“Buyer and Seller agree to mediate any dispute or claim arising between them out of this Agreement, or any resulting transaction, before resorting to arbitration or court action…. If, for any dispute or claim to which this paragraph applies, any party commences an action without first attempting to resolve the matter through mediation, or refuses to mediate after a request has been made, then that party shall not be entitled to recover attorney fees, even if they would otherwise be available to that party in any such action.”

These same provisions are commonly contained in CAR forms for the sale of large apartment complexes, and similar provisions are included in purchase and sale agreements for commercial and industrial properties as well.  This article, although focusing on recent court decisions in the residential area, equally applies to commercial and industrial agreements.   California courts will specifically enforce those provisions so long as they are included in the parties’ contracts. 

The good news for parties who successfully mediate is their entitlement to recover attorneys’ fees.  The bad news for prevailing parties who fail to request mediation before filing suit, or who decline a request to mediate by the other side who is filing suit, is the loss of attorneys’ fees, even when prevailing.  Recent cases have strictly enforced this rule.

In 2004’s seminal case, the court strictly enforced the provisions of paragraph 17A.  The sellers of a home were sued for specific performance by buyers who claimed the sellers reneged on an obligation.  Following the requirements of paragraph 17A, the prospective buyers requested that the recalcitrant sellers mediate.  The sellers refused, were sued and while they prevailed on the merits as to liability, they were unsuccessful in their efforts to recover attorneys’ fees.  The putative sellers’ defense was they perceived mediation would be unsuccessful.  Additionally, they agreed during the litigation to mediate and they had engaged in substantive settlement discussions.  The court rejected these facts as not complying with paragraph 17A.  Lauding pre-dispute mediation as strong California public policy, the court noted that the parties were only $18,000 apart in failed settlement discussions, but they had generated several hundred thousand dollars in combined legal expenses in litigation.  What is noteworthy is the buyers actually filed suit before requesting mediation in order to record notice that a lawsuit was pending.  It was the putative sellers’ refusing to mediate which caused the loss of fees under 17A.

This rule was followed in a 2007 case where the putative sellers, defending a specific performance action, had requested the putative buyer to mediate under paragraph 17A.  However, the suing putative buyer refused and lost not only the specific performance lawsuit, but was assessed a significant award of attorneys’ fees as well.

Another case in 2008, but regarding nondisclosure of defects, involved an unhappy buyer who hired a private investigator to locate the sellers in order to serve them with a lawsuit.  Once the sellers were located, the buyers failed to request mediation before proceeding to court.  The good news for the buyers is that they prevailed in recovering $13,000 in damages over nondisclosed defects; the bad news is that their failure to request mediation once their investigator located the sellers and before filing the lawsuit cost them $113, 000 in attorneys’ fees they otherwise would have recovered.

In summary, if paragraph 17A of the standard CAR form is used by the parties for the sale of residential real estate, or if the parties use similar language for the sale of large apartment buildings, commercial or industrial properties, be sure to request mediation before filing suit.  As defendant you must agree to a mediation if requested.  No matter how correct your legal position may be on the merits, you will lose your right to recover attorneys’ fees as a prevailing party unless the provisions of 17A are strictly met.

In the third ruling, Office of Chief Counsel IRS Memorandum 201021049, the IRS concluded that it could consider the community property assets of a taxpayer's registered domestic partner when determining the reasonable collection potential of an Offer in Compromise.

History of California's Community Property Law and the IRS's Application of This Law to Married Couples

California is one of nine community property states, with the others being Arizona, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In California, as well as the other community property states, community property is an ownership right, akin to an equal partnership where each partner contributes labor and effort. To the extent the partnership generates income or acquires property because of this labor and effort, it belongs to the partnership, and thus equally to each partner. The community property system is usually justified by the idea that such joint ownership recognizes the theoretically equal contributions of both partners to the creation and operation of the community.

For federal income tax purposes, the IRS has long recognized Poe v. Seaborn, 282 U.S. 101 (1930), the U.S. Supreme Court case, which held that community earnings and deductions of a husband and wife were to be split equally (the so-called "income splitting rule"). Thus, if spouses elected to file separate income tax returns (e.g., married, filing separately) each spouse would report one-half of all community income and deductions on their separate return, regardless of which spouse actually earned the income or paid the deductions.

California Extends its Community Property Ownership Laws to Registered Domestic Partners, Thus Conflicting with the IRS's Position

While California's community property ownership rules date back to before its statehood, it was not until 2005 that California law directed that these rules apply to registered domestic partners. Despite the 2005 law, domestic partners' earned income was still not treated as community property for state income tax purposes. But California later amended that law, and starting in 2007, allowed registered domestic partners the same filing status and income-splitting options as a husband and wife. Thus, the 2007 amendment extended full community property treatment to California's registered domestic partners. California's extension of its community property ownership laws to registered domestic partners however, left the IRS in a legal quagmire.

Only one year earlier, in 2006, in Chief Counsel Advice ("CCA") 200608038, the IRS had taken the position that Seaborn's income-splitting rule, which applies to federally recognized spouses, was not similarly available to California registered domestic partners. Since federal tax law generally respects state property law characterization and definitions, U.S. v. Mitchell, 403 U.S. 190 (1971), Burnet v. Harmel, 287 U.S. 103 (1932), the IRS's position in CCA 200608038 directly conflicted with California's property law.

The IRS Reverses Itself

The IRS, recognizing this legal contradiction, has reversed its position with the Rulings, now recognizing California’s community property ownership laws with respect to California's registered domestic partners.

Specifically, the Rulings conclude:

1. For tax years beginning after December 31, 2006, a California registered domestic partner must report one-half of the community income, whether received in the form of compensation for personal services or income from property, on his or her federal income tax return.²

2. Each domestic partner is entitled to half of the credits for income tax withholding from the wages of the other domestic partner.

3. The requirement under California law to treat a domestic partner's earnings as community property, does not result in a transfer of property by one domestic partner to the other for federal gift tax purposes.

4. For tax years beginning before June 1, 2010, registered domestic partners may, but are not required to, amend previously filed returns to report income in accordance with the Rulings.

Although registered domestic partners are still not permitted to file federal joint income tax returns (this is available for opposite-sex spouses only because the Defense of Marriage Act does not recognize same-sex unions), the income-splitting rule now available to California domestic partners should make federal income tax reporting easier and potentially decrease overall income tax liability, especially if one partner has a very large income and the other has little or none. For example, under the Rulings, if one domestic partner earns $200,000 in a given year and the other domestic partner earns nothing, each partner reports $100,000 of income and, absent any itemized deductions, pays approximately $21,709 in income tax, resulting in a $43,418 total tax liability. Prior to the Rulings one partner would report $200,000 of income while the other partner would report nothing, resulting in approximately $51,117 of total income tax liability.

The Rulings however, could actually have a negative impact on some domestic partners, especially if one partner who has a much lower income than the other qualifies for federal tax credits or deductions which are phased out at higher income levels. By counting one-half of the higher-earning partner's income, the lower-earning partner could lose some of these benefits. For example, the child income tax credit is reduced for single taxpayers who earn more than $75,000.

Despite some of the potential drawbacks, the Rulings are a positive development for advocates of same-sex marriage. It appears to be another step towards recognizing that a couple's federal taxes should reflect the status of their relationship under state law.

Amending Prior Year Returns

If California domestic partners revisit their returns for tax years 2007 - 2009 and realize that they would have paid less income tax by splitting their income and deductions, they should consider filing amended returns in order to claim the refunds. Generally, the deadline to file an amended return is three years from the date the original return was filed. For example, for 2007, the first tax year subject to the Rulings, if you filed by April 15, 2008, the deadline for filing an amended return appears to be April 15, 2011. We suggest domestic partners consult with their tax preparers to determine what deadline applies for them and whether they should file amended returns. Many preparers believe that earlier returns may also be amended; if you are considering this you should see your tax preparer immediately.

How This Impacts Your Estate Plan

Because of these Rulings, estate planners are also re-evaluating the use of joint trusts for some registered domestic partners and transmutation of the character of some assets. We suggest that domestic partners discuss this issue with their estate-planning attorney.

How California's Community Property Laws Will Affect a Domestic Partner's Offer in Compromise

In Chief Counsel Advice 201021409, the IRS addressed another aspect of the community property system in relation to Offers in Compromise ("OIC") under Internal Revenue Code section 7122. The IRS has recognized that in community property states, community property assets should be considered when determining the reasonable collection potential of that taxpayer's OIC. Since California registered domestic partners share an equal interest and liability in California community property, the IRS concluded that it can consider the community assets of the registered domestic partnership when determining whether to accept a domestic partner's OIC under section 7122. This will make it harder for a registered domestic partner taxpayer to settle for less than the full amount of any federal tax liability.

Application of the Rulings to Same-Sex Spouses

The Rulings only address registered domestic partnerships and not same-sex couples who are legally married under California law. As the Rulings address the concept of community property under state law, and same-sex spouses are subject to the same community property laws that domestic partners are, it appears likely that the Rulings similarly apply to married same-sex couples.

Legal Precedent of the Rulings

Private Letter Rulings are written memoranda furnished by the IRS National Office in response to requests by taxpayers under published annual guidelines. Chief Counsel Advice are written advice or instructions prepared by the Office of Chief Counsel and issued to field or service center employees of the IRS or Office of Chief Counsel. Although neither can be relied on as precedent, they are often helpful in understanding the position of the IRS with respect to the issues addressed.

^{1 For purposes of this Alert, all couples who are affected by these rulings will be collectively referred to as domestic partners.}

^{2 This requirement applies to all unfiled income tax returns.}

For instance, when experts are involved in civil cases, in lawsuits where damages to businesses are in question, Certified Public Accountants or economists are often required to examine past performance and trends of activities relevant to the lawsuit and to project future performance and trends. In construction defect or non-performance cases, experts on construction repairs, often contractors themselves or civil engineers, are required to explain what did occur, as well as what should have occurred. In the increasingly complex world of computer technology, forensic computer experts are often required to untangle and explain what is located on or deleted from personal computers, or the parties’ other questionable activities, and what are the consequences of those actions.

The test of whether the expert witness is truly an expert is, in the words of the California Supreme Court, “whether the witness has sufficient knowledge, skill or experience in the field so that his or her testimony would be likely to assist the jury in its search for the truth.” In making this determination, the courts look to the proffered expert’s education, training, professional career in the particular field, specialized expertise and training in a relevant sub-field, speaking and teaching experience on the subjects and previous experience serving as an expert. Serving as a consultant is up to the attorney making the selection; qualifying as an expert under the Evidence Code is up to the judge.

One usually starts as a consultant before being designated as an expert. When performing as a consultant/expert, one’s tasks can be as simple as analyzing data and opining on the results. Conversely, tasks can be as complicated and time-consuming as performing multiple tests at various sites or in laboratories, or inspecting persons or machines or to be in a position to reach a conclusion. That conclusion must be one that the expert feels comfortable explaining to a judge or jury in the context of what sometimes can be withering cross-examination by the opposing counsel.

Providing forensic expert testimony is often an adjunct to one’s regular duties in a given field. Experts are compensated initially by the parties retaining them to assist as an undisclosed “consultant” in guiding complicated or technical issues in a case. This often starts at the beginning of a case and involves helping guide the discovery process, e.g., written interrogatories, document requests, depositions of parties or percipient witnesses. In addition, the duties of a consultant often involve preparation of a written report. The time period one serves as a consultant can last a year or longer. If it appears that a trial may be necessary in order to resolve the conflict, the consultant is then “disclosed” fifty days before trial as an expert who is subject to deposition by the opposing parties’ lawyers about his/her opinion and report if one is prepared. In that setting, the expert’s fees are paid by the party taking the deposition. It is common for each side’s experts to sit in during depositions of the other side’s experts.

The standard four questions posed to any expert at his or her deposition are: (1) what were you hired to do, (2) what did you do, (3) what is your opinion and (4) can you explain your opinion? This is not always as simple as it sounds. It is not uncommon during the early stages of an engagement that the opinion reached is not what the lawyers or parties are hoping to hear. In that situation, the undisclosed consultant may be replaced by another undisclosed consultant to provide fresh and independent findings and, it is hoped, reach a different conclusion. That is why the “undisclosed consultant” does not become a “disclosed expert” until lawyers and clients are satisfied with the results.

Finally, if a case does end up in a courtroom, the party hiring the expert again becomes responsible for the fees as the expert explains to the jury, or to the judge in a court trial, how the technical issues frame each party’s entitlements, or lack thereof. It is also common for each side’s experts to sit in during the trial testimony of the other expert. They then battle it out in front of the trier of fact to establish which party is right and which is not.

The most credible experts are those whose forensic testimony is divided equally between work for plaintiffs and work for defendants. Similarly, performing expert work for a number of different law firms adds to credibility. Otherwise, an expert, whose opinion is correct in the abstract can be denigrated as a “homer,” i.e., an expert who regularly testifies for a particular side or firm in all cases or, even worse, be deemed a “pay and say” type, i.e., “pay me a fee and I’ll say what you want.” If you are hired as an expert and reach the point of being deposed before trial, or examined in court during trial, remember to be on the lookout for the one trick question asked of all experts. The issue is never how much are you being paid “for your testimony;” the answer should always be, “I am being paid for my time, not testimony”

Do you have expertise in a particular field that is beyond the basic understanding of most lay persons? Perhaps you have a second or expanded career as a forensic expert to pursue!

Businesses with strong internet presences, active competitors, or strident critics may wish to secure a .co domain before non-trademark owners have the opportunity. 

A Top Level Domain (TLD) is the last portion of an internet address, such as .com, .net or .org.  Countries outside the United States use country-specific TLDs for their domestic websites, so that many country-specific domains end in .ca for Canada, .de for Germany, .cn for the People's Republic of China, .hk for Hong Kong, etc.  The portion of the domain immediately prior to the TLD is called the Second Level Domain.  This is the "google" part of www.google.com.

Colombia's efforts to popularize the .co domain internationally is not without precedent.  In 2000, the tiny Polynesian country of Tuvalu reached a deal to capitalize on its assigned country code Top Level Domain (ccTLD) of .tv in a leasing arrangement worth millions of dollars.  The abbreviation conveniently appealed to those in the television industry in English speaking countries, and today a wide variety of businesses from MTV to Major League Baseball own a .tv domain.

Colombia is now hoping to follow in Tuvalu's footsteps with its own ccTLD, assigned as .co.  It has conducted consumer surveys that show that many U.S. consumers associate .co with words like company, corporation or commerce, and its marketing of the .co domain points out that many businesses outside the U.S. use .co in addition to a specific ccTLD (e.g., www.amazon.co.uk; www.google.co.jp). 

For businesses locked out of their preferred domain name by another entity that owns the .com version, the .co may present an attractive alternative, particularly since internet users may pay little attention to the difference between a .com and a .co at the end of a URL.  Other businesses may simply want to prevent domain name confusion by registering and parking a .co domain that could be confusingly similar to their own .com version.

Under the launch protocol adopted for this ccTLD, Colombian trademark owners have had the first chance to register their exact-match domain names.  In the second round of applications for domains, trademark owners anywhere else in the world are permitted to request their exact trademark as a domain, provided that their trademark was registered in any country prior to June 30, 2008.  This sunrise period for registered trademark owners ends June 10, 2010, after which anyone interested in registering a domain may do so.

Anyone who applies for an exact-match domain based on a trademark registration must be prepared to pay for between one and five years of domain registration.  Application fees start at $205 and one year of registration runs between $25 and $39.99, depending on which registrar you select.

Application for a domain during this sunrise period is not a guarantee that the domain will be awarded.  Where there are multiple applicants for the same domain, an auction will be held and the domain will be awarded to the highest bidder.

The proliferation of TLDs makes it nearly impossible for any business to eliminate the possibility of domain name confusion in the public, and we do not recommend that a business rush to register a .co domain unless doing so fits its business goals.  However, with the .co domain there is probably an increased likelihood of consumer confusion with an identical .com domain for the same mark.  While the .co domains will be subject to Uniform Dispute Resolution Policy (UDRP) rules, which will enable a mark owner to take possession of a domain registered in bad faith and for the purposes of confusing the public, trademark owners whose businesses are frequently sought by unsophisticated consumers may conclude that $250 (for the application and a year's registration) is a small price to pay to reduce the likelihood of confusion with a business of another name.

You can get more information on the .co launch at www.cointernet.co/domain.  Registrars participating in the .co launch include Network Solutions and GoDaddy.com.  Find a complete list of accredited registrars at www.cointernet.co/registrars/co-registrars.

Thereafter, the Supreme Court again addressed the issue of proper licensing in the case of MW Erectors, Inc. v. Niederhauser Ornamental and Metal Works Co., Inc. (2005). Even though the subcontractor, MW Erectors, had obtained the proper specialty license a mere eighteen days after commencing work on the project, the Court held that it could not recover any compensation whatsoever because it did not strictly comply with the statute. MW had not been properly licensed “at all times during the performance of that act or contract.” (Business and Professions Code §7031(a).) The court did, however, reject the argument of general contractor Niederhauser, which had hired MW, that the subcontractor should also be denied recovery because it was not properly licensed when the contract was entered into. The Court said no, proper licensing need not be in effect at the time the contract was executed, so long as proper licensing is in place during the entire time when the actual work was performed.

Recently, two cases touched upon aspects of the contractor licensing scheme in California, but neither decision shows any indication of softening the effect of the consumer-protection based licensing laws.

In the case of White v. Cridlebaugh (2009), Cridlebaugh contracted with White to construct a retirement home. White, as property owner, was the nominal general contractor but believed that Cridlebaugh would follow existing written plans and specifications to construct the facility. White had disputes with Cridlebaugh, ultimately terminating him from the project without making full payment. Cridlebaugh’s company then recorded a mechanic’s lien against the property.

Evidence at the lien foreclosure trial showed that Cridlebaugh’s company held both Class A and B contractor’s licenses. However, the licenses were both held in the name of one Robert Diani as RMO (Responsible Managing Officer) and RME (Responsible Managing Employee). Unfortunately for Cridlebaugh, however, Diani had left the country on a church mission two years before the White job began and Diani had no knowledge of the White contract or project. The court noted that under §7068.2 of the Business and Professions Code, if an RMO or RME disassociates from the licensed company, then the company has 90 days to replace the qualifying licensee. If the qualifying individual is not replaced within 90 days, the entity’s contractor’s license is automatically suspended. Not only did Cridlebaugh not succeed on appeal, but the Court imposed disgorgement penalty provisions of §7031(b) to require Cridlebaugh to pay back the $84,621.45 it had received from White, plus interest and court costs. The Court reasoned that the unqualified terms of the statute made it clear that it applied, regardless of the prejudice imposed.

More recently still, in the case of Alatriste v. Cesar’s Exterior Designs, Inc. (April 6, 2010), the Court of Appeal held in favor of the plaintiff, homeowner Alatriste. Alatriste had contracted with Cesar’s to perform landscaping work. Cesar’s was unlicensed at the time it began work on the Alatriste home, a fact which Cesar’s maintained Alatriste was well aware of. Following a dispute, Cesar’s quit the job after five months. Alatriste, the owner, then sued Cesar’s under various fraud theories, including a claim under Business & Professions Code §7031(b) to recover all monies paid to Cesar’s.

Alatriste sought recovery for the total amount paid to the contractor, because Cesar's was unlicensed at the time it performed the work. Cesar's argued that under §7031(b), Alatriste should be barred from obtaining reimbursement for all monies paid because he had prior knowledge that Cesar's was an unlicensed contractor.

Citing Hydrotech Systems, Ltd., the Court held that §7031(a)'s “shield” provision provides a complete defense to a claim for payment by an unlicensed contractor, and it applies equally to the “sword” provision of §7031(b). Therefore, Alatriste's knowledge that Cesar's was unlicensed did not bar his claim for reimbursement of payments made for the unlicensed work. The appeals court affirmed the judgment that Alatriste's prior knowledge of Cesar's unlicensed status did not bar his §7031(b) claim.

Second, the appeals court rejected Cesar's claim that Alatriste should not be reimbursed for work or materials paid for by Alatriste during the time that Cesar's was properly licensed during performance of the work. Cesar's had obtained a proper license two months prior to the termination of its work. The Court reasoned that even though §7031(b) does not mirror the exact language of §7031(a) in that it does not indicate the contractor must be licensed during the performance “at all times” in order for the contractee to have a complete defense to any offsets to recovery, the legislature's intent was to provide for such. §7031(b) broadly reads that “a person who utilizes the services of an unlicensed contractor may bring an action…to recover all compensation paid to the unlicensed contractor for performance of any act or contract.” This does not mean that the right to reimbursement could be offset by work the contractor performed with a valid license or, the appeals court reasoned, the legislature would have clearly said so. The Court affirmed the judgment that Alatriste was entitled to recover payments for materials and labor because Cesar's was not licensed during the entire performance of the contract.

Conclusions and Recommendations

These two cases illustrate that efforts are being made by contractors to either enforce payment or avoid disgorgement, even when they are not in strict compliance with the contractor licensing laws. Despite the harsh and seemingly inequitable results, the courts have remained consistent in their interpretation of the statute and the Supreme Court's rulings in this area. Efforts by contractors to argue they should be paid for parts of projects during which they had obtained a license have been rebuffed. Similarly, attempts to avoid disgorgement and reimbursement have failed as well, even when the theory of offset, rather than direct recovery, has been put forth.

For contractors and specialty contractors, always ensure that you have proper licensing in place at all times, at the very least during the entirety of the performance of the work. For owners and general contractors who utilize subcontractors, always check the entire license history of a claimant to see if there has been a fatal lapse in licensing or an improper license for the specialty work performed.

The attorney work-product protection for recorded witness statements, however, was recently called into question by the Fifth District Court of Appeal in Coito v. Superior Court (2010) 182 Cal.App.4th 758, when it decided that such statements are no longer protected from disclosure. This decision has made a huge impact throughout the legal community. Attorneys on both sides of the bar (those representing plaintiffs and those representing defendants) have expressed their dissatisfaction with the result of Coito. Some attorneys have said that they may need to change their practice by adding the unwieldy process of separating a witness’ verbatim words from the attorney’s mental impressions, by putting the latter in a separate file labeled “attorney work product.” Other attorneys have gone so far as to write amicus letters to the California Supreme Court urging them to review or depublish the Coito decision.

In Coito, Jeremy Wilson, the 13-year-old son of petitioner Debra Coito (“Coito”), died in a drowning accident in Modesto, California, on March 9, 2007. Coito filed a complaint for wrongful death soon thereafter, naming various defendants, including the State of California. Six other adolescents were present at the scene of the drowning and witnessed the incident. After the co-defendant, the City of Modesto, decided to take the depositions of five of the six witnesses, counsel for the state sent two investigators to take recorded statements from four of the adolescents. Counsel for the state provided the investigator with questions that he wanted answered and the statements from each juvenile were saved onto a separate compact disc (CD).

Soon after the interviews were completed, attorneys for Coito served the state with written interrogatories (including form interrogatories) and document demands seeking names and information about witnesses from whom written or recorded statements had been obtained. The document demanded discovery of the four recorded statements from the juveniles. The state objected to the requested discovery, based on the attorney work-product privilege.

Coito filed a motion to compel production of the statements. The state opposed the motion relying heavily on Nacht & Lewis (1996) 47 Cal.App.4th 214. After hearing the matter, the superior court issued a written order denying Coito’s motion to compel. The superior court held that the list of potential witnesses from whom written or recorded statements had been obtained, sought by way of form interrogatories, would constitute qualified attorney work-product, and the recorded witness statements would be entitled to absolute work-product protection.

Coito’s attorneys petitioned the Appellate Court for a writ of mandate seeking to vacate the trial court’s holding. The Fifth District Court of Appeal sided with Coito and issued the writ of mandate.

The Court reasoned that while a witness’s statement that has been taken by an attorney or their representative can be said to be in part the product of the attorney’s work, it did not necessarily follow that the witness statement is entitled to work-product privilege. After generally discussing the absolute versus qualified work-product privileges¹, and “derivative” versus “nonderivative” material², the Court sought to discredit and distinguish the Nacht & Lewis decision relied upon by the superior court.

In Nacht & Lewis, the court found that a response to form interrogatories seeking a list of the potential witnesses interviewed by counsel (which interviews were recorded in notes or otherwise) would constitute qualified work product because it would tend to reveal counsel’s evaluation of the case by identifying persons who claimed knowledge of the incident from whom counsel deemed it important to obtain statements. The Nacht & Lewis court further concluded that the notes or recorded statements taken by counsel would be protected by the absolute privilege because they would reveal counsel’s impressions, conclusions, opinions, or legal research or theories. The Coito Court found the opinion in Nacht & Lewis to be a cursory one; the Court noted that Nacht & Lewis contained no analysis to support its conclusions and failed to acknowledge the contrary precedent. The Court then held that recorded witness statements and lists of witnesses from whom statements have been obtained are not attorney work product entitled to protection.

In his dissent, Justice Kane disagreed with the majority’s refusal to apply the qualified work product privilege to attorney-recorded witness statements. He also disagreed with the majority’s blanket overruling of the objection to form interrogatories requesting a list of witnesses from whom recorded statements have been obtained without acknowledging that, with a proper showing, a valid objection on work-product grounds could in fact be made. According to a recent article published in The Recorder Newspaper on April 16, 2010, it is widely expected that the California Supreme Court will take up the case, especially in light of Justice Kane’s vehement dissent.

While the bar awaits a ruling by the California Supreme Court (if it in fact decides to take up the case), attorneys should consider taking steps to ensure protection of their work-product with respect to witness interviews. Some attorneys may choose to undertake the process of separating a witness’ words from the attorney’s impressions and conclusions by putting the latter in a separate memo or file explicitly referring to such material as “attorney work-product.” Others may be able to negotiate agreements early on in a case regarding the scope of discovery of witness interviews. Either way, business as usual will no longer suffice. Unfortunately, clients may be forced to shoulder the additional litigation costs generated by either of these two courses of action.

^{1 The absolute work-product privilege is set forth in Code of Civil Procedure Section 2018.030(a) and provides that any “writing that reflects and attorney’s impression, conclusions, opinions, or legal research or theories . . .” are “not discoverable under any circumstances.”  A classic example of a document protected under the absolute work-product doctrine is a memorandum written by an attorney, after taking a statement from a potential witness, summarizing the attorney’s impressions and conclusions.  On the other hand, the qualified work-product protection (Code of Civil Procedure Section 2018.030(b)) provides qualified protection in that such work product “is not discoverable unless the court determines that denial of discovery will unfairly prejudice the party seeking discovery in preparing that party’s claim or defense . . .”}

^{2 Work-product protection extends only to “derivative” material, which is material created by or derived from an attorney’s work on behalf of a client that reflects the attorney’s evaluation or interpretation of the law or the facts involved.  “Derivative” material includes, diagrams prepared for trial, audit reports, appraisals, and other expert opinions, developed as a result of the initiative of counsel in preparing for trial.  In contrast, “nonderivative” material is that which is only evidentiary in nature.  It is not protected even if a great deal of attorney work has gone into locating and identifying it.  Examples of “nonderivative” material include the identity and location of physical evidence and the identity and location of witnesses.}

What happens if a dispute arises between the attorney and client after a successful settlement in mediation, when a "side agreement" has been made to facilitate the settlement? This is precisely what happened in Porter v. Wyner, a case recently decided by the California Court of Appeal for the Second District in Los Angeles. In this case, the Porters, the plaintiffs, hired attorneys Steven Wyner and Marcy Tiffany to sue a school district and the California Department of Education for violations of the educational rights of disabled children. The parties in the lawsuit agreed to conduct a mediation before a retired judge. Before the mediation, all the parties signed an agreement that the mediation was confidential in accordance with California Evidence Code sections 1115 through 1128 and 703.5. ¹ During the drafting of the settlement agreement, two additional issues arose between the Porters and their attorneys. First, there arose a question about the tax ramifications of the settlement that had not been discussed during mediation. A tax specialist was retained to assist in structuring the settlement. Who should pay for the services of the tax specialist? Second, the Porters requested a reimbursement from the settlement of attorney fees they previously paid their lawyers, and also felt Mrs. Porter, a paralegal, was entitled to payment for services she provided during the case. These disputes resulted in a separate lawsuit between the Porters and their attorneys over the handling of the mediation.

As this case proceeded to trial, the Porters' former attorneys objected to the Porters referring to anything that was discussed during the mediation on the basis that it was confidential and privileged. The trial court denied the objection and during trial, the jury heard extensive testimony about the mediation discussions between the Porters and their attorneys. The jury returned a verdict in favor of the Porters for $262,000 plus interest. After the trial, the attorneys asked the trial court to grant a new trial based upon an irregularity in the proceedings. The trial court, on the basis of a new California Supreme Court case called Simmons v. Ghaderi (2008) 44 Cal.4th 570, granted the motion for new trial. The lawyers appealed the judgment and the Porters appealed the order granting new trial.

The appellate court reviewed the statutes governing mediation confidentiality and concluded that the intent for confidentiality is for information that flows between the disputants and the mediator. Because the disputants are not the attorneys and clients, the mediation confidentiality does not apply. Significantly, the court pointed out that if it were to extend the confidentiality protection to the communications between attorney and client during mediation, the client would be effectively giving up the right to sue his or her own attorney for wrongdoing, which is an outcome litigants might not foresee by agreeing to mediation.

The appellate court held that the mediation privilege did not apply to the communications between the Porters and their attorneys over their "side agreement" therefore it was not an error to permit the jury to hear evidence on those discussions.

In a dissenting opinion, one judge disagreed with the majority's findings because discussions about the "side agreement" were only arising in the context of resolving the dispute between the parties. In the judge's view, all discussions between the Porters and their attorneys should have been protected under the mediation privilege.

Ultimately, the lesson learned from the Porters’ dispute with their lawyer is that communication between attorney and client over what confidentiality in mediation means is critical. Attorneys cannot use the safe haven of mediation confidentiality statutes to shield either bad advice or "side agreements" from judicial scrutiny should something go wrong after the mediation concludes.²

¹ Evidence Code § 1119(A) states that “No evidence of anything said or any admission made for the purpose of mediations or a mediation consultation is admissible or subject to discovery, and disclosure of the writing shall not be compelled, in any . . . proceeding in which pursuant to law, testimony can be compelled to be given.”

² The issue of the scope of the mediation privilege would apply regardless of whether the case resulted in a settlement or not.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Act") set forth rules regarding estate, gift and generation-skipping transfer taxes for the then forthcoming decade. The basic arrangement of the Act included periodic decreases of maximum tax rates, periodic increases of applicable exemptions, a complete repeal of the federal estate and generation-skipping taxes in 2010, and a "sunset" provision in 2011, restoring tax rates and exemptions to levels applicable under the rules in place in 2001.

Throughout 2009, the general consensus among the estate planning community was that Congress would act to preserve the federal estate and generation-skipping taxes and perpetuate exemptions and tax rates similar to those available in 2009 - a $1 million gift tax exemption and $3.5 million estate and generation-skipping transfer tax exemptions, all with a maximum tax rate of 45%. Despite some effort in the House of Congress last December, no action was taken. Accordingly, we now find ourselves dealing with the "repeal" of the federal estate tax laws for 2010, or, at least until Congress reaches a consensus on permanent estate tax reform.

The purpose of this memorandum is to provide our clients with detailed information about the state of the federal estate tax laws and describe some of the issues that may arise from estate planning documents written based upon the rules as they applied prior to 2010, i.e., issues that may arise based on the widespread belief that the federal estate and gift tax structure would remain in place.

It is important to note in California the electorate voted a number of years ago to amend the State's Constitution to eliminate the possibility of California imposing its own separate estate tax. However, in a number of States, legislation is in place that allows for the imposition of estate/gift taxes on transfers of wealth during lifetime or on death, regardless of whether or not a federal estate tax exists. That is at least one issue we do not have to contend with in California.

We believe it is important that our estate planning clients be aware of the changes to the federal estate tax structure. While it is possible that the changes may have little or no effect on your particular estate plan, we advise that you read this memorandum and return the enclosed card if you would like to learn more about this topic by attending a seminar hosted by Fitzgerald Abbott & Beardsley's Estates & Trusts Practice Group or by contacting your estate planning attorney to schedule a review of your estate plan.

Federal taxation of gifts during life and after death

The federal estate and gift taxes are taxes on the transfer of property as a gift (i.e., for less than the property's fair market value). The 2001 Act gradually reduced the maximum rate of the federal estate tax (and the generation-skipping transfer tax on transfers to a person two or more generations below the decedent or donor) from 55% to 45%. It also gradually increased the amount of property one could pass free of federal estate tax from $675,000 per person in 2001 to $3.5 million per person in 2009. The 2001 Act suspends the estate tax for 2010 only. Unlike the federal estate tax and GST tax, the federal gift tax continues to apply without interruption to certain transfers of property during the donor’s lifetime.

While the estate tax was in effect, a beneficiary of a decedent's estate received property with a basis for income tax purposes equal to fair market value as of the decedent's date of death. This was referred to as a "stepped-up basis." Upon a later sale of the property, the beneficiary would have a taxable capital gain limited to the appreciation in value of the property occurring between the decedent's date of death and the date of sale. Appreciation in value during the decedent's lifetime was extinguished for purposes of the capital gains tax. The stepped-up basis rules provided a significant advantage in most estates by eliminating the potential for a capital gains tax to apply upon property passing to a decedent's beneficiary.

Property passing by gift during the donor's lifetime is received by the donee with what is referred to as a "carry-over basis." This means that the gifted property is valued for gift tax purposes based on its fair market value; however, the basis of the gifted property in the donee's hands is limited to the basis that applied when the such property was in the donor's hands. Upon a later sale or other taxable disposition, the donee's gain would be based upon all appreciation in value occurring since the donor acquired it (subject to all basis adjustments during the donor's ownership).

The tax rules applicable to property transferred from a donor or decedent in 2010

In 2010, while the estate tax and GST tax are suspended, a beneficiary receives property from a decedent's estate with a transferred basis.

During 2010, the gift tax remains in effect, with a $1,000,000 exclusion amount and a maximum rate of 35%. The donee continues to receive the gift property with a carry-over basis.

To mitigate the effect of the transferred basis for property passing at death in 2010, the 2001 Act provides for a limited basis increase. The basis increase is $1,300,000 (which can be augmented by certain unused net loss and capital loss carry forwards.) An additional $3,000,000 in basis increase can be allocated to property passing directly to a surviving spouse or to a special form of trust (a "marital trust") for the sole benefit of the surviving spouse.

The basis increase cannot be applied to IRAs, qualified plan benefits, residual payments from works-for-hire or other property having the status of "income in respect of a decedent." Such property will continue to be taxed as ordinary income in the hands of the beneficiary; however, those assets will not be diminished by the estate or GST taxes during 2010.

The basis increase is allocated by the executor (if there is a probate proceeding). If the basis increase is not fully used by the executor, any other person in actual or constructive possession of the decedent's property can claim the basis increase. Other persons who may be in actual or constructive possession include a trustee of a revocable living trust or a person taking a decedent's interest by right of survivorship, and such persons can claim the available basis increase. Each person claiming a share of the basis increase must file a "Return Relating to Large Transfers at Death" ("2010 Returns"). Depending upon how an estate is divided, any number of 2010 Returns may need to be prepared and filed for one decedent.

At this time, no guidance exists to resolve possible conflicts regarding allocation of the basis increase between or among executors, trustees and/or any other persons in actual or constructive possession of the decedent's property.

How the suspension of the estate tax may affect decedent's estates and their beneficiaries

Replacing the estate tax with a tax on capital gains will affect beneficiaries in a variety of ways depending upon the circumstances.

Under the estate tax rules, a primary goal is the efficient use of the decedent's credit against the estate tax. While the estate tax is suspended, the goal will be to allocate the decedent's basis increase in accordance with the decedent's wishes without wasting any of the decedent's available basis increase.

Plans with formula allocation provisions

Suspension of the estate tax may result in unintended consequences for beneficiaries of estate plans containing formula allocation provisions.

A formula that allocates property among multiple classes of beneficiaries by reference to the estate tax exclusion amount will not work properly while the estate tax is suspended. A common allocation formula segregates the maximum amount of the decedent's estate that can pass free of the estate tax to a class of beneficiaries (such a children, extended family or friends), while allocating property subject to the estate tax to a different class of beneficiary (such as a spouse or charity). In a no-estate tax environment, the allocation scheme described above can inadvertently disinherit an entire class of beneficiaries.

Waste of the Basis Increase

When the decedent is survived by a spouse, a formula allocation provision may divide the entire estate between the bypass trust and a marital trust that qualifies for the unlimited estate tax marital deduction (known as a "QTIP" trust). If the spouse is the beneficiary of both trusts, he or she is not disinherited. However, the use of the decedent’s additional $3,000,000 of basis increase allocable to a surviving spouse may be wasted. With rare exceptions, the bypass trust will not qualify to absorb the additional basis increase allocable to the surviving spouse; however, the QTIP trust should qualify. If applying the formula provision allocates the entire estate to a bypass trust, the surviving spouse will not be disinherited, but $3,000,000 of additional basis increase could be wasted unless the Bypass qualifies as a QTIP trust.

Estates comprised of assets with unrealized gains in excess of the aggregate available basis increase will put the administrator of the estate in a no win situation. Even if the decedent's overall plan for the distribution of his or her estate at death will be implemented as desired to maximize the basis increase, the allocation of the basis increase is likely to present difficulties for the executor/ trustee or beneficiary.

• Should the basis increase be allocated to some bequests and devises, but not others?

• Should the basis increase be allocated in proportion to the unrealized gain?

• Should the basis increase be allocated in proportion to the value of property received by each beneficiary?

• Should a probate proceeding be opened so that an executor will be appointed who will have authority over the allocation of basis increase?

Other issues arising because of suspension of the estate tax

With an estate tax exclusion amount of $3,500,000, the estate tax is predicted to apply to fewer than 2% of the estates of all US persons dying in 2009.

In contrast, the transferred basis rules will affect all beneficiaries.

The recipient of property from a person who died while the estate tax was in force knows that his or her basis for income tax purposes in property received from a decedent will equal the fair market value of the property when the decedent died. The recipient of property from a person who dies while the transferred basis rules are in effect will need to know the following:

• The basis of the property in the hands of the decedent.

• Whether unused loss carry forwards may be available to supplement the decedent's basis increase.

• Whether, or how much of, the decedent's basis increase has been, or can be, allocated to the property he or she receives.

Depending upon the circumstances, each person claiming the basis increase must file a separate 2010 Return. Since few people maintain records necessary to ascertain the exact basis in his or her property, there is little chance that the decedent's basis increase will be allocated efficiently.

Next Steps

We hope that this memorandum has provided you with information about the current state of the estate/gift tax laws and attendant issues/concerns that the "repeal" of the estate tax laws may bring up in your particular circumstance. We recognize that these are complex concepts and may be difficult to apply to your particular situation. Accordingly, we encourage you to return the enclosed card indicating your interest in attending a seminar sponsored by Fitzgerald Abbott & Beardsley's Estates & Trust Practice Group or having your personal estate planning attorney review your documents to determine what changes, if any, need to be made to your estate plan to ensure that it will continue to express your wishes.

For many years, the Federal Trade Commission (“FTC”) has enforced laws aimed at preventing advertisers from utilizing deceptive business practices when using endorsements and testimonials in their advertisements. In order to make these laws more user-friendly, the FTC also publishes interpretive guides that provide examples of acceptable and unacceptable endorsements and testimonials. When an advertiser employs unacceptable tactics, it is liable for deceptive advertising under Section 5 of the FTC Act (15 U.S.C. §45).

Until recently, the FTC's interpretation of its advertising laws focused on traditional advertising venues. Imagine the standard weight loss commercial depicting the slender woman stating that she lost 80 pounds using the newest weight loss diet or supplement. These laws are what required the advertiser to make the reluctant disclosure “these results are not typical” somewhere in the commercial.

With the public increasingly relying on user generated content in blog entries, message boards or social networking websites, on December 1, 2009, the FTC revised its interpretation of these advertising laws to clarify that the laws apply to information circulated even in the informal media of blogs and other social media. While the underlying law did not change, the impact of the new interpretation is sweeping. Understanding these deceptive advertising laws is now crucial not only to the conventional advertiser, but also to any company or person who uses the internet to promote their particular product or service and even to casual bloggers whose enthusiasm for particular products may make them unwittingly subject to liability. In such a case, both the producer of the product and the person actually making the statement may be liable.

WILL YOU BE LIABLE?

When determining whether consumer generated content about a product is an “endorsement” and therefore subject to FTC regulation, ask yourself the following question: when posting positive statements about a product or service, is the speaker: (1) acting solely independently or (2) acting on another's behalf? If the speaker is acting independently, then there is no endorsement and no liability. However, how the FTC determines whether the speaker is acting independently may surprise you.

Among other things, the FTC will ask the following questions when making a determination: Is the person paid by the company? Did the person receive the product for free? Has the person previously received products from the same or similar company? More importantly, it does not matter whether the company has control over whether the person's review is positive or negative. Even if the company has no control, if the person is not acting independently in the eyes of the FTC, then the FTC Act applies and any endorsement must disclose all material connections between the speaker or author and the company in question.

WHAT IS A MATERIAL CONNECTION?

A material connection is anything that connects the reviewer and the maker of the product and would influence how a consumer views the endorsement and evaluates the reviewer's statements about the company's product. In every instance where a material connection is not obvious to the audience, it must be disclosed. For example, viewers expect that celebrities are paid to appear in a commercial, so a celebrity's endorsement in a television commercial does not require a disclaimer explaining his or her incentive for making the endorsement.

Blogs and other social media, on the other hand, are informal and often appear to be more personal. When a celebrity makes the same comment in his or her blog, the fact that the celebrity is being compensated for the endorsement is not as obvious to the consumer. Since this knowledge would affect the credibility a consumer places on the celebrity's endorsement, if the compensation arrangement is not disclosed, the blog entry is deceptive and violates the FTC Act.

Material connections encompass more than just compensation. They can include a person's relationship to the company through employment or a financial interest in the company. In addition, if a product is provided to a person free of charge with the hope that the person will review the product, the fact that the person received the product for free is a material connection that must be disclosed. Thus, if a restaurant comps the meal of a person it recognizes as an active blogger with the idea that a positive review would soon be posted on the internet, both that individual and the restaurant are liable if adequate disclosures are not made.

SUBSTANTIATING CLAIMS

Another important rule that applies to this expanding world of social media endorsements is that the company must have adequate substantiation of the results depicted in a person’s statement. Adequate substantiation is proof that the results are generally representative of what any customer can expect. This point is illustrated in the following example that is taken directly from the FTC's new interpretation of the law:

The advertiser requests that a blogger try a new body lotion and write a review of the product on her blog. Although the advertiser does not make any specific claims about the lotion’s ability to cure skin conditions and the blogger does not ask the advertiser whether there is substantiation for the claim, in her review the blogger writes that the lotion cures eczema and recommends the product to her blog readers who suffer from this condition. The advertiser is subject to liability for misleading or unsubstantiated representations made through the blogger’s endorsement. The blogger also is subject to liability for misleading or unsubstantiated representations made in the course of her endorsement. The blogger is also liable if she fails to disclose clearly and conspicuously that she is being paid for her services. The advertiser should also monitor bloggers who are being paid to promote its products and take steps necessary to halt the continued publication of deceptive representations when they are discovered.

It is important to understand that the liability of the advertiser and the blogger above would be exactly the same if all the advertiser did was provide the product to the blogger for free with the intention that the blogger would review the product. Actual money (compensation) does not need to change hands.

The fact that people who disseminate information through the internet may be categorized as endorsers under the FTC Act puts a company who makes use of this inexpensive avenue for promotion of its product at greater risk of being liable for deceptive advertising.

BEST PRACTICES:

For Advertisers:

• Monitor third party reviews that are easily searchable (Yelp, Amazon, industry-specific sites) to determine whether there are any credible and misleading statements being made. While you are not liable for deceptive reviews by individuals with whom you have no material connection, evaluate whether any of the reviews are concerning and warrant action on your part to distance your business from any suspicion of connection.
• Take affirmative steps to correct deceptive statements, such as asking bloggers to amend their reviews. Ensure that your employees, their immediate families and others with material connections to you know that they should not make endorsements without disclosing their connection to you.
• Evaluate any company policies regarding providing any free goods to those from whom you are seeking positive reviews, and consider whether you are willing to accept the disclosure as the price of that review.

For Reviewers:

• Disclose your connections wherever there is a possibility that it could influence a reader's perception of your review, including your past or present employment with a company, receipt of complimentary goods, banner advertising on your blog site, or any other benefits.
• Avoid making unsubstantiated claims about products, unless those claims are so obviously humorous that no reader is likely to be deceived.

The underlying principle to remember is the question of whether knowledge of undisclosed information would affect the weight or credibility a consumer gives to the person’s statement. If the answer to that question is yes, then both the company and the person making the statement have an affirmative duty to make accurate statements and to make the required disclosures.

For more information regarding the revised FTC interpretations, including information on why "Results Not Typical" may no longer be a sufficient disclaimer in traditional advertising, follow the link below to access the revised Guides Concerning the Use of Endorsements and Testimonials in Advertising. (16 C.F.R. Part 255).  http://www.ftc.gov/os/2009/10/091005revisedendorsementguides.pdf

Overcoming the anti-SLAPP hurdle by demonstrating the probability of success on the merits of a defamation case at the outset of the litigation is often difficult because not all negative comments about a business or service are actionable.  In Milkovich v. Lorain Journal Co. (1990) 497 U.S. 1, the United States Supreme Court clarified the law of defamation as it pertains to opinion statements.  The Court ruled that opinion statements based on false facts are actionable, but specifically excepted statements of opinion based on true and disclosed facts.  See Milkovich, 497 U.S. 1, 11-23.  After Milkovich, the relevant question is not merely whether the published statement is fact or opinion, but whether a reasonable fact finder could conclude that the published statement declares or implies a false assertion of fact.  See Franklin v. Dynamic Details, Inc. (2004) 116 Cal.App.4th 375, 385. 

The Franklin court held that emails asserting that plaintiff stole copyrighted material, plagiarized data, breached a nondisclosure agreement, and was a dishonorable person, constituted defendant’s protected opinions based on fully disclosed, true facts, and thus were not actionable.  The court concluded that defendant's emails were true because he identified the facts upon which his opinions were based (namely the text of plaintiff's original email and the links to referenced websites), and the existence, content, and layout of the websites were not in dispute in any material way.  The court also decided that defendant’s emails did not imply the existence of any other facts upon which his opinion was based.  Accordingly, the court decided that the reasonable reader was “free to accept or reject the author’s opinion based on [his] own independent evaluation of the facts” and “free to form another, perhaps contradictory opinion from the same facts.”  See Franklin, 116 Cal.App.4th 375, 388-389, quoting Standing Committee v. Yagman (9th Cir. 1995) 55 F.3d 1430, 1440. 

When deciding whether to initiate litigation regarding a negative online review, the injured party not only needs to consider whether the negative comments are actionable (as discussed above), but also needs to recognize that it may only initiate suit against the reviewer (known as posters), not the host site (i.e. Yelp.com).  Section 230(c) of the federal Communications Decency Act (CDA) protects the sites from defamation suits so long as they did not create the objectionable material.  Moreover, if the objectionable review is anonymous, the injured party may need to hire a high-tech private investigator to reveal the identity of the poster.

In an effort to curb lawsuits stemming from its online reviews, Yelp.com (among other sites), has actively encouraged the parties to meet and settle their grievances.  In addition, Yelp.com has followed other sites, by allowing business owners and service providers to respond online to the negative feedback. 

If your business or service is negatively reviewed, it is important to carefully weigh all of the factors outlined above.  If the offending post is truly defamatory - that is, it proclaims an opinion based on false assertions of fact, litigation may be appropriate.  Prior to heading down the path to court, however, you may want to contact the poster through the host site in an effort to settle the matter.  Often times, such discussions will lead to the review being tempered or removed in its entirety.  Another option is to encourage your loyal clients and fans to post favorable reviews.  Such reviews will veil the offending post and allow your business and service to garner positive attention.

If you are already a Facebook user and you would like to make a trademark you own part of your Facebook URL, consider staying up tonight or logging on over the weekend or early next week in order to sign up. (New Facebook users will be able to select vanity URLs as well, but not until June 28, 2009.)

In Tritek, two equal shareholders, Prospect Development, Inc. ("Prospect") and Andre Rerolle, owned Tritek Telecom, Inc., a closely-held California corporation. Tritek's board of directors consisted of Rerolle and Chik-Lun Mak (Prospect's sole owner). The corporation engaged an outside attorney to serve as its "Outside Counsel."

In 2007, disputes arose between Mak and Rerolle concerning the operation of the company. The parties bickered for several months until Mak and Prospect initiated a shareholder derivative action in the name of the corporation against Rerolle and Tritek (and others) alleging that their conduct had harmed the corporation and its shareholders and seeking a return of their investment in Tritek. The Outside Counsel initially represented Rerolle and Tritek in the shareholder action.  He subsequently removed himself as counsel for Tritek, and was disqualified as counsel for Rerolle having previously given advice to both Rerolle and Mak as corporate counsel.  Mak and Prospect subsequently filed additional legal proceedings seeking, among other relief, to enforce Mak's "absolute" rights to inspect Tritek's books and records pursuant to Corporation Code Section 1603.

Rerolle, Outside Counsel, and Tritek opposed Mak's petition to inspect all corporate books and records objecting that his broad request encompassed privileged attorney-client communications and attorney work-product documents generated by Tritek and Rerolle in defense of Mak's shareholder derivative action. Over those objections, the trial court ordered Tritek to produce the entire content of the Outside Counsel's case files relating to Mak's shareholder action, all communications between counsel and any director or officer of Tritek, and any case files evidencing Tritek's involvement in any litigation. Tritek appealed the trial court's ruling arguing that it improperly ordered the disclosure of privileged documents.

The Court of Appeal agreed with Tritek and found that Mak did not have a right to inspect the privileged documents relating to Tritek and Rerolle's defense of the shareholder derivative action. In reaching that conclusion, the Court recognized that the inspection rights granted by Corporations Code section 1602 represents a "legislative judgment that directors are better able to discharge [their fiduciary] duties if they have free access to information concerning the corporation." Tritek, at 1390. Therefore, "disinterested" directors (those that the Court identified as making "decisions on the merits of the issues rather than being governed by extraneous considerations or influences") are presumed to be acting in good faith in the interests of the corporation and shareholders. Id.

However, because Mak had sought to enforce his inspection rights after having initiated his shareholder action against Tritek and Rerolle, the Court concluded that he was not disinterested. Instead, the documents Mak sought in his capacity as a director would be used to advance his personal interests in his shareholder action against the corporation. Consequently, the Court concluded that Mak's loyalties were divided. Under those circumstances, the Court determined that when a director of a company becomes adverse to that company, he or she has no right to access privileged documents generated in defense of a suit brought by the director against the company.

Tritek's ruling highlights an important exception to the absolute inspection rights codified in Corporations Code Section 1602. Simply put, when a director becomes adverse to the corporation, he or she loses inspection rights to a specific universe of corporate records. Savvy directors, corporate accountants, and corporate counsel should be mindful not only of the exception identified in Tritek, but also when it is triggered. In the context of a business "divorce," it is crucial that the controlling directors/shareholders take steps, along with experienced corporate counsel, to preserve critical company information, including understanding when a director's access to corporate records is not an absolute right. On the flipside, a disgruntled director making an inspection demand prior to the initiating a legal action likely maximizes the universe of accessible documents. In either event, understanding the ruling of Tritek is critical to protecting or discovering corporate information.

Who Gets It?

The new law entitles employees who are terminated involuntarily (a term that is not defined in the law) between September 1, 2008, and December 31, 2009, and their covered dependents, to a subsidy of 65 percent of their COBRA premiums. The COBRA premium can be up to 102 percent of the group premium. Obviously, this means the employee must be enrolled in group coverage through the employer at the time of termination. The law applies only to employees whose individual income is less than $125,000 per year, or whose combined family income is less than $250,000 per year.

The subsidy and elections for cheaper coverage are NOT available for qualifying events other than involuntary termination. Thus, employees and their eligible dependents who experience COBRA-qualifying events such as voluntary termination, divorce, reduction in hours or a dependent child becoming ineligible under the health plan, are not eligible for the subsidy or to elect cheaper coverage.

Also, under the federal COBRA, the employer must employ 20 or more employees. However, under Cal-COBRA, employees of employers with 2 to 19 employees are covered. Under the new stimulus bill, if a state COBRA law's coverage requirements are comparable to the federal COBRA's coverage requirements, an employee might be entitled to the subsidy, even if the employer does not have 20 employees.

Because the term "involuntarily terminated" is not defined, it currently appears that the subsidy is available to ALL involuntarily terminated employees (including those terminated for performance or disciplinary reasons) who have not engaged in gross misconduct. Both COBRA and Cal-COBRA disqualify employees terminated for gross misconduct.

What Do They Get?

Eligible employees who elect coverage will receive a subsidy of 65 percent of the COBRA premium for up to 9 months for any group health plan in which they participated at the time of termination, excluding flexible spending accounts for healthcare. Thus, eligible employees who elect coverage will pay only 35 percent of the COBRA for up to 9 months.

If an eligible employee elected coverage prior to the effective date of the law, that employee will be eligible for the new subsidy, but not retroactive to their termination date.

New or Extended Election Period and Cheaper Option

Under COBRA, an eligible employee must elect continuation coverage within 60 days of receiving notice from the plan administrator that a qualifying event has occurred (and must make the first premium payment within 45 days of electing). Employees who were terminated since September 1, 2008, who did not elect COBRA continuation coverage, will have a new election period. Those employees will have 60 days after they receive the notices required by the Act to elect COBRA coverage at the subsidized rate. Their COBRA coverage would start on the effective date of the Act but would not continue past the date that would have been the end of the maximum coverage period had they elected it initially. That date would still not extend past 18 months after termination. The new law does not make clear whether an employee who elected COBRA initially, but lost coverage due to nonpayment of premiums, will be entitled to the notices or the premium subsidy.

COBRA also now allows involuntarily terminated employees and their dependents 90 days to select coverage under a different, lower-cost coverage option than the one they were enrolled when they were involuntary terminated. This option, however, is available only if an employer allows these changes. This option would also have to be offered to active employees, and could not be a limited option such as dental, vision or health FSA benefits, or certain treatment provided by on-site medical facilities.

Who Pays The Subsidy?

Initially, the former employer will pay the 65 percent subsidy. The employer will not receive any direct reimbursement for the subsidy payments, but will recoup them through credits against its monthly income tax withholding and FICA taxes (employer and employee portion). If that is not enough to fully reimburse the employer in a tax quarter, the balance will supposedly be paid by check from the U.S. Treasury.

To receive the payroll tax credit, the employer must submit reports to the Treasury attesting to the involuntary termination of the former employees receiving the COBRA premium subsidy and the actual amount of payroll taxes offset for the reporting period and the estimated payroll taxes to be offset during the next reporting period.

Notices

Information about the new subsidy, and the option to enroll in different coverage, must be added to current COBRA notices or provided in separate documents. The notice must include: (1) the forms to establish eligibility for the subsidy; (2) the plan administrator's contact information; (3) a description of the 60-day extended election period; (4) a description of a qualified beneficiary's obligation to notify the plan of health coverage under another group plan or Medicare and the penalty for failure to do so; and (5) a prominently displayed description of the qualified beneficiary's right to a reduced premium and the conditions for receiving the reduced premium. The notices also must be sent, within 60 days of the effective date of the new law, to qualified beneficiaries who are eligible for the subsidy and are already receiving COBRA coverage or are still in their initial election period. Notices to the last two groups must be sent within 60 days of the effective date of the new law. (Model notices must be provided by the Secretary of Labor within 30 days of the effective date of the new law).

Penalties On Beneficiaries

As under the current COBRA, if a qualified beneficiary receiving COBRA continuation coverage or the subsidy becomes eligible for other group health coverage or becomes entitled to Medicare benefits after the election period, or otherwise is disqualified from COBRA coverage, the beneficiary must so notify the employer. If the beneficiary, without reasonable cause, fails to notify the employer providing premium assistance of eligibility of such other coverage, the beneficiary will have to pay a penalty equal to 110 percent of the premium reduction the qualified beneficiary received after the beneficiary was disqualified from the assistance.

Also, if a qualified beneficiary with an individual income of more than $125,000, or family income more than $250,000, receives any COBRA subsidy, the amount of the subsidy received will be added directly to that person's income tax liability for the year(s) in which the subsidy was received.

Your Decisions May Be Second Guessed

If a qualified beneficiary is denied the COBRA subsidy or election of cheaper coverage, the beneficiary may file an appeal with the Labor and Treasury departments. Those departments must make an eligibility decision within 15 business days of receiving the appeal. The Departments' review is "de novo" and any determination by the Departments is to be given deference by reviewing courts.

On January 29, 2009, President Barack Obama delivered on his promise by signing the Lilly Ledbetter Fair Pay Restoration Act. The Act, the first piece of legislation signed by the new president, was designed specifically to overturn the U.S. Supreme Court's 2007 decision in Ledbetter v. Goodyear Tire & Rubber Co., which held that the charge-filing deadline on compensation discrimination claims under Title VII of the Civil Rights Act of 1964 begins to run on the date of the first allegedly discriminatory pay decision. The Act makes it easier for employees to recover on claims for historical discriminatory disparities in pay and benefits. Under the Act, the charge-filing periods of 300/180 days (300 days in most states and 180 days in states that do not have a fair employment agency) will be triggered each time compensation is paid pursuant to a discriminatory compensation or practice.

Background-The Ledbetter Decision
In the Ledbetter case, the plaintiff, Lilly Ledbetter, worked as a manager in Goodyear's Gadsden, Alabama plant from 1979 until accepting an early-retirement package in 1998. During most of that time, Ledbetter's salary was determined annually and was based on her supervisor's ranking of her performance. Ledbetter's performance reviews typically placed her near the bottom of rankings with her coworkers, and, consequently, she received small salary increases. In her last two years of employment, she was in a job slated for layoff and, consistent with company policy, did not receive any raises. By the time of her retirement, Ledbetter's meager annual raises resulted in a large pay gap between her compensation and that of her male coworkers.

In July 1998, Ledbetter filed a charge with the Equal Employment Opportunity Commission (EEOC), alleging, among other things, that she was unlawfully discriminated against on account of sex because she received lower pay from Goodyear than male coworkers in violation of Title VII. She filed suit in November 1999. Ledbetter's disparate pay claim was tried before a jury, which returned a verdict in her favor and awarded her $223,776 in back pay, $4,662 for mental anguish and $3,285,979 in punitive damages. In moving for judgment notwithstanding the verdict, Goodyear argued, among other things, that Ledbetter's claim was barred by Title VII's charge-filing deadline.

The district court denied Goodyear's motion, but reduced the award substantially and entered judgment for $360,000, plus attorneys' fees and costs. Goodyear appealed. The Eleventh Circuit Court of Appeals reversed the district court's denial of the employer's motion. The appellate court concluded that Ledbetter's pay at the time she filed her EEOC charge was the result of long-past decisions that she could not challenge outside of Title VII's charge-filing time period. Ledbetter appealed.

The U.S. Supreme Court affirmed the Eleventh Circuit Court's decision and ruled that Ledbetter's pay claim was untimely because she did not file a charge of discrimination with the EEOC within the statutory time period. In so ruling, the Court held that a pay-setting decision, like a termination or demotion, is "a discrete act" forming the basis of a Title VII claim and thus triggering the 180-day period to file a charge. Based on this starting point, the court ruled that Ledbetter filed her charge of discrimination years after the deadline had passed.

What the Act Does
Although combating gender-based pay discrimination was the impetus for the legislation, the Act prohibits pay discrimination based on all of the protected categories under Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Americans with Disabilities Act, and the Rehabilitation Act, i.e., race, color, religion, national origin, age, and disability. The Act provides that the charge-filing periods would commence when: (1) a discriminatory compensation decision or other practice is adopted; (2) an individual becomes subject to the decision or practice; or (3) an individual is affected by an application of a discriminatory compensation decision or practice (including each time wages, benefits, or other compensation is paid). Thus, the statute of limitations restarts each time an employee receives a paycheck based on a discriminatory compensation decision.

The law is retroactive to May 28, 2007, the day before the Ledbetter decision, and applies to all pay discrimination claims pending on or after that date.

What The New Act Means for Employers
The Act is primarily procedural and therefore imposes no new substantive requirements on employers beyond what is already required. Nevertheless, the Act is likely to trigger a surge in pay discrimination claims and unanticipated liability. Employers will need to be much more vigilant about regularly auditing their compensation practices and correcting the "effects" of allegedly discriminatory employment decisions made in the past. Employers should also develop objective, measurable guidelines for compensation decisions to be applied consistently and uniformly with job classification, work group, department or business unit.

Furthermore, employers should implement processes that ensure that managers and supervisors do not have unrestricted discretion when evaluating compensation. Instead, as with all other adverse employment actions, employers should have in place some procedure for review of pay-related decisions.

Employers should also reevaluate their document retention policies to determine how long they maintain documentation regarding compensation decisions.

Lastly, employers may want to consider performing periodic reviews of compensation data to determine if any statistical disparities exist across gender, race and ethnic lines. If there are such disparities, employers may want to make appropriate adjustments.

The Future of the Estate Tax
The growing federal budget deficit has all but insured that the
estate tax is here to stay. Currently, all that a person can leave
to heirs without paying any estate tax is $2M; beginning in
2009 that number will rise to $3.5M. Barack Obama is in
favor of retaining the $3.5M exemption and the 45% rate that
will be in effect next year; John McCain has proposed a $5M
exemption and a 15% rate.

And then there is the gift tax to consider. Each of us can
transfer up to $1M tax free during life-plus $12,000 each
year to an unlimited number of benefi ciaries. Gifts in excess
of these limits are taxed at 45%. Gifting to heirs during life
makes a lot of sense if assets are expected to appreciate. Once
the gift is made, any appreciation in the value of the property
transferred occurs outside of the donor's estate, which lessens
the estate tax burden at death.

For many families, proper estate planning that preserves the
estate tax exemption of the fi rst spouse or partner to die all
but takes care of any estate tax concerns they may have. But
for many other families, total net worth exceeds the amount
that is exempt from estate tax-especially here in the Bay Area
with our extremely high housing prices and dense concentration
of successful entrepreneurs.

Estate Tax Reduction Strategies
Families with taxable estates may utilize a number of estate
planning techniques that reduce estate taxes through lifetime
transfers to heirs. As a general matter, these strategies work
best when interest rates are low and/or the assets transferred
are temporarily depressed in value.

Grantor Retained Annuity Trusts
Consider the grantor retained annuity trust (GRAT), a creature
of statute-fully sanctioned by the IRS. GRATs are very
simple. The creator of a GRAT transfers property to a trust in
exchange for a fi xed annuity. Ideally, the transferred property
is likely to be much more valuable at some later point. Stock
in a privately held company that is about to go public and
securities that have lost signifi cant value in the recent crash
and are currently undervalued are good candidates.

The IRS makes an assumption about what the property will
be worth at the termination of the trust based on a variable
interest rate called the "7520 rate." The 7520 rate for
November 2008 is 3.6%. That assumed value-reduced by the
value of the annuity stream that is paid to the creator of the
trust-determines the value of the gift to the benefi ciaries. If
the present value of the annuity equals the value of the assets
transferred, the GRAT is "zeroed out" and no gift is deemed
to be made. To the extent that the assets in the trust appreciate
faster than the assumed rate of return, the excess is transferred
to the benefi ciaries free of transfer tax. The more the
assets appreciate, the more that is transferred without tax.

Sales to Intentionally Defective Grantor Trusts
Another very popular strategy is the sale of assets to an
intentionally defective grantor trust (IDGT). IDGTs are
"defective" in that the creator of the trust remains responsible
for the taxes on income earned by the trust-which is actually
another "free" transfer of wealth to the benefi ciaries. Under
this strategy, the creator of the trust sells assets to the trust
in exchange for an installment note that bears interest at the
adjusted federal rate for the appropriate term. Because the
trust is a grantor trust, the creator of the trust recognizes no
gain upon the sale. The rate for a note for a term longer than
three years but not longer than nine years is currently 3.19%.
This means that any appreciation in the assets that exceeds
3.19% is transferred tax-free to the benefi ciaries of the trust.

Charitable Lead Annuity Trusts
On the charitable side, the strategy that works especially well
when interest rates are low is the charitable lead annuity trust,
or CLAT. CLATs are similar to GRATs in that when these
trusts are optimally structured, a majority of the gains in the
value of the assets of the trust will be passed to the donor's
heirs. The primary difference between a CLAT and a GRAT
is the identity of the recipient of the annuity stream. With a
CLAT, a charitable benefi ciary receives the annuity. At the
end of the term, what is left in the trust goes to individual
benefi ciaries the donor has named (generally family members).
As with a GRAT, the IRS assumes that the trust corpus
will earn returns at the current 7520 rate (3.6% in November,
2008). To the extent that the assets outperform the 7520 rate,
the excess is transferred to the donor's heirs free of gift or
estate tax.

Establishing a GRAT or CLAT and selling assets to an
IDGT are just three of the many estate planning techniques
that pack special punch in a down market. As always, the
lawyers in the Estates & Trusts and Tax groups at Fitzgerald
Abbott & Beardsley LLP are available to help you evaluate
these and other strategies in light of your unique financial
situation.

An EIR must propose mitigation measures that are designed to minimize the project's significant impacts by substantially reducing or avoiding them.   Courts generally defer to an agency's decision on the effectiveness of the mitigation measures proposed by an EIR.    
(a) On-site Mitigation
On-site mitigation measures can include features incorporated into a project that reduce its GHG emissions and/or on-site measures that offset those emissions.  Some commentators recommend that agencies first look at reducing the energy required by the project, then at measures to offset any remaining energy related emissions.   Some examples of on-site mitigation measures include: construction of energy-efficient buildings; minimizing and recycling construction-related waste; maximizing water conservation measures; and installation of solar systems to meet energy and hot water demands.
(b)  Off-site Mitigation
 Once all onsite mitigation measures have been undertaken to maximally avoid and reduce the project’s greenhouse gas emissions, a lead agency may rely upon contributions to off-site mitigation programs for additional mitigation.   For instance, a project could contribute to a program that invests in biomass, wind power, solar power, alternative vehicle fuels, or increased energy efficiency programs.  Alternatively, a project could offset GHG emissions by making a monetary contribution to a tree-planting program that would provide carbon sequestration over a reasonable period of time, commensurate with the planned life of the project.  Substantial evidence should be presented to explain the rationale supporting selection of the measure, its duration, details on the selection, and a quantification of the GHG reduction, if available.  
 An off-site mitigation approach may need to give the highest priority to offsets within California in order to contribute to state-wide greenhouse gas emissions reduction to help ensure that the offsets comply with California environmental laws and emission standards.  
(1) Carbon Offset Credit Programs
 Carbon offset credit programs are a type of off-site mitigation.  There are two categories of carbon offset credit programs.  The first is "carbon offsets," which are credits or certificates that represent the right to claim responsibility for greenhouse gas emission reductions.   For example, a carbon offset provider might use proceeds to pay for a landfill methane collection system or tree planting effort that otherwise might not have occurred.   The second category of offsets is so-called Renewable Energy Credits (RECs).  These represent that portion of the cost of a project to generate renewable energy that exceeds the cost of generating conventional energy.  These are often generated by clean energy providers, who cannot recover the true costs of constructing and operating their power projects through sales in the conventional energy market.  To account for this they sell the energy itself at the standard price for such energy, and market the differential in the form of a REC; RECs, however, are largely unregulated.  
 Last November the Federal Trade Commission announced its intent to begin an investigation into the validity of advertising claims made for both carbon offsets and RECs.   The Attorney General’s Office and state Assemblyman Pedro Nava (D-Santa Barbara) have both weighed in on the need to place some controls over the fast growing business of selling carbon offsets to consumers and businesses.  The response consists of proposed legislation that would establish a certification program for companies selling carbon offsets in California.
F.  June 2008 OPR Technical Advisory
OPR’s Technical Advisory was intended as an interim step in the development of formal CEQA Guidelines on the question of GHG emissions/climate change.  While a full analysis of the OPR Technical Advisory is beyond the scope of this article, it appears the document does little more than reiterate many of the existing CEQA principles and analytic frameworks noted in this article.  More specifically and somewhat disappointingly, the OPR Technical Advisory does not address the most controversial unresolved aspect of the CEQA GHG/climate change analysis, the determination of significance.  The OPR Technical Advisory states, “[a]lthough climate change is ultimately a cumulative impact, not every individual project that emits GHG must be found to contribute to a significant cumulative impact on the environment.”   OPR, however, does not offer any advice as to what methodology, evidence or legal authority a lead agency might lawfully rely upon to support such a conclusion.
III. Conclusion
 Based on the foregoing, the requirements for the legally sufficient treatment of GHG emissions and climate change issues in CEQA documents are in the initial stages of development.  Little statutory, regulatory or caselaw guidance yet exists.  At some point more solid legal guidance may be available from the CEQA Guidelines, the state legislature, or the courts, but that could be several years from now.  In the interim, a transparent acknowledgement of uncertainty coupled with best efforts at completing all aspects of the analysis CEQA demands is the most legally defensible course to follow.

While the new federal regulations are not likely to impact most California employers, they do provide a useful reminder of the importance of internal wage and hour compliance audits. This is particularly true in California where the strict state law overtime standards are coupled with severe penalties, a lengthy statute of limitations for wage claims, and enforcement mechanisms that are easily accessible to employees. Below is a comparison of some of the key areas in the new federal white collar exemption regulations, followed by a description of the stricter existing California standard that employers in this state must follow:

1. The Minimum Salary Provision
Under the revised federal standard, in order to be exempt from overtime under the administrative, professional or executive exemption, the employee in question must receive a minimum salary of $455 a week or $23,660 per year.

California's minimum salary standard for the same white collar overtime exemptions requires payment of twice the state minimum wage based on a 40-hour work schedule. This cannot be prorated, even if the employee is part time.
Continued - page 2
 
Thus, the current minimum salary requirement, based on the state's $6.75 per hour minimum wage, equates to $540 per week or $28,080 per year.

2. The Highly Paid White Collar Employee Exemption
The new federal rules allow employers to consider exempt certain white collar employees who earn over $100,000 per year if they customarily or regularly perform just one of the exempt duties contained in the professional, administrative or executive exemptions. For example, an executive who customarily and regularly directs the work of at least two other employees, and earns more than $100,000 per year, would presumably be exempt under federal law even if that executive did not have hiring and firing authority, and did not run a division or department.

The highly paid white collar employee exemption does not exist under state law. Therefore, the fact that an employee makes over $100,000 a year does not by itself mean that the employee is exempt. Even highly paid employees in California must satisfy all of the criteria of the executive, administrative or professional exemptions, or some other state law overtime exemption, in order to be lawfully excluded from overtime.

3. Learned Professionals
Under federal law, a professional may be exempt if he or she: (1) satisfies the general exempt criteria, including the salary requirement, and (2) has a primary duty which is the performance of work that requires knowledge of an advanced type in a field of science or learning customarily acquired through a prolonged course of intellectual instruction and study. The Department of Labor has indicated that a four year college degree in a specialized field of instruction may satisfy the learned professional exemption.

In contrast, the California Labor Commissioner has indicated that state law requires a specialized degree of
a higher level than a bachelors' degree, meaning at least a masters' degree in a particular field, in order to be an exempt learned professional. These employees must also meet all of the general professional exempt criteria under state law.

4. Outside Sales  
Federal law applies a qualitative approach to this exemption -- in order to be exempt, outside salespersons must have the "primary duty" of making sales or obtaining orders for services or the use of facilities for which consideration will be paid. This test is focused not strictly on time spent, but on what is the functional heart of the job. The federal exemption also requires that outside sales employees customarily and regularly be engaged in such work away from the employer's premises.

California's outside sales exemption, like most of its white collar exemptions, utilizes a strict quantitative duties test: in order to be exempt, the employee in question must spend more than 50% of his or her work time performing exempt outside sales work.

Note: Under the different approaches of state and federal law, it is theoretically possible to spend more than 50% of work time in exempt work yet not have exempt duties as the "primary function" of the job. In practice, however, the California quantitative test is usually stricter than the federal primary function test. Employees who pass the California test, therefore, are almost always exempt under federal law.

The detail needed for a full compliance review in relation to any of the overtime exemptions is not possible in a written article of this size. Employers should consult with experienced employment counsel to ensure that each of their exempt positions is consistent with state overtime laws.

Because closely held businesses frequently combine compensating the owners for personal services they provide to the company and rewarding them for the other commitments that they make, such as providing at risk capital, deferring bonus payments or other distributions, the Section 409A rules create several challenges for closely held businesses. Therefore, it is important for business owners to understand the implications of Section 409A. Most importantly, a closely held business owner should become familiar with the following definitions:

• A deferral of compensation occurs when an individual has a legally binding right during a taxable year to compensation that (i) has not been actually or constructively received and included in the individual’s gross income and (ii) is payable to such individual in a later taxable year.
• A nonqualified deferred compensation plan is any agreement, method or arrangement that provides for the deferral of compensation. The definition includes arrangements that apply to one or more individuals and is not limited to arrangements between an employer and an employee.
• Compensation is not subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial.

Failure to comply with the Section 409A rules causes a 20% excise tax penalty and potentially substantial interest penalties to be imposed on workers who participate in the non-complying arrangement.

The following types of arrangements are exempt from Section 409A:

• Salary paid on an employer’s regular payroll schedule
• Incentive bonus arrangements paid within 2 ½ months of the end of the year in which the bonus is earned (the year in which the services are provided)
• Incentive stock options (ISOs) and nonstatutory stock options (NSOs) issued with an exercise price of not less than fair market value (“FMV”) on the date of grant. Therefore, NSOs with an exercise price that is less than the FMV of the stock on the grant date will be subject to Section 409A.

Most employers, especially closely held corporations because they may not have an in-house compliance officer, are usually unaware that they are subject to Section 409A or that they may be in violation of the regulations. Here is a checklist of year 2006 action items for closely held corporations needing to comply with 409A:

• Identify plans that may be affected - Review compensation plans to determine if any benefits payable under the plans fall within the Section 409A definition of deferred compensation.
• Identify changes - For each existing deferred compensation plan, identify what changes, if any, are required to bring it into compliance with Section 409A.
• Preserve or abandon grandfathered status - Identify grandfathered plans and amounts and decide whether to preserve grandfathered status or bring the entire plan into compliance with Section 409A. To retain grandfathered status, put procedures in place to avoid inadvertently modifying the plan and thereby triggering Section 409A coverage.
• Allow changes in time and form of payment - If permitting participants to change time and form of payment elections, ensure that all election changes are made and plans amended by the end of 2006 -the ability to make these changes expires December 31, 2006. Elections made in 2006 may not apply to payments that otherwise would have been made in 2006 or cause later payments to be accelerated into 2006.
• Eliminate links to elections under qualified plans - Existing plans with payments linked to elections under qualified plans may continue to operate with this feature only through December 31, 2006. During 2006, alternative payment structures must be designed for implementation by 2007. Plans must be amended by the end of 2006 to incorporate acceptable payment features.
• Consider design changes to meet an exception - Consider alternative design options for noncompliant provisions (e.g., whether an existing plan can be modified to fit within the short-term deferral exception from coverage under 409A).
• Establish performance criteria and solicit elections for performance-based awards - For 2006 performance-based awards, establish performance criteria in writing within 90 days after the beginning of the performance period. Ensure that elections are made at least six months before the end of the performance period.
• Substitute discounted stock options and SARs - Stock options and SARs may be replaced with nondiscounted stock options and SARs that will qualify for exemption from 409A, so long as the replacement takes place by the end of 2006.
• Comply with writing requirement - Ensure that the material terms of all deferred compensation arrangements are set forth in writing to meet the new 409A writing requirement. Material terms include the amount deferred under the arrangement and the time and form of payment.
• Comply with new reporting requirements - Report on Forms W-2 or 1099-MISC all 2005 deferrals and earnings (see above). Report any amounts that become taxable because of noncompliance with 409A.
• Amend documents - Amend all plan documents by December 31, 2006 to bring plans into compliance with 409A or to convert plans into arrangements not subject to 409A.

Section 409A creates special challenges for closely held corporations because many are not accustomed to the increased level of documentation. Following these guidelines and adopting basic protocols can substantially lessen the impact of the regulations on the company. If you have any questions about Section 409A on your deferred compensation plans, please contact us.

Practically speaking, the Court's ruling is likely to result in an increase in retaliation claims against employers. Faced with increasing uncertainty over whether particular actions can be deemed retaliatory, employers will be forced to second-guess decisions they make that could somehow impact an employee who may have exercised a protected right. Undoubtedly, employees who file retaliation claims will have a much easier time establishing the basic elements of their case and having their case tried before a jury.

The Facts of Burlington Northern
The plaintiff Sheila White was the only woman who worked in the Maintenance of Way department at Burlington Northern's Tennessee Yard in Memphis. White had experience operating a forklift, but was hired by Burlington Northern in 1997 to be a "track laborer." Shortly after she started in the job, however, a forklift position opened up and White was reassigned to operate the forklift, although she continued to perform some track laborer tasks. 

White had problems right away with her supervisor Bill Joiner, who repeatedly told her that women should not be working in the Maintenance of Way department and made insulting and inappropriate remarks to her in front of her male colleagues. After White complained to Burlington officials, Joiner was suspended for ten days and ordered to attend a sexual harassment prevention session.

When the Burlington official who had hired White, Marvin Brown, told White about Joiner being disciplined, he also told her she would be reassigned from forklift duty and would return to performing only track labor tasks. Brown explained to White that co-workers had complained that it was only fair for a "more senior man" to have the "less arduous and cleaner job" of forklift operator. Shortly thereafter, Ms. White filed a complaint with the Equal Employment Opportunity Commission (EEOC), claiming that the reassignment was due to illegal gender-based discrimination and retaliation for her complaints against Joiner.

A few weeks later, White got into an argument with her immediate supervisor and was suspended without pay for insubordination. When White filed an internal grievance, Burlington Northern concluded that she had not been insubordinate and reinstated her with back pay for the 37 days of pay she lost as a result of the suspension.

White filed her retaliation lawsuit in federal court in Tennessee. White based her claim of retaliation on two specific actions by her employer: the decision to transfer her from forklift duty to track laborer and the decision to suspend her without pay. In response, Burlington Northern argued the claim should not be tried before a jury and should be dismissed because White could not prove that she had suffered a materially adverse employment action—a necessary element of any retaliation claim. More specifically, the Company argued that changing White's work duties could not meet the legal standard for retaliation, since she remained in the same job and under the same job description as when she was hired. The Company also claimed that since White was reinstated with pay, she didn't suffer any legally recognizable harm for the period during which she was suspended.

The trial court allowed the case to go to a jury. The jury found in favor of White and awarded her damages in the amount of $43,500. On appeal, a sharply divided Sixth Circuit Court of Appeals ruled in favor of Burlington Northern. Following an en banc rehearing of the case, the Sixth Circuit, in another split decision, found for White. Burlington Northern appealed to the U.S. Supreme Court.

The Supreme Court's Holding
When the Supreme Court initially agreed to hear the case, it did so with the understanding that it was to address only one issue: the appropriate standard for determining what constitutes an adverse employment action in a retaliation case. More specifically, the Court was intending to resolve a split amongst the federal circuit courts over what employment actions could be deemed sufficiently materially adverse to an individual's employment. Some circuit courts require the retaliation to reach the level of an "ultimate employment action," such as actions affecting "hiring, granting leave, discharging, promoting, and compensating." Other courts hold that illegal retaliation is any material action which "dissuades a reasonable worker from making or supporting a charge of discrimination," which means that it does not have to rise to the level of an ultimate action. The Sixth Circuit, from which this case was appealed, employs an intermediate standard, but one which is identical to the standard required to prove employment discrimination. That standard holds that a plaintiff must show an "adverse employment action," which it defines as a "materially adverse change in the terms and conditions" of employment. The Court's opinion was expected to—and in fact did—address which, if any, of these standards should be applied.

The Court, however, was not expected to address the issue of whether or not retaliation claims could be premised on actions taken by the employer that were wholly unrelated to the terms and conditions of employment. In this case, there was no question that the actions taken by Burlington Northern against Ms. White were directly related to her employment. Accordingly, the facts of the case did not require the Court to address the issue of actions unrelated to employment. Nevertheless, the Court addressed the issue and made a finding that could prove especially troublesome for employers.

No Link to Employment Necessary to Prove Material Adversity
Not surprisingly, the Court held, with respect to the first issue, that, in order to prove a retaliation claim, an employee must demonstrate that, as a result of actions taken by the employer, he or she suffered an "injury or harm" which was "materially adverse." The Court, according to the decision, adopted this standard in order to "separate significant from trivial harms" and therefore will exclude "petty slights or minor annoyances."

As mentioned above, the Court also addressed the issue of whether the anti-retaliation provision of Title VII was confined to actions occurring at the workplace or related to employment. Prior to this opinion, the majority rule amongst federal courts was that an employee claiming retaliation had to demonstrate that the alleged retaliatory conduct adversely affected the terms and conditions of his and her employment. In so doing, these courts imported the standard used in Title VII discrimination cases, which explicitly limits the scope to actions that affect employment or alter workplace conditions.

The Supreme Court, however, found no statutory basis for this rule of limiting the types of actions which could be considered retaliation to those which were directly related to the terms and conditions of employment. The Court opined that the language of the anti-retaliation provision of Title VII suggests that Congress intended to prevent an employer from interfering with an employee's efforts to secure or advance enforcement of the Title VII's guarantees. The Court therefore concluded that the anti-retaliation provision applies to any actions that "well might have 'dissuaded a reasonable worker from making or supporting a charge of discrimination,'" regardless of whether those actions are related to the worker's employment.

As a consequence of the Court's decision with respect to this issue, employers are likely to see a significant increase in the number of retaliation cases in which an employee perceives he has been retaliated against because of actions taken by his or her employer that have nothing to do with the individual's employment (such as filing criminal charges against a former employee who had complained about discrimination or refusing to invite an employee to a weekly company social event.) Allegations that, prior to this opinion, would not have been enough to satisfy the basic elements of a retaliation claim, will now easily satisfy the threshold requirements.

"Reasonable Person" Standard
In addition, the Court adopted an objective standard for purposes of determining what conduct is sufficiently materially adverse to dissuade an employee from complaining about discrimination. In other words, an individual employee's "unusual subjective feelings" will not be relevant. The focus, according to the Court, is on the materiality of the employer's action and "the perspective of a reasonable person in the plaintiff's position." The Supreme Court further explained that "the significance of any given act of retaliation will often depend upon the particular circumstances. Context matters." For example, the Court notes that a change in work schedule may be insignificant to most workers, but "may matter enormously to a young mother with school age children."

What the Decision Means for Employers
The Court's decision in Burlington Northern will prove problematic to employers for a number of reasons. First, employers can expect that the number of retaliation cases will rise significantly, given that the threshold for proving retaliation has been drastically lowered. Additionally, employers can expect that the cost of litigating retaliation cases will increase, as judges will be disinclined to dismiss cases at an earlier stage and instead will be inclined to allow the cases to be heard by juries. 

Finally, employers should take steps internally to ensure that supervisors and managers are well-trained in how to respond to employees who may have engaged in some kind of legally protected activity. The Supreme Court has cast a much broader retaliation net; employers must now do even more to avoid getting caught in it.

NEW LAWS
The following is a brief summary of employment-related bills (organized by bill number) that have now been signed into law.
AB 1368 (Karnette) Existing worker’s compensation law specifies that when a doctor examines an employee for a work-related injury and prepares a report addressing the issue of permanent disability due to a claimed injury, the doctor is required to determine what approximate percentage of the medical condition is a result of the work-related injury and what approximate percentage is a result of other factors. AB 1368 excludes from this statutory requirement any state and local public safety workers who suffer from hernia, heart trouble or pneumonia as a result of that employee’s service. The law was designed to protect the rights of law enforcement officials (particularly after 9/11) to receive worker’s compensation benefits without having to prove what caused their illnesses.

AB 1553 (Evans) provides for tolling of the time period for a party to demand or commence arbitration of a controversy pursuant to an arbitration agreement when the party commences a civil action in court based on that controversy.

AB 1835 (Lieber) calls for an increase in the minimum wage to $7.50 in 2007 and to $8.00 in 2008

AB 2068 (Nava) extends for another two years the right of workers who are enrolled in employer-provided group health plans to “predesignate” their treating physicians for work-related injuries, a right that otherwise would expire on April 1, 2007. The new law also deletes the 7% statewide cap on who can pre-designate and clarifies that medical groups and corporations are considered “physicians” for purposes of pre-designation.

AB 2087 (Benoit) requires the Administrative Director of the Division of Workers’ Compensation to compile a list of all self-insured employers’ liability and make that information publicly available on the Department of Industrial Relations’ Internet Website.

AB 2095 (Niello) limits the provisions of recent legislation requiring sexual harassment training for supervisory employees to apply the training requirement only to those supervisory employees within California. AB 2095 also provides that an employer is deemed to be in compliance with existing law requiring hours worked to appear on itemized wage statements if the hours worked in excess of the normal work period are itemized on the statement accompanying the pay.

AB 2125 (Vargas), another worker’s comp-related bill, makes numerous technical and non-controversial changes to the Insurance Code designed to improve the Department of Insurance’s administration and assist in its ability to oversee the insurance industry.

AB 2292 (Montanez) prohibits the Department of Industrial Relations from taking action to collect a deceased employee’s accrued and unpaid compensation, if a dependent, personal representative, heir, or other person entitled to the deceased employee’s accrued and unpaid compensation is determined to exist.

AB 3051 (Koretz) provides an exemption for employees in the motion picture and broadcasting industry to the Labor Code’s requirements regarding “termination pay.” The bill permits employers in the motion picture and broadcasting industry to pay their employees their final pay by the next regular pay period (as opposed to immediately upon discharge).
 
SB 293 (Ducheny) restructures the state’s administration of the federal Workforce Investment Act of 1998 (which offers a comprehensive range of workforce development activities through statewide and local organizations) to streamline the workforce investment board process and duties at both the state and local levels. SB 293 also authorizes local workforce investment boards to submit unified local job training plans.

SB 1428 (Scott) clarifies that a statutory payroll company is the employer of record of workers in the motion picture industry for tax reporting and benefit purposes.

SB 1690 (Romero) authorizes the Employment Training Panel, on a limited basis, to fund the training of workers in seasonal industries. This bill also amends the Unemployment Insurance Code to authorize the Employment Development Department to round up the State Disability Insurance weekly benefit amount to the nearest dollar when the round up exceeds the weekly maximum benefit.

SB 1719 (Cedillo) allows unionized employees in the live theatrical and concert industries who are dispatched from hiring halls to negotate alternative systems for final payment of wages.

SIGNIFICANT VETOES
The Governor vetoed thirteen employment-related bills that came out of this year’s legislative session. Some of these bills, and the reasons given by the Governor for his decisions to veto, are discussed below.

AB 675 (Klehs) would have required companies with assets of more than $10 million to file additional tax and accounting information with the state Franchise Tax Board. Supporters of the bill claimed that it would have increased corporate accountability. The Governor in his veto message claimed it would have done nothing more than impose “additional bureaucracy and unnecessary costs on top of many significant legal and oversight protections put in place after the Enron scandal.”

AB 1884 (Chu) would have allowed locked-out workers to collect unemployment benefits. The Governor claimed the bill would have encouraged strikes.

AB 2209 (Pavley) would have barred employer-employee agreements that prohibit workers from collecting unemployment and would have required employers that engaged in fraud or other misconduct during a lockout to repay employees for lost benefits. While the Governor considered the bill “well-intentioned,” he refused to sign it because the bill failed to adequately define “fraud” and “misconduct” and therefore could be abused.

AB 2555 (Oropeza) would have boosted penalties for violating gender-equity wage requirements. The Governor vetoed this bill for the third time, noting that existing “law already provide[s] criminal and civil penalties for an employer that pays discriminatory wage rates to employees on account of gender.”

AB 2593 (Keene) would have created an exemption for commercial drivers under a collective bargaining agreement to the Labor Code’s requirements regarding meal periods. This bill is almost identical to one passed by the legislature and signed by the Governor last year. That bill related to employees in the motion picture industry. In rejecting AB 2593, the Governor noted that, while he considers the Labor Code’s provisions regarding meal and rest periods “confusing” and “burdensome,” he cannot support the bill “because it singles out a specific group of employers and employees for relief from a problem that plagues almost every industry in this state.”

SB 1414 (Midgen) would have required large employers to spend a specified percentage of their total wages on employee health insurance costs. The Governor called the bill “arbitrary” and not sufficiently “comprehensive” to deal with the state’s health insurance crisis.

CONCLUSION
All told, it was not a particularly ground-breaking year as far as employment-related legislation is concerned. Nonetheless, several of these laws will have significant (and perhaps non-obvious) implications for California employers. For example, the minimum wage increase will have a direct impact on employees classified as exempt from overtime pay pursuant to the white collar and/or inside salesperson exemptions, as the minimum salary requirement for those overtime exemptions is based on the minimum wage rate. Employers should therefore review the salaries being paid to exempt employees to ensure those employees continue to satisfy the minimum salary requirements, as well as all other elements of the exemptions.
Finally, not all of the new laws will apply to every employer. Employers should consult with appropriate trade associations and experienced employment law counsel to determine which laws apply to them. Employers may obtain additional information regarding each of the new laws from the official California legislative information website at www.leginfo.ca.gov.

There were two notable exceptions to the equal treatment of married couples and RDPs under state law. First, AB 205 instructed RDPs to continue to file their state income tax returns using the same filing status that they use for their federal returns. Second, transfers of real property between RDPs would continue to trigger a property tax reassessment. Recent legislation has been enacted to address these issues. Beginning with the 2007 tax year, RDPs are required to file their California state income tax returns like married couples – either “married/RDP filing jointly” or “married/RDP filing separately.” Transfers of real property between RDPs no longer trigger property tax reassessments.
 
Property Tax Reform
In 1978, California voters approved Proposition 13, which caps the rate at which property taxes can be levied on real property. Transfers of property generally result in property being reassessed at a higher value, which translates to higher property taxes. Transfers between spouses are exempt from reassessment. Although AB 205 did not extend this exception for transfers between married couples to RDPs, SB 565, which took effect on January 1, 2006, did just that. This new law specifically gave RDPs the ability to transfer real property to each other during life and at death without triggering a reassessment. However, SB 565 was not retroactive, so transfers between RDPs that occurred prior to January 1, 2006 were still subject to reassessment.

SB 559, passed earlier this year, addressed this problem by allowing RDPs whose property was reassessed as a result of a transfer between them to seek a new reassessment. This new reassessment will restore the assessed value of the property to its pre-transfer value as if the transfer never occurred. Only transfers made between RDPs during the period after their date of registration through December 31, 2005 are eligible for a new reassessment; transfers between partners that occurred prior to their registration date are still subject to reassessment and will not be adjusted.
 
State Income Tax Filing Requirements
AB 205 instructed RDPs to continue to file their state income tax returns as if they were single persons and prohibited RDPs from treating earned income as community property.

This all changed with the recent passage of SB 1827, which requires RDPs to file their California state income tax returns like married couples beginning in tax year 2007. RDPs, like married couples, are now allowed to choose to file either as “married/RDP filing jointly” or “married/RDP filing separately.” However, because the federal law does not recognize RDP status, RDPs must continue to file their federal returns individually, either as “single” or “head of household.”

This makes for a very confusing situation – not to mention more work for taxpayers and their accountants. Existing California law requires taxpayers to transfer their adjusted gross income (AGI) calculation from their federal tax returns to their California state tax returns. California taxpayers use federal AGI to determine limitations on certain deductions and credits on their California state tax returns. Since RDPs cannot file a joint federal income tax return, partners will continue to compute federal AGI separately on their individual returns. Simply adding together the federal AGI of two partners computed on individual returns could very well result in a different number than if AGI were computed on a joint return.

Recent Legislative Changes
SB105, signed into law in October 2007, revised the way RDPs compute AGI for California state income tax purposes. RPDs with “RDP adjustments” are instructed to complete a mock-up federal return (or state worksheet) to determine their AGI for state tax purposes – instead of simply adding together the federal AGI figures calculated on their individual returns.

Franchise Tax Board Draft Publication -Guidance for RDPs
In an effort to shed some light on how the new rules will work, the Franchise Tax Board has been releasing draft publications on this topic. Draft FTB Publication 737 – “Tax Information for Registered Domestic Partners” – sets forth guidelines that certain RDPs must follow when filing their 2007 California tax returns. The publication focuses on computation of AGI for RDPs who will have “RDP adjustments.”

RDP adjustments are adjustments to AGI that may be necessary because RDPs are required to report income individually on their federal returns, but combine income on their state returns. RDP adjustments may also be required where federal and state laws treat transactions between RDPs and married couples differently.

Examples of RDP adjustments include the following:

• Capital losses
• Transactions between RDPs
• Sale of residence
• Dependent care assistance
• Investment interest
• Qualified residence acquisition loan and equity loan interest
• Expense depreciation property limitations
• Individual retirement accounts
• Education loan interest
• Rental real estate passive loss
• Rollover of publicly traded securities gains into specialized small business investment companies

What To Do
The first step for RDPs will be to determine whether to file jointly or separately in California. Although the Franchise Tax Board has estimated that filing jointly will be preferable for most taxpayers, each situation is unique and in many cases filing separately may result in lower taxes overall. Even if RDPs choose to file as “married/RDP filing separately” in California, their state and federal returns will require different calculations.  RDPs must follow California’s community property rules and split income on their state returns, while reporting their own respective earned income on their federal returns.

For RDPs who have RDP adjustments, Draft Publication 737 provides instructions on how to calculate the AGI figure that they will use on their California state tax returns. To determine the AGI figure, RDPs must either complete a mock-up federal return, as mentioned above, or complete a worksheet found in Publication 737. Calculations using either method should yield the same result. Whichever method RDP taxpayers decide to use, they must file a copy with their California tax returns, but should not file a copy with their federal tax returns.
 
The mock-up return and worksheet allow RDPs to determine what their combined AGI would have been if they were allowed to file as “married filing jointly” on their federal return. The partners will then use this combined AGI figure on their California return. Consequently, instead of three returns – two federal and one state – RDPs that have RDP adjustments will actually have to complete at least four returns: two individual federal returns, one joint federal mock-up return (or worksheet) to determine AGI, and a joint California return. RDPs that do not have any RDP adjustments can simply combine the federal AGI number from both individual returns filed with the IRS and transfer the combined amount to their California tax return.

Practical Tips
RDPs who have used separate accountants in the past are well advised to work with one tax professional this year so that positions taken on the various returns will be consistent. Now more than ever, it is important for RDPs to work with tax preparers who are intimately familiar with the new filing rules and who are keeping abreast of updates and clarifications issued by the Franchise Tax Board.

Senate Bill (SB) 929: Reduction in Hourly Rates for Computer Professionals
Labor Code section 515.5 establishes an overtime exemption for employees in the computer software field who meet certain conditions related to their job duties and who earn an hourly rate of
$41.00 per hour, indexed for inflation. Effective January 1, 2008,
SB 929 reduces the minimum hourly wage for computer professionals to not less than $36.00 per hour, with annual adjustments by the Department of Industrial Relations.

SB 812: Alternative Workweek Schedules for Pharmacists
SB 812 provides that pharmacists employed under California Wage Order 7 may adopt alternative workweek schedules allowed by Wage Order 4, including the provisions for alternative workweeks available to health care industry employees.

SB 869: Increased Publicity for Violations of Workers Compensation Statutes
SB 869 requires the Labor Commissioner to establish a program that identifies employers who unlawfully fail to provide workers compensation insurance and to publish a report identifying these violators on the Labor Commissioner’s website. The Commissioner must also notify the Governor, the Insurance Commissioner and the Administrative Director of the Division of Workers Compensation of the report’s availability.

AB 338: Increased “Window Period” to Exhaust Temporary Disability Benefits for Workers Compensation Purposes
Current law caps an injured worker’s eligibility for temporary disability benefits at 104 weeks within a two-year period. For injuries occurring after January 1, 2008, AB 338 extends the “window period” from two years to five years and provides that the start date for this window period is the date of injury rather than the commencement of temporary disability payments.
 
AB 632: Whistleblower Protections Extended to Medical Professionals
This law expands whistleblower protections to professional members of health facility staffs. The bill prohibits retaliation or discrimination against a physician staff member who notifies a relevant entity, including a health care facility, government accreditation committee, or peer review body, of suspected unsafe patient care and conditions occurring in the health facility.

AB 650: Employers Must Notify Employees of Eligibility for Tax Credits
California employers are required to notify their employees that they may be eligible for the federal Earned Income Tax Credit one week before, one week after, or at the same time that the employer provides a W-2 Form or similar wage statement. The notice must either be hand-delivered to the employee, or mailed to the employee’s last known address.

In addition to 2007 legislation, the following bills passed in 2005 and 2006 impose new requirements on California employers in 2008.
SB 101: Restrictions on Displaying SSNs
Labor Code section 226 requires an employer to furnish each employee with an accurate itemized statement showing, among other things, the name of the employee and his or her Social Security number. Enacted in 2005, SB 101, which went into effect on January 1, 2008, requires that employers include no
more than the last four digits of the employee’s Social Security number or an employee identification number on the itemized
wage statement.

AB 1835: Minimum Wage Increase
Enacted in 2006, AB 1835 calls for an automatic increase in California’s minimum wage to $8.00 per hour beginning
January 1, 2008.

SB 1613: Cell Phone Restrictions
Another bill passed in 2006, SB 1613, effective July 1, 2008, prohibits drivers from using a cell phone while driving unless the driver is using a hands-free device.

Final Sexual Harassment Training Regulations
In July 2007, California’s Office of Administrative Law approved Fair Employment and Housing Commission regulations governing mandatory sexual harassment training and education. The regulations clarify that the harassment training law applies
to companies which regularly employ fifty or more employees or “receive the services” of fifty or more persons. Employees located outside California as well as independent contractors or temporary workers must be counted to determine applicability, but only supervisors located in California are required to receive training. The regulations also specifically enumerate two methods for tracking employer compliance and identify the quali
fications trainers must possess to provide the required sexual
harassment training.

New Employment Eligibility Verification (I-9) Form Required
U.S. Citizenship and Immigration Services has issued a new Form I-9 that employers must use to verify employment eligibility of all new hires or re-verifications. Employers not currently using the new Form I-9 are subject to penalties. The form only needs to be used for new employees and re-verifications; current employees do not need to complete new forms, unless the employee’s status needs to be re-verified on other grounds.

Case Law Developments
In 2007, both California and federal courts issued employment-related decisions on a wide variety of issues. Here are just a few of the important decisions that came out of the courts last year.

California Supreme Court Classifies Pay for Missed Meal/Rest Breaks as Wages
In Murphy v. Kenneth Cole, the California Supreme Court held that the “one hour of pay at the employee’s regular rate of compensation,” which employers must provide employees for each day they miss the statutorily mandated meal break/rest breaks, is to be considered wages. As such, claims for failure to provide
meal periods are subject to the three-year statute of limitations applicable to violations of California’s wage laws.

Employers May Satisfy Statutory Reimbursement Obligation by Paying Employees Enhanced Compensation
In Gattuso v. Harte-Hanks Shoppers, Inc., the California Supreme Court ruled that an employer may satisfy its reimbursement obligation under Labor Code section 2802 by paying employees enhanced compensation in the form of increases in base salary or commission rates in lieu of employees’ actual costs incurred in performing their job duties. Such plans are legal as long as the employer apportions the enhanced compensation so that it is clear what amount is being paid for labor performed and what amount is reimbursement for business expenses.

Court Significantly Limits Viability of Class Action Waivers in Pre-Employment Arbitration Agreements
In a split four to three decision, the California Supreme Court ruled in Gentry v. Circuit City that a class action waiver cannot be enforced where the
claims at issue may not be waived as a matter of law and where a class action would be a “significantly more effective means” of resolving the claims at issue. The court in Gentry did not invalidate all class action waivers, nor did it question the validity of arbitration clauses in employment agreements. Yet, the fallout from Gentry may mean that despite some employers’ efforts to keep employee grievances outside of the class action juggernaut, courts may nonetheless find that a class action is a superior method of resolving employment disputes.

Under a Profit Sharing Plan, an Employer May Factor Losses Caused by Employees in Determining Available Profit
In Prachasaisoradej v. Ralphs Grocery Company, the California Supreme Court held that Ralphs Grocery’s profit-sharing plan did not violate California’s long-standing prohibitions against deducting from an employee’s wages the costs of routine accidents, loss of equipment, cash register shortages, and workers compensation costs. In support of the Ralphs Grocery plan, the court held that some profit-sharing plans do not violate the law where certain costs are deducted from revenue in order to determine the amount of bonus profits per employee.

In the MW Erectors decision, the court addressed a case from the Orange County Superior Court.  In its ruling, the Supreme Court made the following broad decisions:
(1) Section 7031(a) of the California Business and Professions Code bars a person from suing to recover compensation for any work performed under an agreement for services requiring a contractor's license unless proper licensing was in place at all times during contractual performance;
(2) Section 7031(a) does not allow a contractor who is unlicensed at any time during performance to recover compensation, even if there was a period of time during which work was performed when proper licenses were in place;
(3) The substantial compliance doctrine is not available to a contractor who was not properly licensed before performance was commenced under the contract; and
(4) A contractor who was properly licensed during performance, but not at the time a contract was executed, could recover for such services.
 
This decision has a far reaching impact as it not only reaffirms California's punitive and strict licensing scheme, but also closes certain loopholes which in the past have afforded contractors some modest flexibility.

In its decision, the Supreme Court began by emphasizing the legislative purpose of the licensing law: to protect the public.  In the MW Erectors case, MW was a subcontractor to Niederhauser which, in turn, had a contract with the general contractor.  MW executed two subcontracts with Niederhauser, one for structural steel and the other for ornamental steel.  MW commenced work under the structural contract on December 3, 1999, but did not obtain a C-51 structural steel specialty license until December 21 of that year.

MW later sued Niederhauser and its bonding company seeking amounts due under both the structural steel contract and the ornamental steel contract.  Niederhauser moved for summary judgment on the grounds that MW was barred by § 7031(a) because it was not properly licensed at all times during the performance of its two contracts.  Niederhauser argued that MW did not obtain its C-51 structural steel license until December 21, 1999, and that MW never obtained a C-23 ornamentals license.  Niederhauser further asserted that the substantial performance doctrine did not apply because MW could not prove that it had ever held a contractor's license before commencing work on December 3, 1999.  It was not disputed by the parties that a C-51 license was required for work under both contracts and that this license was not obtained until eighteen (18) days after work commenced.  MW also admitted that it never obtained a C-23 license.  MW defended the summary motion by arguing that it was in "substantial compliance" with the C-51 license requirement, and that no C-23 license was necessary for the ornamental work.

The trial court granted summary judgment for Niederhauser and dismissed the subcontractor's complaint.  The Court of Appeal reversed the trial court ruling.  The Court held that MW could not recover compensation for the relatively short period of time before it secured the C-51 license.  However, the appellate court reasoned that MW was entitled to recover the amounts which were due for work performed after it had obtained the proper license.  A further appeal was taken, and the California Supreme Court affirmed in part and reversed in part. 

As to the right to compensation for performance while properly licensed, the Supreme Court disagreed with the Court of Appeal, and held that MW, though it was properly licensed 18 days after it commenced work on the project, could not recover any compensation because it did not comply strictly with the statute.
Specifically, the statute requires that a contractor suing for compensation plead and prove that it was properly licensed "at all times during the performance of that act or contract."  §7031(a).  Here, the strict interpretation of the licensing law becomes apparent:  Even though MW obtained its proper C-51 license the company lacked the proper license when it commenced work on the project.  Therefore, the Supreme Court reasoned, §7031(a) completely barred MW from recovering any compensation for its work.

The Supreme Court also addressed the doctrine of "substantial compliance."  Under that doctrine, a contractor may recover if it can prove that it was properly licensed at some time prior to performance under the contract.  It can attempt to avoid a later lapse in proper licensing under this "substantial compliance" exception.  However, in the MW Erectors case the contractor conceded that it had never held a valid California contractor's license until after it had commenced performance of the structural steel contract.  The Court therefore ruled that the contractor was ineligible under §7031(a) to invoke the doctrine of substantial compliance.  Thus, the subcontractor received no relief under that doctrine.

The Court also addressed the argument raised by Niederhauser that since the subcontractor was not properly licensed at the time it executed the contract, even if it became licensed before it began to perform, it should still be barred from recovering any compensation.  The Court disagreed with that interpretation and ruled that proper licensing is not required as of the date of execution of the contract, as long as proper licensing is in effect during the time when the actual work was performed.
Conclusions and Recommendations

The strict statutory scheme requiring proper licensing at all times during the performance of the contract has been reaffirmed by California's highest court. This remains an absolute must for contractors performing work for compensation in this state.  The court also strictly construed the doctrine of substantial compliance such that it will not be applicable unless the contractor can prove that at some point prior to execution of a construction contract it did hold proper licensing in this state.  It remains the burden of the contractor to explain any subsequent lapse of proper licensing during the period of the performance of the work.  Finally, the only benefit in the decision for a contractor not otherwise in compliance is that it is not strictly necessary for the contractor to have held the proper license at the time the contract was entered into, as long as the proper license was obtained and in place during the entire time the work was performed.

Word to the wise:  Always ensure that you have proper licensing in place at all times, at the very least during the entirety of the performance of the work.  Out of state contractors in particular should confirm proper licensing before commencing any job in California.  The doctrine of substantial compliance will only afford relief if proper licensing can be proved to exist at some time prior to the execution of the construction contract.

The Facts: The Club Refused to Budge
In 1987, B. Birgit Koebke purchased a membership in the Bernardo Heights Country Club for $18,000. The Club facilities included a golf course, club house, and dining room.

Koebke’s membership gave her special perks. According to the Club’s bylaws, she could play as much golf as she liked without paying additional fees. If she ever married or had children, her spouse and children could play golf with her at anytime without paying additional fees, and they could sign charge slips for food at the Club. Koebke could even transfer her membership to her surviving spouse or one of her surviving children upon her death. But if she died unmarried, her membership could not be transferred.

In contrast to a member’s spouse and children, “guests” at the Club received significantly fewer benefits. The Club’s rules defined “guests” as people other than a member’s spouse or children. Guests could use the Club, but they could not golf more than six times per year, and they could not golf more than once a month. Guests were required to pay a fee and register each time they golfed, and they could not sign charge slips for food.

Koebke and Kendall E. French became a couple in 1993. In 1995, Koebke requested the Club allow French to receive spousal golfing privileges, such as permission to play golf with Koebke at anytime without paying additional fees. But the Club “ ‘decided to continue its present policy that non-married significant others would have no privileges at the Club.’ “ (Koebke opinion at p. 2). In 2000, Koebke and French wrote a joint letter to the Club. They explained that although they could not legally marry, they had registered as domestic partners in the state of California. The Club still refused to budge, stating that its bylaws did not allow non-spouses to have spousal benefits.

The Law: the Domestic Partner Act and the Unruh Act
Koebke and French sued the Club, claiming, among other things, that the Club violated the Unruh Act by discriminating against them on the basis of marital status. The Unruh Act states in part that: “All persons within jurisdiction of this state are free and equal, and no matter what their sex, race, color, religion, ancestry, national origin, disability, or medical condition are entitled to the full and equal accommodations, advantages, facilities, privileges, or services in all business establishments of every kind whatsoever.” (Civ. Code, § 51(b).)
 
The trial court and the Court of Appeal found there could be no Unruh Act violation, but the California Supreme Court disagreed. The court framed the issue as whether the Club “currently violates the Unruh Act by denying plaintiffs, who are registered as domestic partners, the same benefits it extends to married couples.” (Koebke opinion at pp. 5-6).

The court began its analysis by examining the Domestic Partner Act that went into effect on January 1, 2005. The Domestic Partner Act allows same-sex couples who share residences to file a Declaration of Domestic Partnership with the Secretary of State. Registered domestic partners “have the same rights, protections, and benefits,” and are subject to “the same responsibilities, obligations, and duties under law, whether they derive from statutes, administrative regulations, court rules, government policies, common law, or any other provisions or sources of law, as are granted to and imposed upon spouses.” Former, current, and surviving domestic partners all receive these rights and responsibilities. (Family Code, § 297.5). After reviewing the statute, the court concluded that “a chief goal of the Domestic Partner Act is to equalize the status of registered domestic partners and married couples.” (Koebke opinion at p. 7).

With this purpose of the Domestic Partner Act strongly in mind, the court turned its gaze to the Unruh Act. Unlike “race” and “religion,” the Unruh Act does not list marital status as a category that requires protection from discrimination. Still, unlisted categories are entitled to protection if they pass the three-part framework in Harris v. Capital Growth Investors XIV (1991) 52 Cal.3d 1142: (1) whether the category involves personal characteristics, (2) whether a legitimate business interest justifies the discrimination, and (3) whether creating the category would cause adverse consequences.

Tackling the first element, the court found that marital status is undoubtedly personal, declaring that “the decision whether to enter into a domestic partnership is motivated by personal values and beliefs.” For the second element, the Club contended the discrimination was justifiable for insurance purposes. The court rejected this argument, stating that “Registered domestic partners occupy a legal status that, like marital status, is formalized, public and verifiable.” Finally, the court found that allowing Koebke and French’s lawsuit to proceed would not mean that all couples would be treated like married couples under the law. The court made clear that its ruling “affects only registered domestic partners, not all unmarried couples.” (Koebke opinion at pp. 10-14).

After dismissing the Club’s remaining arguments, the court concluded that “the Unruh Act prohibits discrimination against domestic partners registered under the Domestic Partner Act in favor of married couples.” (Koebke opinion at p. 16). The court consequently allowed Koebke and French to proceed with their suit against the Club in the trial court.

Implications: Registered Domestic Partners May Not Be Discriminated Against
The ruling is significant for several reasons. It affirms the intent of the Domestic Partner Act to give registered domestic partners the same legal status as married couples. It declares that registered domestic partners may not be discriminated against in business establishments under the Unruh Act. And it allows Koebke and French to continue their suit so that someday they may golf together at the Club on equal terms.

Since the ruling makes clear that only registered domestic partners receive protection from discrimination under the law, un-registered domestic partners should consider registering. Businesses should also examine whether they are providing equal treatment to registered domestic partners and married couples.

You should also be aware that any person, such as a relative or friend, who believes that your agent is not acting consistently with your wishes as you express them and your AHCD can bring a legal action to address this issue. Such an action could call into question the interpretation of your wishes, the diagnosis of “persistent vegetative state,” and what measures are in your best interest. Only an AHCD that you sign with the advice of an attorney can expressly eliminate the authority of another person (other than a court appointed conservator) to challenge your agent’s interpretation of your wishes.
If you have already signed an AHCD or similar document, this is a good time to review its contents. Are the agents that you selected still appropriate? Do you have special wishes regarding the disposition of your remains that should be included in your directive? Do your health care documents include separate provisions or a release form addressing HIPAA (the new medical information privacy law), so your agent can easily obtain information about your condition? Did you execute a Power of Attorney for Health Care between January 1, 1984 and January 1, 1992? If so, it has expired. Your adult children should also consider documenting their wishes.

There are three significant legal cases: Karen Ann Quinlan was 21 when her legal battles began; Nancy Cruzan was 25 when she had her accident; and Terri Schiavo was 26 when she suffered cardiac arrest resulting in brain damage. All three of these young women’s families were embroiled in legal fights that lasted years because the children had no written instructions. Clearly, health care documents are not just for older people.

Making your wishes known while you have the opportunity to do so can avoid conflicts between family members at a time of great emotional stress. In addition to signing an AHCD, you can also benefit your loved ones by signing the proper documents to appoint an agent to manage your financial affairs in the event of your incapacity, nominate a guardian for your minor children, and dispose of your assets upon death. Please contact us if we can assist you with these important matters.

Factual Background
The Lodge at Torrey Pines Partnership was formed to develop, own, and operate The Lodge at Torrey Pines Hotel (“LTP”) in La Jolla, California. Plaintiff Scott Jones began working at The Lodge in the mid-1990s. He began his career at the Lodge working as a supervisor in The Grill, a restaurant at The Lodge.

In 2000, The Lodge began major reconstruction of LTP with the goal of creating a five diamond hotel. The Grill remained open during the reconstruction even though the hotel was being demolished around it. In October 2000, The Lodge hired Jean Weiss as LTP’s food and beverage director. At that time, Jones was in charge of The Grill. Weiss promised Jones the position of assistant food and beverage director when the new hotel opened.

Shortly after Weiss arrived, he and kitchen manager Jerry Steen developed “a special bond of joke telling” that involved daily jokes and sexual remarks about women employees and Jones. Weiss used foul language and derogatory sex-based words in jokes that Jones found highly offensive and degrading.

Several female employees complained to Jones that they felt uncomfortable around Weiss and Steen. Early in 2001, Jones complained to Weiss that Steen was aggressive and unprofessional in the workplace toward women. In February or March, Weiss threatened to fire Jones if he “aired any dirty laundry”—i.e., spoke to the Human Resources (HR) Department.

Jones then met with Jim Fulks, the HR director. During the meeting, Jones complained about sexual orientation discrimination and harassment at LTP and about the sexual harassment of his female coworkers. He became very emotionally upset and expressed the need to see a therapist for counseling. Fulks told Jones he would have to ask Weiss’s permission to seek counseling and suggested he quit his job because “things like this get worse.”

When Jones returned to work the next day, he received an “Employee Warning Notice” for absenteeism from Weiss and was shortly thereafter placed on a 30-day performance improvement plan. Weiss also stopped talking to Jones and excluded him from weekly LTP management meetings.

Jones was eventually placed on disability leave for several months because of “on-the-job harassment.” While Jones was on leave, his employer proposed that he transfer to another job. When he returned to work, his supervisors continued to pressure him to transfer. He refused, and instead filed a complaint with the California Department of Fair Employment and Housing (“DFEH”).

Jones returned to work at LTP as manager of The Grill, but he continued to be excluded from meetings and several co-workers advised him to “watch his back.” After he filed an amended complaint with the DFEH, he was issued several other warning notices for various minor infractions at work.
On January 22, 2002, Jones submitted a letter of resignation, giving two weeks’ notice.

In May 2003 Jones filed his lawsuit. By the time the case reached a jury, Jones was asserting two claims under FEHA:
(1) sexual orientation discrimination against The Lodge and (2) retaliation against his supervisor and The Lodge. The jury awarded Jones compensatory damages of $155,000 against the supervisor and $1,395,000 against The Lodge.

After trial, however, the court granted the defendants’ motions for judgment notwithstanding the verdict and concluded that Jones had not presented sufficient evidence of having suffered an adverse employment action. The trial judge also found that individuals cannot be liable for retaliation. After appeals from both parties, the Court of Appeal reinstated the original judgment against both defendants, finding that individuals may be liable for retaliation under FEHA per California Government Code section 12940(h).

California Supreme Court Opinion
In a fractious 4-3 decision, the California Supreme Court reversed the Court of Appeals decision regarding individual liability. The majority found no reason to distinguish between acts of discrimination, for which there is no individual liability under FEHA, and acts of retaliation. To reach this conclusion, the Court had to dissect the different terminology used in FEHA’s discrimination and retaliation provisions. While the discrimination provision (Gov’t Code §12940(a)) only references the term “employer,” the retaliation provision (Gov’t Code §12940(h)) uses the term “employer” in addition to the terms “labor organization, employment agency [and] person” (emphasis added). Writing for the majority, Justice Chin found that the word “person” in the anti-retaliation section of FEHA was ambiguous. The Court explored the legislative history behind the amendment that added the word “person” to subsection (h) and concluded that the lack of fanfare for this amendment, which was deemed “technical” and “noncontroversial,” indicated that the Legislature did not intend for the amendment to create individual liability for retaliation claims.

In addition, the Court noted that restricting liability to employers protects supervisors’ independent judgment and limits potential conflicts of interest faced by managers who might be afraid to make necessary personnel decisions because they fear possible personal liability. Further, since corporate personnel decisions are often collective, the Court also acknowledged that it can be problematic in such situations to portion out liability to individuals. Finally, the Court explained that the outcome preserves the opportunity for employees to sue employers, entities with deeper pockets than most individual defendants.

While this decision is considered a legal victory for employers, it should have little or no practical impact on an employer’s policies or practices prohibiting harassment, discrimination and retalition.. Although, because of Jones, individuals can no longer be held personally liable for their retaliatory conduct, they can still be held personally responsible for unlawful harassment.  And, of course, regardless of individual liability, employers will still be on the hook for unlawful retaliation by supervisors, as the Lodge was liable to Jones for nearly $1.4 million in damages. As a result, regardless of the ruling in Jones, it remains critical for employers to adopt and enforce their policies against harassment, discrimination and retaliation and to train managers and supervisors to avoid this unlawful conduct.

In 250 L.L.C., the landlord and tenant entered into a five-year commercial lease which required a security deposit equal to one month’s rent, plus an irrevocable letter of credit equal to eighteen (18) months base rent (the “security deposit”). The tenant stopped paying rent one year into the lease. The landlord gave written notice to the tenant that the premises would be deemed abandoned and the lease would be terminated unless the landlord received written notice from the tenant to the contrary and was paid outstanding rent. The landlord did not receive any notice that the tenant did not intend to abandon the premises nor was any outstanding rent remitted. As a result, the landlord applied the remaining balance on the letter of credit to future rent due under the lease that was to be incurred as a result of the tenant’s vacating the premises before the lease expired. Subsequently, the tenant sued for the return of the security deposit on the grounds that the landlord’s retention of the security deposit to offset landlord’s damages for lost rent post termination was in violation of Section 1950.7 of the California Civil Code, which governs security deposits in commercial leases.

Among other things, California Civil Code Section 1950.7(c) provides that a landlord may apply a portion of the security deposit that is “reasonably necessary to remedy defaults in payment of rent, to repair damages to the premises caused by the tenant, or to clean the premises upon termination of the tenancy, if the payment or deposit is made for any or all of those specific purposes.” One of the issues before the Court in 250 L.L.C. was whether Section 1950.7(c) of the California Civil Code permitted a landlord to retain the security deposit to offset any damages the landlord might otherwise be entitled to receive for future unpaid rent due to a tenant’s breach of the lease.

The Court of Appeals held that California Civil Code Section 1950.7 did not afford the landlord such a right. Instead, the Court interpreted Section 1950.7(c) to limit the application of security deposit funds to unpaid rental obligations arising pre-termination.
Notwithstanding its ruling, the Court noted that the protections of California Civil Code Section 1950.7 can be waived to allow commercial landlords to apply the security deposit against damages for unaccrued future rents. For such a waiver to be effective, the lease must provide that the security deposit may be used to offset landlord’s “damages” arising out of a tenant’s breach of the lease and must contain a clear, explicit waiver by the tenant of any and all of its rights under California Civil Code Section 1950.7. In the absence of such language, the application of any portion of a commercial security deposit to offset the landlord’s damages for future lost rents would be unlawful and may subject the landlord to liability for a tenant’s actual damages resulting from the wrongful withholding of the security deposit. Most importantly, the landlord would be required to return to the tenant the portion of the security deposit that landlord was unable to use.

Commercial landlords and tenants entering into leases post250 L.L.C. should review the security deposit provisions in their leases with their attorneys to ensure that the terms contained in such leases adequately protect their interests and clearly convey their intent with respect to the security deposit.

The most risky and troublesome of these relationships are those that involve supervisors and their subordinates. Recognizing the risks of such romances, many employers have instituted policies either limiting or prohibiting supervisor/subordinate dating. Yet, until now, where the relationships have been truly consensual and welcome, and have not involved any element of coercion, the risks involved with such relationships have been primarily related to disruption of the business rather than legal liability. Businesses have recognized the negative effect on the morale and productivity of other employees created by the perception, or reality, of favoritism towards the supervisor’s “paramour.” The risk has been primarily viewed as non-legal because several courts, including one California appellate court, have refused to recognize legal challenges by other employees who claimed that the favoritism received by the supervisor’s paramour was a form of sexual harassment.

Recently the California Supreme Court weighed-in on the paramour issue in Miller v. Department of Corrections. In this case, involving the fallout resulting from a prison warden dating several subordinates, the Court made clear that California’s sexual harassment law, contained in the Fair Employment and Housing Act, could be used to sue employers over paramour favoritism. This case dramatically increases the risk of permitting supervisor/ subordinate relationships in the workplace — a risk exacerbated by California’s harassment law which provides for strict liability for employers when their supervisors engage in harassment, even if the employer is unaware of the misconduct.

The Facts of Miller v. Department of Corrections
The background facts of the Miller case highlight the potential problems with supervisor/subordinate relationships. The prison warden in the case had sexual relationships with not one, but at least three of his subordinates. The plaintiff in the case, an employee who ultimately reported to the warden, alleged that the warden showed a long pattern of favoritism in job benefits and conditions towards the employees he was dating. Further, the paramours themselves were abusive to their co-employees, presumably because they felt safe from discipline because of their sexual relationship with the boss. The Supreme Court last week reversed an appellate court ruling that had dismissed the plaintiff’s claim.

The Supreme Court’s Holding
In a detailed analysis of the underlying law, including decisions from both the federal and state courts and administrative agencies, the Supreme Court recognized that sexual harassment has been broadly defined to include any activity that was severe or pervasive and interfered with one gender’s ability to work successfully in a workplace. The Supreme Court determined that the prior cases where courts had rejected paramour claims involved only isolated instances of favoritism. The Court concluded that there was no blanket rule barring paramour favoritism claims, but instead they should be judged under the same standards as more traditional harassment claims. Where the favoritism and offensive conduct sends a clear message to co-employees that dating the boss is key to advancement, or the relationship significantly disrupts other employees’ work performance, the other employees may have a viable harassment claim.

The Lesson For Employers
Given the California Supreme Court’s expansive interpretation of harassment law in the area of supervisor/subordinate relationships, it is now extremely risky for any employer covered by the Fair Employment Housing Act to permit supervisor/subordinate relationships in the workplace. Employers that already have addressed this issue have developed carefully worded policies that prohibit such relationships, and require transfer of the supervisor, or if transfer is not feasible or practical, termination of that supervisor, when such romances develop.
Employers should also recognize this development as yet another step in the continuous expansion of regulation and risk in the area of sexual harassment. All California businesses should engage in a regular review of their compliance and risk management in this area. That should include making sure that effective anti-harassment policies and practices are in place, and supervisors and other members of management are effectively trained on preventing harassment in the workplace. For employers who have at least 50 employees, that training of supervisors is now mandatory under California law.

Because of the substantial gross revenue threshold, $2,000,000 (it was set at $500,000 in the initial draft of the legislation), many organizations will not be subject to the mandatory audit requirement. However, for 11% of the estimated 88,000 charities in California, it will apply. Other charitable entities exempted from complying with the Act include religious organizations, educational institutions, cemeteries and hospitals.
 
The fact that an organization is not subject to the audit requirements of the Nonprofit Integrity Act does not mean that it should not voluntarily comply in order to satisfy donor expectations.  The topic of increasing nonprofit oversight has been discussed in the media recently and has raised the public's awareness that financial transparency is a positive feature when deciding which organization receives a donation.

According to the Act, regardless of an organization’s gross revenues or its purpose, the board of directors of all California nonprofits must review and approve the compensation and benefits of an entity's president or CEO and its treasurer or CFO "to assure that it is just and reasonable." Additionally, under the Act, all charitable entities must register with the Registry of Charitable Trusts within thirty days (instead of the six month requirement under prior law) after they first acquire or accrue assets. 

Professional Fundraisers to be Held Accountable
The Act may make the celebrity-studded charitable fundraiser a thing of the past. The push for increased oversight of these types of events is in direct response to recent scandals involving the alleged disappearance of funds that were raised at gala events attended by celebrities. The lion's share of the money collected never reached the designated charities' coffers. It is alleged that a significant part of the donations received were used to pay celebrities' appearance fees, which besides payments of cash, included Rolex watches, exotic cruises, transportation on private jets and, in one instance, a Harley-Davidson motorcycle.
 
Under the Act, professional fundraisers will have to disclose their fees and charges, restrict payments to celebrities and turn over donations to the charities within five days of collection. "We needed to deal with the relationships between charities and commercial fund raisers and better protect charities so that they have more control over their money," said Tom Dresslar, a spokesman for the Attorney General's office.

California: The First of Many States
While California may have been the first state to pass legislation cracking down on nonprofits, 16 other states have similar legislation pending, including New York whose proposed reforms are broader than those contained in California's Nonprofit Integrity Act.

In addition, the Senate Finance Committee has held several hearings on potential abuses by nonprofit organizations, with proposed federal nonprofit legislation possible as early as March, 2005. The focus of the legislation at the federal level will be on tax reporting compliance, especially relating to the preparation of Form 990 for charitable organizations, which are viewed by Dean Zerbe, Senior Tax Counsel for the Senate Finance Committee, as typically "incomplete, inaccurate, and late." The federal legislation will likely also contain a section limiting the size of a nonprofit's board of directors to 15.  This type of provision is clearly in response to the perception that very large boards do not have a sufficient number of directors with responsibility for the affairs of the organization. The notion of board responsibility is also a key theme of the legislation currently pending in New York.
 
Finally, the Internal Revenue Service has sent out at least 2,000 letters to charitable entities across the country alerting them that stricter enforcement by the IRS of provisions of the Internal Revenue Code relating to such entities is in the offing. More audits of nonprofits by the IRS are also expected.

Board members and executive staff members of nonprofits should carefully review the provisions of the Act to see how such provisions may apply in their particular circumstance. Unfortunately, with the effective date being only two months away, charities in California do not have the luxury of time in implementing the more significant changes mandated under the Act. Charities and their legal counsel are encouraged to keep on top of any legislation that may be proposed at the federal level as such changes will most likely be broader in scope and application than the provisions of the Act.

One significant positive development for California employers over the past decade has been the increasing availability of employment practices liability insurance, or “EPLI.”  The need is clear:  employment lawsuits by disgruntled employees can be burdensome and disruptive to large businesses, and devastating to smaller companies.  The ever-expanding number of legal protections applicable to employees in California means that most employers will face employment-related litigation at some point in time.  In the absence of insurance coverage, even claims that are ultimately found meritless can result in tens or even hundreds of thousands of dollars in attorneys’ fees.  The demand for EPLI has created an increasingly competitive market – products that were once affordable only to the largest corporations are now realistic purchases for mid-size, and even smaller businesses.  Options to make insurance more affordable – defense only policies, large deductible insurance – have increased the number of businesses that can afford some coverage.

Like all insurance products, EPLI policies have significant limitations.  When understood fully and used appropriately, the policies can be a very effective risk management tool.  On the other hand, employers that fail to fully understand the scope and limits of their policies may exacerbate their liability exposure by taking risky personnel actions based on erroneous conclusions that any resulting claims will be covered.  There is no substitute for an employer’s careful study of its EPLI policy, with guidance from an experienced broker, and if necessary, insurance coverage counsel.  However, a few issues are worth highlighting because they reflect common areas of concern with respect to EPLI policies.

Understand the Exclusions
The most common and costly errors that businesses make in relation to EPLI policies are misunderstanding the policies’ exclusions.  It is critical that EPLI policy holders recognize that most policies exclude broad categories of employment-related claims.  While exclusions vary from policy to policy, some categories of exclusions appear frequently in EPLI products:
 
(1)  Wage/contract claims:  Many EPLI policies do not cover claims for unpaid wages under the California Labor Code, or lost wages and benefits resulting from a breach of employment contract.  Employers must understand the difference between excluded wage claims and non-excluded damage claims, including lost income, that are tied to covered causes of action.  For example, many policies cover discriminatory termination claims, and will pay for, within policy limits, all compensatory damages for such claims, including "backpay."  On the other hand, claims that an employer simply failed to pay all wages due to an employee typically are not covered. 

(2)  NLRA/ERISA claims:  EPLI policies often exclude claims related to employee benefit plans regulated by ERISA, such as health and pension plans, as well as claims relating to union activity regulated by the National Labor Relations Act.  Policies may exclude other similar specialized statutory areas that relate to employment.
(3)  Punitive damages:  Insurance policies in California cannot provide coverage for punitive damages.  Employers must understand that this exclusion applies even to covered claims such as discrimination for which punitive damages may be recoverable.  Employers must therefore carefully monitor any litigation that involves insurance coverage to ensure that the all steps are being taken to minimize the risks of punitive damages. 

Evaluate Choice of Counsel Provisions
Many employers are surprised to learn when they are faced with covered employment litigation that their policy does not authorize them to use their existing outside employment counsel to defend the lawsuit -- even in cases where some, but not all of the claims are covered by insurance.  Typically, employers only are permitted to use counsel of their choice when they have purchased an EPLI policy that reserves the insured's right to pick its litigation counsel.  For most other policies, the insurance carrier will usually assign the employer's defense to one of its "panel" firms -- usually national firms that regularly handle covered claims for that carrier.  While many of these firms are quite experienced in employment litigation, their regular relationship with the carrier, and unfamiliarity with the individual covered businesses, is a source of concern for some employers.

For employers who would prefer that their regular counsel be used for employment litigation, they should evaluate the cost and benefit of choice of counsel provisions at the time that they purchase or renew their EPLI policies.  For businesses that are comfortable being assigned to panel counsel, it remains important that they closely monitor the litigation to ensure that the assigned counsel is adequately protecting the interests of the business, even when those interests are not completely aligned with the carrier.  Where those interests clearly conflict, the employer may have the right to demand that the carrier appoint and pay for independent counsel.

Master Tender Procedures and Timing Issues
Mistakes in understanding when the carrier must be notified of a claim, and what timing rules govern whether a particular policy governs a potential claim can result in delay or even loss of coverage.  Policies differ on whether claims must be tendered at the demand letter stage, or the employer can wait until an administrative agency action or civil lawsuit has been filed.  Employers should review these tender and timing issues, and institute procedures to ensure that covered claims don't slip through the cracks.

Special Note:  New USSERA Poster Requirement:  Recent federal legislation requires all employers, as of March 15, 2005, to display in the workplace a poster detailing employee rights under the Uniform Services Employment and Reemployment Rights Act. A copy of the required poster can be found at www.dol.gov/vets/programs/userra/poster.pdf.

On July 1, 2004, the effective date of California's Paid Family Leave law, the state will become the first in the nation to provide compensation for employees who take time off to care for ill family members and newborn or adopted children.  While the new law required employers to begin payroll deductions on January 1, 2004, the benefits become available to employees on July 1st. With less than one month before the effective date, employers should make sure that they understand the new law's requirements, and have policies in place to implement its provisions. The key provisions of the new law are as follows:

Paid Family Leave is paid exclusively through employee payroll deductions
Like state disability, Paid Family Leave is funded exclusively through employee deductions. California employers will be indirectly impacted, however, by the net reduction in take home pay in comparison to out of state businesses. 

The new law does not create any entitlement to time off
Paid Family Leave will most frequently impact employers with 50 or more employees, who are covered by the FMLA and California Family Rights Act. Those employers are already required by statute to provide leave for eligible employees to care for sick family members and newborn/ adopted children, the same categories of employees eligible for pay under the new statute.
 
While the Paid Family Leave law applies to nearly all California employers, it does not require that employers too small to be covered by the FMLA make leave available for family leave purposes. However, many smaller employers allow some time off to care for sick family members or to spend time with new children - whether as a matter of policy or practice. Those absences may trigger eligibility for compensation from the state's Paid Family Leave fund.  Thus, smaller employers, like larger FMLA-covered businesses, must be conscious of the law's procedures and requirements.

Vacation exhaustion requirements are limited by the new state law
The most significant HR impact of the new law may be its limitation on vacation exhaustion requirements before the law's compensation provisions are triggered. Employers may require employees to use a maximum of two weeks' accrued paid vacation before taking advantage of Paid Family Leave.

Although both the statute and proposed regulations are ambiguous, it appears that employers cannot require the use of more than two weeks vacation,  or any sick leave, for employees eligible for Paid Family Leave.

This restriction may require many employers to revise their leave policies to the extent those policies require employees to use more than two weeks of their vacation accrual for family leave purposes. The law's seven day waiting period runs concurrently with any employer-required vacation usage.

Employers must provide employees notice of their rights
Employers must notify employees of Paid Family Leave rights by providing Employment Development Department (EDD) Form DE 2511 to all new employees as of January 1, 2004, and to all current employees who need to use the benefit after July 1, 2004. The EDD has also created a revised multi-purpose poster for the workplace that includes descriptions of unemployment, disability and Paid Family Leave rights.   These materials may be downloaded from the EDD's website. (see below)

Coverage includes domestic partners
Paid Family Leave is available to employees who need to take leave to care for a same-sex domestic partner, as well as parents, spouses and children. Larger California employers should also be aware that family leave rights under the California Family Rights Act will be extended to employees who need time off to care for same-sex domestic partners in January, 2005, as a result of the passage of Assembly Bill 205.

Forms, publications and additional information are available on the EDD's website at: www.edd.cahwnet.gov/direp.pflpub.asp

This article highlights the different types of ADR methods available and explains some of the advantages and disadvantages of each method. The article's main goals are to make readers aware of these methods and to assist readers in making an informed decision when utilizing one of the alternatives as a means of resolving a dispute before having the case tried by a judge or a jury.

Mediation
Mediation is the term given for the process in which a neutral person or persons facilitate communication between the parties to assist them in reaching a mutually acceptable agreement. The process is typically voluntary unless the agreement requires the parties to mediate before commencing a lawsuit, or the court orders the parties to mediate.

Generally, the advantages of mediation over litigation include flexibility, cost savings, and speed. The mediation process is completely driven by the parties' choice. From the selection of the mediator, the timing of the mediation, and even to the refusal to mediate, the parties alone dictate those decisions. Mediation allows the parties to devise a creative solution that is a "win-win" solution for both parties. Mediation rarely results in a "winner-take-all" decision. Furthermore, the parties themselves participate in resolving the dispute. In a typical mediation, the parties sit in the same room and hear what the other side has to say. As for cost savings and speed, mediation typically encourages settlement at a much earlier stage than a hearing in front of a judge or jury.

The only possible risk associated with mediation is that matters disclosed during mediation may educate the opposing party should the mediation not result in settlement. In other words, mediation gives the opposing party a sneak preview of the strengths and weaknesses of the case.

Contractual Arbitration
"Contractual Arbitration" generally refers to the process whereby parties submit their disputes for resolution by one or more impartial third persons in lieu of a trial by a judge or jury. By definition, contractual arbitration only arises when the parties to the dispute have agreed by a written agreement to submit the dispute to arbitration. Should one party refuse to arbitrate, both state and federal law provide for enforcement of such procedures.

In comparison to mediation, the main difference between mediation and contractual arbitration is that an arbitrator's decision in a contractual arbitration is binding on the parties. Subject to certain limited grounds for judicial review, since the arbitrator's award is not directly enforceable, the court's role is limited to confirming the award and entering judgment for the prevailing party. The court does not review the merits of the action.

Some of the potential advantages that contractual arbitration provides in comparison to a judge or jury trial include: speedier resolution of the matter; savings in client's time and expenses; greater choice in the selection of an arbitrator (including one with expertise in the subject of the dispute); greater privacy; and, if applicable, less risk for the possibility of punitive damages issued by a judge or jury.

One potential drawback with contractual arbitration includes the perception that arbitrators are more likely than judges to make compromise awards that satisfy neither party. Furthermore, there is generally no right to discovery in arbitration. Lastly, there is no assurance that an arbitrator will apply the rules of law. An arbitrator may make an award that is based on fairness as opposed to rules of law or evidence that would apply in court proceedings. Some of these disadvantages, including the right to discovery, however, can be modified in the arbitration agreement, by the parties' stipulation, or by the procedural rules governing the arbitration.

Court-Sponsored Alternative Dispute Resolution
In addition to mediation and contractual arbitration, which are options that the parties can utilize before or after a lawsuit is filed, the judge presiding over the case often requires the parties to engage in some form of nonbinding, alternative dispute resolution proceeding before setting a trial date for the case. The local court rules of the county in which the case is filed often dictate the judge's decision to order the parties to ADR. The forms of ADR ordered by the court include judicial arbitration and mandatory settlement conferences.

Generally, court-ordered ADR has certain advantages over private ADR. First, since the court orders ADR, a party can utilize court-ordered ADR without having to obtain the consent of the other party. Second, the parties do not have to arrange for or administer the procedure. Third, since it is court ordered, the procedures are usually available at no cost to the parties. Fourth, unless the parties stipulate otherwise, the procedures are nonbinding, which means that a party receiving an adverse ruling does not have to accept the arbitrator's ruling and instead can request a trial de novo. Fifth, the timing of the ADR procedure is usually fixed by the court to occur before the court grants a hearing date.

On the other hand, in relation to private ADR, there are several disadvantages. Since one of the court's interests is to remove cases from the judicial system, the arbitrator may push to achieve settlement. This is particularly true with mandatory settlement conferences held close to the date of trial. Furthermore, when compared to private ADR, there is a limited choice of neutrals and there is no assurance that the parties will have someone with the background and qualifications that may be desirable for the case. Lastly, the procedure ordered by the court may not be appropriate for the case. For example, a court may order judicial arbitration at an early stage in the case when mediation may be more appropriate.

What Does All This Mean To You?
Although this article only provides a synopsis of the more prevalent methods of ADR available to litigants, the brevity of this article does not imply that ADR is insignificant. This article is meant to provide a snapshot of the options litigants have short of a judge or jury trial. There is certainly more to these topics (including variations of the methods analyzed above) than meets the eye. As explained, regardless of the alternative dispute resolution method, having a case resolved by an alternative dispute resolution process can be an effective procedure in avoiding a judge or jury trial.

What Is A Preferential Transfer?
The concept of a preferential transfer is common in bankruptcy and insolvency situations, and is solely a creature of statute. Under the provisions of Section 547 of the Bankruptcy Code, a preferential transfer is defined as a transfer meeting all of the following criteria:

• A transfer.
• Of property of the debtor.
• To or for the benefit of a creditor.
• For or on account of an antecedent debt owed by the debtor to the creditor.
• Made while the debtor was insolvent.
• Made within ninety (90) days before the bankruptcy filing.
• That enables such creditor to receive more than it would under a case under Chapter 7 (liquidation).

If you are the recipient of a preferential transfer, namely if you receive payment from a customer on an old debt within 90 days from the filing of a bankruptcy by the customer, then the Bankruptcy Code requires that you disgorge it to the bankruptcy estate. This can work a severe financial hardship, especially if the debtor already owed your company a substantial amount of money when the bankruptcy was filed. How can you avoid or lessen the effect of the preferential transfer statute?

One of the keys to avoid having to return such a payment lies in the definition of a "preference." Can you argue that the transfer is not a preference at all? The other main defenses to a preference claim are set forth in the Bankruptcy Code itself.

In order for a payment or transfer to be subject to recall, it must meet all of the specific criteria set forth in the Bankruptcy Code. It must be a transfer of property of the debtor. This most frequently is a payment of money, but can also represent the transfer of inventory or other property of the debtor to a creditor.

The transfer must be in payment of an "antecedent" debt. In other words, the payment by the debtor must have been in satisfaction of an old or preexisting debt owed by the debtor to the creditor, as opposed to a current obligation.

The transfer must be made within ninety (90) days of the date on which the debtor files its bankruptcy petition. This time period is strictly construed, so transfers which fall just outside the period, for example on the 91st day before filing, do not meet the strict statutory criteria. Such payments cannot be preferences. This raises questions about when exactly a transfer occurs, which could avail you of a successful temporal defense to the claim.

The Bankruptcy Code contains a presumption that all transfers made within ninety (90) days before the filing of the petition are made at a time when the debtor was insolvent. Thus, unless there is a significant issue about the solvency of the debtor during the preference period, this presumption usually will prevail.

Finally, the transfer must also enable that creditor to receive more from the debtor than it would under a Chapter 7 liquidation.

If all the requirements are met, and if a preferential transfer is called back, then it does give rise to a claim by the creditor against the debtor estate in the amount of the disgorgement. However, this is generally little solace for the creditor, since bankruptcy cases usually take years to pay a dividend to creditors, and the amount is often only pennies on the dollar. Thus, it is most important to avoid as much of a preferential transfer as is possible.

How Do You Defend Against The Effect Of The Preference Statute?
There are several statutory defenses available to a creditor who receives a payment, in addition to arguing that the transfer was not, in fact, a preference. Probably most well known is the "ordinary course of business" defense. This defense is provided in the Bankruptcy Code and covers payments made by a debtor which are in the normal and ordinary course of that debtor's dealings with the creditor. For example, a payment on account of an invoice which bears terms of net (30) would give rise to the defense if the transfer by the debtor was in fact made within the thirty (30) day period. This would constitute a payment on a current obligation. However, as is often the case, payments by soon-to-be debtors are often late, quite beyond the terms of the invoice or the creditor's normal practices, and such payments which may be made forty-five (45), sixty (60) or ninety (90) days after the date of the original invoice are almost invariably found not to be "within the ordinary course of business." If a defense does not apply, the creditor in most cases must return some or all of the transfer.

Another defense which is recognized in the Bankruptcy Code is referred to as "contemporaneous exchange for new value." In this defense, the creditor must show that, at the time it received payment from the debtor, it transferred to the debtor a new value, usually consisting of product or services, in contemporaneous exchange for the payment. Each of the elements of this defense must be established, and the burden of proof as to each element rests upon the creditor. In order to prevail on this defense, the creditor must prove that it and the debtor intended to exchange payment for the new value, and that the transfer or payment was in fact a substantially contemporaneous exchange. The most clear example of this would be a COD transaction where product and services are not supplied unless payment is immediately tendered. However, many transactions are not this clean, and it becomes a matter of argument as to whether a payment which is made by the debtor close in time to the provision of the product or services satisfies the "contemporaneous" requirement of the defense. Court decisions have generally not afforded much latitude to transactions which are not virtually simultaneous for purposes of this defense; however, creative arguments can be made on your behalf which might allow you to negotiate a compromise of the amount of money returned to the bankruptcy estate.

The Bankruptcy Code also offers other defenses, but those generally do not cover normal transactions between creditors and debtors, but may apply if the transaction includes unique facts such as lien releases and other factors.

Recommended Strategies
A creditor receiving a preferential transfer notice must act quickly. The Bankruptcy Code contains many headlines, most of them short and which are strictly construed by the courts. A prompt response to such a notice is a must.

Due to the technical nature of the preference statute, a prompt response from your legal counsel is advised. This response will analyze whether the transfer is "preferential" at all, under the strict definition in the law. If it appears on its face that the transfer may be preferential, the next level of analysis is whether any defenses apply to shelter some or all of the payment. This analysis requires a thorough understanding of the facts of the case, the timing of the payment and of the transfer, and of all the available defenses. Often, a successful result can be achieved through such a legal and factual negotiation.

It is expected that, as proposed, the Sarbanes-Oxley oversight provisions of SB 1262 would apply to approximately 11 percent of the state's 88,000 registered nonprofit entities. Florence Green, executive director of the California Association of Nonprofits ("CAN"), believes that the cost of complying with the Nonprofit Integrity Act could cost nonprofits organizations as much as $7,000 per year. While agreeing with the intent of the legislation, CAN has already voiced certain objections to the bill in a press release issued on March 11th. In particular, CAN would like to see the audit trigger raised from $500,000 to $1,000,000 in order to protect grassroots organizations from incurring the expenses necessary to satisfy the requirements under SB 1262.

The proposed regulations are more stringent for professional fundraisers. The push for increased oversight of these types of organizations is in direct response to recent scandals involving the alleged disappearance of funds that were raised at gala events attended by celebrities that never reached the designated charities' coffers. Under SB 1262, professional fundraising organizations will have to disclose their fees and charges, restrict payments to celebrities and turn over donations to the charities within five days of collection."We needed to deal with the relationships between charities and commercial fundraisers and better protect charities so that they have more control over their money," said Tom Dresslar, a spokesman for the Attorney General's office.

California Legislation Follows Lead Set by New York AG's Office
As in California, Attorneys General in several states, including New York, have recently proposed state laws containing provisions similar to those codified in the Sarbanes-Oxley Act that would apply to nonprofits and their auditors. Many states are watching to see what happens with the New York legislation, which is pending in that state's Senate as Bill S-4836. This bill has been revised substantially since it was first introduced based on input from various nonprofit associations.

The revised New York proposal now provides that certification of financial data is required of organizations with revenues in excess of $1,000,000 or assets in excess of $3,000,000 rather than applying to organizations with revenues above $250,000 as originally conceived. Similar to California's SB 1262, the revised proposal retains the provision requiring a nonprofit to set up an audit committee of directors not doing business with the nonprofit. Another substantial revision in the legislation is that an executive committee need only be formed in the event that the board of directors of a nonprofit has more than 25 members. This provision in the New York legislation is clearly in response to the perception that very large boards do not have a sufficient number of directors who feel responsible for the affairs of the organization. In circumstances where organizations have smaller boards, the creation of an executive committee is strongly encouraged but not required. The message of board responsibility is a key theme in many aspects of the New York legislation. Finally, with regard to interested party transactions, the legislation, as revised, allows the Attorney General to challenge in court interested party transactions it considers objectionable, even if such transactions have been approved by the board after full disclosure.

While California may soon pass legislation that will apply Sarbanes-Oxley-type accountability to nonprofit boards of directors and their auditors, based on the extensive revisions to New York's proposal as a result of comments from nonprofit associations, it is likely that the final version of SB 1262 will be adapted to suit both the size and resources of smaller nonprofit organizations. CAN Director of Public Policy Ken Larsen commented, "It's too early to say what the final version of the bill will look like, but the Attorney General has already incorporated some of our [CAN] suggestions, and we remain hopeful that the Attorney General will incorporate our remaining recommendations."

While we wait to see what the final version of SB 1262 will look like and whether or not it will pass, nonprofit organizations can voluntarily put in place procedures and policies that will surely be required in some form in the future. By instituting measures that demonstrate good corporate governance, nonprofits of all sizes and with various revenue streams can show that they are striving for better accountability, which should be a popular selling point with existing and potential donors. Taken partly from SB 1262 and the legislation proposed in New York, following is a list of recommended actions that nonprofits can implement to exhibit their willingness to address the public's concerns:

• Create an audit committee comprised of independent members which includes at least one financial expert. If the nonprofit organization is small, it can create a finance committee that will function as an audit committee with an accountant or other financial expert available to assist with the review and interpretation of financial reports.
• Require that the executive director or CFO publicly attest to the accuracy, completeness and fairness of the organization's financial statements. Make the organization's written policies regarding internal accounting controls available to the public.
• Adopt a code of ethics for the organization's management and board members. Ensure that this information is available to the public upon request.
• Recruit board members who are financially savvy. Train board members who are not familiar with financial statements on methods for interpreting them.

The fact that SB 1262 has been proposed and is sponsored by the Attorney General's office should serve as a wake-up call to California nonprofit organizations and professional fundraising companies. As noted above, some larger nonprofit organizations have already undertaken to satisfy the spirit of Sarbanes-Oxley-type requirements by overhauling their internal governance controls and implementing sound financial management measures. The need for most nonprofit organizations to do this is and will continue to be necessary to shore up donor confidence in charitable giving.