Category Archives: Business Torts

Supreme Court of Virginia Addresses the Reach of Conspirator Liability under the Virginia Business Conspiracy Act

The Supreme Court of Virginia recently addressed conspirator civil liability under the Virginia Business Conspiracy Act, Va. Code §§ 18.2-499 and -500.  Borrowing from Illinois law, the Court recited that “[t]he function of the conspiracy claim is to extend liability in tort beyond the active wrongdoers to those who have merely planned, assisted or encouraged the wrongdoer’s acts.”   While the case does not really change the substance of Virginia law, the opinion in Gelber v. Glock offers language that will likely appear in every future Virginia brief on conspirator liability and in the conspiracy jury instructions.

Tucked into the back of a 39-page opinion dealing with a family feud over an estate, the Supreme Court provides its tutorial on conspirator liability.   Admittedly, this is not federal law, but VBCA claims often appear in E.D. Va. litigation when state claims are before the federal court under diversity jurisdiction or pendent jurisdiction.

The Family Feud Case

The case is Gelber v. Glock, Record No. 160500 (June 22, 2017), a decision from an appeal heard during the Supreme Court of Virginia’s February 2017 Session.  The facts are those of the classic family feud.  In an early will, Mrs. Gelber left her estate to be divided among her five children.  Subsequent estate documents seemingly altered this directive—Mrs. Gelber’s real and personal property was to go to just one of her daughters.  The Executors sued on multiple theories, including a claim that the lucky daughter was part of a civil conspiracy with one of her sisters and a brother-in-law.

The Circuit Court for Henrico County granted a Motion to Strike the conspiracy claim.   The Supreme Court found no error in this circuit court ruling.  Given this straightforward appellate finding, the Supreme Court perhaps likely could have addressed the conspiracy Assignment of Error in a single paragraph.  But the Justices chose to give us a powerful tutorial on conspirator liability under the VBCA.  The tutorial is perhaps dicta, but it is nonetheless part of the Supreme Court opinion.

The Language of the Virginia Business Conspiracy Act

The VBCA is a two-part statute found in Title 18 of the Virginia Code, the criminal law title.  Va. Code § 18.2-499 identifies the elements of the criminal conspiracy. The next section, Va. Code § 18.2-500, provides for civil remedies for conspiracy violations.  Subpart A of the section reads:

Any person who shall be injured in his reputation, trade, business or profession by reason of a violation of § 18.2-499, may sue therefor and recover three-fold the damages by him sustained, and the costs of suit, including a reasonable fee to plaintiff’s counsel, and without limiting the generality of the term, “damages” shall include loss of profits.

The Reach and Purpose of Civil Conspiracy Liability

The real punch from the Gelber decision is the confirmation of conspirator liability beyond the primary tortfeasor.  The decision explains, “the object of a civil conspiracy claim is to spread liability to persons other than the primary tortfeasor.”  Gelber at 37.  The Court expands its discussion in footnote 21.  Quoting from Beck v. Prupis, 162 F. 3rd 1090, 1099 n. 18 (11th Cir. 1998), aff’d, 529 U.S. 494 (2000), the Gelber Court adds that “[i]n a civil context … the purpose of the conspiracy claim is to impute liability– to make X jointly liable with D for what D did to P.”   This is language is straight from Prosser and Keeton on Torts § 46 (5th Ed. 1984).

The Gelber opinion continues, in the same footnote 21, “[t]hus, a civil conspiracy plaintiff must prove that someone in the conspiracy committed a tortious act that proximately caused his injury; the plaintiff can then hold other members of the conspiracy liable for that injury.”  In support of this statement, the Supreme Court cites authority not only from the 11th Circuit, but also from the 8th Circuit, and from the Utah federal court and the Illinois Supreme Court.

The cited Eighth Circuit decision, Simpson v. Weeks, 570 F.2d 240, 242-43 (8th Cir. 1978), provides a clever analogy, “[t]he charge of conspiracy in a civil action is merely the string whereby the plaintiff seeks to tie together those who, acting in concert, may be held responsible for any overt act or acts.”   The Utah federal court decision, Boisjoly v. Morton Thiokol, Inc., 707 F. Supp. 795, 803 (D. Utah 1988), explains that “[c]ivil conspiracy is essentially a tool allowing a plaintiff injured by the tort of one party to join and recover from a third party who conspired with the tortfeasor to bring about the tortious act.”

Finally, Gelber confirms that conspiracy liability is the same for low-level players as it is for conspiracy kingpins.  The cited Supreme Court of Illinois decision, Adcock v. Brakegate, Ltd., 645 N.E.2d 888, 894 (Ill. 1994), offers, “[t]he function of the conspiracy claim is to extend liability in tort beyond the active wrongdoers to those who have merely planned, assisted or encouraged the wrongdoer’s acts.”

Summary: Gelber and VBCA Conspirator Liability

The Supreme Court of Virginia ranges far and wide for its authority on conspirator civil liability perhaps because a clear statement of civil liability tied to a conspiracy claim was previously missing from the Virginia case law.  For instance, plaintiffs looking for authority for conspirator civil liability have frequently cited Carter v. Commonwealth, 232 Va. 122 (1986), a criminal case about vicarious liability for the use on a firearm in a felony.  This is not to say that Virginia law was any different before Gelber, but that it was challenging to find on-target Virginia citations supporting conspirator civil liability.

Expect that the Gelber language will be prominent in trial briefs and jury instructions for future VBCA claims in the state courts and in the federal courts.

Personal Jurisdiction in the Internet World Redux

In this Blog post, we look at two recent Judge Ellis decisions on personal jurisdiction: Zaletel v. Prisma Labs, Inc., 226 F.Supp.3d 599 (E.D. Va. 2016), and Thousand Oaks Barrel Co., LLC v. Deep South Barrels LLC, 2017 WL 1074936 (E.D. Va. 2017).

It seems that the Alexandria federal court’s Friday Motions Docket often has at least one personal jurisdiction motion.  You might think that a simple test for personal jurisdiction could be applied to greatly reduce the frequency that this issue comes before the courts.  But think again.  Pulitzer Prize winner Thomas Friedman contends in his recent best-seller, Thank You for Being Late, that the pace of technological change has for at least the last 10 years been accelerating faster than we can adapt.  Why, then, should we expect the law of personal jurisdiction to keep up with the changing technology landscape?   As Friedman argues, it is not just technology per se that is accelerating, it is everything that is driven by technology that is also accelerating at unsettling speeds.  This understandably includes the exploding e-commerce world.

Zippo: a 20-year old Precedent for the Internet World   

The most widely cited case on personal jurisdiction in the Internet world is now 20 years old.  In Zippo Manufacturing Co. v. Zippo Dot Com, Inc. Co., 952 F.Supp. 1119 (W.D. Pa. 1997), the court divided Internet activities into three kinds – active, passive, and interactive.  The jurisdictional question was decided based on where a website fell within these categories.  Think back to 1997, the year of the Zippo decision. The leading ISP was AOL, and the majority of online users joined the Internet via dial-up access.  Amazon (first known as Cadabra, Inc.) was just getting started and was only beginning to sell books online.  The leading web browser was Netscape, and e-commerce was not much more than a handful of infrequently accessed “storefronts.”   Times have changed.

Fourth Circuit Law on Personal Jurisdiction in the Internet World

The controlling law in the Fourth Circuit is from 2002 – ALS Scan, Inc. v. Digital Service Consultants, Inc., 293 F.3d 707 (4th Cir. 2002).   In that case, now 15 years old, Judge Niemeyer wrote, “the convergence of commerce and technology thus tends to push the analysis to include a ‘stream-of-commerce’ concept under which each person who puts an article into commerce is held to anticipate suit in any jurisdiction where the stream takes the article.”  The Court lamented that the Supreme Court had not provided updated guidance.  Absent such controlling authority, Judge Niemeyer settled on the model developed in Zippo.

Zippo provides a three-part test:  A state may, “consistent with due process, exercise judicial power over a person outside of the state when that person (1) directs electronic activity into the state, (2) with the manifested intent of engaging in business or other interactions within the state, and (3) that activity creates, in a person within the state a potential cause of action cognizable in the state’s courts.”  ALS Scan, 293 F.3d at 714.

Later, in 2013, the Fourth Circuit revisited ALS Scan in Unspam Technologies, Inc. v. Chernuk, 716 F.3d 322 (4th Cir. 2013).   In Chernuk, the defendants were four foreign banks that were alleged to have financed the credit card operations for illegal prescription pharmacies.  They were sued as part of an alleged global conspiracy to market and sell pharmaceuticals online.  Chernuk adopted with minor adjustments the three-part test from ALS Scan.  Relying on some interim Supreme Court guidance, the Fourth Circuit added that “it is the defendant’s actions, not his expectations, that empower a State’s courts to subject him to judgment.”

Zaletel v. Prisma Labs—70 Million Downloads, but no Personal Jurisdiction

In Zaletel, a 2016 trademark case involving s photo-filtering app known as “Prisma,” Judge Ellis applies a somewhat modified ALS Scan test.  Before getting to the core of the legal analysis, Judge Ellis walks us through International Shoe and the difference between general jurisdiction and specific jurisdiction.  He then introduces the central issue with a quote from Chernuk.  The Fourth Circuit has adopted the three-part inquiry “to determine whether a defendant is subject to jurisdiction in a State because of its electronic transmissions to that State.”   That inquiry, the judge writes, should consider: “(1) the extent to which the defendant purposely availed itself of the privilege of conducting activities in the forum state; (2) whether the plaintiff’s claims arose out of those activities; and (3) whether the exercise of personal jurisdiction is constitutionally reasonable.”

Judge Ellis refers to the first part of this test as the “purposeful availment” prong, which he explains “is grounded on the traditional due process concept of minimal contacts.”  To determine whether a foreign defendant has purposely availed itself of the privilege of conducting business in a state, the court should ask whether “the defendant’s conduct in connection with the forum state are such that he could reasonably anticipate being haled into court there.”  To satisfy this standard, “a defendant outside the forum state must have at least ‘aimed’ its challenged conduct at the forum state.”  Chernuk at 328.

The defendant in Zaletel had no Virginia presence and did not sell its app directly into Virginia.  The app, however, could be downloaded from the Google Store.  Judge Ellis reverted to the more general “stream of commerce” theory.  Simply placing products into the stream of commerce, even with the expectation that they would be purchased in the forum state, is not enough to constitute “activity purposely directed” at the forum state.  The Prisma Labs app was downloaded more than 70 million times, but apparently not specifically aimed at Virginia.  Due process requires that a defendant be haled into court in a forum state based on his own affiliation with the state, and “not based on the ’random, fortuitous, or attenuated’ contacts he makes by interacting with other persons affiliated with the State.”  The Zaletel court must have recognized that some percentage of the 70 million downloads likely landed in Virginia, it was not by defendant’s doing.  Something more is required.

Thousand Oaks Barrel Co.—99 Shipments Supports Personal Jurisdiction

Three months after Zaletel, Judge Ellis again addressed personal jurisdiction in a trademark/copyright case.  Thousand Oaks Barrel sued Deep South Barrels, a Texas company that made and sold oak mini-barrels similar to the Thousand Oaks Barrel product, claiming trademark and copyright violations in Virginia.  Judge Ellis applied the now familiar ALS Scan test with specific reference to Zippo.  Restated again with minor adjustments in this decision, the three-part test is that a State can exercise personal jurisdiction over a nonresident defendant when that defendant “(1) directs electronic activity into the state, (2) with the manifested intent of engaging in business or other interactions within the state, and (3) that activity creates, in a person within the state, a potential cause of action cognizable in the state’s courts.”

Judge Ellis concluded first that Plaintiff Thousand Oaks established a prima facie case of personal jurisdiction over Deep South Barrels by showing that “Deep South Barrels directed electronic activity into Virginia with the manifest intent to do business with Virginia residents when it set up an interactive e-commerce website accessible to Virginia residents and used that website to fulfill Virginia customers’ Internet purchases.”  The facts established that website customers in Virginia could purchase the Deep South mini-barrels directly over the website, and that approximately 99 shipments originated from website sales to Virginia customers.  The judge found that Deep South Barrels’s use of an interactive e-commerce website to sell even a modest quantity of products to Virginia residents was sufficient to show that the defendant “purposely availed itself of the privilege of conducting activities [in Virginia].”

Summary

The center of the test for personal check jurisdiction in Internet or cyberspace transactions is whether there has been “purposeful availment” by the defendant, which requires that the commerce in question be aimed at the forum state.  The Zippo test addresses the relatively easy questions of personal jurisdiction with passive websites (no personal jurisdiction) and sales from highly active website (personal jurisdiction).   By the broad swath of middle-ground interactivity remains uncertain territory.

The current Fourth Circuit test yields what might tactfully be described as uneven results.  In Zaletel, 70 million downloads of the defendant’s app – of which some percentage were certainly to Virginia customers – did not support personal jurisdiction because the defendant did not aim at Virginia.  Yet the same judge only three months later and applying the same test concluded that 99 shipments of oak mini-barrels was sufficient for personal jurisdiction.

Judge Ellis’s analysis seems to be consistent between the two cases.  The problem is that the legal test for personal jurisdiction in the Internet world is from a bygone era, leaving us with no clear test of the critical “purposeful availment” analysis.

EDVA: Legal Malpractice Does Not Give Rise to Breach of Fiduciary Duty Claim

A claim of legal malpractice by client against a former attorney does not, at the same time, give rise to a breach of fiduciary claim under Virginia law, according to Judge Henry Hudson of the Eastern District of Virginia (Richmond Division).  Judge Hudson’s ruling is a development in the law of fiduciary duty, and it goes into territory that has not yet been covered by the Virginia Supreme Court.

In Kylin Network (Beijing) Movie & Culture Media Co. Ltd v. Fidlow, 3:16-cv-999-HEH, 2017 WL 889620 (E.D. Va. Mar. 6, 2017), the case began with a Chinese company that wanted to make a movie about the life of martial arts legend Bruce Lee.  The company hired the defendants (a Virginia attorney and his former law firm) to negotiate and obtain the movie rights with the supposed copyright owner.  According to the Complaint, after some negotiation, the attorney recommended that the plaintiff pay $1 million to the supposed seller of the rights.  After the payment was made, the plaintiff allegedly discovered the seller did not have good title to the movie rights.  The unhappy client then filed a three-count complaint in federal court against its former attorney for legal malpractice, breach of fiduciary duty, and fraud.

The defendants sought to dismiss all counts of the Complaint under Fed. R. Civ. P. 12(b)(6).  The defendants first argued that the legal malpractice claim failed due to the plaintiff’s contributory negligence.  While Judge Hudson recognized that contributory negligence could be a complete defense to legal malpractice, he ruled that the defense had to be resolved at trial by the fact-finder when “reasonable minds could disagree” on the disputed facts.  Thus, the judge denied the 12(b)(6) motion on this count.

The defendants, however, had better luck on the remaining two counts.  The plaintiffs’ breach of fiduciary duty claim, according to Judge Hudson, was based upon duties arising from the attorney-client relationship.  In turn, this relationship was based in contract, specifically the written engagement agreement between the law firm and the clients that gave rise to the legal malpractice claim.  Judge Hudson noted that the Virginia Supreme Court has not ruled on the issue, but based upon prior precedent, he held that the breach of fiduciary duty had to arise from a duty independent of the attorney-client contract.  According to Judge Hudson, “[i]n Virginia, because legal malpractice is a contract claim, an additional claim for breach of fiduciary duty must be based on something other than a violation of a duty arising under the attorney-client relationship.”

Judge Hudson then made short work of the remaining fraud count, dismissing it on similar grounds and holding that such a claim must arise from a source other than the contractual relationship between the parties.

The plaintiffs’ legal malpractice claim survived the 12(b)(6) stage, which appears to be the true core of the plaintiffs’ case.  But Judge Hudson’s opinion is notable as a development in the law of fiduciary duty in Virginia, a claim that seems to appear more frequently in business litigation in the Eastern District.

Suing a URL: A Roadmap to a Cybersquatting Action

As more economic activity occurs online, internet domain addresses are increasing in value, especially for small- and medium-sized businesses.  Businesses of all sizes need to pay attention to the security of their internet domain addresses, and a recent EDVA decision highlights the dangers of losing control of a business’s domain address.

In Jacobs Private Equity, LLC v. <JPE.com>, Case No. 1:16-cv-01331, 2017 WL 830397 (E.D. Va. Feb. 2, 2017), Magistrate Judge Ivan D. Davis faced a “cybersquatting” claim that is becoming more common.  Plaintiff Jacobs Private Equity, LLC, operated www.jpe.com as its website for over 12 years.  One day, however, its employees suddenly found that their login credentials to the website no longer worked.  According to the Complaint, an employee was the victim of an email “phishing” scheme where she was conned into divulging her login credentials.  The hackers then logged into the internet domain registry and changed the password to the business’s account.  As a result, the business lost control over its website and email addresses, and a new entity registered its purported ownership of the domain address.

Represented by Mark H. M. Sosnowsky of Drinker Biddle’s DC office, the business filed suit in the Eastern District of Virginia under the federal Anti-Cybersquatting Consumer Protection Act (the “ACPA”), 15 U.S.C. § 1125(d), et seq.  The Eastern District frequently sees these actions because many of the most popular internet domain registrars have offices in northern Virginia.  In this case, VeriSign, Inc., served as the registry, and it has an office in Reston, Virginia.

Suing an Internet Address

In a marriage of ancient legal principles and new information technology, a lawsuit under the ACPA is an in rem action against the internet domain address itself (and similar to an in rem action against a parcel of real estate or tangible personal property).  While the actual internet domain address is named as a defendant, the real defendant is, of course, the party who registered the address.

An ACPA action also involves elements of traditional trademark law.  In fact, the ACPA is part of Title 15 of the U.S. Code which focuses on federal law governing trademarks, also commonly referred to as the Lanham Act.  Under the ACPA, a court may order the forfeiture or cancellation of a domain name, or transfer of a domain address to the rightful owner of the mark. The ACPA applies, for the most part, to marks that are distinctive or famous.

A Common Problem

Fraudulent phishing schemes, such as the one that snared Jacobs Private Equity, are unfortunately increasingly common.  The usual pattern for this scheme is that bad actors outside of the United States will either take over the registration for a valuable website, or will watch for a non-renewal of registration for an active website.  The new party will swoop in, register the domain, and then offer to sell the domain back to the previous user for exorbitant amounts.  This frequently ensnares small businesses who fail to renew a website registration, such as by relying upon an expired credit card for an expected “auto-renewal” that never occurs.  The ACPA was enacted in 1999 in hopes of curbing such problems.

Elements of an ACPA Claim

Judge Davis’s opinion provides a useful roadmap for cybersquatting claims.  Treating an internet domain address as a trademark, a plaintiff must prove two elements to succeed on a cybersquatting claim:

  1. The domain name is identical or confusingly similar to the plaintiff’s mark.
  2. The registrant had bad-faith intent to profit from the domain name.

Traditional Trademark Law

The ACPA protects both registered trademarks and unregistered, common law marks.  While a common course of action for a business is to register its trademarks with the U.S. Patent & Trademark Office, a business may also acquire common law trademark rights by actual use of the mark in the market place.  For example, a small jewelry shop that has operated for 15 years as “Kitty’s Fine Jewelry” likely has a common law trademark rights in the name.  And if that small jewelry shop also operated a website (such as www.kittysfinejewelry.com), it will likely have a strong ACPA claim against a subsequent registration of the domain by a party acting in bad faith.  A business need not make a formal registration with the USPTO to have such protection.

Proving Bad Faith

Proving “bad faith intent” is often the challenge in these types of cases.  Because we cannot see into a person’s mind to determine intent, the ACPA sets forth nine “factors” that a court “may consider” in determining a person’s intent.  These factors operate as non-exclusive guides to the court (which is a concept similar to the common law “badges of fraud” used in traditional fraudulent conveyance law).  The nine factors under § 1125(d)(1)(B)(i) are as follows:

  1. Any preexisting trademark or other rights in the name used in the domain address.
  2. Whether the domain name contains the legal name of the person or a name that is commonly used to identify the person.
  3. Prior use of the domain name in connection with bona fide goods or services.
  4. Legitimate noncommercial or fair use of the mark in a site that uses the mark in the domain address.
  5. Intent to divert consumers from the mark owner’s online location to another site that could harm the goodwill represented by the mark.
  6. Whether the person offered to sell the domain name back to the mark owner for financial gain without having used the domain in any legitimate business activities. (This factor also includes whether the person has engaged in such activity in the past, indicating a pattern of such conduct.)
  7. Providing false or misleading contact information during the registration of the domain address.
  8. Acquiring multiple domain names which are identical or confusingly similar to multiple preexisting marks.
  9. Whether the mark is distinctive or famous at the time of registration of the domain name.

Of course, not all of these factors will apply in a given case, and there is no set standard for how many factors need to be present to establish bad faith.  Rather, a court has wide-latitude in these fact-intensive cases.

Service of Process Issues

In Jacobs Private Equity, the new registrant of the disputed internet domain address never responded to the complaint, so Judge Davis recommended that a default judgment be entered.  In Judge Davis’s Report and Recommendation (“R&R”), he first focused on the efforts that the plaintiff went to effect service of process.  The plaintiff tried the telephone number, mailing address, and email address listed by the new registrant, but all turned out to be bogus.  The plaintiff then sought court approval to publish notice of the lawsuit in The Washington Times.  Once this was accomplished, the court was satisfied that the default judgment could be granted.

The Plaintiff Prevails

Even though the defendant defaulted, Judge Davis still performed the ACPA statutory analysis in his R&R.  He determined that the plaintiff had a valid common law trademark rights in “JPE” and that the new registrant acted in bad faith by providing bogus contact information to VeriSign, among other factors.  No objections to Judge Davis’s R&R were ever filed, and on March 2nd, District Judge Liam O’Grady adopted the R&R in full, ordering the internet register to return the domain address to the plaintiff.

Alternatives to Litigation

 While the ACPA provides a legal remedy in federal court, aggrieved mark owners can also pursue an administrative challenge to bad-faith registration.  Known as a “Uniform Domain Name Dispute Resolution Policy” (“UDRP”) proceeding, the action is essentially a private arbitration filed with the internet registry overseeing the disputed domain.  While it can be faster and cheaper than litigation, the range of remedies allowed in such an arbitration are fewer than those available from a federal court.  And a successful arbitration can have little or no deterrence or precedential value against other cybersquatters targeting a specific website.

 Conclusion

The ACPA provides a legal remedy to businesses and individuals who have been victimized by the theft  or loss of control of their internet domains.  The statutory framework is straight-forward, but proving bad-faith intent can be challenging, especially when defendants evade service of process or mask their identities.  Yet, with the rise of online commerce (especially for small- and medium-sized businesses), we will likely see more incidents of stolen internet websites, and by virtue of the Eastern District’s geographic location, more cybersquatting claims brought in this court.

Handling Overlapping and Duplicative Damages

In a recent case, Judge Liam O’Grady astutely handled in his Jury Instructions and a Special Verdict Form the prospect of a jury’s duplicative and overlapping damage determinations.  He then resolved the parties’ dispute on overlapping damages when he decided post-verdict remittitur motion.  This case provides a roadmap for practitioners on how to handle similar problems in future cases.

Multi-count Complaint and Overlapping Damages

The case of Hair Club for Men, LLC v. Ehson et al, Civil Action No. 1:16cv236–LO/JFA involved a two-year covenant not-to-compete.  Plaintiff (a former employer) sued to enforce the covenant against a departing employee and her new employer.  Plaintiff sought not only an injunction but also considerable damages.

The Complaint alleged the usual suite of claims found in covenant-not-to-compete cases. The leading claim was for Breach of Contract, followed by claims for Trade Secrets Misappropriation, Tortious Interference, Unjust Enrichment, and Breach of Fiduciary Duty.

The case narrowed at summary judgment when the Court held that the defendants were liable on certain counts.  Judge O’Grady ruled that the non-compete covenant was enforceable, and that, as a matter of law, the ex-employee breached her fiduciary duty.  But still the Trade Secrets and Tortious Interference claims had to be tried, and the measure of damages for all claims was left open for trial.  Perhaps surprisingly, the case did not settle after these rulings.

Seven months after filing of the Complaint, the case went to a jury trial for four days.  The jury’s Special Verdict Form awarded Breach of Contract damages of $156,096, and then awarded damages of $258,330 on each of the three remaining counts.  Additionally, the jury responded to the question of whether the damages awarded were duplicative by circling “Yes.”

Jury Instructions and Special Verdict Form

Judge O’Grady’s jury instructions navigated through the duplicative damages issue, and the Special Verdict Form focused the jury on the key question of duplication.  Jury Instruction No. 39 addressed the possibility of overlapping damage awards:

In this case, Hair Club seeks to recover the same type of damages for lost profits on its breach of contract, breach of fiduciary duty of loyalty, misappropriation of trade secrets and tortious interference with contract and business advantage claims. A party is not entitled to multiple recovery for its losses. However, if you find that Hair Club has proved every element of each of its damages, and is entitled to recover for its claimed losses, you will be asked whether the recovery is duplicative, so that Hair Club does not recover more than it is entitled.

On the Special Verdict Form, Question No. 7 asked “Are any of the answers to questions 1, 3, 5, or 6 duplicative?”, followed by a simple “Yes/No” option.  (The four identified questions corresponded to Plaintiff’s four separate remaining counts.)

Dealing with Duplicative Damages

Despite the simple “Yes/No” question, the jury’s verdict left uncertainty as to the overall damages.  If the Court simply added all of the multiple damage awards, then the result would be a judgment for $934,086.  Plaintiff agreed that the jury intended that the three awards of $258,330 were for the same conduct and damage.  But Plaintiff also argued that the Breach of Contract damages should be added to the common damages, for a total damage award of $414,426.  Judge O’Grady, however, concluded that the appropriate total damage award was $258,330.

Virginia law prohibits the award of duplicative damages “when the claims, duties, and injuries are the same.” Wilkins v. Peninsula Motorcars, Inc., 266 Va. 558, 587 S.E.2d 581 (2003).  Judge O’Grady added that the “two claims are not duplicative if the conduct underlying the claims is different.”  For this, he cited Advance Marine Enterprises, Inc. v. PRC Inc., 256 Va. 106, 501 S.E.2d 148 (1998), and his analysis tracks the Wilkins opinion.  The trial court must “evaluate whether multiple damage awards constitute impermissible double recovery” and that under Virginia law it is the responsibility of the trial court in reviewing a verdict to supervise “the damage awards to avoid double recovery.”

Plaintiff relied on Advanced Marine to argue that the damages were in part separate and therefore should be added to yield the aggregate damage award, but Judge O’Grady distinguished Advance Marine.   In that case, the plaintiff proved a common set of compensatory damages under separate claims for Trade Secrets Misappropriation and Business Conspiracy.  While the plaintiff was limited to only one set of compensatory damages, the plaintiff was allowed to recover both punitive damages under the Trade Secrets claim and to treble the compensatory damages under the Business Conspiracy claim.

Judge O’Grady summed his conclusion by stating that “compensatory damages for the same injury, based on the same evidence, should be awarded only once.  This was consistent with Advance Marine.  This rule holds even if the injury is articulated in multiple causes of action with separate burdens of proof.”  But equally important, the judge ruled that it was his responsibility to make the determination using the jury’s answers on the Special Verdict Form.

Summary

The dilemma of overlapping and repetitive damages arises frequently.  In the case before Judge O’Grady, the jury considered damages on four separate counts.  The trial evidence, however, addressed the damages as a single compensatory loss.  When the jury answered that the damages were duplicative, it was then the trial judge’s responsibility to resolve the parties’ disagreement on the extent of the duplication.

Too often, a jury’s verdict states only its liability findings and separate awards on multiple counts.  In this situation, a judge ventures into potentially dangerous territory if he or she imputes that the damages are duplicative.

A question for both trial lawyers and judges is how best to manage this issue to steer away from the quagmire.  Judge O’Grady’s jury instruction in Hair Club cleanly instructs on duplicative damages.  He coupled his Instructions with the simple Special Verdict Form question about duplication.  In Hair Club, this seems to have worked well, and perhaps is the model for multi-count cases where the claimed damages overlap.

Defend Trade Secrets Act of 2016 Delivers New Relevancy for the “Long Arm” of FRCP 4(k)(2)

In this blog post, we reach back to a 2003 Judge Ellis opinion applying FRCP Rule 4(k)(2). In Graduate Management Admission Council v. RPV Narasimha RJU d/b/a GMATPlus.com, 241 F. Supp. 2d 589 (E.D. Va. 2003) (the “GMAC Case”), the judge applied this little-known rule to rescue a complaint from dismissal for lack of in personam jurisdiction.  The decision has had little visibility, but with the recent enactment of the Defend Trade Secrets Act of 2016 (“DTSA/2016”) the rule and the Judge Ellis’s opinion have new relevancy.   Stated differently, Rule 4(k)(2), as applied by Judge Ellis thirteen years ago, potentially turbocharges DTSA/2106’s role in trade secrets litigation involving overseas defendants.

Rule 4(k)(2), the Federal Long-arm Statute

Rule 4(k)(2) is buried deep in Rule 4, which has the innocent title of “Summons.”  Rule 4(k), titled “Territorial Limits of Effective Service,” also seems easily overlooked.   Our target, subpart 4(k)(2), provides:

(2) Federal Claim Outside State-Court Jurisdiction. For a claim that arises under federal law, serving a summons or filing a waiver of service establishes personal jurisdiction over a defendant if:

     (A) the defendant is not subject to jurisdiction in any state’s courts of general jurisdiction; and

     (B) exercising jurisdiction is consistent with the United States Constitution and laws.

It’s a decent bet that most of us (except some of the patent bar), even those with decades of federal court experience, have never before encountered Rule 4(k)(2).  Since its arrival in 1993, the rule has only rarely been applied, and the limited appearances have mostly been in patent and copyright cases.

The 2003 GMAC Case

In the GMAC Case, Judge Ellis rescued a copyright infringement complaint by resorting to Rule 4(k)(2) on behalf of a plaintiff who was having difficulty establishing in personam jurisdiction using Rule 4(k)(1) and the Virginia long-arm statute.   The issue was jurisdiction over an Indian citizen who was selling copyrighted GMAT questions marketed as test preparation resources for aspiring MBA candidates.   The solicitations and sales of the test preparation materials were made over the Internet, and seemingly were not directed to any one state but at a broader United States market.  The defendant failed to answer GMAC’s complaint notwithstanding adequate service in India.

Following routine court procedures, Judge Ellis referred the case to Magistrate Sewell to prepare the R&R report.  The magistrate considered the jurisdiction claim under Rule 4(k)(1) and the Virginia-long arm statute as the complaint alleged.  The magistrate concluded that while the conduct fell within the expansive reach of the long-arm statute, the constitutional due process requirements for in personam jurisdiction were not met.

The case might have disappeared from the radar screen at that point, but Judge Ellis saved the case using Rule 4(k)(2).  GMAC’s complaint came before Judge Ellis when the plaintiff challenged the R&R report.  The judge agreed with the magistrate’s conclusions regarding the Virginia long-arm statute, but he applied retroactively Rule 4(k)(2) (the plaintiff had not alleged jurisdiction under Rule 4(k)(2)), which is often referred to as the Federal long-arm statute, to find in personam jurisdiction.   Citing authority from the 1st Circuit and the 7th Circuit, Judge Ellis explained:

Rule 4(k)(2) was added in 1993 to deal with a gap in federal personal jurisdiction law [identified in Omni Capital Int’l, Ltd v. Rudolph Wolff & Co., 484 U.S. 97 (1987)] in situations where a defendant does not reside in the United States, and lacks contacts with a single state sufficient to justify personal jurisdiction, but has enough contacts with the United States as a whole to satisfy the due process requirements.

The GMAC Case fell into the gap identified in the referenced 1987 Supreme Court decision, only to be rescued by the little-known rule.

Judge Ellis’ decision is important not just because it reminds that Rule 4(k)(2) is part of the landscape, but also for his retroactive use of the rule and how he assigned the burden of the tricky third element in the analysis under the rule.

Three-part Analysis Under Rule 4(k)(2)

When Rule 4(k)(2) comes into play, it tracks a three-part analysis taken directly from the rule’s text.  First, the rule applies the same minimum contacts due process analysis that is conducted under Rule 4(k)(1), but with the significant difference that the relevant forum is the United States as a whole, not an individual state.  The second element of the rule is that the claim arises under federal law.   In the GMAC Case, Judge Ellis cited five federal statutes, including the Copyright Act, invoked in the complaint.

The third and final element—the tricky element—requires a showing that the defendant is not subject to the jurisdiction of the courts of general jurisdiction in any particular state.  Courts have wrestled with how to assign the burden on this element.  Does the plaintiff have to prove a negative across 50 states?  Or does the burden fall to the defendant to establish that at least one state should have jurisdiction?

Judge Ellis answered the burden question—it is the defendant’s burden to identify some other forum state, and if no state is identified then Rule 4(k)(2) applies.   The defendant in the GMAC Case was in default and did not appear; Judge Ellis found that there was no evidence showing the jurisdiction was not available in any one state, and from there moved to his conclusion that Rule 4(k)(2) gave the court jurisdiction.  The judge followed a mix of the 1st Circuit’s pure burden shifting approach from United States v. Swiss American Bank, 191 F.3d 30 (1st Cir. 1999) and the 7th Circuit’s more pragmatic approach in ISI Int’l, Inc. v. Borden Ladner Gervais, LLP, 256 F.3d 548 (7th Cir. 2001) where a defendant must name a suitable forum state or concede that jurisdiction is not available in any state.   Under Judge Ellis’s logic, a defendant who has general contacts with the United States but who coyly argues that it cannot be sued in the forum state and then refuses to identify any other state where the suit could be brought faces in personam jurisdiction under Rule 4(k)(2).

The Rule 4(k)(2) case law in the years since the GMAC Case is sparse outside the patent arena.  Not surprisingly, because the cases where the rule has been applied are mostly patent and copyright matters, the Federal Circuit has spoken.    In Merial Ltd. v. Cipla Ltd, 681 F.3d 1283 (Fed. Cir. 2012), the Federal Circuit employed an analysis much like Judge Ellis’s GMAC Case opinion, and approved retroactive application of the rule.

The 4th Circuit’s consideration of Rule 4(k)(2) is not completely blank.   In the few reported cases, the court has been generally hostile to Rule 4(k)(2) argument, but has not offered much analysis.  In Base Metal Trading v. OJSC Novokuznetsky Aluminum Factory, 283 F.3d 208 (4th Cir. 2002), the Court rejected jurisdiction based on Rule 4(k)(1), and noted that there was insufficient evidence generally of contacts with the United States to support the Rule 4(k)(2) argument.   The same result for the same reason appears in Saudi v. Northrop Grumman Corp., 427 F.3d 271 (4th Cir. 2005).  More recently, in Unspam Techs., Inc. v. Chernuk, 716 F.3d 322 (4th Cir. 2013), in a case that alleged a conspiracy involving illegal prescription drugs, the appellate court rebuffed the Rule 4(k)(2) jurisdiction argument against four foreign banks that processed the associated credit card transactions.  The opinion cryptically states that jurisdiction “would not, in the circumstances here, be ‘consistent with the United States Constitution and laws.’”

The Combination of Rule 4(k)(2) and DTSA/2016

As suggested above, Rule 4(k)(2) and the GMAC case might easily have been left in the irrelevancy bin.  In copyright, patent, and trademark cases where the defendant is foreign, perhaps from India or China, the evidence often is sufficient to pinpoint one or more states, or at least to provide sufficient contacts to satisfy the due process concerns associated with suing the foreign persons or entities in the federal courts in those states.  These cases likely arise after infringing goods are being sold and/or marketed, which means that there typically is evidence which supports jurisdiction under Rule 4(k)(1) and state long-arm statutes.  In the few cases where a defendant might contest state-specific activity, Rule 4(k)(2) allows the plaintiff to hold the defendant in the proceeding.

Claims alleging trade secrets misappropriation, on the other hand, very well might present facts that confirm misappropriation, but where the facts precede any significant targeted sales and marketing by the misappropriator.   The plaintiff could be seeking at an early stage to enjoin sales, and perhaps is aiming to employ DTSA/2016’s civil seizure remedies, including the ex parte remedies.   The conduct might come within DTSA/2016’s broad “misappropriation” definition, but limited facts connecting the activity to any one state could defeat in personam jurisdiction under Rule 4(k)(1) and state long-arm statutes.

Until the DTSA/2016 enactment, trade secrets claims were governed by state laws, which meant that Rule 4(k)(2)’s application was blocked because the second element of the analysis could not be satisfied.  Under DTSA/2016, just about every trade secrets claim is now a federal claim, and the rule’s three-step analysis can now be satisfied.  This does not negate the requirement of established contacts with the United States generally, but trade secrets cases against foreign defendants now have a fortified argument to get around the earlier nemesis of the lack of in personam jurisdiction

Conclusion        

The combination of Rule 4(k)(2), as applied by Judge Ellis back in 2003 in the GMAC Case, and the enactment of DTSA/2016 potentially opens wide the doors of federal courthouses to trade secrets litigation against overseas defendants.   For litigators who represent foreign companies, there is new concern that their clients can now be forced to defend trade secrets cases in the U.S. federal courts.  And for those attorneys whose clients have reason to complain about misappropriation of their trade secrets by overseas entities, the combination of Rule 4(k)(2) and DTSA/2016 is an invitation to bring their claims here.

New Federal Trade Secrets Law: Defend Trade Secrets Act of 2016 Signed into Law on May 11, 2016

On May 11, 2016, President Obama signed into law the Defend Trade Secrets Act of 2016 (“DTSA”) , which dramatically expands federal jurisdiction over trade secret claims.  The impetus for this law was to provide some response to the reports of Chinese and possibly Iranian hacking into U.S. corporate and government sites.  Prior bills were introduced in 2013 and 2014.  These served as models for the eventual statute.  The new law, however, closely resembles in many ways the current state trade secrets laws but provides jurisdiction in federal courts.

The federal Intellectual Property protection scheme until now has been a three-legged approach: Patent protection, trademark laws, and copyright provisions.  After the DTSA, however, the trade secrets protection of the enactment becomes the fourth leg.  While the new law overlaps in many respects the Uniform Trade Secrets Act (“UTSA”) on the books in 47 states (including Virginia, Maryland, and D.C.), the DTSA changes the federal jurisdiction analysis, expands the definition of “trade secrets,” adds new remedies, and includes express whistleblower protections.  While the DTSA does not significantly alter the substance of U.S. trade secrets law, the procedures and available civil remedies – especially the civil ex parte seizure terms – introduce new and potentially powerful enforcement tools.

The DTSA arrives as an amendment to the Economic Espionage Act of 1996, 18 USC  § 1331 et seq.   The coverage below highlights five points in the new law.

  1. Federal Jurisdiction. Just about any trade secret claims is now a federal claim which can provide subject matter jurisdiction in the federal courts.  2(b)(1) allows for civil actions this way:

An owner of a trade secret that is misappropriated may bring a civil action under this subsection if the trade secret is related to a product or service used in, or intended for use in, interstate or foreign commerce.

This expansive coverage seemingly reaches to the limits of the Commerce Clause as a basis for Congressional action and federal court jurisdiction.

Previously, the Economic Espionage Act was mostly a criminal statute that offered no private civil action route.  Now with passage of the DTSA, nearly any trade secret claim can be brought by a private party in the federal courts.  It is no longer necessary to cleverly plead a Computer Fraud and Abuse claim (18 § USC 1030 et seq.) or some other federal claim to get a case into federal court when there is no diversity jurisdiction.

  1.    Broader Definition of “Trade Secrets?”   Much of the new law’s substance is found in the Definitions, either already included in or added to 18 USC § 1839.  For example, the current “trade secrets” definition reads:

(3) the term “trade secret” means all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if—

(A) the owner thereof has taken reasonable measures to keep such information secret; and

(B)  the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, the public [].

Most any type of information can qualify as a trade secret under this definition provided the information is a secret and the owner took reasonable steps to maintain the secrecy.  This is slightly different than the UTSA definition, which list eight specific types of trade secrets but then applies roughly the same two-part test found in subparts (A) and (B) above.  If there is a difference, then the DTSA offers the broader definition.

The statute also adds definitions of “misappropriation” and “improper means.”  These track almost exactly the UTSA definitions.

  1. Ex Parte Seizure Remedy.   The DTSA goes beyond the state laws where it includes in Sec. 2(b)(2) a “Civil Seizure” remedy:

(i) APPLICATION.—Based on an affidavit or verified complaint satisfying the requirements of this paragraph, the court may, upon ex parte application but only in extraordinary circumstances, issue an order providing for the seizure of property necessary to prevent the propagation or dissemination of the trade secret that is the subject of the action.

The drafters plainly contemplate a preliminary civil remedy that goes beyond any currently available Fed. R. Civ. P. 65 TRO or Preliminary Injunction.

The statute spells out the process for obtaining a Seizure Order, and limits what a court may order.  The seizure is not a private action, but would be conducted by federal or local law enforcement.  Then the court “shall secure the seized material from physical and electronic access during the seizure and while in the custody of the court.”

But even with the various statutory protections, the availability of an ex parte seizure remedy markedly expands the potency of the law.

  1. Trade Secrets Misappropriation as Racketeering Activity.   3(b) amends the RICO statute’s definition of Racketeering Activity found in 18 USC 1961(1) to include “sections 1831 and 1832 (relating to economic espionage and theft of trade secrets).”

If RICO claims have faded in the last decade, this will surely boost their popularity and frequency.  Expect to see DTSA claims coupled with a RICO count built around the trade secrets allegations.

  1. Whistleblower Protection. 7(b) provides immunity from all criminal and civil liability for disclosure of trade secrets made “in confidence to a Federal, State, or local government official, either directly or indirectly, or to an attorney” provided the disclosure is “solely for the purpose of reporting or investigating a suspected violation of law . . .”

Employers are now required to provide notice of this immunity.  Sec. 7(a)(3)(A) includes this language:

An employer shall provide notice of the immunity set forth in this subsection in any contract or agreement with an employee that governs the use of a trade secret or other confidential information.

Subsequent paragraphs restrict remedies available to employers who fail to include the immunity notice; the failure precludes recovery of exemplary damages and attorneys’ fees in a subsequent suit against disclosing employee.  Also, the statute by its terms applies to all contracts entered into or updated after the law’s enactment (on May 11, 2016).   This notice requirement and remedy restriction seemingly applies to employment contracts, employee handbooks, consulting contracts, and even to routine employee/consultant non-disclosure agreements.

  1. Summary—What to Expect from the DTSA

The first consequence of the DTSA in the EDVa will likely be a shifting of trade secrets litigation from the state courts to the federal court.  As mentioned, the necessity of pleading other claims to secure federal jurisdiction has been removed.  Also, we can expect frequent tag-along RICO counts, at least until case law addresses the consequences of the RICO definition adjustments to include trade secrets.

We also should see some early clarifying opinions on the DTSA definitions—is the substantive law essentially unchanged, or is there a broader “trade secrets” definition to be applied?

The Civil Seizure provisions will also be tested early.   Expect the courts to use these rarely, and to impose stringent requirements.  The quasi-criminal process will probably be pushed back except for the most egregious cases, and certainly the court and the clerks will show minimal interest in having to supervise seizures and take possession of the offending materials.  The DTSA allows for the appointment of special masters to handle details of seizures—expect the courts to utilize this option.

The remaining consequence is that entities should and will quickly modify and amend their agreements to include the DTSA immunity notice.

EDVA Provides Road Map to Enforce a Contractual Waiver of the Statute of Limitations Defense

Business attorneys frequently agonize over the statute of limitations. After a debt has gone unpaid, attorneys often seek an alternative to filing suit to provide more time to collect the debt before the running of the statute of limitations. Many attorneys demand a debtor execute a waiver of a statute of limitations defense in return for refraining from filing suit. Such waivers, however, contain hidden landmines due to a little-known Virginia statute. The Eastern District of Virginia recently relied upon that statute to allow a debtor to escape repayment of a $235,000 loan despite signing such a waiver. This case is a warning to corporate practitioners and creditors’ counsel, but it also provides a road map to successfully navigate this statutory minefield.

In Slaey v. Harrington, 1:14-cv-1210, 2015 WL 5139317 (E.D. Va. Sept. 1, 2015), Judge T.S. Ellis reversed the EDVA bankruptcy court which initially ruled in favor of the creditor. The facts of the case are straight-forward. Harrington (an attorney) loaned $235,000 to Slaey (a client of Harrington’s) in 2002 in return for a signed promissory note requiring repayment in 30 days. Slaey, however, failed to repay the loan. Approximately three days prior to the expiration of Virginia’s statute of limitations, Harrington had Slaey sign a written agreement that purported to waive any defense of the statute of limitations in a subsequent lawsuit. Based upon this new agreement, Harrington did not file suit until five years later during Slaey’s Chapter 11 bankruptcy proceeding. Slaey opposed, arguing that Harrington’s claim was time-barred under Virginia law and that the waiver signed five years earlier was unenforceable under Section 8.01-232(A) of the Virginia Code.

Normally, most defenses to a breach of contract action are waivable by a defendant, and this general rule has led many attorneys to mistakenly assume that they can easily contract around a looming statute of limitations defense. But little-known Va. Code § 8.01-232(A) restricts the enforceability of such waivers, and unfortunately, the statute is not a model of clarity:

Whenever the failure to enforce a promise, written or unwritten, not to plead the statute of limitations would operate as a fraud on the promisee, the promisor shall be estopped to plead the statute. In all other cases, an unwritten promise not to plead the statute shall be void, and a written promise not to plead the statute shall be valid when (i) it is made to avoid or defer litigation pending settlement of any case, (ii) it is not made contemporaneously with any other contract, and (iii) it is made for an additional term no longer than the applicable limitations period.

The bankruptcy court initially agreed with Harrington’s argument that to ignore Slaey’s waiver would operate as a “fraud” on Harrington, and thus, the first sentence of the statute should apply. In doing so, the bankruptcy court relied upon a 1938 Fourth Circuit case that broadly interpreted the term “fraud” in this context. In Tucker v. Owen, 94 F.2d 49 (4th Cir. 1938), the Fourth Circuit focused on the apparent purpose of the statue to protect creditors and noted that the “[Virginia] Legislature intended to stigmatize as fraudulent the failure of a debtor to keep a promise of this sort upon which his creditor has relied, and to estop the debtor from pleading the defense when at his request the suit has been delayed.” Based upon this, the bankruptcy court sided with Harrington and enforced the waiver of the statute of limitations defense.

After Slaey appealed to the U.S. District Court, Judge Ellis reversed. The judge noted that two years after the Tucker case, the Supreme Court of Virginia handed down a contrary ruling in Soble v. Herman, 9 S.E.2d 459 (Va. 1940). In that case, the Supreme Court rejected the Fourth Circuit’s reasoning and held that the “fraud” exception must be interpreted narrowly. Looking to the elements of common law fraud, the Virginia high court stated that the exception only applied if the debtor misrepresented a present fact at the time of execution of the waiver.

Judge Ellis noted that the bankruptcy court should have followed the Virginia Supreme Court’s Soble decision and not the Fourth Circuit’s Tucker opinion since the question turned on interpretation of a Virginia statute. Judge Ellis found no evidence in the record of Slaey’s intentions at the time she executed the waiver, let alone “clear and convincing evidence” that she never intended to comply with the agreement. This was fatal to Harrington’s claim. According to Judge Ellis, “[s]imply put, therefore, the circumstances presented here involve merely an unfulfilled written promise on Slaey’s part not to assert a statute of limitations defense in a future suit brought by Harrington. Such a naked, unfulfilled promise is precisely what the Soble court made clear would not satisfy the limited fraud exception set forth in Va. Code § 8.01-232(A).”

While this case stands as a warning to corporate practitioners, the most useful part of this opinion is the road map through section 8.01-232(A) provided by Judge Ellis. After noting that unwritten waivers are flatly barred under the statute, the judge turned to written waivers:

[A] written promise not to plead the statute is generally valid and enforceable only if three specified requirements are met, namely, if the written promise (i) is made to avoid or defer litigation pending settlement of a case, (ii) is not made contemporaneously with any other contract, and (iii) is made for an additional term not longer than the applicable limitations period.

The only exception to this rule, according to Judge Ellis, is the “limited” fraud exception. To trigger this exception, a creditor must meet the heavy burden of showing the debtor misrepresented a present fact at the time of the waiver (as opposed to merely failing to fulfill a future promise such as payment). As a practical matter, most creditors will not successfully meet this burden.

Thus, Judge Ellis’s opinion essentially means that creditors must strictly follow the road map to enforce a limited, written waiver of a statute of limitations defense. For example, such a waiver must come after a promissory note has been signed (and cannot be included in the promissory note itself), must be contained in a separate document, and can only extend the time to file suit to a date that is twice the amount of time under the applicable statute of limitations (meaning that if the applicable statute of limitations is three years, the waiver can only extend the time to file suit another three years). The practical effect is that general, open-ended waivers of the defense are unenforceable under the statute.

Judge Ellis’s ruling makes sense as a matter of statutory interpretation. To otherwise apply a broad reading of the “fraud” exception would allow the exception to swallow the rest of the statute, encouraging a creditor to draft an open-ended waiver and then claim that the failure of a debtor to pay the legitimate obligations operated as a fraud on the creditor. The Fourth Circuit, however, may have the final say as Harrington has already filed a Notice of Appeal with the district court. Assuming that Harrington follows through on the appeal, a decision from the appellate court can be expected in the fall or winter of 2016. But regardless of the outcome, this case stands as a warning and a road map for Virginia corporate practitioners and creditors’ counsel.

Making New Law, the EDVA Bankruptcy Court Allows a Debtor Corporation to Sue its Own Successor

The Bankruptcy Court of the Eastern District of Virginia recently extended the reach of trustees standing in the shoes of debtor corporations to pursue assets that were transferred to successor entities prior to a bankruptcy petition. Judge Keith L. Phillips of the Richmond Division did not let the lack of prior precedent stand in his way, stating, “Although there appears to be no Virginia case specifically stating that a corporate entity may pursue a successor liability claim against its alleged successor in interest, there is also no case that prohibits such an application of successor liability theory.” This new precedent will be useful to creditors and trustees that seek to recover assets that have been transferred to new, successor entities, leaving behind only liabilities with the previous entity.

In In re: Anderson & Strudwick, Inc., Adv. Proc. No. 14-03175-KLP (E.D. Bkr. Apr. 8, 2015), the bankruptcy trustee, standing in the shoes of the Chapter 7 debtor corporation, asserted a claim for successor liability against Counterclaim Defendants Sterns Agee Group, Inc. and Sterne, Agee & Leach, Inc. (together, “Sterne Agee”). A successor liability claim seeks to tag a new entity with the liability of a previous entity, and it is an exception to the general rule of limited corporate liability. As a practical matter, these fact-intensive claims often appear alongside fraudulent conveyance claims and are frequently invoked by creditors attempting to collect on prior judgments or obligations against entities that have sold their assets in bulk.

According to the trustee’s counterclaim, Stern Agee purchased most, if not all, of the assets from the debtor three years prior to the debtor being put into involuntary bankruptcy. In addition to the asset purchase, Sterne Agee allegedly hired most of the debtor’s employees, including all but one of the debtor’s former directors. All of the debtor’s branch office managers allegedly moved over to similar positions at Sterne Agee. The debtor’s previous president and CEO allegedly became a senior managing director at Sterne Agee, and the majority of the debtor’s sales force also allegedly moved to Sterne Agee. Finally, the trustee alleged that Sterne Agee published a press release stating that it would continue service of the debtor’s customers, and the customers would see no change from their previous experience with the debtor.

Stern Agee’s purchase agreement with the debtor, however, excluded all liabilities of the debtor that were not necessary for the continued operation of the debtor’s business, according to the Counterclaim. This left the debtor with no remaining assets with which to operate its business or pay its remaining liabilities, and this led to the Trustee’s claim for successor liability against Sterne Agee.

Sterne Agee moved to dismiss the trustee’s claim on the grounds that Virginia law did not authorize a claim by a corporation against its own successor entity (normally, successor liability claims are brought by the third-party creditors of the defunct entity). Judge Phillips, after citing the alleged connections described above between the debtor and Sterne Agee, held that these allegations sufficiently stated a claim for successor liability. He then examined whether the debtor could bring such a claim against its own successor entity and concluded that no prior Virginia case law prevented the trustee’s claim. The judge relied upon prior Fourth Circuit precedent in Steyr-Daimler-Puch of Am. Corp. v. Pappas, 852 F.2d 132, 135-36 (4th Cir. 1988) which held that if state law authorizes an alter ego claim by a corporation, then that claim passes into the bankruptcy estate and to the trustee after a petition is filed. Judge Phillips analogized an alter ego claim to a successor liability claim, and finally concluded that the successor liability claim was not specific to any one creditor and any recovery would only benefit the bankruptcy estate (and all creditors). Thus, Judge Phillips allowed the odd situation of a debtor entity asserting a successor liability claim against its own successor.

There will be no appellate review of Judge Phillips’s decision because the parties ultimately settled their claims prior to trial. Thus, the judge’s decision will stand, and it provides a useful tool for creditors and trustee counsel looking to assert successor liability claims involving Virginia state law.

Implied Covenant Does Not Add to the Terms of a Contract under Virginia Law

In a July 28th opinion, the Eastern District provided some much-needed clarity on whether an implied covenant of good faith and fair dealing alters or adds terms in a written contract.  Judge Gerald Bruce Lee held that “Virginia law does not recognize an independent cause of action” for a breach of the implied covenant and granted summary judgment against the party asserting the claim.

In Middle East Broadcasting Networks, Inc. v. MBI Global, LLC, No. 1:14-cv-01207, 2015 WL 4571178 (E.D. Va. July 28, 2015), the Plaintiff was a news broadcaster that had operated a bureau in Baghdad, Iraq, since 2004.  In 2013, the Plaintiff solicited proposals to build a special Blast Resistant Building (“BRB”), with a delivery of no later than December 31, 2013.  The Defendant, billing itself as “an expert ‘in the construction of BRBs’ and an ‘expert in the delivery of BRBs to locations in the Middle East,’” accepted the challenge, and the parties entered into a contract.  The delivery date, however, slipped several times to the following summer due to the Defendant’s difficulty in paying a subcontractor.  The parties finally agreed to a contract amendment that required delivery by August 3, 2014, and that this deadline “‘would not be waived or excused for any reason whatsoever.’”  The Defendant then missed the August 3rd deadline and never delivered the BRB.  After the Plaintiff filed suit for breach of contract, the Defendant counterclaimed for breach of the contract’s implied covenant of good faith and fair dealing.  After discovery, the Plaintiff moved for Summary Judgment on the implied covenant counterclaim.

Judge Lee granted the Plaintiff’s Summary Judgment motion on the breach of the implied covenant of good faith and fair dealing claim “because Virginia law does not recognize an independent cause of action for this claim.”  Judge Lee went on to cite prior Eastern District case law that recognized that while such an implied covenant does exist in every contract under Virginia law, the covenant “simply bars a party from acting in such a manner as to prevent the other party from performing his obligations under the contract.”

Judge Lee then used this analysis to determine that the Defendant had failed to demonstrate a genuine issue of material fact as to whether the Plaintiff had done something to prevent the Defendant from performing under the contract.  Notably, Judge Lee implicitly rejected the Defendant’s argument that the implied covenant somehow adds obligations to the contract.

This decision is useful guidance for practitioners who often see breach of contract claims paralleled with breach of implied covenant claims in commercial litigation.  Prior to this opinion, different Virginia courts had gone in different ways when facing the question of whether an implied covenant added to the express terms of a contract.  Judge Lee’s opinion adds much-needed clarity to the subject and essentially answers that question in the negative.  Business litigators can rest (somewhat) more easily by knowing that the four-corners of the contract will not be expanded by a nebulous, undefined, implied covenant.