Florida Commercial Litigation Update: Cross-Border Contracts and Forum Selection Clauses

May 28th, 2015

Florida’s Third District Court of Appeal, in Michaluk v. Credorax (USA) Inc., Case No. 3D14-985, 40 Fla. L. Weekly D1133a (Fla. 3d DCA May 13, 2015), available here, recently underscored the importance of careful contract drafting in commercial transactions, especially those involving cross-border issues.

For example, individuals and businesses who conduct their affairs across multiple jurisdictions often use forum selection clauses to establish by contract how a dispute or claim resulting from the contract will be resolved, including whether the dispute will be subject to a specific body of law or process of resolution, and/or will be initiated in a specific jurisdiction or venue.  Thus, these clauses typically identify which law will govern a dispute or interpretation of the contract (e.g., the laws of Malta), where the dispute will be brought (e.g., Broward County, Florida) and/or which dispute resolution process will govern any dispute (e.g., litigation in state and federal courts, as opposed to arbitration, mediation or any other process).

The court in Michaluk addressed the interpretation of a written forum selection clause as being either mandatory or permissive with respect to venue.  Specifically, the contract at issue in that case—an “Introducer Agreement” between, on the one hand, a foreign (Maltese) bank and processor of credit or debit card payments for online sellers and, on the other hand, a foreign (Canadian) consultant—provided for payment to the consultant of a transaction fee for the solicitation of new business and bank clients.  Under the clause, titled “Governing Law and Jurisdiction,” the contracting parties agreed as follows:

This Agreement shall be governed by and construed in accordance with the Laws of Malta and each party hereby submits to the jurisdiction of the Courts of Malta as regards any claim, dispute or matter arising out of or in connection with this Agreement, its implementation and effect.

After a dispute over the payment of certain transaction fees, Michaluk (the consultant) filed a complaint in Florida state court against the foreign bank (Credorax Malta) and its U.S. affiliate (Credorax USA) alleging claims for fraud in the inducement, unfair and deceptive trade practices, unjust enrichment, and breach of contract.  The defendants moved to dismiss the lawsuit for, among other reasons, improper venue, arguing that the parties’ contract contained a mandatory forum selection clause designating the venue for any dispute under the contract to Malta alone.  The plaintiff responded that the clause was merely permissive, such that the contract did not prohibit the filing of a lawsuit in a different jurisdiction (other than Malta).

The trial court ruled that the language in the forum selection clause was mandatory; however, on appeal, the appellate court ruled the other way, finding the language at issue to be permissive and not mandatory.

Preliminarily, the Third District reaffirmed the line of cases holding that forum selection clauses should be enforced in the absence of a showing that enforcement would be unreasonable or unjust, noting that forum selection clauses are now “routinely enforced” given present-day commercial realities and expanding international trade.

The court in Michaluk then clarified the material difference between mandatory and permission forum selection clauses, stating that a forum selection clause will be deemed mandatory where, by its express terms, suit may be filed only in the forum named in the clause, whereas a permissive clause is essentially a “consent” to specific jurisdiction or venue in the named forum and does not exclude jurisdiction or venue in any other jurisdiction.  The critical inquiry is whether the plain language used by the contracting parties indicates “exclusivity.”  Therefore, a forum selection clause will be deemed permissive absent words of exclusivity.  Federal and state case law reflects the varying—and sometimes seemingly inconsistent—interpretations of the exclusivity of a forum selection clause.

Michaluk, citing the decisions of other courts interpreting forum selection clauses employing similar language to the language used in the “Introducer Agreement” quoted above, highlights the judiciary’s wordsmithery in this context.  For example, as noted in Michaluk, the following forum selection clauses were found to be mandatory:

This Agreement and the rights and obligations of the parties shall be governed by and construed in accordance with the laws of the State of Florida. The parties hereto consent to Broward County, Florida as the proper venue for all actions that may be brought pursuant hereto.  [See Golf Scoring Sys. Unlimited, Inc. v. Remedio, 877 So. 2d 827 (Fla. 4th DCA 2004).]

Any controversy relating to this agreement or any modification or extension of it and any proceeding relating thereto shall be held in Minneapolis, Minnesota. The parties hereby submit to jurisdiction for any enforcement of this agreement in Minnesota.  [See Sonus-USA v. Thomas W. Lyons, Inc., 966 So. 2d 992 (Fla. 5th DCA 2007).]

In contrast, the following similar clauses, which likewise employ the terms “shall be” to denote words of exclusivity, were found to be permissive:

Any litigation concerning this contract shall be governed by the law of the State of Florida, with proper venue in Palm Beach County.  [See Regal Kitchens, Inc. v. O’Connor & Taylor Condo. Constr., Inc., 894 So. 2d 288 (Fla. 3d DCA 2005).]

This instrument shall be construed in accordance with the laws of Massachusetts. The Guarantor hereby consents to the jurisdiction of the state and federal courts of the Commonwealth of Massachusetts.  [See Shoppes Ltd. P’ship v. Conn, 829 So. 2d 356 (Fla. 5th DCA 2002).]

Ultimately in Michaluk, the Third District found the forum selection language used in the “Introducer Agreement” (quoted above) to be permissive, concluding that use of the word “submits to the jurisdiction,” instead of “consents to the jurisdiction,” failed to provide the requisite exclusivity to render the clause mandatory.

Michaluk is unique, because, among other reasons, the parties in that case stipulated that the language of the forum selection clause was unambiguous; and, further, the trial court did not hold an evidentiary hearing that might have provided a factual basis to resolve any purported claim of ambiguity or other material factor related to contract construction, such as parol evidence of the parties’ intent when they drafted the contract or the threshold issue of which party drafted the clause at issue (as, in many jurisdictions, including Florida, contracts may be construed against the drafter if other rules of construction do not apply).  The court in Michaluk also cautioned that the diverse language in forum selection clauses often prevents “direct application of or reliance on” prior court decisions.

At bottom, the Michaluk decision underscores the importance of careful contract drafting up-front, before costly and unpredictable litigation ensues, especially in cross-border, commercial dealings that implicate diverse forums, laws and dispute resolution processes.  When disputes and/or litigation do arise, the decision also reaffirms the importance of exploring all prosecution (or defense) strategies, including, without limitation, an evidentiary challenge of the underlying construction of the contract—something that apparently was not done in Michaluk and materially impacted the contract interpretation in that case.

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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Complex Litigation Update: Eleventh Circuit Holds Engle-progeny State-law Claims Preempted by Federal Law

May 7th, 2015

On April 8, 2015, the United States Court of Appeals for the Eleventh Circuit issued its opinion in Graham v. R.J. Reynolds Tobacco Co., holding that Engle-progeny based strict-liability and negligence claims, i.e. those claims premised solely on the facts found in the landmark Florida class action case R.J. Reynolds Tobacco Co. v. Engle and its clarifying progeny, are preempted by Federal law. In so holding, however, the Court emphasized that it expressed no opinion as to the validity of other Engle based claims and that injured plaintiffs could still pursue strict-liability and negligence claims so long as they do not rely on the Engle jury findings to do so.

Although limited to the facts of Engle, the decision serves as a primer on the concept of preemption, especially for those who may otherwise not face such issues in their practices. The decision also serves as a guidepost to possible preemption issues which may arise for businesses in industries which are subject to both federal and state regulations. A copy of the opinion can be read here.

  1. The Engle Cases

In order to fully understand the Court’s rationale in Graham, some background information is necessary. The Graham case was born out of the remnants of a 1994 class-action lawsuit in which 700,000 Floridians brought state-law damages claims against multiple tobacco companies for various medical conditions allegedly caused by the plaintiffs’ addiction to cigarettes. R.J. Reynolds Tobacco Co. v. Engle, 672 So. 2d 39 (Fla. 3d DCA 1996). Ultimately, a class-wide trial was held on the issue of liability and the jury rendered a verdict for the class plaintiffs on all counts, including strict liability and negligence claims. After trial on liability, the Florida Supreme Court decertified the class but allowed the former class members to pursue causes of action individually. These new individual cases by former Engle class action plaintiffs are known as “Engle-progeny cases.”

However, when decertifying the class, the Florida Supreme Court held that jury findings would have a “res judicata effect” in future cases brought by decertified class members against the tobacco companies. Among the findings in Engle which could be applied going forward was that the defendant tobacco companies “placed cigarettes on the market that were defective and unreasonably dangerous” and that “all Engle defendants were negligent.”

  1. The Graham Case: A Factual Overview.

The Graham case is an Engle-progeny case. In Graham, Plaintiff, the personal representative of his wife’s estate, brought a wrongful-death action against R.J. Reynolds Tobacco and Phillip Morris USA, Inc. alleging that the decedent was addicted to cigarettes and this addition caused her death. Included in the Plaintiff’s multi-count complaint were claims for strict liability based on the fact that “the cigarettes sold and placed on the market by the defendants were defective and unreasonably dangerous,” and a negligence claim based on the fact that the defendants were negligent “with respect to smoking and health and the manufacture, marketing and sale of their cigarettes.”

At trial, the tobacco companies objected to the use of the Engle findings regarding defective products and negligence. Ultimately, the jury found in favor of the Plaintiff. Following the jury’s verdict, the Defendants filed a renewed motion for judgment as a matter of law claiming that federal law preempted the jury’s finding of tort liability based on the Engle jury findings. The District Court denied the motion and the Defendants appealed.

  • A Primer on Preemption

As explained by the Court in Graham:

Federal law may preempt state law in three ways. First, Congress has the authority to expressly preempt state law by statute. Second, even in the absence of an express preemption provision, the scheme of federal regulation may be so pervasive as to make reasonable the inference that Congress left no room for the States to supplement it. Third, federal and state law may impermissibly conflict, for example where it is impossible for a private party to comply with both state and federal law, or where the state law at issue stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.

Graham, — F.3d –, 2015 WL 1546522, *11 (11th Cir. April 8, 2015). These broad categories are known as express preemption, field preemption, and conflict/obstacle preemption, respectively.

In Graham, the Court was faced with a conflict preemption issue: whether the legal duties imposed by an adoption of the Engle findings regarding defective products and negligence which underpin the strict-liability and negligence claims stand as an obstacle to the accomplishment of federal objectives in the regulation of, but not the outright banning of, cigarettes.

As explained by the Court in Graham, a party alleging that state law is preempted under the theory of conflict preemption faces “a high threshold” because of the “presumption against preemption – namely, that ‘we start with the assumption that the historic police powers of the States were not to be superseded by [federal law] unless that was the clear and manifest purpose of Congress.’” Graham, 2015 WL 1546522 at 12 (quoting Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947)).

When faced with conflict preemption challenges, especially those based on frustration of objective, courts look to congressional intent. As explained in Graham:

In assessing the extent to which state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress, what constitutes a sufficient obstacle is a matter of judgment, to be informed by examining the federal statute as a whole and identifying its purpose and intended effects. To begin then we must first ascertain the nature of the federal interest.

2015 WL 1546522 at 12 (internal quotations and citations omitted).

  1. The Court’s Rationale

In ruling that the wholesale adoption of Engle findings to individual plaintiff claims for strict liability and negligence was preempted and therefore barred, the Court first looked to Congress’s intent in tobacco regulation. The Court noted that Congress had passed at least seven statutes regarding the regulation of tobacco in the fifty years since it had evidence that cigarettes adversely effected health. The Court noted that while Congress knew such information and possessed the power to ban tobacco, Congress chose not to. Instead, Congress focused on reforms to labeling, marketing, and advertising in an effort to fully inform users of cigarettes danger and “thereby permit[] free but informed choice.” Id. at 13.

The Court concluded that Congress made such decisions to balance the competing interests of protecting public health while acknowledging the important role tobacco production and manufacturing plays in the national economy. An example of this balance noted by the Court was Congress’s expansion of authority to the FDA to regulate tobacco products, while expressly prohibiting the FDA from banning all cigarettes or requiring the reduction of nicotine yields of a tobacco product to zero. Thus, the Court found “Congress has never intended to prohibit consumers from purchasing cigarettes. To the contrary, it has designed a ‘distinct regulatory scheme’ to govern the product’s advertising, labelling, and – most importantly – sale.” Id. at 14; citing FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 155 (2000).

In turning to how the strict liability and negligence claims in Engle-progeny cases based on the Engle jury’s findings frustrate the congressional objectives, the Court found that the Engle court’s findings imposed a duty on all cigarette manufacturers that was breached every time the manufacturers placed a cigarette on the market.

As explained by the Court:

In sum, brand-specific defects were not determined during Phase I; they do not need to be determined during Engle-progeny trials, either. And the class definition is of no help, because it does not distinguish among plaintiffs who smoked different brands at different times—all addicted smokers are the same; so, too, are all cigarettes. Thus, as a result of the interplay between the Florida Supreme Court’s interpretations of the Engle findings and the strictures of due process, the necessary basis for Graham’s Engle-progeny strict-liability and negligence claims is that all cigarettes sold during the class period were defective as a matter of law. This, in turn, imposed a common-law duty on cigarette manufacturers that they necessarily breached every time they placed a cigarette on the market. Such a duty operates, in essence, as a ban on cigarettes. Accordingly, it conflicts with Congress’s clear purpose and objective of regulating—not banning—cigarettes, thereby leaving to adult consumers the choice whether to smoke cigarettes or to abstain. We therefore hold that Graham’s claims are preempted by federal law.

Graham, 2015 WL 1546522 at 18.

  1. Analysis of Graham

In essence, the Court held that the express absence of prohibition of a product in a heavily regulated area of law is evidence of congressional intent not to prohibit the product and, as such, can serve as the basis for a preemption challenge to state and common law duties which would require a product’s banning. While this logic may seem expansive, it is consistent with the existing tobacco related case law.

In FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120 (2000), the Supreme Court addressed the issue of whether the FDA had the authority to regulate tobacco products. In determining that Congress had not intended the FDA to regulate tobacco, the Supreme Court looked to both the existing regulatory scheme in cigarette regulation and the statutory mandate of the FDA. Similar to the court in Graham, the Supreme Court concluded that Congress had established a comprehensive regulatory scheme for tobacco products that existed outside of the Food, Drug, and Cosmetic Act. This scheme regulated, rather than prohibited tobacco product use. Id. at 139.

However, the Supreme Court concluded that if tobacco could be properly classified as a product that falls under FDA authority, the agency would have no choice but to ban tobacco as a misbranded product due to the unreasonable health risks associated with its use. Id. at 137. This, the Supreme Court concluded, would go against congressional intent and objectives in regulating the tobacco industry. Id. at 139. Thus, the Supreme Court ultimately concluded that the FDA lacked jurisdiction to regulate tobacco products. (Note, subsequent to this decision, Congress granted the FDA the authority to regulate but not ban cigarette products. See generally 21 U.S.C. § 387g.).

  1. Preemption Quagmires In Other Regulated Industries

The issue of preemption often arises in industries which are regulated at both the state and federal levels or in those areas, where traditional state common law duties may conflict with a robust federal scheme. Of note, these areas include food & drug law and the budding cannabis marketplace.

In the context of food & drug law, the preemption issue has arisen in a series of cases regarding whether state common law duties associated with theories of negligence (similar to those in the Graham case above) can coexist with duties imposed on drug and medical device manufacturers under the Federal Food, Drug, and Cosmetic Act (FD&C Act). Though the results of those cases were mixed, and a comprehensive analysis of each is beyond the scope of this article, the essence of the issue is best capsulated in the dissent of Wyeth v. Levine, 129 S. Ct. 1187 (2009). As painstaking detailed in the dissent, the issue in such cases is whether Congress intended the federal regulatory agency to be the exclusive means of regulation. If so, state common law duties will be preempted. Compare, Wyeth, 129 S. Ct. 1187 (2009)(holding that the FD&C Act did not preempt state common law causes of action for negligence and strict product liability against a brand name drug manufacturer for failure to warn of dangers of its drug products because of Congress’s long standing view that traditionally regarded state law as a complementary form of drug regulation) with Pliva, Inc. v. Mensing, 131 S.Ct 2567 (2011) (holding that because of the unique requirements placed upon generic drug manufacturers under the FD&C Act which prohibit them from unilaterally modifying their labels, state tort law claims were preempted).

Another area where preemption may come into play is the burgeoning cannabis industry. Although twenty-three states and the District of Columbia currently have laws legalizing marijuana in some form, (either medicinal or recreational), marijuana remains a Schedule I controlled substance under the Controlled Substances Act (“CSA”). Thus, under federal law, the use, possession, sale, cultivation and transportation of marijuana in the United States remains illegal. Recently, Colorado’s recreational use laws have become the subject of litigation based on the ideas of express and conflict preemption.

In two separate cases, one brought in the United States District Court for the District of Colorado by a group of Sheriffs from Colorado and neighboring states, and the other brought directly in the Supreme Court by Nebraska and Oklahoma, the plaintiffs have argued that Colorado’s recreational use laws are preempted by federal law. More specifically, in each case the plaintiffs argue that Colorado’s recreational use laws are expressly preempted by the CSA. In addition, the plaintiffs argue that even if the CSA does not expressly preempt Colorado law, Colorado’s recreational use laws stand as an obstacle to the overarching federal regulatory scheme regarding cannabis, which not only includes the CSA but also several international treaties. The courts have yet to decide these cases and it remains to be seen whether preemption arguments become the new arrow in the quiver of the anti-cannabis contingency.

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. In addition, Fuerst Ittleman David & Joseph provides comprehensive representation to highly regulated businesses, including clients operating in the financial services, biotechnology, and international trade industries, and frequently lectures on these subjects for industry trade groups. The firm has more recently been called upon to combine its Food and Drug and Anti-Money Laundering practice areas in assisting marijuana-related businesses achieve financial compliance. Please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690 with any questions.

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Florida Litigation Update: Voluntarily Dismissal Trumps Arbitration Award

May 7th, 2015

Over the past few years, we have written about significant developments in the area of commercial arbitration proceedings here [Complex Commercial Litigation Update: New York’s Separate Entity Rule and the Reemergence of Florida as a Potential Gateway for Judgment Creditors to Seize Debtors’ Foreign Assets in Enforcement and Collection Proceedings], here [Florida Litigation Update: Arbitration Clauses are Not Always Enforceable], here [Litigation Update: Appellate Arbitration], here [Litigation Update: American Arbitration Association Announces Changes to Commercial Arbitration Rules] and here [Florida Complex Litigation Update: Raymond James Financial Services, Inc. v. Phillips: Florida Supreme Court rules that statute of limitations applies to arbitration].

We continue our coverage of this critically important issue today. Recently, the Florida Third District Court of Appeal, in Laquer v. Falcone, Case Nos. 3D14-1803, 3D14-1804, 40 Fla. L. Weekly D936b (Fla. 3d DCA Apr. 22, 2015), available here,  addressed whether the voluntary dismissal of a claim referred to arbitration divests the arbitrator of jurisdiction to enter an award even after maintenance of a final evidentiary hearing.  Under the facts in Laquer v. Falcone, the Third District found that the arbitrator did lack jurisdiction to enter an award.

The appellant in Laquer v. Falcone (Edie Laquer) filed a lawsuit against the appellants (Arthur Falcone and various companies) known as the “Joint Venture Lawsuit” involving a dispute over Laquer’s equity interest in a multi-million dollar real estate project in downtown Miami known as the “Miami WorldCenter” project.  In separate foreclosure actions, the bank(-mortgagee) sued Laquer.  Laquer, in the Joint Venture Lawsuit, then filed cross-claims against Falcone, alleging that Falcone breached a duty to defend in the foreclosure actions.  Falcone, based on a dispute resolution provision in the underlying corporate operating agreements between the parties, responded by moving to compel arbitration of the “duty-to-defend”/indemnification cross-claims.

The trial court denied the motion to compel, finding that the parties waived their right to compel arbitration by participating in the foreclosure lawsuits and the Joint Venture Lawsuit.  On appeal, in 13 Parcels LLC v. Laquer, 104 So. 3d (Fla. 3d DCA 2012), available here, the Third District reversed, holding that the arbitration provision in the operating agreements controlled the duty-to-defend cross-claims, which limited issue did not appear in the record to have been waived or raised in any other litigation matters between the parties.

On remand after the first appeal in 13 Parcels, Falcone subsequently moved to compel arbitration of the entire Joint Venture Lawsuit, as opposed to merely the duty-to-defend cross-claims.  The trial court denied this motion to compel, which the Third District affirmed in Falcone v. Laquer, 132 So. 3d 1171 (Fla. 3d DCA 2014), available here.  The appellate court in Falcone v. Laquer found that the Joint Venture Lawsuit was “a much larger case” than the duty-to-defend claim, and that the “larger” lawsuit included claims, parties and alleged agreements that were not governed by the arbitration provision.  Separately, the appellate court found that the parties seeking to compel arbitration had waived any limited right to arbitrate the Joint Venture Lawsuit by the filing of a motion to dismiss, discovery requests, discovery responses, a motion for summary judgment and counterclaims, all which were deemed by the court to be “consistent with the alleged right to compel arbitration.”

On remand again after the Falcone v. Laquer appeal, the trial court stayed the duty-to-defend cross-claims from the pending lawsuit pending arbitration, pursuant to the Florida Arbitration Code, Fla. Stat. § 682.03 (2010), available here, allowing a trial court to stay severable issues subject to arbitration, and the trial court referred the cross-claims to arbitration.

Before the start of arbitration, Laquer settled with the bank in the foreclosure actions.  Laquer, in the Joint Venture Lawsuit, then filed voluntary dismissals of the duty-to-defend cross-claims.  Notwithstanding, the arbitrator conducted an arbitration hearing, at which Laquer argued that the arbitrator lacked subject matter jurisdiction and the hearing was “futile” because there was no arbitrable dispute after Laquer had voluntarily dismissed the cross-claims.  After a three-day evidentiary hearing, at which Laquer did not participate while Falcone presented witnesses and exhibits, the arbitrator entered a final arbitration award against Laquer, concluding in the award that Laquer would take “nothing” in the duty-to-defend cross-claims.

Lacquer opposed confirmation of the arbitrator’s award, which opposition the trial court denied by confirming the award.  Lacquer thereafter moved for rehearing and reconsideration, and to vacate the award.  At a non-evidentiary hearing on those motions, Falcone argued that the stay of litigation pending arbitration rendered Laquer’s notices of voluntary dismissal ineffective.  The trial court agreed, finding that, because Laquer did not “come forward to lift the stay,” the voluntary dismissals were improper.

On appeal, now the third in the saga, the Third District in Laquer v. Falcone addressed two issues:  (1) whether the trial court’s stay rendered the voluntary dismissals “ineffective” such that the arbitrator retained jurisdiction to enter an award on the duty-to-defend cross-claims; and (2) if the stay did not render the voluntary dismissals ineffective, whether the voluntary dismissals deprived the arbitrator of jurisdiction to enter an award.  The appellate court answered the first issue in the negative, and the latter in the positive, and thus effectively vacated the arbitration award.

Specifically, as to the stay issue, the Third District found that the voluntary dismissals were consistent with the central purpose of a stay, i.e., “to prevent the taking of any further steps in the action during the period of the stay.”  In other words, Laquer “ceased to take any further steps in the action when she put an end to the action altogether.”  Thus, the stay on the cross-claims did not preclude the filing of voluntary dismissals or render them ineffective.

As to the arbitrator’s jurisdiction, the Third District agreed with Laquer’s position that the trial court erred when it confirmed the arbitration award because there was no dispute left to arbitrate.  Relying on Florida Rule of Civil Procedure 1.420(a)(1), available here, the court highlighted that this rule allows a plaintiff to dismiss an action, a claim or any part of an action or claim without court-order by filing a notice of dismissal at any time before a hearing on motion for summary judgment.  However, under the Second District’s decision in Soares Da Costa Construction Services, LLC v. Alta Mar Development LLC, 85 So. 3d 1172 (Fla. 2d DCA 2012), available here, the Third District noted in Laquer v. Falcone that the filing of voluntary dismissals under Rule 1.420(a)(1) is subject to an exception where a defendant demonstrates “serious prejudice” if the dismissal is allowed.  The court added that serious prejudice in this context includes situations where the defendant (1) is entitled to receive affirmative relief, or a hearing and disposition of the case on the merits, (2) has acquired substantial rights in the case or (3) where dismissal is inequitable, citing the Fifth District’s decision in Ormond Beach Associates Limited v. Citation Mortgage, Ltd., 835 So. 2d 292 (Fla. 5th DCA 2002), available here.

However, the appellate court found that the so-called “Ormond Beach exception” did not apply to the facts at issue in Laquer v. Falcone.  First, Falcone was not seeking any affirmative relief; and, regardless, the duty-to-defend cross-claims, which were the only claims compelled to arbitration, were dismissed.  Second, the Third District found that Falcone failed to demonstrate serious prejudice, rejecting Falcone’s argument that the final arbitration award empowered Falcone to obtain attorneys’ fees, costs and expenses incurred as a result of Laquer’s demand that Falcone defend the foreclosure actions and of Falcone’s subsequent efforts to avoid arbitration of the dispute.

Thus, the court in Laquer v. Falcone held that Falcone had not acquired substantial rights in the litigation for purposes of the Ormond Beach exception.

Preliminarily, the court distinguished Soares, noting that the parties in that case stipulated to a stay pending arbitration and expressly acknowledged that “the issues raised in the arbitration proceedings [in that case] were the same issues underlying the [Soares] Complaint.”  Additionally, in contrast to the timing of the voluntary dismissal in Laquer v. Falcone, the plaintiff in Soares filed the notice of voluntary dismissal after the arbitrator entered an award in favor of the defendant in that case.  Thus, in Soares, the Second District found that the defendant in that case had acquired substantial rights in the litigation after the defendant prevailed on his counterclaim in the arbitration because the defendant’s motion to confirm the arbitration award acted as a “counterclaim” in the main action once the motion to confirm was filed and served.  The appellate court in Soares further noted that, based on the stipulation between the parties in that case for arbitration, the parties each attached “some level of importance” to the arbitrator’s determination for purposes of the substantial-rights analysis.

The court in Laquer v. Falcone also found that the arbitrator exceeded his jurisdiction when it made findings of fact supporting the final arbitration award relative to the Joint Venture Lawsuit, because the only issue compelled to arbitration was the duty-to-defend issue and the Third District already had held that the Joint Venture Lawsuit was not subject to arbitration in Falcone v. Laquer (the second appeal).

Finding that Laquer’s voluntary dismissal deprived the arbitrator of subject matter jurisdiction over the arbitrable issue (the duty-to-defend cross-claims), and that the arbitrator thus exceeded his jurisdiction when entering a final arbitration award, the Third District in Laquer v. Falcone reversed the trial court’s judgment affirming the award.

In sum, the foregoing appellate decisions reinforce the important strategic implications related to motions to compel arbitration for both sides of the ledger at all stages of litigation.  Among other considerations, litigants should carefully assess up-front how their conduct in the actual litigation and/or in other pending litigation might impact their subsequent ability to demand arbitration or, conversely, to resist it.  For example, in 13 Parcels, the court compelled arbitration of a limited claim when the parties had not waived the claim or raised it in any other litigation; whereas, in Falcone v. Laquer, based on waiver, the court refused to compel arbitration of the entire lawsuit when the party seeking to compel had affirmatively participated in the suit (by, among other things, moving to dismiss, engaging in discovery and moving for summary judgment).  Similarly, in Soares, the parties’ pre-arbitration stipulation helped support affirmance of the arbitration award in that case.  Further, plaintiffs should consider up-front the timing of voluntarily dismissals, given that the filing of a notice of voluntary dismissal before an arbitration hearing may deprive the arbitrator jurisdiction to entertain the arbitration (as in Laquer v. Falcone), while the filing of a notice of voluntary dismissal after the entry of an arbitration award may be too late to resist the arbitration (as in Soares, where the defendant there already had acquired substantial rights in the cause when the voluntary dismissal notice was filed).  As for defendants, they likewise should consider up-front whether or not to seek affirmative relief in any action for arbitration purposes, which the defendant did in Soares by filing a counterclaim in the arbitration and then moving to confirm the arbitrator’s award.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes.  The firm also specializes in wealth preservation and asset protection designed to preserve wealth, protect assets and form the foundation for continued, protected wealth-creation (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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Trade Based Money Laundering in the News: Miami-Area Electronics Exporters Targeted in FinCEN Anti-Money Laundering Initiative

April 22nd, 2015

On April 21, 2015, the Financial Crimes Enforcement Network (FinCEN) issued a Geographic Targeting Order (GTO) to approximately 700 businesses in the Miami, FL area which export electronics, including mobile phones.  The GTO implements several reporting requirements for these businesses when they are involved in currency transactions over $3,000, which is significantly lower than the usual $10,000 threshold.  The report to the government (typically referred to as an Form 8300) includes information about the transaction and the people involved.

According to the FinCEN press release, the purpose of the GTO is to “shed light on cash transactions that may be tied to trade-based money laundering schemes.”  Criminal organizations including drug cartels, crime syndicates, and terrorist-financing operations use trade-based money laundering to move and launder incredibly large sums of money just by buying and selling merchandise in international markets.

According to the Financial Action Task Force (FATF), an intergovernmental body formed in the late 1980s to combat money laundering and other financial crimes, anywhere from $590 billion to $1.5 trillion in illegally obtained money was laundered world-wide in 2012 through trade based money laundering.  There are four basic techniques for laundering money through trade:

  • over- and under-invoicing of goods and services;
  • multiple invoicing of goods and services;
  • over- and under-shipments of goods and services; and
  • falsely described goods and services.

A common method of  bringing “clean” money into a country, involves a company undervaluing its imports or overvaluing its exports.  To move money out of a country, the opposite would occur.  For example, a U.S. company could sell $2 million in products to a cartel-linked company or customer in Latin America.  The U.S. company then invoices these products upon export for only $1 million.  The foreign customer obtains the products – for which they paid only $1 million – and resells them in country for the full $2 million.  This creates $1 million in laundered money.  The problem of import-export invoice discrepancy is so large, that the Global Financial Integrity and the International Monetary Fund estimate that the difference between the declared value of Mexican exports to the United States in 2013 was almost $40 billion higher than the declared value of those same imports into the U.S. Of course, this is only one example of a trade based money laundering transaction. The list of other trade based money laundering transactions is seemingly endless, but FinCEN is clearly mobilizing to reign it in.

Under the GTO, select businesses operating in the area immediately around Miami International Airport, as well as their agents, subsidiaries, and franchisees, must now file FinCEN Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business,” anytime they receive currency, cashier’s checks, or money orders in an amount over $3,000 in an export transaction.  (As noted in the title of the Form, such reporting normally is required for transactions in excess of $10,000, not $3,000.)  The businesses must also obtain the customer’s telephone number, a copy of a valid photo identification, and written certification from the customer as to whether he or she is conducting the transaction on behalf of another person.  With respect to the transaction itself, the Form must also include a description of the goods involved in the transaction, the name and phone number of the person receiving the goods, and the final address to which such goods are being shipped.

FinCEN has been using GTOs to combat money laundering since August 1996, when certain licensed money transmitters in the New York metropolitan area were required by FinCEN to report information about the senders and recipients of all cash-purchased transmissions to Colombia of $750 or more.  Over the last two decades, other GTOs have targeted such areas as the Los Angeles Fashion District, armored car and money couriers in San Diego County, and wire transfer agents in Arizona.

In issuing the GTO, FinCEN Director Jennifer Shasky Calvery stated, “We are committed to shedding light on shady financial activity wherever we find it.  We will continue issuing GTOs, as necessary, as well as exercising FinCEN’s other unique anti-money laundering authorities, to ensure a transparent financial system that impedes money launderers and other criminals from masking their identity and illicit activity.”

And certainly GTOs can have an enormous impact on money-laundering operations.  In the aftermath of the first GTO involving New York area money transmitters, the U.S. Department of Treasury found that the targeted money transmitters’ business volume to Colombia dropped approximately 30%; the volume of transactions at other, non-targeted businesses fell at a similar level.  This would imply that in addition to the government-stated goals of collecting data and transparency, the practical effect of a GTO is to shift money laundering activity away from the targeted area.  Returning to the August 1996 New York GTO, U.S. Customs (now U.S. Customs and Border Protection) reported a marked increase in interdiction and seizure activity involving cash smuggling at the U.S.-Mexico border immediately after the GTO went into effect.

It will be interesting to see where the money laundering activities will shift as a result of the new Miami-area GTO.  According to Export-Import Bank figures, the top 10 electronics exporters operating in the GTO-targeted area accounted for over $212 Million in exports over the last seven years.  Therefore, if the historical effectiveness of GTOs in squeezing trade-based money laundering into other geographic areas is any indication, the Miami export trade community is in for a major hit.

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Class Action Litigation Update: Who Should Decide Whether an Arbitration Clause Permits Classwide Arbitration: the Court or the Arbitrator?

April 2nd, 2015

Over the past two years, a series of court cases has renewed the debate over the availability of classwide arbitration in agreements that lack an express class waiver provision. Specifically, these cases raise the critical question of who—the court or an arbitrator—may construe whether an arbitration agreement permits class arbitration when the parties have not expressly agreed to a procedure.

The United States Supreme Court has yet to definitively address this issue and, this past month, declined to review a decision holding that a court, and not an arbitrator, determines the availability of classwide arbitration. Opalinski v. Robert Half International Inc., 761 F.3d 326 (3d Cir. 2014), cert. denied No. 14- 625, — S. Ct. —-, 2015 WL 998611 (U.S. Mar. 9, 2015). The Supreme Court’s decision to decline certiorari was surprising since there is a split of authorities in this gateway function among courts. Indeed, several district courts have relied on a plurality decision by the Supreme Court in holding that this issue is a procedural question, and not an arbitrability question. (Procedural questions are decided by arbitrator, whereas the core issue of arbitrability is reserved for the courts to decide.) On the other hand, two federal circuit courts held that this determination should be reserved for the court.

In light of the Supreme Court’s denial of certiorari in Opalinski, circuit courts are left without adequate direction, and continue to leave open this gateway issue. For example, if a circuit court rules that an arbitrator should determine the availability of classwide arbitration, the decision would create a circuit split on the issue and could present a better opportunity for the Supreme Court to address this specific question.

It remains to be seen whether any future circuit court cases will align with or contradict the decisions reached in the United States Courts of Appeals for the Third and Sixth Circuits. Until the Supreme Court offers guidance on this issue, companies using consumer arbitration agreements will need to defer to court decisions in the circuits where they operate to discern who should decide the availability of classwide arbitration.

Background

In Green Tree Financial Corporation v. Bazzle, 539 U.S. 444, 452-3 (2003), the Supreme Court evaluated whether the Federal Arbitration Act permits class-wide arbitration hearings, and concluded that an arbitrator should determine whether a contract forbids class arbitration. In support of this decision, the Court explained that the question of who should decide this issue “is a procedural one for arbitrators” because it concerns the procedure to be used in arbitrating the parties’ dispute, not whether they agreed to arbitration or whether the agreement applied to the underlying dispute. The opinion goes on to explain that this issue is not an arbitrability question because it “concerns neither the validity of the arbitration clause nor its applicability to the underlying dispute between the parties,” and does not ask “whether the parties wanted a judge or an arbitrator to decide whether they agreed to arbitrate a matter.” For these reasons, the Supreme Court determined that the matter of contract interpretation should be left for an arbitrator and not the courts.

Subsequent Supreme Court decisions, however, have cast doubt on Bazzle. In Stolt-Nielson, S.A. v. Animal Feeds International Corp., 559 U.S. 663, 680 (2010), the Supreme Court emphasized that “only a plurality” in Bazzle reached a conclusion on the issue. Thus, the Bazzle decision should be treated as non-binding. Then, in a note in the opinion for Oxford Health Plans LLC v. Sutter, 133 S. Ct. 2064, 2069 n.2 (2013), the Supreme Court expressly stated that “this Court has not yet decided whether the availability of class arbitration is a question of arbitrability.”

Court Decisions that Follow the Bazzle Rationale

Since its decision in Oxford, the Supreme Court has not addressed the issue of who should decide whether an arbitration clause permits classwide arbitration. Although no federal circuit courts of appeal have decided this question, some federal district courts have opted to follow Bazzle. See Guida v. Home Sav. of Am. Inc., 793 F. Supp. 2d 611, 615-19 (E.D.N.Y. 2011); Hesse v. Sprint Spectrum L.P., No. C06–0592JLR, 2012 WL 529419 (W.D. Wash. Feb. 17, 2012); Lee v. JPMorgan Chase & Co., 982 F. Supp. 2d 1109, 1112-14 (C.D. Cal. 2013); In re A2P SMS Antitrust Litig., No. 12-CV-2656 (S.D.N.Y. May 29, 2014); Sandquist v Lebo Auto. Inc., 228 Cal. App. 4th 65, 78-79 (2014).

These courts have concluded that the class arbitration question is for arbitrators to decide because it determines the procedures the parties will use to arbitrate their dispute. These courts have dismissed arguments pointing out the differences between individual and class arbitration, finding those differences to be insignificant because they are “more relevant to the issue of whether the parties agreed to class arbitration…than to the issue of whether the court or the arbitrator decides if an agreement contemplates class arbitration.” See Sandquist v. Lebo Automative, Inc. at 78-79. In Sandquist, the court reasoned that this issue is a procedural one because “a class action is a procedural device.” It is important to note that while these cases follow the Bazzle rationale, they do not provide an explanation or analysis to support this argument.

Court Decisions that Reject the Bazzle Rationale

            In the last two years, some courts have expressly rejected the Supreme Court’s rational in Bazzle. Most notably, the United States Courts of Appeals for the Third and Sixth Circuits have held that the issue of who should decide whether classwide arbitration applies is an arbitrability question for courts to decide because it determines whose claims the parties must arbitrate and, therefore, fundamentally affects both the nature and scope of the parties’ arbitrations.

In Reed Elsevier, Inc. ex rel. LexisNexis Div. v. Crockett, 734 F.3d 594, 597-99 (6th Cir. 2013), the Sixth Circuit held that the “question [of] whether an arbitration agreement permits classwide arbitration is a gateway matter, which is reserved ‘for judicial determination unless the parties clearly an unmistakably provide otherwise.’” Upon review, the Sixth Circuit determined that the agreement at issue in Reed Elsevier was at best “silent or ambiguous as to whether an arbitrator should determine the question of classwide arbitratability; and that is not enough to wrest that decision from the courts.” The Sixth Circuit made clear that the “principal reason to conclude that this arbitration clause does not authorize classwide arbitration is that the clause nowhere mentions it.”

In 2014, the Sixth Circuit again held that courts should decide the issue of classwide arbitration. In Huffman v. Hilltop Companies, LLC, 747 F.3d 391, 398-99 (6th Cir. 2014), the Sixth Circuit held that “[a]s was the case in Reed Elsevier, here the parties’ agreement is silent as to whether an aribtrator or a court should determine the question of classwide arbitrability.” In its opinion, the Sixth Circuit went on to reiterate that “the determination [of whether an arbitration agreement permits classwide arbitration] lies with this court” and not arbitrators.

Similarly, in Opalinski v. Robert Half Inc., 2014 U.S. App. LEXIS 14538 (3d Cir. July 30, 2014), the Third Circuit held that absent a clear agreement otherwise, a court and not an arbitrator, must decide if an agreement to arbitrate also authorizes classwide arbitration. The Third Circuit’s opinion explained that “questions of arbitrability” are limited to a narrow range of gateway issues. For example, they may include “whether the parties are bound by a given arbitration clause” or “whether an arbitration clause in a concededly binding contract applies to a particular type of controversy.” Id. at 84. On the other hand, however, questions that the parties would likely expect the arbitrator to decide are not “questions of arbitrability.” Questions that fall into the category of non-arbitrability include ‘“procedural’ questions that grow out of the dispute and bear on its final disposition” as well as allegations of waiver, delay, or similar defenses to arbitrability. In reaching this decision, the Third Circuit relied on the Supreme Court’s opinion in Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002), and explained that the crucial consideration in its analysis should be the contracting parties’ expectations because courts should not “forc[e] parties to arbitrate a matter they may well not have agreed to arbitrate.” On March 9, 2015, the Supreme Court denied the petition for certiorari.

Since the Third Circuit’s Opalinski decision in July 2014, there has not been much judicial activity on this issue. No other federal circuit courts have issued opinions regarding the question of who should decide issues of classwide arbitration. In the last few months, California appellate courts have also relied on the Third and Sixth Circuits’ reasoning in finding that this issue is an arbitrability question for the courts and not arbitrators.

For example, the California Court of Appeal for the Fourth District held that it was “not persuaded by Bazzle and its rationale for concluding the Class Arbitration Question is a procedural matter for arbitrators” and decline[d] to follow BazzleSandquist, or similar cases adopting Bazzle’s rationale. Network Capital Funding Corporation v. Papke, 230 Cal.App.4th 503, 511-14 (2014). Instead, the court explicitly stated that “we agree with Opalinski, Huffman, and Reed Elsevier, and conclude the Class Arbitration Question is an arbitrability question for courts.” Id. The opinion further explained:

The Class Arbitration Question also is not analogous to issues the Supreme Court has found pose a procedural question for arbitrators to decide. For example, whether the parties agreed to arbitrate on an individual or class basis is not analogous to whether the claimant satisfied all prerequisites to arbitration established by the parties’ agreement. Similarly, the Class Arbitration Question is not analogous to whether the statute of limitations bars a party’s claims or ’allegation[s] of waiver, delay, or a like defense to arbitrability,’ all of which the Supreme Court has found to be procedural matters. Neither Bazzle nor any of the cases adopting its rational provides an explanation or analysis of how the Class Arbitration Question grows out of the parties’ underlying dispute or bears on the dispute’s final disposition.

Id.see also Garden Fresh Restaurant Corp. v. Superior Court, 231 Cal.App.4th 678 (2014)(holding that, where an arbitration agreement does not “clearly and unmistakably” provide for class and/or representative arbitration, the issue of whether a collective arbitration is allowed is a “gateway issue” for the court to determine).

A Potential Circuit Split?

A recent case that could turn the tide in this debate was decided in the Southern District of New York earlier this month. In In re A2P SMS Antitrust Litig., No. 12-CV-2656 (AJN), 2015 WL 876456, at *2-7 (S.D.N.Y. Mar. 2, 2015), the Southern District of New York held that an arbitrator should decide the availability of classwide arbitration and certified the question for an interlocutory appeal to the Second Circuit. In its decision, the court relied on the Supreme Court’s opinion in Bazzle and found that determining the availability of classwide arbitration is a procedural one for arbitrators. If the Second Circuit grants the petition for review, it will be in the position to decide whether to follow the Third and Sixth Circuits’ rationale or follow the Supreme Court’s opinion in Bazzle and effectively create a circuit split on this issue.

Conclusion

With the exception of the recent California and New York cases, the law in this area appears to be at a standstill. It remains to be seen whether the circuit courts will adopt differing jurisprudential opinions and create a circuit split on this issue. Thus, in the absence of a clear decision by the Supreme Court, the question of whether the court, or the arbitrator,  determines the availability of classwide arbitration where an arbitration agreement lacks an express class waiver provision continues to be an unresolved issue.

In order to avoid the uncertainty posed by agreements that are silent on this issue, parties entering into arbitration agreements can insert a provision into the agreement that expressly allows or disallows class arbitration. Furthermore, in anticipation of a possible dispute over whether an agreement authorizes classwide arbitration, parties should include clear and unambiguous language specifying whether a court or an arbitrator should decide the question of arbitrability. By including these types of provisions into the agreement’s terms, parties can avoid the possibility of being forced to arbitrate a matter that they did not expressly agree to at the outset.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in all areas of complex litigation, including pre-litigation and arbitration. Should you have any questions or need further assistance, please contact us via email at contact@fuerstlaw.com or via telephone at 305-350-5690.

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Exporters and Trade-Based Money Laundering

March 19th, 2015

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

You arrived at work today to find the perfect storm of export issues: a shipment of mobile phones to one of your most established South American customers has been detained by the Commerce’s Office of Export Enforcement (OEE); the federal government has seized $40,000 from your company’s checking account; and the banks have frozen all of your accounts. The only clue you have to this mess is from your freight forwarder. When the OEE seized your merchandise, one of the agents told your shipper that the merchandise was being seized, because it is “involved in money laundering.”

You are now afraid to make any other shipments, your company can no longer receive or send payments and that $40,000 is a huge hit to your revenues. And what do they mean by money laundering? You deal only with established customers and you have great relationships with them. They pay their invoices promptly, usually in cash or wire transfers (so no credit card fees), and they order thousands of phones per month. In fact, they send you so much business that you even give them significant discounts off of the regular invoice prices for most of the products you sell.

Where do you even begin to sort out this mess?

In the “old days” (like 10-15 years ago), illicit organizations such as drug cartels, terrorist networks and crime syndicates used to move their ill-gotten dollars, euros and pesos in cash by using couriers in cross-border travel. When law enforcement largely shut down those traditional systems, these criminals turned to a more potent option: trade-based money laundering (TBML). Through export (and import) transactions, criminals can move and launder incredibly large sums of money just by buying and selling merchandise in international markets.

According to the Financial Action Task Force (FATF), an intergovernmental body formed in the late 1980s to combat money laundering and other financial crimes, anywhere from $590 billion to $1.5 trillion in illegally obtained money was laundered world-wide in 2012 through TBML. There are four basic techniques for laundering money through trade:

  • over- and under-invoicing of goods and services;
  • multiple invoicing of goods and services;
  • over- and under-shipments of goods and services; and
  • falsely described goods and services.

To bring “clean” money into a country, a company need only undervalue its imports or overvalue its exports. To move money out of a country, the opposite would occur. For example, a U.S. company could sell $2 million in products to a cartel-linked company or customer in Latin America. The U.S. company then invoices these products upon export for only $1 million. The foreign customer obtains the products – for which they paid only $1 million – and resells them in country for the full $2 million. This creates $1 million in laundered money. The problem of import-export invoice discrepancy is so large, that the Global Financial Integrity and the International Monetary Fund estimate that the difference between the declared value of Mexican exports to the United States in 2013 was almost $40 billion higher than the declared value of those same imports into the U.S.

The company in this scenario may have unwittingly triggered several “red flags” that would indicate an involvement in TBML. According to U.S. Immigration and Customs Enforcement (ICE), indictors of TBML include:

  • Payments to vendors by unrelated third parties;
  • False reporting, such as commodity misclassification, commodity over- or under-valuation;
  • Commodities being traded that do not match the business involved;
  • Unusual shipping routes or transshipment points;
  • Packaging inconsistent with the commodity or shipping method;
  • Double-invoicing;

and many more. The Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) have identified other “red flags” that you can read about here.

In this case, the “significant discounts” to customers could appear as undervaluations, depending on how invoices are prepared. Additional factors may also contribute to exports being labeled as trade-based money laundering transactions; for example, accepting payments in cash, receiving wire transfers from unrelated parties and customer orders for products or in quantities that law enforcement officials may believe are unreasonable, given the customer.

When enforcement comes in money laundering cases, it can take several forms and come from several fronts. Enforcement measures include seizure and forfeiture of merchandise, seizure of funds that can be traced to the money laundering activity, civil penalties and/or criminal charges. These measures are being used by the federal government, state governments and even local governments which take part in multi-jurisdictional task forces (which are often funded by the seizures they make). In addition, banks and credit card companies may suspend accounts to avoid being seen by law enforcement as being complicit in money laundering activities. In 2013, banking giant HSBC agreed to pay $1.92 billion to U.S. authorities in fines for its complacency in laundering drug money for Mexican cartels; no bank wants that to happen to them.

Now understanding what the situation may be, the challenge is responding quickly and appropriately to the seizures. “Red flags” which otherwise could indicate money laundering may also have completely legal business rationales. For example, is the South American company that is buying the large quantities of mobile phones the largest reseller of mobile phones in that country? If so, such sales volume may be reasonable. Did you perform due diligence on the customer to ensure they are who they say they are? Are the discounts properly noted on invoices and in keeping with discounts offered by other industry leaders? Do the funds represented by the seized bank deposits line up perfectly with invoices for shipments? These are the types of arguments that must be made in negotiations with law enforcement and in petitions seeking return of seized property. The real key is assembling and presenting strong documentary evidence demonstrating that money laundering is not taking place; merely professing innocence usually will not result in mitigation of the seizures.

Money laundering charges are notoriously difficult to fight; however, a company’s best practice to keep itself from unwittingly participating in a money laundering violation is to have a strong anti-money laundering (AML) program. An AML program is a set of procedures designed to guard against someone using your company to launder money. It derives from requirements for financial institutions under the Bank Secrecy Act and the USA PATRIOT ACT (Title 31 of the United States Code), and includes such features as a customer identification or “know your customer” (KYC) program. [These requirements are akin to verifying the consignee and end-user of an export against denied party lists and understanding the intended end use of merchandise before export.] Though not technically required for most exporters, any company selling products into high-risk regions or receiving payments from third parties would be advised to have an AML program in place.

Assuming you have vigilantly and rigorously implemented and maintained your AML program (and your export compliance program), your company should be able to identify and avoid those situations which may result in your company inadvertently becoming involved in a money laundering transaction. If your company exports its products from the United States and does not have an effective AML compliance program, your company faces an enhanced risk of enforcement measures that could put it out of business for good.

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Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?

January 28th, 2015

Attorneys Andrew Ittleman and Jessika Tuazon of Fuerst Ittleman David & Joseph published their article, “Federal Marijuana Regulation: Why is Flexibility Critical in the Dawn of Legalization?” in the December 2014 issue of the Food and Drug Law Institute’s Food and Drug Policy Forum. A copy of the article is available here.

In the article, Mr. Ittleman and Ms. Tuazon confront “the complex question of how the federal government should go about the process of ending its decades-old prohibition of cannabis and bring about a regulatory regime designed to address the wide array of risks and opportunities presented by legalization.” After describing the history of the federal government’s prohibition of marijuana, as well as the efforts of various states to legalize it in various forms, the article recommends that “rather than attempting to devise a statutory scheme for cannabis in an echo chamber, Congress should be carefully studying the successes and failures of the individual states’ efforts to regulate marijuana, as they are the perfect ‘social and economic experiments’ encouraged by traditional notions of federalism.” The article further suggests that instead of “starting from scratch in developing regulations for marijuana, the government could – and should – borrow elements from regulatory regimes already in place for analogous products.” The article also describes how existing federal agencies – including the FDA, the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), and

the Bureau of Alcohol, Tobacco, Firearms, and Explosives (“ATF”) – could all be delegated jurisdiction by Congress to regulate marijuana, as all three agencies

are well suited to handle the added task of regulating and enforcing laws overseeing the manufacture, distribution, and sale of marijuana.

Most importantly, Mr. Ittleman and Ms. Tuazon recommend that in undertaking the regulation of marijuana, the federal government should proceed flexibly, giving due regard to the marijuana industries already developing in numerous jurisdictions in the United States, as well as regulatory regimes already in place for analogous articles, including alcohol and tobacco. The article concludes with the following recommendations:

First, we respectfully submit that Congress should carefully study the marijuana industries already developing in numerous jurisdictions in the United States, and should likewise invite the individual states to participate in Congress’s legislative process. Additionally, because of the value of the data currently being developed

in states which have legalized marijuana in one way or another, the federal government should support the states in their efforts to regulate marijuana by providing regulatory guidance and law enforcement resources as requested by the states. The federal government should also continue to loosen restrictions on banks and other federally regulated financial institutions wishing to do business with licensed marijuana related companies, as the all-cash business model of the typical dispensary will only lead to security risks and the tainting of the information needed by Congress when considering how to govern the interstate market for cannabis.

Second, we respectfully submit that in evaluating its own regulation of medicinal and recreational cannabis, the federal government should look to regulatory regimes already in place for analogous articles, including alcohol and tobacco. By doing so, the process of writing regulations for the marijuana industry can be far more economical, and will give the regulated industry better notice and more opportunity to comply.

Third, we should all appreciate the scope of the task at hand, and understand that there is much more at issue than simply rescheduling or “legalizing” cannabis. Once prohibition has ended, marijuana may be available nationwide in the form of buds, edibles, drinks, tinctures and concentrates, potentially for medicinal and recreational purposes, and every possible variation on the manufacturing, distribution and use will be subject to regulation. It is therefore critical that Congress proceed deliberately so as to avoid a gap between the end of prohibition and the beginning of regulation, and flexibly so as to take all of the various forms and uses of cannabis into consideration.

Finally, everyone participating in the process of ending the federal government’s prohibition of cannabis should appreciate the magnitude of the black market and understand that it will not disappear overnight following a rescheduling. It is the black market, perhaps above all else, that mandates that Congress proceed deliberately when legalizing cannabis, to ensure that all possible voices are heard and seriously considered. Indeed, if federal regulation of cannabis is overly restrictive, leading to higher costs or elimination of choice for consumers, consumers will revert to the same black markets they have used for the past 40 years. A black market for cannabis – even following a federal rescheduling – will trigger all of the “Cole Memo Priorities” currently sought to be quelled by the Obama administration, including the diversion of profits to criminal enterprises, access to cannabis by children, and other adverse health consequences. Congress should thus take care to end prohibition deliberately, comprehensively, and with due regard for every interested party.

Fuerst Ittleman David & Joseph provides comprehensive representation to highly regulated businesses, including clients operating in the financial services, biotechnology, and international trade industries, and frequently lectures on these subjects for industry trade groups. The firm has more recently been called upon to combine its Food and Drug and Anti-Money Laundering practice areas in assisting marijuana-related businesses achieve financial compliance.

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Personal Liability for Export Violations: Civil Penalties for Individuals May be Trekking Toward You

January 27th, 2015

The following article was written by Stephen Wagner for the Export Compliance Training Institute. Mr. Wagner is a faculty member for the Institute, and frequently lectures and writes on export compliance and enforcement matters. We repost Mr. Wagner’s article here with the Institute’s permission.

You run a small tech company that customizes other manufacturers’ desktop and laptop computers for your customers. You can install special chipsets, encryption hardware and software, upgrade the fans and power units to make them “ruggedized” for field use-whatever your clients need. You are the sole owner of the company and, except for occasional part-time help, the only employee.

One of your customers is an American research scientist with whom you have been working for years. He is on a special project at a university in a former Soviet republic and his team liked what you had done for his computer so much, you upgraded multiple machines for them and sent them out. Today, Special Agents from the Office of Export Enforcement visited your office and told you that you may have violated export control laws, because these computers required some sort of license. From your own research after they left, you have learned that your company could be liable for hundreds of thousands of dollars in civil penalties. The Special Agents told you that they didn’t see any potentially criminal liability issues.

If your company got hit with those sorts of penalties, you would have to close it down. You’re wondering if there are any other risks that you need to consider.

Generally speaking, the owners (equity holders), directors and officers of corporations and limited liability companies do not face personal liability for their corporate actions. Under the Business Judgment Rule, there is a presumption against individual liability if decisions are made on an informed basis, in good faith and with the best interests of the corporation at heart.

However, personal liability can attach for company actions under multiple circumstances; for example, if company officials intentionally act in a criminal or fraudulent manner, breach their fiduciary duties to the company or if the company is found to be an “alter ego” of the individual. The “alter ego” doctrine is especially important for small or closely held companies. As an attorney, I recommend to my smaller, corporate clients that they strictly observe corporate formalities (have regular director and shareholder meetings, execute formal resolutions, have company bank accounts that are separate from their personal accounts, not commingle personal and company assets, etc.) as a means to avoid a court “piercing the corporate veil” and extending corporate liability to a company’s owner(s), director(s) and officers.

Until recently, I would have said taking such actions to ensure that a company is not considered to be the alter ego of its owners/operators would protect an exporter from individual civil liability in the event that a company has export violations. And then came Trek.

In United States v. Trek Leather, Inc., and Harish Shadadpuri, 781 F.Supp.2d 1306, (CT.Int’l Trade, 2011), a company had improperly imported merchandise into the United States. The U.S. government (U.S. Customs and Border Protection) brought legal action against both the company and its president, individually. The applicable customs law in Trek provides “no person by fraud, gross negligence, or negligence” may “enter, introduce or attempt to introduce any merchandise into the United States by means of” misrepresentations or omissions. 19 U.S.C. § 1592(a)(1)(A) (emphasis added). The court in the Trek case applied the laws of agency – which state that an agent who actually commits a civil wrong is generally liable for the act along with the principal, even though the agent was acting for the principal – to find that not only is the company (i.e., the principal) liable for the import violation, but the president (its agent) is personally liable as well. Further ruling that the company’s president, Harish Shadadpuri, was indeed a “person” within the meaning of the statute, and is therefore covered by the statute, the Court of International Trade found both the company and its president liable on a theory of gross negligence.

On appeal to the Federal Circuit, the court held that corporate officers may be held personally liable for civil penalties even without the government piercing the corporate veil or when the officers themselves do not act in a manner that violates the Customs statute. United States v. Trek Leather, Inc., 767 F.3d at 1288, 96-99 (Fed. Cir. 2014) (en banc).The Trek court found that to impose personal liability, the corporate officer or his or her agent must only take some action that “introduce[s]” goods into the United States.

So what does the Trek decision mean for exporters? It may mean that individuals who take actions which violate export control laws can face civil liability in the form of monetary penalties for their actions.

Just like the customs law at issue in Trek, the Export Administration Regulations (EAR) provides:

No person may engage in any conduct prohibited by or contrary to, or refrain from engaging in any conduct required by, the EAA, the EAR, or any order, license or authorization issued thereunder.

15 C.F.R. §764.2(a) (emphasis added). Similarly, under the ITAR regulations,

Any person who is granted a license or other approval or who acts pursuant to an exemption under this subchapter is responsible for the acts of employees, agents, and all authorized persons to whom possession of the defense article or technical data has been entrusted regarding the operation, use, possession, transportation, and handling of such defense article or technical data abroad.

22 C.F.R. §127.1(c). In the same manner that the court in Trek found that company’s president to be a “person” covered by the statute and, therefore, personally liable for civil penalties arising from import violations, BIS, DDTC or a court could impose civil penalties on individual persons for their company’s export violations as well.

While individuals have often been charged, convicted, fined, and imprisoned for criminal violations of export control laws, I can think of no instance in which an individual has been assessed civil penalties for export violations committed by his or her company. Trek may now open the door for such civil penalties. With federal budgets tightening and the ruling of Trek relieving the government of any obligation to pierce the corporate veil, enforcement agencies may use the ruling to increase their assessments of civil penalties against companies and their principals. On December 18, 2014, for example, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) filed a lawsuit seeking $1 Million in civil penalties against the former compliance officer of MoneyGram for violations of the Bank Secrecy Act. This is the first attempt by this enforcement agency to hold an individual personally responsible for the anti-money-laundering failures of his employer.

It is likely that smaller exporters, and especially closely-held companies, may have a higher risk, because day-to-day operations – including export matters – are usually vested in just a few people. The fewer the people involved in an export transaction at a company, the easier it may be for government investigators and enforcement officials to affix individual liability. However, export program managers, compliance personnel, and even the “front line” employees responsible for export operations at larger exporters may also be at risk.

The ruling in Trek highlights the importance of an exporter- large or small – having a strong compliance program, using robust compliance procedures and safeguards which are implemented and maintained on an on-going basis and relying on agents such as freight forwarders and attorneys with proven compliance experience. Each of these measures will help ensure that companies and their individual officers, directors and employees are remaining compliant with respect to export matters.

Trek may also highlight the need for individuals involved in a company’s export operations to seek certain protections from their employers. Such individuals may well demand proper insurance and indemnification from the company for their export activities. They may also need to review company governance documents (such as bylaws and board resolutions) to ensure that the company is adequately protecting them from possible risks.

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Complex Commercial Litigation Update: New York’s Separate Entity Rule and the Reemergence of Florida as a Potential Gateway for Judgment Creditors to Seize Debtors’ Foreign Assets in Enforcement and Collection Proceedings

January 13th, 2015

All too often a judgment-creditor hits a roadblock when a judgment-debtor attempts to evade enforcement of a money judgment by shielding the debtor’s assets located outside of the jurisdiction where the judgment was obtained, whether in other parts of the United States and/or throughout the world.  The creditor then must chase the debtor’s foreign assets around the globe, where blocking statutes and bank secrecy regimes in other countries often significantly hinder, if not halt, the chase.

International banking cities in the United States with foreign bank branches have struggled with this issue for years, especially given recent globalization and advances in centralized operational technology, which now allow financial institutions to communicate with their branches and affiliates in a matter of seconds or a few keystrokes.

Litigants, lawyers, financial regulators and the courts likewise have struggled with this issue in the context of post-judgment enforcement proceedings, where international comity and foreign interests must be balanced with the rights of creditors to collect upon their final judgments.

Several legal decisions recently emanating out of New York have clarified various important issues in the matter, making the creditor’s chase for foreign assets more difficult in certain respects but easier in others. Specifically, for nearly a century, the courts in New York employed a common law rule—known as the separate entity rule—providing that, even when a bank-garnishee with a New York branch is subject to personal jurisdiction, the bank’s other branches are to be treated as separate entities for certain purposes, including pre-judgment attachments and post-judgment freezes and turnover orders.  The separate entity rule thus required a creditor to track down and serve each and every bank branch where a debtor might be hiding assets and to successfully freeze (or enjoin) those assets before they were transferred or withdrawn by the debtor.

In 2009, the tides seemingly turned in favor of the creditors, when the New York Court of Appeals ruled that a creditor could reach beyond New York’s borders to seize assets held elsewhere.  Specifically, in Koehler v. Bank of Bermuda, the highest court in New York held that a creditor could seek the turnover of stock certificates located outside the United States if the court had personal jurisdiction over the garnishee bank.  The Koehler decision spawned a frenzy by judgment creditors viewing New York as a potential haven for collecting assets located worldwide from banks with branches in that state.

Years later in 2013, Motorola (the global telecommunications giant), after having obtained a judgment of more than $3 billion against various Turkish companies and their beneficial Turkish owners, obtained a post-judgment collection order restraining the debtors and anyone with notice of the order from transferring the debtors’ property.  Motorola served the restraining order on, among other international banks with branches in the United States, the New York branch of Standard Chartered Bank (SCB), a foreign bank existing under the laws of the United Kingdom.  SCB, which had no connection to the dispute between Motorola and the bank’s customers, did not locate any of the debtors’ assets at its New York branch, but, following a global search of its other branches, found $30 million worth of debtor-related assets in its branches located in the United Arab Emirates (UAE).  SCB froze those assets in accordance with the restraining order, but the regulatory banking authorities in the UAE and Jordon quickly intervened and unilaterally debited the $30 million from SCB’s account with the UAE’s central bank.  SCB then took the matter to court, arguing, in relevant part, that service of the restraining order on SCB’s New York branch was effective only as to assets located at that sole branch.   In other words, relying on New York’s separate entity rule, the foreign bank garnishee (SCB) argued that the judgment creditor (Motorola) could not freeze the judgment debtors’ funds located in the bank’s foreign branches by merely serving its New York branch alone.  In response, the creditor asserted that the separate entity rule was no longer valid law in light of Koehler.

The case identified above, Motorola Credit Corp. v. Standard Chartered Bank, garnered significant attention from the business and legal communities, including global financial and banking institutions, and was recently decided in October 2014.

Significantly, the same court that had previously allowed a judgment creditor to reach beyond the jurisdiction’s borders in Koehler prevented a creditor from doing this inStandard Chartered Bank.  In a 5-2 decision, with a strong dissent, the majority expressly adopted the separate entity rule for post-judgment enforcement and collection proceedings, holding that the rule precludes a creditor from ordering a garnishee bank operating branches in New York to restrain a debtor’s assets held in foreign branches of the bank.

The majority in Standard Chartered Bank preliminarily found the separate entity rule to be “a firmly established principle of New York law.”  The majority also distinguishedKoehler, noting that the rule was not expressly raised in that case; the case involved neither bank branches nor assets held in bank accounts (but stock certificates); and the foreign bank at issue there had conceded the court’s personal jurisdiction over the bank.  The Standard Chartered Bank majority also relied on various policy reasons supporting adoption of the separate entity doctrine, including that “international banks have considered the doctrine’s benefits when deciding to open branches in New York,” and that the doctrine “promotes international comity and serves to avoid conflicts among competing legal systems.”  Ultimately, the majority concluded “that abolition of the separate entity rule would result in serious consequences in the realm of international banking to the detriment of New York’s preeminence in global financial affairs.”

In sharp contrast, the dissent in Standard Chartered Bank deemed the separate entity rule to be “outmoded” and “a step in the wrong direction.”  The dissent likewise maintained that “use of the separate entity rule to address potential comity issues is akin to using a cannon to kill a fly,” and that a bank’s concerns about double-liability (between responding to a US court-order and respecting a foreign country’s blocking statutes and banking privacy laws) and other potentially conflicting exposure could be addressed on a case-by-case basis.  The Standard Chartered Bank dissent also viewed the majority’s opinion to conflict with the same court’s holding in Koehler.  According to the dissent, the foreign bank simply “ha[d] aided its fugitive customers by erecting a monumental roadblock to [the judgment creditor]’s enforcement of a staggering judgment.”

As of the writing of this article, only two reported decisions have been decided in the wake of Standard Chartered Bank’s adoption of the separate entity rule.

In Lease Finance Group, LLC v. Fiske, a New York state trial court ruled that service in Pennsylvania of a non-domesticated New York judgment upon a domestic bank with branches throughout the United States, including in Georgia and New York, does not subject the debtor’s account in Georgia to the jurisdiction of New York courts for purposes of enforcing the New York judgment.  However, the court in Fiske expressly noted that Standard Chartered Bank did not define the separate entity rule’s “scope in regard to domestic branches of banks located in foreign states.”

Additionally, in Motorola Credit Corp. v. Uzan, in post-judgment discovery proceedings related to Standard Chartered Bank, a New York federal district court addressed whether a New York judgment creditor (again, Motorola, in that case), through subpoenas issued on New York offices of international banks, could obtain discovery regarding accounts held by the judgment debtors or their agents in various foreign branches of those banks, including in France, Switzerland, Jordan and the UAE.  Conducting a particularized analysis of the respective interests of those foreign jurisdictions and a “full consideration of international comity” as set forth in the United State Supreme Court’s seminal decision in Societe Nationale Industrielle Aerospatiale v. United States District Court for the Southern District of Iowa, the court in Uzan ordered the New York branches of banks in France, Jordan and the UAE to comply with the subject subpoenas and discovery requests.  The court otherwise quashed (denied) enforcement of the subpoenas directed to the Swiss banks, concluding that the blocking statutes and bank privacy regime in Switzerland “is not merely protective of private interests, but expressive of public interest” and that Switzerland viewed its “bank secrecy as a positive social value and benefit.”

In sum, the foregoing decisions—Standard Chartered Bank, Fiske and Uzan—have provided creditors with new tools and strategies to chase and seize a debtor’s foreign assets, including the important discovery tools endorsed in Uzan.  The decisions, while adopting the separate entity rule, also have left open numerous important legal questions, including the applicability of the rule to branches located outside of the jurisdiction of the judgment but within the United States and its territories; the extent that the corporate relationship between a bank and its affiliates distinguishes the rule’s application; and the degree to which a banking branch or affiliate conducts business within a jurisdiction for jurisdictional purposes, such as the foreign bank in Koehler, where the creditor was allowed to obtain foreign assets by serving a local branch over which the court had personal jurisdiction.

The analysis in this context is also subject to forum-specific considerations, as the policy interests underlying the separate entity rule as applied in New York City might differ from those in other important banking cities in the United States, such as Miami, Atlanta, Chicago, San Francisco, Boston, Philadelphia, Dallas, Los Angeles, Minneapolis and so forth.  Those differences, of course, as well as the different laws in those respective jurisdictions, can lead to strategies that favor creditors’ enforcement efforts or, conversely, debtors’ asset-protection efforts.

For example, the separate entity rule is not the law in Florida, as affirmed in Tribie v. United Development Group International LLC.  Notably, the court in Tribie rejected the bank’s (there, Wells Fargo’s) reliance on the separate entity rule to quash a writ of garnishment seeking discovery regarding the debtor’s assets at all of the bank’s branches, describing the rule as “a somewhat dated and seldom-cited legal doctrine.”  The court thus required the bank to respond to the subject discovery by identifying, in relevant part, “whether Wells Fargo knows of other persons [or entities] indebted to [the debtor]” (emphasis added), including, presumably, the bank’s other branches holding the debtor’s assets.  Similarly, in a case involving a judgment creditor’s request for an order directing a bank’s disbursement of a judgment debtor’s (there, the American Samoa Government’s) garnished funds under Hawaiian law, the court in Marisco, Ltd. v. American Samoa Government  “predict[ed] that the Hawai’i Supreme Court would decline to adopt the separate entity rule” and directed the bank to disburse the debtor’s (a government entity’s) garnished funds.

Whether a creditor is attempting to seize foreign assets or a debtor is attempting to protect its assets in any jurisdiction, the individuated analyses in Tribie and Mariscounderscore the importance of the specific factual circumstances at issue and of the applicable authority where the dispute is focused and/or litigated.

The recent case law regarding financial institutions as a means of seizing foreign assets also underscores the reemergence of jurisdictions with important banking ties—such as Miami, Florida—as potential gateways for not only litigation in this area but the resolution of all types of global legal disputes, including international arbitrations.  Indeed, Miami already promotes its relatively lower costs (as compared to other major banking cities, like New York, Los Angeles and San Francisco in the United States, and Paris and London abroad), multi-lingual professional force and central-location easily reachable from South America, Europe and Asia, among its unique benefits for handling international business and legal matters.  Florida law regarding the separate entity rule, especially when compared to New York law as addressed in the recent cases cited in this article, now provides yet another feather in Miami’s cap as an ideal destination for litigation regarding the seizure of foreign assets, international arbitrations, the confirmation of arbitration awards and all garnishment and other collection proceedings related thereto.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in all areas of complex civil and criminal litigation, pre-litigation and arbitration, including international and domestic business disputes.  The firm also provides wealth preservation and asset protection services designed to form the foundation for continued, protected wealth-creation (both domestically and offshore).  Please contact us by email at contact@fuerstlaw.com or telephone at 305.350.5690 with any questions.

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FDA Regulatory Update: Forecasting FDA Regulation of Laboratory Developed Tests (LDTs) in 2015

January 7th, 2015

2015 is proving to be a landmark year for FDA’s regulation of laboratory developed tests. As we have previously discussed (see our blog here), the U.S. Food and Drug Administration (FDA) has been expressing its intention to begin exercising regulatory authority over laboratory developed tests (LDTs) for years. In the Federal Register, FDA has defined LDTs as “a class of in vitro diagnostics that are manufactured, including being developed and validated, and offered, within a single laboratory.” Examples of these tests include genetic tests, emerging diagnostic tests, and tests for rare conditions. While FDA has claimed authority to regulate LDTs under the Food, Drug, and Cosmetics Act (FDCA), it has not drafted applicable regulations. Consequently, the primary federal regulation of laboratories and LDTs has been under the Clinical Laboratory Amendments of 1988 (“CLIA”).

While historically FDA has continued to claim authority to regulate LDTs, the agency consistently maintained the position that it would not enforce regulations regarding LDTs. FDA began departing from its “enforcement discretion” position on June 10, 2010, when it issued five Untitled Letters to companies stating that their tests did not qualify as LDTs as they were “not developed by and used in a single laboratory.” (To read the FDA’s Untitled Letters to Industry, please click herehereherehere, and here.) In those instances, FDA determined that it would regulate those tests as medical devices and require premarket approval. In June 2010, FDA stated that increased regulation of LDTs may be necessary due to the changing nature of LDTs from “generally relatively simple, well-understood pathology tests” to tests that “are often used to assess high-risk but relatively common diseases and conditions and to inform critical treatment decisions.” (To read the full text of the Federal Register notice regarding federal oversight of LDTs, please click here.)

In 2012, the Food and Drug Administration Safety and Innovation Act (“FDASIA”) was signed into law requiring that FDA notify Congress if it intended to issue guidance on the regulation of LDTs. On July 31, 2014, in compliance with FDASIA, FDA notified Congress that it would issue two draft guidance documents pertaining to its regulation of LDTs. Shortly thereafter, FDA issued these guidance documents entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Framework Guidance”) and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)” (hereinafter FDA’s “Notification Guidance”). (For the full text of FDA’s notification and the two anticipated draft guidance documents, please click here.)

FDA’s Framework Guidance adopts the same definition of LDTs that FDA proposed in 2010, “an IVD that is intended for clinical use and designed, manufactured and used within a single lab.” It also identifies three groups of LDT: (1) LDTs that are subject to full enforcement discretion, (2) LDTs that are subject to partial enforcement discretion, and (3) LDTs that are subject to complete FDA regulation. Essentially, FDA explains how it will regulate these different types of LDTs under the current framework of medical devices. For example, low-risk LDTs are classified as class I medical devices and will be subject to partial enforcement discretion. FDA has grouped LDTs that are moderate- to high-risk into tests that FDA intends to fully regulate. Moderate-risk LDTs are those classified as class II devices, which will be required to gain clearance or approval through submissions to FDA. High-risk LDTs are those with the same intended use as a cleared or approved companion diagnostic, LDTs with the same intended use as a class III device approved by FDA, and LDTs for determining safety and effectives of blood or blood products.

The anticipated Notification Guidance describes how laboratories must notify FDA if they intend to “manufacture, prepare, propagate, compound or process” an LDT. FDA also plans to exercise enforcement discretion when it comes to establishment registration and devices listing for LDTs, as long as the laboratories notify FDA that they are manufacturing an LDT within six months after the final Framework Guidance is finalized by FDA. After notification, FDA will issue a notification confirmation number to the laboratory. The Notification Guidance also goes on to explain the types of record keeping, procedures, and reporting requirements the laboratories will need to incorporate into their procedures.

While the two guidance documents place a very high burden on the developers of LDTs, it is important to note that the guidance documents are themselves neither laws nor regulations. FDA specifically states that “[g]uidance documents represent FDA’s current thinking on a topic.  They do not create or confer any rights for or on any person and do not operate to bind FDA or the public.  You can use an alternative approach if the approach satisfies the requirements of the applicable statutes and regulations.” However, FDA does utilize such guidance documents regularly in its oversight of industry.

Most recently, the House Energy and Commerce Committee has issued a white paper regarding its 21st Century Cure Initiative in which it requests input related to FDA’s proposed LDT regulatory framework. This white paper sets forth eleven questions related to the proposed LDT guidance documents to which the committee seeks answers. These questions relate to a range of issues including: the clarification between the practice of medicine and developing these types of tests, the delineation between what constitutes a device and what constitutes a test not subject to device regulation, how will FDA determine the risk in its “risk-based” approach, the implementation of post-market processes to reduce hurdles to patient access to tests, and separation of CLIA and FDA regulation of LDTs, among others. The Committee requested that all comments be submitted by last week, so we should have a better idea of the reaction to these comments and FDA’s proposed guidance documents in the next few weeks.

Based on this timeline, we expect 2015 to be a remarkable year for LDT regulation as FDA’s policies and regulatory framework evolves and these types of tests are subjected to heightened scrutiny. It will be interesting to see how industry responds to this development in FDA’s LDT policies. In the past, various members of industry have submitted citizen petitions urging FDA not to regulate LDTs so there will likely be a strong reaction from industry to FDA’s notice to Congress and these two draft guidance documents. Fuerst, Ittleman, David, and Joseph, PL will continue to monitor the developments in FDA’s regulation of laboratory developed tests.

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