”  504 U.S. 268. In other words, it is payee’s position as a government official that is “the coercive effect on the payor.” Fountain, at 7.

The Third Circuit interpreted Evans in United States v. Antico, 275 F.3d 245, 257 (3d Cir. 2001), and found “no official act . . . need be proved to convict under the Hobbs Act.” Further, a Hobbs Act conviction was upheld where jury instructions were given that told to jury to decide “whether the giver gave the payments . . . because he believed the defendant would use his office for acts not properly related to his official duty.” Antico, at 259.

Additionally in United States v. Urban, 404 F.3d 754 (3d Cir. 2005), the Third Circuit expanded the foundation laid in Antico by ruling the following:

 a Hobbs Act conviction [is upheld] where the government adduced substantial evidence that (1) the payors made payments to the defendants knowing they were public officials exercising governmental authority; (2) the payors made payments in order to assure advantageous exercise of that government authority; and (3) the defendants knew that the [payors’] payments were made for an improper purpose, i.e., the influencing of their governmental authority.

Urban, 404 F.3d at 769 (internal quotations omitted).

Reasonable Belief 

The payor’s belief must be considered when determining a Hobbs Act conviction under official right. As articulated in United States v. Mazzei, 521 F.2d 639, 643 (3d Cir. 1975) (en banc), the Third Circuit established that no actual power needed to be had by the payee, only that “a reasonable belief that the state system so operated that the power in fact of defendant’s office included the effective authority.” In other words, the payee need not have statutory power, or actual power, as long as the evidence indicates that the payor reasonably believed that the power existed.

This notion was extended in United States v. Bencivengo, 749 F.3d 205 (3d Cir. 2014), where the Third Circuit ruled that so long as “a payor reasonably believed the defendant possessed ‘influence,’ if not ‘effective power,’” the Hobbs convictions will stand. Fountain at 9 (quotingBencivengo, 749 F.3d. at 212-13). The Third Circuit further wrote:

 a public official has, and agrees to wield, influence over a governmental decision in exchange for financial gain, or where the official’s position could permit such influence, and the victim of an extortion plan reasonably believes that the public official wields such influence, that is sufficient to sustain a conviction under the Hobbs Act, regardless of whether the official holds any [actual] power over the decision.

Bencivengo, 749 F.3d at 212-13.

Collectively, these cases are known as the “classic” official right extortion cases, with reasonableness underlying each decision. While the classic official right extortion cases previously discussed help shape the parameters of the Hobbs Act, the Third Circuit in United States v. Fountain applied the facts before them to clarify the mental states required of the payor and payee to uphold a conviction for Hobbs extortion.

United States v. Fountain

A Factual Overview

Between 2007 and 2012, an IRS employee, Patricia Fountain (“Fountain”), “orchestrated several schemes to fraudulently obtain cash refunds from the IRS.” Fountain, at 3. As an employee for the IRS, Fountain used “her knowledge of the IRS’s fraud detection procedures to avoid suspicion . . . including [the knowledge that] claims below $1,500 would not be flagged for review.” Id. During the five year scheme, Fountain employed various personnel including her significant other, friends, and hairdresser to recruit individuals to provide their personal information to file a claim, and then retain a portion of the refund. Fountain’s hairdresser recruited Deborah Alexander who “provid[ed] personal information so that Fountain could file fraudulent tax returns in [her] name.” Id. at 5.

At Fountain’s trial, “a jury convicted Fountain [and the other defendant’s] on multiple counts of conspiracy and filing false claims to the IRS in violation of 18 U.S.C. §§ 286 and 287. Fountain was also convicted on one count of Hobbs Act Extortion . . . .” Id. at 4. The “extortion count against Fountain alleged that she obtained and attempted to obtain money from Alexander under color of official right as an IRS employee.”Id. at 5.

Fountain filed a motion for a judgement of acquittal on the Hobbs Act charges, claiming the evidence was insufficient “to support a conviction for extortion under color of official right.” Id. at 5. However, when appealing the sufficiency of the evidence, evidence is reviewed “in the light most favorable to the Government, afford[s] deference to a jury’s findings, and draw[s] all reasonable inferences in favor of the jury verdict.”Id. (internal quotations omitted).

The Hobbs Act count rested on the jury finding that Fountain received a $400 payment from Alexander, so that Fountain would not “red flag” the claim. However, Fountain contended that this evidence was not sufficient, and Alexander “only knew Fountain worked for the IRS,” but “never directly dealt with Fountain.” Id.

The Court’s Rationale

The Third Circuit ruled that the Hobbs extortion conviction must stand because “the evidence adduced at trial was sufficient to support Fountain’s Hobbs Act Conviction.” Id. at 6. This case combined the precedent previously discussed and applied the facts of his case to the precedent, “while emphasizing different aspects of the payor’s motivation are consistent in accounting for the payor’s reasonable belief as a reflection of the coercive effect of the defendant’s official acts.” Id. at 9.

The Third Circuit further stated:

Thus, our case law articulates a unified standard for official right extortion cases: We will uphold a conviction for Hobbs Act extortion where the evidence indicates (1) that the payor made a payment to the defendant because the payor held a reasonable belief that the defendant would perform official acts in return, and (2) that the defendant knew the payor made the payment because of that belief.

Id. at 10.

Therefore, the Third Circuit “agree[ed] with the District Court that a rational juror could conclude that Alexander paid Fountain $400 with the understanding that Fountain would use her position at the IRS to help her obtain a cash refund, and that Fountain knew that Alexander paid her for that reason.” Id. at 11.

It is important to note that it was not necessary for the Third Circuit to “find that Fountain actually used her position or performed an official act in furtherance of the scheme to uphold her conviction.” Id. Rather, the Court’s focus was on Alexander’s state of mind.

The Third Circuit concluded that it would be easy for the jury to find “that Alexander reasonably believed Fountain would help her obtain the refund” and the jury “could have found that Alexander reasonably feared reprisal.” Id.

Fountain’s Rebuttal

Fountain attempted to argue that “[t]he evidence in support of the Hobbs Act charge was insufficient because the Government failed to prove that she used the power of her employment at the IRS to induce Alexander to pay her in exchange for filing a false claim with the IRS.” Id. at 13. However, as made clear by the Third Circuit, “inducement is not an element of Hobbs Act extortion under color of official right.” Id.

The Third Circuit’s ruling is simple: a conviction under the Hobbs Act will be sustained where the payor made a payment to a defendant with the reasonable belief that the defendant would perform official acts and the defendant knew the payor made the payments because of this reasonable belief.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in the areas of white color criminal defense, criminal tax defense, and criminal appellate practice. Should you have any questions or need further assistance, please contact us by email atcontact@fuerstlaw.com or telephone at 305.350.5690.

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United States Court of Appeals for the First Circuit: United States Bankruptcy Code Preempts Puerto Rico from Providing Municipalities with Statutory Bankruptcy Relief

July 22nd, 2015

On July 6, 2015, the First Circuit held that the United States Bankruptcy Code preempts the Commonwealth of Puerto Rico’s attempt to enact laws to provide its municipalities with bankruptcy relief. More specifically, in its opinion in Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico, the First Circuit held that section 903(1) of Chapter 9 of Bankruptcy Code (“Chapter 9”) preempted the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), which was passed by the Puerto Rican legislature in an effort to provide Puerto Rican municipalities with bankruptcy relief.

1.Background

Under the United States Constitution, States cannot independently provide statutory bankruptcy relief to its municipalities because doing so “would require impairing the obligation of contracts in violation of the Contracts Clause.” See Franklin at 10. Generally speaking, the “Contracts Clause”, found at Art. I, §10, clause 1  of the U.S. Constitution, prohibits States from passing laws that retroactively impair contract rights. As a result of this prohibition, in 1933, Congress enacted Chapter 9 of the Bankruptcy Code to provide state municipalities with bankruptcy relief that the Contracts Clause barred states from enacting themselves.

Chapter 9 provides that a municipality qualifies as a debtor only if it “is specifically authorized . . . to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to [so] authorize.” 11 U.S.C. § 109(c)(2). Therefore, while local municipalities can qualify for bankruptcy relief, the federal government cannot independently authorize a municipality to be a debtor for purposes of Chapter 9 bankruptcy relief because only a State has that power.

In 1938, Congress revised the Bankruptcy Code to give Puerto Rico the ability to authorize its municipalities to obtain federal municipal bankruptcy relief under Chapter 9. However, in 1984, Congress amended the Chapter 9 definition of “State” to include Puerto Rico “except for the purpose of defining who may be a debtor under [C]hapter 9 of [the Bankruptcy Code].” 11 U.S.C. § 101(52). As a result of the Chapter 9 amendment, Congress expressly barred Puerto Rico and its municipalities from obtaining federal bankruptcy relief under Chapter 9.

However, due to the recent and grave financial crisis plaguing the island, in June, 2014, Puerto Rico attempted to allow its utility companies and municipalities to restructure their debt by enacting its own municipal bankruptcy law, called the “Recovery Act”. It was the passage of the Recovery Act and the anticipated bankruptcy of a financially distressed Puerto Rican public utility, the Puerto Rican Electric Power Authority (“PREPA”), that sparked this action.

Here, the plaintiffs, Franklin, Oppenheimer Rochester, Blue Mountain Capital Management, LLC, (collectively “Plaintiffs”), who collectively hold two billion dollars in bonds issued by PREPA, brought suit against the Commonwealth of Puerto Rico, Puerto Rico’s governor, Puerto Rico’s Secretary of Justice, and the Government Development Bank (collectively “Defendants”) to challenge the Recovery Act and enjoin its implementation. The District Court ruled in Plaintiffs’ favor and permanently enjoined the Recovery Act, ruling that the Act is preempted under 11 U.S.C. § 903(1). The First Circuit confronted the issue on appeal.

2.The First Circuit’s Determination

The First Circuit stated that “[t]he primary issue on appeal is whether § 903(1) preempts Puerto Rico’s Recovery Act. That question turns on whether the definition of ‘State’ in the federal Bankruptcy Code—as amended in 1984—renders § 903(1)’s preemptive effect inapplicable to Puerto Rico.” See Franklin at 4.

Section 903(1) provides as follows: “a State law prescribing a method of composition of indebtedness of such municipality may not bind any creditor that does not consent to such composition.” 11 U.S.C. § 903(1). As explained by the First Circuit, “§903(1), ensures the uniformity of federal bankruptcy laws by prohibiting state municipal debt restructuring law that bind creditors without their consent.” Franklin, at 4.

In finding that § 903(1) applies to Puerto Rico, the First Circuit noted that there is no indication in Chapter 9 that suggests that Puerto Rico or its municipalities are exempt from § 903(1) prohibitions. In fact, the 1984 amendment of Chapter 9 explicitly states that Puerto Rico is a “State” “except for the purpose of defining who may be a debtor under chapter 9 of [the Bankruptcy Code].” 11 U.S.C. § 101(52). Thus, under § 903(1), Puerto Rico is barred from restructuring municipal debt without the consent of the municipalities’ creditors.

Here, although Puerto Rico modeled the Recovery Act after Chapter 9, the First Circuit found that it provided less protection for creditors than the federal Chapter 9 counterpart. The Recovery Act provides two ways of obtaining bankruptcy relief: Chapter 2 “Consensual Debt Relief,” and Chapter 3 “Debt Enforcement.” According to the First Circuit, Chapter 2 “permit[ed] a binding modification, including debt reduction, to a class of debt instruments with the assent of creditors holding just over one-third of the affected debt,” which reduced protections for creditors. See Franklin at 18-19. The First Circuit also found that Chapter 3 debtors “may [have] avoid[ed] certain contractual claims,” which again reduced protections for creditors. See Franklin at 19. Additionally, unlike Chapter 9, the Recovery Act allowed the Puerto Rican governor to issue an involuntary proceeding if the Government Development Bank found that it would be in the best interest of both the municipality and the Commonwealth.

The Recovery Act attempted to make municipalities barred from filing for federal bankruptcy relief eligible for bankruptcy relief at the Commonwealth level through the Puerto Rican Government Development Bank. The First Circuit found that the Act made municipalities eligible to seek both Chapter 2 and Chapter 3 relief and request an involuntary proceeding, each of which reduced protections for creditors investing in Puerto Rico by binding them without their consent. Thus, the First Circuit found that the Recovery Act was preempted by § 903(1)’s prohibition.

3.Impact on Industry

Puerto Rico claims that its debt-saddled municipalities and utilities are left with no relief as a result of the First Circuit’s determination. However, the First Circuit indicated that Puerto Rico’s recourse lies with Congress, not the courts. The First Circuit noted that Puerto Rico may request that Congress amend Chapter 9 or enact legislation to provide the territory with federal bankruptcy relief because  Congress, not the courts, maintains the power to grant Puerto Rican municipalities federal bankruptcy protection.

Puerto Rico is currently seeking authorization and other relief directly from Congress. Judge Torruella’s concurrence in Franklin, however, pointed out that Puerto Rico has no political representation in Congress, and therefore, holds little to no bargaining power when requesting aid from the federal legislature. Thus, Puerto Rican municipalities in need of bankruptcy relief hopefully await on Puerto Rico to request relief through Congressional legislation or for Puerto Rico to appeal to obtain a Supreme Court determination.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in the areas of tax, tax litigation, and complex administrative litigation. Should you have any questions or need further assistance, please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690.

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Tax Litigation Update: DC Circuit Rejects IRS’s Broad Interpretation of Anti-Injunction Act

July 22nd, 2015

On June 19, 2015, the United States Court of Appeals for the District of Columbia Circuit held that a nonprofit organization was not barred by the Anti-Injunction Act from bringing suit against the IRS because it had no other remedy for its alleged injury. In Z Street v. John Koskinen, available here, the IRS argued that the Anti-Injunction Act prohibits any suit aiming to “restrain the assessment or collection of any tax,” but the Court rejected the IRS’s overly broad view. Here, where a nonprofit organization claimed its application for a 501(c)(3) tax exemption was being delayed by the IRS on the basis of the organization’s political views, the Court held that because there was no other statutory procedure available, the nonprofit’s suit could move forward.

Background

Z Street is a nonprofit organization “devoted to educating the public about Zionism” and “the facts relating to the Middle East.” As such, Z Street applied for a section 501(c)(3) tax exemption. However, during its application process, a conversation between Z Street’s lawyer and an IRS agent revealed the agency’s alleged “Israel Special Policy,” which results in “increased scrutiny[y]” for applications from organizations holding “political views inconsistent with those espoused by the Obama ministration.” Z Street claimed it fell under this policy and consequently experienced an unreasonable delay in the processing of its application as compared to organizations with other political views.

Z Street sued the IRS under the Declaratory Judgment Act, 28 U.S.C. § 2201, claiming that the “Israel Special Policy” violated the First Amendment through blatant viewpoint discrimination. The relief Z Street sought was a declaration to that effect, and an injunction barring the IRS from applying its “Israel Special Policy” to Z Street’s pending application, instead requiring the IRS to adjudicate the application “expeditiously and fairly.”

The IRS moved to dismiss for lack of subject-matter jurisdiction and failure to state a claim, arguing that Z Street’s suit was barred by the Anti-Injunction Act, which prohibits suits to “restrain the assessment or collection of any tax,” and the doctrine of sovereign immunity. The IRS further argued that the plaintiff had other remedies at law available, and disputed the existence of the “Israel Special Policy.” However, at the motion to dismiss stage, the District Court was required to assume the truth of all material factual allegations in the complaint, and therefore assumed that the IRS did in fact have an “Israel Special Policy” that delayed the processing of section 501(c)(3) applications.

The District Court denied the IRS’s motion to dismiss, writing that Z Street’s First Amendment claim “cannot be properly characterized as a lawsuit implicating the ‘assessment or collection’ of taxes” because Z Street was only seeking a constitutionally valid process without delay. It also held that the claim for injunctive relief was appropriate because no other remedy at law would cure Z Street’s injury. The District Court then certified an order for interlocutory appeal to the D.C. Circuit.

Proper Scope of the Anti-Injunction Act

The D.C. Circuit began its analysis by summarizing the cases that best describe the purpose of the Anti-Injunction Act. In short, the D.C. Circuit came up with four principles presented through case law:

  • Outside of certain statutorily authorized actions, like those brought pursuant to 26 U.S.C. § 7428, the Anti-Injunction Act bars suits to litigate an organization’s tax status.

The two primary cases the Court cited as support for this proposition were Bob Jones University v. Simon, 416 U.S. 725 (1974), available here, and Alexander v. “Americans United” Inc., 416 U.S. 752 (1974), available here. In Bob Jones, the IRS moved to withdraw Bob Jones’ section 501(c)(3) status because it refused to admit African-American students, and the University sued to maintain its exemption. In “Americans United,” a non-profit group challenged its reclassification from a section 501(c)(3) to a section 501 (c)(4) organization due to its lobbying activities. In both cases, the Supreme Court found that the Anti-Injunction Act barred the suits, because “prior to the assessment and collection of any tax, a court may [not] enjoin the Service from revoking [tax exempt status],” as written in the Bob Jones opinion.

  • The Anti-Injunction Act does not apply in situations where the plaintiff has no alternative means to challenge the IRS’s action.

In South Carolina v. Regan, 465 U.S. 367 (1984), available here, the state challenged an amendment to the Internal Revenue Code that altered the taxation of certain state-issued bonds. South Carolina paid no taxes, and therefore it was unable to utilize any statutory procedure to contest the constitutionality of the tax. Here, the Court held South Carolina’s suit was not barred by the Anti-Injunction Act, because Congress did not intend the Anti-Injunction Act to apply to actions brought by aggrieved parties for whom it has not provided an alternative remedy.

  • The Anti-Injunction Act does not apply in situations where the plaintiff has no “implication[s]” for tax assessment or collection.

The D.C. Circuit considered the Anti-Injunction Act in a different light in Cohen v. United States, 650 F.3d 717 (D.C. Cir. 2011) (en banc), available here. There, taxpayers challenged a special procedure the IRS had established for refunding an unlawfully collected tax. The Court rejected the government’s argument that the case was barred by the Anti-Injunction Act because it held that the case did not involve the “assessment or collection” of taxes because “[t]he IRS previously assessed and collected the excise tax at issue” and the U.S. Treasury already received the money. Therefore, the Court held that the Anti-Injunction Act is not an obstacle to other claims seeking to enjoin the IRS outside the assessment and collection of tax.

  • In administering the tax code, the IRS may not discriminate on the basis of viewpoint.

Finally, the last series of cases cited by the D.C. Circuit in explaining the scope of the Anti-Injunction Act demonstrated that there is a requirement for viewpoint neutrality in the government’s provision of financial benefits, rather than having the tax code “discriminate invidiously … in such ways as to aim at the suppression of dangerous ideas;” see e.g. Regan v. Taxation with Representation of Washington, 461 U.S. 540 (1983), available here.

Applying the Anti-Injunction Act Propositions

The D.C. Circuit in this case disagreed with the positions articulated by the IRS and Z Street. On the one hand, the D.C. Circuit rejected the IRS’s broad approach that this was more in line with Bob Jones/“Americans United.” On the other, the Court disagreed with Z Street’s argument that it was in line with Cohen. The Court reasoned that Bob Jones and “Americans United” were different because in those cases the plaintiffs sought to litigate their tax status, whereas Z Street in this case sought to prevent the IRS from unconstitutionally delaying consideration of its application. Z Street’s suit did not have the obvious purpose of securing assurance that donations will “qualify as charitable deductions” like in “Americans United.”

However, while Bob Jones and “Americans United” did not apply to this particular fact pattern, neither did Cohen. The Court wrote that unlike Cohen, Z Street’s suit could have had implications for assessment and collection, such as obtaining a tax exemption earlier than expected. Instead, the Court resolved that Z Street’s suit fit best with the scenario presented in South Carolina.

The D.C. Circuit held that the Anti-Injunction Act should not bar Z Street’s suit because the plaintiff had no other remedy for its alleged injury. The Court detailed why neither section 7428 (if Z Street had waited 32 additional days to file suit), nor remedies offered by sections 6213 (deficiency petition) or 7422 (refund suit), could provide the relief that Z Street sought. The Court also added that the IRS’s sovereign immunity argument could not bar the suit, because 5 U.S.C. § 702, the Administrative Procedure Act, “waived sovereign immunity with respect to suits for nonmonetary damages that allege wrongful action by an agency or its officers or employees.” The D.C. Circuit affirmed the District Court’s denial of the IRS’s motion to dismiss.

The significance of this D.C. Circuit decision is the interpretation of the Anti-Injunction Act, and subsequently how courts will handle governmental defenses in tax litigation. By rejecting a broad reading of the Anti-Injunction Act, the Court reduced the IRS’s ability to claim that lawsuits are barred on the grounds that they may interfere with IRS’s tax collection efforts.

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

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