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Archive for the ‘Commercial Litigation/Directors & Officers’ Category

The Cannabis Industry Takes Another Step Towards Mainstream

Posted on: November 12th, 2018

By: David Molinari

In 1996, the People of the State of California first passed an initiative to legalize medicinal cannabis. The legislature toyed with drafting the statutory framework regulating the medical cannabis industry. Finally, in 2014 the first “legal” medicinal dispensaries began to open throughout the state. The economic impact of medicinal cannabis was so significant that four years later recreational cannabis was overwhelmingly voted into existence. The cannabis industry has elbowed its way to the table claiming a seat alongside tech industry, manufacturing industry and agricultural industry. One tell-tale sign that the cannabis industry has taken steps toward mainstream, its “inventory” is an insurable commodity under a commercial property and general liability insurance policy.

Green Earth Wellness Center operated a retail medical marijuana business and an adjacent growing facility. Atain Specialty Insurance Company issued Green Earth a commercial property and general liability insurance policy. A wildfire broke out and advanced toward Green Earth’s business. Although the fire did not destroy the business, smoke and ash from the fire overwhelmed Green Earth’s ventilation system; causing damage to Green Earth’s marijuana plants. Green Earth made a claim under the policy for loss of its inventory due to the smoke and ash which Atain denied.

Separately, thieves entered Green Earth’s growing facility and stole some of the marijuana plants. Again, Green Earth made a claim under its policy and again Atain denied the claim. Green Earth eventually commenced an action for breach of contract and bad faith. Atain filed a Motion for Summary Judgment raising, among other issues, that in light of federal law and federal public policy, it was illegal for Atain to pay damages to marijuana plants and products. Atain argued that the application of an exclusionary provision in the policy for contraband or property in the course of an illegal transportation or trade requires that coverage be denied; even if the policy would otherwise have provided coverage.

The Court noted that the policy itself did not define the term “contraband.” The Court acknowledged application of federal law, particularly 21 U.S.C. 841(a)(1) that makes possession of marijuana for distribution a federal crime. However, the Court took note that such a federal prohibition has become more “nuanced” as an increasing number of states have enacted regulations for medicinal and recreational cannabis. Enforcement of the Controlled Substance Act in states that have enacted statutes regulating use and distribution is at times ambivalent and erratic. Other than pointing to the federal criminal statutes, Atain offered no evidence that the application of existing federal public policy would result in criminal enforcement against Green Earth. Atain also failed to assert Green Earth’s operations were in violation of state law.

In rejecting Atain’s public policy and illegality defense to coverage for inventory damage, the Court turned to the parties’ intention regarding coverage of Green Earth’s marijuana. The evidence suggested that the parties mutually intended to include coverage for the marijuana plants constituting Green Earth’s inventory. Atain drafted the medicinal marijuana dispensary supplemental application form that asked several questions about inventory: Such as, how much inventory is displayed to customers, how much inventory is kept on the premise during non-business hours and whether the inventory is stored in a locked safe. Before entering the policy, Atain knew Green Earth was operating a cannabis business. Atain knew or should have known at the time of the policy inception that federal law (at least nominally) prohibited such a business; but Atain nevertheless elected to issue the policy and collect premiums.  Atain never sought to disclaim coverage for Green Earth’s inventory before the claims were made. By issuing the policy and taking premiums, it was clear that the carrier would not raise the contraband exclusion to marijuana inventory.

The Court assumed Atain had legal counsel and obtained opinions and assurances from its own legal counsel before embarking on the business of insuring marijuana operations. The Court viewed the case as a breach of contract action. Atain, through its policy, made contractual promises and then breached them refusing to entertain Atain’s argument that the Court must declare the policy unenforceable as against public policy. It was irrelevant under the Court’s analysis that possession and sale of marijuana was a federal crime or that marijuana should under a public policy argument be determined an uninsurable commodity.

The lesson for insurers: the cannabis industry is an expanding multi-billion-dollar industry where entrepreneurs will spend money on insurance premiums to protect its investment and inventory. A carrier entering a policy knowing the insured’s business is cannabis very well may be obligated to cover claims or face the risk of damages for breaching the policy.

If you have any questions or would like more information, please contact David Molinari at [email protected].

Come See the Debtor Side of Sears – Legal Issues for Creditors

Posted on: November 7th, 2018

By: Matthew Weiss

On Monday October 15, Sears Holdings filed for Chapter 11 bankruptcy in the Southern District of New York, claiming approximately $7 billion in assets and $11 billion in liabilities. The bankruptcy of what was at one time the nation’s largest retail company is anticipated to result in the closing of 142 of Sears’ remaining stores before the end of the year.  It is believed that Sears currently has more than 100,000 creditors.

It remains to be seen whether Sears will be able to successfully reorganize, or whether it will suffer the same fate as other recent retailers in bankruptcy such as Toys-R-Us and be forced to liquidate its assets. As Sears’ substantial debts are sorted out, creditors and vendors of the retailer should keep the following in mind to preserve their interests:

Reclamation Demands: Vendors may issue reclamation demands on Sears pursuant to section 546(c) of the Bankruptcy Code, which authorizes a seller of goods to reclaim those goods if the debtor received them while insolvent, within 45 days before the commencement of a bankruptcy case. Because Sears has been legally insolvent for a long time, all vendors who have provided goods to Sears within 45 days of the bankruptcy filing (since September 1, 2018) have the ability to demand the reclamation of those goods by filing a written notice with the bankruptcy court.

Clawback Claims: Creditors are actively investigating whether claims exist against Sears’ former CEO, Eddie Lampert, for engaging in improper transactions involving the debtor. Lampert has had interests on both sides of transactions involving Sears in recent years and remains the Chairman even though he has resigned as CEO. For example, he is also the chairman of Sears’ real estate spinoff entity, Seritage Growth Properties, which acquired the real estate on which 230 Sears and Kmart stores are located (valued at $2.7 billion) and now collects rent from those stores. Additionally, Lampert individually and through his hedge fund, ESL Investments, Inc., has loaned Sears $2.66 billion through a variety of financing transactions.  These transactions have allowed Lampert to control the terms of the financing arrangements and benefit from interest payments by Sears. Thus, creditors will attempt to argue that Lampert deliberately stripped Sears of its assets through fraudulent transfers. The Official Committee of Creditors will likely argue that these assets should be clawed back into the bankruptcy estate pursuant to section 548 of the Bankruptcy Code.  Under relevant Delaware law, creditors have four years to assert fraudulent transfer claims and they must prove both that Sears was insolvent at the time the transactions occurred and that it did not receive reasonably equivalent value for the transfers. Other claims could be asserted against Lampert, including fraud and shareholder derivative suits for breach of fiduciary duty, although those will be harder to prove. Lampert and other directors have already settled four lawsuits involving the creation of Seritage Growth Properties for approximately $40 million.

Low Priority Creditors: After Sears’ secured creditors and prior creditors are paid, the remaining creditors, including unsecured vendors, service providers, shareholders, and pensioners, will have to fight over whatever assets remain.  Sears’ largest unsecured creditor is the Pension Benefit Guaranty Corp., a federally chartered corporation that insures pensions. PBGC claims that Sears underfunded its pension obligations by $1.5 billion.

Sears has also said that it will continue paying employees’ wages and benefits, honoring member programs, and paying vendors and suppliers in the ordinary course of business for all goods and services provided on or after the date of the bankruptcy filing. Sears specifically has said that customer loyalty programs, warranties, protection agreements, and guarantees would continue for the time being. Nonetheless, because Sears has only received $300 million in debtor-in-possession financing, there is a looming threat that the debtor will be forced to liquidate, which could shut down the entire business as a going concern. Therefore, vendors and customers should be wary about continuing to do business with Sears and Kmart until they appear to be on more solid financial footing.

For more information, please contact Matthew Weiss at [email protected].

Office of Inspector General Approves Warranty Program for Medical Device Manufacturer

Posted on: November 5th, 2018

By: Ali Sabzevari

The Department of Health and Human Services Office of Inspector General recently approved a medical device manufacturer’s proposed warranty program, which provides a refund to the hospital at which a patient underwent joint replacement surgery using the manufacturer’s knee or hip implant and related products, if the patient was readmitted within 90 days because of a surgical site infection or need for implant replacement surgery. The proposed model could serve as a road map for these kinds of risk sharing arrangements.

Advisory Opinion No. 18-10, which can be accessed here, set forth that although the suggested warranty implicates the safe harbor regulations to the anti-kickback statute, 42 C.F.R. § 1001.952, the “Proposed Arrangement poses a sufficiently low risk of fraud and abuse under the anti-kickback statute.”

The anti-kickback statute makes it a criminal offense to knowingly and willfully offer, pay, solicit, or receive any remuneration to induce or reward referrals of items or services reimbursable by a Federal health care program. See section 1128B(b) of the Act. Where remuneration is paid purposefully to induce or reward referrals of items or services payable by a Federal health care program, the anti-kickback statute is violated. By its terms, the statute ascribes criminal liability to parties on both sides of an impermissible “kickback” transaction. For purposes of the anti-kickback statute, “remuneration” includes the transfer of anything of value, directly or indirectly, overtly or covertly, in cash or in kind. The statute has been interpreted by several federal courts to cover any arrangement where one purpose of the remuneration was to obtain money for the referral of services or to induce further referrals.

The U.S. Department of Health and Human Services has promulgated safe harbor regulations that define practices that are not subject to the anti-kickback statute because such practices would be unlikely to result in fraud or abuse. See 42 C.F.R. § 1001.952. The safe harbors set forth specific conditions that, if met, assure entities involved of not being prosecuted or sanctioned for the arrangement qualifying for the safe harbor. However, safe harbor protection is afforded only to those arrangements that precisely meet all of the conditions set forth in the safe harbor.

The Advisory Opinion concludes that the Proposed Arrangement would not generate prohibited remuneration under the anti-kickback statute. Value-based care and risk sharing models continue to gain appeal, and the Office’s approval of this warranty program shows that the era of value-based care is here to stay.

If you have any questions or would like more information, please contact Ali Sabzevari at [email protected].

PUNITIVE DAMAGES: How Much Is Too Much?

Posted on: November 1st, 2018

By: Rebecca Smith

On August 10, 2018, in the first Roundup cancer lawsuit to proceed to trial, a jury awarded Dewayne Johnson a total of $289 million dollars. On Monday, October 22, 2018, a San Francisco Superior Court Judge refused to overturn the jury verdict, however, ruled that if plaintiff would accept a reduction in the punitive damages from $250 million to $39 million she would deny Monsanto’s Motion for New Trial. On Friday, October 26, 2018, attorneys for Plaintiff Johnson accepted the trial court’s reduction of the punitive damage, reducing the total verdict to Mr. Johnson from $289 million to $78 million.

This case involved the trial of design defect and failure to warn claims asserted by Dewayne Johnson alleging that his exposure to glyphosate and glyphosate-based herbicides (Roundup) developed by Monsanto caused him to develop non-Hodgkin’s Lymphoma. At trial, the jury was asked to resolve the complex question of whether plaintiff’s exposure to Roundup caused his Lymphoma, to which the jury responded affirmatively. Monsanto challenged that determination in post-trial motions, however, Judge Suzanne Bolanos denied such contest, finding there was no legal basis to disturb the jury’s determination that plaintiff’s exposure to Roundup was a substantial factor in causing his Lymphoma. Judge Bolanos, however, did “disturb” the punitive damage award.

Monsanto had argued that there was no clear and convincing evidence of a specific managing agent authorizing or ratifying malicious conduct and accordingly that punitive damages should not be awarded. Judge Bolanos, however, indicated that when the entire organization is involved in acts that constitute malice, there is no danger a blameless corporation will be punished for bad acts of which it had no control. Further, she held that the jury could have concluded that Monsanto acted with malice by consciously disregarding a probable safety risk of Roundup and continuing to market and sell its products without a warning.

In addressing the amount of the punitive damages, Judge Bolanos began her disagreement with the jury. The award, she indicated, was extremely high for a single plaintiff and consisted largely of non-economic damages which the due process case law recognizes as a punitive element. Pointing to the prior U.S. Supreme Court decision of State Farm Mut. Auto Ins. Co. v. Campbell that “[p]unitive damages found to exceed the ceiling of what due process allows must be reduced,” Judge Bolanos ordered the ratio of compensatory damages to punitive damages be reduced to one to one.  Accordingly, the court held that regardless of the reprehensibility of Monsanto’s conduct, the constitutionally required punitive award could be no more than the compensatory damages award of $39 million.

It is unlikely that this case will end here. While the plaintiff has accepted the reduction in the punitive damages and accordingly, the reduced amount will be entered as a judgment, this does not preclude Monsanto from appealing the judgment. Further, should Monsanto appeal the judgment, plaintiff has reserved its right to appeal the reduction of punitive damages. This is a case well worth watching.

If you have any questions or would like more information, please contact Rebecca Smith at [email protected].

Women On Board

Posted on: October 16th, 2018

By: Rebecca Smith

Nearly one-quarter of California-headquartered publicly held domestic or foreign corporations have no female directors.  No later than the close of the 2019 calendar year, those companies will need to add at least one.  Senate Bill 826 (SB 826) signed by Governor Brown on September 30, 2018 has mandated this change.  And, if the board of directors of a corporation is larger than four board members, the required number of women on the board increases.  If the number of directors is six or more, the corporation must have a minimum of three directors, if the number of directors is five, the corporation shall have a minimum of two directors.  Corporations will be allowed until the close of the 2021 calendar year to add the additional female directors beyond one.

There is a strong likelihood that this new law will be challenged in the courts.  The first argument being made is that the law will displace an existing member of the board of directors solely on the basis of gender.  The new law has attempted to address this by indicating:  “A corporation may increase the number of directors on its board to comply with this section.”  The argument being made is that the law focuses too narrowly on gender instead of other aspects of diversity, including race and sexual orientation.  The government may have to prove not only that there is disparity in board representation among men and women, but also that such a divide is a sufficient reason to create a special law for women.

The other issue in the forefront is to which companies the law will apply.  While the statute provides that the companies will be determined by the location of the principal executive offices according to the corporation’s SEC 10-K form, challenges are being made that the law should not apply to businesses headquartered in California, but incorporated elsewhere.  The new Section 2115.5 of the Corporations Code has attempted to address this issue by indicating that the new requirements shall apply to a foreign corporation that is a publicly held corporation to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated.  That being said, the “internal affairs doctrine” may provide a basis for the challenge.  The internal affairs doctrine, a choice of law rule in corporation law, provides that the internal affairs of a corporation will be governed by the corporate statutes and case law of the state in which the corporation is incorporated.

So what happens if a company does not comply:  A fine of $100,000 for a first violation, and a fine of $300,000 for a second or subsequent violation.  For purposes of imposing the fine, each director seat required by the section to be held by a female, which is not held by a female during at least a portion of the calendar year is considered a violation.  For the time being, California companies with their principal executive offices in California should start to think about how to comply with the law by the end of 2019 and stay tuned for any changes.

If you have any questions or would like more information, please contact Rebecca Smith at [email protected].