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Table of Contents

Beyond Civility Page 1. Attorney Professionalism Beyond Civility 1

Electronic Signatures Page 2. Electronic Signatures 12

10 Recent Decisions Every Attorney Should Know Page 3. Halliburton Co. v. Erica P. John Fund_ Inc._ 134 S. Ct. 2398 51 4. Food Lion, LLC v. Dean Foods Co. (In re Southeastern Milk Antitrust Liti... 76 5. Glazer v. Whirlpool Corp. (In re Whirlpool Corp. Front-Loading Washer Pr... 94 6. Whirlpool Corp. v. Glazer, 134 S. Ct. 1277 111 7. Good v. Am. Water Works Co., 2014 U.S. Dist. LEXIS 154788 112 8. Painter v. Atwood, 2014 U.S. Dist. LEXIS 153342 116

Commercial Real Estate Panel - Legal UPdates and Financing Trends Page 9. 26 CFR 145D-1 122 10. IRC Sec. 45D 144 11. OAC Ann. 12222-1-05 152 12. ORC Ann. 5725.33 165 13. ORC Ann. 5726.54 169 14. ORC Ann. 5729.16 171 15. ORC 5733.058 173

Ethics Panel - Supervision and Legal Outsourcing Page 16. Supervision & Legal Outsourcing 176

Providing Effective Leadership in our Supervisory Roles Page 17. Coaching Supervision - KMK - Dec. 2014 281 18. Average Leadership Is Ruining Business 300 19. Bad Good Great Managers 305 20. Building a High Trust Culture- Respect 308

Beyond Civility Page 1 of 309

Beyond Civility Communication for Effective Governance

Political gridlock in Washington accomplished at least one useful thing. Local political leaders and public officials knew they could do better and decided to address the problem from the ground up by building relationships and improving communication—starting with their own!

On the tenth anniversary of 9/11 a bi-partisan group of judges, elected officials, Democratic and Republican Party leaders, business people, academics and media representatives began a non-profit organization called Beyond Civility: Communication for Effective Governance (BC). Our goal was to reduce the polarizing demonization of ideological adversaries and the dysfunction it causes; to increase the ability of advocates on different sides of important issues to communicate to solve problems rather than endlessly arguing about them.

The approaches we developed vary. Communication Workshops bring politically diverse groups of 12 to 20 people to three half-day sessions to identify specific barriers to problem solving dialogue and to learn and practice techniques for overcoming them.

Side-by-Sides place two well known elected officials, a Democrat and a Republican, on stage to answer questions about the people and events from their early years that helped form their world views and thus their political positions today.

Back-to-Backs have engaged high profile advocates known to hold opposite views on such critical and controversial issues as the death penalty, income disparity, taxes, voter ID laws, and the like in a kind of reverse public debate.

All these programs are designed to build personal relationships and respect for different points of view and the people who hold them. They bring citizens together to witness partisan leaders demonstrate understanding and respect for people and ideas we frequently demonize and often don’t understand.

Beyond Civility events offer unique opportunities for citizens to see the people behind the political personas and sound bites, to engage with leaders as normal, interesting human beings.

Beyond Civility Page 2 of 309

Why Go “Beyond Civility”?

Many of us observe the national political scene with dismay and yearn for greater civility. We’d like to keep those wolves, polarization and demonization, away from our door here in River City. But what do we mean by civility? When someone addresses us, ever so politely, by saying “with all due respect,” we hear the undertone and think that what they are really saying is “you don’t have a clue.” Which is precisely why our group selected the name “Beyond Civility,” with the emphasis on the word “Beyond”.

Our mission is to find ways to diminish divisive communication in governance, and in the public arena, so that well reasoned problem-solving can take place, so that even when positions or beliefs are polarized, a useful conversation continues, rather than being shut down with combative language. Then reasonable, evidence-based, compromises can be explored.

In the last couple of years, we’ve learned a lot in our Beyond Civility “movement”. First, that when you come to understand how your negotiating partner’s belief system was formed, what have come to be their “moral intuitions,” and know something of their life story, the influences of their formative years, of family, teachers, friends, and other leaders, it becomes much easier to talk meaningfully and problem solve together. This is true for our public servants, the engaged citizenry and even in our very personal relationships.

And, we have learned that communication is a choice. The mindful selection of the words we speak matters. They drive another away and evoke an angry response, or encourage meaningful listening and a search for understanding and solutions. We do not fool ourselves into believing we can influence campaign rhetoric. But once the dust settles and our public servants take a seat at the governance table, how they choose to communicate with each other, in private and in public, and the words we choose as we communicate with our public servants, as well as with others who agree or disagree with our thinking, makes a difference.

Beyond Civility Page 3 of 309

Side-by-Side

It is easy to objectify and demonize people we don’t know personally. We know that with many friends and family members relationships foster empathy and compassion that can trump animosities that arise from differences in values and opinions. Unfortunately, it seems Americans have few personal relationships with people other than family who don’t share their politics or ideology.

Side-by-Side events break down stereotypes and invite audiences to come to know local political figures as unique individuals. Typically, two politicians — a Democrat and a Republican – take turns answering questions designed to elicit stories about and reflections on their formative early life experiences. Audiences report overwhelming increases in respect for the politicians holding views least like their own and in confidence that they could have a constructive conversation with them. Similarly, Side-by-Side presenters themselves seem to find bonds of recognition and respect that can support trust and collaboration in the future.

Beyond Civility Page 4 of 309

Back-to-Back Arguments are rarely productive when we feel we aren’t being heard or understood. We tend to keep repeating ourselves, usually at higher volumes! If you want to stop someone from shouting and improve the chances of their listening to you, first demonstrate that you understand their point. In Back-to-Backs, high profile advocates of opposing positions on important legal or public policy issues agree to articulate as convincingly as possible the other side’s views. They must keep at it until the person on the other side says “I couldn’t have said it better myself.” Back-to-Backs are challenging, as you can imagine, but they’re fun, engaging and informative. They also demonstrate a skill notably lacking in today’s polarized political climate: the ability to understand and show respect for someone else’s position even while believing and advocating to the contrary. Trying on the shoes of others, especially those with whom we most strongly disagree, can open minds and soften hearts. Doing this requires self-confidence, courage and determination. We are grateful to all of our participants for stepping forward to demonstrate this depolarizing exercise, and hope others – politicians and citizens alike – will follow their example and try it themselves.

Beyond Civility Page 5 of 309

Communication Workshops One of Beyond Civility’s first initiatives to improve governance was to invite a bi- partisan group of approximately 20 local elected and civic leaders to explore together the neurological and social barriers to constructive dialogue between people who view each other as adversaries. The morning was structured much like a class, led by a communication professor, in which various communication techniques were explained and demonstrated. Several versions of workshops followed until the current, revised format was developed in 2013. Today, select bi-partisan groups of fifteen to twenty business, media and government leaders, with direct or indirect involvement in local politics, spend three half days together developing and practicing strategies for conducting difficult conversations successfully. Communication experts still facilitate the sessions and present the latest in brain research and communication theories, but participants are incorporated as experts themselves and participate in teaching as well as learning. Perhaps the core value of the meetings comes from sharing specific communication challenges and brainstorming solutions by the participants themselves and, of course, from the relationships formed in the process. Plans are underway to extend workshop opportunities to civic and governmental boards that sometimes face fractious internal deliberations and contentiously expressed public opinion.

Beyond Civility Page 6 of 309

Events

Back-to-Backs • September 16th, 2014 Income Disparity Back-to-Back: David Mann & George Vincent • February 11th, 2014 Death Penalty Back-to-Back: Joe Deters & David Singleton • November 21st, 2013 Voter Suppression v. Voter Fraud Back to Back: Tim Burke & Alex Triantifilou • May 2nd, 2013 State Legislation Back-to-Back: Lou Blessing & Denise Driehaus

Side-by-Sides

• November 11th, 2014 Side-by-Side: John Cranley & Steve Chabot • March 12th, 2014 Side-by-Side: Chris Monzel & Wendell Young • October 22nd, 2013 Side-by-Side: Greg Hartmann & Todd Portune • May 20th, 2013 Side-by-Side: Yvette Simpson & Amy Murray • March 12th, 2013 Side-by-Side: Former Cincinnati Mayors Ken Blackwell & Jerry Springer • January 10th, 2013 Side-by-Side: Councilman P.G. Sittenfeld & Local Tea Party Founder Mike Wilson • November 12th, 2012 Side-by-Side: Vice-Mayor Roxanne Qualls & State Senator Bill Seitz

Other Events

• Communication Workshop Fall 2014 • Community Dialogue: July 12th, 2014 • Communication Workshop Spring 2014 • January 21st, 2014 A Forum on Civility • Communication Workshop 2013 • Communication Workshop 2012

Beyond Civility Page 7 of 309

Beyond Civility Steering Committee Conveners Beth Myers, Esq. Judge, Hamilton County Court of Common Pleas, past President of the Cincinnati Bar Association Timothy Black, Esq. United States District Judge, Southern District of Ohio, Western Division at Cincinnati Founders Bea Larsen, Esq. Senior Mediator, Center for the Resolution of Disputes Robert Rack, Esq. Retired Chief Circuit Mediator, United States Court of Appeals for the Sixth Circuit Members Gene Beaupre, Assistant Director, Philosophy, Politics and the Public Honors, Xavier University Lou Blessing, Esq. Former Speaker Pro tem, Ohio House Tim Burke, Esq. Chair, Hamilton County Democratic Party and President of the Democratic County Chairs of Ohio Denise Driehaus, Ohio State Representative Bill Fee, Retired Vice President & General Manager of WCPO-TV Pat Fischer, Esq. Judge, Ohio First District Court of Appeals; past President of the Ohio State Bar Association Kevin Flynn, Esq. Member, Cincinnati City Council Colin Groth, President, Charter Committee of Greater Cincinnati, Director of Strategic Assistance, Strive Together David Holthaus, Former Editorial Page Editor, The Cincinnati Enquirer Dan Hurley, Producer and host of Local 12 Newsmakers and reporter for the station for over 30 years. David Mann, Esq. Vice-Mayor, Cincinnati City Council; Former US Congressman, First District of Ohio Amy Murray, Member, Cincinnati City Council Jerry Newfarmer, Former Cincinnati City Manager, President and CEO of Management Partners Dan Peters, President, the Lovett & Ruth Peters Foundation Ken Parker, Assistant US Attorney, Office of the US Attorney, Southern District of Ohio Yvette Simpson, Esq. Member, Cincinnati City Council David Singleton, Esq. Executive Director, Ohio Justice and Policy Center; Assistant Professor, Chase Law School Dale Stalf, Esq. Chair, Litigation Practice Group at Wood & Lamping LLP; Member of the Board of Trustees of the Cincinnati Bar Foundation. Alex Triantafilou, Esq. Chairman, Hamilton County Republican Party George H. Vincent, Esq. Managing Partner, Dinsmore & Shohl LLP

CBA Representative Maria Palermo, Esq. Assistant Counsel, Cincinnati Bar Association Beyond Civility Page 8 of 309

Cincinnati Enquirer 06/17/2013 Copy Reduced to %d%% from original to fit letter page Page : A10

CINCINNATI.COM FACEBOOK.COM/OPINIONATI @CINCIENQUIRER

MARGARET E. BUCHANAN President and publisher CAROLYN K. WASHBURN Editor and vice president DAVID HOLTHAUS opinion Editorial page editor PAGE A10 » MONDAY, JUNE 17, 2013 CIVIL WAYS TO SOLVE REAL PROBLEMS an partisan politicians govern collaboratively? We still hope so. ROBERT In an Enquirer op-ed RACK JR. last September, a local Cgroup of civic leaders calling itself Beyond Civility: Communication for Effective Governance announced its Robert Rack Jr. is retired chief circuit intention to address the disabling mediator, U.S. Court of Appeals for the problem of political polarization. We 6th Circuit in Cincinnati. noted that in a healthy democracy, as in any healthy relationship, it is criti- the change in their attitude. It seems cal that people with different views the stories transformed the present- be able to hear and be heard by each ers from political symbols to people other. We reported on communication with families and influences and trou- workshops for elected and civic lead- bles not so unlike our own, opening ers, and promised a series of Side-by- the space for empathy and enabling a Side presentations in which pairs of more genuine human connection. high-profile leaders would tell stories In a unique event we called a Back- of their early political and social for- to-Back, Republican State Rep. Lou mation. Now, a year later, we’d like to Blessing and Democratic State Rep. share what we’ve learned from this Denise Driehaus bravely took the experience. stage at the College of Mount St. Jo- First, we learned from recent stud- seph to argue as persuasively as pos- ies in psychology and neuroscience sible the opposing party’s position on that people form what moral psychol- several controversial statewide is- ogist Jonathan Haidt calls our moral sues. And they had to keep explaining intuitions early in life. Those beliefs until the other said, “I couldn’t have steer our thinking and listening into said it better myself.” and through adulthood. They dictate It’s hard to measure the true im- whom we trust and believe and what pact of something like this, but the we accept as true or false. As anyone audience reported in overwhelming who has tried to change another per- percentages that the reverse debate son’s mind on a political or religious format contributed to their ability to topic knows, these beliefs are usually “hear and appreciate the different unshakable. To argue facts against perspectives presented.” More than them is not just futile, but often 80 percent said they felt “much better counter-productive. informed about the issues,” and al- The next discovery was the power most half said their opinions were of stories to build connections be- affected by the presentations. While tween people. After our Side-by-Side changing minds was not the goal, presenters described their families opening minds was, and that appears and the people and events that shaped to have occurred. them from childhood, audiences re- The Beyond Civility group now is ported in overwhelming percentages redesigning the communication work- that their negative assumptions and shops and planning another series of attitudes about the presenting indi- Side-by-Sides to start in the fall. If viduals were softened or even there are more public figures willing changed. While they might still dis- to engage in Back-to-Back issue disagree with the presenter whose party cussions, we’d love to do that again, affiliation was different from their also. Other initiatives are on the own, they said they believed they drawing board and will be announced. could more easily have a productive Meanwhile, we hope leaders and citi- conversation with that person and zens alike will experiment with ways that they would be more likely to to increase real, problem-solving Republican State Sen. Bill Seitz and Democratic Cincinnati Vice Mayor Roxanne Qualls listen to what he or she had to say in conversation. A healthy democratic were the first to come together at Beyond Civility’s “Side-by-Side” events in the future. Many were surprised by society depends on it. ■ November. PROVIDED

READCopyright AND © 2013, SHARE The Enquirer. OPINIONS All rights reserved. Use of this site signifies your agreement toJune the 17,Terms 2013 of 11:39 Service am and/ Powered Privacy by Policy TECNAVIA , updated March 2007. 06/17/2013

READ MANY MORE LETTERS: You may share your opinion in print and online. To comment ‘READER ESSAYS’ AND EXPERT online: Cincinnati.com/blogs/letters. Email letters to [email protected], or send to Enquirer COLUMNS: Send your column of 300 words or fewer, with Opinions Page, 312 Elm St., Cincinnati, OH 45202; email is preferred. Include name, address, aphotoandasentenceaboutyourself(community,occu- community and day phone. Letters may be edited for space and clarity, and may be published pation, etc.), to [email protected], “Reader Essay” in or distributed in print, electronic or other forms. the subject line. Beyond Civility Page 9 of 309

Beyond Civility Page 10 of 309

feature article An Insider’s Take

By Michael A. Hirschfeld

was somewhat taken aback when I the downtown branch of the Cincinnati and nonproft organizations. It was an received a letter this summer from Public Library. We were greeted by the incredibly diverse group in terms of U. S. District Court Judges Sandra project planners, mediator and former backgrounds, political afliations and IBeckwith and Timothy Black asking if CBA President Bea Larsen and former leanings. As we introduced ourselves, II would be interested in participating Federal Court Mediator Robert Rack, I was secretly thinking of the fun (and in “Beyond Civility: Communication who were the originators and key drivers challenges) this might present. Trough for Efective Governance.” Although of the concept. Our class, the third so the course of the three workshops spread I believed I had exhibited appropriate held, was composed of lawyers, judges, across over just one month, we had the professionalism and civility as a practic- elected ofcials, government relations opportunity to learn more about each ing attorney for more than 37 years, my executives and consultants, as well as participant as a person — their back- initial reaction was that it must be some members of the media and for-proft ground, and the environment and people form of an intervention. Teir letter went on to explain that it was really a series of three separate workshops with a diverse participant group. Te focus was on Back-to-Back CLE Series: Understanding Your Ideological Opposite improving civil discourse in our commu- A collaboration of Beyond Civility and the Cincinnati Bar Associaton nity and beyond to address the problems of increasing political polarization and gridlock. Never one to refuse the request of a federal judge (much less two I respect highly), I responded afrmatively and marked my calendar for the meeting !"#$%&'"(#)$*&+,,-", dates, not really sure what adventures may lay ahead. Hear Hamilton County Prosecutor Joe Deters In late September I received a warm and Ohio Justice & Policy Center Director welcoming letter and, packet from the David Singleton argue the other side’s judges and Sean Comer, the Beyond position on controversial death penalty issues. Civility project manager, providing a list of the 16 other participants along with Tuesday, February 11, 2014 a confdential “framing style inventory” 5:30 to 6:30 p.m. Registration & Light Refreshments to be completed and returned prior to 6:30 to 8 p.m. Program the frst session, to determine the beliefs I hold about interpersonal relationships 1.5 Hours CLE Credit and communications. Afer completing and analyzing the inventory, it became Location clear to me that perhaps I wasn’t as un- St. John’s Unitarian Universalist Church derstanding of my own style as I thought, 320 Resor Ave. and that there could be some interesting Cincinnati, OH 45220 lessons for me to learn. Our initial workshop was held on a Pre-registration required at (513) 699-4028 or beautiful Friday morning in October at at cincybar.org. www.CincyBar.org February 2014 CBA REPORT l 9! ! Beyond Civility Page 11 of 309

feature article

who played important roles in shap- ect include the “Side-by-Side” series A recent poll conducted by AP-GfK ing their views and outlook. Learning in which local political fgures from found that Americans are suspicious of more about each individual provided diferent parties share memories of early each other in everyday encounters, and fascinating insights, dispelling initial experiences that infuenced their current less than one-third of Americans believe impressions and stereotypes, and signif- thinking and positions, and the “Back- most people can be trusted, a continu- cantly changing my perspective. Led by to-Back” discussions of current issues in ing decline from prior polls. Te Beyond our facilitators, Sherri Goren Slovin, a which partisan advocates are challenged Civility project attempts, one participant Cincinnati lawyer, mediator and confict to present convincingly the opposite at a time, to rebuild the “social trust” resolution trainer, as well as professors side’s point of view until the other side necessary to facilitate communications, Gail Fairhurst and Heather Zoller of the concedes “I couldn’t have said it bet- open dialogue and compromise, in which University of Cincinnati, we also learned ter myself.” Both series are open to the people are willing to work for the com- various tools and techniques to encour- public and well worth attending. mon good with those who are diferent age more active listening, to recognize I’ve attempted to adopt the tools and from them. Te project’s goal is that this those social triggers that generate certain strategies learned during the workshops level of honest and open discourse can responses in both the speaker and listen- in my professional and personal life, and fow throughout our community and be- er, to develop a repertoire for reframing have found them to be useful in avoiding yond, particularly as our society appears the conversation, to enter into dialog that stereotyping, hasty judgments, unfound- increasingly fragmented and divided. both maintains one’s own values but al- ed assumptions and my own biases. As a Te Beyond Civility project provides lows others the space to hold their values result, I hope I’ve become a better listener solutions to bridge those gaps and allow and positions, to enter into appropriate and problem solver, able to “drill down” us to engage constructively in controver- discussion and civil engagement, and to on what others are really saying (and sial topics. We lawyers owe it to those we problem solve when difering values are feeling), as well as better able to under- serve to strive to achieve those goals. present. stand how my own circumstances may Te fnal workshop was held at the color my interpretation of others’ expres- Hirschfeld is a partner at Graydon Head & Ritchey Cincinnati Bar Association ofces and sions and emotions. LLP. concluded with a wine and cheese recep- tion including the convening judges, planners, steering committee members, present and past participants of the Be- yond Civility workshops, and benefactors of the project including representatives from the Cincinnati Bar Foundation and the Seasongood Good Government Foundation. Te goals of the Beyond Civility project — to elevate public discourse and problem solving by connecting those who may be in a position to best model and infuence appropriate communication and problem solving skills and behaviors in a productive manner — became clearer as the workshops progressed. It was fascinating to hear personal stories of the difcult communication situations participants personally had experienced, and their eforts to handle them, both successfully and unsuccessfully, were tremendous learning opportunities. Particularly powerful were the discussions among Keith A. Hock, CPA, CFF, MAFF, CVA 312 Walnut Street political leaders who acknowledged their Director, Financial Advisory Services Suite 1600 public and private discussions are ofen Cincinnati, OH 45202 approached very diferently, given the media’s need for a quick “sound bite,” as [email protected] www.gbqconsulting.com opposed to nuanced explanations. 513.252.0223 In addition to the workshops, other initiatives of the Beyond Civility proj-

10 l February 2014 CBA REPORT www.CincyBar.org Electronic Signatures Page 12 of 309

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Citation: 37 Idaho L. Rev. 237 2000-2001

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INTRODUCTION TO THE UNIFORM ELECTRONIC TRANSACTIONS ACT: PRINCIPLES, POLICIES AND PROVISIONS

PATRICIA BRUMFIELD FRY*

TABLE OF CONTENTS

I. IN TROD UCTION ...... 237 II. WHAT IS ELECTRONIC COMMERCE ...... 238 III. LEGAL BARRIERS TO ELECTRONIC COMMERCE ...... 241 A. Evidence and Memorial ...... 243 B. Notice and Communication ...... 244 C. Ritual and Precaution ...... 244 D . Token or Property ...... 246 IV. INTRODUCTION TO THE UNIFORM ELECTRONIC TRANSACTIONS ACT ...... 247 V. THE PROVISIONS OF THE UNIFORM ELECTRONIC TRANSACTIONS ACT ...... 250 A Scope ...... 25 1 B. Electronic Records and Signatures ...... 255 C. Security Procedures and Attribution ...... 257 D. Electronic Agents and Automated Transactions ...... 261 E. Record-keeping and Evidence ...... 264 F. Time and Place of Sending and Receipt ...... 266 G. Consum er Protection ...... 268 H . Transferable Records ...... 269 I. Governm ent Records ...... 272 VI. CONCLUDING THOUGHTS ...... 272

I. INTRODUCTION

Our lives have changed. Like it or not, the Internet, and the computers which make it possible and essential, have begun to cause fundamental change in human society. Information has become

* Professor of Law, University of Missouri-Columbia. The author is a member of the University's Center for the Digital Globe. She is a member of the National Confer- ence of Commissioners on Uniform State Laws representing the State of Missouri, and a member of its Executive Committee. During the process of drafting the Uniform Elec- tronic Transactions Act, she was a member of the Conference for the State of North Da- kota. The opinions in this article are those of the author alone. Electronic Signatures Page 14 of 309

238 IDAHO LAW REVIEW [Vol. 37

broadly and cheaply accessible and communication is possible on a worldwide basis. Individuals comparison shop at the click of a mouse, exchange views and diatribes with anyone who cares to listen from anywhere, and opine about what's right and what's wrong with their world. Teenagers "chat" with their friends in real time conversations, all from the comfort of their rooms. Increasing numbers spend their daily working lives manipulating, collecting, storing, and otherwise dealing with information. Existing industries struggle to remain competitive against new challengers, while new industries emerge. Some of these changes may appear superficial; all pose challenges for existing social structures, including law.' The full scope and range of these changes may not become apparent for generations, but the legal system is beginning to come to grips with some of the initial challenges. These beginnings challenge participants to re-examine concepts and philosophies. They challenge our understanding of legal principles and concepts and ask us to think about the purposes of law itself. The experience of the drafters who created the Uniform Elec- tronic Transactions Act,' the focus of this Symposium, illustrate some early steps in the evolution of legal thought about electronics and their impact on the law. This Symposium may open some threads for further discussion. This paper describes some of the factors which were considered and the decisions which were made during the drafting process. It then reviews the provisions of the Uniform Electronic Transactions Act. As the provisions of the Act are reviewed, the discussion addresses some claims which have been expressed subsequent to the approval of the Act. It is hoped that through this description and discussion, future drafters may gain from our experience and persons seeking to deal with the Act will be able to gain an enhanced understanding of its provisions.

II. WHAT IS ELECTRONIC COMMERCE

Some of the initial impacts of the computerization of our society have been experienced in the realm of electronic commerce. Commer-

1. Similar "superficial" changes came about with the Interstate Highway Sys- tem commenced in the 1950s. The highways contributed to changed housing patterns, increased the mobility of Americans, dispersed economic activity outside the central core of major cities. increased the connections between urban centers, and increased the mobility of the average individual. The rise of the suburbs, if nothing else, has had significant impacts on life in the United States. Francis X. Markey, The Interstate Highway System, at http://www.dismal.comn/top25/t25_highways.stm. 2. Hereafter sometimes termed UETA. The Uniform Electronic Transactions Act was approved by the National Conference of Commissioners on Uniform State Laws at its annual meeting in August 1999. Electronic Signatures Page 15 of 309

20011 INTRODUCTION TO THE UNIFORM 239 ELECTRONIC TRANSACTIONS ACT

cial interactions may be affected by computerization in two fundamental ways, and each is being addressed by legal reformers both domestically and internationally. One major area of change may be found in the development of new products and services, enabled by computerization. Such new offerings, whether they take the form of products or services, raise such questions as the appropriate scope of protection for developers3 and the adequacy of existing contract or other law for the governance of the relation between parties at each level of the chain of distribution." In other words, in some transactions the medium itself is an inherent part of the subject matter of the transaction and decisions about the propriety of law reform focus on governance of the transaction dealing with that subject matter. This area of development will not be addressed in this paper. A seemingly more modest area of change arises from the fact that computers and the Internet permit new media for commercial transactions. 5 In this case, the issue becomes the extent to which the medium for communi- cating or recording data affects or should affect the transaction. This is the area addressed by the Uniform Electronic Transactions Act and the subject of this paper. The image which springs to the mind of most people when the term "electronic commere"' is used generally is a retail purchase using an Internet site. While relatively rare only a decade ago," such transactions have become familiar to an ever escalating number of individuals.' A purchaser accesses a website, selects a product, and pro-

3. See, e.g., State St. Bank & Trust Co. v. Signature Fin. Group, Inc., 927 F. Supp. 502 (D. Mass. 1996). 4. For a controversial adaptation of contract law to govern the licensing of information products, and the first attempt to frame a complete and coherent statutory treatment for the subject, see UNIF. COMPUrER INFO. TRANSAcTIoNs Acr (2000), available at http://www.law.upenn.edu/bll/ule/ucita/ucita1200.htm. 5. While this may initially appear to be a modest area of change, a recent report estimates that more than half of all adults now have and use Internet access and that more than half of those individuals have purchased a product online. It also reports that the proportion of those using the Internet for purchases increases as people become more experienced with using the Internet. Lee Rainie, et al., More Online, Doing More, Pew Internet Project: Internet Tracking Report, The Pew Internet & American Life Proj- ect (Feb. 28, 2001), at http://www.pewinternet.org/reports/toc.asp? Report=30 [hereinafter Pew Internet Tracking Report]. 6. See Barry M. Leiner, et al., A Brief History of the Internet, at http://www .isoc.orginternetlhistory/brief.html. As a medium for mass communication, the Internet often is dated from the release in 1994 of the National Research Council report titled Re- alizing the Information Future: The Internet and Beyond, available at http://www.nap. edu/books/0309050448/html/index.html. 7. Pew Internet Tracking Report, supra note 5. Electronic Signatures Page 16 of 309

IDAHO LAW REVIEW [Vol. 37

ceeds through a series of computer screens, filling in information as part of the process of acquiring that product. In all probability, the purchaser will be asked to furnish a name and address for shipping the item, as well as a credit card number and authorization to bill the purchase to that account. There may be a confirmation screen which reflects the details of the purchase and asks the purchaser to confirm the transaction by clicking on the appropriate button. The customer may establish an account with the vendor, creating some sort of password or other mutual secret, permitting the customer to avoid filling in details in favor of information retained by the vendor from prior transactions.8 Taken literally, however, electronic commerce ranges from old- fashioned telephone conversations, through the use of facsimiles, electronic mail and electronic data interchange, to establishing a presence on and conducting retail transactions through the use of Internet websites9 As comfortable as the Internet transaction is becoming for increasing numbers of individuals, perhaps the earliest form of an automated purchase transaction is the commercial electronic data interchange [EDI] transaction.10 For well over twenty years, industry has been automating its routine office processes, reducing costs, increasing efficiency, and accelerating exchanges. EDI involves automating the procurement process by eliminating paper forms in favor of pre-approved standard formats for computer-based exchanges of information. Although the Internet is used today for EDI exchanges, it originally was based on the use of electronic communications across e- mail systems or dedicated telephone lines, or via the use of third parties to collect, sort and transmit communications. EDI is an essential element of just-in-time manufacturing and the dominant mode for procurement in a variety of industries." While electronic media and their commercial use thus predate the Internet, and are not confined to Internet-based transactions, the Internet currently forms the basis for much electronic commerce. Whether the focus is on the small-dollar business-to-consumer retail transaction, the commercial business-to-business EDI transaction, or any of the myriad of transactions falling between them, issues arise concerning the effect on the transaction of the use of electronic media.

8. The paradigm transaction may be explored at many websites. One example may be found at http://www.amazon.com. Q_ -Y.TrTA R§ nfll 11n) __..J fltfl.... l.~.... V. Oev Un£L X~ &t,Q.. kn w- Official Commns. 10. See Electronic Messaging Services Task Force, The Commercial Use of Elec- tronic Data Interchange-A Report and Model Trading Partner Agreement, 45 BUS. LAW. 1645 (June 1990) [hereinafter EDI Report]. 11. JOHN F. DOLAN, COMMERCIAL LAW: ESSENTIAL TERMS AND TRANSACTIONS § 3.6 (2d ed. 1997). Electronic Signatures Page 17 of 309

2001] INTRODUCTION TO THE UNIFORM 241 ELECTRONIC TRANSACTIONS ACT

In each manifestation, electronic commerce presents challenges for the legal system. In each manifestation, electronic commerce has also produced unexpected changes and altered relationships. 2

III. LEGAL BARRIERS TO ELECTRONIC COMMERCE

Perhaps the first and one of the most fundamental challenges is presented by the simple fact that transactions may be memorialized on electronic media, rather than solely on paper. It is no longer accurate to say that paper is required in order to assure that there will be a record of a transaction, that a party receives a copy of terms and conditions, or that notice is given to a counter party.1 3 It is not accurate to say that paper is required in order to assure that someone has signed a letter or memorandum. Yet most of our laws were written during an era when paper was the only realistic medium for commu- nicating and storing information, for symbolizing our assent or knowledge, and when our mental constructs for such concepts as notice, communication, sending and delivering information, recording the terms of final agreements, etc. depended on paper. Extending beyond the classic Statute of Frauds, our legislatures have imposed innumerable writing and signing requirements for a variety of reasons. 14 Each local, state, or national law or regulation that requires a writing or signature, delivery, or production of an original record im- pairs electronic commerce. The efficiencies are lost if the law requires the production of paper copies. A study by the Federal Reserve Bank of Boston identified more than 2,500 state law rules requiring that canceled checks be stored by drawers. These statutes appear to be de-

12. EDI Report, supra note 10. 13. The National Consumer Law Center and Consumer Federation of America asserted that "[u]ntil the Internet achieves the same degree of universality as the U.S. Postal System, electronic commerce and electronic delivery of information cannot replace real paper." Comments to the Department of Commerce Office of General Counsel (March 17, 2000), at http://www.consumerlaw.org [hereinafter Comments to the Department of Commerce]. 14. The author searched Westlaw databases of unannotated statutes for versions of the words "write" and "sign" on October 22, 1999. Those searches produced the following number of statutory references to those words. N . D ...... 1418

C al ...... 18674

Ill ...... 3605 The author did not examine each of the items to determine precisely the nature and character of the reference to one of the two words. Electronic Signatures Page 18 of 309

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signed to assure that records of financial transactions will be available upon subsequent audit. Such records can be made available electronically, but not if the statute says only the original canceled check will suffice. Additionally, the burden is not imposed on those who draw and are required to store the canceled checks. Such rules also mean that the check collection system cannot short-circuit the physical travels of the check. If a bank's customers are required by law to store the physical, canceled checks, the bank cannot store them or authorize anyone earlier in the collection chain to do so. The first step toward laying a legal foundation for electronic commerce is to clear away the barriers to electronic commerce, and the first and most obvious barrier is found in laws that require paper.15 Before even this obvious step can be taken, however, it is necessary to identify the policies which are expressed in paper requirements and analyze the extent to which those policies may be served by electronic media. The work of identification and analysis has been ongoing for some years. In the United States, much of this work was conducted by the American Bar Association's Business Law section.16 The original Statute of Frauds states that its purposes are the prevention of frauds and perjuries. It sought to prevent these evils by requiring as a predicate to the enforcement of agreements that 'the agreement ... or some memorandum of note thereof" be signed by the party to be charged in the litigation. 7 Arguments have been made that the Statute is no longer relevant in light of changes in procedure

15. The burdens of paper are not insignificant. For example, banks are required to furnish periodic statements to credit card customers. If it costs $1.25 to prepare and mail a paper account statement, a bank with 800,000 cards outstanding will spend $1,000,000 during each account statement. In an exchange with Roland Brandel of Morri- son & Foerster, San Francisco, CA, the author was advised that an estimate of $1.00 to $1.25 per statement has been validated by bank employees. A second example comes from the 1997 flooding of the Red River Valley in Minnesota and North Dakota. Stories have circulated that employees of a major bank were forced to use canoes to travel through the file storage warehouse of a major bank in order to retrieve documents. The physical dimensions of file storage facilities is perhaps best illustrated from the closing scene of the film Raiders of the Lost Ark, in which the Ark of the Covenant is hidden from all evil-doers by storing it in U.S. government warehouses. 16. The Electronic Commercial Practices Subcommittee of the Uniform Com- mercial Law Committee was the body primarily charged with this work. Much of the discussion of the purposes of paper and signature requirements is based on the work of that body. A preliminary discussion of that work may be found in Patricia Brumfield Fry, X ark w spot Nw e..L New Ccepts f-r Co...... ri. Law, 2.. LO. L. L. REV. 607 (1993). 17. Stat. 29 Car. 2. The transactions falling within the statute included transfers of interests in real estate, contracts not capable of performance within one year of their making, certain transactions for the sale of goods, and promises to answer for the debt of another, amongst others. Electronic Signatures Page 19 of 309

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and trial practice' and there is a long tradition of criticism and praise of the Statute in the United States.1 ' Most of its provisions were repealed by Parliament in 1954.20 Although abolition of the Statute of 2 1 Frauds for sales was proposed during the Article 2 revision process, this proposition proved highly controversial and was withdrawn. In- stead, current drafts modify the Statute of Frauds slightly and raise the dollar threshold for transactions. 22 While the furor over the Stat- ute of Frauds is not new, the Article 2 controversy reveals that the Statute has strong support from the legal profession within the United States. Thus, it becomes necessary to identify and understand the policies which are implemented through paper and signature requirements. Functions which have been identified include evidence and memorial, notice and communication, ritual and precaution, and token or property.

A. Evidence and Memorial

Words on paper may be stored and retrieved in the future as they originally were expressed. With a record of a transaction, the vagaries of human memory are avoided. Furthermore, the existence of a piece of paper created, and perhaps signed, contemporaneously with a transaction in and of itself offers some evidence that the transaction occurred. In other words, the information placed on the paper supports an inference that the transaction occurred and offers reasonably reliable evidence of the terms of that transaction. In like manner, information stored on other media can support an inference that the transaction occurred and offer reasonably reliable evidence of the terms of that transaction. The record of the information relieves us of any need to rely on the vagaries of human memory or interested recollection.

18. See, e.g., Hugh E. Willis, The Statute of Frauds-A Legal Anachronism, 3 IND. L.J. 427 (1928). 19. This history is briefly discussed in EA. FARNSWORTH, CONTRACTS, § 6.1 (3d ed. 1999). It also is discussed in MuRPHY, ET AL., STUDms iN CoNTRACr LAW 191-94 (5th ed. 1997). 20. LAW REFORM ACT (ENFORCEMENT OF CONTRACTS), 2 & 3 Eliz. 2, c. 34(1954). 21. July 1996 Draft of Revised UCC Article 2, Sales § 2-201. The text of drafts of Revised UCC Article 2, as well as of other pending or final uniform law projects may be found at http://www.law.upenn.edu/library/ulc/ulc.htm. 22. November 2000 Draft of Revised UCC Article 2, Sales § 2-201. Similarly, in the Uniform Computer Information Transactions Act, a record authenticated by the party to be charged is required in any transaction in which the contract fee is $5,000 or more, provided that the duration of the contract term is not one year or less. UNIF. COMPUTER INFO. TRANSACTIONS ACT § 201. Electronic Signatures Page 20 of 309

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B. Notice and Communication Words on paper may be sent by one party and received by the other. Words on paper may be retained by either of the parties for future reference. In both commercial and consumer contexts, many laws require notices to be sent by one party to the other or provide certain consequences when a notice is sent by one party to the other.2 In the consumer context, merchants may be required to send various notices to the consumer.2 Frequently contracts will specify that certain notices must be sent by one party to the other, and in others contract law may imply such an obligation.25 The communication of information by one party to the other, as well as the ability of a person to access information, clearly constitute a major function of paper requirements. Once again, however, the medium is not the essential element. The information which is contained in the writing or other medium is the essential element and electronic media may fulfill the underlying policies.

C. Ritual and Precaution Writings, and the formalities attendant upon their reading and signing, may be used to impress upon individuals that the actions being taken are significant and consequential. Writings or signatures may be required as a means of emphasizing the significance of an act or to alert individuals that their actions require consideration. For example, UCC Article 9 specifies that a debtor may waive certain post- default rights only by an agreement authenticated after default.26 Re- quirements that information be displayed in a record in a "conspicuous" manner also are designed to assure that those affected by the provisions are alerted to their presence. 2 Some laws require separate

23. For example, the UCC permits a merchant seller to make a written request for a statement of defects after goods have been rejected. U.C.C. § 2-605(1)(b). If a merchant buyer fails to specify a defect in a written response, the buyer is precluded from relying on the defect as a basis for rejection of goods. Id. Section 2-609(1) permits a party to a sales contract to demand in writing adequate assurances of performance from the other party. Id. 24. An obvious example is the periodic statement of account sent by banks or credit card companies. See Truth-in-Lending Act, 15 U.S.C. § 1637 (discussing open-end credit); Electronic Fund Transfer Act, 15 U.S.C. § 1693d (discussing accounts which may be accessed for consumer electronic funds transfers). 25. See Wal-Noon Corp. v. Hill, 45 Cal. Rptr. 3d 605 (Cal. App. 1975) (implying a condition precedent of notice to a landlord before the landlord was obligated to perform a covenant for roof repairs). 26. U.C.C. § 9-624. 27. Indeed, the UCC definition of "conspicuous" provides that information is conspicuous "when it is so written that a reasonable person against whom it is to operate ought to have noticed it." U.C.C. § 1-201(10) (West 2000). Electronic Signatures Page 21 of 309

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signatures attached to specific provisions as a means of maximizing the potential the particular provisions will come to the attention of the signer.2 Notices subsequent to breach may enable persons to seek advice of counsel, seek to cure defaults, and seek alternative ar- 29 rangements. In each of these circumstances, once again the information is the critical element, not the medium. However, these functions focus on the psychological or emotional impact of events on actors, rather than merely the communication of the information. It has been argued that individuals (consumers) do not understand that their actions in electronic media may have legal effects or that individuals (consumers) do not regard actions in electronic media with the same seriousness or 3 solemnity as those accorded to the same actions using paper media. 1 On the other hand, the recent Pew Internet Tracking Report indicates significant increases in the online population and that more than half of those with Internet access use it to purchase products. 31 If the assertion is true that persons do not regard Internet-based transactions as being somehow "real" or giving rise to enforceable obligations, the expanding Internet population and expansion in the Internet consumer marketplace suggest that such attitudes are rapidly being displaced by an understanding that economic transactions are being accomplished.

28. See, e.g., CAL. FIN. CODE § 22341 (requiring notice to borrowers that their home is being used as collateral for a loan, and requiring that the borrower's signature on that notice be obtained). 29. See WHITE & SUMMERS, UNIFORM COMMERCIAL CODE 317 (5th ed. 2000) (discussing the requirement under UCC § 2-602 of notice to the seller when goods are rejected); In re Press, Inc., 890 F.2d 896 (7th Cir. 1989). Pre-contractual notice to consumers in certain credit or lease transactions is required by 15 U.S.C. § 1631 (Truth-in-Lending Act). 30. See Letter from Consumer Federation of Amnerica and National Consumer Law Center to Federal Trade Commission (March 26, 1999); Gail T. Hillebrand, Uniform Electronic TransactionsAct: Challenges and Opportunities, at http://www.consumer law .org /consumer/e_commerce/uniform act.html; Gail T. Hillebrand & Margot Saunders, E- Sign and UETA What Should States Do Now?, 5 No. 10 Cyberspace Law (Jan. 2001). See also Memorandum from National Consumer Law Center, The Need to Protect Consumers -- EspeciallyLow-Income Consumers - from UETA, (undated) (Copy in author's files.) The highly publicized Napster litigation has had a great deal of attention from the mass media, and has included reports on the potential for liability for copyright infringement if unauthorized material is copied and of the possibility that Napster will become a fee- based service. Public awareness of the seriousness of conduct using the Internet must have been enhanced by such reports. 31. Pew Internet Tracking Report, supra note 5. Electronic Signatures Page 22 of 309

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D. Token or Property

The writing itself may be a token, i.e., an item of property that may be transferred and sold. UCC Articles 3 and 7 define specific types of negotiable instruments that are created when writings are issued and specify the consequences of transferring such instruments to good faith purchasers for value. In each case, when the appropriate delivery has occurred, the transferee acquires rights in the property - the paper itself - which have legal consequences. The law governing negotiable instruments is based on the fundamental assumption that some token exists which may be signed, issued and physically delivered, and which may be transferred by indorsement and delivery. 32 In the computerized world, however, innumerable copies can be made which cannot be distinguished from one another.3 3 Even highly secure electronic records, encrypted with secure keys, may be copied repeatedly. Displacement of the fundamental assumptions of negotiable instruments theory, without consideration of and adjustment to its consequences, would play havoc with significant elements of commercial markets. In this instance, electronic records cannot serve the same functions as paper records." Because of the use of paper as a token or thing, it is not possible to simply wave a magic wand and redefine writings and signatures to include their electronic counterparts. In most instances such a redefi- nition would serve admirably. It certainly would suffice in all cases in which the purpose of the writing or signing requirement is to insure that there is a record of a transaction which preserves its terms or a record preserving evidence of the parties' assent to the transaction. Electronic records can serve those functions quite well. The body of law governing negotiable instruments would be badly disrupted by such a change. The rights and liabilities that now depend on or arise from negotiable instruments law can be managed in a legal scheme, but not in one dependent upon the transfer of a single, unique token. Until that sort of technology is in place, however, a provision which merely changes the definition of writing and signature would disrupt the check collection system, the investment markets, commodity and other markets. In the meantime, electronic analogues to the existing

32. See, e.g., U.C.C. §§ 3-201; 7-501 (regarding negotiation of instruments). 33. The author has been told that object-based technology can create a single, unique, identifiable original. Whether this is correct or not, such technology is not in general use as a medium for markets and other technologies permit the production of copies which are indistinguishable from originals. 34. Nothing in this analysis suggests that the incidents of negotiability cannot exist in the electronic environment. Rather this analysis suggests that different criteria for establishing those incidents are required. For an explanation of one possible scheme, see the discussion of transferable records infra Part V.B. Electronic Signatures Page 23 of 309

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paper-worlds requires rethinking of the concepts and functions involved in systems based on negotiability.

IV. INTRODUCTION TO THE UNIFORM ELECTRONIC TRANSACTIONS ACT

The Uniform Electronic Transactions Act35 (UETA) is the product of the National Conference of Commissioners on Uniform State Laws"5 and was approved by its sponsor at its 1999 Annual Meeting. Once the proposal for the project was approved in 1996, a Drafting Commit- tee was appointed and a chair and reporter were named. 7 Over a period of two years, the Drafting Committee met to consider and debate drafts. On each occasion, observers from a wide range of government and industry sectors participated throughout the 2.5 day sessions." As is required by the rules of the National Conference, at two annual meetings, in 1998 and 1999, the work of the Drafting Committee was presented to the full membership of the Conference and debated at length. As a result of these discussions a variety of changes were made to the draft, continuing until the final vote for approval in 1999.1' Upon approval, and after several months of delay to permit

35. All references to the UETA are to the Final Act as approved by the National Conference of Commissioners on Uniform State Laws at its 1999 Annual Meeting. 36. The National Conference of Commissioners on Uniform State Laws (the Conference) consists of members appointed by their respective states. Its 300-plus members all are members of the bar of a state and come from all parts of the legal profession, with a roughly even split between practitioners, academics and judges. One member from each state is a member of that state's legislative drafting service. Its purpose is to identify appropriate subjects for uniform enactment, prepare proposed legislation and encourage state enactment of uniform acts. 37. The Drafting Committee consisted of the author, who acted as chair, Ste- phen Y. Chow of Massachusetts, Kenneth W. Elliott of Oklahoma, Henry Deeb Gabriel, Jr. of Louisiana, Bion M. Gregory of California, Joseph P. Mazurek of Montana and Pam- ela M. Sargent of Virginia. Professor D. Benjamin Beard of Idaho served as reporter for the project. The American Bar Association appointed Amelia H. Boss of New Jersey to serve as its advisor to the Drafting Committee. In addition, C. Robert Beattie served as adviser to the Business Law section and Thomas J. Smedinghoff served as adviser to the Science & Technology section of the American Bar Association. The Uniform Law Confer- ence of Canada was engaged in drafting similar legislation. The chair of its drafting committee, John Gregory, also participated in the meetings of the Drafting Committee. In addition, members of the Drafting Committee and observers were permitted to participate in online discussions conducted under the aegis of the Canadian project. The exchange of information and views was invaluable to the drafters. The exchange of ideas, suggestions and comments between the two projects was invaluable. 38. Despite the open character of the meetings and several requests to persons identified with consumer advocacy, consumer advocates did not participate in the drafting process. 39. The Constitution of NCCUSL requires that an act be considered at a minimum of two annual meetings prior to submission for a final vote. NCCUSL Const. § 8.2. Electronic Signatures Page 24 of 309

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styling and preparation of comments, the UETA was presented to the states for enactment toward the end of 1999. It has been enacted in twenty-three states and is pending in more than twenty more.0 The UETA is designed to build a solid legal foundation for the use of electronic media in transactions. The Act is designed to facilitate and support the development of the information economy, and in particular its place in commercial transactions, throughout the states. Given 'the dramatic evolution of the Internet during the past ten years, the need for a legal infrastructure for electronic commerce has developed swiftly. If the states act swiftly and in a uniform and constructive manner, the traditional role of the states in commercial law may be maintained. If they fail to do so, the imperative need for commercial certainty may lead to a significant shift of a part of the authority of the states to the national government." The UETA deals with electronic records and messages. It is designed to be evolutionary, leaving existing law undisturbed while establishing certainty and stability by affirming the equivalency of electronic records and signatures with paper media. It takes the position that the medium of transactions should not determine their treatment in the law. Despite its evolutionary character, however, it would be a mistake to regard the UETA as a minor step. It represents a significant shift from much of the early thinking about electronic commerce, one which appears to be affecting others. 2 Its scope is broad and will

40. The UETA has been enacted, in one form or another, in: Arizona, California, Delaware, Florida, Hawaii, Iowa, Idaho, Indiana, Kansas, Kentucky, Maine, Maryland, Michigan, Minnesota, Nebraska, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Utah, Virginia. It has been introduced and is pending in Alabama, Alaska, California (amendment to conform to uniform version), Connecticut, District of Columbia, Illinois, Massachusetts, Mississippi, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, North Dakota, Oregon, Tennessee, Texas, U.S. Virgin Islands, Vermont, West Virginia, Wisconsin. 41. The first stop in this process already has occurred. On June 30, 2000, Presi- dent Clinton signed the Electronic Signatures in Global and National Commerce Act, 15 U.S.C. §§ 7001-7006, 7021, 7031 [hereinafter E-sign], which preempts all state and federal laws to the extent of the Commerce power and to the extent that they provide for different legal treatment for covered electronic records and signatures. For convenience, citations to E-Sign will refer to the section numbers contained in the uncodified Act. 42. For example, much of the earliest legislation on the enforceability of electronic records focused on the application of security technologies for the purpose of identi- bring parties or assuring that records had not been altered. A comparison of the UETA with the Digital Signature Guidelines issued by the Information Security Committee, American Bar Association Section of Science & Technology, Electronic Commerce Divi- sion, http://www.abanet.org/scitech/ecliscdsgfree.html, will show a significant shift in philosophy and approach. In a project which proceeded in parallel to the project to draft the UETA, Canada's Uniform Law Conference prepared the Uniform Electronic Com- merce Act, which adopts many of the same policies. See http//www.law.ualberta. ca/alri/ulc/current/euecafa.htm. Electronic Signatures Page 25 of 309

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affect increasing numbers of transactions as people and industry migrate to electronic technologies. The principles which governed the drafting of the UETA are fairly simple to state,'4 although they were not simple to implement. They may be briefly described as follows: A. Legal barriers to electronic commerce are to be eliminated. Requirements for paper and ink should be eliminated except in those few circumstances where electronic records and signatures cannot satisfy the policies underlying paper requirements. 4 In the course of eliminating those requirements, care should be taken to avoid raising new barriers through imposing legal requirements incompatible with legitimate methods of transacting business. B. Barriers should be removed in a manner which assures that the parties' selection or choice of medium does not alter the outcome of disputes between the parties, i.e., whether the parties deal in the paper world or the electronic world, their relationship should be subject to the same legal principles.8 If the medium has the potential to dictate the outcome of disputes arising from transactions, the selection of medium will become a legal issue rather than a business choice. C. The law should maintain neutrality. It should neither assume nor require any particular medium or technology.46 Electronic technologies should be treated on a par with paper media - neither better nor worse. 47 It should neither assume nor require any particular business model for transactions. The focus should be on the purpose of the legal requirement, rather than the form by which it is satisfied. This also should assure that the draft does not itself become a barrier to

43. The following statement of principles is paraphrased and adapted from Patricia Fry, The Medium Shall Not Be the Message: Securing Legal Certainty for Elec- tronic Transactions with the Uniform Electronic TransactionsAct, in The Emerging Law of Cyberbanking & Electronic Commerce (1999). 44. This statement is deceptively simple. It implicates the scope of the Act and reflects a decision that the Act should be inclusive rather than exclusive, it should include all requirements except those specifically excluded. It has been challenged by consumer advocates. See Hillebrand & Saunders, supra note 30. 45. This principle also is challenged by consumer advocates, who assert that electronic technologies create opportunities for new forms of fraud and over-reaching and that it is essential to create a system of regulatory oversight to prevent those opportunities. See Letter to Federal Trade Commission, supra note 30. 46. This approach contrasts with that in the Digital Signature Guidelines, which not only assume a specific technology but also mandate a specific business model for its use. See supra note 42 and accompanying text. 47. E-Sign takes the same position and restrains regulatory agencies from imposing requirements on electronic commerce, even in regulated settings, which impose greater burdens than those imposed on paper. See E-sign § 104(b). Electronic Signatures Page 26 of 309

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electronic commerce as technology and business practices continue to shift and evolve."8 Markets and people should be free to select technologies and business methods according to their needs. D. The draft should make the minimum necessary changes to existing law. Treating electronic transactions differently from paper raises barriers, distorts the evolution of commercial and technological processes, and increases potential that revision will be required in the short term in order to accommodate legitimate transaction structures. Accordingly, the draft should be procedural, i.e. focused on the media involved, rather than affecting the substantive law applicable to transactions. Similarly, no special rules for consumer protection are to be included; consumer protection issues are left to existing state law and to existing legal allocations of power between consumers and their counter-parties. 9 Finally, regulation should be avoided.50 Con- sistent with the principle that electronic transactions and records should be treated on a par with paper, electronic transactions and records should be governed by the same regulations, but not by separate or additional regulations. E. The draft should afford legal certainty to electronic commerce. Doubts about the enforceability of electronic transactions should not arise from the parties' selection of media. F. Uniformity of law amongst the states is essential to the continued evolution and development of electronic commerce. The Inter- net does not respect geopolitical boundaries and different rules amongst the states can only hinder electronic commerce. In the interest of uniformity, areas not yet ripe for prompt, uniform treatment should be avoided. The need for prompt enactment of uniform rules outweighs the desirability of addressing such issues as jurisdiction. 51

48. The need to avoid assumptions about technological or business models is illustrated by the Digital Signature Guidelines, which do both. See supra, note 42. The technological underpinnings of the Guidelines have continued to evolve, as have the business models employed by entities using the technology. See, e.g., http://www.identrus. corn. 49. This policy should be compared with the consumer consent provisions of E- Sign § 101(c). This policy has been criticized by consumer advocates. See supra note 30 and materials cited therein. 50. This may be the single policy which has resulted in criticism from consumer advocates. They argue that significant new consumer protections are required in order to insulate consumers from unsavory practices. See Hillebrand & Saunders, supra note 30. 51. The need for prompt enactment was one of the major justifications for the federal preemption of state law embodied in E-Sign. Donnie L. Kidd & William H. Daughtrey, Adapting Contract Law to Accommodate Electronic Contracts: Overview and Suggestions, 26 RuTlERs COmpurER & TECH. L.J. 215 (2000). Electronic Signatures Page 27 of 309

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V. THE PROVISIONS OF THE UNIFORM ELECTRONIC TRANSACTIONS ACT

Turning to the implementation of these principles in the UETA, the pivotal provisions of the Act provide that an electronic record, electronic signature, or electronic contract shall not be denied validity on the sole ground that it is electronic, 2 that electronic records shall not be denied admissibility into evidence on the sole ground that they are electronic or are not original,53 and that if an offer evokes an electronic response, a contract may be formed with the same effect as if the record was not electronic." The devil, and the challenge, is always in the details.

A. Scope

One of the most difficult problems to resolve was the question of the appropriate scope of the statute. Literally thousands, perhaps tens of thousands, of paper and signing requirements are buried in state law. 55 These can range from the steps a legislature must follow to demand a special session, to how to execute a will, to rules for filing financing statements with the state, for giving consumer notices, and for contract formation. And some of the rules are tied to property and legal rights and obligations that cannot readily be translated into the electronic world, e.g., checks and other negotiable instruments. Although there was some early sentiment favoring a statute which explicitly listed the provisions of state law which would be amended," pragmatists prevailed. They argued, with some merit, that the resources of the Drafting Committee would not permit such specific itemization and evaluation of writing and signing requirements,

52. UETA § 7. See also E-Sign § 101(a), which incorporates the operative language of the UETA. 53. UETA§ 13. 54. Id. § 14. These provisions are found also in E-Sign § 101(h), which adds the words "so long as the action of any such electronic agent is legally attributable to the person to be bound." This seems a change without substantive effect. 55. See, e.g., figures cited in note 13, supra. Many requirements may be found in laws that never use words like "writing" or "signature." They may be found in laws refer- ring to originals, documents, delivery, personal service, etc. 56. Such sentiment also was expressed outside the drafting process. Christopher B. Woods, Comment, Commercial Law: Determining Repugnancy in an Electronic Age" Excluded Transactions Under Electronic Writing and SignatureLegislation, 52 OKLA. L. REv. 411 (1999). A special committee chaired by David Whitaker was appointed during the drafting process to study the scope issue. The report of the special committee may be accessed through http://www.uetaonline.com by connecting to The ETA Forum and following the link to the report of the October 1998 Drafting Committee meeting. Electronic Signatures Page 28 of 309

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and that a demand that state legislatures do so prior to enactment would unduly delay enactment. The Act applies only to transactions between parties each of which has agreed to conduct transactions electronically. 57 Consensus emerged that the best approach is to provide that the UETA applies to electronic records and electronic signatures "relating to a transaction."5 Section 3 then proceeds to create appropriate exclusions. It excludes transactions and records governed by rules of law relating to the creation and execution of wills and codi- cils, and testamentary trusts.59 It excludes existing Article 1 of the UCC, with the exception of sections 1-107 and 1-206, Articles 3 through 9 of the Code as currently approved, and the Uniform Com- puter Information Transactions Act. It recognizes that some states may choose to specifically exclude particular statutes, although the comments urge caution in selecting additional exclusionsw In addition, section 3 explicitly states that the Act will apply whenever electronic records or signatures are used for purposes subject to a law not specifically excluded, even if those records or signatures governed for other purposes by one of the excluded laws. 61 For example, while UCC Articles 9 applies generally to a transaction creating a security interest in personal property, it excludes landlord's liens. The LIETA would apply to the creation of a landlord's lien in the absence of a specific state exclusion. Similarly, although checks are governed by UCC Articles 3 and 4, many other statutes provide for the retention or production of copies of canceled checks. For the latter purposes, the UETA would permit the production of an electronic copy of the canceled check. A second restriction on the scope of the UETA is found in section 5(b) which provides that the Act applies only to transactions62 between parties which have agreed to transact electronically. This provision has been criticized by some as creating artificial barriers to

57. UETA §5. 58. Id. §3. 59. Id. E-Sign also excludes (1) court orders or notices or official court documents, (2) any notice of cancellation of utility services, (3) any post-breach notice relating to a lease or financing on a primary residence, (4) notice of cancellation or termination of health or life insurance, (5) notice of recall of a product, and (6) any document required to accompany transportation or handling of hazardous materials. E-sign § 103(b). 60. UETA § 3. Mindful of the fact that a state might elect to take undue advantage of the opportunity to provide for additional exclusions, and in light of the California act's long laundry list of exclusions (Cal. Civ. Code §§ 1633.1 et seq.), E-Sign specifically states that any additional exclusions will survive preemption only if consistent with its provisions. E-sign § 102(a)(1). 61. UETA § 3(c). 62. "Transaction" is defined as "an action or set of actions occurring between two or more persons relating to the conduct of business, commercial, or governmental affairs." UETA § 2(16). Electronic Signatures Page 29 of 309

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electronic commercel and by others on the ground it improperly per- 6 mits the agreement to be found from the context of the transaction. ' The requirement of an agreement to act electronically was regarded by many as an essential requirement if persons were to remain free to choose to deal electronically or not. Since the definition of "agreement" specifies that it is 'the bargain of the parties in fact, as found in their language or inferred from other circumstances," the conclusion was reached that the requirement of an agreement to deal electronically should not present a barrier to electronic commerce. The comment to UETA section 5(b) encourages courts to interpret the parties' words and conduct liberally in order to determine whether the required agreement exists. Examples of facts from which the required agreement may be found are included in the comment, and range from a formal, recorded agreement setting forth provisions for the conduct of electronic transactions through initiation of Internet purchases to the use of business cards containing business e-mail addresses. The range of transactions falling within the definition of "agreement" concerns consumer advocates, who argue that unscrupulous merchants may conceal agreements for electronic transactions in boi- lerplate adhesion contracts or refuse to make terms available to consumers." As the comment to section 5 notes, the drafters were of the view that such conduct should be policed by the courts applying traditional contracts or torts doctrines.67 Furthermore, section 5(c) explicitly states that any party is free to refuse to conduct transactions, or a specific transaction electronically. The drafters were convinced that these provisions, accompanied as they are by existing state law policies on the policing of inappropriate contracting behavior, strike an appropriate balance between facilitating electronic commerce and protecting individuals from the effects of electronic records in the absence of agreement.6 '

63. See, e.g., Raymond T. Nimmer, Electronic Signaturesand Records: The New United States Perspective, 17 Computer & Internet Lawyer 8 (Dec. 2000). 64. Hillebrand & Saunders, supra note 30; see also National Consumer Law Center memorandum, supra note 30. 65. UETA § 2(1); see also U.C.C. § 1-201(3). 66. See Hillebrand and Saunders, What Should States Do Now?, supra note 30. 67. UETA § 5, cmt. para. 5. 68. The provisions of E-Sign section 101(c) offer a marked contrast to the UETA. E-Sign specifies that merchants desiring to use electronic media for legally required notices to consumers must first advise the consumer of the notices which may be included and of the hardware and software which will be needed, then obtain the consent of the consumer to receive electronic notices in a manner that demonstrates the consumer's ability to receive electronic communications from the merchant. The controversy which accompanied these provisions is manifested in the provision of section 105(a) requiring Electronic Signatures Page 30 of 309

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Given the breadth of the UETA, the exclusions become critical. The exclusions nevertheless are very limited, including testamentary documents, most of the UCC,6 and any other statutes specifically excluded. All other electronic transactions and records are included. 70 The next limitation on the impact of the UETA derives from its character. The Act only applies to the procedural aspects of the transaction, i.e., the use of electronic communications and records. A transaction subject to the Act remains subject to applicable substantive rules of law.7 The Act is designed to interact with, not supplant, the bodies of law which otherwise govern contract formation, record- retention, the performance of obligations and the rights and liabilities of the parties. In other words, while the UETA assures that requirements for paper or signatures may be satisfied electronically, it does not otherwise validate any transaction. An electronic record of a gambling debt remains as unenforceable as a paper record of a gambling debt. If a person's name and address must be recited in a writing before the writing is legally effective, the same information must be re- 7 2 cited in an electronic record before that record is legally effective.

the Secretary of Commerce to study the comparative effectiveness of delivery of electronic records to consumers as compared with delivery of paper via the United States Postal Service and to report to Congress within 12 months, and the provision of section 105(b) requiring the Secretary of Commerce and Federal Trade Commission to report to Con- gress within 12 months evaluating the benefits and burdens of the consent procedure. In addition, the provisions of section 103(b)(2), excluding various post-breach notices, are subject to the provisions of section 103(c)(2), permitting federal regulatory agencies to determine that an exception is no longer required for the protection of consumers, and to extend the application of E-Sign to such exception. 69. Several reasons dictated this exclusion. Much of the UCC has been revised over the past decade in ways that deal, at least in part, with the use of electronic media. Furthermore, numerous provisions beyond Articles 3, 4 and 7 distinguish between negotiable instruments and other records. See, e.g., Uniform Commercial Code § 2-509(2) (al- locating the risk of loss for goods held by a bailee and shifting the risk to the buyer on receipt of a negotiable document of title covering the goods). 70. While E-Sign contains similar and additional exclusions, its scope also is broader. It applies to any transaction in or affecting interstate commerce. E-sign § 101(a). 71. UETA § 5(e). See also E-sign § 101(b): This title does not- (1) limit, alter, or otherwise affect any requirement imposed by a statute, regulation or rule of law relating to the rights and obligations of persons under such statute, regulation, or rule of law other than a requirement that contracts or other records be written, signed, or in nonelectronic form .... Id. 72. UETA Prefatory Note, § 5(e) and cmt. Electronic Signatures Page 31 of 309

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B. Electronic Records and Signatures

As noted above, the pivotal provisions of the UETA provide that electronic records, electronic signatures, and the contracts made through their use will be treated on a par with paper-based transactions.7" Thus the Act can be understood only when these concepts have been mastered. The concept of the electronic record is the immediate result of the work of the Electronic Commercial Practices Subcommittee described above.74 The term "record" is defined in the UETA to mean 'information that is inscribed on a tangible medium or that is stored in an 75 electronic or other medium and is retrievable in perceivable form." Thus a 'record" may be on paper, on a disc or cassette, or stored in digital memory. 6 As new technologies come onto the market, a record might be stored in bubble memory or holograms or new media not yet conceived. It might also be carved into granite, painted onto a cow or wall, or otherwise stored in non-paper tangible media. The Act specifies that the records to which it applies must be electronic. An "electronic record" is any record "created, generated, sent, communicated, received, or stored by electronic means."' The term "electronic" is broadly defined as "relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities." 8 As the comments note, most current technologies fall within this definition. As new technologies emerge, the comment encourages courts to construe the term liberally in order to fulfill the purpose of validating transactions. The Act "covers intangible media which are technologically capable of storing, transmitting and

73. The central thrust of the criticism of consumer advocates is that this policy is wrong. They have argued that new consumer protections are required by the differences between paper and electronic records, that merchants should not be permitted to require electronic communications if they deal with consumers in stores or shopping malls, that authentication technology must be used for electronic signatures and all risk of loss from the failure of an authentication technology, whether through fraud, mistake, technological failure or theft, must fall on the merchant. They urge regulations based on the credit card system for all business-to-consumer electronic commerce. See Comments to the Department of Commerce, supra note 13. 74. See supra text accompanying notes 15-33. That project developed the concept of "record," a concept which includes both writings and electronic media within its scope. See Fry, supra note 16, at 6. 75. UETA § 2(13). 76. The concept of a record has been accepted beyond the confines of the UETA. It is incorporated into the federal E-Sign Act, § 106(9), and is found in several products of the Uniform Law Conference. See, e.g., UNIF. COMPUTER INFO. TRANSACTIONS ACT § 102(54); proposed Revised UCC Article 2 § 2-102(34) (2000 Annual Meeting Draft). 77. UETA § 2(7). 78. Id. § 2(5). Electronic Signatures Page 32 of 309

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reproducing information in human perceivable form, but which lack the tangible aspect of paper, papyrus or stone." 9 Defining the electronic signatures to be embraced within the Act required the same type of analysis as that which led to the definition of record. At one extreme, statutes were in existence which provided that any record verified by the use in the approved manner of public keys, certificates and dual key encryption were signed by the person whose encryption key had been used." At the opposite extreme, the UCC states that signatures include "any symbol executed or adopted by a party with present intention to authenticate a writing.'*' The American Bar Association's Model EDI Trading Partner Agreement provides that any symbols or codes affixed to or contained in covered records are signatures and are sufficient to verify the origin of the record. 2 In retail Internet-based transactions, the closest thing to a signature occurs when the customer clicks a button labeled "I agree," 'purchase now," or "buy now." Consistent with the underlying policies of the UETA, the term "electronic signature" is defined as "an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.8 3 This broad definition is designed to assure that whatever a signer adopts or uses in order to sign the electronic record, it will be recognized as satisfying legal requirements for signatures.8 The comment notes that the purpose of the definition is to overcome unwarranted biases against electronic methods of signing and authenticating records.8 It also is intended to assure that it is possible to "sign" a record regardless of the technology used or new technological developments. The legal effect of the signature is governed by other law.w The definition of "electronic signature" includes several elements, each of which must coincide in order for a signature to be present. Some affirmative step must be taken by the signer, and it must be done with the intent to sign the record. Just as a manual signature or other attachment of a tangible signature requires an affirmative act with the intent to sign, in the electronic environment an analogous

79. UETA § 2, cmt. 4. 80. E.g., UTAH CODE ANN. § 46-3-406. 81. U.C.C. § 1-201(39). 82. See EDI Report, supra note 10 at 1690-91. 83. UETA § 2(8). 84. Similarly, the UCC definition of "signed" is to be liberally construed, and applies to any symbol adopted by the party, whether that symbol is a manual signature, an X, initials or a thumbprint. Even a preprinted letterhead may serve. U.C.C. § 1-201(39), cmt. 39. 85. UETA § 2, cmt. 7. 86. UETA § 9. Electronic Signatures Page 33 of 309

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action and intent are required. In addition, the "electronic signature" must be attached to or logically associated with a record. Manual signatures are readily associated with writings, generally appearing on the writing itself.87 In an electronic environment, the "attachment" of the signature to the electronic record itself may depend on the vagaries of storage systems. Thus the definition requires that the signature be "attached to or logically associated" with the record." As to what may constitute an electronic signature, the definition explicitly refers to "an electronic sound, symbol, or process." Thus, assuming the requisite intent and logical association, a manual signature transmitted via facsimile technology would qualify, as would a typed name, a digitized picture or image of a manual signature, or an alphanumeric string or asterisk. If the parties want greater assurances of the identity of a person using the signature, they may demand biometrics or dual key encryption. Where attribution is not given such priority, the signature might be found in the process of "clicking through" a series of screens to affirm intention to make an Internet purchase or in the process of clicking on a button labeled "I agree" or "purchase now." The critical factor is the intention with which the particular sound, symbol or process is used.9

C. Security Procedures and Attribution

A moment's reflection leads to the conclusion that the 'intent to sign" the record may derive from a number of different motivations. In the paper world, people sign writings to signify agreement, to signify origin, to demonstrate that they have seen or received something. Any such intention can support a signature under the UETA. The legal consequences and effect of that signature will have to be determined by other law. Furthermore, while the UETA furnishes an answer to whether the record is signed, it gives less guidance as to who signed the record. According to UETA section 9(a), the attribution of a signature, or its connection to the signer, may be established by any means. The UETA does clarify that evidence relevant to the estab- lishment of electronic signatures will include the application of technological security procedures as well as contextual evidence.9 ' It

87. For example, UCC section 3-204 specifies that an indorsement is a signature "made on an instrument ...... 88. UETA § 2(8). 89. This term is used to connote technologies which measure the physical characteristics, such as fingerprints or retinas, of individuals. 90. UETA § 2, cmt. 7. 91. While E-Sign adopts the UETA definition of signature, it does not contain a provision explaining how to establish attribution. Electronic Signatures Page 34 of 309

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seems apparent to the author that proponents seeking to establish that a process is an electronic signature will need to explain their processes to any trier of fact and that the system's characteristics will be significant in determining attribution issues. Turning to security procedures, the UETA provides the following definition: "Security procedure" means a procedure employed for the purpose of verifying that an electronic signature, record, or performance is that of a specific person or for detecting changes or errors in the information in an electronic record. The term includes a procedure that requires the use of algo- rithms or other codes, identifying words or numbers, encryption, or callback or other acknowledgment procedures. 2 The Act does not provide that a security procedure has any particular legal effect. In contrast to such statutes as the Utah Digital Signature Law," the UETA does not seek to fix the consequences of or attach a particular consequence to the use of specific technologies. A significant amount of attention was given by the Drafting Committee to the impact of security procedures, and the Drafting Committee was aware of various statutory approaches which do prescribe the legal effect of specific technologies. Nevertheless, the conclusion reached was that the UETA should not follow suit. Several concerns were expressed, starting with the underlying principles that governed the entire drafting process. The Act is designed to facilitate electronic commerce, not to either encourage or discourage its use. Its goal is to eliminate barriers to electronic commerce by assuring that electronic transactions and records are treated on a par with paper, neither better nor worse. Barriers are to be removed in a manner which assures that the parties' selection of a medium does not alter the outcome of disputes between the parties. Therefore the law should maintain neutrality, both as to technologies and as to business models. The Drafting Committee was concerned that specification of an outcome or legal conclusion when parties had implemented particular security technology might skew or hinder continuing technological development and the evolution of commercial practices. In this regard it was noted that no technological solutions to the attribution issue are perfect and parties need the freedom to select procedures that combine the appropriate blend of assurance with costs in relation to the nature of the underlying transaction. There was concern that if specific legal consequences were attached to the

92. UETA § 2(14). 93. UTAH CODEANN. § 46-3-101. Electronic Signatures Page 35 of 309

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use of a particular level of or functionality of security technology, the specification itself would influence the selection or application of technologies. If the threshold for security technologies was too steep, it would impose costs on parties which might be out of proportion to the risks. If the threshold was too low, it would visit consequences which might not be warranted. Concern also was expressed that technologically-based security procedures were apt to be established by parties with significant technological capabilities, but such models as the Digital Signature Guidelines or the Utah statute placed the risk of technological or business model flaws on the other party, generally the party applying encryption to a message to be sent to the party which had put the system or technology in place and insisted upon its use. In other words, there was concern that specification of the legal consequences of the use of particular types or levels of security technology might adversely impact parties lacking a level of technological sophistication which would enable them to assess the risks inherent in the technology or to rebut assertions of its use. For all of these reasons, the decision was made to rely on the parties' business decisions concerning levels of security. Thus, the UETA generally provides that in case of a dispute over the attribution of a signature or record, any relevant evidence may be introduced.9 If a technologically-advanced security procedure is used, with or without agreement, and that procedure offers forensic verification of the identity of the person signing the record, those facts should be submitted to the trier of fact. With a sufficiently strong procedure, the evidence of attribution would be rather compelling, with a weak procedure the evidence would have less impact. In either case, other evidence may be introduced to either tie a party to a particular record or transaction or to disavow it, but the decision would be left to the trier of fact in light of all relevant evidence. If the parties have agreed to the use of an identifying security procedure, and the procedure has been applied, the consequences of its use will depend on the provisions of an enforceable agreement. Whether or not a security procedure is applied, if a party denies a signature, the proponent of the signature may introduce any evidence available to it, technological or not, which tends to support the identification of the signature with the other party." Independent of technological solutions to attribution concerns, the law has long required various forms of verification or acknowledgment. Such methods as the use of notarial jurats may be required

94. UETA § 9, cmt. 95. Id. Electronic Signatures Page 36 of 309

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as a means of offering additional third party assurance that a record is signed by the purported signer. At the same time, notarial jurats afford assurances that the signer appears capable of understanding the nature and effect of the signature, through the evaluation of the no- tary of the signer. In other settings, laws require signers to affirm the accuracy or representations made or of authority to sign.9 Usages and rules in this respect vary from state to state, yet any rule which requires the application or embossing of a seal on paper or third party signatures presents issues and possible barriers to electronic commerce. While there have been suggestions that new rules for such verifications or acknowledgments should be established for the electronic environment,' the Drafting Committee concluded that changes in the substantive rules governing notaries or acknowledgments was not an appropriate subject for the Act and in all probability would delay enactment. Nevertheless, the determination was made that it was necessary that the Act contain provisions dealing with notariza- tion. Accordingly, section 11 provides that laws requiring notariza- tion, verification, acknowledgment or oaths may be satisfied with electronic signatures. It also specifies that all other required information, save and except the application or embossing of a seal, must be attached to or logically associated with a record. Thus, the UETA does not make any effort to rationalize, rethink, or offer uniform solutions to the variety of state laws governing these topics. It does assure that existing state laws may be satisfied when parties use electronic me- 98 dia. Certain security procedures may be used to affirm the accuracy of electronic records which have been received. If an encrypted message has been altered, either intentionally or through communication errors, it will not decrypt. The inability to decrypt the message is in itself evidence that what was received is not what was sent.99 Call- back or confirmation procedures may be used to assure that what is received matches what was sent. The Act generally supports the enforcement of any contractual provisions governing the use of such procedures,"° but it also contains a provision governing the impact of failure to apply an agreed security procedure. Section 10(1) provides that if the parties have agreed to a security procedure for the purpose of detecting changes or errors, and a party's failure to comply with the

96. See, e.g., CAL. ELEc. CODE § 2150 (providing that an applicant for voter registration must sign affidavit under penalty of perjury). 97. Such provisions have been enacted in Utah. UTAH CODE ANN. § 46-1-1 (No- taries Public Reform Act). 98. Id. UETA § 11, cmt. 99. See Digital Signature Guidelines, supra note 42. 100. UETA §§ 5, 10. Electronic Signatures Page 37 of 309

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procedure results in an undetected change or error, the other party may avoid that record. The provision only applies if there is an agreement for the use of a technology or process for the purpose of detecting changes or errors. The provision only applies if one of the parties to that agreement fails to conform to the procedure and that failure causes the non-conforming party to miss a change or error. Fi- nally, this provision does not affect the validity or enforceability of any other transaction or record. Section 10(1) simply permits the conforming party to avoid, at its election, any legal effect which might otherwise have applied to the receipt or transmission of that record. 101 In some cases parties require the addressee of messages to acknowledge their receipt.' In others, a practice of acknowledging receipt may be adopted by an addressee. In either case, the UETA makes clear that such an acknowledgment establishes the fact of receipt but does not, without more, establish the content of the information received. 0 3 Furthermore, if a person is aware that a record has not in fact been sent or received, that person cannot rely on the rules for sending and receiving contained in the UETA. The legal consequences of the sending or receiving are then determined by other applicable law.'04

D. Electronic Agents and Automated Transactions

Although the use of automated programs for the conduct of transactions has been possible for over two decades, with the emer- gence of the Internet automation of transactions has emerged from the commercial uses of electronic data interchange and penetrated consumer markets. In the EDI transaction, it was quite possible for a company to program its computers to generate and transmit transaction sets ordering supplies or acknowledging or confirming orders without the intervention of human beings. 105 In today's retail Internet transaction, the Internet-based merchant will use software, an "electronic agent,"'' 0 to gather ordering information from a customer by

101. Id. § 10(1) and cmt. The comment notes that this provision is consistent with the Restatement 2nd of Contracts. It constitutes a particular articulation of the general rules applicable to mistakes. Id. 102. See EDI Report, supra note 10. 103. UETA § 15(f). 104. Id. § 15(g). This provision also limits the power of the parties to vary the provisions of this section in cases where other law mandates sending or receipt. Where such other law exists, the provisions may be varied only to the extent that other law permits variation by agreement. Id. 105. EDI Report, supra note 10. 106. UETA § 102(6). The Act defimes "electronic agent" as "a computer program or an electronic or other automated means used independently to initiate an action or re- Electronic Signatures Page 38 of 309

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asking the customer to enter specific information and to solicit the 0 7 customer's final decision to purchase. The law generally assumes the existence of human actors as decision makers. From one perspective, electronic agents are "conducting" the transaction and manifesting the assent. From another, they are merely tools used by individuals or other actors. Concern has been expressed that automated transactions might be challenged on the ground that human beings have not been involved and thus pre- programmed operations of computers or other devices will not be regarded as sufficient "manifestations of assent" to bind humans to the consequences of those operations. 08 To allay such concerns, the Act explicitly provides that a contract may be formed by the interaction of electronic agents, whether that interaction is with other electronic agents or with individuals. '° In addition, concerns have been expressed that in automated transactions an inadvertent pressing of a computer button may result in a party being bound without intending to contract. The argument is made that persons may not understand that pushing a computer's "enter" key or clicking on a "purchase now" button, i.e., hitting a single computer key, may not be understood by the person interacting with the electronic agent to be a legally effective act. Other concerns were expressed that, particularly with "clickwrap" transactions,11 0 ea- ger consumers might hurry through opening screens without understanding the gravity of that action.' 1

spond to electronic records or performances in whole or in part, without review or action by an individual." Id. 107. See, e.g., http://www.amazon.com or http://www.quikbook.com. It also is possible for a purchaser to use software that will search for available offers, select among them and interact with the seller's webpage to conclude a transaction. 108. The concern over this dichotomy is enhanced when so-called intelligent agents, software that can "learn" and evolve after being launched, are considered. It is quite possible for a party to launch software capable of initiating, performing and con- summating transactions without the intervention of a human being. 109. UETA § 14. Subsection (2) provides explicitly that if an individual performs actions he or she is free to refuse, and if the individual knows or has reason to know those actions will cause the electronic agent to complete the transaction or performance, the actor is bound. Id. § 14(2). The terms of the contract governing that transaction or performance is, of course, governed by general principles of law. Id. § 14(3). E-Sign is on accord. See E-Sign § 101(h). 110. These are transactions in which the terms and conditions of a software or information license are contained in initial or opening screens which appear when first loaded into a computer. It is common for such programs to require or compel the user through those screens before securing access to the information which is the subject of the transaction. See, e.g., Hill v. Gateway 2000, Inc., 105 F.3d 1147 (7th Cir. 1997), reh. den. 1997. 111. Another concern is that because the terms of such transactions are located on merchant's websites and may be changed from time to time, purchasers may not be Electronic Signatures Page 39 of 309

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These concerns have been so pervasive that the '!ETA includes a special right to avoid such a transaction for inadvertent error in automated transactions."2 If the electronic agent did not allow for the prevention or correction of an error, the other party may avoid a transaction or legal consequence caused by an inadvertent error."8 The avoidance is subject to several conditions. First, on learning that the other party believed a transaction had occurred, the individual must give prompt notice of the error and that he or she did not intend to be bound. In addition, the individual may not have used or received the benefit of the transaction. Finally, the individual must take reasonable steps to return any consideration received as a result of the transaction, including compliance with any reasonable instructions given by the other party for return or destruction of the item."'

able to retain or later access those terms in the event of a dispute. E-Sign provides that a court may deny enforceability to an electronic record if the record "is not in a form that is capable of being retained and accurately reproduced for later reference by all parties or persons who are entitled to retain the contract or other record." E-Sign § 101(e). While Hillebrand and Saunders appear to assume that this provision requiibs that a copy be furnished to a consumer at the outset of a transaction, the language of the statute does not do so. See Hillebrand & Saunders, supra note 30. The federal act instead requires that the record be in a form that is capable of being retained and reproduced for later reference. If E-Sign did contain the provisions claimed by Hillebrand and Saunders, the provision would render all electronic records subject to subsequent attack. Furthermore, a party seeking to enforce the provisions of some term must have retained the record or otherwise bear the burden of establishing its contents. If the party did retain the record, it would be discoverable. If the party did not, its evidence of the contents of the record would be discoverable. On the other hand, the UBTEA does specify that any legally required notices or information which must be sent to consumers have not been provided if the sender or its information processing systems "inhibit] the ability of the recipient to print or store the electronic record." UETA § 8(a). This provision, which refers to existing state consumer protection laws, seeks to strike an appropriate balance implementing policies requiring communication or posting of information without requiring merchants to assume all risks of system configuration. 112. UETA § 10(2). The drafters regarded this provision as an addition to the otherwise applicable rules governing mistake. The provision specifically states that in cases where the special provisions do not apply, the effect of any change or error is governed by other law, including the law of mistake, and by the parties' contract, if any. UETA § 10(3). 113. This provision is designed to encourage parties acting through electronic agents to build into their systems methods for avoiding or discouraging such errors. For example, it is reasonably common for retail Internet merchants to provide confirmation screens which reflect the transaction data received and ask for an additional action to verify the transaction. Others may transmit an email verification of the transaction, with a request to notify promptly in the event of error. See, e.g., http//www.biztravel.com. 114. UETA § 10(2) and cmt. This provision also has been criticized by Hillebrand and Saunders, who state the provision is illusory unless the courts "require an effective, well-designed prevention opportunity that draws an active response from the consumer, rather than just any passive order confirmation screen .... Hillebrand & Saunders, su- pm note 30, at 7. The UETA relies on existing doctrines, such as unconscionability and Electronic Signatures Page 40 of 309

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E. Record-keeping and Evidence

Validation of the use of electronic records and communications in transactions accomplishes little if the parties cannot be assured that they may store their records electronically and enforce transactions with the use of electronic records. Concerns have been expressed, however, that electronic records are not inherently reliable and may be altered without generating the same sort of forensic evidence of tampering which would result if paper records were altered.' On the other hand, the Drafting Committee remained mindful of its goal to permit electronic commerce to be treated on a par with paper records and its purpose to avoid imposing or creating new barriers to electronic commerce. Various parties advised the Drafting Committee that the costs of storing paper records are becoming prohibitive, describing warehouses the size of football fields and vast repositories of miles of filing cabinets. The Drafting Committee concluded that all that was required to assure the admissibility of electronic records was a provision specifying that electronic records shall not be denied admissibility solely because they are in electronic form."' With respect to record-keeping, however, more guidance was believed appropriate. Concern was expressed by many that without guidance, parties might be unsure of their ability to retain records in electronic form. Furthermore, while one purpose of record-retention is to preserve records which will be admissible in the event of litigation, records also are required to be retained by various regulators, taxing authorities, auditors, etc. Re- tained records also may be consulted with parties wishing clarification of their rights and obligations. The amount of specification required or appropriate was the subject of much discussion. Ultimately the Drafting Committee chose to establish standards to guide parties seeking to retain records in electronic formats. Accordingly, UETA section 12(a) provides that a record is to be retained electronically in an electronic record which accurately reflects the information con-

fraud, for the policing of inappropriate behavior in electronic transactions and eschews additional regulation. A similar concern is expressed in E-Sign, which requires studies of the effectiveness and costs of the specified consumer protections and permits regulatory exemption from their provisions. E-sign §§ 103(c)(2), 105(b). These sections explicitly limit the interpretation power of regulators by requiring a finding that methods selected to carry out regulatory goals "are substantially equivalent to the requirements imposed on" paper and will not impose undue costs on electronic commerce. E-Sign § 104(b)(2)(c)(ii)(I). 115. This is one of the concerns expressed by consumer advocates and urged as a reason for increasing regulation in this area. See Hillebrand & Saunders, supra note 30, at 3-4. 116. UETA § 13. This provision was drafted in consultation with Professor Leo Whinery, University of Oklahoma Law Center, Reporter for the Drafting Committee to Revise Uniform Rules of Evidence. Electronic Signatures Page 41 of 309

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tained in the record when first generated in final form and which remains accessible for later reference. This standard applies whenever the law requires that a record be retained, whenever the law requires that a record be presented or retained in its original form, or whenever a law imposes consequences if the record is not presented or re- 1 1 7 tained in its original form. The federal E-Sign act repeats the provisions of the UETA, but contains additional detail. E-Sign section 101(d)(1)(B) states that the record must "remain[] accessible to all persons who are entitled to access by statute, regulation, or rule of law, for the period required by such statute, regulation, or rule of law, in a form that is capable of being accurately reproduced for later reference, whether by transmission, printing, or otherwise.1 1 8 In addition to the general standard, UETA section 12 provides some additional clarification. The requirement to retain a record does not extend to information which is designed solely to enable the required information to be sent, communicated or received.' Parties receive explicit permission to use third parties to handle their record- keeping.12 0 In addition, the UETA explicitly states that these provisions apply to checks to the extent they are within the scope of the Act, simply requiring retention of a record of the information on the 21 front and back of the check.

117. Since the UETA excludes most of the UCC, this provision does not apply to the presentment or delivery of negotiable instruments. See, e.g., U.C.C. § 3-501(b)(2) (providing that a person to whom presentment is made may demand exhibition of the instrument). 118. As has been noted, this provision apparently is interpreted by consumer advocates to require that the record actually be furnished to the consumer at the outset of the transaction. See supra note 30. The language of the statute, however, is that the information be in a form capable of being reproduced. If a consumer has chosen to use a de- vice which lacks the capacity to print or download the information, both statutes impose the risk on that consumer. THOMAS J. SMEDINGHOFF, ELEcFRoNIC TRANSACnONS IN THE NEW E-SIGN LAW: WHAT IT MEANS AND HOW IT WORKS (2000). 119. UETA § 12(b). Of course, if the information which must be retained or which a party seeks to introduce into evidence is the addressing information itself, that information will not be available if it has not been retained. 120. UETA § 12(c). It has been suggested by some that the use of third-parties to store records offers additional assurances of the reliability of records which have been stored electronically. In addition, given the potential for damage to a party's computer system from sabotage (hackers or viruses) or weather (lightning), the use of off-site storage for copies of records is attractive. Whatever the reason for retaining the third-party, this provision explicitly validates outsourcing record-keeping. 121. Id. In light of the research by the Federal Reserve Bank of Boston, the Drafting Committee was urged to and did include this specific reference to checks in section 12. Even in cases involving records, other than checks, which relate to transactions governed by bodies of law excluded from the UETA for one reason or another, to the ex- Electronic Signatures Page 42 of 309

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Two other provisions of section 12 have been circumscribed dra- matically by the provisions of the federal E-Sign Act. One of these provisions recognized that a state might enact legislation, subsequent to the enactment of the UETA, which specifically prohibited the use of an electronic record for evidentiary, audit, or like purposes. 2 2 The other provided that a governmental agency might impose requirements, in addition to those found in section 12(a), for the retention of records subject to the agency's jurisdiction.1 2 3 E-Sign limits the ability of states to enact legislation requiring paper or manual signatures, both in the preemption provisions of E-Sign section 102 and in the provisions of E-Sign section 104, which limits the authority to require paper to situations involving compelling governmental interests tied 124 to law enforcement or national security.

F. Time and Place of Sending and Receipt

One of the most difficult issues for any drafters attempting to deal with electronic commerce, and one on which there does not seem to be any developing consensus, relates to issues arising from the ir- relevance of geography in electronic commerce. There is a cluster of issues for electronic commerce which arise out of this fact, not the least of which is the appropriate measure of jurisdiction over parties to electronic transactions. Although there is an evolving body of case law discussing the Constitutional limits of personal jurisdiction in the United States, and the courts of other nations have asserted jurisdiction over companies operating within the United States, the Drafting Committee declined to address the jurisdiction issue. That issue, as well as questions of choice of law and the enforceability of contractual provisions selecting a forum for disputes and a governing law, continues to be debated in local, national and international venues. It is sufficiently contentious that the Drafting Committee was concerned that attempts to resolve the issue would delay the project and/or delay en- 1 2 actment.

tent that the record is being used for some reason within the scope of this Act, section 12 permits retention in electronic form provided its requirements are satisfied. Id. § 12. 122. Id. § 12(). 123. Id. § 12(g). 124. E-Sign § 104. Subsection (a) is interpreted by many to permit regulators to require paper for filings under its permission for the agency or organization to require filings to conform to "specified standards or formats." Id. Clearly, however, subsection (b) applies to all other requirements and bars paper requirements except in the limited circumstances identified in the text. See id. 125. The jurisdiction issues are reviewed and recommendations made in the recent report from the Cyberspace Committee of the Business Law section of the American Bar Association, TransnationalIssues in Cyberspace: A Project on the Law Relating to Ju- risdiction,at http://www. abanet.org/buslaw/cyber/initiativesvjurisdiction.html. Electronic Signatures Page 43 of 309

2001] INTRODUCTION TO THE UNIFORM 267 ELECTRONIC TRANSACTIONS ACT

The UETA addresses a more modest issue, one which may con- tribute to the development of a consensus on appropriate jurisdictional limits and one which should assist in answering a number of other questions. The Drafting Committee again refrained from establishing new substantive rules and regulations. " Instead, the UETA confines itself to establishing the place and time of electronic communications. Whatever substantive or jurisdictional rules may evolve in the future, they may be applied in light of section 15 of the UETA, which specifies both the time and place of sending and receipt of communications. Section 15(a) specifies that, unless otherwise agreed between the parties, an electronic record is sent when it is properly addressed or otherwise directed to an information system that the addressee has designated or uses for such communications and from which the recipient is able to retrieve the record.127 Similarly, an electronic record is received, unless otherwise agreed, when it enters an information processing system the recipient has designated or uses and is in a form capable of being processed by that system.ss

126. The National Consumer Law Center has urged that a provision be added to the UETA specifying that any consumer contract entered into by a resident of the state is governed by the law of that state. See Memorandum of National Consumer Law Center, The Need to Protect Consumers - Especially Low-Income Consumers - from UETA, supra note 30. This is somewhat ironic, since the Drafting Committee was advised that some Attorneys General specifically did not want the UETA to specify the time when electronic records or transactions became effective [whether upon sending or receipt], because of concern that such provisions might change existing law upon which their consumer protection jurisdiction depended. 127. Although the comments are silent on this point, it is the recollection of the author that the purpose of requiring that the communication be sent to an information processing system from which the recipient is able to retrieve the record is to assure capability. It is not designed to permit the recipient to block the other party's ability to send notices or information by the simple expedient of failing to access the system or failing to pay subscriptions to access providers. Just as a letter is sent to an addressee when it is placed in the postal system containing appropriate postage and bearing an address which the recipient has designated or uses, an electronic record is sent when it is directed to an information processing system which the recipient uses. The fact that a postal addressee fails to retrieve mail from a postal box or closes the box without notice does not affect the fact of sending via the mail. By the same token, the fact that an electronic addressee fails to retrieve electronic information from the system used, or terminates relations with that system without notice to the sender, should not affect the fact of sending the electronic record. The responsibility of the sender is to send the information; if the law requires delivery of the information, other issues arise which are not affected by this provision of the UETA. See UETA § 15(a) and cmt. 128. Id. § 15(b). Once again, the goal is to assure that the information arrives, not that the addressee actually accesses or reads it. The risk of being bound to something contained within or resulting from receipt of the information appropriately falls on the addressee, who may choose whether to read or learn of the information or not. Electronic Signatures Page 44 of 309

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In addition to identifying the time of sending and receipt, section 15 adopts the policy that the location of the computers or systems processing the information is irrelevant. Similarly, the Committee was of the opinion that the physical location of the human that transmits or to whom the message is addressed was not critical. With the advent of laptop computers and wireless technologies, the physical location of the human being may be entirely fortuitous. The Act takes the position that the critical geographic factor is the location of the place of business of the party. If the person has more than one place of business, the place of sending or receipt is the place of business having the closest relationship to the underlying transaction and if a party does not have a place of business, the record is sent or received from the residence of the party. The legal effect of these timing and geography rules is left to other law governing the transaction. 29

G. Consumer Protection

The UETA does not distinguish between consumers and others. 130 Instead, it specifies that if a rule of law requires that information be provided in writing, the information may be furnished in a record that 3 is capable of retention by the addressee.1 1 It further provides that a record is not capable of retention if either the sender or an information processing system used by it inhibits the ability of the recipient to 32 print or store the record.1 Many statutes which require that information be provided, sent, or delivered also contain specific requirements for formatting, display or posting, or specifying the method of communication. In order to provide some guidance for those required to furnish information, beyond the simple statement that electronic media may be used, and in order to assure that the specifics of those state laws will be observed, section 8 adds that those additional requirements must be satisfied, subject to only two exceptions. If the law that requires the information provides that parties may vary its provisions by agreement, section 8(d) permits the parties using electronic media to do so. Similarly if the law that requires the information mandates use of regular

129. See cmt. to UETA § 15. 130. Advocates for consumer protection organizations do not believe these provisions are sufficient. Their specific assertions are discussed throughout this text. Even if the drafters might have considered some of their proposals during the drafting process, the enactment of E-Sign seriously limits the ability of the Act's sponsors to propose any changes to the text of the UETA. 131. UETA § 8(a). 132. Gail T. Hillebrand and Margot Saunders have claimed this provision is inadequate and that the record-retention provisions of E-Sign afford greater protection. The author disagrees, for the reasons stated in supra notes 114 -15 and accompanying text. Electronic Signatures Page 45 of 309

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United States mail service but provides that the parties may agree to different methods, such agreements also are effective in the electronic environment. In other words, section 8 permits the use of electronic media in circumstances where other law requires that information be provided, sent or delivered, but does not relieve the parties of their obligation to conform to all other requirements of those statutes or regulations. Finally the parties are permitted to agree to changes in those requirements only to the extent that the other law permits vari- ance by agreement.

H. Transferable Records

The one place where the UETA violates the policies of minimal- ism, neutrality, and facilitation rather than encouragement is located in section 16, which establishes the new concept of 'transferable record." A transferable record is an electronic promissory note or document of title. Under the provisions of section 16 the person in control of the record may enjoy the incidents of negotiability. This departure from the principles which otherwise governed the drafting of the UETA was undertaken because the Drafting Committee was convinced that in this particular setting the lack of governing law seriously impeded the development of electronic systems. As has been noted, the one area of civil law where electronic records clearly cannot serve the functions of writings is in the area of negotiable instruments.1 33 At the same time, it is obvious that electronic systems may accomplish many of the goals of negotiability. For example, for many years the wholesale funds transfer system has handled more value than all other payment systems. UCC Article 4A establishes a legal regime for this system which governs the passage of rights from one party to the next by looking to ascertainable events in the movement of the funds. It is not built on the same model as Article 3, governing notes and drafts, but accomplishes the same functions of governing a payment system and the rights and liabilities of the parties." The Drafting Committee was advised that in order to permit parties to create electronic analogues for paper-based systems, significant investments of capital would be required. However, the lack of a legal framework establishing rules that would permit the electronic records to have legal effects on a par with paper records discouraged such investment.3'

133. See supra text accompanying notes 31-33. 134. U.C.C. Article 4A Prefatory Note. 135. UETA § 16, cmt. 1. For an example of how parties may implement systems dealing in transferable records, see Freddie Mac, "Preliminary Specifications for Elec- Electronic Signatures Page 46 of 309

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After substantial negotiations involving representatives of regulators and industry, the provisions in UETA section 16 were adopted by the Drafting Committee. 3 6 These provisions are expected to constitute only the first step in developing appropriate rules governing electronic markets, with further development anticipated as experience is gained in the workings of such markets. Nevertheless, the provisions of the Act establish minimum rules for the creation of systems and markets in electronic records. While the provisions of section 16 are described below, full exploration of the subject deserves its own paper. No effort will be made to fully explore the implications of these provisions; this paper will content itself with description."3 7 The first requirement for establishing a market is the creation of a transferable record, "an electronic record that: (1) would be a note under [UCC Article 3] or a document under [UCC Article 7] if the electronic record were in writing, and (2) the issuer expressly has agreed is a transferable record."'1 3 Thus, before this provision applies, the record must satisfy the requirements of UCC Article 3 for a note or of UCC Article 7 for a warehouse receipt or bill of lading, and the issuer must have explicitly stated that it should be treated as a transferable record. In addition, the benefits of the section are only available if a person has "control" of the record. The concept of "control" is derived from the revised UCC Article 9,139 governing security interests, and requires a system which "reliably establishes [a] person as the person to which the transferable record was issued or transferred. '14 0 It does not specify how such a system must function, relying instead on the crite- rion of reliably establishing the person to whom the record was issued or transferred. However, the Act does provide that a system satisfies these provisions if the transferable record is created, stored and assigned in a such a manner that:

tronic Loan Documentation, Second Discussion Draft, March 2, 2001." The transmittal letter which accompanied this draft stated "[the potential benefits of electronic mort- gages directly relate to our mission of achieving the most dependable supply of mortgage funds at the lowest possible cost, through improving capital markets and the origination, closing, and servicing processes." (on file with author). Letter of Greg Foley, Director, Single-Family Group, Mortgage Asset Acquisition and Custody, Freddie Mac, dated March 2, 2001. (on file with author). 136. UETA § 16. Identical provisions, with the sole exception that they are limited to real property secured notes, have been incorporated into E-Sign § 201. 137. For an early treatment of the subject, see Jones and Winn, It's real - here are the details, 10 BuS. L. TODAY 8 (March/April 2001). 138. UETA § 16(a). 139. See U.C.C. revised § 9-105 (1999); see also U.C.C. § 8-106 (1987) (governing control of investment securities). 140. UETA § 16(b). Electronic Signatures Page 47 of 309

2001] INTRODUCTION TO THE UNIFORM 271 ELECTRONIC TRANSACTIONS ACT

1. A single, authoritative copy of the record exists which is unique, identifiable and, except as required for revision, cannot be altered. It is necessary that, if any copies may exist, those copies are reliably identifiable as copies and not the authoritative copy. Any transfers must be possible only with the assent of the party in control, as must any revision;141 2. The authoritative copy must identify the person as-

serting control as either the person to whom the record was2 issued or to whom it has most recently been transferred;" and 3. The authoritative copy must be communicated to and maintained by the person asserting control or its designated 4 custodian. 1

If these conditions are satisfied, the person in control of the transferable record has the same rights and defenses as a holder of a note under UCC Article 3 or negotiable document under UCC Article 7. If the person otherwise satisfies the requirements to be a holder in due course or a holder by due negotiation," the person has the rights and defenses of such a holder or purchaser. Delivery, possession and indorsement are not required. As the comments to section 16 note, the primary essential is that the system used is able to securely and demonstrably permit transfer of rights in the record from one person to another in a manner which assures that only one "holder" exists. The Drafting Committee believed that, at least in today's technologies, some sort of third party registry probably would be the most effective way to satisfy the requirements of this section. Nevertheless, in keeping with its policies against specifying technologies or business models, and in keeping with its awareness of the rapid pace of technological development, 5 section 16 does not require any particular technology or model.4 While the person in control of a transferable record enjoys rights similar to those of a holder of a negotiable instrument, the obligor under the transferable record also enjoys the rights and defenses of an equivalent obligor under the UCC. Furthermore, an obligor may assure itself that a person requesting payment or performance is a per-

141. Id. § 16(c)(1), (4)-(6). 142. Id. § 16(cX2). 143. Id. § 16(c)(3). 144. Id. § 16(d) (explicitly referencing U.C.C. §§ 3-302(a), 7-501 and 9-308). 145. Id. § 16, cmt. 2. For an example of a third party registry, see the system for issuance and transfer of electronic cotton warehouse receipts under 7 C.F.R. § 735. Electronic Signatures Page 48 of 309

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son in control by demanding reasonable proof, which may include ac- 14 6 cess to the authoritative copy and related business records. While these provisions establish a framework for a system of markets in electronic records, they are not complete. They were drafted under the assumption that many of the rules applicable to any 147 such systems would be created by system rules or other agreement. Until some experience is gained with transferable records and the systems created to implement-them, it seemed most prudent to avoid over-regulating.

I. Government Records

Sections 17, 18 and 19 of the UETA authorize governmental entities, at all levels of the state, to create and retain electronic records and to convert written records into electronic databases. These provisions have been bracketed, and it is assumed that they will be enacted only in those states where this authorization will be helpful.1 48 The Drafting Committee was urged by representatives of various state agencies to include provisions authorizing them to migrate to electronic technologies, and of course any governmental rules concerning commercial interactions with governmental agencies will have a major impact on the adoption of technologies, methods of record-keeping, and business models selected by commerce. The Drafting Committee did not feel at liberty to do more than authorize government agencies. We were convinced that a mandate would harm enactment, due to the price tag which could accompany such a bill in many states. Instead, these provisions authorize agencies to create and retain records, to accept and distribute electronic records, and to write the regulations which necessarily must govern their use of electronic technologies. Finally, it encourages and urges all such regulations to encourage and promote interoperability of their systems.

VI. CONCLUDING THOUGHTS

A century ago, most homes did not have electricity or indoor plumbing. Telephones and automobiles were rare. Airplanes were un- known, plastics and mass-produced steel had not emerged, nor had

146. Id. § 16(e)-(f). 147. Such rules have the effect of agreements under UETA § 2(1). 148. According to one summary of the 2000 enactments, fourteen states enacted these provisions without material change, three states adopted provisions tailored specifically to their needs, and five states deleted the provisions. ALSTON & BIRD, SUMMARY OF STATE VARIATIONS IN ADOPTION OF THE UNIFORM ELEcTRONIc TRANSAcnoNs AcT IN THE NEW E-SIGN LAW: WHAT IT MEANS AND HOW IT WORKS (2000). Electronic Signatures Page 49 of 309

2001] INTRODUCTION TO THE UNIFORM ELECTRONIC TRANSACTIONS ACT

kitchen appliances, television or movies. 149 Technological change is not a stranger to society or the legal system but it sometimes seems each generation must learn anew how to address such change. Our generation is immersed in that process today. It is hoped that these remarks can assist those who seek to understand the UETA, and the policies and principles which form its basis. It is hoped also that these remarks may assist others as they seek to address additional issues arising from technological change.

149. CHARLES JONSCHER, THE EVOLUTION OF WIRED LIFE: FROM THE ALPHABET TO THE SOUL-CATCHER CHIP-How INFORMATION TECHNOLOGIES CHANGE OUR WORLD 1-2 (1999). Electronic Signatures Page 50 of 309 10 Recent Decisions Every Page 51 of 309 Attorney Should Know

| | Caution As of: November 21, 2014 3:35 PM EST

Halliburton Co. v. Erica P. John Fund, Inc. Supreme Court of the United States March 5, 2014, Argued; June 23, 2014, Decided No. 13-317

Reporter 134 S. Ct. 2398; 189 L. Ed. 2d 339; 2014 U.S. LEXIS 4305; 82 U.S.L.W. 4522; Fed. Sec. L. Rep. (CCH) P98,003; 88 Fed. R. Serv. 3d (Callaghan) 1472; 24 Fla. L. Weekly Fed. S 897; 2014 WL 2807181 HALLIBURTON CO., et al., Petitioners v. ERICA P. JOHN of certiorari, the corporation appealed the judgment of the FUND, INC., fka ARCHDIOCESE OF MILWAUKEE U.S. Court of Appeals for the Fifth Circuit which precluded SUPPORTING FUND, INC. price impact evidence at the class certification stage to rebut the presumption of reliance. Notice: The LEXIS pagination of this document is subject to change pending release of the final published version. Overview The corporation contended that current economic realities Subsequent History: Remanded by Erica P. John Fund, no longer justified the presumption that the purchaser relied Inc. v. Halliburton Co., 765 F.3d 550, 2014 U.S. App. LEXIS upon the alleged misrepresentations based on the stock price 16652 (5th Cir. Tex., Aug. 28, 2014) in an efficient market reflecting the misrepresentations. The corporation also argued that evidence that the alleged Prior History: [***1] ON WRIT OF CERTIORARI TO misrepresentations did not impact the price was appropriate THE UNITED STATES COURT OF APPEALS FOR THE to rebut the presumption and preclude class certification. FIFTH CIRCUIT The U.S. Supreme Court unanimously held that the Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423, corporation was entitled to present price impact evidence in 2013 U.S. App. LEXIS 8933 (5th Cir. Tex., 2013) addressing class certification to rebut the presumption of reliance in the securities fraud case. The presumption Disposition: 718 F. 3d 423, vacated and remanded. remained viable and could be rebutted by proof of a lack of market efficiency, and the purchaser was not required to Core Terms prove price impact at the class certification stage. However, the corporation was entitled to an opportunity to rebut the presumption of reliance before class certification with investors, stock, market price, misrepresentation, class evidence of a lack of price impact, and such evidence was certification, securities, traded, predominance, invoke, class appropriate to counter the purchaser’s showing of market action, buy, misstatement, alleged misrepresentation, efficiency in an attempt to establish that common issues did rebutting a presumption, markets, public information, cause not predominate for purposes of class certification. of action, prerequisites, certification, requirements, publicly, transact, private cause of action, fraud-on-the-market, merits, Outcome overruling, company’s, materiality, hypothesis, decisions The judgment precluding price impact evidence at the class certification stage was vacated, and the case was remanded Case Summary for further proceedings. Unanimous Decision; 2 Concurrences. Procedural Posture Respondent purchaser of securities brought a putative class LexisNexis® Headnotes action against petitioner corporation alleging that the corporation made misrepresentations which artificially Evidence > Inferences & Presumptions > Presumptions > inflated the price of the securities. Upon the grant of a writ Creation 10 Recent Decisions Every Page 52 of 309 Attorney Should Know

Page 2 of 25 134 S. Ct. 2398, *2398; 189 L. Ed. 2d 339, **339; 2014 U.S. LEXIS 4305, ***1

Evidence > Inferences & Presumptions > Presumptions > Civil Procedure > ... > Class Actions > Prerequisites for Class Rebuttal of Presumptions Action > Superiority Securities Law > ... > Elements of Proof > Reliance > Fraud on Securities Law > ... > Securities Exchange Act of 1934 the Market Actions > Implied Private Rights of Action > Class Actions

HN1 Investors can recover damages in a private securities Securities Law > ... > Elements of Proof > Reliance > General Overview fraud action only if they prove that they relied on the defendant’s misrepresentation in deciding to buy or sell a HN4 Requiring direct proof of reliance in a securities fraud company’s stock. Investors can satisfy this reliance action would place an unnecessarily unrealistic evidentiary requirement by invoking a presumption that the price of burden on the 17 C.F.R. § 240.10b-5 (2013) plaintiff who stock traded in an efficient market reflects all public, has traded on an impersonal market. That is because, even material information—including material misstatements. In assuming an investor could prove that he was aware of the such a case, anyone who buys or sells the stock at the misrepresentation, he would still have to show a speculative market price may be considered to have relied on those state of facts, i.e., how he would have acted if the misstatements. However, a defendant can rebut this misrepresentation had not been made. Requiring proof of presumption in a number of ways, including by showing individualized reliance from every securities fraud plaintiff that the alleged misrepresentation did not actually affect the effectively would prevent plaintiffs from proceeding with a stock’s price—that is, that the misrepresentation had no class action in § 240.10b-5 suits. If every plaintiff had to price impact. prove direct reliance on the defendant’s misrepresentation, individual issues then would overwhelm the common ones, Governments > Courts > Judicial Precedent making class certification under Fed. R. Civ. P. 23(b)(3) inappropriate. HN2 Before overturning a long-settled precedent, the U.S. Supreme Court requires special justification, not just an Evidence > Inferences & Presumptions > Presumptions > argument that the precedent was wrongly decided. Creation

Securities Law > ... > Implied Private Rights of Action > Securities Law > ... > Elements of Proof > Reliance > Fraud on Elements of Proof > General Overview the Market

Securities Law > ... > Elements of Proof > Reliance > General HN5 Securities fraud plaintiffs can in certain circumstances Overview satisfy the reliance element of a 17 C.F.R. § 240.10b-5 (2013) action by invoking a rebuttable presumption of HN3 15 U.S.C.S. § 78j(b) and 17 C.F.R. § 240.10b-5 (2013) reliance, rather than proving direct reliance on a prohibit making any material misstatement or omission in misrepresentation. The presumption is based on what is connection with the purchase or sale of any security. known as the “fraud-on-the-market” theory, which holds Although § 78j(b) does not create an express private cause that the market price of shares traded on well-developed of action, the U.S. Supreme Court recognizes an implied markets reflects all publicly available information, and, private cause of action to enforce the provision and its hence, any material misrepresentations. Rather than implementing regulation. To recover damages for violations scrutinize every piece of public information about a company of § 78j(b) and § 240.10b-5, a plaintiff must prove: (1) a for himself, the typical investor who buys or sells stock at material misrepresentation or omission by the defendant; (2) the price set by the market does so in reliance on the scienter; (3) a connection between the misrepresentation or integrity of that price—the belief that it reflects all public, omission and the purchase or sale of a security; (4) reliance material information. As a result, whenever the investor upon the misrepresentation or omission; (5) economic loss; buys or sells stock at the market price, his reliance on any and (6) loss causation. The reliance element ensures that public material misrepresentations may be presumed for there is a proper connection between a defendant’s purposes of a § 240.10b-5 action. misrepresentation and a plaintiff’s injury. The traditional (and most direct) way a plaintiff can demonstrate reliance is Evidence > Inferences & Presumptions > Presumptions > by showing that he was aware of a company’s statement and Creation engaged in a relevant transaction—e.g., purchasing common Securities Law > ... > Elements of Proof > Reliance > Fraud on stock—based on that specific misrepresentation. the Market

Civil Procedure > ... > Class Actions > Prerequisites for Class HN6 Based on the fraud-on-the-market theory, a plaintiff Action > Predominance must make the following showings to demonstrate that the 10 Recent Decisions Every Page 53 of 309 Attorney Should Know

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presumption of reliance applies in a given securities fraud HN10 In securities class action cases, the crucial requirement case: (1) that the alleged misrepresentations were publicly for class certification will usually be the predominance known; (2) that they were material; (3) that the stock traded requirement of Fed. R. Civ. P. 23(b)(3). in an efficient market; and (4) that the plaintiff traded the stock between the time the misrepresentations were made Evidence > Inferences & Presumptions > Presumptions > and when the truth was revealed. Creation Securities Law > ... > Elements of Proof > Reliance > Fraud on Evidence > Inferences & Presumptions > Presumptions > the Market Creation Securities Law > ... > Elements of Proof > Reliance > Fraud on HN11 To invoke the presumption of reliance in a securities the Market fraud action, a plaintiff must prove that: (1) the alleged misrepresentations were publicly known; (2) they were HN7 The presumption of reliance in a securities fraud case material; (3) the stock traded in an efficient market; and (4) is rebuttable rather than conclusive. Specifically, any the plaintiff traded the stock between when the showing that severs the link between the alleged misrepresentations were made and when the truth was misrepresentation and either the price received (or paid) by revealed. Each of these requirements follows from the the plaintiff, or his decision to trade at a fair market price, fraud-on-the-market theory underlying the presumption. If will be sufficient to rebut the presumption of reliance. So for the misrepresentation was not publicly known, then it could example, if a defendant could show that the alleged not have distorted the stock’s market price. So too if the misrepresentation did not, for whatever reason, actually misrepresentation was immaterial—that is, if it would not affect the market price, or that a plaintiff would have bought have been viewed by the reasonable investor as having or sold the stock even had he been aware that the stock’s significantly altered the total mix of information made price was tainted by fraud, then the presumption of reliance available—or if the market in which the stock traded was would not apply. In either of those cases, a plaintiff would inefficient. And if the plaintiff did not buy or sell the stock have to prove that he directly relied on the defendant’s after the misrepresentation was made but before the truth misrepresentation in buying or selling the stock. was revealed, then he could not be said to have acted in reliance on a fraud-tainted price. Governments > Courts > Judicial Precedent Evidence > Inferences & Presumptions > Presumptions > HN8 The principle of stare decisis has special force in Creation respect to statutory interpretation because Congress remains Securities Law > ... > Elements of Proof > Reliance > Fraud on free to alter what courts have done. the Market

Evidence > Inferences & Presumptions > Presumptions > HN12 The first three prerequisites of the presumption of Creation reliance in a securities fraud case are directed at price Securities Law > ... > Elements of Proof > Reliance > Fraud on impact—whether the alleged misrepresentations affected the Market the market price in the first place. In the absence of price impact, the fraud-on-the-market theory and presumption of HN9 Although the presumption of reliance in a securities reliance collapse. The fundamental premise underlying the fraud case is a judicially created doctrine designed to presumption is that an investor presumptively relies on a implement a judicially created cause of action, the misrepresentation so long as it was reflected in the market presumption is a substantive doctrine of federal securities-fraud law. That is because it provides a way of price at the time of his transaction. If it was not, then there satisfying the reliance element of the 17 C.F.R. § 240.10b-5 is no grounding for any contention that the investor indirectly (2013) cause of action. As with any other element of that relied on that misrepresentation through his reliance on the cause of action, Congress may overturn or modify any integrity of the market price. aspect of courts’ interpretations of the reliance requirement, including the presumption itself. Evidence > Inferences & Presumptions > Presumptions > Creation

Civil Procedure > ... > Class Actions > Prerequisites for Class Securities Law > ... > Securities Exchange Act of 1934 Action > Predominance Actions > Implied Private Rights of Action > Class Actions Securities Law > ... > Securities Exchange Act of 1934 Securities Law > ... > Elements of Proof > Reliance > Fraud on Actions > Implied Private Rights of Action > Class Actions the Market 10 Recent Decisions Every Page 54 of 309 Attorney Should Know

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HN13 The presumption of reliance in a securities fraud case alleging that the corporation made misrepresentations which can be rebutted by appropriate evidence, including evidence artificially inflated the price of the securities. Upon the grant that the asserted misrepresentation (or its correction) did not of a writ of certiorari, the corporation appealed the judgment affect the market price of the defendant’s stock. Defendants of the U.S. Court of Appeals for the Fifth Circuit which may introduce price impact evidence at the class certification precluded price impact evidence at the class certification stage, so long as it is for the purpose of countering a stage to rebut the presumption of reliance. plaintiff’s showing of market efficiency, rather than directly rebutting the presumption. Overview: The corporation contended that current economic realities no longer justified the presumption that the Civil Procedure > ... > Class Actions > Prerequisites for Class purchaser relied upon the alleged misrepresentations based Action > Predominance on the stock price in an efficient market reflecting the Evidence > Inferences & Presumptions > Presumptions > misrepresentations. The corporation also argued that Rebuttal of Presumptions evidence that the alleged misrepresentations did not impact the price was appropriate to rebut the presumption and Securities Law > ... > Securities Exchange Act of 1934 Actions > Implied Private Rights of Action > Class Actions preclude class certification. The U.S. Supreme Court unanimously held that the corporation was entitled to Securities Law > ... > Elements of Proof > Reliance > Fraud on present price impact evidence in addressing class certification the Market to rebut the presumption of reliance in the securities fraud HN14 Any showing that severs the link between the alleged case. The presumption remained viable and could be rebutted misrepresentation and the price received (or paid) by the by proof of a lack of market efficiency, and the purchaser plaintiff for securities is sufficient to rebut the presumption was not required to prove price impact at the class of reliance because the basis for finding that the fraud had certification stage. However, the corporation was entitled to been transmitted through market price would be gone. And an opportunity to rebut the presumption of reliance before without the presumption of reliance, a 17 C.F.R. § 240.10b-5 class certification with evidence of a lack of price impact, (2013) suit cannot proceed as a class action: each plaintiff and such evidence was appropriate to counter the purchaser’s would have to prove reliance individually, so common showing of market efficiency in an attempt to establish that issues would not predominate over individual ones, as common issues did not predominate for purposes of class required by Fed. R. Civ. P. 23(b)(3). Price impact is thus an certification. essential precondition for any § 240.10b-5 class action. Outcome: The judgment precluding price impact evidence While plaintiffs are allowed to establish that precondition at the class certification stage was vacated, and the case was indirectly, it does not require courts to ignore a defendant’s remanded for further proceedings. Unanimous Decision; 2 direct, more salient evidence showing that the alleged Concurrences. misrepresentation did not actually affect the stock’s market price and, consequently, that the presumption does not apply. Headnotes EVIDENCE §182;SECURITIES REGULATION §16; > Lawyers’ Edition Display FRAUD -- PROOF OF RELIANCE -- PRESUMPTION ; > Headnote: Decision [1] [**339] Company alleged to have made misrepresentations to inflate stock price held (1) to have failed to justify Investors can recover damages in a private securities fraud overruling prior Supreme Court decision presuming action only if they prove that they relied on the defendant’s classwide reliance in deciding issue of class certification in misrepresentation in deciding to buy or sell a company’s action under 15 U.S.C.S. § 78j(b); but (2) allowed to present stock. Investors can satisfy this reliance requirement by evidence to rebut presumption. invoking a presumption that the price of stock traded in an efficient market reflects all public, material Summary information--including material misstatements. In such a case, anyone who buys or sells the stock at the market price Procedural posture: Respondent purchaser of securities may be considered to have relied on those misstatements. brought a putative class action against petitioner corporation However, a defendant can rebut this presumption in a 10 Recent Decisions Every Page 55 of 309 Attorney Should Know

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number of ways, including by showing that the alleged on the 17 C.F.R. § 240.10b-5 (2013) plaintiff who has traded misrepresentation did not actually affect the stock’s on an impersonal market. That is because, even assuming an price--that is, that the misrepresentation had no price investor could prove that he was aware of the impact. (Roberts, Ch. J., joined by Kennedy, Ginsburg, misrepresentation, he would still have to show a speculative Breyer, Sotomayor, and Kagan, JJ.) state of facts, i.e., how he would have acted if the misrepresentation had not been made. Requiring proof of COURTS §776; > OVERTURNING PRECEDENT individualized reliance from every securities fraud plaintiff ; > Headnote: effectively would prevent plaintiffs from proceeding with a class action in § 240.10b-5 suits. If every plaintiff had to LEdHN[2] [2] prove direct reliance on the defendant’s misrepresentation, individual issues then would overwhelm the common ones, Before overturning a long-settled precedent, the U.S. making class certification under Fed. R. Civ. P. 23(b)(3) Supreme Court requires special justification, not just an inappropriate. (Roberts, Ch. J., joined by Kennedy, Ginsburg, argument that the precedent was wrongly decided. (Roberts, Breyer, Sotomayor, and Kagan, JJ.) Ch. J., joined by Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) EVIDENCE §182;SECURITIES REGULATION §16.5; > FRAUD -- PRESUMPTION OF RELIANCE ; > Headnote: SECURITIES REGULATION §16.5; > PURCHASE OR SALE -- MISREPRESENTATION -- CAUSE OF ACTION LEdHN[5] [5] ; > Headnote: Securities fraud plaintiffs can in certain circumstances satisfy the reliance element of a 17 C.F.R. § 240.10b-5 LEdHN[3] [3] (2013) action by invoking a rebuttable presumption of 15 U.S.C.S. § 78j(b) and 17 C.F.R. § 240.10b-5 (2013) reliance, rather than proving direct reliance on a prohibit making any material misstatement or omission in misrepresentation. The presumption is based on what is connection with the purchase or sale of any security. known as the “fraud-on-the-market” theory, which holds Although § 78j(b) does not create an express private cause that the market price of shares traded on well-developed of action, the U.S. Supreme Court recognizes an implied markets reflects all publicly available information, and, private cause of action to enforce the provision and its hence, any material misrepresentations. Rather than implementing regulation. To recover damages for violations scrutinize every piece of public information about a company of § 78j(b) and § 240.10b-5, a plaintiff must prove: (1) a for himself, the typical investor who buys or sells stock at material misrepresentation or omission by the defendant; (2) the price set by the market does so in reliance on the scienter; (3) a connection between the misrepresentation or integrity of that price--the belief that it reflects all public, omission and the purchase or sale of a security; (4) reliance material information. As a result, whenever the investor upon the misrepresentation or omission; (5) economic loss; buys or sells stock at the market price, his reliance on any and (6) loss causation. The reliance element ensures that public material misrepresentations may be presumed for there is a proper connection between a defendant’s purposes of a § 240.10b-5 action. (Roberts, Ch. J., joined by misrepresentation and a plaintiff’s injury. The traditional Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) (and most direct) way a plaintiff can demonstrate reliance is by showing that he was aware of a company’s statement and EVIDENCE §182; > SECURITIES FRAUD -- engaged in a relevant transaction--e.g., purchasing common PRESUMPTION OF RELIANCE ; > Headnote: stock--based on that specific misrepresentation. (Roberts, LEdHN[6] [6] Ch. J., joined by Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) Based on the fraud-on-the-market theory, a plaintiff must make the following showings to demonstrate that the CLASS ACTIONS §16; > CERTIFICATION -- SECURITIES presumption of reliance applies in a given securities fraud FRAUD ; > Headnote: case: (1) that the alleged misrepresentations were publicly known; (2) that they were material; (3) that the stock traded LEdHN[4] [4] in an efficient market; and (4) that the plaintiff traded the stock between the time the misrepresentations were made Requiring direct proof of reliance in a securities fraud action and when the truth was revealed. (Roberts, Ch. J., joined by would place an unnecessarily unrealistic evidentiary burden Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) 10 Recent Decisions Every Page 56 of 309 Attorney Should Know

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EVIDENCE §182;SECURITIES REGULATION §16; > In securities class action cases, the crucial requirement for FRAUD -- PRESUMPTION OF RELIANCE -- REBUTTAL class certification will usually be the predominance ; > Headnote: requirement of Fed. R. Civ. P. 23(b)(3). (Roberts, Ch. J., joined by Kennedy, Ginsburg, Breyer, Sotomayor, and LEdHN[7] [7] Kagan, JJ.) The presumption of reliance in a securities fraud case is EVIDENCE §182; > SECURITIES FRAUD -- rebuttable rather than conclusive. Specifically, any showing PRESUMPTION OF RELIANCE ; > Headnote: that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his LEdHN[11] [11] decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. So for example, if a To invoke the presumption of reliance in a securities fraud defendant could show that the alleged misrepresentation did action, a plaintiff must prove that: (1) the alleged not, for whatever reason, actually affect the market price, or misrepresentations were publicly known; (2) they were that a plaintiff would have bought or sold the stock even had material; (3) the stock traded in an efficient market; and (4) he been aware that the stock’s price was tainted by fraud, the plaintiff traded the stock between when the then the presumption of reliance would not apply. In either misrepresentations were made and when the truth was of those cases, a plaintiff would have to prove that he revealed. Each of these requirements follows from the directly relied on the defendant’s misrepresentation in fraud-on-the-market theory underlying the presumption. If buying or selling the stock. (Roberts, Ch. J., joined by the misrepresentation was not publicly known, then it could Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) not have distorted the stock’s market price. So too if the misrepresentation was immaterial--that is, if it would not COURTS §775.5; > STARE DECISIS -- STATUTORY have been viewed by the reasonable investor as having INTERPRETATION ; > Headnote: significantly altered the total mix of information made available--or if the market in which the stock traded was LEdHN[8] [8] inefficient. And if the plaintiff did not buy or sell the stock The principle of stare decisis has special force in respect to after the misrepresentation was made but before the truth statutory interpretation because Congress remains free to was revealed, then he could not be said to have acted in alter what courts have done. (Roberts, Ch. J., joined by reliance on a fraud-tainted price. (Roberts, Ch. J., joined by Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.)

EVIDENCE §182; > PRESUMPTION OF RELIANCE -- EVIDENCE §182; > SECURITIES FRAUD -- SECURITIES FRAUD ; > Headnote: PRESUMPTION OF RELIANCE ; > Headnote:

LEdHN[9] [9] LEdHN[12] [12]

Although the presumption of reliance in a securities fraud The first three prerequisites of the presumption of reliance case is a judicially created doctrine designed to implement in a securities fraud case are directed at price a judicially created cause of action, the presumption is a impact--whether the alleged misrepresentations affected the substantive doctrine of federal securities-fraud law. That is market price in the first place. In the absence of price because it provides a way of satisfying the reliance element impact, the fraud-on-the-market theory and presumption of of the 17 C.F.R. § 240.10b-5 (2013) cause of action. As with reliance collapse. The fundamental premise underlying the any other element of that cause of action, Congress may presumption is that an investor presumptively relies on a overturn or modify any aspect of courts’ interpretations of misrepresentation so long as it was reflected in the market the reliance requirement, including the presumption itself. price at the time of his transaction. If it was not, then there (Roberts, Ch. J., joined by Kennedy, Ginsburg, Breyer, is no grounding for any contention that the investor indirectly Sotomayor, and Kagan, JJ.) relied on that misrepresentation through his reliance on the integrity of the market price. (Roberts, Ch. J., joined by CLASS ACTIONS §16; > CERTIFICATION -- SECURITIES Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) ACTION ; > Headnote: EVIDENCE §182; > SECURITIES FRAUD -- LEdHN[10] [10] PRESUMPTION OF RELIANCE ; > Headnote: 10 Recent Decisions Every Page 57 of 309 Attorney Should Know

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LEdHN[13] [13] executives (collectively Halliburton), alleging that they The presumption of reliance in a securities fraud case can be made misrepresentations designed to inflate Halliburton’s rebutted by appropriate evidence, including evidence that stock price, in violation of section 10(b) of the Securities the asserted misrepresentation (or its correction) did not Exchange Act of 1934 and Securities and Exchange affect the market price of the defendant’s stock. Defendants Commission Rule 10b-5. The District Court initially denied may introduce price impact evidence at the class certification EPJ Fund’s class certification [***2] motion, and the Fifth stage, so long as it is for the purpose of countering a Circuit affirmed. But this Court vacated that judgment, plaintiff’s showing of market efficiency, rather than directly concluding that securities fraud plaintiffs need not prove rebutting the presumption. (Roberts, Ch. J., joined by loss causation--a causal connection between the defendants’ Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, JJ.) alleged misrepresentations and the plaintiffs’ economic losses--at the class certification stage in order to invoke CLASS ACTIONS §16;EVIDENCE §182; > CLASS Basic’s presumption of reliance. On remand, Halliburton CERTIFICATION -- SECURITIES FRAUD -- argued that class certification was nonetheless inappropriate PRESUMPTION OF RELIANCE ; > Headnote: because the evidence it had earlier introduced to disprove loss causation also showed that its alleged misrepresentations LEdHN[14] [14] had not affected its stock price. By demonstrating the Any showing that severs the link between the alleged absence of any “price impact,” Halliburton contended, it misrepresentation and the price received (or paid) by the had rebutted the Basic presumption. And without the benefit plaintiff for securities is sufficient to rebut the presumption of that presumption, investors would have to prove reliance of reliance because the basis for finding that the fraud had on an individual basis, meaning that individual issues would been transmitted through market price would be gone. And predominate over common ones and class certification without the presumption of reliance, a 17 C.F.R. § 240.10b-5 would be inappropriate under Federal Rule of Civil (2013) suit cannot proceed as a class action: each plaintiff Procedure 23(b)(3). The District Court rejected Halliburton’s would have to prove reliance individually, so common argument and certified the class. The Fifth Circuit affirmed, issues would not predominate over individual ones, as concluding that Halliburton could use its price impact required by Fed. R. Civ. P. 23(b)(3). Price impact is thus an evidence to rebut the Basic presumption only at trial, not at essential precondition for any § 240.10b-5 class action. the class certification [***3] stage. While plaintiffs are allowed to establish that precondition indirectly, it does not require courts to ignore a defendant’s Held: direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market 1. Halliburton has not shown a “special justification,” price and, consequently, that the presumption does not Dickerson v. United States, 530 U.S. 428, 443, 120 S. Ct. apply. (Roberts, Ch. J., joined by Kennedy, Ginsburg, 2326, 147 L. Ed. 2d 405, for [**345] overruling Basic’s Breyer, Sotomayor, and Kagan, JJ.) presumption of reliance. Pp. ___ - ___, 189 L. Ed. 2d, at 349-356.

Syllabus (a) To recover damages under section 10(b) and Rule 10b-5, a plaintiff must prove, as relevant here, “ ’reliance upon the [**344] Investors can recover damages in a private misrepresentation or omission.’ ” Amgen Inc. v. Connecticut securities fraud action only if they prove that they relied on Retirement Plans and Trust Funds, 568 U.S. ___, ___, 133 the defendant’s misrepresentation in deciding to buy or sell S. Ct. 1184, 185 L. Ed. 2d 308. The Court recognized in a company’s stock. In Basic Inc. v. Levinson, 485 U.S. 224, Basic, however, that requiring direct proof of reliance from 108 S. Ct. 978, 99 L. Ed. 2d 194, this Court held that every individual plaintiff “would place an unnecessarily investors could satisfy this reliance requirement by invoking unrealistic evidentiary burden on the . . . plaintiff who has a presumption that the price of stock traded in an efficient traded on an impersonal market,” 485 U.S., at 245, 108 S. market reflects all public, material information--including Ct. 978, 99 L. Ed. 2d 194, and “effectively would” prevent material misrepresentations. The Court also held, however, plaintiffs “from proceeding with a class action” in Rule that a defendant could rebut this presumption by showing 10b-5 suits, id., at 242, 108 S. Ct. 978, 99 L. Ed. 2d 194. To that the alleged misrepresentation did not actually affect the address these concerns, the Court held that plaintiffs could stock price--that is, that it had no “price impact.” satisfy the reliance element of a Rule 10b-5 action by Respondent Erica P. John Fund, Inc. (EPJ Fund), filed a invoking a rebuttable presumption of reliance. The Court putative class action against Halliburton and one of its based that presumption on what is known as the 10 Recent Decisions Every Page 58 of 309 Attorney Should Know

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“fraud-on-the-market” theory, which holds that “the market 247, 108 S. Ct. 978, 99 L. Ed. 2d 194, identifying a number price of shares traded on well-developed markets reflects all of classes of investors for whom “price integrity” is publicly available information, and, hence, any material supposedly “marginal [***6] or irrelevant.” But Basic never misrepresentations.” Id., at 246, 108 S. Ct. 978, 99 L. Ed. 2d denied the existence of such investors, who in any event rely 194. [***4] The Court also noted that the typical “investor at least on the facts that market prices will incorporate who buys or sells stock at the price set by the market does public information within a reasonable period and that so in reliance on the integrity of that price.” Id., at 247, 108 market prices, however inaccurate, are not distorted by S. Ct. 978, 99 L. Ed. 2d 194. As a result, whenever an fraud. Pp. ___ - ___, 189 L. Ed. 2d, at 352-354. investor buys or sells stock at the market price, his “reliance on any public material misrepresentations . . . may be (c) The principle of stare decisis has “ ’special force’ ” “in presumed for purposes of a Rule 10b-5 action.” Id. at 247, respect to statutory interpretation” because “ ’Congress 108 S. Ct. 978, 99 L. Ed. 2d 194. Basic also emphasized that remains free to alter what [the Court has] done.’ ” John R. the presumption of reliance was rebuttable rather than Sand & Gravel Co. v. United States, 552 U.S. 130, 139, 128 conclusive. Pp. ___ - ___, 189 L. Ed. 2d, at 349-351. S. Ct. 750, 169 L. Ed. 2d 591. So too with Basic’s presumption of reliance. The presumption is not inconsistent (b) None of Halliburton’s arguments for overruling Basic so with this Court’s more recent decisions construing the Rule discredit the decision as to constitute a “special justification.” 10b-5 Central Bank of Denver, N. A. v. Pp. ___ - ___, 189 L. Ed. 2d, at 351-354. cause of action. In First Interstate Bank of Denver, N. A., 511 U.S. 164, 114 S. (1) Halliburton first argues that the Basic presumption is Ct. 1439, 128 L. Ed. 2d 119, and Stoneridge Investment inconsistent with Congress’s intent in passing the 1934 Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 128 Exchange Act--the same argument made by the dissenting S. Ct. 761, 169 L. Ed. 2d 627, the Court declined to Justices in Basic. The Basic majority did not find that effectively eliminate the reliance element by extending argument persuasive then, and Halliburton has given no new liability to entirely new categories of defendants who reason to endorse it now. Pp. ___ - ___, 189 L. Ed. 2d, at themselves had not made any material, public 351-352. misrepresentation. The Basic presumption, by contrast, merely provides an alternative means of satisfying the Basic (2) Halliburton also contends that rested on two reliance element. Nor is the Basic presumption inconsistent premises that have been undermined by developments in with [***7] the Court’s recent decisions governing class economic theory. First, it argues that the Basic Court action certification, which require plaintiffs to prove--not espoused “a robust view of market efficiency” that is no simply plead--that their proposed class satisfies each longer tenable in light of empirical evidence ostensibly requirement of Federal Rule of Civil Procedure 23, [***5] showing that material, public information often is not quickly incorporated into stock prices. The Court in Basic including, if applicable, the predominance requirement of acknowledged, however, the debate among economists Rule 23(b)(3). See, e.g., Wal-Mart Stores, Inc. v. Dukes, 564 about the efficiency of capital markets and refused to U.S. ___, ___, 131 S. Ct. 2541, 180 L. Ed. 2d 374. The Basic endorse “any particular theory of how quickly and presumption does not relieve plaintiffs of that burden but completely publicly available information is reflected in rather sets forth what plaintiffs must prove to demonstrate market price.” 485 U.S., at 248, n. 28, 108 S. Ct. 978, 99 L. predominance. Finally, Halliburton emphasizes the possible Ed. 2d 194. The Court instead based the presumption of harmful consequences of the securities class actions reliance on the fairly modest premise that “market facilitated by the Basic presumption, but such concerns are professionals generally consider most publicly announced more appropriately addressed to Congress, which has in fact material statements about companies, thereby affecting responded, to some extent, to many of them. Pp. ___ - ___, stock market prices.” Id., at 247, n. 24, 108 S. Ct. 978, 99 189 L. Ed. 2d, at 354-356. L. Ed. 2d 194. Moreover, in making the presumption 2. For the same reasons the Court declines to overrule rebuttable, [**346] Basic recognized that market efficiency Basic’s presumption of reliance, it also declines to modify is a matter of degree and accordingly made it a matter of the prerequisites for invoking the presumption by requiring proof. Halliburton has not identified the kind of fundamental plaintiffs to prove “price impact” directly at the class shift in economic theory that could justify overruling a certification stage. The Basic presumption incorporates two precedent on the ground that it misunderstood, or has since constituent presumptions: First, if a plaintiff shows that the been overtaken by, economic realities. defendant’s misrepresentation was public and material and Halliburton also contests the premise that investors “invest that the stock traded in a [***8] generally efficient market, ’in reliance on the integrity of [the market] price,’ ” id., at he is entitled to a presumption that the misrepresentation 10 Recent Decisions Every Page 59 of 309 Attorney Should Know

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affected the stock price. Second, if the plaintiff also shows Malcolm L. Stewart argued the cause for petitioner as that he purchased the stock at the market price during the amicus curiae, by special leave of court. relevant period, he is entitled to a further presumption that he purchased the [**347] stock in reliance on the defendant’s Judges: Roberts, C. J., delivered the opinion of the Court, misrepresentation. Requiring plaintiffs to prove price impact in which Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, directly would take away the first constituent presumption. JJ., joined. Ginsburg, J., filed a concurring opinion, in which Halliburton’s argument for doing so is the same as its Breyer and Sotomayor, JJ., joined. Thomas, J., filed an argument for overruling the Basic presumption altogether, opinion concurring in the judgment, in which Scalia and and it meets the same fate. Pp. ___ - ___, 189 L. Ed. 2d, at Alito, JJ., joined. 356-357. 3. The Court agrees with Halliburton, however, that Opinion by: ROBERTS defendants must be afforded an opportunity to rebut the presumption of reliance before class certification with Opinion evidence of a lack of price impact. Defendants may already introduce such evidence at the merits stage to rebut the [*2405] Chief Justice Roberts delivered the opinion of the Basic presumption, as well as at the class certification stage Court. to counter a plaintiff’s showing of market efficiency. Forbidding defendants to rely on the same evidence prior to HN1 [1] [1] Investors can recover damages in a private class certification for the particular purpose of rebutting the securities fraud action only if they prove that they relied on presumption altogether makes no sense, and can readily lead the defendant’s misrepresentation in deciding to buy or sell to results that are inconsistent [***9] with Basic’s own a company’s stock. In Basic Inc. v. Levinson, 485 U.S. 224, Basic logic. allows plaintiffs to establish price impact 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988), we held that indirectly, by showing that a stock traded in an efficient investors could satisfy this reliance requirement by invoking market and that a defendant’s misrepresentations were a presumption that [**348] the price of stock traded in an public and material. But an indirect proxy should not efficient market reflects all public, material preclude consideration of a defendant’s direct, more salient information—including material misstatements. In such a evidence showing that an alleged misrepresentation did not case, we concluded, anyone who buys or sells the stock at actually affect the stock’s price and, consequently, that the Basic presumption does not apply. Amgen does not require the market price may be considered to have relied on those a different result. There, the Court held that materiality, misstatements. though a prerequisite for invoking the Basic presumption, We also held, however, that a [***11] defendant could rebut should be left to the merits stage because it does not bear on this presumption in a number of ways, including by showing the predominance requirement of Rule 23(b)(3). In contrast, that the alleged misrepresentation did not actually affect the the fact that a misrepresentation has price impact is “Basic’s stock’s price—that is, that the misrepresentation had no fundamental premise.” Erica P. John Fund, Inc. v. “price impact.” The questions presented are whether we Halliburton Co., 563 U.S. ___, ___, 131 S. Ct. 2179, 180 L. should overrule or modify Basic’s presumption of reliance Ed. 2d 24. It thus has everything to do with the issue of and, if not, whether defendants should nonetheless be predominance at the class certification stage. That is why, if afforded an opportunity in securities class action cases to reliance is to be shown through the Basic presumption, the rebut the presumption at the class certification stage, by publicity and market efficiency prerequisites must be proved showing a lack of price impact. before class certification. Given that such indirect evidence of price impact will be before the court [***10] at the class I certification stage in any event, there is no reason to artificially limit the inquiry at that stage by excluding direct Respondent Erica P. John Fund, Inc. (EPJ Fund), is the lead evidence of price impact. Pp. ___ - ___, 189 L. Ed. 2d, at plaintiff in a putative class action against Halliburton and 358-360. one of its executives (collectively Halliburton) alleging violations of section 10(b) of the Securities Exchange Act of 718 F. 3d 423, vacated and remanded. 1934, 48 Stat. 891, 15 U.S.C. §78j(b), and Securities and Exchange Commission Rule 10b-5, 17 CFR §240.10b-5 Counsel: Aaron M. Streett argued the cause for petitioners. (2013). According to EPJ Fund, between June 3, 1999, and December 7, 2001, Halliburton made a series of David Boies argued the cause for respondent. misrepresentations regarding its potential liability in asbestos 10 Recent Decisions Every Page 60 of 309 Attorney Should Know

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litigation, its expected revenue from certain construction earlier introduced to disprove loss causation also showed contracts, and the anticipated benefits of its merger with that none of its alleged misrepresentations had actually another company—all in an attempt to inflate [***12] the affected its stock price. By demonstrating the absence of price of its stock. Halliburton subsequently made a number any “price impact,” Halliburton contended, it had rebutted [*2406] of corrective disclosures, which, EPJ Fund contends, Basic’s presumption that the members of the proposed class caused the company’s stock price to drop and investors to had relied on its alleged misrepresentations simply by lose money. buying or selling its stock at the market price. And without EPJ Fund moved to certify a class comprising all investors the benefit of the Basic presumption, investors would have who purchased Halliburton common stock during the class to prove reliance on an individual basis, meaning that period. The District Court found that the proposed class individual issues would predominate over common ones. satisfied all the threshold requirements of Federal Rule of The District Court declined to consider Halliburton’s Civil Procedure 23(a): It was sufficiently numerous, there argument, holding that the Basic presumption applied and were common questions of law or fact, the representative certifying the class under Rule 23(b)(3). App. to Pet. for parties’ claims were typical of the class claims, and the Cert. 30a. representatives could fairly and adequately protect the The Fifth Circuit affirmed. 718 F. 3d 423 (2013). The court interests of the class. App. to Pet. for Cert. 54a. And except found that Halliburton had preserved its price impact for one difficulty, the court would have also concluded that argument, but to no avail. Id., at 435-436. While the class satisfied the requirement of Rule 23(b)(3) that “the acknowledging that “Halliburton’s price impact evidence questions of law or fact common to class members could be used at the trial on the merits to refute the predominate over any questions affecting only individual presumption of reliance,” id., at 433, the court held that members.” See id., at 55a, 98a. The difficulty was that Halliburton could [***15] not use such evidence for that Circuit precedent required securities fraud plaintiffs to purpose at the class certification [*2407] stage, id., at 435. prove “loss causation”—a causal connection between the “[P]rice impact evidence,” the court explained, “does not defendants’ alleged misrepresentations and the plaintiffs’ bear on the question of common question predominance economic losses—in order to invoke [***13] Basic’s [under Rule 23(b)(3)], and is thus appropriately considered presumption of reliance and obtain class certification. App. only on the merits after the class has been certified.” Ibid. to Pet. for Cert. 55a, and n. 2. Because EPJ Fund had not demonstrated such a connection for any of Halliburton’s We once again granted certiorari, 571 U.S. ___, 134 S. Ct. alleged misrepresentations, the District Court refused to 636, 187 L. Ed. 2d 415 (2013), this time to resolve a conflict certify the proposed class. Id., at 55a, 98a. The United States among the Circuits over whether securities fraud defendants Court of Appeals for the Fifth Circuit affirmed the denial of may attempt to rebut the Basic presumption at the class class certification on the same ground. Archdiocese of certification stage with evidence of a lack of price impact. Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F. We also accepted Halliburton’s invitation to reconsider the 3d 330 (2010). presumption of reliance for securities fraud claims that we We granted certiorari and vacated the judgment, finding adopted in Basic. nothing in “Basic or its logic” to justify the Fifth Circuit’s requirement that securities [**349] fraud plaintiffs prove II loss causation at the class certification stage in order to invoke Basic’s presumption of reliance. Erica P. John Fund, Halliburton urges us to overrule Basic’s presumption of Inc. v. Halliburton Co., 563 U.S. ___, ___, 131 S. Ct. 2179, reliance and to instead require every securities fraud plaintiff 180 L. Ed. 2d 24, 32 (2011) (Halliburton I). “Loss causation,” to prove that he actually relied on the defendant’s we explained, “addresses a matter different from whether an misrepresentation in deciding to buy or sell a company’s investor relied on a misrepresentation, presumptively or stock. HN2 LEdHN[2] [2] Before overturning a long-settled otherwise, when buying or selling a stock.” Ibid. We precedent, however, we require “special justification,” not remanded the case for the lower courts to consider “any just an argument that the precedent was wrongly decided. further arguments against class certification” that Halliburton Dickerson v. United States, 530 U.S. 428, 443, 120 S. Ct. had preserved. Id., at ___, 131 S. Ct. 2179, 180 L. Ed. 2d 24, 2326, 147 L. Ed. 2d 405 (2000) (internal quotation marks 34. omitted). [***16] Halliburton has failed to make that showing. On [***14] remand, Halliburton argued that class certification was inappropriate because the evidence it had A 10 Recent Decisions Every Page 61 of 309 Attorney Should Know

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HN3 LEdHN[3] [3] Section 10(b) of the Securities Exchange To address these concerns, Basic held that HN5 LEdHN[5] Act of 1934 and the Securities and Exchange Commission’s [5] securities fraud plaintiffs can in certain circumstances Rule 10b-5 [**350] prohibit making any material satisfy the reliance element of a Rule 10b-5 action by misstatement or omission in connection with the purchase invoking a rebuttable presumption of reliance, rather than or sale of any security. Although section 10(b) does not proving direct reliance on a misrepresentation. The Court create an express private cause of action, we have long based that presumption on what is known as the recognized an implied private cause of action to enforce the “fraud-on-the-market” theory, which holds that “the market provision and its implementing regulation. See Blue Chip price of shares traded on well-developed markets reflects all Stamps v. Manor Drug Stores, 421 U.S. 723, 730, 95 S. Ct. publicly available information, and, hence, any material 1917, 44 L. Ed. 2d 539 (1975). To recover damages for misrepresentations.” Id., at 246, 108 S. Ct. 978, 99 L. Ed. 2d 194. The Court also noted that, rather than scrutinize every violations of section 10(b) and Rule 10b-5, a plaintiff must piece of public information about a company for himself, prove “‘(1) a material misrepresentation or omission by the the typical “investor who buys or sells stock at the price set defendant; (2) scienter; (3) a connection between the by the market does so in reliance on the integrity of that misrepresentation or omission and the purchase or sale of a price”—the belief that it reflects all public, material security; (4) reliance upon the misrepresentation or omission; information. Id., at 247, 108 S. Ct. 978, 99 L. Ed. 2d 194. (5) economic loss; and (6) loss causation.’” Amgen Inc. v. [**351] As a result, whenever the investor buys or sells Connecticut Retirement Plans and Trust Funds, 568 U.S. stock at the market price, his “reliance on any public ___, ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 316 (2013) material misrepresentations . . . may be presumed for (quoting Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. purposes of a Rule 10b-5 action.” Ibid. ___, ___, 131 S. Ct. 1309, 179 L. Ed. 2d 398, 409 (2011)). HN6 LEdHN[6] [6] Based on this theory, a plaintiff must The reliance element “‘ensures that there is a proper make the following [***19] showings to demonstrate that connection between a defendant’s misrepresentation and the presumption of reliance applies in a given case: (1) that [***17] a plaintiff’s injury.’” 568 U.S., at ___, 133 S. Ct. the alleged misrepresentations were publicly known, (2) 1184, 185 L. Ed. 2d 308, 316 (quoting Halliburton I, 563 that they were material, (3) that the stock traded in an U.S., at ___, 131 S. Ct. 2179, 180 L. Ed. 2d 24, 31). “The efficient market, and (4) that the plaintiff traded the stock traditional (and most direct) way a plaintiff can demonstrate between the time the misrepresentations were made and reliance is by showing that he was aware of a company’s when the truth was revealed. See id., at 248, n. 27, 108 S. statement and engaged in a relevant transaction—e.g., Ct. 978, 99 L. Ed. 2d 194; Halliburton I, supra, at ___, 131 purchasing common stock—based on that specific S. Ct. 2179, 180 L. Ed. 2d 24, 32. misrepresentation.” Id., at ___, 131 S. Ct. 2179, 180 L. Ed. 2d 24, 31. HN7 LEdHN[7] [7] At the same time, Basic emphasized that the presumption of reliance was rebuttable rather than HN4 LEdHN[4] [4] In Basic, however, we recognized that conclusive. Specifically, “[a]ny showing that severs the link requiring such direct proof of reliance “would place an between the alleged misrepresentation and either the price unnecessarily unrealistic evidentiary burden on the Rule received (or paid) by the plaintiff, or his decision to trade at 10b-5 plaintiff who has traded on an impersonal market.” a fair market price, will be sufficient to rebut the presumption 485 U.S., at 245, 108 S. Ct. 978, 99 L. Ed. 2d 194. That is of reliance.” 485 U.S., at 248, 108 S. Ct. 978, 99 L. Ed. 2d because, even assuming an investor could prove that he was 194. So for example, if a defendant could show that the aware of the misrepresentation, he would still have to “show alleged misrepresentation did not, for whatever reason, a speculative state of facts, i.e., how he would have acted . actually affect the market price, or that a plaintiff would . . if the misrepresentation had not been made.” Ibid. have bought or sold the stock even had he been aware that the stock’s price was tainted by fraud, then the presumption We also noted that “[r]equiring proof of individualized of reliance would not apply. Id., at 248-249, 108 S. Ct. 978, reliance” from every securities fraud plaintiff “effectively 99 L. Ed. 2d 194. In either of those cases, a plaintiff would would . . . [*2408] prevent[ ] [plaintiffs] from proceeding have to prove that he directly [***20] relied on the with a class action” in Rule 10b-5 suits. Id., at 242, 108 S. defendant’s misrepresentation in buying or selling the stock. Ct. 978, 99 L. Ed. 2d 194. If every plaintiff had to prove direct reliance on the defendant’s misrepresentation, B “individual issues then would [***18] . . . overwhelm[ ] the common ones,” making certification under Rule 23(b)(3) Halliburton contends that securities fraud plaintiffs should inappropriate. Ibid. always have to prove direct reliance and that the Basic 10 Recent Decisions Every Page 62 of 309 Attorney Should Know

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Court erred in allowing them to invoke a presumption of is known as the “efficient capital markets hypothesis.” Basic reliance instead. According to Halliburton, the Basic stated that “the market price of shares traded on presumption contravenes congressional intent and has been well-developed markets reflects all publicly available undermined by subsequent developments in economic theory. information, and, hence, any material misrepresentations.” Neither argument, however, so discredits Basic as to Id., at 246, 108 S. Ct. 978, 99 L. Ed. 2d 194. From that constitute “special justification” for overruling the decision. statement, Halliburton concludes that the Basic Court espoused “a robust view of market efficiency” that is no 1 longer tenable, for “‘overwhelming empirical evidence’ now ‘suggests that capital markets are not fundamentally Halliburton first argues that the Basic presumption is efficient.’” Brief for Petitioners 14-16 (quoting Lev & de inconsistent with Congress’s intent in passing the 1934 Villiers, Stock Price Crashes and 10b-5 Damages: A Legal, Exchange Act. Because “[t]he Section 10(b) action is a Economic, and Policy Analysis, 47 Stan. L. Rev 7, 20 ‘judicial construct that Congress did not enact,’” this Court, (1994)). To support this contention, Halliburton cites studies Halliburton insists, “must identify—and borrow from— purporting to show that “public information is often not [*2409] the express provision that is ‘most analogous to the incorporated immediately (much less rationally) into market private 10b-5 right of action.’” Brief for Petitioners 12 prices.” Brief for Petitioners 17; see id., at 16-20. See also (quoting Stoneridge Investment Partners, LLC v. Brief for Law Professors as Amici Curiae 15-18. Scientific-Atlanta, Inc., 552 U.S. 148, 164, 128 S. Ct. 761, 169 L. Ed. 2d 627 (2008); Musick, Peeler & Garrett v. Halliburton does not, of course, maintain that capital markets Employers Ins. of Wausau, 508 U.S. 286, 294, 113 S. Ct. are always inefficient. Rather, in its view, Basic’s 2085, 124 L. Ed. 2d 194 (1993)). According to Halliburton, fundamental error was to ignore the fact [***23] that the closest analogue to section 10(b) is section 18(a) of the “‘efficiency is not a binary, yes or no question.’” Brief for Act, [***21] which creates an express private cause of Petitioners 20 (quoting Langevoort, Basic at Twenty: action allowing investors to recover damages based on Rethinking Fraud on the Market, 2009 Wis. L. Rev. 151, misrepresentations made in certain regulatory filings. 15 167)). The markets for some securities are more efficient U.S.C. §78r(a). That provision requires an investor to prove than the markets for others, and even a single market can that he bought or sold stock “in reliance upon” the process different kinds of information more or less defendant’s misrepresentation. Ibid. In ignoring this direct efficiently, depending on how widely the information is reliance requirement, the argument goes, the Basic Court disseminated and how easily it is understood. Brief for relieved Rule 10b-5 plaintiffs of a burden that Congress Petitioners at 20-21. Yet Basic, Halliburton asserts, glossed [**352] would have imposed had it created the cause of over these nuances, assuming a false dichotomy that renders action. the presumption of reliance both underinclusive and overinclusive: A misrepresentation can distort a stock’s EPJ Fund contests both premises of Halliburton’s argument, market price even in a generally inefficient market, and a arguing that Congress has affirmed Basic’s construction of misrepresentation can leave a stock’s market [*2410] price section 10(b) and that, in any event, the closest analogue to unaffected even in a generally efficient one. Brief for section 10(b) is not section 18(a) but section 9, 15 U.S.C. Petitioners at 21. §78i—a provision that does not require actual reliance. Halliburton’s criticisms fail to take Basic on its own terms. We need not settle this dispute. In Basic, the dissenting Halliburton focuses on the debate among economists about Justices made the same argument based on section 18(a) the degree to which the market price of a company’s stock that Halliburton presses here. See 485 U.S., at 257-258, 108 reflects public information about the company—and thus S. Ct. 978, 99 L. Ed. 2d 194 (White, J., concurring in part the degree to which an investor can earn an abnormal, and dissenting in part). The Basic majority did not find that above-market return by trading on such information. argument persuasive then, and Halliburton has given us no [***24] See Brief for Financial Economists as Amici Curiae new reason to endorse it now. 4-10 (describing the debate). That [**353] debate is not new. Indeed, the Basic Court acknowledged it and declined 2 to enter the fray, declaring that “[w]e need not determine by adjudication what economists and social scientists have Halliburton’s primary argument for overruling Basic is debated through the use of sophisticated statistical analysis [***22] that the decision rested on two premises that can no and the application of economic theory.” 485 U.S., at longer withstand scrutiny. The first premise concerns what 246-247, n. 24, 108 S. Ct. 978, 99 L. Ed. 2d 194. To 10 Recent Decisions Every Page 63 of 309 Attorney Should Know

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recognize the presumption of reliance, the Court explained, to “beat the market” by buying the undervalued stocks and was not “conclusively to adopt any particular theory of how selling the overvalued ones. Brief for Petitioners 15-16 quickly and completely publicly available information is (internal quotation marks omitted). [*2411] See also Brief reflected in market price.” Id., at 248, n. 28, 108 S. Ct. 978, for Vivendi S. A. as Amicus Curiae 3-10 (describing the 99 L. Ed. 2d 194. The Court instead based the presumption investment strategies of day traders, volatility arbitragers, on the fairly modest premise that “market professionals and value investors). If many investors [**354] “are generally consider most publicly announced material indifferent to prices,” Halliburton contends, then courts statements about companies, thereby affecting stock market should not presume that investors rely on the integrity of prices.” Id., at 247, n. 24, 108 S. Ct. 978, 99 L. Ed. 2d 194. those prices and any misrepresentations incorporated into Basic’s presumption of reliance thus does not rest on a them. Reply Brief 14. “binary” view of market efficiency. Indeed, in making the presumption rebuttable, Basic recognized that market But Basic never denied the [***27] existence of such efficiency is a matter of degree and accordingly made it a investors. As we recently explained, Basic concluded only matter of proof. that “it is reasonable to presume that most investors—knowing that they have little hope of The academic debates discussed by Halliburton have not outperforming the market in the long run based solely on refuted the modest premise underlying [***25] the their analysis of publicly available information—will rely presumption of reliance. Even the foremost critics of the on the security’s market price as an unbiased assessment of efficient-capital-markets hypothesis acknowledge that public the security’s value in light of all public information.” information generally affects stock prices. See, e.g., Shiller, Amgen, 568 U.S., at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, We’ll Share the Honors, and Agree to Disagree, N. Y. Times, 317 (emphasis added). Oct. 27, 2013, p. BU6 (“Of course, prices reflect available information”). Halliburton also conceded as much in its In any event, there is no reason to suppose that even reply brief and at oral argument. See Reply Brief 13 Halliburton’s main counterexample—the value investor—is (“market prices generally respond to new, material as indifferent to the integrity of market prices as Halliburton information”); Tr. of Oral Arg. 7. Debates about the precise suggests. Such an investor implicitly relies on the fact that degree to which stock prices accurately reflect public a stock’s market price will eventually reflect material information are thus largely beside the point. “That the . . . information—how else could the market correction on price [of a stock] may be inaccurate does not detract from which his profit depends occur? To be sure, the value the fact that false statements affect it, and cause loss,” which investor “does not believe that the market price accurately is “all that Basic requires.” Schleicher v. Wendt, 618 F. 3d reflects public information at the time he transacts.” Post, at 679, 685 (CA7 2010) (Easterbrook, C. J.). Even though the ___, 189 L. Ed. 2d, at 367. But to indirectly rely on a efficient capital markets hypothesis may have “garnered misstatement in the sense relevant for the Basic presumption, substantial criticism since Basic,” post, at ___, 189 L. Ed. he need only trade stock based on the belief that the market 2d, at 364 (Thomas, J., concurring in judgment), Halliburton price will incorporate public information within a reasonable has not identified the kind of fundamental shift in economic [***28] period. The value investor also presumably tries to theory that could justify overruling a precedent on the estimate how undervalued or overvalued a particular stock ground that it misunderstood, or has since [***26] been is, and such estimates can be skewed by a market price overtaken by, economic realities. Contrast State Oil Co. v. tainted by fraud. Khan, 522 U.S. 3, 118 S. Ct. 275, 139 L. Ed. 2d 199 (1997), unanimously overruling Albrecht v. Herald Co., 390 U.S. C 145, 88 S. Ct. 869, 19 L. Ed. 2d 998 (1968). HN8 LEdHN[8] [8] The principle of stare decisis has Halliburton also contests a second premise underlying the “‘special force’” “in respect to statutory interpretation” Basic presumption: the notion that investors “invest ‘in because “‘Congress remains free to alter what we have reliance on the integrity of [the market] price.’” Reply Brief done.’” John R. Sand & Gravel Co. v. United States, 552 14 (quoting 485 U.S., at 247, 108 S. Ct. 978, 99 L. Ed. 2d U.S. 130, 139, 128 S. Ct. 750, 169 L. Ed. 2d 591 (2008) 194; alteration in original). Halliburton identifies a number (quoting Patterson v. McLean Credit Union, 491 U.S. 164, of classes of investors for whom “price integrity” is 172-173, 109 S. Ct. 2363, 105 L. Ed. 2d 132 (1989)). So too supposedly “marginal or irrelevant.” Reply Brief 14. The with Basic’s presumption of reliance. HN9 LEdHN[9] [9] primary example is the value investor, who believes that Although the presumption is a judicially created doctrine certain stocks are undervalued or overvalued and attempts designed to implement a judicially created cause of action, 10 Recent Decisions Every Page 64 of 309 Attorney Should Know

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we have described the presumption as “a substantive doctrine 23. Those decisions have made clear that plaintiffs wishing of federal securities-fraud law.” Amgen, supra, at ___, 133 to proceed through a class action must actually prove—not S. Ct. 1184, 185 L. Ed. 2d 308, 317. That is because it simply plead—that their proposed class satisfies each provides a way of satisfying the reliance element of the Rule requirement of Rule 23, including (if applicable) the 10b-5 cause of action. See, e.g., Dura Pharmaceuticals, Inc. predominance requirement of Rule 23(b)(3). See Wal-Mart v. Broudo, 544 U.S. 336, 341-342, 125 S. Ct. 1627, 161 L. Stores, Inc. v. Dukes, 564 U.S. ___, ___, 131 S. Ct. 2541, Ed. 2d 577 (2005). As with any other element of that cause 180 L. Ed. 2d 374, 406 (2011); Comcast Corp. v. Behrend, of action, Congress may overturn or modify any aspect of 569 U.S. ___, ___, 133 S. Ct. 1426, 185 L. Ed. 2d 515, 519 our interpretations of the reliance requirement, including the (2013). [***31] According to Halliburton, Basic relieves Basic presumption itself. Given that possibility, we see no Rule 10b-5 plaintiffs of that burden, allowing courts to reason to exempt [***29] the Basic presumption from presume that common issues of reliance predominate over ordinary principles of stare decisis. individual ones.

To buttress its case for overruling Basic, Halliburton contends That is not the effect of the Basicpresumption. HN10 that, in addition to being wrongly decided, the decision is LEdHN[10] [10] In securities class action cases, the crucial inconsistent with our more recent decisions construing the requirement for class certification will usually be the Rule 10b-5 cause of action. As Halliburton notes, we have predominance requirement of Rule 23(b)(3). The Basic held that “we must give ‘narrow dimensions . . . to a right presumption does not relieve plaintiffs of the burden of of action Congress did not authorize when it first enacted proving—before class certification—that this requirement is the statute and did not expand when it revisited the law.’” met. Basic instead establishes that a plaintiff satisfies that Janus Capital Group, Inc. v. First Derivative Traders, 564 burden by proving the prerequisites for invoking the U.S. ___, ___, [**355] 131 S. Ct. 2296, 180 L. Ed. 2d 166, presumption—namely, publicity, materiality, market 174 (2011) (quoting Stoneridge, 552 U.S., at 167, 128 S. Ct. efficiency, and market timing. The burden of proving those 761, 169 L. Ed. 2d 627); see, e.g., [*2412] Central Bank of prerequisites still rests with plaintiffs and (with the exception Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 of materiality) must be satisfied before class certification. U.S. 164, 114 S. Ct. 1439, 128 L. Ed. 2d 119 (1994) Basic does not, in other words, allow plaintiffs simply to (refusing to recognize aiding-and-abetting liability under plead that common questions of reliance predominate over the Rule 10b-5 cause of action); Stoneridge, supra (refusing individual ones, but rather sets forth what they must prove to extend Rule 10b-5 liability to certain secondary actors to demonstrate such predominance. who did not themselves make material misstatements). Yet the Basicpresumption, Halliburton asserts, does just the Basic does afford defendants an opportunity to rebut the opposite, expanding the Rule 10b-5 cause of action. Brief presumption of reliance with respect to an individual for Petitioners 27-29. plaintiff by showing that he did not [***32] rely on the integrity of the market price in trading stock. While this has Not so. In Central Bank and Stoneridge, we declined to the effect of “leav[ing] individualized [**356] questions of extend Rule 10b-5 liability to entirely new [***30] categories reliance in the case,” post, at ___, 189 L. Ed. 2d, at 368, of defendants who themselves had not made any material, there is no reason to think that these questions will public misrepresentation. Such an extension, we explained, overwhelm common ones and render class certification would have eviscerated the requirement that a plaintiff inappropriate under Rule 23(b)(3). That the defendant might prove that he relied on a misrepresentation made by the attempt to pick off the occasional class member here or defendant. See Central Bank, supra, at 180, 114 S. Ct. 1439, there through individualized rebuttal does not cause 128 L. Ed. 2d 119; Stoneridge, supra, at 157, 159, 128 S. Ct. individual questions to predominate. 761, 169 L. Ed. 2d 627. The Basic presumption does not eliminate that requirement but rather provides an alternative [*2413] Finally, Halliburton and its amici contend that, by means of satisfying it. While the presumption makes it facilitating securities class actions, the Basic presumption easier for plaintiffs to prove reliance, it does not alter the produces a number of serious and harmful consequences. elements of the Rule 10b-5 cause of action and thus Such class actions, they say, allow plaintiffs to extort large maintains the action’s original legal scope. settlements from defendants for meritless claims; punish innocent shareholders, who end up having to pay settlements Halliburton also argues that the Basic presumption cannot and judgments; impose excessive costs on businesses; and be reconciled with our recent decisions governing class consume a disproportionately large share of judicial action certification under Federal Rule of Civil Procedure resources. Brief for Petitioners 39-45. 10 Recent Decisions Every Page 65 of 309 Attorney Should Know

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These concerns are more appropriately addressed to price. So too if the misrepresentation was immaterial—that Congress, which has in fact responded, to some extent, to is, if it would not have “‘been viewed by the reasonable many of the issues raised by Halliburton and its amici. investor as having significantly [***35] altered the “total Congress has, for example, enacted the Private Securities mix” of information made available,’” Basic, supra, at Litigation [***33] Reform Act of 1995 (PSLRA), 109 Stat. 231-232, 108 S. Ct. 978, 99 L. Ed. 2d 194 (quoting TSC 737, which sought to combat perceived abuses in securities Indus. v. Northway, Inc., 426 U.S. 438, 449, 96 S. Ct. 2126, litigation with heightened pleading requirements, limits on 48 L. Ed. 2d 757 (1976))—or if the market in which the damages and attorney’s fees, a “safe harbor” for certain stock traded was inefficient. And if the plaintiff did not buy kinds of statements, restrictions on the selection of lead or sell the stock after the misrepresentation was made but plaintiffs in securities class actions, sanctions for frivolous before the truth was revealed, [*2414] then he could not be litigation, and stays of discovery pending motions to dismiss. said to have acted in reliance on a fraud-tainted price. See Amgen, 568 U.S., at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 326. And to prevent plaintiffs from circumventing HN12 LEdHN[12] [12] The first three prerequisites are these restrictions by bringing securities class actions under directed at price impact—“whether the alleged state law in state court, Congress also enacted the Securities misrepresentations affected the market price in the first Litigation Uniform Standards Act of 1998, 112 Stat. 3227, place.” Halliburton I, 563 U.S., at ___, 131 S. Ct. 2179, 180 which precludes many state law class actions alleging L. Ed. 2d 24, 33). In the absence of price impact, Basic’s securities fraud. See Amgen, supra, at ___, 133 S. Ct. 1184, fraud-on-the-market theory and presumption of reliance 185 L. Ed. 2d 308, 326. Such legislation demonstrates collapse. The “fundamental premise” underlying the Congress’s willingness to consider policy concerns of the presumption is “that an investor presumptively relies on a sort that Halliburton says should lead us to overrule Basic. misrepresentation so long as it was reflected in the market price at the time of his transaction.” 563 U.S., at ___, 131 S. III Ct. 2179, 180 L. Ed. 2d 24, 33. If it was not, then there is “no grounding for any contention that [the] investor[ ] Halliburton proposes two alternatives to overruling Basic indirectly relied on th[at] misrepresentation[ ] through [his] that would alleviate what it regards as the decision’s most reliance on the integrity of the market price.” Amgen, supra, serious flaws. The first alternative would require plaintiffs at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 324. to prove that a defendant’s misrepresentation actually affected the stock [***34] price—so-called “price Halliburton [***36] argues that since the Basic presumption impact”—in order to invoke the Basic presumption. It hinges on price impact, plaintiffs should be required to should not be enough, Halliburton contends, for plaintiffs to prove it directly in order to invoke the presumption. Proving demonstrate the general efficiency of the market in which the presumption’s prerequisites, which are at best an the stock traded. Halliburton’s second proposed alternative imperfect proxy for price impact, should not suffice. would allow defendants to rebut the presumption of reliance with evidence of a lack of price impact, not only at the Far from a modest refinement of the Basic presumption, this merits stage—which all agree defendants may already proposal would radically alter the required showing for the do—but also before class certification. reliance element of the Rule 10b-5 cause of action. What is called the Basic presumption actually incorporates two A constituent presumptions: First, if a plaintiff shows that the defendant’s misrepresentation was public and material and HN11 LEdHN[11] [11] As noted, to invoke the Basic that the stock traded in a generally efficient market, he is presumption, a plaintiff must prove that: (1) the alleged entitled to a presumption that the misrepresentation affected misrepresentations were publicly known, (2) they were the stock price. Second, if the plaintiff also shows that he material, (3) the stock traded in an efficient market, and (4) purchased the stock at the market price during the relevant the plaintiff traded the stock between when the period, he is entitled to a further presumption that he misrepresentations were made and when the truth was purchased the stock in reliance on the defendant’s revealed. See Basic, 485 U.S., at 248, n. 27, 108 S. Ct. 978, misrepresentation. 99 L. Ed. 2d 194; Amgen, supra, at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 314. Each of these requirements follows By requiring plaintiffs to prove price impact directly, from the fraud-on-the-market [**357] theory underlying the Halliburton’s proposal would take away the first constituent presumption. If the misrepresentation was not publicly presumption. Halliburton’s argument for doing so is the known, then it could not have distorted the stock’s market same as its primary argument for overruling [***37] the 10 Recent Decisions Every Page 66 of 309 Attorney Should Know

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Basic presumption altogether: Because market efficiency is takes account [***39] of material, public information about not a yes-or-no proposition, a public, material the company. See App. 217-230 (describing the results of misrepresentation might not affect a stock’s price even in a the study). The episodes examined by EPJ Fund’s event generally efficient market. But as explained, Basic never study included one of the alleged misrepresentations that suggested otherwise; that is why it affords defendants an form the basis of the Fund’s suit. See id., at 230, 343-344. opportunity to rebut the presumption by showing, among See also In re Xcelera.com Securities Litigation, 430 F. 3d other things, that the particular misrepresentation at issue 503, 513 (CA1 2005) (event study included effect of did not affect the stock’s market price. For the same reasons misrepresentation challenged in the case). we declined to completely jettison the Basic presumption, we decline to effectively jettison half of it by revising the Defendants—like plaintiffs—may accordingly submit price prerequisites for invoking it. impact evidence prior to class certification. What defendants may not do, EPJ Fund insists and the Court of Appeals held, [**358] B is rely on that same evidence prior to class certification for the particular purpose of rebutting the presumption Even if plaintiffs need not directly prove price impact to altogether. invoke the Basic presumption, Halliburton contends that defendants should at least be allowed to defeat the This restriction makes no sense, and can readily lead to presumption at the class certification stage through evidence bizarre results. Suppose a defendant at the certification stage that the misrepresentation did not in fact affect the stock submits an event study looking at the impact on the price of price. We agree. its stock from six discrete events, in an effort to refute the plaintiffs’ claim of general market efficiency. All agree the 1 defendant may do this. Suppose one of the six events is the specific misrepresentation asserted by the plaintiffs. All There is no dispute that defendants may introduce such agree that this too is perfectly acceptable. Now evidence at the merits stage to rebut the Basic presumption. [***40] suppose the district court determines that, despite HN13 LEdHN[13] [13] Basic itself “made clear that the the defendant’s study, the plaintiff has carried its burden to presumption was just that, and could be rebutted by prove market efficiency, but that the evidence shows no appropriate evidence,” including evidence that the asserted price impact with respect to the specific misrepresentation misrepresentation [***38] (or its correction) did not affect [**359] challenged in the suit. The evidence at the the market price of the defendant’s stock. Halliburton I, certification stage thus shows an efficient market, on which supra, at ___, 131 S. Ct. 2179, 180 L. Ed. 2d 24, 32; see the alleged misrepresentation had no price impact. And yet Basic, supra, at 248, 108 S. Ct. 978, 99 L. Ed. 2d 194. under EPJ Fund’s view, the plaintiffs’ action should be certified and proceed as a class action (with all that entails), Nor is there any dispute that defendants may introduce price even though the fraud-on-the-market theory does not apply impact evidence at the [*2415] class certification stage, so and common reliance thus cannot be presumed. long as it is for the purpose of countering a plaintiff ’s showing of market efficiency, rather than directly rebutting Such a result is inconsistent with Basic’s own logic. Under the presumption. As EPJ Fund acknowledges, “[o]f course . Basic’s fraud-on-the-market theory, market efficiency and . . defendants can introduce evidence at class certification of the other prerequisites for invoking the presumption lack of price impact as some evidence that the market is not constitute an indirect way of showing price impact. As efficient.” Brief for Respondent 53. See also Brief for explained, it is appropriate to allow plaintiffs to rely on this United States as Amicus Curiae 26. indirect proxy for price impact, rather than requiring them to prove price impact directly, given Basic’s rationales for After all, plaintiffs themselves can and do introduce evidence recognizing a presumption of reliance in the first place. See of the existence of price impact in connection with “event supra, at ___ - ___, ___ - ___, 189 L. Ed. 2d, at 350-351, studies”—regression analyses that seek to show that the 356-357. market price of the defendant’s stock tends to respond to pertinent publicly reported events. See Brief for Law But an indirect proxy should not preclude direct evidence Professors as Amici Curiae 25-28. In this case, for example, when such evidence is available. [***41] As we explained EPJ Fund submitted an event study of various episodes that in Basic, HN14 LEdHN[14] [14] “[a]ny showing that might have been expected to affect the price of Halliburton’s severs the link between the alleged misrepresentation and . stock, in order to demonstrate that the market for that stock . . the price received (or paid) by the plaintiff . . . will be 10 Recent Decisions Every Page 67 of 309 Attorney Should Know

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sufficient to rebut the presumption of reliance” because “the Price impact is different. The fact that a misrepresentation basis for finding that the fraud had been [*2416] transmitted “was reflected in the market price at the time of [the] through market price would be gone.” 485 U.S., at 248, 108 transaction”—that it had price impact—is “Basic’s S. Ct. 978, 99 L. Ed. 2d 194. And without the presumption fundamental premise.” Halliburton I, 563 U.S., at ___, 131 of reliance, a Rule 10b-5 suit cannot proceed as a class S. Ct. 2179, 180 L. Ed. 2d 24, 29. It thus has everything to action: Each plaintiff would have to prove reliance do with the issue of predominance at the class certification individually, so common issues would not “predominate” stage. That is why, if reliance is to be shown through the over individual ones, as required by Rule 23(b)(3). Id., at Basic presumption, the publicity and market efficiency 242. 108 S. Ct. 978, 99 L. Ed. 2d 194. Price impact is thus prerequisites must be proved before class certification. an essential precondition for any Rule 10b-5 class action. Without proof of those prerequisites, the fraud-on-the-market Basic While allows plaintiffs to establish that precondition theory underlying the presumption completely collapses, indirectly, it does not require courts to ignore a defendant’s rendering class certification inappropriate. direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market But as explained, publicity and market efficiency are price and, consequently, that the Basic presumption does not nothing more than prerequisites for an indirect showing of apply. price impact. There is no dispute that at least such indirect proof of price impact [***44] “is needed to ensure that the 2 questions of law or fact common to the class will ‘predominate.’” Amgen, 568 U.S., at ___, 133 S. Ct. 1184, The Court of Appeals relied on our decision in Amgen in 185 L. Ed. 2d 308, 313 (emphasis deleted); see id., at ___, holding that Halliburton could not introduce evidence of 133 S. Ct. 1184, 185 L. Ed. 2d 308, 320. That is [*2417] so lack of price impact at the class certification stage. The even though such proof is also highly relevant at the merits question in Amgen was whether plaintiffs [***42] could be stage. required to prove (or defendants be permitted to disprove) materiality before class certification. Even though materiality Our choice in this case, then, is not between allowing price is a prerequisite for invoking the Basic presumption, we impact evidence at the class certification stage or relegating held that it should be left to the merits stage, because it does it to the merits. Evidence of price impact will be before the not bear on the predominance requirement of Rule 23(b)(3). court at the certification stage in any event. The choice, We reasoned that materiality is an objective issue susceptible rather, is between limiting the price impact inquiry before to common, classwide proof. 568 U.S., at ___, 133 S. Ct. class certification to indirect evidence, or allowing 1184, 185 L. Ed. 2d 308, 336. We also noted that a failure consideration of direct evidence as well. As explained, we to prove materiality would necessarily defeat every plaintiff’s see no reason to artificially limit the inquiry at the claim on the merits; it would not simply preclude invocation certification stage to indirect evidence of price impact. of the presumption and thereby cause individual questions Defendants may seek to defeat the Basic presumption at that of reliance to predominate over common ones. Ibid. See stage through direct as well as indirect price impact evidence. also id., at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 340. In this latter respect, we explained, materiality differs from the *** publicity and market efficiency prerequisites, neither of which is necessary to prove a Rule 10b-5 claim on the More than 25 years ago, we held that plaintiffs could satisfy merits. Id., at ___-___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, the reliance element of the Rule 10b-5 cause of action by 324-325. invoking a presumption that a public, material misrepresentation will distort the price of stock traded in an [**360] EPJ Fund argues that much of the foregoing could efficient market, and that anyone who [***45] purchases the be said of price impact as well. Fair enough. But price stock at the market price may be considered to have done so impact differs from materiality in a crucial respect. Given in reliance on the misrepresentation. We adhere to that that the other Basic prerequisites must still be proved at the decision and decline to modify the prerequisites for invoking class [***43] certification stage, the common issue of the presumption of reliance. But to maintain the consistency materiality can be left to the merits stage without risking the of the presumption with the class certification requirements certification of classes in which individual issues will end of Federal Rule of Civil Procedure 23, defendants must be up overwhelming common ones. And because materiality is afforded an opportunity before class certification to defeat a discrete issue that can be resolved in isolation from the the presumption through evidence that an alleged other prerequisites, it can be wholly confined to the merits misrepresentation did not actually affect the market price of stage. the stock. 10 Recent Decisions Every Page 68 of 309 Attorney Should Know

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[**361] Because the courts below denied Halliburton that the reliance element of the implied Rule 10b-5 cause of opportunity, we vacate the judgment of the Court of Appeals action—the requirement that the plaintiff buy or sell stock for the Fifth Circuit and remand the case for further [***47] in reliance on the defendant’s misstatement—when proceedings consistent with this opinion. they transact on modern, impersonal securities exchanges. Were the Rule 10b-5 action statutory, the Court could have It is so ordered. resolved this question by interpreting the statutory language. Without a statute to interpret for guidance, however, the Concur by: GINSBURG; THOMAS Court began instead with a particular policy “problem”: for investors in impersonal markets, the traditional reliance Concur requirement was hard to prove and impossible to prove as common among plaintiffs bringing 10b-5 class-action suits. Justice Ginsburg, with whom Justice Breyer and Justice Id., at 242, 245, 108 S. Ct. 978, 99 L. Ed. 2d 194. With the Sotomayor join, concurring. task thus framed as “resol[ving]” that “‘problem’” rather than interpreting statutory text, id., at 242, 108 S. Ct. 978, Advancing price impact consideration from the merits stage 99 L. Ed. 2d 194, the Court turned to nascent economic to the certification stage may broaden the scope of discovery theory and naked intuitions about investment behavior in its available at certification. See Tr. of Oral Arg. 36-37. But the efforts to fashion a new, easier way to meet the reliance Court recognizes that it is incumbent upon the defendant to requirement. The result was an evidentiary presumption, show the absence of price impact. See ante, at ___ - ___, based on a “fraud on the market” theory, that paved the way 189 L. Ed. 2d, at 357. The Court’s judgment, therefore, for class actions under Rule 10b-5. [***46] should impose no heavy toll on securities-fraud Today we are asked to determine whether Basic was plaintiffs with tenable claims. On that understanding, I join correctly decided. [**362] The Court suggests that it was, the Court’s opinion. and that stare decisis demands that we preserve it. I Justice Thomas, with whom Justice Scalia and Justice Alito disagree. Logic, economic realities, and our subsequent join, concurring in the judgment. jurisprudence have undermined [***48] the foundations of the Basic presumption, and stare decisis cannot prop up the The implied Rule 10b-5 private cause of action is “a relic of facade that remains. Basicshould be overruled. the heady days in which this Court assumed common-law powers to create causes of action,” Correctional Services I Corp. v. Malesko, 534 U.S. 61, 75, 122 S. Ct. 515, 151 L. Ed. 2d 456 (2001) (Scalia, J., concurring); see, e.g., J. I. Understanding where Basic went wrong requires an Case Co. v. Borak, 377 U.S. 426, 433, 84 S. Ct. 1555, 12 L. explanation of the “reliance” requirement as traditionally Ed. 2d 423 (1964). We have since ended that practice understood. because the authority to fashion private remedies to enforce “Reliance by the plaintiff upon the defendant’s deceptive federal law belongs to Congress alone. Stoneridge Investment acts is an essential element” of the implied 10b-5 private 1 Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 164, cause of action. Stoneridge, supra, at 159, 128 S. Ct. 761, 128 S. Ct. 761, 169 L. Ed. 2d 627 (2008). Absent statutory 169 L. Ed. 2d 627. To prove reliance, the plaintiff must authorization for a cause of action, “courts may not create show “‘transaction causation,’” i.e., that the specific one, no matter how desirable that might be as a policy misstatement induced “the investor’s decision to engage in matter.” Alexander v. Sandoval, 532 U.S. 275, 286-287, 121 the transaction.” Erica P. John Fund, Inc. v. Halliburton S. Ct. 1511, 149 L. Ed. 2d 517 (2001). Co., 563 U.S. ___, ___-___, 131 S. Ct. 2179, 180 L. Ed. 2d 24, 29 (2011). Such proof “ensures that there is a proper Basic Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 99 L. ‘connection between a defendant’s misrepresentation and a Ed. 2d 194 (1988), demonstrates [*2418] the wisdom of this plaintiff’s injury’”—namely, that the plaintiff has not just rule. Basic presented the question how investors must prove lost money as a result of the misstatement, but that he was

1 As the private Rule 10b-5 action has evolved, the Court has drawn on the common-law action of deceit to identify six elements a private plaintiff must prove: “‘(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.’” Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U.S. ___, ___-___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 316 (2013). 10 Recent Decisions Every Page 69 of 309 Attorney Should Know

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actually defrauded by it. Id., at ___, 131 S. Ct. 2179, 180 L. First, Basic suggested that plaintiffs could meet the reliance Ed. 2d 24, 31; see also Dirks v. SEC, 463 U.S. 646, 666-667, requirement “‘indirectly,’” id., at 245, 108 S. Ct. 978, 99 L. n. 27, 103 S. Ct. 3255, 77 L. Ed. 2d 911 (1983) (“[T]o Ed. 2d 194. The Court reasoned that “‘ideally, [the market] constitute a violation of Rule 10b-5, there must be fraud. . . transmits information to the investor in the processed form . [T]here always are winners and losers; but those who have of a market price.’” Id., at 244, 108 S. Ct. 978, 99 L. Ed. 2d ‘lost’ have not necessarily been defrauded”). Without that 194. An investor could thus be said to have “relied” on a [***49] connection, Rule 10b-5 is reduced to a “‘scheme of specific misstatement if (1) the market had incorporated that investor’s insurance,’” because a plaintiff could recover statement into the market price of the security, and (2) the investor then bought or sold that security “in reliance on the whenever the defendant’s misstatement distorted the stock integrity of the [market] price,” id., at 247, 108 S. Ct. 978, price—regardless of whether the misstatement had actually 99 L. Ed. 2d 194, i.e., based on his belief that the market tricked the plaintiff into buying (or selling) the stock in the price “‘reflect[ed]’” the stock’s underlying “‘value,’” id., at first place. Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 244, 108 S. Ct. 978, 99 L. Ed. 2d 194. 336, 345, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005) (quoting [*2419] Basic, supra, at 252, 108 S. Ct. 978, 99 L. Second, Basic created a presumption that this “indirect” Ed. 2d 194 (White, J., concurring in part and dissenting in form of “reliance” had been proved. Based primarily on part)). certain assumptions about economic theory and investor behavior, Basic afforded plaintiffs who traded [***52] in The “traditional” reliance element requires a plaintiff to efficient markets an evidentiary presumption that both steps “sho[w] that he was aware of a company’s statement and of the novel reliance requirement had been satisfied—that engaged in a relevant transaction . . . based on that specific (1) the market had incorporated the specific misstatement misrepresentation.” Erica P. John Fund, supra, at ___, 131 into the market price of the security, and (2) the plaintiff did S. Ct. 2179, 180 L. Ed. 2d 24, 28. [***50] But investors who transact in reliance on the integrity of that price. 3 Id., at purchase stock from third parties on impersonal exchanges 247, 108 S. Ct. 978, 99 L. Ed. 2d 194. A defendant was (e.g., the New York Stock Exchange) often will not be ostensibly entitled to rebut the presumption by putting forth aware of any particular statement made by the issuer of the evidence that either of those steps was absent. Id., at 248, security, and therefore cannot establish that they transacted 108 S. Ct. 978, 99 L. Ed. 2d 194. based on a specific misrepresentation. Nor is the traditional reliance requirement amenable to class treatment; the II inherently individualized nature of the reliance inquiry renders it impossible for a 10b-5 plaintiff to prove that Basic’s reimagined reliance requirement was a mistake, and common questions predominate over individual ones, the passage of [*2420] time has compounded its failings. making class certification improper. See Basic, supra, at First, the Court based both parts of the presumption of 242, 108 S. Ct. 978, 99 L. Ed. 2d 194; Fed. Rule Civ. Proc. reliance on a questionable understanding of disputed 23(b)(3). economic theory and flawed intuitions about investor behavior. Second, Basic’s rebuttable presumption is at odds [**363] Citing these difficulties of proof and class with our subsequent Rule 23 cases, which require plaintiffs certification, 485 U.S., at 242, 245, 108 S. Ct. 978, 99 L. Ed. seeking class certification to “‘affirmatively demonstrate’” 2d 194, the Basic Court dispensed with the traditional [***53] certification requirements like the predominance of reliance requirement in favor of a new one based on the common questions. Comcast Corp. v. Behrend, 569 U.S. fraud-on-the-market theory. 2 The new version of reliance ___, ___, 133 S. Ct. 1426, 185 L. Ed. 2d 515, 521 (2013) had two related parts. (quoting Wal-Mart Stores, Inc. v. Dukes, 564 U.S. ___, ___,

2 In the years preceding Basic, lower courts and commentators experimented with various ways to facilitate 10b-5 class actions by relaxing or eliminating the reliance element of the implied 10b-5 action. See, e.g., Blackie v. Barrack, 524 F. 2d 891 (CA9 1975); Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. 1143 (1982); [***51] Note, The Reliance Requirement in Private Actions under SEC Rule 10b-5, 88 Harv. L. Rev. 584, 592-606 (1975). The “fraud-on-the-market theory” is an umbrella term for those varied efforts. Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N. C. L. Rev. 435, 439-457 (1984).

3 An investor could invoke this presumption by demonstrating certain predicates: (1) a public statement; (2) an efficient market; (3) that the shares were traded after the statement was made but before the truth was revealed; and (4) that the statement was material. Basic, 485 U.S., at 248, n. 27, 108 S. Ct. 978, 99 L. Ed. 2d 194. 10 Recent Decisions Every Page 70 of 309 Attorney Should Know

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131 S. Ct. 2541, 180 L. Ed. 2d 374, 390 (2011)). Finally, 25 J. Finance 383, 388 (1970)). 4 The upshot of the Basic’s presumption that investors rely on the integrity of hypothesis is that “the market price [***55] of shares traded the market price is virtually irrebuttable in practice, which on well-developed markets [will] reflec[t] all publicly means that the “essential” [**364] reliance element available information, and, hence, any material effectively exists in name only. misrepresentations.” Basic, supra, at 246, 108 S. Ct. 978, 99 L. Ed. 2d 194. At the time of Basic, this version of the A efficient capital markets hypothesis [*2421] was “widely accepted.” See Dunbar & Heller 463-464. Basic based the presumption of reliance on two factual assumptions. The first assumption was that, in a This view of market efficiency has since lost its luster. See, “well-developed market,” public statements are generally e.g., Langevoort, Basic at Twenty: Rethinking Fraud on the “reflected” in the market price of securities. 485 U.S., at Market, 2009 Wis. L. Rev. 151, 175 (“Doubts about the 247, 108 S. Ct. 978, 99 L. Ed. 2d 194. The second was that strength and pervasiveness of market efficiency are much investors in such markets transact “in reliance on the greater today than they were in the mid-1980s”). As it turns integrity of that price.” Ibid. In other words, the Court out, even “well-developed” markets (like the New York created a presumption that a plaintiff had met the two-part, Stock Exchange) do not uniformly incorporate [**365] fraud-on-the-market version of the reliance requirement information into market prices with high [***56] speed. because, in the Court’s view, “common sense and “[F]riction in accessing public information” and the presence probability” suggested that each of those parts would be of “processing costs” means that “not all public information met. Id., at 246, 108 S. Ct. 978, 99 L. Ed. 2d 194. will be impounded in a security’s price with the same alacrity, or perhaps with any quickness at all.” Cox, In reality, both of the Court’s key assumptions are highly Understanding Causation in Private Securities Lawsuits: contestable and do not provide the necessary support for Building on Amgen, 66 Vand. L. Rev. 1719, 1732 (2013) Basic’s [***54] presumption of reliance. The first (hereinafter Cox). For example, information that is easily assumption—that public statements are “reflected” in the digestible (merger announcements or stock splits) or market price—was grounded in an economic theory that has especially prominent (Wall Street Journal articles) may be garnered substantial criticism since Basic. The second incorporated quickly, while information that is broadly assumption—that investors categorically rely on the integrity applicable or technical (Securities and Exchange of the market price—is simply wrong. Commission filings) may be incorporated slowly or even ignored. See Stout, supra, at 653-656; see e.g., In re Merck 1 & Co. Securities Litigation, 432 F. 3d 261, 263-265 (CA3 2005) (a Wall Street Journal article caused a steep decline in The Court’s first assumption was that “most publicly the company’s stock price even though the same information available information”—including public misstatements—“is was contained in an earlier SEC disclosure). reflected in [the] market price” of a security. Id., at 247, 108 S. Ct. 978, 99 L. Ed. 2d 194. The Court grounded that Further, and more importantly, “overwhelming empirical assumption in “empirical studies” testing a then-nascent evidence” now suggests that even when markets do economic theory known as the efficient capital markets incorporate public information, they often fail to do so hypothesis. Id., at 246-247, 108 S. Ct. 978, 99 L. Ed. 2d 194. accurately. Lev and de Villiers, Stock Price Crashes and Specifically, the Court relied upon the “semi-strong” version 10b-5 Damages: A Legal, [***57] Economic and Policy of that theory, which posits that the average investor cannot Analysis, 47 Stan. L. Rev. 7, 20-21 (1994); see also id., at 21 earn above-market returns (i.e., “beat the market”) in an (“That many share price movements seem unrelated to efficient market by trading on the basis of publicly available specific information strongly suggests that capital markets information. See, e.g., Stout, The Mechanisms of Market are not fundamentally efficient, and that wide deviations Inefficiency: An Introduction to the New Finance, 28 J. from fundamentals . . . can occur”(footnote omitted)). Corp. L. 635, 640, and n. 24 (2003) (citing Fama, Efficient “Scores” of “efficiency-defying anomalies”—such as market Capital Markets: A Review of Theory and Empirical Work, swings in the absence of new information and prolonged

4 The “weak form” of the hypothesis provides that an investor cannot earn an above-market return by trading on historical price data. See Dunbar & Heller, Fraud on the Market Meets Behavioral Finance, 31 Del. J. Corporate L. 455, 463-464 (2006) (hereinafter Dunbar & Heller). The “strong form” provides that investors cannot achieve above-market returns even by trading on nonpublic information. See ibid. The weak form is generally accepted; the strong form is not. See ibid. 10 Recent Decisions Every Page 71 of 309 Attorney Should Know

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deviations from underlying asset values—make market appears to be true; some investors “attempt to locate efficiency “more contestable than ever.” Langevoort, Taming undervalued stocks in an effort to ‘beat the market’ . . . in the Animal Spirits of the Stock Markets: A Behavioral essence betting that the market . . . is in fact inefficient”). Approach to Securities Regulation, 97 Nw. U. L. Rev. 135, Indeed, securities transactions often take place because the 141 (2002); Dunbar & Heller 476-483. Such anomalies transacting parties disagree on the security’s value. See, e.g., make it difficult to tell whether, at any given moment, a Stout, Are Stock Markets Costly Casinos? Disagreement, stock’s price accurately reflects its value as indicated by all Market Failure, and Securities Regulation, 81 Va. L. Rev. publicly available information. In sum, economists now 611, 619 (1995) (“[A]vailable evidence suggests that . . . understand that the price impact Basic assumed would investor disagreement inspires the lion’s share of equities happen reflexively is actually far from certain even in transactions”). “well-developed” markets. Thus, Basic’s claim that “common sense and probability” support a presumption of Other investors trade for reasons entirely unrelated to reliance rests on shaky footing. price—for instance, to address changing liquidity needs, tax concerns, or portfolio balancing requirements. See id., at 2 657-658; see also Cox 1739 (investors may purchase “due to portfolio rebalancing arising from its obeisance to an The Basic Court also grounded the presumption of reliance indexing strategy”). These investment decisions—made in a second assumption: [***58] that “[a]n investor who with indifference to price and thus without regard for price buys or sells stock at the price set by the market does so in “integrity”—are at odds with Basic’s understanding of what reliance on the integrity of that price.” 485 U.S., at 247, 108 motivates investment decisions. In short, [***60] Basic’s S. Ct. 978, 99 L. Ed. 2d 194. In other words, the Court assumption that all investors rely in common on “price assumed that investors transact based on the belief that the integrity” is simply wrong. 5 market price accurately reflects the underlying “‘value’” of the security. See id., at 244, 108 S. Ct. 978, 99 L. Ed. 2d 194 The majority tries (but fails) to reconcile Basic’s assumption (“‘[P]urchasers generally rely on the price of the stock as a about investor behavior with the reality that many investors reflection of its value’”). The Basic Court appears to have do not behave in the way Basic assumed. It first asserts that adopted this assumption about investment behavior based Basic rested only on the more modest view that only on what it believed to be “common sense.” Id., at 246, [***61] “‘most investors’” rely on the integrity of a 108 S. Ct. 978, 99 L. Ed. 2d 194. The Court found it “‘hard security’s market price. Ante, at ___, 189 L. Ed. 2d, at 354 to imagine that there ever is a buyer or seller who does (quoting not Basic, but Amgen Inc. v. Connecticut Retirement [*2422] not rely on market integrity. Who would knowingly Plans & Trust Funds, 568 U.S. ___, ___, 133 S. Ct. 1184, roll the dice in a crooked crap game?’” Id., at 246-247, 108 185 L. Ed. 2d 308, 317 (2013) (emphasis added)). That S. Ct. 978, 99 L. Ed. 2d 194. gloss is difficult to square with Basic’s plain language: “An investor who buys or sells stock at the price set by the [**366] The Court’s rather superficial analysis does not market does so in reliance on the integrity of that price.” withstand scrutiny. It cannot be seriously disputed that a Basic, 458 U.S., at 247, 108 S. Ct. 978, 99 L. Ed. 2d 194; see great many investors do not buy or sell stock based on a also id., at 246-247, 108 S. Ct. 978, 99 L. Ed. 2d 194 (“‘[I]t belief that the stock’s price accurately reflects its value. is hard to imagine that there ever is a buyer or seller who Many investors in fact trade for the opposite reason—that is, does not rely on market integrity’”). In any event, neither because they think the market has under- or overvalued the Basic nor the majority offers anything more than a judicial stock, and they believe they can profit from that mispricing. hunch as evidence that even “most” investors rely on price Id., at 256, 108 S. Ct. 978, 99 L. Ed. 2d 194 (opinion of integrity. White, J.); see, [***59] e.g., Macey, The Fraud on the Market Theory: Some Preliminary Issues, 74 Cornell L. [**367] The majority also suggests that “there is no reason Rev. 923, 925 (1989) (The “opposite” of Basic’s assumption to suppose” that investors who [*2423] buy stock they

5 The Basic Court’s mistaken intuition about investor behavior appears to involve a category mistake: the Court invoked a hypothesis meant to describe markets, but then used it “in the one way it is not meant to be used: as a predictor of the behavior of individual investors.” Langevoort, Theories, Assumptions, and Securities Regulation: Market Efficiency Revisited, 140 U. Pa. L. Rev. 851, 895 (1992). The efficient capital markets hypothesis does not describe “how investors behave; [it] only suggests the consequences of their collective behavior.” Cox 1736. “Nothing in the hypothesis denies what most popular accounts assume: that much information searching and trading by investors, from institutions on down, is done in the (perhaps erroneous) belief that undervalued or overvalued stocks exist and can systematically be discovered.” Langevoort, Theories, supra, at 895. 10 Recent Decisions Every Page 72 of 309 Attorney Should Know

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believe to be undervalued are “indifferent to the integrity of that the District Court appropriately certified the class based market prices.” Ante, at ___, 189 L. Ed. 2d, at 354. Such on the presumption of reliance). But, invoking the Basic “value investor[s],” according to the majority, “implicitly presumption does not actually prove that individual questions rel[y] on the fact that a stock’s market price will eventually of reliance will not overwhelm the common questions in the reflect material information” and “presumably tr[y] to case. Basic still requires a showing that the individual estimate how undervalued or overvalued a particular stock investor bought or sold in reliance on the integrity of the is” by reference to the market price. Ibid. Whether market price and, crucially, permits defendants to rebut the [***62] the majority’s unsupported claims about the thought presumption by producing evidence that individual plaintiffs processes of hypothetical investors are accurate or not, they do not meet that description. See id., at 249, 108 S. Ct. 978, are surely beside the point. Whatever else an investor 99 L. Ed. 2d 194 (“Petitioners . . . could rebut the believes about the market, he simply does not “rely on the presumption of reliance as to plaintiffs who would have divested themselves of their Basic [***64] shares without integrity of the market price” if he does not believe that the relying on the integrity of the market”). Thus, by its own market price accurately reflects public information at the terms, Basic entitles defendants to ask each class member time he transacts. That is, an investor cannot claim that a whether he traded in reliance on the integrity of the market public misstatement induced his transaction by distorting price. That inquiry, like the traditional reliance inquiry, is the market price if he did not buy at that price while inherently individualized; questions about the trading believing that it accurately incorporated that public strategies of individual investors will not generate “‘common information. For that sort of investor, Basic’s critical fiction answers apt to drive the [**368] resolution of the litigation,’” falls apart. Wal-Mart Stores, supra, at ___, 131 S. Ct. 2541, 180 L. Ed. 2d 374, 390. See supra, at ___ - ___, 189 L. Ed. 2d, at B 365-366; see also Cox 1736, n. 55 (Basic’s recognition that defendants could rebut the presumption “by proof the Basic’s presumption of reliance also conflicts with our more investor would have traded anyway appears to require recent cases clarifying Rule 23’s class-certification individual inquiries into reliance”). requirements. Those cases instruct that “a party seeking to maintain a class action ‘must affirmatively demonstrate his Basic thus exempts Rule 10b-5 plaintiffs from Rule 23’s compliance’ with Rule 23.” Comcast, 569 U.S., at ___, 133 proof requirement. Plaintiffs [*2424] who invoke the S. Ct. 1426, 185 L. Ed. 2d 515, 521 (quoting Wal-Mart, 564 presumption of reliance are deemed to have shown U.S., at ___, 131 S. Ct. 2541, 180 L. Ed. 2d 374, 390. To predominance as a matter of law, even though the resulting prevail on a motion for class certification, a party must rebuttable presumption leaves individualized questions of demonstrate through “evidentiary proof” that “‘questions of reliance in the case and predominance still unproved. law or fact common to class members predominate over any Needless to say, that exemption was beyond the Basic questions [***63] affecting only individual members.’” 569 Court’s power to grant. 6 U.S., at ___, 133 S. Ct. 1426, 185 L. Ed. 2d 515, 519 (quoting Fed. Rule Civ. Proc. 23(b)(3)). C

Basic permits plaintiffs to bypass that requirement of It would be bad enough if Basic merely provided an end-run evidentiary proof. Under Basic, plaintiffs who invoke the around Rule 23. But in practice, the so-called “rebuttable presumption of reliance (by proving its predicates) are presumption” is largely irrebuttable. deemed to have met the predominance requirement of Rule 23(b)(3). See ante, at ___, 189 L. Ed. 2d, at 355; Amgen, The Basic Court ostensibly afforded defendants an supra, at ___, 133 S. Ct. 1184, 185 L. Ed. 2d 308, 314) opportunity to rebut the presumption by providing evidence (Basic “facilitates class certification by recognizing a that either aspect of a plaintiff’s fraud-on-the-market rebuttable presumption of classwide reliance”);Basic, 485 reliance—price impact, or reliance on the integrity of the U.S., at 242, 250, 108 S. Ct. 978, 99 L. Ed. 2d 194 (holding market price—is missing. 485 U.S., at 248-249, 108 S. Ct.

6 The majority suggests that Basic squares with Comcast Corp. v. Behrend, 569 U.S. ___, 133 S. Ct. 1426, 185 L. Ed. 2d 515 (2013), and Wal-Mart Stores, Inc. v. Dukes, 564 U.S. ___, 131 S. Ct. 2541, 180 L. Ed. 2d 374 (2011), [***65] because it does not “relieve plaintiffs of the burden of proving . . . predominance” but “rather sets forth what they must prove to demonstrate such predominance.” Ante, at ___ - ___, 189 L. Ed. 2d, at 355-356. This argument misses the point. Because Basic offers defendants a chance to rebut the presumption on individualized grounds, the predicates that Basic sets forth as sufficient to invoke the presumption do not necessarily prove predominance. 10 Recent Decisions Every Page 73 of 309 Attorney Should Know

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978, 99 L. Ed. 2d 194. As it turns out, however, the realities defendant’s deceptive acts”—actual reliance, not the fictional of class-action procedure make rebuttal based on an “fraud-on-the-market” version—“is an essential element of individual plaintiff’s lack of reliance virtually impossible. the §10(b) private cause of action.” Stoneridge, 552 U.S., at At the class-certification stage, rebuttal is only directed at 159, 128 S. Ct. 761, 169 L. Ed. 2d 627. the class representatives, which means that counsel only needs to find one class member who can withstand the III challenge. See Grundfest, [***66] Damages and Reliance Principles of stare decisis do not compel us to save Basic’s Under Section 10(b) of the Exchange Act, 69 Bus. Lawyer muddled logic and armchair economics. We have not 307, 362 (2014). After class certification, courts have hesitated to overrule decisions when they are “unworkable refused to allow defendants to challenge any plaintiff’s or are badly reasoned,” Payne v. Tennessee, 501 U.S. 808, reliance on the integrity of the market price prior to a 827, 111 S. Ct. 2597, 115 L. Ed. 2d 720 (1991); when “the determination on classwide liability. See Brief for Chamber theoretical underpinnings of those decisions are called into of Commerce of the United States of America et al. as Amici serious question,” State Oil Co. v. Khan, 522 U.S. 3, 21, 118 Curiae 13-14 (collecting cases rejecting postcertification S. Ct. 275, 139 L. Ed. 2d 199 (1997); when the decisions attempts to rebut individual class members’ reliance on have become “irreconcilable” with intervening developments price integrity as not pertinent to classwide liability). One in “competing legal doctrines or policies,”Patterson v. search for rebuttals on individual-reliance grounds turned McLean Credit Union, 491 U.S. 164, 173, 109 S. Ct. 2363, up only six cases out of the thousands of Rule 10b-5 actions 105 L. Ed. 2d 132 (1989); or when they are otherwise “a brought since Basic. Grundfest, supra, at 360. 7 positive detriment to coherence and consistency in the law,” The apparent unavailability of this form of rebuttal has [***69] ibid. Just one of these circumstances can justify our troubling implications. [**369] Because the presumption is correction of bad precedent; Basic checks all the boxes. conclusive in practice with respect to investors’ reliance on price integrity, even Basic’s watered-down reliance In support of its decision to preserve Basic, the majority requirement has been effectively eliminated. Once the contends that stare decisis “has ‘special force’ ‘in respect to presumption attaches, the reliance element is no longer an statutory interpretation’ because ‘Congress remains free to obstacle to prevailing on the claim, even though many class alter what we have done.’” Ante, at ___, 189 L. Ed. 2d, at members will not have transacted in reliance on price 354 (quoting John R. Sand & Gravel Co. v. United States, integrity, see supra, at ___ - ___, 189 L. Ed. 2d, at 365-366. 552 U.S. 130, 139, 128 S. Ct. 750, 169 L. Ed. 2d 591 (2008); And without a functional reliance requirement, the “essential some internal quotation marks omitted). But Basic, of element” that ensures the plaintiff [*2425] has actually been course, has nothing to do with statutory interpretation. The defrauded, see Stoneridge, 552 U.S., at 159, 128 S. Ct. 761, case concerned a judge-made evidentiary presumption for a 169 L. Ed. 2d 627, Rule 10b-5 becomes the very “‘scheme judge-made element of the implied 10b-5 private cause of of investor’s insurance’” the rebuttable presumption was action, itself “a judicial construct that Congress did not supposed to prevent. See Basic, supra, at 252, 108 S. Ct. enact in the text of the relevant statutes.” Stoneridge, supra, 978, 99 L. Ed. 2d 194 (opinion of White, J.). 8 at 164, 128 S. Ct. 761, 169 L. Ed. 2d 627. We have not afforded stare decisis “special force” outside the context of *** statutory interpretation, [**370] see Michigan v. Bay Mills Indian Community, 572 U.S. ___, ___, n. 6, 134 S. Ct. 2024, For these reasons, Basic should be overruled in favor of the 188 L. Ed. 2d 1071, 1089 (2014) (Thomas, J. dissenting) straightforward rule that “[r]eliance by the plaintiff upon the and for good reason. In statutory cases, it is perhaps

7 The absence of postcertification rebuttal is likely attributable in part to the substantial in terrorem settlement pressures brought to bear by certification. See, e.g., Nagareda, Class Certification in the Age of Aggregate Proof, 84 N. Y. U. L. Rev. 97, 99 (2009) (“With vanishingly rare exception, class certification sets the litigation on a path toward resolution by way of settlement, not full-fledged testing of the plaintiffs’ case by trial”); see also Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 163, 128 S. Ct. 761, 169 L. Ed. 2d 627 (2008) [***67] (“[E]xtensive discovery and the potential for uncertainty and disruption in a lawsuit allow plaintiffs with weak claims to extort settlements from innocent companies”).

8 Of course, today’s decision makes clear that a defendant may rebut the presumption by producing evidence that the misstatement at issue failed to affect the market price of the security, see ante, at ___ - ___, 189 L. Ed. 2d, at 357-360. But both parts of Basic’s [***68] version of reliance are key to its fiction that an investor has “indirectly” relied on the misstatement; the unavailability of rebuttal with respect to one of those parts still functionally removes reliance as an element of proof. 10 Recent Decisions Every Page 74 of 309 Attorney Should Know

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plausible that Congress watches over its enactments and At any rate, arguments from legislative inaction are will step in to fix our mistakes, so we may leave to Congress speculative at best. “[I]t is ‘ “impossible to assert with any the judgment whether the interpretive [***70] question is degree of assurance that congressional failure to act better left “‘settled’” or “‘settled right,’” Square D Co. v. represents” affirmative congressional approval of’ one of Niagara Frontier Tariff Bureau, Inc., 476 U.S. 409, 424, this Court’s decisions.” Bay Mills, supra, at ___, 134 S. Ct. 106 S. Ct. 1922, 90 L. Ed. 2d 413 (1986). But this rationale 2024, 188 L. Ed. 2d 1071, 1107 (Thomas, J., dissenting) is untenable when it comes to judge-made law like “implied” quoting Patterson, supra, at 175, n. 1, 109 S. Ct. 2363, 105 private causes of action, which we retain a duty to L. Ed. 2d 132). “‘Congressional inaction lacks persuasive superintend. See, e.g., [*2426] Exxon Shipping Co. v. Baker, [**371] significance’” because it is indeterminate; “‘several 554 U.S. 471, 507, 128 S. Ct. 2605, 171 L. Ed. 2d 570 equally tenable inferences may be drawn from such (2008) (“[T]he judiciary [cannot] wash its hands of a inaction.’” Central Bank of Denver, N. A. v. First Interstate problem it created . . . simply by calling [the judicial Bank of Denver, N. A., 511 U.S. 164, 187, 114 S. Ct. 1439, doctrine] legislative”). Thus, when we err in areas of 128 L. Ed. 2d 119 (1994) (quoting Pension Benefit Guaranty judge-made law, we ought to presume that Congress expects Corporation v. LTV Corp., 496 U.S. 633, 650, 110 S. Ct. us to correct our own mistakes—not the other way around. 2668, 110 L. Ed. 2d 579 (1990)). Therefore, “[i]t does not That duty is especially clear in the Rule 10b-5 context, follow . . . that Congress’ failure to overturn a . . . precedent where we have said that “[t]he federal courts have accepted is reason for this Court to adhere to it.” Patterson, supra, at and exercised the principal responsibility for the continuing 175, n. 1, 109 S. Ct. 2363, 105 L. Ed. 2d 132. elaboration of the scope of the 10b-5 right and the definition of the duties it imposes.” Musick, Peeler & Garrett v. That is especially true here, because Congress passed a law Employers Ins. of Wausau, 508 U.S. 286, 292, 113 S. Ct. to tell us not to draw any inference from its inaction. The PSLRA expressly states that “[n]othing in this Act . . . shall 2085, 124 L. Ed. 2d 194 (1993). be deemed to create or ratify any implied private right of Basic’s presumption of reliance remains our mistake to action.” Notes following [***73] 15 U.S.C. §78j-1, p. 430. correct. Since Basic, Congress has enacted two major If the Act did not ratify even the Rule 10b-5 [*2427] private securities laws: the Private Securities Litigation Reform Act cause of action, it cannot be read to ratify sub silentio the of 1995 (PSLRA), 109 Stat. 737, and the Securities Litigation presumption of reliance this Court affixed to that action. [***71] Uniform Standards Act of 1998 (SLUSA), 112 Stat. Further, the PSLRA and SLUSA operate to curtail abuses of 3227. The PSLRA “sought to combat perceived abuses in various private causes of action under our securities securities litigation,” ante, at ___, 189 L. Ed. 2d, at 356, and laws—hardly an indication that Congress approved of SLUSA prevented plaintiffs from avoiding the PSLRA’s Basic’s expansion of the 10b-5 private cause of action. restrictions by bringing class actions in state court, ibid. Congress’ failure to overturn Basic does not permit us to Neither of these Acts touched the reliance element of the “place on the shoulders of Congress the burden of the implied Rule 10b-5 private cause of action or the Basic Court’s own error.” Girouard v. United States, 328 U.S. 61, 70, 66 S. Ct. 826, 90 L. Ed. 1084 (1946). presumption.

Contrary to respondent’s argument (the majority wisely *** skips this next line of defense), we cannot draw from Congress’ silence on this matter an inference that Congress Basic took an implied cause of action and grafted on a approved of Basic. To begin with, it is inappropriate to give policy-driven presumption of reliance based on nascent weight to “Congress’ unenacted opinion” when construing economic theory and personal intuitions about investment behavior. The result was an unrecognizably broad cause of judge-made doctrines, because doing so allows the Court to action ready made for class certification. Time and create law and then “effectively codif[y]” it “based only on experience have pointed up the error of that decision, Congress’ failure to address it.” Bay Mills, supra, at ___, making it all too clear that the Court’s attempt to revise 134 S. Ct. 2024, 188 L. Ed. 2d 1071, 1107 (Thomas, J., securities law to fit the alleged “new realities of financial dissenting). Our Constitution, however, demands that laws markets” should have been left to Congress. 485 U.S., at be passed by Congress and signed by the President. U.S. 255, 108 S. Ct. 978, 99 L. Ed. 2d 194 (opinion of White, J.). Const., Art. I, §7. Adherence to Basic based on congressional inaction would invert that requirement by insulating error from correction merely because Congress failed to pass a References law on the subject. Cf. Patterson, supra, at 175, n. 1, 109 S. Ct. 2363, 105 L. Ed. 2d 132 [***72] (“Congressional (Matthew Bender 3d ed.) L Ed Digest, Class Actions § 16; inaction cannot amend a duly enacted statute”). Securities Regulation § 16.5 L Ed Index, Class Actions or 10 Recent Decisions Every Page 75 of 309 Attorney Should Know

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Proceedings; [***74] Securities Regulation Supreme from provision of federal statute not expressly providing for Court.Supreme Court.Implication of private right of action one--Supreme Court. 10 Recent Decisions Every Page 76 of 309 Attorney Should Know

| | Positive As of: November 21, 2014 3:40 PM EST

Food Lion, LLC v. Dean Foods Co. (In re Southeastern Milk Antitrust Litig.) United States Court of Appeals for the Sixth Circuit July 25, 2013, Argued; January 3, 2014, Decided; January 3, 2014, Filed File Name: 14a0001p.06 No. 12-5457

Reporter 739 F.3d 262; 2014 U.S. App. LEXIS 66; 2014 FED App. 0001P (6th Cir.); 93 Fed. R. Evid. Serv. (Callaghan) 302 In re: SOUTHEASTERN MILK ANTITRUST HOLDINGS: [1]-District court did not err by applying the LITIGATION;FOOD LION, LLC and FIDEL BRETO, on rule of reason to determine whether the alleged restraint was behalf of himself and all others similarly situated, unreasonable because the restraint appeared to involve a Plaintiffs-Appellants, v. DEAN FOODS COMPANY, vertical relationship, as the agreement between the processed NATIONAL DAIRY HOLDINGS, L.P., DAIRY FARMERS milk bottlers and a dairy farmer cooperative under which OF AMERICA, INC., DAIRY MARKETING SERVICES, the bottlers agreed to buy the raw milk it needed from the LLC, and SOUTHERN MARKETING AGENCY, INC., cooperative in exchange for the cooperative’s hampering Defendants-Appellees. the processing plants’ partnership ability to effectively complete; [2]-The district court should have at least Subsequent History: Rehearing, en banc, denied by Food Lion, LLC v. Dean Foods Co. (In re Southeastern Milk considered the fact that a more detailed market analysis may Antitrust Litig.), 2014 U.S. App. LEXIS 4225 (6th Cir., Mar. not have been required under the circumstances; [3]-The 4, 2014) processed cheese retailers presented some evidence of US Supreme Court certiorari denied by Dean Foods Co. v. antitrust injury, including the fact that after the merger of the Food Lion, LLC, 2014 U.S. LEXIS 7716 (U.S., Nov. 17, processed milk bottlers they were charged 7.9% more for 2014) milk than an econometric analysis could justify.

Prior History: [**1] Appeal from the United States District Outcome Court for the Eastern District of Tennessee at Greeneville. Nos. 2:07-cv-00188; 2:08-md-01000—J. Ronnie Greer, Judgment reversed; case remanded. District Judge. In re Southeastern Milk Antitrust Litig., 2012 U.S. Dist. LexisNexis® Headnotes LEXIS 44221 (E.D. Tenn., Mar. 27, 2012)

Antitrust & Trade Law > Regulated Practices > Private Core Terms Actions > General Overview

Civil Procedure > Appeals > Summary Judgment Review > antitrust, district court, geographic, milk, rule of reason, Standards of Review conspiracy, summary judgment, Merger, anticompetitive, horizontal, locations, Defendants’, prices, hypothetical, Civil Procedure > Appeals > Standards of Review > De Novo plants, per se rule, monopolist, customers, suppliers, markets, Review buyers, cases, raw milk, reliable, purchaser, vertical, parties, HN1 An appellate court reviews the district court ’s grant of costs, granting summary judgment, magistrate judge summary judgment de novo. Yet it must be mindful that courts are generally reluctant to use summary judgment Case Summary dispositions in antitrust actions due to the critical role that intent and motive have in antitrust claims and the difficulty Overview of proving conspiracy by means other than factual inference. 10 Recent Decisions Every Page 77 of 309 Attorney Should Know

Page 2 of 18 739 F.3d 262, *262; 2014 U.S. App. LEXIS 66, **1; 2014 FED App. 0001P (6th Cir.), ***Cir.)

Antitrust & Trade Law > Regulated Practices > Private only be used when the restraint has ″such predictable and Actions > Sherman Act pernicious anticompetitive effect, that there is limited potential for procompetitive benefit. Once applied, no HN2 See 15 U.S.C.S. § 1. consideration is given to the intent behind the restraint, to Antitrust & Trade Law > Regulated Practices > Private any claimed pro-competitive justifications, or to the Actions > Sherman Act restraint’s actual effect on competition. Applying this standard, then, should be done reluctantly and infrequently, HN3 Plaintiffs must first show that an agreement between informed by other courts’ review of the same type of two or more economic entities exists since unilateral conduct restraint, and only when the rule of reason would likely would not violate 15 U.S.C.S. § 1. justify the same result.

Antitrust & Trade Law > Regulated Practices > Private Antitrust & Trade Law > ... > Price Fixing & Restraints of Actions > Sherman Act Trade > Per Se Rule & Rule of Reason > General Overview HN4 Because nearly every agreement between parties could HN8 Unless the restraint falls squarely into a per se be considered a restraint of trade, the United States Supreme category, the rule of reason should be used instead. Unlike Court has limited 15 U.S.C.S. § 1 to apply only to the per se rule, the rule of reason utilizes a burden-shifting ″unreasonable″ restraints of trade. Whether the restraint is framework that allows the court to analyze the history of the ″unreasonable″ is determined by one of two approaches — restraint and the restraint’s effect on competition. First, the either the per se rule or the ″rule of reason.″ If the rule of plaintiff must establish a prima facie case by showing five reason is used, plaintiffs must additionally show that the elements: (1) a conspiracy (2) that produced anticompetitive restraint produced anticompetitive effects within the relevant effects; (3) that the scheme affected relevant product and product and geographic markets, while the per se rule is geographic markets; (4) that the conspiracy’s goal and reserved for restraints that are so clearly unreasonable that related conduct was illegal; (5) and that the restraint was the their anticompetitive effects within geographic and product proximate cause of the plaintiff’s antitrust injury. If a markets are inferred. Finally, regardless of which approach plaintiff passes over these hurdles, the burden then shifts to is used, the plaintiff must also establish that the illegal the defendant to produce evidence that the restraint in conspiracy caused injury to the plaintiff. question has ″procompetitive effects″ that are sufficient to justfiy the otherwise anticompetitive injuries. Finally, if the Antitrust & Trade Law > Regulated Practices > Private Actions > Sherman Act defendant meets this burden, the plaintiff may still prevail by showing that any legitimate objectives can be achieved HN5 Plaintiffs must present evidence showing that the in a substantially less restrictive manner. defendants’ agreement ″unreasonably restrains trade″ in order to satisfy the second requirement of an antitrust claim. Antitrust & Trade Law > ... > Price Fixing & Restraints of Trade > Cartels & Horizontal Restraints > General Overview Civil Procedure > Appeals > Standards of Review > De Novo Antitrust & Trade Law > ... > Price Fixing & Restraints of Review Trade > Per Se Rule & Rule of Reason > General Overview HN6 An appellate court reviews a question of law de novo. Antitrust & Trade Law > ... > Price Fixing & Restraints of Trade > Vertical Restraints > General Overview Antitrust & Trade Law > ... > Price Fixing & Restraints of Trade > Per Se Rule & Rule of Reason > General Overview HN9 When determining whether to use the per se rule or the rule of reason, courts must consider the type of restraint at HN7 A restraint may be deemed unreasonable either because issue — whether it is horizontal or vertical. An agreement it fits within a class of restraints that has been held to be ″per between competitors at the same level of the market se″ unreasonable, or because it violates what has come to be structure is horizontal. Horizontal restraints are considered known as the ″Rule of Reason.″ The less common method to be more threatening, and thus result in per se treatment of determining whether the restraint is unreasonable is the more regularly. Vertical restraints — agreements between per se rule. Certain agreements, such as horizontal price parties at different levels of the market structure, such as fixing and market allocation, are thought so inherently manufacturers and distributors— have more redeeming anticompetitive that each is illegal per se without inquiry qualities (e.g., allowing for distribution efficiencies) and are into the harm it has actually caused. The per se rule should subjected to the rule of reason. 10 Recent Decisions Every Page 78 of 309 Attorney Should Know

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Antitrust & Trade Law > ... > Price Fixing & Restraints of approach aligns with the United States Supreme Court ’s Trade > Cartels & Horizontal Restraints > General Overview recognition of the value of the ″quick look″ approach as an Antitrust & Trade Law > ... > Price Fixing & Restraints of abbreviated form of the rule of reason analysis used for Trade > Vertical Restraints > General Overview situations in which an observer with even a rudimentary understanding of economics could conclude that the HN10 The conspiracy’s effect on the plaintiff is not the sole arrangements in question would have an anticompetitive means of determining whether a restraint is horizontal or effect on customers and markets. Applying this test is useful vertical. The agreement which causes the effect is when the anticompetitive nature of an agreement is so determinative. For example, a facially vertical restraint blatant that a detailed review of the surrounding marketplace imposed by a manufacturer only because it has been coerced would be unnecessary. In the same way that this analysis by a ″horizontal cartel″ agreement among his distributors is occupies territory between the per se and rule of reason in reality a horizontal restraint. tests, so the burdens and presumptions do as well. Once anticompetitive behavior is shown to a court’s satisfaction, Antitrust & Trade Law > ... > Price Fixing & Restraints of even without detailed market analysis, the burden shifts to Trade > Per Se Rule & Rule of Reason > General Overview the defendant who must justify the agreement at issue on procompetitive grounds by providing some ″competitive HN11 Courts cannot act perfunctorily when distinguishing justification″ for the restraint at issue. restraints that merit a per se approach from those that deserve rule of reason analysis, and the court may apply the Antitrust & Trade Law > ... > Price Fixing & Restraints of per se rule only if a restraint clearly and unquestionably falls Trade > Per Se Rule & Rule of Reason > General Overview within one of the handful of categories that have been collectively deemed per se anticompetitive. HN15 Whatever tool is used to judge an agreement, the essential inquiry remains the same — whether or not the Antitrust & Trade Law > ... > Price Fixing & Restraints of challenged restraint enhances competition. There is generally Trade > Cartels & Horizontal Restraints > General Overview no categorical line to be drawn between restraints that give Antitrust & Trade Law > ... > Price Fixing & Restraints of rise to an intuitively obvious inference of anticompetitive Trade > Per Se Rule & Rule of Reason > General Overview effect and those that call for more detailed treatment. What is required, rather, is an enquiry meet for the case, looking HN12 Applying the rule of reason is the default position to the circumstances, details, and logic of a restraint. The and can be applied to horizontal restraints as well if they do object is to see whether the experience of the market has not fit into existing categories of per se violations. Indeed, been so clear, or necessarily will be, that a confident the Sixth Circuit has an automatic presumption in favor of conclusion about the principal tendency of a restriction will the rule of reason standard, while the per se rule is reserved follow from a quick (or at least quicker) look, in place of a only for those infrequent occasions of clear cut cases in more sedulous one. which the trade restraint is so unreasonably anticompetitive that they present straightforward questions for reviewing Civil Procedure > ... > Summary Judgment > Entitlement as courts. Matter of Law > General Overview

Civil Procedure > ... > Summary Judgment > Entitlement as HN16 In applying the summary judgment standard, the Matter of Law > Appropriateness court must review the facts and draw all reasonable inferences in favor of the non-moving party. HN13 Summary judgment is only appropriate when there are no genuine issues of material fact, and the moving party Civil Procedure > Appeals > Standards of Review > Abuse of is entitled to judgment as a matter of law. Fed. R. Civ. P. Discretion 56(c). Evidence > Admissibility > Expert Witnesses

Antitrust & Trade Law > ... > Price Fixing & Restraints of Evidence > Admissibility > Expert Witnesses > Daubert Trade > Per Se Rule & Rule of Reason > General Overview Standard

HN14 The United States Court of Appeals for the Sixth HN17 The district court ’s decision to exclude an expert’s Circuit has characterized ″quick look″ analysis as a third testimony under the standard required by Daubert v. Merrell type of category arising from the blurring of the line Dow Pharm., Inc., is reviewed for abuse of discretion. A between per se and rule of reason cases. This less-rigid district court abuses its discretion when it applies the wrong 10 Recent Decisions Every Page 79 of 309 Attorney Should Know

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legal standard, misapplies the correct legal standard, or Market power is defined as the ability to charge a relies on clearly erroneous findings of fact. An appellate supracompetitive price — a price above a firm’s marginal court will not find an abuse of discretion unless it has a cost. Such power could cover the nation, but it may exist in definite and firm conviction that the trial court committed a much smaller areas as well. clear error of judgment. Antitrust & Trade Law > Regulated Practices > Monopolies & Evidence > Admissibility > Expert Witnesses > Daubert Monopolization > General Overview Standard HN22 Using the hypothetical monopolist as an entity that HN18 Admissibility of expert testimony is governed by controls all the suppliers in a proposed market, a question is Fed. R. Evid. 702 and informed by the seminal case posed: could a monopolist profit if it imposed a ″small but applying Rule 702, Daubert v. Merrell Dow Pharmaceuticals, significant non-transitory increase in price″ (″SSNIP″)? Inc. In Daubert , the United States Supreme Court explained Typically, the increase that is posited is five percent. If that unlike an ordinary witness an expert is permitted wide buyers in a defined area would respond to a small, lasting latitude to offer opinions, including those that are not based increase in price — a SSNIP — by purchasing from another on firsthand knowledge or observation. The Supreme Court supplier, rendering the SSNIP unprofitable, the market has also recognized that implicit in the rule is a district court’s been too narrowly defined. Similarly, a market is too small gatekeeping responsibility, ensuring that an expert’s if additional suppliers would enter a market in response to testimony both rests on a reliable foundation and is relevant one firm’s price increase. In either of those cases, the to the task at hand. question about a SSNIP must be reconsidered and applied to a wider area. This should continue only until buyers in the Evidence > Admissibility > Expert Witnesses relevant market respond to a SSNIP by purchasing regardless of the increase. Although the Merger Guidelines, including HN19 See Fed. R. Evid. 702. the hypothetical monopolist, are useful and informative for courts in analyzing some antitrust violation claims, they Antitrust & Trade Law > Regulated Practices > Price Fixing & Restraints of Trade > Horizontal Market Allocation were written to describe the analytical process that the Department of Justice and Federal Trade Commission will HN20 Geographic market is defined as the region in which employ in determining whether to challenge a horizontal the seller operates, and to which the purchaser can merger. practicably turn for supplies. Outlining a geographic market entails mapping an area within which the defendant’s Evidence > Admissibility > Expert Witnesses customers who are affected by the challenged practice can HN23 practicably turn to alternative suppliers if the defendant An expert’s opinion must use valid facts to be were to raise its prices or restrict its output. This process is reliable. Facts can be undependable for numerous reasons, fact-intensive and focused on the commercial realities of the including actual information that is of poor quality, and industry. These include considerations of areas where contradictory facts present in the record. products are marketed, or where the defendant perceives Evidence > Admissibility > Expert Witnesses that it is competing; any applicable regulatory standards; transportation costs and challenges such as risk of spoilage, HN24 Expert reports must be based on proper facts, but ″ size, or weight; and other factors bearing upon where each of those facts does not have to occupy an independent customers might realistically look to buy the product. part of the record for an expert to be able to use them when Finally, a geographic market must be sizeable enough to be crafting an opinion. ″economically significant.″ Antitrust & Trade Law > ... > Per Se Rule & Rule of Antitrust & Trade Law > ... > Price Fixing & Restraints of Reason > Per Se Rule Tests > Manifestly Anticompetitive Trade > Exclusive & Reciprocal Dealing > Exclusive Dealing Effects Antitrust & Trade Law > ... > Per Se Rule & Rule of Reason > Per Se Rule Tests > Manifestly Anticompetitive HN25 Commercial realities should be contemplated when a Effects geographic market is being created. The hypothetical monopolist test and Tampa Electric both require data based HN21 The purpose of defining a geographic market is to on actual circumstances, e.g., where a buyer and/or seller is reveal whether, or to what extent, market power exists. located. Both inquiries, however, also require estimates, and 10 Recent Decisions Every Page 80 of 309 Attorney Should Know

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even discount the value of data based on actual behaviors. HN29 Antitrust plaintiffs cannot survive motions for The question about buyers in Tampa Electric, for instance, summary judgment without adequately alleging an antitrust focuses on where they can ″practicably″ turn for supplies — injury. In addition to having to show injury-in-fact and not where they actually do. Moreover, the hypothetical proximate cause, antitrust plaintiffs must specifically monopolist construct requires speculation about a buyer’s establish ″antitrust injury.″ It is not enough to simply allege likely reaction to a supplier’s price increase. Quite obviously, that an individual competitor suffered adverse effects from the estimate should be informed by actual evidence when the defendants’ contract or conspiracy. Rather, antitrust possible, but actual evidence does not have to be based on injury is (1) injury of the type the antitrust laws were the particular parties’ behaviors. In other words, a nationwide intended to prevent and (2) injury that flows from that estimate of demand elasticity that is used to predict the which makes defendants’ acts unlawful. The antitrust injury reaction of retailers in the southeast to a price increase requirement is critical because it ensures that the injury would be a reliable method of calculation. should reflect the anticompetitive effect of the defendant’s actions. This ensures that a plaintiff can recover only if the Antitrust & Trade Law > ... > Per Se Rule & Rule of loss stems from a competition-reducing aspect or effect of Reason > Per Se Rule Tests > Manifestly Anticompetitive the defendant’s behavior. Effects Antitrust & Trade Law > ... > Per Se Rule & Rule of HN26 At its most basic, the hypothetical monopolist Reason > Per Se Rule Tests > Manifestly Anticompetitive construct requires selection of the smallest area in which a Effects small but significant non-transitory increase in price could be successfully imposed. For that construct to be valuable in Antitrust & Trade Law > ... > Private Actions > Remedies > a case, the area at issue must encompass at least some of the General Overview locations of the seller and the buyer, including where the HN30 A multiple regression analysis is useful in quantifying buyer could turn for supplies if prices increased. The the relationship between a dependent variable (e.g., the availability of suppliers that are actually alternatives is price of milk) and independent variables (e.g., energy costs limited by the economic realities of the industry at issue. and/or demand factors). This type of model can also control Applied in that way, the hypothetical monopolist and the for other independent variables so as to isolate and identify Tampa Electric standard are practically equivalent: the the effect of a single independent variable on the dependent hypothetical monopolist is a useful framework for organizing variable. the factors the courts have applied in geographic market definition. Antitrust & Trade Law > ... > Per Se Rule & Rule of Reason > Per Se Rule Tests > Manifestly Anticompetitive Antitrust & Trade Law > ... > Per Se Rule & Rule of Effects Reason > Per Se Rule Tests > Manifestly Anticompetitive Effects Antitrust & Trade Law > ... > Private Actions > Remedies > General Overview HN27 Multiple courts of appeal have held that market definition is a question of fact. Accordingly, that question is HN31 When competition is limited pursuant to an agreement better left for a jury to decide. and customers are punished through higher prices, the injury clearly results from anticompetitive conduct. Antitrust & Trade Law > ... > Private Actions > Remedies > General Overview Counsel: ARGUED: Neil K. Gilman, HUNTON & WILLIAMS LLP, Washington, D.C., for Appellants. HN28 Regardless of whether the court uses the rule of reason or the per se rule, antitrust plaintiffs must still prove Paul H. Friedman, DECHERT LLP, Washington, D.C., for that the restraint at issue caused them to suffer an antitrust Appellees. injury. ON BRIEF: Neil K. Gilman, Richard L. Wyatt, Jr., Todd M. Antitrust & Trade Law > ... > Private Actions > Remedies > Stenerson, HUNTON & WILLIAMS LLP, Washington, General Overview D.C., Gordon Ball, BALL & SCOTT, Knoxville, Tennessee, Civil Procedure > ... > Summary Judgment > Burdens of R. Laurence Macon, AKIN GUMP STRAUSS HAUER & Proof > Nonmovant Persuasion & Proof FELD LLP, San Antonio, Texas, for Appellants. 10 Recent Decisions Every Page 81 of 309 Attorney Should Know

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Paul H. Friedman, DECHERT LLP, Washington, D.C., and economies of scale,″ which would result in millions of Carolyn Hazard Feeney, DECHERT LLP, Philadelphia, dollars in cost savings. As they began consolidating, certain Pennsylvania, Steven R. Kuney, WILLIAMS & agreements were negotiated, with input from the Department CONNOLLY LLP, Washington, D.C., W. Todd Miller, of Justice, to avoid antitrust problems. To secure financing BAKER & MILLER PLLC, Washington, D.C., Jerry L. for the merger, Suiza purchased DFA’s ownership interest in Beane, Kay Lynn Brumbaugh, ANDREWS KURTH LLP, exchange for cash, six dairy processing plants, and two Dallas, Texas, for Appellees. contractual provisions related to DFA’s ability to provide raw milk to the merging companies’ processing plants. One Judges: Before: ROGERS and COOK, Circuit Judges; provision promised DFA a specific sum of money if its * VAN TATENHOVE, District Judge. supply contracts for plants previously owned by Suiza were terminated within twenty years. The other provision Opinion by: GREGORY F. VAN TATENHOVE stipulated that Dean Foods would owe DFA liquidated [*269] damages if DFA were not provided an opportunity Opinion to supply raw milk for the plants Dean Foods owned prior to the merger. [*268] [***2] GREGORY F. VAN TATENHOVE, District Judge. Dean Foods Company and Suiza Foods Corporation The six processing plants that DFA received from Suiza were the two largest [**2] processed milk bottlers in the were quickly transferred [**4] to a newly formed partnership country in 2001. At that time, they announced plans to called National Dairy Holdings (″NDH″), which DFA partly merge their operations, which the Department of Justice owned. NDH was formed to compete with Dean Foods, and approved subject to divestment of particular milk processing after it added five more processing plants Dean Foods plants. The merged company, now known as Dean Foods, is divested, it became the second largest milk bottler in the accused of violating 15 U.S.C. § 1 of the Sherman Antitrust southeast. NDH had four owners. Two owners were former Act by conspiring with a raw milk supplier/milk processor Suiza executives, and one was a former business partner of and the purchaser of the divested processing facilities to DFA’s chief executive officer. Together, they owned a 50% divide markets and restrict output. The district court granted equity interest. DFA owned the other 50% equity interest, summary judgment for Defendants, ruling that Plaintiffs and it possessed the power to ″veto any agreement that could not provide sufficient proof of injury, nor could they would substantially affect the operation of NDH, contracts, establish the relevant antitrust geographic market, primarily or capital expenditures greater than $50,000, and the because their expert’s testimony was excluded. Two retailers acquisition, expansion or disposal of NDH’s facilities.″ The of processed milk, Food Lion LLC and Fidel Breto, appeal Department of Justice’s Antitrust Division approved NDH’s both of these conclusions. For the following reasons, we purchase and operation of the eleven plants. REVERSE and REMAND. These facts set the stage for the illegal conspiracy that Food I Lion and Fidel Breto (″Plaintiffs″), two retailers of processed milk, have alleged — a conspiracy in which DFA serves as A the keystone. With NDH as Dean Foods’ largest competitor, Prior to 2001, Dean Foods Company and Suiza Foods it would stand to reason that if NDH were weakened, Dean Corporation competed to process and sell bottled milk to Foods would enjoy a stronger position in the marketplace retailers. Suiza was the largest processor of milk in the for selling processed milk. [**5] Although DFA’s ownership United States, and Dean Foods was the second largest. Both stake provides an obvious incentive to fully support NDH’s processors purchased their raw milk from other entities. fledgling enterprise, DFA’s raw milk supply agreements Dairy Farmers of America (″DFA″), a dairy farmer with the merged company create fertile soil for the [**3] cooperative, was Suiza’s primary supplier and business development [***4] of a conflict of interest. Supported by partner, owning almost 34% of Suiza Dairy Group, which several disputed factual allegations, the essence of Plaintiffs’ was a subsidiary of Suiza’s. Dean Foods obtained its raw conspiracy claim is as follows: milk predominantly from independent farmers. NDH knowingly accepted ’second best’ plants, [***3] Dean Foods and Suiza merged in 2001 under the operated those plants at losses and eventually name Dean Foods, hoping to obtain ″distribution efficiencies shuttered some of those plants in an unlawful

* The Honorable Gregory F. Van Tatenhove, United States District Judge for the Eastern District of Kentucky, sitting by designation. 10 Recent Decisions Every Page 82 of 309 Attorney Should Know

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agreement with its competitor Dean/Suiza because, summary judgment dispositions in antitrust actions due to in return, its parent company, DFA, received a the critical ’role that intent and motive have in antitrust commitment from Dean/Suiza to allow it to supply claims and the difficulty of proving conspiracy by means raw milk to each Dean/Suiza bottling plant, other than factual inference.’″ Expert Masonry, Inc. v. including the pre-merger Dean plants previously Boone County, Kentucky, 440 F.3d 336, 341(6th Cir. 2006) supplied by independent dairy farmers. (quoting Smith v. Northern Mich. Hosps.., 703 F.2d 942, 947 (6th Cir. 1983)). [Appellant Br. at 15.] A B Unfortunately, there is no general agreement on the exact The Plaintiffs originally brought suit in the district court standards to use when resolving antitrust cases. As much as based on five claims, alleging violations of Sections 1 and 2 we might wish that a precise process with clear elements of the Sherman Antitrust Act and Section 3 of the Clayton existed, antitrust cases in this circuit, and in others, apply Act. The district court granted summary judgment to the various approaches to adjudicating antitrust claims. There Defendants on Counts II, III, and IV, but denied summary are some areas of consensus, however. A good starting point judgment on Counts I and V. After the close of discovery, is the statute itself. Section 1 of the Sherman Act states that the Defendants again moved for summary judgment on HN2 ″Every contract, combination in the form [**8] of trust several additional grounds [**6] that had not been raised or otherwise, or conspiracy, in restraint of trade or commerce previously. The district court found the additional arguments among the several States, or with foreign nations, is Defendants raised to be convincing and granted summary declared to be illegal.″ 15 U.S.C. § 1. HN3 The plaintiffs judgment in favor of Defendants on Counts I and V, ruling must first show, therefore, that an agreement between two or that the Plaintiffs failed to meet the requirements for more economic entities exists since unilateral conduct establishing an antitrust violation under Section 1 of the would not violate this statute. Nat’l Hockey League Players Sherman Antitrust Act. Plaintiffs now appeal the district Ass’n v. Plymouth Whalers Hockey Club, 419 F.3d 462, 469 court’s ruling on Count I. (6th Cir. 2005).

In Count I, the Plaintiffs allege that the Defendants engaged Next, HN4 because nearly every agreement between parties in a conspiracy not to compete, in violation of 15 U.S.C. § could be considered a restraint of trade, the Supreme Court 1. For a plaintiff to successfully bring an antitrust claim has limited Section 1 to apply only to ″unreasonable″ under Section 1 of the Sherman Act, the plaintiff must restraints of trade. Nat’l Hockey League Players, 419 F.3d establish that the defendant’s actions constituted an at 469 (citing Nat’l Collegiate Athletic Ass’n v. Board of unreasonable restraint of trade which caused the plaintiff to Regents of Univ. of Okla., 468 U.S. 85, 98, 104 S. Ct. 2948, experience an antitrust injury. Expert Masonry, Inc. v. Boone 82 L. Ed. 2d 70 (1984)). Whether the restraint is ″ ″ County, Kentucky, 440 F.3d 336, 342 [*270] (6th Cir. 2006) unreasonable is determined by one of two approaches — (quoting Crane & Shovel Sales Corp. v. Bucyrus-Erie Co., either the per se rule or the ″rule of reason.″ Id. at 469; Care 854 F.2d 802, 805 (6th Cir. 1988)). In its second summary Heating & Cooling, Inc. v. American Standard, Inc., 427 judgment opinion, the district court found that: 1) Plaintiffs F.3d 1008, 1012 (6th Cir. 2005). [***6] If the rule of reason failed to establish that the restraint on trade was is used, plaintiffs must additionally show that the restraint unreasonable, largely because the court excluded the produced anticompetitive effects within the relevant product testimony of Plaintiffs’ expert; and 2) that Plaintiffs and geographic markets, while the per se rule is reserved [**7] failed to establish the requisite element of injury. In re [**9] for restraints that are so clearly unreasonable that their Southeastern Milk Antitrust Litig., 2:08-MD-1000, 2012 anticompetitive effects within geographic and product U.S. Dist. LEXIS 44221, 2012 WL 1032797, at *6, 12 (E.D. markets are inferred. Expert Masonry, 440 F.3d at 342-43. Tenn. Mar. 27, 2012). [***5] Those decisions are the subject Finally, regardless of which approach is used, the plaintiff of this review. must also establish that the illegal conspiracy caused injury to the plaintiff. Id. at 342, 345 (quoting Crane & Shovel II Sales Corp. v. Bucyrus-Erie Co., 854 F.2d 802, 805 (6th Cir. 1988)); see also In re Cardizem CD Antitrust Litigation, 332 HN1 This Court reviews the district court’s grant of F.3d 896, 909 n.15 (6th Cir. 2003) (noting that the per se summary judgment de novo. Yet it must be mindful that rule does not negate the need for plaintiffs to establish ″[i]n this circuit, courts are generally reluctant to use antitrust injury). 10 Recent Decisions Every Page 83 of 309 Attorney Should Know

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In the case at hand, the parties do not contest the first applied, ″no consideration is given to the intent behind the required element — the existence of a conspiracy. The restraint, to any claimed pro-competitive justifications, or to district court [*271] found enough evidence of a conspiracy the restraint’s actual effect on competition.″ Id. at 906-07 for Plaintiffs to persist past summary judgment on that (quoting Nat’l College Athletic Ass’n v. Board of Regents, element of their § 1 claim, and accordingly, that issue is not 468 U.S. 85, 100, 104 S. Ct. 2948, 82 L. Ed. 2d 70 (1984)). challenged here. The dispute instead centers on whether the Applying this standard, then, should be done reluctantly and district court erred in applying the rule of reason instead of infrequently, informed by other courts’ review of the same the per se rule. Even if the conspiracy at issue is not a per type of restraint, and only when the rule of reason would se violation, Plaintiffs maintain that proof of a geographic likely justify the same result. Leegin Creative Leather market was unnecessary, and thus contest the district court’s Products, Inc. v. PSKS, Inc., 551 U.S. 877, 886-87, 127 S. [**10] finding that they failed to provide sufficient evidence Ct. 2705, 168 L. Ed. 2d 623 (2007) [**12] (citations of an appropriate geographic market. Finally, the parties omitted); see also Nat’l Hockey League Players, 325 F.3d at also dispute the district court’s finding that Plaintiffs have 718-19 (cautioning that the Supreme Court has described not provided sufficient evidence of antitrust injury. the per se rule as a ″demanding″ rule that should be applied ″only in clear cut cases″) (citations omitted). B HN8 Unless the restraint falls squarely into a per se As explained above, the HN5 Plaintiffs must present category, the rule of reason should be used instead. Expert evidence showing that the Defendants’ agreement Masonry, 440 F.3d at 343. Unlike the per se rule, the rule of ″unreasonably restrains trade″ in order to satisfy the second reason utilizes a burden-shifting framework that allows the requirement of an antitrust claim. Re/Max Intern., Inc. v. [*272] court to ″analyze the history of the restraint and the Realty One, Inc., 173 F.3d 995, 1012 (6th Cir. 1999). In the restraint’s effect on competition.″ Nat’l Hockey League case at hand, the district court applied the rule of reason to Players, 325 F.3d at 718. First, the plaintiff must establish determine whether the alleged restraint was unreasonable, a a prima facie case by showing five [***8] elements: (1) a decision which Plaintiffs now contest. The district court’s conspiracy (2) that produced anticompetitive effects; (3) decision to use the rule of reason is HN6 a question of law, that the scheme ″affected relevant product and geographic [***7] see Expert Masonry, 440 F.3d at 342, which we markets″; (4) that the conspiracy’s goal and related conduct review de novo. See Associated Gen. Contractors of Ohio, was illegal; (5) and that the restraint was the proximate Inc. v. Drabik, 250 F.3d 482, 484 (6th Cir. 2001) (citation cause of the plaintiff’s antitrust injury. Expert Masonry, 440 omitted). F.3d at 343 (citing Care Heating & Cooling, 427 F.3d at 1014). If a plaintiff passes over these hurdles, the burden 1 then shifts to the defendant to produce evidence that the restraint in question has ″procompetitive [**13] effects″ that ″ HN7 A restraint may be deemed unreasonable either are sufficient ″to justfi[y] the otherwise anticompetitive because it fits within a class of restraints that has been held injuries.″ Expert Masonry, 440 F.3d at 343 (quoting Nat’l to be ’per se’ unreasonable, or because it violates what has Hockey League Players, 325 F.3d at 718). Finally, if the ″ come to be known as the ’Rule of Reason.’ FTC v. Indiana defendant meets this burden, the plaintiff may still prevail Fed’n of Dentists, 476 U.S. 447, 457-58, 106 S. Ct. 2009, 90 by showing that ″any legitimate objectives can be achieved L. Ed. 2d 445 (1986) [**11] (quoting Chicago Bd. of Trade in a substantially less restrictive manner.″ Id. (quoting Nat’l v. United States, 246 U.S. 231, 238, 38 S. Ct. 242, 62 L. Ed. Hockey League Players, 325 F.3d at 718) (quotation marks 683 (1918)). The less common method of determining omitted). whether the restraint is unreasonable is the per se rule. ″Certain agreements, such as horizontal price fixing and HN9 When determining whether to use the per se rule or the market allocation, are thought so inherently anticompetitive rule of reason, courts must consider the type of restraint at that each is illegal per se without inquiry into the harm it has issue — whether it is horizontal or vertical. Expert Masonry, actually caused.″ In re Cardizem CD, 332 F.3d at 907 440 F.3d at 344. An agreement ″between competitors at the (quoting Copperweld Corp. v. Independence Tube Corp., same level of the market structure″ is horizontal. Sancap 467 U.S. 752, 768, 104 S. Ct. 2731, 81 L. Ed. 2d 628 Abrasives Corp. v. Swiss Indus. Abrasives, 19 F. App’x 181, (1984)). The per se rule should only be used when the 191 (6th Cir. 2001) (quoting Crane & Shovel Sales Corp. v. restraint has ″such predictable and pernicious anticompetitive Bucyrus-Erie Co., 854 F.2d 802, 805-06 (6th Cir. 1988)). effect,″ that there is ″limited potential for procompetitive Horizontal restraints are considered to be more threatening, benefit.″ Id. (quoting State Oil Co., 522 U.S. at 10). Once and thus result in per se treatment more regularly. See 10 Recent Decisions Every Page 84 of 309 Attorney Should Know

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Expert Masonry, 440 F.3d at 344 (citing examples from which causes the effect is determinative. See Business cases). Vertical restraints — agreements between parties ″at Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, different levels of the market structure, such as manufacturers 730 n.4, 108 S. Ct. 1515, 99 L. Ed. 2d 808 (1988). [**14] and distributors″— have more redeeming qualities [**16] For example, ″a facially vertical restraint imposed by (e.g., allowing for distribution efficiencies) and are subjected a manufacturer only because it has been coerced by a to the rule of reason. Total Benefits Planning Agency, Inc. v. ’horizontal cartel’ agreement among his distributors is in Anthem Blue Cross & Blue Shield, 552 F.3d 430, 435 (6th reality a horizontal restraint.″ Id. In this case, the agreement Cir. 2008) (quoting Leegin Creative Leather Products, 551 was between Dean Foods and DFA — Dean Foods agreed to U.S. 877, 127 S. Ct. 2705, 168 L. Ed. 2d 623); see also buy the raw milk it needed from [***10] DFA, thus creating Expert Masonry, 440 F.3d at 344-45. a vertical relationship, in exchange for DFA’s hampering NDH’s ability to effectively compete. 2 Plaintiffs’ explanation that NDH acted as it did because of After careful consideration, the district court concluded that a horizontal agreement between Dean Foods and NDH has the agreement at issue in this case should be scrutinized no logical basis because such an arrangement would present under the rule of reason because ″the essence of [***9] the an agreement whereby Dean Foods simply benefits and agreement alleged by the Plaintiffs is one between Dean in NDH is harmed. Rather, DFA is the sine qua non for this its role as a processor of bottled milk and DFA in its role as conspiracy; NDH would compete but for DFA and the a supplier of raw milk, and that the [ ] supply agreements for non-price restrictions it allegedly imposed on NDH. raw milk are central to the completion of the alleged conspiracy.″ In re Southeastern Milk Antitrust Litig., 2012 HN11 ″Courts cannot act perfunctorily when distinguishing U.S. Dist. LEXIS 44221, 2012 WL 1032797, at *12. The restraints that merit a per se approach from those that ″substantial vertical elements″ were too significant for the deserve rule of reason analysis,″ and the court may apply district court to agree with Plaintiffs that the essence of the the per se rule ″only if a restraint clearly and unquestionably conspiracy was horizontal. [Id.] falls within one of the handful of categories that have been collectively deemed per se anticompetitive.″ Expert Plaintiffs have previously characterized the conspiracy as a Masonry, 440 F.3d 336, 343-44. Here, Plaintiffs [**17] have complex relationship among DFA, Dean Foods, and NDH. not alleged facts that would place this situation into one of That arrangement, however, necessarily involves vertical those limited categories. Rather, the restraint at issue elements in the relationship [**15] between DFA and Dean appears to involve a vertical relationship, thus requiring the Foods. Yet now on appeal, Plaintiffs contend that the Court to apply the rule of reason. See Care Heating, 427 conspiracy is much simpler than previously alleged, and F.3d at 1013-14. urge this Court to find that Defendants have committed a per se violation of the Sherman Act. In support of this Moreover, even if the agreement is horizontal in the way contention, Plaintiffs reassert that the Defendants’ agreement Plaintiffs now claim, HN12 applying the rule of reason is is horizontal, arguing that ″the conspiracy here is the the default position and can be applied to horizontal agreement between Dean/Suiza and NDH not to compete.″ restraints as well if they do not fit into existing categories of This argument, however, is unavailing. Plaintiffs should not per se violations. E.g., F.T.C. v. Indiana Fed’n of Dentists, be able to [*273] change their characterization of the 476 U.S. at 458-59 (applying the rule of reason to a conspiracy midstream in order to gain a more favorable horizontal agreement where ″the economic impact″ of a outcome. business practice was ″not immediately obvious″). Indeed, the Sixth Circuit has an ″automatic presumption in favor of Plaintiffs concede that the reason NDH would agree to the rule of reason standard,″ Care Heating, 427 F.3d at 1012 weaken itself is unclear until NDH’s ownership structure is (citing Bus. Elecs. Corp., 485 U.S. at 726), while the per se disclosed. Plaintiffs explain that NDH conspired with Dean rule is reserved only for those infrequent occasions of ″clear Foods only because DFA owned and controlled NDH, and cut cases″ in which the trade restraint is ″so unreasonably because the conspiracy served DFA’s purposes. Assuming anticompetitive that they present straightforward questions Plaintiffs’ theory of their injury is true, they suffered harm for reviewing courts.″ Id. at 1012. because of the result from the agreement between Dean Foods and DFA. HN10 The conspiracy’s effect on the Finally, HN13 summary judgment is only appropriate when plaintiff, however, is not the sole means of determining there are no genuine issues of [**18] material fact, and the whether a restraint is horizontal or vertical. The agreement moving party is entitled to judgment as a matter of law. Fed. 10 Recent Decisions Every Page 85 of 309 Attorney Should Know

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R. Civ. P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, that this simple logic equation overlooks the recent 323-25, 106 S. Ct. 2548, 91 L. Ed. 2d 265 (1986). Here, deterioration of clearly defined types of market analyses in when [***11] considering the allegations contained in the favor of a more case-by-case approach. Realcomp II, Ltd. v. parties’ briefs, it appears that a factual dispute exists as to FTC, 635 F.3d 815, 826 (6th Cir. 2011) (″The Court has the exact nature of the conspiracy, and as to whether it was moved away from . . . reliance upon fixed categories and obviously anticompetitive. For instance, the [*274] toward a continuum, within which the extent of the inquiry Defendants have produced evidence that the agreement at is tailored to the suspect conduct in each particular case.″) issue may have had procompetitive aspects, which would (quoting Polygram Holding, Inc. v. FTC, 416 F.3d 29, indicate that this situation would not fall into the categories 34-34, 367 U.S. App. D.C. 367 (D.C. Cir. 2005)) (internal of per se unreasonable restraints on trade. [E.g., Appellee quotation marks omitted). Br. at 42 n.16 (presenting evidence that plant closures HN14 This Court has characterized ″quick look″ analysis as reduced costs and rationalized assets, resulting in cost a third type of category arising from the blurring of the line savings).] Another factual dispute exists as to whether NDH between per se and rule of reason cases. See Expert was truly weakened due to the agreement between Dean Masonry, 440 F.3d at 343. This less-rigid approach aligns Foods and DFA. [Appellee Br. at 12-13 (referencing evidence with the Supreme Court’s recognition of the value of the of active competition between Dean and NDH after the ″quick look″ approach as an abbreviated [**21] form of the merger)]. Depending on the situation, full supply contracts rule of reason analysis used for situations in which ″an such as those involved in this case ″may well be of observer with even a rudimentary understanding of economic advantage to buyers as well as to sellers, and thus economics could conclude that the arrangements in question indirectly of advantage to the consuming public.″ Standard would have an anticompetitive effect on customers and Oil Co. v. United States, 337 U.S. 293, 306, 69 S. Ct. 1051, markets.″ Cal. Dental Ass’n v. FTC, 526 U.S. 756, 770, 119 93 L. Ed. 1371 (1949). [**19] Additionally, the Department S. Ct. 1604, 143 L. Ed. 2d 935 (1999). Applying this test is of Justice fully reviewed and sanctioned the agreement at useful when the anticompetitive nature of an [*275] issue here, which presumably would not have occurred if agreement is so blatant that a detailed review of the the agreement was a per se unreasonable restraint on trade. surrounding marketplace would be unnecessary. Id. at Therefore, especially at the summary judgment stage, this is 769-70. In the same way that this analysis occupies territory not a ″clear cut″ case of an obviously anticompetitive trade between the per se and rule of reason tests, so the burdens restraint, and thus the district court was correct to apply the and presumptions do as well. Once anticompetitive behavior default standard of the rule of reason. is shown to a court’s satisfaction, even without detailed market analysis, the burden shifts to the defendant who must 3 justify the agreement at issue on procompetitive grounds by As explained above, when applying the rule of reason providing some ″competitive justification″ for the restraint analysis, plaintiffs generally must establish the effect on the at issue. Realcomp, 635 F.3d at 825. relevant geographic and product markets. However, courts have recently begun to view the rule of reason in a broader HN15 Whatever tool is used to judge an agreement, ″the manner in certain cases. Plaintiffs contend that even if the essential inquiry remains the same — whether or not the Court applies the rule of reason to their case, under the challenged restraint enhances competition.″ Cal. Dental so-called ″quick look″ rule of reason analysis, they still Ass’n, 526 U.S. at 780 (quoting Nat’l College Athletic should not be required to prove geographic market because Ass’n, 468 U.S. at 104). the adverse market effects are implied by the obvious violation of the Defendants. Once the district court decided [***13] [T]here is generally no categorical that the rule of reason applied, it granted summary judgment [**22] line to be drawn between restraints that give to the Defendants, without addressing whether a quick-look rise to an intuitively obvious inference of analysis might be appropriate. ″[T]he alleged agreements anticompetitive effect and those that call for more challenged [**20] by Plaintiffs ought to be subject to the detailed treatment. What is required, rather, is an rule of reason analysis, requiring that [***12] Plaintiffs enquiry meet for the case, looking to the establish the relevant geographic antitrust market, something circumstances, details, and logic of a restraint. The they cannot do. For this reason, Defendants are entitled to object is to see whether the experience of the summary judgment as to Count I of Plaintiffs’ complaint.″ market has been so clear, or necessarily will be, In re Southeastern Milk Antitrust Litig., 2012 U.S. Dist. that a confident conclusion about the principal LEXIS 44221, 2012 WL 1032797, at *12. Plaintiffs submit tendency of a restriction will follow from a quick 10 Recent Decisions Every Page 86 of 309 Attorney Should Know

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(or at least quicker) look, in place of a more no longer be relevant. However, the district court may yet sedulous one. determine that a full rule of reason analysis is still required, in which case Plaintiffs would not be able to establish the Cal. Dental Ass’n, 526 U.S. at 780-81. relevant market apart from the testimony of Professor Froeb, whose testimony was excluded by the district court. Here, using the quick-look analysis, Plaintiffs do not Thus, on remand, Professor Froeb’s testimony about necessarily need to show geographic market evidence to geographic market may yet return to prominence, and defeat summary judgment. The district court did not therefore we review the decision to exclude it. distinguish between the two types of rule of reason analysis as explained above — the full rule of reason analysis and In applying the rule of reason to the case at hand, the district the quick-look form of analysis. See Cal. Dental Ass’n, 526 court required the Plaintiffs to establish and define the U.S. at 769-70. Under the quick-look standard, the Plaintiffs relevant geographic market, but also held that Plaintiffs’ have met their burden of raising a genuine issue of material expert witness, Professor Luke Froeb, formed his opinion fact as to whether Dean Foods violated the antitrust laws concerning geographic market by using an unreliable even without establishing the relevant geographic market. method. In re Southeastern Milk Antitrust Litig., 2012 U.S. HN16 In applying the summary judgment standard, Dist. LEXIS 44221, 2012 WL 1032797, at *12. As a result, [**23] the Court must review the facts and draw all Plaintiffs lacked a required [**25] element of a rule-of-reason reasonable inferences in favor of the non-moving party. claim, and Defendants were granted summary judgment. Id. Logan v. Denny’s, Inc., 259 F.3d 558, 566 (6th Cir. 2001) Plaintiffs contend that the exclusion of Froeb’s testimony (citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, was improper. 106 S. Ct. 2505, 91 L. Ed. 2d 202 (1986)). Accordingly, when construing the facts and record evidence in Plaintiffs’ HN17 The district court’s decision to exclude Froeb under favor, the alleged unlawful conduct has obviously adverse, the standard required by Daubert v. Merrell Dow Pharms.., anticompetitive effects; and for purposes of summary 509 U.S. 579, 113 S. Ct. 2786, 125 L. Ed. 2d 469 (1993), is judgment, the district court should have at least considered reviewed for abuse of discretion. Ky. Speedway, LLC v. the fact that a more detailed market analysis may not have Nat’l Ass’n of Stock Car Auto Racing, 588 F.3d 908, 915 been required under these circumstances. See Realcomp, (6th Cir. 2009). ″A district court abuses its discretion when 635 F.3d at 825. While it is true that the vertical elements of it ’applies the wrong legal standard, misapplies the correct the Defendants’ agreement require a rule of reason analysis, legal standard, or relies on clearly erroneous findings of the agreement between the horizontal competitors for the fact.’″ Romberio v. UnumProvident Corp., 385 F. App’x express purpose of limiting competition between them 423, 428 (6th Cir. 2009) (quoting Schachner v. Blue Cross could be viewed as a ″facially anticompetitive restraint,″ & Blue Shield of Ohio, 77 F.3d 889, 895 (6th Cir. 1996)). and the district court should consider this possibility on This Court will not find an abuse of discretion unless it has remand. Realcomp, 635 F.3d at 827. Even though Dean a ’definite and firm conviction that the trial court committed Foods’ alleged conduct is not illegal per se, the evidence in a clear error of judgment.’″ Id. (quoting Miami Univ. the record and the allegations in Plaintiffs’ complaint are Wrestling Club v. Miami Univ., 302 F.3d 608, 613 (6th Cir. sufficient to shift the burden to Dean Foods to present some 2002)). This issue was clearly appealed and briefed procompetitive benefits [**24] of the alleged conduct. See extensively, and for the reasons explained below [***15] Expert Masonry, 440 F.3d at 343. the district court should not have excluded Froeb’s testimony. See Ky. Speedway, 588 F.3d at 918. [***14] C 1 Under a quick-look analysis, the Plaintiffs do not necessarily need to establish [*276] either product or geographic1 HN18 Admissibility [**26] of expert testimony is governed market evidence in order to defeat summary judgment. In by Federal Rule of Evidence 7022 and informed by the that event, the exclusion of their expert’s testimony would seminal case applying Rule 702, Daubert v. Merrell Dow

1 The definition of product market is not at issue on appeal. 2 HN19 ″A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if: (a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.″ Fed. R. Evid. 702. 10 Recent Decisions Every Page 87 of 309 Attorney Should Know

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Pharmaceuticals, Inc., 509 U.S. 579, 113 S. Ct. 2786, 125 L. exist in much smaller areas as well. Compare United States Ed. 2d 469 (1993). In Daubert, the Supreme Court explained v. Grinnell Corp., 384 U.S. 563, 575, 86 S. Ct. 1698, 16 L. that ″[u]nlike an ordinary witness . . . an expert is permitted Ed. 2d 778 (1966) (finding a national market), with United wide latitude to offer opinions, including those that are not States v. Phila. Nat’l Bank, 374 U.S. 321, 361, 83 S. Ct. based on firsthand knowledge or observation.″ Daubert, 509 1715, 10 L. Ed. 2d 915 (1963) (finding a four-county region U.S. at 593. The Supreme Court also recognized that a market). In either case, a geographic market must be implicit in the rule is a district court’s gatekeeping drawn to consist of the smallest area of overlap of Plaintiffs’ responsibility, ″ensuring that an expert’s testimony both and Defendants’ locations, and in which prices could be rests on a reliable foundation and is relevant to the task at increased without retailers turning to alternative suppliers or hand.″ Id. at 597. other milk processors entering the area. See Hovenkamp, supra, § 3.6. [*277] HN20 Geographic [**27] market is defined as ″the region in which the seller operates, and to which the The hypothetical [**29] monopolist is a related concept. See purchaser can practicably turn for supplies.″ Tampa Elec. U.S. Dep’t of Justice and Fed. Trade Comm’n, 1997 Co. v. Nashville Coal Co., 365 U.S. 320, 327, 81 S. Ct. 623, Horizontal Merger Guidelines (″Merger Guidelines″); see 5 L. Ed. 2d 580 (1965); see E.I. DuPont de Nemours & also FTC v. Whole Foods Market, Inc., 548 F.3d 1028, 1038 Comp. v. Kolon Indus., Inc., 637 F.3d 435, 442 n.2 (4th Cir. (D.C. Cir. 2008) (acknowledging the use of this construct 2011) (explaining that this standard applies to § 1 Sherman when examining a market); Ky. Speedway, 588 F.3d at 918 Act claims); see also Spirit Airlines, Inc. v. Northwest (same). HN22 Using the hypothetical monopolist as an Airlines, Inc., 431 F.3d 917, 932-33 (6th Cir. 2005). entity that controls all the suppliers in a proposed market,3 Outlining a geographic market entails mapping an area a question is posed: could a monopolist profit if it imposed ″within which the defendant’s customers who are affected a ″small but significant non-transitory increase in price″ by the challenged practice can practicably turn to alternative (″SSNIP″)? Id. Typically, the increase that is posited is five suppliers if the defendant were to raise its prices or restrict percent. Ky. Speedway, 588 F.3d at 918. If buyers in a its output.″ Kolon Indus., 637 F.3d at 441-42 (citations defined area would respond to a small, [*278] lasting omitted). This process is fact-intensive and focused on the increase in price — a SSNIP — by purchasing from another ″commercial realities of the industry.″ Brown Shoe Co. v. supplier, rendering the SSNIP unprofitable, the market has United States, 370 U.S. 294, 336, 82 S. Ct. 1502, 8 L. Ed. 2d been too narrowly defined. See FTC v. Tenet Healthcare 510 (1962). These include considerations of areas where Corp., 186 F.3d 1045, 1053, n.11 (8th Cir. 1999) products are marketed, or where the defendant perceives [***17] (citing Merger Guidelines § 1.21)). Similarly, a that it is competing; any applicable regulatory standards; market is too small if additional suppliers would enter a transportation costs and challenges such as risk of spoilage, market in response to one firm’s price increase. Id. at 1052 size, or weight; and ″other factors bearing upon [***16] (citing Bathke, 64 F.3d at 346). In either of those cases, the where customers might realistically [**28] look to buy the question about a SSNIP must be reconsidered [**30] and product.″ Kolon Indus., 637 F.3d at 442-43 (citations applied to a wider area. omitted). Finally, a geographic market must be sizeable enough to be ″economically significant.″ Brown Shoe, 370 This should continue only until buyers in the relevant U.S. at 336-37. market respond to a SSNIP by purchasing regardless of the increase. Merger Guidelines § 1.0. Although the Merger HN21 The purpose of defining a geographic market is to Guidelines, including the hypothetical monopolist, are useful reveal whether, or to what extent, market power exists. and informative for courts in analyzing some antitrust Thompson v. Metro. Multi-List, Inc., 934 F.2d 1566, 1573 violation claims, Ky. Speedway, 588 F.3d at 918 (citing (11th Cir. 1991). Market power is defined as the ability to Whole Foods, 548 F.3d at 1038), they were written to charge a supracompetitive price — a price above a firm’s ″describe the analytical process that the [Department of marginal cost. Herbert Hovenkamp, Federal Antitrust Policy: Justice and Federal Trade Commission] will employ in The Law of Competition and Its Practice, §§ 3.1, 3.1a (4th determining whether to challenge a horizontal merger.″ ed. 2011). Such power could cover the nation, but it may Merger Guidelines § 0.2.

3 ″A market is defined as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area would likely impose at least a ’small but significant nontransitory’ increase in price, assuming the terms of sale of all other products are held constant.″ Merger Guidelines § 1.0. 10 Recent Decisions Every Page 88 of 309 Attorney Should Know

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2 106 S. Ct. 1348, 89 L. Ed. 2d 538 (1986)). Second, the court cited testimony from [**33] Froeb’s deposition, finding that The process for excluding Professor Froeb’s testimony he clearly testified that the proposed geographic market was involved two orders from the district court and one from the founded on something other than the Tampa Electric standard magistrate judge. [**31] This circuitous path warrants — that is, the market area ″in which the seller operates, and explanation. In August, 2010, the district court initially to which the purchaser can practicably turn for supplies.″4 denied summary judgment to Defendants on Count I — Id. (citing Tampa Electric, 365 U.S. at 327). Third, Froeb violation of 15 U.S.C. § 1 by conspiring to restrain trade — did not consider ″commercial realities.″ Id. Finally, the but granted summary judgment on Counts III and IV, which court claimed that Froeb mistakenly premised the geographic alleged monopolization in violation of 15 U.S.C. § 2. In re market on only one customer — Food Lion. Id. (citing Southeastern Milk Antitrust Litig., 730 F. Supp. 2d 804, 825, Apani Southwest, Inc. v. Coca-Cola Enters., Inc., 300 F.3d 826, 828 (E.D. Tenn. 2010) on reconsideration in part, 620, 632-33 (5th Cir. 2002)). 2:08-MD-1000, 2012 U.S. Dist. LEXIS 44221, 2012 WL 1032797 (E.D. Tenn. Mar. 27, 2012). Froeb’s evidence Four months later, the magistrate judge assigned to this case played no part in the district court’s conclusion as to Count issued an order excluding Froeb’s geographic market I, but it was the decisive factor in ruling against Plaintiffs on testimony pursuant to Rule 702. The order explained that Counts III and IV, both of which require a party to establish Defendants had to prevail on their motion to exclude a geographic market. Id. at 825-28. Froeb’s testimony because the summary judgment decision previously issued by the district court established the law of Froeb had marked out the geographic market for Counts III the case. This was most clearly true for Froeb’s testimony and IV by looking at regions where Dean Foods sells, and pertaining to the monopoly claims, but [**34] the magistrate Food Lion buys, processed milk. He examined the states of judge concluded likewise for the [***19] conspiracy claim, Georgia, North Carolina, and Virginia as possible markets, using different deposition testimony from Froeb to support but individually each state was too small for the imposition this conclusion. Froeb had testified that the same analytic of a profitable price increase because suppliers would framework was used to demarcate the geographic markets prevent a price increase by shipping cheaper milk into the for both claims, and the magistrate judge reasoned that if the affected area. A regional market including Georgia, North framework was unreliable for the monopoly claims, it must [**32] Carolina, Virginia, South Carolina, and the [***18] also be so for the conspiracy claim. eastern part of Tennessee, however, was found to be sizeable enough. In making that determination, Froeb relied This lengthy journey to exclusion finally culminated with on estimates of transportation costs and elasticity of demand. the district court’s order on Plaintiffs’ motion to reconsider the magistrate judge’s decision, in which the court affirmed In reaching its conclusion, the district court did not evaluate the magistrate judge’s decision to exclude Froeb’s testimony. Froeb’s methods under Rule 702 and Daubert. Instead, The district court was skeptical that it needed to rule on the while assuming that Froeb’s testimony was reliable and same issue again, but it decided the cautious approach was relevant, the court identified four ways that Froeb’s most prudent and considered Defendants’ Daubert motion methodology was not in compliance with the Supreme anew, but as an alternative holding to the prior order. Court’s requirements for discerning geographic market; Nevertheless, Froeb’s opinions were excluded again on because of this, the court held that Plaintiffs failed to similar grounds as before. Once again, the district court establish a genuine issue of material fact on this required found that Froeb’s deposition testimony did not satisfy the element. In re Southeastern Milk Antitrust Litig., 730 F. Tampa Electric standard because he had used the Supp. 2d at 825. In support of this conclusion, the district hypothetical monopolist construct improperly. The court court first cited two Supreme Court cases for the proposition reemphasized the lack of consideration of commercial that raising a genuine issue of material fact cannot be done [**35] realities — e.g., information about Plaintiffs’ solely through expert testimony unsupported by facts in the purchasing behavior or pricing, how retailers in the record. Id. at 828 (citing Brooke Group Ltd. v. Brown & prescribed markets currently obtain supplies, or actual Williamson Tobacco Corp., 509 U.S. 209, 242, 113 S. Ct. elasticity of demand — and the lack of reliance on facts in 2578, 125 L. Ed. 2d 168 (1993) and Matsushita Elec. Indus. the record. Froeb’s model, based only on Food Lion’s Co. v. Zenith Radio [*279] Corp., 475 U.S. 574, 581 n.5, locations, was again disparaged according to the principle

4 It is unclear whether Froeb’s statement applies to the geographic market created for the monopoly claims in Counts 3 and 4, the conspiracy claim in Count 2, or both. 10 Recent Decisions Every Page 89 of 309 Attorney Should Know

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that ″a geographic market cannot ordinarily be defined by Southeastern Milk Antitrust Litig., 730 F. Supp. 2d at 825. In reference to a single customer.″ Id. (citing Apani Southwest support of that criticism, the district court cited two Supreme Inc., 300 F.3d at 632-33). Court decisions. Id. In Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 106 S. Ct. 1348, 89 L. Ed. 3 2d 538 (1986), the Court affirmed the lower court’s decision to exclude an expert report that utilized assumptions about The district court’s reasoning in its decision to exclude a competitor’s costs because the study used assumptions Froeb’s testimony rests on an incomplete review of the facts and estimates as inputs that were ″implausible [**38] and and the application of incorrect legal standards. See inconsistent with record evidence.″ Id. at 594 & n.19. In Romberio, 385 F. App’x at 428. First, the blanket exclusion Brooke Group Ltd., the Supreme Court reiterated its prior of Froeb’s testimony was not warranted by his alleged use message: HN23 an expert’s opinion must use valid facts to of one customer when defining a market. Froeb defined his be reliable. 509 U.S. at 242. Facts can be undependable for markets differently for the monopoly claims and the numerous reasons, including actual information that is of conspiracy claim. For the monopoly claims, Froeb clearly poor quality, [***21] and contradictory facts present in the stated, ″[m]y analysis is motivated by including regions record. Id. (citing J. Truett Payne Co., Inc. v. Chrysler where Dean and Food Lion engage in the sale and purchase Motors Corp., 451 U.S. 557, 564-65, 101 S. Ct. 1923, 68 L. of milk.″ [R. 1159-5 at 39.] In [*280] contrast, for the Ed. 2d 442 (1981)). None of those reasons, however was conspiracy (or coordinated action) claim, ″the candidate relied on by the district court in the case at hand. Rather, the area should [***20] include plants owned by all the alleged sole reason for excluding Froeb’s testimony was the absence [**36] conspirators.″ Id. at 33. Froeb proceeded to draw a of facts in the record. Thus, the cited precedent does not map encompassing the processing locations owned by Dean adequately support the district court’s conclusion. Foods, NDH, and DFA while making assumptions about the locations of ″customers.″ The result was a more expansive Froeb’s report is bereft of citations to an underlying footprint than that which Food Lion occupies.5 This error document or report as he opines on the relatively elementary began with the magistrate judge’s order, which quoted economic concepts of competition between processing plants Froeb’s deposition. The magistrate judge focused on Froeb’s and the benefits one firm could garner by eliminating explanation that he used ″the same analytic framework″; but competition. [R. 1159-5 at 15.] Following that explanation, the judge did not refer to the surrounding context, in which Froeb extensively cited facts from government studies, Froeb explains that he is struggling to answer the questions academic publications, and the record itself as he created a posed to him, in part because he is unsure of what the geographic market. [See, e.g., id. at 19 n.34 [*281] (citing questioner was asking. Clearly, the methods for creating data showing demand for [**39] milk is relatively insensitive geographic markets for the monopoly claims and the to price); see also id. at n.35 (citing information in the conspiracy claim were built on different foundations. record showing the same result);6 id. at 25 n.48 (citing Consequently, the exclusion of one does not necessitate the record evidence regarding transportations costs; id. at 26 exclusion of the other. n.50 (same); id. at 26-27 n.51 (citing reports and record evidence as inputs for factoring transportation costs).] In Second, the requirement that an expert base his findings on sum,HN24 expert reports must be based on proper facts, but facts in the record is a proper legal proposition, but it was each of those facts does not have to occupy an independent misapplied. In the district court’s order on summary part of the record for an expert to be able to use them when judgment, it emphasized that ″[t]here is nothing in this crafting an opinion. record to illustrate that Professor Froeb has based his opinions on evidence in the record; in fact, he appears to Third, lack of reliance on evidence in the record was admit that he did not do so, relying instead on a theoretical combined with criticism that ″commercial realities″ were model he constructed for the purpose of the analysis.″ In re not considered.HN25 Commercial realities should be

5 Orders 5 and 7 cover all or part of fourteen states: Alabama, Arkansas, Florida, Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia. Plaintiff Fidel Breto has one store located in Tennessee, and Food Lion has 1,300 stores in 11 states: Delaware, [**37] Florida, Georgia, Kentucky, Maryland, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia, and West Virginia. The states in Orders 5 and 7 in which Plaintiffs are located are as follows: Florida, Georgia, Kentucky, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia.

6 Price elasticity is noted as a foundational element in Froeb’s definition of a geographic market. 10 Recent Decisions Every Page 90 of 309 Attorney Should Know

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contemplated when a geographic market is being created. others goes to the ″accuracy of the conclusions, not to the See Kolon Indus., 637 F.3d at 442-443. The district court reliability of the testimony.″ In re Scrap Metal Antitrust was troubled by the absence of actual information from Litigation, 527 F.3d 517, 530-31 (6th Cir. 2008) (quoting Food Lion, such as Food Lion’s purchasing habits, where it Jahn v. Equine Servs., PSC, 233 F.3d 382, 383 (6th Cir. actually sought out supplies, and data about price elasticity. 2000)). The hypothetical monopolist test and Tampa Electric both require data based on actual circumstances, e.g., where a Finally, the district court found that Froeb did not apply the buyer and/or seller [**40] is located. Both inquiries, Tampa Electric standard when forming the geographic however, also require estimates, and even discount the value market. Quoting Froeb’s deposition testimony, the district of data based on actual behaviors. The question about court found that he denied that his market analysis looked at buyers in Tampa Electric, for instance, focuses on where the [*282] area ″in which the seller operates [**42] and to they can ″practicably″ turn for supplies — not where they which the purchaser can practically turn for supplies.″ actually do. See Morgenstern v. Wilson, 29 F.3d 1291, 1296-97 (8th Cir. 1994); [***22] Bathke v.Casey’s General When a similar question was posed again, Froeb repeated Stores, Inc., 64 F.3d 340, 346 (8th Cir. 1995). Moreover, the his disclaimer that his model was based on a different hypothetical monopolist construct requires speculation about approach. Because Froeb’s version of the hypothetical a buyer’s likely reaction to a supplier’s price increase. [***23] monopolist test was applied unconventionally — or Merger Guidelines § 1.21. Quite obviously, the estimate at least purportedly so, based on his deposition testimony — should be informed by actual evidence when possible, id., his opinion was categorized as unreliable. but actual evidence does not have to be based on the particular parties’ behaviors. In other words, a nationwide HN26 At its most basic, the hypothetical monopolist estimate of demand elasticity that is used to predict the construct requires selection of the smallest area in which a reaction of retailers in the southeast to a price increase SSNIP could be successfully imposed. For that construct to would be a reliable method of calculation. Thus, the be valuable in a case, the area at issue must encompass at hypothetical monopolist test does not require Froeb to use least some of the locations of the seller (Defendants) and the data from Food Lion in place of data gleaned from a broader buyer (Plaintiffs), including where the buyer could turn for sample. supplies if prices increased. See Merger Guidelines §§ 1.21, 1.22. The availability of suppliers that are actually Furthermore, Froeb did not completely ignore commercial alternatives is limited by the economic realities of the realities. He may have neglected to include important facts; industry at issue. See id. at § 1.21. Applied in that way, the and those identified [**41] by the district court may have hypothetical monopolist and the Tampa Electric standard more closely aligned his analysis with that explained in the are practically equivalent: the hypothetical monopolist is ″a Merger Guidelines. See Merger Guidelines § 1.21 (″In useful framework for organizing the factors the courts have considering the likely reaction of buyers to a price increase, applied in geographic market definition.″ 2 Earl W. Kinter the Agency will take into account all relevant evidence, [**43] et al., Federal Antitrust Law § 10.15 (2013). including, but not limited to, the following: evidence that buyers have shifted or have considered shifting purchases between different geographic locations in response to relative Notwithstanding Froeb’s disclaimer, he also states in his changes in price or other competitive variables . . . .″). But deposition that he ″started with areas 5 and 7 because that actual inputs were considered, most notably transportation seemed to include all three of the defendants.″ [R. 1159-5 at costs and plant locations inside and outside of the proposed 27.] Fidel Breto’s one location was within that area, as were geographic market. Including some facts while omitting some of Food Lion’s stores.7 Practicable alternative suppliers

7 With regard to Plaintiffs’ locations, Froeb graphs Orders 5 and 7, including many locales lacking any stores owned by Plaintiffs, and makes the following assumption:

Customers locate [**44] stores near population centers and locate distribution centers to minimize the cost of distribution to stores. In the model, customer locations are represented by a grid of 119 evenly-spaced customer locations within Order Nos. 5 and 7. The total measure of demand at each location is proportional to the census population nearest that point.

[Id. at 32 n.60.] Froeb’s reason for doing this rather than mapping Plaintiffs’ locations is unclear, but his more extensive (and, albeit, 10 Recent Decisions Every Page 91 of 309 Attorney Should Know

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were also considered,8 extending as far away as 300 miles filed [**47] a Daubert motion, objecting to Cotterill’s from Milk Orders 5 and 7 and including all ″regulated, testimony; and the matter was referred to the magistrate non-captive″ plants. Opposing counsel asked if a smaller judge, who denied Defendants’ motion and ruled that market were contemplated, and Froeb replied that the Cotterill’s testimony was admissible. The district court market he described in his report was the only one never formally ruled on the [***25] objection, but when considered. In their [***24] response on appeal, Defendants granting summary judgment to Defendants on the injury criticize Froeb’s market delineation and suggest that the element, the wording of the opinion led the Plaintiffs to market is ″much smaller.″ HN27 Multiple courts of appeal believe that the district court was agreeing with the have held that market definition is a question of fact. Kolon Defendants’ objection, contrary to the ruling of the Indus., 637 F.3d at 442 (citing cases from the First, Second, magistrate judge. Because of that conclusion, the Plaintiffs Third, Fifth, Ninth, and Tenth Circuits9). Accordingly, have argued that the district court erred in not giving proper [*283] that question is better left for a jury to decide.10 deference to the magistrate judge’s findings, and that this Court should now review the decision concerning the In conclusion, Froeb’s testimony should not have been admissibility of expert testimony for abuse of discretion. excluded on the grounds relied upon by the district court. See KY Speedway, 588 F.3d at 915 (citing Hardyman v. Norfolk & W. Ry. Co., 243 F.3d 255, 258 (6th Cir. 2001)). D However, although the district court never explicitly As explained above,HN28 regardless of whether the court addressed Defendants’ objections to Cotterill’s testimony, uses the rule of reason or the per se rule, antitrust plaintiffs the summary judgment opinion strongly suggests that the must still prove that the restraint at issue caused them to district court concurred with the magistrate judge. The court suffer an antitrust injury. Expert Masonry, 440 F.3d at 342, did not exclude Cotterill’s testimony, but simply concluded 343. In its second summary judgment opinion, the district that it ″does not create a [**48] material issue of fact.″ In re court found that Plaintiffs had failed to ″allege an injury of Southeastern Milk Antitrust Litig., 2012 U.S. Dist. LEXIS the kind which the antitrust laws are designed to prevent.″ 44221, 2012 WL 1032797, at *6. Federal Rule of Civil In re Southeastern Milk Antitrust Litig., 2012 U.S. Dist. Procedure 56 on Summary Judgment contains similar LEXIS 44221, 2012 WL 1032797, at *6. The district court’s language, and legions of cases do likewise when discussing justification for this conclusion was that Plaintiffs’ injury the summary judgment standard. See e.g., In re Cardizem expert, Professor Ronald Cotterill, had conducted an CD, 332 F.3d at 906. No doubt it would have been clearer econometric analysis which partly attributed an increase in for the district court to explain with particularity why the price of milk to the merger itself rather than to any Defendants’ objections were not compelling. Nevertheless, anticompetitive conduct. Id. The Defendants had previously it is obvious that the district court considered Cotterill’s

hypothetical) rendering may be reliable under the principle that the greater includes the lesser. Froeb’s model includes the actual locations of Defendants’ (sellers) processing plants and, arguably at least, the practicable alternatives for Plaintiffs (buyers). His inclusion of additional (perhaps superfluous) buyers does not undermine his conclusion that prices could be manipulated. It should not be inferred that we are opining on the correctness of Froeb’s conclusions, we merely note that his method harmonizes with the Tampa Electric standard.

8 ″The model specifically considers (1) the locations of plants and customers, (2) the elasticity of demand for milk, determined by parameters that measure both demand [**45] and cost characteristics of the milk industry, and (3) the costs of transporting bottled milk.″ [R. 1159-5 at 31.]

9 Coastal Fuels of Puerto Rico, Inc. v. Caribbean Petroleum Corp., 79 F.3d 182, 196 (1st Cir. 1996); Todd v. Exxon Corp., 275 F.3d 191, 199 (2d Cir. 2001); Weiss v. York Hosp., 745 F.2d 786, 825 (3d Cir. 1984); Heatransfer Corp. v. Volkswagenwerk, A.G., 553 F.2d 964, 979 (5th Cir. 1977); Oahu Gas Serv., Inc. v. Pac. Res. Inc., 838 F.2d 360, 363 (9th Cir. 1988); Westman Comm’n Co. v. Hobart Int’l, Inc., 796 F.2d 1216, 1220 (10th Cir. 1986); see also Thompson v. Metropolitan Multi-List, Inc.., 934 F.2d 1566, 1573-74 (11th Cir. 1991) (citing Graphic Prods. Distribs., v. Itek Corp.., 717 F.2d 1560 (11th Cir. 1983)).

10 Plaintiffs urge us to hold that the district court erred when it relied on Froeb’s deposition testimony more heavily than the contents of his expert report. Traveling down that line of argument is unnecessary. Simply reiterating a long-standing and unremarkable principle is sufficient: the law establishes burdens of persuasion, and parties must bear those burdens. Clear deposition testimony that contradicts one’s own expert report may make bearing that burden [**46] more difficult, and that challenge may grow more daunting when the testimony and report are related to a difficult legal issue. Ultimately, we trust that courts vigorously endeavor to rule properly by reviewing the evidence put before them. The onus is on the parties to advocate clearly. 10 Recent Decisions Every Page 92 of 309 Attorney Should Know

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testimony in light of the magistrate judge’s opinion and measuring the injury Defendants’ conspiracy inflicted, after [*284] independent examination of the evidence. In re Cotterill merely discerned that after controlling for natural Southeastern Milk Antitrust Litig., 2012 U.S. Dist. LEXIS cost increases, prices rose an additional 7.9% between 2002 44221, 2012 WL 1032797, at *5-6.11 Consequently, we and 2007. This time period coincides with the timing of the review the district court’s grant of summary judgment merger, and the court accordingly concluded that Cotterill’s concerning the issue of antitrust injury de novo. In re calculations only revealed [**51] the impact of the merger, Cardizem CD, 332 F.3d at 905-06 (citation omitted). which was not contested. Id.

HN29 Antitrust plaintiffs cannot survive motions for In reaching that conclusion, the court relied on two facts. summary judgment without adequately alleging an antitrust First, in Cotterill’s deposition testimony he stated that the injury. Expert Masonry, Inc., 440 F.3d at 345. In addition to purpose of his calculation was ″to analyze whether in fact having to show injury-in-fact and proximate cause, antitrust the creation of NDH and the assertion that there would be plaintiffs must [***26] specifically establish ″antitrust economies of size and lower prices through efficiencies injury.″ In re Cardizem CD, 332 F.3d at 909. It is not enough generated by that creation from January 1, 2002 going to simply allege that an individual competitor suffered forward, whether that in fact was true or not.″ 2012 U.S. adverse effects from the defendants’ contract or conspiracy. Dist. LEXIS 44221, [WL] at *6 (quoting Cotterill Depo. Care Heating & Cooling, Inc., 427 F.3d at 1014-15. Rather, April 12, 2010, at 17). Second, during the Department of ″[a]ntitrust injury is (1) injury of the type the antitrust laws Justice’s review of the merger, it created a model to estimate were intended to prevent and (2) injury that flows from that the potential merger’s price-effect. Id. In Cotterill’s expert which makes defendants’ acts unlawful.″ In re Cardizem report, he explained that his model was similarly designed CD, 332 F.3d at 909 [**50] (quoting Brunswick Corp. v. to that of [***27] the Department of [*285] Justice, and Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 489, 97 S. Ct. 690, consequently, the court concluded that Cotterill’s regression 50 L. Ed. 2d 701 (1977)) (internal quotation marks omitted). analysis must have measured the effect of the merger as The antitrust injury requirement is critical because it ensures well. Id. that ″the injury should reflect the anticompetitive effect″ of the defendant’s actions. Brunswick Corp., 429 U.S. at 489. That conclusion, however, was based on flawed propositions, This ″ensures that a plaintiff can recover only if the loss and summary judgment was not warranted on the issue of stems from a competition-reducing aspect or effect of the injury. Although Cotterill made the statement quoted above, defendant’s behavior.″ In re Cardizem CD, 332 F.3d at he added — in the same sentence as the testimony was 909-10 (quoting Atlantic Richfield Co. v. USA Petroleum, transcribed — that he was also charged with discerning ″ 495 U.S. 328, 342-43, 110 S. Ct. 1884, 109 L. Ed. 2d 333 whether in fact there [**52] is a reliable economic model (1990)). of collusion rather than independent self-interest that says, yes, they did engage in actions that in fact are consistent In the case at hand, the district court concluded that only with collusive decisions by Dean, DFA, and NDH, and Plaintiffs had not created a genuine issue of material fact as [those] decisions resulted in elevated prices to the plaintiffs to either aspect of antitrust injury. In re Southeastern Milk in this case.″ Cotterill Depo. at 17-18.12 Answering that Antitrust Litig., 2012 U.S. Dist. LEXIS 44221, 2012 WL question would expose the precise sort of injury and 1032797, at *6. The court reasoned that Cotterill’s multiple causation that is required, especially when Plaintiffs must regression analysis was too simplistic. Id. Instead of benefit from all reasonable inferences. See Logan v. Denny’s,

11 In the context of reviewing a magistrate judge’s decision as to a dispositive motion and after a party’s objection, three other courts of appeal have held that a presumption should exist that a district court properly reviewed the motion. United States v. Hamell, 931 F.2d 466, 468 (8th Cir. 1991) (explaining that unless contrary evidence [**49] is presented, the appellate court should assume a district court engaged in appropriate review); Brunig v. Clark, 560 F.3d 292, 295 (5th Cir. 2009) (″[W]e will not assume that the district court did not conduct the proper review.″); Garcia v. City of Albuquerque, 232 F.3d 760, 766 (10th Cir. 2000) (″[N]either 28 U.S.C. § 636(b)(1) nor Fed. R. Civ. P. 72(b) requires the district court to make any specific findings; the district court must merely conduct a de novo review of the record.″). 12 The entire quote reads as follows:

As I understand it, I have been asked to analyze whether in fact the creation of NDH and the assertion that there would be economies of size and lower prices through efficiencies generated by that creation from January 1, 2002 going forward, whether that in fact was true or not, and whether in fact there is a reliable economic model of collusion rather than 10 Recent Decisions Every Page 93 of 309 Attorney Should Know

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Inc., 259 F.3d 558, 566 (6th Cir. 2001) (citing Anderson v. (holding that there was enough evidence of a conspiracy to Liberty Lobby, 477 U.S. 242, 255, 106 S. Ct. 2505, 91 L. Ed. deny summary judgment); In re Southeastern [*286] Milk 2d 202 (1986)). Antitrust Litig., 2012 U.S. Dist. LEXIS 44221, 2012 WL 1032797, at *6 (″The Court has previously held and now The district court’s concerns regarding Cotterill’s regression reaffirms that the evidence as a whole creates genuine issues analysis also do not support summary judgment. HN30 A of material fact as to whether Defendants entered into the multiple regression analysis is useful in quantifying the alleged agreement.″). This is precisely the kind of injury relationship between a dependent variable (e.g., the price of that the Sherman Act was designed [**55] to prevent. In re milk) and independent variables (e.g., energy costs and/or Cardizem CD, 332 F.3d at 910-11 (quoting Associated Gen. demand factors). Weisfeld v. Sun Chem. Corp.., 84 Fed. Contractors v. Cal. State Council, 459 U.S. 519, 538, 103 S. Appx. 257, 261 n.3 (3rd Cir. 2004). This type of model can Ct. 897, 74 L. Ed. 2d 723 (1983)) (″Preventing that kind of also ″control for other independent variables so as to isolate injury was undoubtedly a raison d’etre of the Sherman Act and identify the effect of a single independent variable on when it was enacted in 1890.″). the dependent variable.″ Weisfeld, 84 F. App’x at 261 n.3. The Department [***28] of Justice used a regression model This conclusion also resolves the question of whether to predict that post-merger prices would rise [**54] by Plaintiffs’ injuries ″flow from that which makes defendants’ 2.5%. Cotterill used a similar model and found that acts unlawful.″ In re Cardizem CD, 332 F.3d at 909. The In post-merger prices actually increased by 7.9%. Use of that re Cardizem CD court explained that HN31 when same widely-accepted model does not necessarily mean that competition is limited pursuant to an agreement and the increase was due to legal causes. customers are punished through higher prices, the injury Cotterill’s model, as applied to the facts, reveals three clearly results from anticompetitive conduct. 332 F.3d at conclusions which, taken together, can be viewed as evidence 909. Accordingly, summary judgment was not warranted of antitrust injury. First, it is clear that Plaintiffs purchased based on the lack of antitrust injury. processed milk from the Defendants. Second, Cotterill’s model indicates that after the merger Plaintiffs were charged III 7.9% more for milk than an econometric analysis could justify. And third, the district court found that evidence For the aforementioned reasons, the district court’s opinion indicated that Dean Foods and NDH, due to the influence of is reversed, and this case is remanded for further proceedings DFA, conspired to avoid competing vigorously. In re consistent with this opinion. Southeastern Milk Antitrust Litig., 730 F. Supp. 2d at 815-16

independent self-interest that says, yes, they did engage in actions that in fact are consistent only with collusive decisions by Dean, DFA, and NDH, and that decisions resulted in elevated prices to [**53] the plaintiffs in this case.

Now, that was a hypothesis, sir.

First of all, there is a story that can be told that supports the defendants—or the plaintiffs. There is a story. There is a hypothesis that supports them.

There is a counter-hypothesis, that is what Dean and Suiza represented to Justice, which in fact there [are] economies of size, there [are] efficiencies, we are going to pass those on and the plaintiffs in this case are going to enjoy the lower prices. That is what we looked at.

Cotterill Depo. at 17-18. 10 Recent Decisions Every Page 94 of 309 Attorney Should Know

| | Caution As of: November 21, 2014 3:39 PM EST

Glazer v. Whirlpool Corp. (In re Whirlpool Corp. Front-Loading Washer Prods. Liab. Litig.) United States Court of Appeals for the Sixth Circuit January 12, 2012, Argued; July 18, 2013, Decided; July 18, 2013, Filed File Name: 13a0180p.06 No. 10-4188

Reporter 722 F.3d 838; 2013 U.S. App. LEXIS 14519; 2013 FED App. 0180P (6th Cir.); CCH Prod. Liab. Rep. P19,191; 86 Fed. R. Serv. 3d (Callaghan) 242 In re: WHIRLPOOL CORPORATION FRONT-LOADING washing machines. The United States District Court for the WASHER PRODUCTS LIABILITY LITIGATION.GINA Northern District of Ohio certified a liability class under GLAZER, Individually and on behalf of all others similarly Fed. R. Civ. P. 23(a), (b)(3). The court of appeals affirmed. situated; TRINA ALLISON, Individually and on behalf of The United States Supreme Court vacated the judgment, all others similarly situated, Plaintiffs-Appellees, v. and remanded the case to the court of appeals for further WHIRLPOOL CORPORATION, Defendant-Appellant. consideration.

Subsequent History: US Supreme Court certiorari denied Overview by Whirlpool Corp. v. Glazer, 134 S. Ct. 1277, 188 L. Ed. 2d 298, 2014 U.S. LEXIS 1484 (U.S., 2014) In a products liability suit brought against the manufacturer of washing machines, the district court did not abuse its Prior History: [**1] Appeal from the United States District discretion in certifying a liability class under Fed. R. Civ. P. Court for the Northern District of Ohio at Cleveland. No. 23(a), (b)(3) comprised of Ohio residents who: (1) purchased 08-wp-65000—James S. Gwin, District Judge. one of the specified washing machines for personal, family, Whirlpool Corp. v. Glazer, 133 S. Ct. 1722, 185 L. Ed. 2d or household purposes; and (2) brought legal claims for 782, 2013 U.S. LEXIS 2695 (U.S., 2013) tortious breach of warranty, negligent design, and negligent In re Whirlpool Corp. Front-Loading Washer Prods. Liab. failure to warn. There were central questions common to the Litig., 2010 U.S. Dist. LEXIS 69254 (N.D. Ohio, July 12, entire class concerning whether a design defect caused mold 2010) to develop in machines, and whether the manufacturer breached a duty to warn consumers about the mold growth. Core Terms Class certification was the superior method to adjudicate this case fairly and efficiently, because class members were district court, class certification, consumers, damages, not likely to file individual actions as the cost of litigation machines, platform, washing machine, class member, would reduce any potential recovery. predominance, plaintiffs’, merits, prerequisites, cleaning, class action, questions, design defect, certification, biofilm, Outcome front-loading, warn, certify, manufactured, commonality, The order was affirmed. laundry, cases, cycle, experienced, mildew, detergent, issues LexisNexis® Headnotes Case Summary

Civil Procedure > ... > Jury Trials > Verdicts > General Procedural Posture Overview

Plaintiff Ohio consumers filed a class action lawsuit against Civil Procedure > ... > Relief From Judgments > Additur & defendant manufacturer, alleging design defects in its Remittitur > Remittiturs 10 Recent Decisions Every Page 95 of 309 Attorney Should Know

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Civil Procedure > Appeals > Standards of Review > Abuse of Civil Procedure > ... > Class Actions > Prerequisites for Class Discretion Action > General Overview

HN1 Whether to grant or deny a motion for remittitur is a HN4 In addition to fulfilling the four prerequisites of Fed. discretionary decision for the district court to make and R. Civ. P. 23(a), a proposed class must also meet at least one explain after that court has carefully reviewed the trial of the three requirements listed in Fed. R. Civ. P. 23(b). Rule evidence to determine whether the jury verdict was 23(b)(3) requires the district court to find that the questions excessive. of law or fact common to class members predominate over any questions affecting only individual members, and that Civil Procedure > Special Proceedings > Class Actions > the class action is superior to other available methods to Appellate Review adjudicate the controversy fairly and efficiently. Civil Procedure > Special Proceedings > Class Actions > Certification of Classes Civil Procedure > Special Proceedings > Class Actions > Certification of Classes Civil Procedure > Appeals > Standards of Review > Abuse of Discretion Civil Procedure > ... > Class Actions > Prerequisites for Class Action > General Overview Civil Procedure > Appeals > Standards of Review > Clearly Erroneous Review Evidence > Burdens of Proof > Allocation

HN2 A district court has broad discretion to decide whether HN5 Plaintiffs carry the burden to prove that the class to certify a class. The United States Court of Appeals for the certification prerequisites are met, and the plaintiffs, as class Sixth Circuit has described its appellate review of a class representatives, are required to establish that they possess certification decision as narrow and very limited. The Sixth the same interest and suffer the same injury as the class Circuit will reverse a class certification decision only if the members they seek to represent. appellant makes a strong showing that the district court’s decision amounted to a clear abuse of discretion. An abuse Civil Procedure > Special Proceedings > Class Actions > of discretion occurs if the district court relies on clearly Certification of Classes erroneous findings of fact, applies the wrong legal standard, misapplies the correct legal standard when reaching a HN6 Class certification is appropriate if the court finds, conclusion, or makes a clear error of judgment. The Sixth after conducting a rigorous analysis, that the requirements Circuit will not find an abuse of discretion unless it reaches of Fed. R. Civ. P. 23 have been met. Ordinarily, this means a definite and firm conviction that the district court that the class determination should be predicated on evidence committed a clear error of judgment. presented by the parties concerning the maintainability of the class action. On occasion it may be necessary for the Civil Procedure > Special Proceedings > Class Actions > court to probe behind the pleadings before coming to rest on Certification of Classes the certification question, and rigorous analysis may involve Civil Procedure > ... > Class Actions > Prerequisites for Class some overlap between the proof necessary for class Action > General Overview certification and the proof required to establish the merits of the plaintiffs’ underlying claims. There is nothing unusual HN3 The class action is an exception to the usual rule that about touching aspects of the merits in order to resolve litigation is conducted by and on behalf of the individual preliminary matters, because doing so is a familiar feature named parties only. To obtain class certification, the plaintiffs must show that (1) the class is so numerous that joinder of of litigation. all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of Civil Procedure > Special Proceedings > Class Actions > the representative parties are typical of the claims or Certification of Classes defenses of the class; and (4) the representative parties will Civil Procedure > ... > Class Actions > Prerequisites for Class fairly and adequately protect the interests of the class. Fed. Action > General Overview R. Civ. P. 23(a). These four requirements—numerosity, commonality, typicality, and adequate representation—serve HN7 Permissible inquiry into the merits of the plaintiffs’ to limit class claims to those that are fairly encompassed claims at the class certification stage is limited: Fed. R. Civ. within the claims of the named plaintiffs because class P. 23 grants courts no license to engage in free-ranging representatives must share the same interests and injury as merits inquiries at the certification stage. Merits questions the class members. may be considered to the extent—but only to the extent—that 10 Recent Decisions Every Page 96 of 309 Attorney Should Know

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they are relevant to determining whether the Fed. R. Civ. P. Civil Procedure > ... > Class Actions > Prerequisites for Class 23 prerequisites for class certification are satisfied. Action > Commonality Civil Procedure > ... > Class Actions > Prerequisites for Class Civil Procedure > Special Proceedings > Class Actions > Action > Typicality Certification of Classes HN13 The two concepts of commonality and typicality tend HN8 Nothing in either the language or history of Fed. R. to merge in practice because both of them serve as guideposts Civ. P. 23 gives a court any authority to conduct a for determining whether under the particular circumstances preliminary inquiry into the merits of a suit in order to maintenance of a class action is economical and whether the determine whether it may be maintained as a class action. named plaintiff’s claim and the class claims are so Rule 23 does not require a district court, in deciding whether interrelated that the interests of the class members will be to certify a class, to inquire into the merits of the plaintiff’s fairly and adequately protected in their absence. In addition, suit. commonality and typicality tend to merge with the Civil Procedure > ... > Class Actions > Prerequisites for Class requirement of adequate representation, although the latter Action > Numerosity factor also brings into play any concerns about the competency of class counsel and any conflicts of interest HN9 While no strict numerical test exists to define that may exist. Due to the intertwined nature of commonality, numerosity under Fed. R. Civ. P. 23(a)(1), substantial typicality, and adequate representation, the Sixth Circuit numbers of affected consumers are sufficient to satisfy this considers them together. requirement. Civil Procedure > Special Proceedings > Class Actions > Civil Procedure > ... > Class Actions > Prerequisites for Class Certification of Classes Action > Commonality Civil Procedure > ... > Class Actions > Prerequisites for Class HN10 A class action may be maintained if there are Action > Commonality questions of law or fact common to the class and the plaintiffs’ claims are typical of the claims of the class. Fed. HN14 There need be only one common question to certify R. Civ. P. 23(a)(2), (a)(3). a class.

Civil Procedure > ... > Class Actions > Prerequisites for Class Evidence > Burdens of Proof > Allocation Action > Commonality Torts > Products Liability > Theories of Liability > Breach of Warranty HN11 To demonstrate commonality, plaintiffs must show that class members have suffered the same injury. Their Torts > Products Liability > Types of Defects > Design Defects claims must depend upon a common contention of such a HN15 To prevail on a claim for tortious breach of warranty, nature that it is capable of classwide resolution—which also known in Ohio as strict liability or breach of implied means that determination of its truth or falsity will resolve warranty, the plaintiffs must prove that (1) a defect existed an issue that is central to the validity of each one of the in the product manufactured and sold by the defendant; (2) claims in one stroke. This inquiry focuses on whether a class the defect existed at the time the product left the defendant’s action will generate common answers that are likely to drive hands; and (3) the defect directly and proximately caused resolution of the lawsuit. the plaintiff’s injury or loss. Breach of implied warranty claim is nearly indistinguishable from a design defect claim Civil Procedure > ... > Class Actions > Prerequisites for Class Action > Typicality under the Ohio Product Liabilities Act.

HN12 Typicality is met if the class members’ claims are Torts > Products Liability > Types of Defects > Design Defects fairly encompassed by the named plaintiffs’ claims. This Torts > Products Liability > Theories of Liability > Negligence requirement insures that the representatives’ interests are aligned with the interests of the represented class members HN16 To prove a claim of negligent design, the plaintiffs so that, by pursuing their own interests, the class must show: (1) a duty to design against reasonably representatives also advocate the interests of the class foreseeable hazards; (2) breach of that duty; and (3) injury members. proximately caused by the breach. 10 Recent Decisions Every Page 97 of 309 Attorney Should Know

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Torts > Products Liability > Types of Defects > Marketing & and efficiently. Class adjudication in these circumstances is Warning Defects more efficient, because it avoids a ″mini-trial″ at certification Torts > Products Liability > Theories of Liability > Negligence that if successful must be repeated at trial or if unsuccessful frees the non-named class members to multiply the litigation. HN17 To prove a claim of negligent failure to warn, the plaintiffs must establish: (1) the manufacturer had a duty to Civil Procedure > Special Proceedings > Class Actions > warn; (2) the duty was breached; and (3) the plaintiff’s Certification of Classes injury proximately resulted from the breach of duty. The plaintiffs must show that in the exercise of ordinary care, the HN22 Fed. R. Civ. P. 23(b)(3) does not mandate that a manufacturer knew or should have known of the risk or plaintiff seeking class certification prove that each element hazard about which it failed to warn, and that the of the claim is susceptible to classwide proof. manufacturer failed to take the precautions that a reasonable Civil Procedure > Special Proceedings > Class Actions > person would have taken in presenting the product to the Certification of Classes public. HN23 A class may be divided into subclasses under Fed. R. Torts > Remedies > Damages > General Overview Civ. P. 23(c)(4)-(5), or a class may be certified for liability Torts > Products Liability > Types of Defects > Design Defects purposes only, leaving individual damages calculations to subsequent proceedings. Because recognition that individual Torts > Products Liability > Types of Defects > Marketing & damages calculations do not preclude class certification Warning Defects under Fed. R. Civ. P. 23(b)(3) is well nigh universal, in the Torts > Products Liability > Theories of Liability > Negligence mine run of cases, it remains the black letter rule that a class may obtain certification under Rule 23(b)(3) when liability HN18 Ohio law permits ordinary consumers who are not in questions common to the class predominate over damages privity of contract with product manufacturers to bring questions unique to class members. claims such as negligent design and negligent failure-to-warn in order to recover damages for economic injury only. Civil Procedure > ... > Notice of Class Action > Content of Notice > Opt Out Provisions Civil Procedure > ... > Class Actions > Prerequisites for Class Action > Predominance HN24 Any class member who wishes to control his or her own litigation may opt out of the class under Fed. R. Civ. P. HN19 Fed. R. Civ. P. 23(b)(3) requires a showing that 23(c)(2)(B)(v). questions common to the class predominate, not that those questions will be answered, on the merits, in favor of the Counsel: ARGUED: Malcolm E. Wheeler, WHEELER class. Because materiality is judged according to an objective TRIGG O’DONNELL LLP, Denver, Colorado, for Appellant. standard. Jonathan D. Selbin, LIEFF, CABRASER, HEIMANN & Civil Procedure > ... > Class Actions > Prerequisites for Class BERNSTEIN, LLP, New York, New York, for Appellees. Action > Predominance ON BRIEF: Malcolm E. Wheeler, Michael T. Williams, HN20 To certify a class action, the predominance inquiry Galen D. Bellamy, Joel S. Neckers, WHEELER TRIGG must focus on common questions that can be proved O’DONNELL LLP, Denver, Colorado, F. Daniel Balmert, through evidence common to the class. A plaintiff class need Anthony J. O’Malley, VORYS, SATER, SEYMOUR AND not prove that each element of a claim can be established by PEASE LLP, Cleveland, Ohio, for Appellant. classwide proof: What the rule does require is that common questions predominate over any questions affecting only Jonathan D. Selbin, Jason L. Lichtman, LIEFF, CABRASER, individual class members. HEIMANN & BERNSTEIN, LLP, New York, New York, for Appellees. Civil Procedure > Special Proceedings > Class Actions > Certification of Classes John H. Beisner, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Washington, D.C., for Amicus Curiae. HN21 The office of a Fed. R. Civ. P. 23(b)(3) certification ruling is not to adjudicate the case; rather, it is to select the method best suited to adjudication of the controversy fairly 10 Recent Decisions Every Page 98 of 309 Attorney Should Know

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Judges: Before: MARTIN and STRANCH, Circuit Judges.* forth below, we AFFIRM the order of the district court certifying a liability class. Opinion by: JANE B. STRANCH I. MOTION TO REMAND Opinion Before returning to the merits of this appeal, we pause briefly to address Whirlpool’s motion requesting that the [*844] [***2] JANE B. STRANCH, Circuit Judge. Gina case be [**4] remanded so the district court may consider in Glazer and Trina Allison filed a class action lawsuit on behalf of Ohio consumers against Whirlpool Corporation the first instance whether Comcast Corp. affects the class alleging that design defects in Whirlpool’s Duet®, Duet certification decision. Contrary to Whirlpool’s suggestion HT®, Duet Sport®, and Duet Sport HT® front-loading that the GVR order constitutes a merits determination in its washing machines (the Duets) allow mold and mildew to favor, our law is clear that a GVR order does not necessarily grow in the machines, leading to ruined laundry and imply that the Supreme Court has in mind a different result malodorous homes. This suit and similar suits filed against in the case, nor does it suggest that our prior decision was Whirlpool in other jurisdictions are consolidated in erroneous. See Cmtys. For Equity v. Mich. High Sch. multi-district litigation managed by the district court in the Athletic Ass’n, 459 F.3d 676, 680 (6th Cir. 2006) (adhering Northern District of Ohio. to original decision). The GVR order is not equivalent to reversal on the merits, Tyler v. Cain, 533 U.S. 656, 666 n.6, The district court certified a liability class under Federal 121 S. Ct. 2478, 150 L. Ed. 2d 632 (2001); Henry v. City of Rules of Civil Procedure 23(a) and (b)(3) comprised of Rock Hill, 376 U.S. 776, 777, 84 S. Ct. 1042, 12 L. Ed. 2d current Ohio residents who purchased one of the specified 79 (1964), nor is it ″an invitation to reverse.″ Gonzalez v. Duets in Ohio primarily for personal, family, or household Justices of the Mun. Court of Boston, 420 F.3d 5, 7 (1st Cir. purposes and not for resale, and who bring legal claims for 2005). We must simply determine whether our original tortious breach of warranty, negligent design, and negligent decision to affirm the class certification order was correct or failure to warn. Proof of damages is reserved for individual whether Comcast Corp. compels a different resolution. See determination. [**3] In re Whirlpool Corp. Front-Loading Cmtys. For Equity, 459 F.3d at 680-81; Kenemore v. Roy, Washer Prods. Liab. Litig., No. 1:08-WP-65000, 2010 U.S. 690 F.3d 639, 642 (5th Cir. 2012). Dist. LEXIS 69254, 2010 WL 2756947, at *4 (N.D. Ohio July 12, 2010). We granted Whirlpool’s request to pursue an The cases Whirlpool cites in support of its motion do not interlocutory appeal of the class certification decision, Fed. persuade us to remand the case to the district court. In Clark R. Civ. P. 23(f), and we affirmed the district court’s opinion v. Chrysler Corp., 80 F. App’x 453, 454 (6th Cir. 2003), and order. Glazer v. Whirlpool Corp., 678 F.3d 409, 421 (6th [**5] the issue on remand from the Supreme Court was Cir. 2012). We denied Whirlpool’s petition for rehearing by whether a punitive damages award violated the defendant’s the panel and for rehearing en banc. Whirlpool filed a due process rights in light of State Farm Mut. Auto. Ins. Co. petition for a writ of certiorari. v. Campbell, 538 U.S. 408, 123 S. Ct. 1513, 155 L. Ed. 2d 585 (2003). HN1 Whether to grant or deny a motion for [*845] The Supreme Court granted Whirlpool’s petition, remittitur is a discretionary decision for the district court to vacated our prior judgment, and remanded the case to this make and explain after that court has carefully reviewed the court for further consideration. Whirlpool Corp. v. Glazer, trial evidence to determine whether the jury verdict was 133 S. Ct. 1722, 185 L. Ed. 2d 782 (2013) (mem.). The excessive. See Sykes v. Anderson, 625 F.3d 294, 322 (6th Supreme Court’s order—known as a grant, vacate, and Cir. 2010). In that situation it was appropriate for this court remand order (GVR)—directed us to reconsider the appeal to remand the case so that the district court could have the in light of Comcast Corp. v. Behrend, 133 S. Ct. 1426, 185 first opportunity to reconsider the damages award. L. Ed. 2d 515 (2013). [***3] See Lawrence v. Chater, 516 U.S. 163, 165-66, 116 S. Ct. 604, 133 L. Ed. 2d 545 (1996) [***4] In United States v. Rapanos, 16 F. App’x 345 (6th (per curiam). After reconsideration, and for the reasons set Cir. 2001), a defendant was convicted of filling wetlands in

* The Honorable Cornelia G. Kennedy, a member of the panel, retired in 2012 while this case was pending in the Supreme Court. This decision is filed by a quorum of the panel pursuant to 28 U.S.C. § 46(d). See United States v. Sandlin, 313 F.3d 351, 352 (6th Cir. 2002) (per curiam); In re Vertrue Inc. Mktg. and Sales Practices Litig., No. 10-3928, 2013 WL 1607295 (6th Cir. Apr. [**2] 16, 2013); Cambio Health Solutions, LLC v. Reardon, 234 F. App’x 331, 333 (6th Cir. 2007); Lewis v. Caterpillar, Inc., No. 94-5253, 1998 WL 416022 (6th Cir. July 9, 1998). 10 Recent Decisions Every Page 99 of 309 Attorney Should Know

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violation of the Clean Water Act (CWA). After the Supreme Whirlpool began manufacturing Duets in 2002. The Court decided that the Army Corps of Engineers exceeded plaintiffs’ causes of action rest on the central allegation that its authority in promulgating a pertinent regulation under all of the Duets share a common design defect—the the CWA, Solid Waste Agency of N. Cook Cnty. v. United machines fail to clean properly their own mechanical States Army Corps of Eng’rs, 531 U.S. 159, 121 S. Ct. 675, components to eliminate soil and residue deposits known as 148 L. Ed. 2d 576 (2001), this court received a GVR order ″biofilm.″ The development of biofilm on mechanical parts in Rapanos directing reconsideration of that case in light of [**8] in turn can lead to rapid growth of mold, mildew, and Solid Waste Agency. Rapanos v. United States, 533 U.S. bacteria in places inside the machines that consumers 913, 121 S. Ct. 2518, 150 L. Ed. 2d 691 (2001) [**6] (mem.). cannot clean themselves. This court appropriately remanded the case to the district court to evaluate in the first instance whether Solid Waste Allison purchased a Whirlpool Duet HT® washing machine Agency undermined the foundation of the criminal in 2005 and Glazer bought a Duet Sport® washing machine indictment. Rapanos, 16 F. App’x 345. in 2006. Allison used high efficiency (HE) detergent in her washing machine, while Glazer used a reduced amount of [*846] In Messer v. Curci, 881 F.2d 219, 220 (6th Cir. 1989) regular detergent. Within six to eight months after their (en banc), this court held that an ″allegation of political purchases, both plaintiffs noticed the smell of mold or patronage hiring, standing alone, does not state a claim for mildew emanating from the machines and from laundry violation of 42 U.S.C. § 1983″ and affirmed a judgment washed in the machines. Allison found mold growing on the dismissing the complaint. The Supreme Court issued a GVR sides of the detergent dispenser, and Glazer noticed mold order, Messer v. Curci, 497 U.S. 1001, 110 S. Ct. 3233, 111 growing on the rubber door seal. Although both plaintiffs L. Ed. 2d 745 (1990) (mem.), directing reconsideration in allowed the machine doors to stand open as much as light of Rutan v. Republican Party of Ill., 497 U.S. 62, 110 possible and also used ordinary household products to clean S. Ct. 2729, 111 L. Ed. 2d 52 (1990), which held that the parts of the machines they could reach, their efforts employment actions based on political affiliation or support achieved only temporary relief from the pungent odors. impermissibly infringed the First Amendment rights of public employees. Because the Messer complaint had been Allison contacted Whirlpool about the mold she found dismissed erroneously, the court immediately remanded the growing in the Duet. A company representative instructed case to the district court to permit the lawsuit to proceed. her to use the washer’s monthly cleaning cycle, add an Messer v. Curci, 908 F.2d 103 (6th Cir. 1990). Finally, Affresh™ tablet to the cleaning cycle, and manually clean United States v. Schmucker, 766 F.2d 1582, 1583 (6th Cir. under the rubber door seal. Allison followed this advice, 1985), did not involve an interlocutory appeal of a class [**9] but the problem persisted. She then contacted a certification order, and Kappos v. Hyatt, 132 S. Ct. 1690, service technician who examined the Duet. He could only 182 L. Ed. 2d 704 (2012), is distinguishable [**7] because advise Allison to leave the door open between laundry that case concerned the procedure for introducing new cycles to allow the machine to air-dry. Glazer [*847] also evidence in district court when a party challenges a patent complained to Whirlpool about mold growing in the Duet decision made by the Patent and Trademark Office. she purchased. A company representative [***6] advised her to switch from regular detergent to HE detergent and In contrast to the cases cited by Whirlpool, the present GVR Glazer did so. She did not, however, utilize the Duet’s order requires us to consider only whether Comcast Corp. cleaning cycle as recommended in Whirlpool’s Use and has any effect on our Rule 23 analysis affirming the district Care Guide. court’s certification of a liability class. We undertake the task assigned to us, see Cmtys. For Equity, 459 F.3d at 680, Both plaintiffs continued to experience mold growth in the deny the motion to remand, see Addo v. Attorney Gen., 355 Duets. Neither of them knew at the time of purchase that a F. App’x 672, 674-75 (3d Cir. 2009) (denying party’s motion Duet could develop mold or mildew inside the machine. If to [***5] remand to district court after receipt of GVR Whirlpool had disclosed this information, plaintiffs allege order), and provide our comprehensive analysis of this case. they would have made different purchasing decisions.

II. FACTS According to the evidence presented in support of the motion for class certification, the Duet® and Duet HT® The named plaintiffs, Gina Glazer and Trina Allison, are front-loading washing machines are built on the ″Access″ Ohio residents. Whirlpool is a Delaware corporation with its platform, sharing nearly identical engineering. Although a principal place of business in Michigan. few functions vary across the Duet models built on the 10 Recent Decisions Every Page 100 of 309 Attorney Should Know

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″Access″ platform, most model differences are aesthetic. platforms were involved and the mold problem was not The smaller-capacity Duet Sport® and Duet Sport HT® restricted to certain models or certain markets. [*848] front-loading washing machines are [**10] built on the Whirlpool’s team also discovered that mold growth could ″Horizon″ platform. With a few differences in function or occur before the Duets were two to four years old, that styling, all Duet models built on the ″Horizon″ engineering traditional household cleaners were not effective treatments, platform are nearly identical. In addition, the ″Access″ and and that consumer laundry habits, including use of non-HE ″Horizon″ engineering platforms are also nearly identical to detergent, might exacerbate mold growth but did not cause each other. The only two differences are that the ″Access″ it. platform is slightly larger than the ″Horizon″ and the ″Access″ platform is tilted a few degrees from the horizontal In a memorandum directed to other team members dated axis, while the ″Horizon″ platform is not. Front-loading June 24, 2004, Anthony Hardaway, Whirlpool’s Lead machines are designed for use with HE detergent. Engineer, Advance Chemistry Technology, wrote that mold growth in the Duets ″occurs under all/any common laundry While all washing machines can potentially develop some conditions″ and ″[d]ata to date show consumer habits are of mold or mildew after a period of use, front-loading machines little help since mold (always present) flourished under all promote mold or mildew more readily because of the lower conditions seen in the Access platform.″ R. 130-4. Hardaway water levels used and the higher moisture content within the further stated: ″As both a biologist and a chemist this machines, combined with reduced ventilation. Plaintiffs’ problem is very troubling in that we are fooling ourselves if expert witnesses, Dr. R. Gary Wilson, Whirlpool’s former we think that we can eliminate mold and bacteria when our Director of Laundry Technology from 1976 to 1999, and Dr. HA wash platforms are the ideal environment for molds and Chin S. Yang, a microbiologist, opine that the common bacteria to flourish. Perhaps we [***8] should shift design defect in the Duets is their failure to clean or rinse [**13] our focus to ’handling’/’controlling’ mold and their own components to remove soil residues on which bacterial levels in our products.″ Id. fungi and bacteria feed, producing offensive odors. Dr. Wilson emphasized that the Duets [**11] fail to self-clean In public statements about mold complaints, Whirlpool the back of the tub holding the clothes basket, the aluminum adopted the term ″biofilm″ to avoid alarming consumers bracket used [***7] to attach the clothes basket to the tub, with words like ″mold,″″mildew,″″fungi,″ and ″bacteria.″ the sump area, the pump strainer and drain hose, the door Although Whirlpool contemplated issuing a warning to gasket area, the air vent duct, and the detergent dispenser consumers about the mold problem, plaintiffs’ expert duct. evidence indicates Whirlpool failed to warn the public adequately about the potential for mold growth in the Duets. Plaintiffs’ evidence confirms that Whirlpool knew the designs of its ″Access″ and ″Horizon″ platforms contributed Later in 2004, Hardaway and other members of the to residue buildup resulting in rapid fungal and bacterial Whirlpool team discussed redesign of the tub used on the growth. As early as September 2003, consumers began ″Horizon″ platform because pooling of soil and water complaining to Whirlpool about the mold problem at the served as a nucleation site for mold and bacteria growth. rate of two to three calls per day. When company They determined that the ″Access″ platform’s webbed tub representatives instructed the consumers to lift up the rubber structure was extremely prone to water and soil deposits, door gaskets on their machines, common findings were and the aluminum basket cross-bar was highly susceptible deposits of water, detergent, and fabric softener, with to corrosion because of biofilm. A number of design factors concomitant growth of mold or mildew. Service technicians contributed to this corrosion, including insufficient draining who examined consumers’ Duets confirmed the existence of of water at the end of a wash cycle and water flowing residue deposits and mold growing inside the machines. backward through the non-return valve between the tub and Whirlpool received complaints from numerous consumers the drain pump. Laboratory analyses confirmed that the who reported breathing difficulties after repair technicians composition of biofilm found in Duets built on the scrubbed the Duets in their homes, releasing mold spores [**14] ″Horizon″ and ″Access″ platforms was identical. In into the air. light of these findings, Whirlpool made certain design changes to later generations of Duets. In 2004 Whirlpool formed an internal team to analyze the mold problem and formulate a [**12] plan. In gathering By 2005, Whirlpool began manufacturing Duets with a information about the consumer complaints, Whirlpool special cycle intended to clean the internal parts of the engineers learned that both the ″Access″ and ″Horizon″ machine. Engineers knew, however, that the new cleaning 10 Recent Decisions Every Page 101 of 309 Attorney Should Know

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cycle would not remove all residue deposits. They were company shipped 41,904 ″Horizon″ platform Duet Sport concerned that the cleaning cycle might not be effective to washing machines to Ohio during the period 2006 through control mold growth and that consumers’ use of bleach in March 2009. the cleaning cycle—as recommended by Whirlpool in its consumer Use and Care Guides—would increase corrosion In opposing the motion for class certification, Whirlpool of aluminum machine parts. Internal Whirlpool documents asserted that most Duet owners have not experienced mold acknowledged by this time that the available data indicated growth in their washing machines and that the [***10] 35% of Duet customers had complained about odor in the incidence of mold growth in the Duets is actually quite rare. Duets and that complaints continued to increase in all As a result, consumers who have not experienced the mold markets. problem cannot prove injury to establish Whirlpool’s tort liability under Ohio law. The company also contended that By March 2006 Whirlpool engineers recognized that class certification was inappropriate because the Duets were consumers might notice black mold growing on the bellows built on different platforms, representing twenty-one different or inside the detergent dispenser, and that laundry [***9] models over a period [**17] of nine model years. According ″ ″ would smell musty if a Duet was heavily infected. By late to Whirlpool, the plaintiffs must prove liability as to each 2006, Whirlpool had received over 1.3 million complaint separate model—a task that would defeat the class action calls at its customer care centers and had completed prerequisites of commonality, predominance, and superiority. thousands of service calls nationwide. Whirlpool also emphasized that consumers’ laundry habits and experiences with the Duets are so diverse that the Faced with [**15] increasing complaints about mold growth named plaintiffs are not typical of the class; hence, they may in Duets and fully aware that other brands were not immune not serve as class representatives. In support of these from similar problems, Whirlpool decided to formulate new positions, Whirlpool presented deposition excerpts, affidavits cleaning products for all front-loading washing machines, from employees and satisfied Duet owners, expert reports, regardless of make or model. The company expected [*849] internal company documents, photographs, copies of Use this ″revolutionary″ product to produce a new revenue and Care Guides, and various articles from Consumer stream of $50 million to $195 million based on the Reports. Although Whirlpool requested and was granted assumption that 50% percent of the 14 million front-loading permission to present live testimony at the class action washing machine owners of any brand might be looking for certification hearing, the company ultimately did not present a solution to an odor problem with their machines. any testimony at the hearing. In September 2007 Whirlpool introduced two new cleaning products to the retail market: Affresh™ tablets for After assimilating the extensive factual record and the front-loading washing machines in use from zero to twelve parties’ oral arguments on the motion to certify a class, the months, and Affresh™ tablets with six door seal cleaning district court determined that the Rule 23(a) and (b)(3) cloths for front-loading washing machines in use more than prerequisites were met as to all issues of liability on twelve months. To encourage sales of these products, plaintiffs’ claims for tortious breach of warranty, negligent Whirlpool marketed Affresh™ as ″THE solution to odor design, and negligent failure to warn. [**18] The court causing residue in HE washers.″ The company placed certified the following liability class: samples of Affresh™ in all new HE washing machines that All persons who are current residents of Ohio and it manufactured and changed its Use and Care Guides to purchased a Washing Machine (defined as advise consumers to use an Affresh™ tablet in the first Whirlpool Duet®, Duet HT®, and Duet Sport® cleaning cycle to remove manufacturing oil and grease. Front-Loading Automatic Washers) for primarily Whirlpool [**16] believed this advice would encourage personal, family or household purposes, and not consumers to use the cleaning cycle and Affresh™ tablets for resale, in Ohio, excluding (1) Whirlpool, any regularly—like teaching vehicle owners to change the oil in entity in which Whirlpool has a controlling interest, their cars periodically. Whirlpool instructed its service and its legal [*850] representatives, officers, technicians and call centers to recommend the use of directors, employees, assigns, and successors; (2) Affresh™ to consumers. But as plaintiff Allison learned Washing Machines purchased through Whirlpool’s from experience, even using Affresh™ tablets in the Duet’s Employee Purchase Program; (3) the Judge to special cleaning cycle did not cure the mold problem. whom this case is assigned, any member of the Whirlpool shipped 121,033 ″Access″ platform Duet washing Judge’s staff, and any member of the Judge’s machines to Ohio from 2002 through March 2009. The immediate family; (4) persons or entities who 10 Recent Decisions Every Page 102 of 309 Attorney Should Know

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distribute or resell the Washing Machines; (5) claims or defenses of the class; and (4) the representative government entities; and (6) claims for personal parties will fairly and adequately protect the interests of the injury, wrongful death, and/or emotional distress. class.″ Fed. R. Civ. P. 23(a). These four requirements—numerosity, commonality, typicality, and [***11] The court declined to certify a class on plaintiffs’ adequate representation—serve to limit class claims to those separate claim under the Ohio Consumer Sales Practice Act, that are fairly encompassed within the claims of the named and that claim is not before us. Whirlpool promptly appealed plaintiffs because class representatives must share the same the district court’s order certifying the liability class. interests and injury as the class members. Dukes, 131 S. Ct. at 2550. III. ANALYSIS HN4 In addition to fulfilling the four prerequisites of Rule A. Standard of Review 23(a), the proposed class must also meet at least one of the three requirements listed in Rule 23(b). [**21] Dukes, 131 HN2 A district court has broad discretion to decide whether S. Ct. at 2548; Young, 693 F.3d at 537. The plaintiffs sought to certify a class. In re Am. Med. Sys., Inc., 75 F.3d 1069, class certification under Rule 23(b)(3), which requires the ″ 1079 (6th Cir. 1996). [**19] This court has described its district court to find that the questions of law or fact appellate review of a class certification decision as ″narrow,″ common to class members [*851] predominate over any ″ Davis v. Cintas Corp., No. 10-1662, 717 F.3d 476, 2013 questions affecting only individual members and that the ″ ″ U.S. App. LEXIS 10856, 2013 WL 2343302, at *5 (6th Cir. class action is superior to other available methods to adjudicate the controversy fairly and efficiently. The HN5 May 30, 2013), and as ″very limited.″ Olden v. LaFarge plaintiffs carry the burden to prove that the class certification Corp., 383 F.3d 495, 507 (6th Cir. 2004). We will reverse prerequisites are met, In re Am. Med. Sys., Inc., 75 F.3d at the class certification decision in this case only if Whirlpool 1079, and the plaintiffs, as class representatives, were makes a strong showing that the district court’s decision required to establish that they possess the same interest and See Olden, 383 F.3d amounted to a clear abuse of discretion. suffered the same injury as the class members they seek to ″ at 507. An abuse of discretion occurs if the district court represent. Dukes, 131 S. Ct. at 2550. relies on clearly erroneous findings of fact, applies the wrong legal standard, misapplies the correct legal standard 2. Consideration of the merits at the class certification stage when reaching a conclusion, or makes a clear error of judgment.″ Young v. Nationwide Mut. Ins. Co., 693 F.3d HN6 Class certification is appropriate if the court finds, 532, 536 (6th Cir. 2012) (citing Pipefitters Local 636 Ins. after conducting a ″rigorous analysis,″ that the requirements Fund v. Blue Cross Blue Shield of Mich., 654 F.3d 618, 629 of Rule 23 have been met. Dukes, 131 S. Ct. at 2551; Young, (6th Cir. 2011), cert. denied, 132 S. Ct. 1757, 182 L. Ed. 2d 693 F.3d at 537; Daffin v. Ford Motor Co., 458 F.3d 549, 532 (2012)). We will not find an abuse of discretion unless 552 (6th Cir. 2006). Ordinarily, this means that the class we reach a ″definite and firm conviction″ that the district determination should be predicated on evidence presented court ″committed a clear error of judgment.″ See id. by the parties concerning the maintainability [**22] of the (citation and internal quotation marks omitted). class action. In re Am. Med. Sys., Inc., 75 F.3d at 1079. On occasion ″it may be necessary for the court to probe behind B. The Class Action Certification the pleadings before coming to rest on the certification question,″ Gen. Tele. Co. of Southwest v. Falcon, 457 U.S. 1. The requirements of Rule 23(a) and (b)(3) 147, 160, 102 S. Ct. 2364, 72 L. Ed. 2d 740 (1982), and ″rigorous analysis″ may involve some overlap between the We [**20] must begin our analysis with a recognition that proof necessary for class certification and the proof required HN3 the ″class action is ’an exception to the usual rule that to establish the merits of the plaintiffs’ underlying claims. litigation is conducted by and on behalf of the individual Dukes, 131 S. Ct. at 2551. [***13] There is nothing unusual named parties only.’″ Wal-Mart Stores, Inc. v. Dukes, 131 S. about ″touching aspects of the merits in order to resolve Ct. 2541, 2550, 180 L. Ed. 2d 374 (2011) (quoting Califano preliminary matters . . . [because doing so is] a familiar v. Yamasaki, 442 U.S. 682, 700-01, 99 S. Ct. 2545, 61 L. Ed. feature of litigation.″ Id. at 2552. But HN7 permissible 2d 176 (1979)). To obtain class certification, the plaintiffs inquiry into the merits of the plaintiffs’ claims at the class must show that ″(1) the class is so numerous that joinder of certification stage is limited: all members is impracticable; (2) there are questions of law or fact common to the class; [***12] (3) the claims or Rule 23 grants courts no license to engage in defenses of the representative parties are typical of the free-ranging merits inquiries at the certification 10 Recent Decisions Every Page 103 of 309 Attorney Should Know

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stage. Merits questions may be considered to the the plaintiffs met the Rule 23 prerequisites for class extent—but only to the extent—that they are certification. See Amgen, 133 S. Ct. at 1194-95. The court relevant to determining whether the Rule 23 denied certification on one legal claim then certified only a prerequisites for class certification are satisfied. liability class on the remaining legal claims, reserving [**25] all damages questions for individual determination. Amgen Inc. v. Conn. Retirement Plans & Trust Funds, 133 By sifting the abundant evidence through the sieve of the S. Ct. 1184, 1194-95, 185 L. Ed. 2d 308 (2013) (citing legal claims, the court satisfied the requirement to perform Dukes, 131 S. Ct. at 2552 n.6 (quoting Eisen v. Carlisle & a ″rigorous analysis.″ Dukes, 131 S. Ct. at 2551; Gooch v. Jacquelin, 417 U.S. 156, 177, 94 S. Ct. 2140, 40 L. Ed. 2d Life Investors Ins. Co. of Am., 672 F.3d 402, 418 (6th Cir. 732 (1974)). 2012) (rejecting similar argument and concluding the district court ″probed behind the pleadings, considering all of the Whirlpool [**23] asserts that the district court relevant documents that were in evidence″). Consequently, inappropriately relied on Eisen to avoid deciding on the we turn to our review of the court’s findings on the four merits several questions of fact arising from the evidence Rule 23(a) factors. presented by the parties in connection with the motion to certify a class. In Eisen, the Supreme Court expressed the 3. Plaintiffs’ proof on the Rule 23(a) prerequisites view thatHN8 ″nothing in either the language or history of Rule 23 . . . gives a court any authority to conduct a a. Numerosity preliminary inquiry into the merits of a suit in order to Whirlpool mounts no specific challenge to the potential size ″ determine whether it may be maintained as a class action. of the class. HN9 While no strict numerical test exists to Eisen, 417 U.S. at 177. This court interpreted Eisen to mean define numerosity under Rule 23(a)(1), ″substantial″ ″ that Rule 23 does not require a district court, in deciding numbers of affected consumers are sufficient to satisfy this whether to certify a class, to inquire into the merits of the requirement. Daffin, 458 F.3d at 552. Whirlpool shipped ″ plaintiff’s suit. Beattie v. CenturyTel, Inc., 511 F.3d 554, thousands of Duets to Ohio for retail sale. Evidence of these 560 (6th Cir. 2007)(emphasis added). shipments to retailers is sufficient to show numerosity of a class consisting of all Ohio residents who purchased a Duet The Supreme Court’s recent opinions in Amgen and Dukes in Ohio primarily for personal, family or household purposes. now clarify that some inquiry into the merits may be See id. necessary to decide if the Rule 23 prerequisites are met. Amgen, 133 S. Ct. at 1194-95; Dukes, 131 S. Ct. at 2551-52. [***15] b. Commonality, typicality, and fair Amgen, however, admonishes district courts to consider at representation the class certification stage only those matters relevant to deciding if the prerequisites of Rule 23 are satisfied. See The [**26] central issues in this appeal spring from the Amgen, 133 S. Ct. at 1194-95. [**24] In other words, district remaining prerequisites of Rule 23. HN10 A class action ″ courts may not turn the class certification proceedings into may be maintained if ″there are questions of law or fact ″ a dress [*852] rehearsal for the trial on the merits. Messner common to the class″ and the plaintiffs’ claims ″are typical v. Northshore Univ. HealthSys., 669 F.3d 802, 811 (7th Cir. of the claims . . . of the class.″ Fed. R. Civ. P. 23(a)(2) & 2012). (a)(3).

[***14] Though the district court below, acting in 2010, HN11 To demonstrate commonality, plaintiffs must show referenced the Eisen language that a merits inquiry is not that class members have suffered the same injury. Dukes, required to decide class certification, we are satisfied that 131 S. Ct. at 2551. ″Their claims must depend upon a the court considered relevant merits issues with appropriate common contention . . . of such a nature that it is capable of reference to the evidence. The record contained extensive classwide resolution—which means that determination of material including: numerous corporate documents; extensive its truth or falsity will resolve an issue that is central to the affidavits from the parties’ experts and witnesses; validity of each one of the claims in one stroke.″ Id. This Whirlpool’s successful evidentiary motion practice; and the inquiry focuses on whether a class action will generate court’s grant of Whirlpool’s motion to present live testimony common answers that are likely to drive resolution of the at the class certification hearing—a right that Whirlpool lawsuit. Id. subsequently chose not to exercise. After reviewing the factual record and entertaining oral argument, the district HN12 Typicality is met if the class members’ claims are court considered merits issues relevant in deciding whether ″fairly encompassed by the named plaintiffs’ claims.″ 10 Recent Decisions Every Page 104 of 309 Attorney Should Know

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Sprague v. Gen. Motors Corp., 133 F.3d 388, 399 (6th Cir. indistinguishable from design defect claim under Ohio 1998) (en banc) (quoting In re Am. Med. Sys., 75 F.3d at Product Liabilities Act (OPLA)). HN16 To prove a claim of 1082)). This requirement insures that the representatives’ negligent design, the plaintiffs must show: (1) [**29] a duty interests are aligned with the interests of the represented to design against reasonably foreseeable hazards; (2) breach class members so that, by pursuing their own interests, of that duty; and (3) injury proximately caused by the [**27] the class representatives [*853] also advocate the breach. Briney v. Sears, Roebuck & Co., 782 F.2d 585, 587 interests of the class members. Id. (6th Cir. 1986) (applying Ohio law). HN17 To prove a claim of negligent failure to warn, the plaintiffs must establish: (1) HN13 These two concepts of commonality and typicality the manufacturer had a duty to warn; (2) the duty was ″tend to merge″ in practice because both of them ″serve as breached; and (3) the plaintiff’s injury proximately resulted guideposts for determining whether under the particular Hanlon v. Lane, 98 Ohio App. 3d circumstances maintenance of a class action is economical from the breach of duty. and whether the named plaintiff’s claim and the class claims 148, 648 N.E.2d 26, 28 (Ohio Ct. App. 1994). As to the latter ″ are so interrelated that the interests of the class members claim, the plaintiffs must show that in the exercise of will be fairly and adequately protected in their absence.″ ordinary care, the manufacturer knew or should have known ″ ″ Dukes, 131 S. Ct. at 2551 n.5. In addition, commonality and of the risk or hazard about which it failed to warn and that typicality tend to merge with the requirement of adequate the manufacturer failed to take the precautions that a representation, although the latter factor also brings into reasonable person would have taken in presenting the play any concerns about the competency of class counsel product to the public.″ Doane v. Givaudan Flavors Corp., and any conflicts of interest that may exist. Id. Due to the 184 Ohio App. 3d 26, 2009 Ohio 4989, 919 N.E.2d 290, 296 intertwined nature of commonality, typicality, and adequate (Ohio Ct. App. 2009). representation, we consider them together. [***17] The claims for tortious breach of warranty and [***16] We start from the premise that HN14 there need be negligent design rise or fall on whether a design defect only one common question to certify a class. See Sprague, proximately causes mold or mildew to develop in the Duets. 133 F.3d at 397. Here the district court identified two Success on the negligent failure-to-warn claim depends on primary questions that will produce in one stroke answers whether Whirlpool had a duty to warn consumers about the that are central to the validity of the plaintiffs’ legal claims: propensity for mold growth [**30] in Duets and breached (1) whether the alleged design defects [**28] in the Duets that duty. The district court correctly ruled that these two proximately cause mold or mildew to develop in the central [*854] questions are common to the entire liability machines and (2) whether Whirlpool adequately warned class. consumers who purchased Duets about the propensity for mold growth in the machines. A quick review of the Whirlpool claims that commonality is defeated because the elements of plaintiffs’ legal claims under Ohio law explains Duets were built over a period of years on two different why the district court found these two questions common to platforms, resulting in the production of twenty-one different all members of the liability class. models during the relevant time frame. While the trial evidence may concern different Duet models built on two HN15 To prevail on a claim for tortious breach of warranty different platforms, the common question of whether design (also known in Ohio as strict liability or breach of implied defects cause mold growth remains across the manufacturing warranty), the plaintiffs must prove that (1) a defect existed spectrum Whirlpool describes. Plaintiffs’ evidence—some in the product manufactured and sold by the defendant; (2) of which comes directly from internal documents authored the defect existed at the time the product left the defendant’s by Whirlpool’s own Lead Engineer of Advance Chemistry hands; and (3) the defect directly and proximately caused Technology, Andrew Hardaway—confirms that the two the plaintiff’s injury or loss. Temple v. Wean United, Inc., 50 platforms are nearly identical, the design issues concerned Ohio St. 2d 317, 364 N.E.2d 267, 270 (Ohio 1977); State various models, and most of the differences in models were Auto. Mut. Ins. Co. v. Chrysler Corp., 304 N.E.2d 891, 895, related to aesthetics, not design.1 Whether the alleged 36 Ohio St. 2d 151 (Ohio 1973). See also Tompkin v. Philip design defects caused biofilm and mold to accumulate in the Morris USA, Inc., 362 F.3d 882, 902 (6th Cir. 2004) Duets is a common issue for all members of the certified (observing that breach of implied warranty claim is nearly class.

1 Although Hardaway subsequently provided Whirlpool with affidavits attempting to change or clarify prior statements he made in internal [**31] company documents addressed to team members working on the mold problem, his credibility is ultimately an issue for the jury to determine. 10 Recent Decisions Every Page 105 of 309 Attorney Should Know

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The Seventh Circuit agreed with this point when it reversed (rejecting claim that design changes defeated commonality the denial of class certification in a similar case challenging and predominance where modifications did not significantly alleged design defects in Sears Kenmore brand front-loading alter the basic defective design). washing machines manufactured by Whirlpool. See Butler v. Sears, Robuck & Co., 702 F.3d 359, 361 (7th Cir. 2012), Because the evidence confirms that the issues regarding cert. granted, judgment vacated, Sears, Roebuck & Co. v. alleged design flaws are common to the class, this case is Butler, 133 S. Ct. 2768, 186 L. Ed. 2d 215, 2013 WL similar to Daffin, where the Ohio plaintiff class alleged that 775366 (U.S. 2013) (No. 12-1067).2 That court stated: ″The a defective throttle body assembly installed in two different basic question in the litigation—were the machines defective model years of minivans [***19] caused the accelerators to in permitting mold to accumulate and generate noxious stick. Daffin, 458 F.3d at 550. Class certification was odors?—is common to the entire mold class, although the appropriate because proof could produce a common answer answer may vary with the differences in design. The about whether the automotive part was defective. Id. individual [***18] questions are the amount of damages Likewise, proof in this case will produce a common answer owed particular class members (the owners of the washing about whether the alleged design defects [**34] in the Duets machines).″ Id. This reasoning is consistent with our own proximately caused mold or mildew to grow in the machines. that ″[n]o matter how individualized the issue of damages Common proof will advance the litigation by resolving this may be,″ determination of damages ″may be reserved for issue ″in one stroke″ for all members of the class. See individual treatment with the question of liability tried as a Dukes, 131 S. Ct. at 2551. class action,″ Sterling v. Velsicol Chem. Corp., 855 F.2d Whirlpool relies on In re American Medical Systems, which 1188, 1197 (6th Cir. 1988), [**32] a course the district court is distinguishable from this case. There the commonality followed here. prerequisite was not satisfied because plaintiffs did not Whirlpool next asserts that consumer laundry habits vary allege any particular defect common to all plaintiffs where widely by household; therefore, proof of proximate cause at least ten different prosthetic implant models had been must be determined individually for each plaintiff in the modified over the years. In re Am. Med. Sys., 75 F.3d at class. The record indicates otherwise. Whirlpool’s own 1080-81. Not only were the unique individual medical documents confirmed that its design engineers knew the histories of the plaintiffs at issue, but proof varied widely mold problem occurred despite variations in consumer among the plaintiffs concerning medical complications laundry habits and despite remedial efforts undertaken by resulting from the implanted devices. Id. at 1081. The consumers and service technicians to ameliorate the mold individual injuries could be attributed to such wide-ranging problem. Plaintiffs’ expert, Dr. Gary Wilson, Whirlpool’s factors as surgical error, anatomical incompatibility, and own former Director of Laundry Technology, opined that infection. Id. Because of these distinguishing circumstances, consumer habits and home environments could influence In re American Medical Systems does not control this case. the amount of biofilm in the Duets, but those factors are not the underlying cause of biofilm. Whirlpool challenges Dr. Whirlpool next contends that the certified class is too broad Wilson’s testimony on the ground that he did not evaluate because it includes Duet owners who allegedly have not later design changes to the Duets to see if those changes experienced a mold problem and are pleased with the rectified the mold problem. Dr. Wilson acknowledged that performance [**35] of their Duets. Satisfied consumers lack Whirlpool made changes to the ″Access″ platform tub anything in common with consumers who may have misused design, but found that other areas of the [*855] machines their machines and complain of a mold problem, Whirlpool [**33] built on the ″Access″ platform continued to collect argues; furthermore, Glazer and Allison are atypical of biofilm. In addition, he examined a later-generation Duet satisfied consumers and cannot represent them. Our Sport built on the ″Horizon″ platform and found that it was precedent indicates otherwise. still manufactured with cavities on the side of the tub exposed to water, increasing the likelihood of biofilm The existence of currently satisfied Duet owners in Ohio did collection. Even removing those cavities, he explained, not preclude the district court from certifying the Ohio class. would not completely eliminate the biofilm problem because In Daffin—also an Ohio defective product case—we of other design defects. See Samuel-Bassett v. KIA Motors affirmed class certification, holding: ″Although the class Am., Inc., 613 Pa. 371, 34 A.3d 1, 22-24 (Pa. 2011) includes those owners who never actually experienced a

2 As in this case, the Supreme Court granted certiorari and remanded the case to the Seventh Circuit for reconsideration in light of Comcast Corp. 10 Recent Decisions Every Page 106 of 309 Attorney Should Know

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manifestation of the alleged defect, the class certification [***21] for their Duets, counsel contended that both was not an abuse of discretion because the class and the plaintiffs ″paid a premium for their Whirlpool washers. named plaintiff meet the elements of Federal Rule of Civil Both of them experienced foul smells from their machines Procedure 23(a) and 23(b)(3).″ Daffin, 458 F.3d at 550. within the first year.″ R. 134 Page ID 4777. When the court [***20] After determining that all the class members asked whether there would be any problem in defining the claimed the delivery of a good that did not conform to class to include Duet owners who have not had any defendant’s warranty, we turned to Rule 23(b)(3). We particular problems with their machines, plaintiffs’ counsel ″ concluded that three common questions—whether the part replied that [h]ere everybody owns the washer that has the ″ ″ at issue was defective; whether that defect reduced the value same defect and the same problem although not everyone, ″ of the car; and whether defendant’s warranty covered the as yet, has necessarily had the odor problem. Id. at 4778-79. Counsel cited Daffin to support [**38] class latent defect—predominated, prompting us to affirm certification where that class included ″those owners who certification [**36] of a class of all vehicle owners. Id. at never experienced a manifestation of the alleged defect.″ Id. 554. Thus, Daffin supports our determinations under Rule at 4780. Based on Daffin, the district court properly included 23(a) [*856] and those further discussed below under Rule all Duet owners in the class. If defective design is ultimately 23(b)(3). proved, all class members have experienced injury as a result of the decreased value of the product purchased. The Finally, Whirlpool contends that the plaintiffs did not raise remedy for class members who purchased Duets at a below a ″premium price″ theory of recovery, but even if premium price but have not experienced a mold problem they did, Ohio law does not allow pursuit of such a theory. can be resolved through the individual determination of The evidentiary record and Ohio law convinces us that these damages as the district court determined. arguments are without merit. As to the legal component of Whirlpool’s argument, the The plaintiffs alleged on behalf of all Duet owners that Ohio cases may not use the phrase ″premium price theory of Whirlpool impliedly warranted that the Duets were of good recovery.″ But HN18 Ohio law permits ordinary consumers and merchantable quality, both fit and safe for their ordinary who are not in privity of contract with product manufacturers intended use. R. 80, Third Amended Master Class Action to bring claims such as negligent design and negligent Complaint ¶ 131, Page ID 1640. Because of the alleged failure-to-warn in order to recover damages for economic design defects and injury only, as the district court exhaustively explained when it denied Whirlpool’s motion to dismiss the Ohio tort [a]s a direct and proximate result of Whirlpool’s claims under Federal Rule of Civil Procedure 12(b)(6). See warranty breach, the Ohio Plaintiffs and the other In re Whirlpool Corp. Front-Loading Washer Prods. Liab. members of the Ohio Class were caused to suffer Litig., 684 F. Supp. 2d 942, 949-51 (N.D. Ohio Nov. 3, 2009) loss attributable to the decreased value of the [**39] (and numerous Ohio state and federal cases cited product itself, and consequential damages—losses therein). sustained by the purchase of the defective product—and the Ohio Plaintiffs and the other [*857] Because all Duet owners were injured at the point members of the Ohio Class will have to spend of sale upon paying a premium price for the Duets as monies to repair and/or replace the washers. designed, even those owners who have not experienced a mold problem are properly included within the certified Id. ¶ 134, Page ID 1640 (emphasis added). The plaintiffs class. Moreover, under the negligent failure-to-warn theory [**37] further alleged that Whirlpool owed a duty to class of liability, the plaintiffs need not prove that mold manifested members ″to exercise ordinary and reasonable care to in every Duet owned by class members because the injury to properly design″ the Duets and that Whirlpool ″had a all Duet owners occurred when Whirlpool failed to disclose pre-sale duty to warn potential purchasers that the [Duets] the Duets’ propensity to develop biofilm and mold [***22] carried with them greater risks of foul [odors] and health growth. See Tait v. BSH Home Appliances Corp., 289 F.R.D. hazards than an ordinary consumer would expect when 466, 479 (C.D. Cal. 2012) (discussing similar point-of-sale using the [Duets] in their intended or reasonably-foreseeable argument when certifying a class where plaintiffs alleged manner.″ Id. ¶¶ 140-41, Page ID 1641. defective design of front-loading washing machines caused development of biofilm and mold). Plaintiffs’ counsel repeated this theme as he opened oral argument in the district court on the motion to certify a Circuit cases support our conclusion. In Wolin v. Jaguar class. After disclosing the prices Glazer and Allison paid Land Rover North America, LLC, 617 F.3d 1168, 1173 (9th 10 Recent Decisions Every Page 107 of 309 Attorney Should Know

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Cir. 2010), a car manufacturer successfully argued before problem. Plaintiffs alleged and argued below that all Duet the district court that class certification was inappropriate owners suffered injury immediately upon purchase of a because the named class plaintiffs did not prove that an Duet due to the design defect in, and the decreased value of, alignment geometry defect causing premature tire wear the [*858] product itself, whether mold causing additional manifested in a majority [**40] of the class members’ consequential damages has yet manifested or not. vehicles. The Ninth Circuit reversed and remanded for class certification, holding that ″proof of the manifestation of a For these reasons, the district court did not abuse its defect is not a prerequisite to class certification[,]″ and that discretion in ruling that the Rule 23(a) prerequisites of ″individual factors may affect premature tire wear, [but] numerosity, commonality, typicality, and adequate they do not affect whether the vehicles were sold with an representation are satisfied for certification of a liability alignment defect.″ Id. See also Tait, 289 F.R.D. at 479 class only. (citing Wolin and our prior opinion in this case to reject an argument that all class members must show actual 4. The Rule 23(b)(3) prerequisites: predominance and manifestation of biofilm in front-loading washing machines superiority to permit class certification). Similarly, in Stearns v. This brings us to the plaintiffs’ showing on the Rule Ticketmaster Corp., 655 F.3d 1013, 1021 (9th Cir. 2011), the 23(b)(3) requirements of predominance and superiority. The appellate court concluded that the plaintiff class sufficiently analyses in many of the cases discussed above confirm the established injury for standing purposes by showing that presence of predominance and superiority in this case, but ″[e]ach alleged class member was relieved of money in the two recent governing Supreme Court cases on predominance transactions.″ These persuasive authorities support our and superiority seal our conviction that this is so: Amgen conclusion under Ohio law that not all class members must Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. demonstrate manifestation of biofilm and mold growth in Ct. 1184, 185 L. Ed. 2d 308 (2013), and Comcast Corp. v. their Duets before those individuals may be included in the Behrend, 133 S. Ct. 1426, 185 L. Ed. 2d 515 (2013). An certified class. orderly analysis begins with examination [**43] of Amgen, If Whirlpool can prove that most class members have not followed by Comcast Corp., which was decided one month experienced a mold problem and that it adequately warned later. [**41] consumers of any propensity for mold growth in the Duets, then Whirlpool should welcome class certification. In Amgen, the Supreme Court affirmed certification of a By proving that the Duets are not defectively designed and class in a securities fraud case brought under § 10(b) and that no warnings were needed (or if they were, that adequate Rule 10b-5 premised on the fraud-on-the-market [***24] warnings were issued to consumers), Whirlpool can obtain theory of liability. Id. at 1190, 1194, 1204. Amgen did not a judgment binding all class members who do not opt out of dispute that Connecticut Retirement met all four of the class the class. action prerequisites of Rule 23(a); the case focused on the Rule 23(b)(3) predominance inquiry. Id. at 1190-91. Amgen [***23] In summary, the trial of common questions will contended that, to demonstrate predominance and insure evoke common answers likely to drive resolution of this class certification, Connecticut Retirement was required to lawsuit. See Dukes, 131 S. Ct. at 2551. Plaintiffs Glazer and prove, not plausibly plead, a central element of its case: the Allison are typical of class members and they, with materiality of Amgen’s alleged misrepresentations or leadership of their class counsel, will fairly represent the omissions. Id. at 1191. The Supreme Court responded to class. The named plaintiffs purchased Whirlpool Duets, Amgen’s position with this holding: believing them to be of good and merchantable quality, fit and safe for their ordinary intended use. Like all Ohio Duet While Connecticut Retirement certainly must prove owners, Glazer and Allison used the washing machines for materiality to prevail on the merits, we hold that their intended use and in a reasonably-foreseeable manner. such proof is not a prerequisite to class certification. The Duets Glazer and Allison purchased developed mold HN19 Rule 23(b)(3) requires a showing that growth despite differences in their laundry habits and questions common to the class predominate, not despite the efforts of service technicians to abate the mold that those questions will be answered, on the problem. Thus, Glazer and Allison will adequately represent merits, in favor of the class. Because materiality is other Duet owners whose machines similarly developed judged according to an objective standard, the [**42] the mold problem. They will also fairly represent materiality of [**44] Amgen’s alleged those Duet purchasers who have not yet experienced a mold misrepresentations and omissions is a question 10 Recent Decisions Every Page 108 of 309 Attorney Should Know

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common to all members of the class Connecticut 693 F.3d at 544; Randleman v. Fid. Nat’l Title Ins. Co., 646 Retirement would represent. F.3d 347, 352-54 (6th Cir. 2011).

Id. at 1191. The Court repeatedly emphasized thatHN20 the Whirlpool does not point to any ″fatal dissimilarity″ among predominance inquiry must focus on common questions that the members of the certified class that would render the can be proved through evidence common to the class. Id. at class action mechanism unfair or inefficient for 1195-96. A plaintiff class need not prove that each element decision-making. See Amgen, 133 S. Ct. at 1197. Instead, ″ of a claim can be established by classwide proof: What the Whirlpool points to ″a fatal similarity—[an alleged] failure rule does require is that common questions ’predominate of proof as to an element of the plaintiffs’ cause of action.″ over any questions affecting only individual [class] Id. (quoting Nagareda, Class Certification in the Age of ″ members.’ Id. at 1196. Aggregate Proof, 84 N.Y.U.L. Rev. 97, 107 (2009)). That contention, the Supreme Court instructs, ″is properly The Court further explained in Amgen that HN21 an addressed at trial or in a ruling on a summary-judgment inability of the plaintiff class ″to prove materiality would motion. The allegation should not be resolved in deciding not result in individual questions predominating. Instead, a whether to certify a proposed class.″ Id. Tracking the failure of proof on the issue of materiality would end the Supreme Court’s reasoning, we conclude here that common case, given that materiality is an essential element of the questions predominate over any individual [**47] ones. class members’ securities-fraud claims.″ Id. at 1191. The Simply put, this case comports with the ″focus of the plaintiff class before the Court was ″entirely cohesive: It predominance inquiry″—it is ″sufficiently cohesive to will prevail or fail in unison. In no event will the individual warrant adjudication by [***26] representation.″ Id. at 1196 circumstances of particular class members bear on the (quoting Amchem Prods., Inc. v. Windsor, 521 U.S. 591, inquiry.″ Id. For this reason, the Court rejected Amgen’s 623, 117 S. Ct. 2231, 138 L. Ed. 2d 689 (1997)). contention that, under Rule 23(b)(3), ″Connecticut Retirement [**45] must first establish that it will win the The Supreme Court’s subsequent decision in Comcast fray. . . . [T]he office of a Rule 23(b)(3) certification ruling Corp. further instructs us on the necessary predominance is not to [*859] adjudicate the case; rather, it is to select the inquiry, but after carefully considering the precepts discussed ’metho[d]’ best suited to adjudication of the controversy there, we conclude that the case does not change the ″ ’fairly and [***25] efficiently.’ Id. Class adjudication in outcome of our Rule 23 analysis. We explain why. these circumstances is more efficient, the Court also explained, because it avoids a ″mini-trial″ at certification In Comcast Corp., the district court certified a liability and that if successful must be repeated at trial or if unsuccessful damages class under Rules 23(a) & (b)(3) comprised of frees the non-named class members to multiply the litigation. more than two million current and former Comcast Id. at 1201. subscribers who sought damages for alleged violations of federal antitrust laws. 133 S. Ct. at 1429-31. Although the Following Amgen’s lead, we uphold the district court’s plaintiffs proposed four different theories of antitrust impact, determination that liability questions common to the Ohio the district court found that only one could be proved in a class—whether the alleged design defects in the Duets manner common to all class plaintiffs: the theory that proximately caused mold to grow in the machines and ″Comcast engaged in anticompetitive clustering conduct, whether Whirlpool adequately warned consumers about the the effect of which was to deter the entry of overbuilders in propensity for mold growth—predominate over any the Philadelphia″ Designated Market Area (DMA). Id. at individual questions. As in Amgen, the certified liability 1430-31 & n.3. class ″will prevail or fail in unison,″ id. at 1191, for all of the same reasons we discussed above in conjunction with The plaintiffs’ expert calculated damages [**48] for the the Rule 23(a) prerequisites of commonality and typicality. entire class using a model that failed to isolate the damages HN22 Rule 23(b)(3) does not mandate that a plaintiff resulting from the one theory of antitrust impact the district seeking class certification prove that each element of the court had allowed to proceed. Id. The court nonetheless [**46] claim is susceptible to classwide proof. Id. at 1196. certified the class, finding that the damages related to the Evidence will either prove or disprove as to all class [*860] allowed theory could be calculated on a classwide members whether the alleged design defects caused the basis. Id. at 1431. The Third Circuit affirmed. Id. collection of biofilm, promoting mold growth, and whether Whirlpool failed to warn consumers adequately of the The Supreme Court reversed in a decision that it described propensity for mold growth in the Duets. See id.; Young, as turning ″on the straightforward application of 10 Recent Decisions Every Page 109 of 309 Attorney Should Know

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class-certification principles.″ Id. at 1433. Because the members. Amgen, 133 S. Ct. at 1195-96; Comcast Corp., plaintiffs would be entitled to damages resulting only from 133 S. Ct. at 1433. Both cases are premised on existing the allowed liability theory if they were to prevail on the class-action jurisprudence. The majority in Comcast Corp. merits, the Court instructed that the ″model purporting to concludes that the case ″turns on the [***28] straightforward serve as evidence of damages . . . must measure only those application of class certification principles,″ 133 S. Ct. at damages attributable to that theory. If the model does not 1433, and the dissent concurs that ″the opinion breaks no even attempt to do that, it cannot possibly establish that new ground on the standard for certifying a class damages are susceptible of measurement across the entire [**51] action under Federal Rule of Civil Procedure ″ class for purposes of Rule 23(b)(3).″ Id. at 1433. 23(b)(3), id. at 1436. The dissent notes other class action principles that remain unchanged. ″[W]hen adjudication of [***27] Neither the Third Circuit nor the district court had questions of liability common to the class will achieve required the plaintiffs to link each liability theory to a economies of time and expense, the predominance standard damages calculation because, those courts reasoned, doing is generally satisfied even if damages are not provable in the so would necessitate inquiry into the merits, which aggregate.″ Id. at 1437. HN23 A class may be divided into [**49] had no place in the class certification decision. Id. subclasses, Fed. R. Civ. P. 23(c)(4)-(5), or, as happened in The Supreme Court rejected that analysis as contradictory to this case, ″a class [*861] may be certified for liability Dukes, 131 S. Ct. at 2551-52 & n.6, and as improperly purposes only, leaving individual damages calculations to permitting plaintiffs to offer any method of damages subsequent proceedings.″ Id. at 1437 n.*. Because measurement, no matter how arbitrary, at the ″[r]ecognition that individual damages calculations do not class-certification stage, thereby reducing the predominance preclude class certification under Rule 23(b)(3) is well nigh requirement of Rule 23(b)(3) ″to a nullity.″ Comcast Corp., universal,″ id. at 1437 (citing, among other cases, Beattie v. 133 S. Ct. at 1433. Due to the model’s inability to CenturyTel, Inc., 511 F.3d 554, 564-66 (6th Cir. 2007)), in distinguish damages attributable to the allowed theory of ″the mine run of cases, it remains the ’black letter rule’ that liability, the Court ruled that the predominance prerequisite a class may obtain certification under Rule 23(b)(3) when of Rule 23(b)(3) did not warrant certification of a class. Id. liability questions common to the class predominate over at 1435. Accordingly, the Court reversed the certification damages questions unique to class members.″ Id. order. Id. Thus, read in light of Amgen, Comcast Corp., Daffin, and This case is different from Comcast Corp. Here the district other cases we have discussed, the evidence and the district court certified only a liability class and reserved all issues [**52] court’s opinion convince us that class certification is concerning damages for individual determination; in the superior method to adjudicate this case fairly and Comcast Corp. the court certified a class to determine both efficiently. See Amgen, 133 S. Ct. at 1191; Olden, 383 F.3d liability and damages. Where determinations on liability and at 507-10. Use of the class method is warranted particularly damages have been bifurcated, see Fed. R. Civ. P. 23(c)(4), because class members are not likely to file individual the decision in Comcast—to reject certification of a liability actions—the cost of litigation would dwarf any potential and damages class because plaintiffs failed to establish that recovery. See Amgen, 133 S. Ct. at 1202; Amchem Prods., damages could be measured on [**50] a classwide Inc., 521 U.S. at 617 (finding that in drafting Rule 23(b)(3), basis—has limited application. To the extent that Comcast ″the Advisory Committee had dominantly in mind Corp. reaffirms the settled rule that liability issues relating vindication of ’the rights of groups of people who to injury must be susceptible of proof on a classwide basis individually would be without effective strength to bring to meet the predominance standard, our opinion thoroughly their opponents into court at all’″); Carnegie v. Household demonstrates why that requirement is met in this case. See Int’l, Inc., 376 F.3d 656, 661 (7th Cir. 2004) (noting that Leyva v. Medline Indus. Inc., 716 F.3d 510, 514 (9th Cir. ″[t]he realistic alternative to a class action is not 17 million 2013) (observing after Comcast that class ″must be able to individual suits, but zero individual suits″ because of show that their damages stemmed from the defendant’s litigation costs). As the district court observed, HN24 any actions that created the legal liability″). class member who wishes to control his or her own litigation may opt out of the class under Rule 23(c)(2)(B)(v). Accordingly, the principles we glean from Amgen and Comcast Corp. include that to satisfy Rule 23(b)(3), named [***29] Once the district court resolves under Ohio law the plaintiffs must show, and district courts must find, that common liability questions that are likely to generate questions of law or fact common to members of the class common answers in this case, the court will either enter predominate over any questions that affect only individual judgment [**53] for Whirlpool or proceed to the question of 10 Recent Decisions Every Page 110 of 309 Attorney Should Know

Page 17 of 17 722 F.3d 838, *861; 2013 U.S. App. LEXIS 14519, **53; 2013 FED App. 0180P (6th Cir.), ***29

plaintiffs’ damages. In the latter event, the court may established numerosity, commonality, typicality, and exercise its discretion in line with Amgen, Comcast Corp., adequate representation. In addition, they showed that and other cases cited in this opinion to resolve the damages common questions predominate over individual ones and issues. that the class action is the superior method to adjudicate Whirlpool’s liability on the legal claims. Because the IV. CONCLUSION district court did not clearly abuse its discretion in certifying In summary, we uphold, under our prescribed narrow a class on the issue of liability only, we AFFIRM. review, the district court’s determination that the Rule 23(a) and (b)(3) class certification prerequisites were met. Plaintiffs 10 Recent Decisions Every Page 111 of 309 Attorney Should Know

| | Neutral As of: November 21, 2014 3:39 PM EST

Whirlpool Corp. v. Glazer Supreme Court of the United States February 24, 2014, Decided No. 13-431.

Reporter 2014 U.S. LEXIS 1484; 134 S. Ct. 1277; 188 L. Ed. 2d 298; 82 U.S.L.W. 3491; 2014 WL 684065 Whirlpool Corporation, Petitioner v. Gina Glazer and Trina Opinion Allison, Individually and on Behalf of All Others Similarly Situated. Petition for writ of certiorari to the United States Court of Prior History: Glazer v. Whirlpool Corp. (In re Whirlpool Appeals for the Sixth Circuit denied. Corp. Front-Loading Washer Prods. Liab. Litig.), 722 F.3d 838, 2013 U.S. App. LEXIS 14519 (6th Cir. Ohio, 2013)

Judges: [*1] Roberts, Scalia, Kennedy, Thomas, Ginsburg, Breyer, Alito, Sotomayor, Kagan. 10 Recent Decisions Every Page 112 of 309 Attorney Should Know

| | Neutral As of: November 21, 2014 3:42 PM EST

Good v. Am. Water Works Co.

United States District Court for the Southern District of West Virginia October 29, 2014, Decided; October 29, 2014, Filed Civil Action No.: 2:14-01374

Reporter 2014 U.S. Dist. LEXIS 154788 CRYSTAL GOOD, individually and as parent and next Virginia Resident, Colours Salon and Boutique, LLC, a friend of minor children M.T.S., N.T.K. and A.M.S. and West Virginia Limited Liability Company; on behalf of MELISSA JOHNSON, individually and as parent of her themselves and all others similarly situated, Plaintiffs and unborn child, MARY LACY and JOAN GREEN and Class Representatives, Plaintiffs: David R. Barney, Jr., JAMILA AISHA OLIVER, WENDY RENEE RUIZ and Kevin W. Thompson, LEAD ATTORNEYS, THOMPSON KIMBERLY OGIER and ROY J. McNEAL and GEORGIA BARNEY, Charleston, WV; Michael G. Stag, Sean Cassidy, HAMRA and MADDIE FIELDS and BRENDA BAISDEN, Stuart H. Smith, LEAD ATTORNEYS, PRO HAC VICE, d/b/a FRIENDLY FACES DAYCARE, and ALADDIN SMITH STAG, New Orleans, LA; P. Rodney Jackson, RESTAURANT, INC., and R. G. GUNNOE FARMS LLC, LEAD ATTORNEY, LAW OFFICE OF P. RODNEY and DUNBAR PLAZA, INC., d/b/a DUNBAR PLAZA JACKSON, Charleston, WV; Stephen H. Wussow, LEAD HOTEL, on behalf of themselves and all others similarly ATTORNEY, SMITH STAG, New Orleans, LA; Van Bunch, situated, Plaintiffs, v. AMERICAN WATER WORKS LEAD ATTORNEY, BONNETT FAIRBOURN COMPANY, INC., and AMERICAN WATER WORKS FRIEDMAN & BALINT, Phoenix, AZ. SERVICE COMPANY, INC., and EASTMAN CHEMICAL COMPANY and WEST VIRGINIA-AMERICAN WATER For American Water Works Company, Inc., a Delaware COMPANY, d/b/a WEST VIRGINIAAMERICAN WATER, corporation, West Virginia American Water Company, [*2] and GARY SOUTHERN and DENNIS P. FARRELL and a West Virginia corporation, Defendants: Thomas J. Hurney, CENTRALWESTVIRGINIAREGIONALAIRPORT Jr., LEAD ATTORNEY, L. Jill McIntyre, JACKSON AUTHORITY, INC., and TRIAD ENGINEERING, INC. KELLY, Charleston, WV. and CAST & BAKER CORPORATION, Defendants. For Chemstream, Inc., a Delaware corporation, J. Clifford Prior History: Good v. Am. Water Works Co., 2014 U.S. Forrest, a Pennsylvania resident, Defendants: Niall A. Paul, Dist. LEXIS 75299 (S.D. W. Va., June 3, 2014) LEAD ATTORNEY, SPILMAN THOMAS & BATTLE, Charleston, WV.

Core Terms For Eastman Chemical Company, a Delaware corporation, Defendant: Marc E. Williams, LEAD ATTORNEY, clawback, disclosure, documents, privileged, inadvertent, NELSONMULLINSRILEY&SCARBOROUGH, producing, parties Huntington, WV.

Counsel: [*1] For Crystal Good, as parent and next friend For Freedom Industries, LLC, a West Virginia corporation, of minor children, M.T.S., N.T.K., and, A.M.S., West Defendant: Stephen L. Thompson, LEAD ATTORNEY, Virginia Residents, Melissa Johnson, a West Virginia BARTH & THOMPSON, Charleston, WV. Resident, Lindsay Huffman, a West Virginia Resident, Aladdin Restaurant, Inc., a West Virginia Limited Liablity For Mountaineer Funding, LLC, a West Virginia corporation, Company, Georgia Hamra, a West Virginia Resident, John WV Funding, LLC, a West Virginia corporation, Defendants: Sarver, a West Virginia Resident, doing business as, Mousie’s Charles J. Kaiser, Jr., Denise Knouse-Snyder, Jeffery D. Car Wash, Nitro Car Care Center, LLC, a West Virginia Kaiser, LEAD ATTORNEYS, PHILLIPS GARDILL Limited Liability Company, Carolyn Burdette, a West KAISER & ALTMEYER, Wheeling, WV. 10 Recent Decisions Every Page 113 of 309 Attorney Should Know

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Judges: John T. Copenhaver, Jr., United States District (Defs.’ Memo. in Supp. at 1-2 (footnotes omitted)(emphasis Judge. in original)).

Opinion by: John T. Copenhaver, Jr. II.

Opinion In 2008, Congress adopted Federal Rule of Evidence 502. Rule 502 was designed to address concerns about broad waiver doctrines that were proliferating in decisional law. MEMORANDUM OPINION AND ORDER See Charles A. Wright et al., Federal Practice and Procedure § 2016.2 (3d ed. 2014) (″This . . . [Rule] was prompted by Pending is the defendants’ motion for a Rule 502(d) order, the concern that aggressive use of waiver . . . caused filed September 12, 2014. considerable costs and considerable anxiety among many litigants, concerns that have increased with the advent of I. frequent discovery of electronically stored information ″ ″ ″ The parties met and conferred in an effort to craft an [( ESI )]. ). agreement respecting the handling of attorney-client and Even prior to the adoption of Rule 502, the civil litigation work product information inadvertently disclosed. They process, especially in the most complex of cases, was appear to concur on [*3] all points except one. The trending toward ″’quick peek’ or ’clawback’ agreements disagreement appears well summarized in the defendants’ [that] might . . . enable[e] the party seeking discovery earlier supporting memorandum of law: access to discovery material via the ’quick peek’ and/or enabling the party producing the information [*5] to Defendants propose that the Rule 502(d) order entered in this case encourage the incorporation ’clawback’ privileged materials mistakenly produced without risk of being found to have waived.″ Id. and employment of time-saving computer-assisted privilege review, while Plaintiffs propose that the The two provisions of Rule 502 that the parties discuss in order limit privilege review to what a computer can their respective briefing are subdivisions (b) and (d), which ″ ″ accomplish, disallowing linear (aka eyes on ) appear below: privilege review altogether. So as to dodge giving ″ ″ something for nothing, Plaintiffs will agree only (b) Inadvertent Disclosure. When made in a federal to a pure quick peek/claw-back arrangement, which proceeding or to a federal office or agency, the would place never-reviewed, never privilege-logged disclosure does not operate as a waiver in a federal documents in their hands as quickly as physically or state proceeding if: possible at the expense of any opportunity for care on the part of a producing party to protect a client’s (1) the disclosure is inadvertent; privileged and work product protected information. (2) the holder of the privilege or protection Defendants do not wish to forego completely the took reasonable steps to prevent option to manually review documents for privilege disclosure; and and work product protection, and there is nothing (3) the holder promptly took reasonable in Rule 502(d) that requires such a commitment. steps to rectify the error, including (if Defendants have every incentive and need to use applicable) following Federal Rule of Civil both search methodologies and computer-assisted Procedure 26(b)(5)(B). review to quickly and efficiently identify candidates for those protections, and will do so in good faith ... as appropriate, [*4] after which attorney review (d) Controlling Effect of a Court Order. A federal and privilege logging can proceed in an organized court may order that the privilege or protection is and efficient way and -- under a Rule 502(d) order not waived by disclosure connected with the -- without the pins-and-needles anxiety of litigation pending before the court -- in which overlooking some nuance or making some mistake event the disclosure is also not a waiver in any out of pure fatigue . . . in other words, without the other federal or state proceeding. requirement of the exercise of some particular quantum of care. Fed. R. Evid. 502(b) and (d). 10 Recent Decisions Every Page 114 of 309 Attorney Should Know

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The defendants have chosen a course that would allow them because those are unlikely to result in any the opportunity to conduct some level of human due significant delays. diligence prior to disclosing vast amounts of information, If the Defendants are worried about the sanctity of some portion of which might be privileged. They also privileged and work product documents, rather appear to desire a more predictable clawback approach than the practical effect of their momentary without facing the [*6] uncertainty inherent in the Rule disclosure, then they are going to take reasonable 502(b) factoring analysis. Nothing in Rule 502 prohibits that steps to protect the sanctity of those documents course. And the parties need not agree in order for that anyway, and therefore they do not need any greater approach to be adopted: clawback protection than that provided by F.R.E. 502(b). A claw-back agreement, often in the form of a Stipulated Protective Order (and sometimes referred (Pls.’ Resp. at 1). to as a ″Rule 502(d) Order″), allows the producing party to avoid the uncertainties of Rule 502(b)’s Inasmuch as defendants’ cautious approach is [*8] not reasonableness requirement by stipulating that any prohibited by the text of Rule 502, and they appear ready to unintended production of privileged materials will move expeditiously in producing documents in the case, be deemed ″inadvertent″ and returned to the their desired approach is a reasonable one. (See Defs.’ producing party. That is, parties to a claw-back Reply at 2 (″Defendants have every reason to implement agreement expressly agree that any inadvertent efficient review techniques and avoid the high costs of production will be excused, and no waiver of manual privilege review for all but the most sensitive privilege will be deemed to have occurred. A document categories″)). claw-back order may be issued at the request of both parties, at the request of one party even when The court, accordingly, will today enter their proposed Rule the other party opposes, or, in some cases, on the 502(d) order. The court does so with the expectation that the court’s own initiative. defendants will marshal the resources necessary to assure that the delay occasioned by manual review of portions of Timothy P. Harkness & Elizabeth M. Zito, eDiscovery for designated categories will uniformly be minimized so that Corporate Counsel § 15:8 (2013) (footnotes omitted). disclosure of the entirety of even the most sensitive categories is accomplished quickly. In the event that, even The plaintiffs appear to recognize as much but believe it is with the defendant’s best efforts, it becomes apparent that essential to the efficient progress of the case that they undue delay is thwarting the progress of the case to the point receive ESI materials expeditiously under Rule 502(b) with that timely compliance with the schedule fixed by the its clawback provision affording protection to defendants court’s orders of September 5 and October 27, 2014, is from misuse of potentially privileged [*7] information and threatened, plaintiffs should file a motion requesting that the communication. They note as follows: approach sought by plaintiffs be adopted for the remainder of discovery and such a motion will be heard on a priority Plaintiffs are willing to agree to an order that basis. provides that the privilege or protection will not be waived and that no other harm will come to the The Clerk is directed to [*9] forward copies of this written Defendants if Plaintiffs are permitted to see opinion and order to all counsel of record and to the privileged or work product protected documents. following individuals designated as liaison counsel in the Under those circumstances, however, Plaintiffs can consolidated action styled Desimone Hospitality Services, see no practical reason for Defendants to engage in LLC v. West Virginia American Water Co., 2:14-14845, any kind of manual privilege review prior to 2014 U.S. Dist. LEXIS 55225 (S.D. W. Va.). production of documents other than to delay the production of documents. Anthony J. Majestro In fact, Plaintiffs can see no very good reason for Guy Bucci any kind of privilege review at all prior to Benjamin L. Bailey production, but are willing to agree to computer-assisted searches and other Scott E. Schuster machine-based privilege reviews as a compromise William F. Dobbs, Jr. 10 Recent Decisions Every Page 115 of 309 Attorney Should Know

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DATED: October 29, 2014 United States District Judge /s/ John T. Copenhaver John T. Copenhaver, Jr. 10 Recent Decisions Every Page 116 of 309 Attorney Should Know

| | Neutral As of: November 21, 2014 3:42 PM EST

Painter v. Atwood

United States District Court for the District of Nevada October 23, 2014, Decided; October 28, 2014, Filed Case No. 2:12-cv-01215-JCM-NJK

Reporter 2014 U.S. Dist. LEXIS 153342 HEATHER PAINTER, Plaintiff, v. AARON ATWOOD, Opinion D.D.S., et al., Defendants.

Prior History: Painter v. Atwood, 912 F. Supp. 2d 962, ORDER 2012 U.S. Dist. LEXIS 176655 (D. Nev., 2012) Presently before the court is defendants/counterclaimants’ Aaron Atwood, D.D.S. (″Dr. Atwood″) and Atwood Urgent Core Terms Dental Care, PLLC (″Atwood Urgent″) and third-party plaintiff Kelli Atwood’s (collectively ″defendants″) renewed summary judgment, sexual assault, emotional distress, motion for partial summary judgment. (Doc. # 89). Plaintiff defendants’, resignation, constructive discharge, Heather Painter filed a response in opposition, (doc. #98), confinement, induced, rape, false imprisonment, plaintiff’s and defendants filed a reply. (Doc. # 109). claim, public policy, deposition, nonmoving, genuine, partial summary judgment, fraudulent inducement, material fact, I. Background alleges, constructive discharge claim, counterclaims, at-will, This is a suit for monetary and declaratory relief for various party’s, negate, notice, sexual tort claims stemming from alleged sexual [*2] harassment. Plaintiff began working at defendant Atwood Urgent in or Counsel: [*1] For Heather Painter, Plaintiff, Counter around July 2010. (Doc. # 1 at ¶ 8). Atwood Urgent is a Defendant, Counter Claimant: Paul S. Padda, LEAD ″24/7″ dental practice that serves patients after business ATTORNEY, Cohen & Padda, LLP, Las Vegas, NV; Ruth L. hours. (See id. at ¶ 9). Plaintiff’s duties included assisting Cohen, LEAD ATTORNEY, Las Vegas, NV. defendant Aaron Atwood, D.D.S. (″Dr. Atwood″) with dental procedures in addition to office and clerical work. For D.D.S. Aaron Atwood, Atwood Urgent Dental Care, (Id. at ¶ 8). Plaintiff would occasionally perform these PLLC, Defendants: Robert L Rosenthal, LEAD ATTORNEY, duties in the evenings. (Id. at ¶ 9). Howard and Howard, Las Vegas, NV. Plaintiff alleges that after a few months of employment, Dr. For Kelli Atwood, Atwood Urgent Dental Care, PLLC, Atwood began to initiate conversations about her dating D.D.S. Aaron Atwood, D.D.S. Aaron Atwood, Counter life. (Id. at ¶ 11). According to plaintiff, Dr. Atwood’s Claimants, ThirdParty Plaintiffs: Robert L Rosenthal, LEAD actions and comments became increasingly sexual and ATTORNEY, Howard and Howard, Las Vegas, NV. aggressive. (See id. at ¶¶ 11-15). Plaintiff alleges that on May 29, 2011, Dr. Atwood requested For D.D.S. Aaron Atwood, Counter Defendant: Robert L that she come in to the office to help him with an after-hours Rosenthal, LEAD ATTORNEY, Howard and Howard, Las appointment. The patient did not show. (Id. at ¶ 17). Plaintiff Vegas, NV. alleges that Dr. Atwood, with no one else in the building, attempted to either rape or sexually assault her. (Id. at ¶ 17). Judges: JAMES C. MAHAN, UNITED STATES Plaintiff resigned from Atwood Urgent shortly thereafter. DISTRICT JUDGE. On July 10, 2012, plaintiff filed a complaint alleging four Opinion by: JAMES C. MAHAN causes of action: (1) intentional infliction of emotional 10 Recent Decisions Every Page 117 of 309 Attorney Should Know

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distress [*3] (″IIED″); (2) battery; (3) false imprisonment; [*5] dispose of factually unsupported claims.″ Celotex and (4) constructive discharge. (See id.). Corp. v. Catrett, 477 U.S. 317, 323-24, 106 S. Ct. 2548, 91 L. Ed. 2d 265 (1986). On January 23, 2013, defendants answered the complaint. (Doc. # 14). The answer included counterclaims and a In determining summary judgment, a court applies a ″ third-party complaint against plaintiff. The counterclaims burden-shifting analysis. When the party moving for allege that Kelli Atwood and Dr. Atwood (″the Atwoods″) summary judgment would bear the burden of proof at trial, entered into a promissory note with plaintiff in exchange for it must come forward with evidence which would entitle it $2,500 with interest accruing on the unpaid principal at 8% to a directed verdict if the evidence went uncontroverted at per annum. (Doc. # 14, ¶¶ 8-9). The parties allegedly trial. In such a case, the moving party has the initial burden entered into the note on February 1, 2011. (Id.). Under the of establishing the absence of a genuine issue of fact on ″ note, plaintiff agreed to repay the Atwoods in monthly each issue material to its case. C.A.R. Transp. Brokerage installments of $214.47 commencing on April 1, 2011, until Co. v. Darden Rests., Inc., 213 F.3d 474, 480 (9th Cir. 2000) the note was paid off on March 1, 2012. (Id. at ¶ 10). (citations omitted). In contrast, when the nonmoving party bears the burden of The Atwoods allege that plaintiff was unable or unwilling to proving the claim or defense, the moving party can meet its repay the money loaned under the note. (Id. at ¶ 14). Based burden in two ways: (1) by presenting evidence to negate an on the foregoing, the Atwoods alleged the following three essential element of the nonmoving party’s case; or (2) by causes of action against plaintiff: (1) breach of contract; (2) demonstrating that the nonmoving party failed to make a unjust enrichment; and (3) breach of the covenant of good showing sufficient to establish an element essential to that faith and fair dealing. party’s case on which that party will bear the burden of proof at trial. See Celotex Corp., 477 U.S. at 323-24. If the This court’s June 18, 2014 order, (doc. #86), denied moving party fails to meet its initial burden, summary defendants’ motion for partial summary judgment. (Docs. judgment must be denied and the court need not consider ## 57& 661). The court found that defendants failed [*4] to the nonmoving party’s evidence. See Adickes v. S.H. Kress properly authenticate the evidence set forth to support their & Co., 398 U.S. 144, 159-60, 90 S. Ct. 1598, 26 L. Ed. 2d motion. Specifically, defendants failed to attach the reporter’s 142 (1970). certification to the excerpts of deposition transcripts used to support their motion. Because the motion relied almost If the moving party satisfies its initial burden, the burden exclusively on the excerpts, the court did not reach the then shifts to the opposing party to establish that [*6] a merits of the motion for partial summary judgment. genuine issue of material fact exists. See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586, 106 S. In response to the order, defendants filed a motion for Ct. 1348, 89 L. Ed. 2d 538 (1986). To establish the existence extension of time to file dispositive motions on June 20, of a factual dispute, the opposing party need not establish a 2014. (Doc. # 87). Plaintiff filed a non-opposition. (Doc. # material issue of fact conclusively in its favor. It is sufficient 90). On June 23, 2014, defendants filed the instant motion that ″the claimed factual dispute be shown to require a jury for partial summary judgment to which they attached the or judge to resolve the parties’ differing versions of the truth reporter’s certificate. (Doc. # 89). at trial.″ T.W. Elec. Serv., Inc. v. Pac. Elec. Contractors Ass’n, 809 F.2d 626, 631 (9th Cir. 1987). II. Motion for Partial Summary Judgment In other words, the nonmoving party cannot avoid summary judgment by relying solely on conclusory allegations that A. Legal Standard are unsupported by factual data. See Taylor v. List, 880 F.2d 1040, 1045 (9th Cir. 1989). Instead, the opposition must go The Federal Rules of Civil Procedure provide for summary beyond the assertions and allegations of the pleadings and judgment when the pleadings, depositions, answers to set forth specific facts by producing competent evidence interrogatories, and admissions on file, together with the that shows a genuine issue for trial. See Celotex Corp., 477 affidavits, if any, show that ″there is no genuine issue as to U.S. at 324. any material fact and that the movant is entitled to a judgment as a matter of law.″ Fed. R. Civ. P. 56(a).A At summary judgment, a court’s function is not to weigh the principal purpose of summary judgment is ″to isolate and evidence and determine the truth, but to determine whether

1 Doc. # 66 is a redacted version of doc. # 57 and is identical in all material respects. 10 Recent Decisions Every Page 118 of 309 Attorney Should Know

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there is a genuine issue for trial. See Anderson v. Liberty Painter v. Atwood, 912 F. Supp. 2d 962, 968 (D. Nev. 2012); Lobby, Inc., 477 U.S. 242, 249, 106 S. Ct. 2505, 91 L. Ed. (see also doc. # 12). 2d 202 (1986). The evidence of the nonmovant is ″to be believed, and all justifiable inferences are to be drawn in his First, we consider defendants’ request for judicial notice. favor.″ Id. at 255. But if the evidence of the nonmoving (Doc. # 77). Defendants request the court take judicial party is merely colorable or is not significantly probative, notice of Magistrate Judge Nancy J. Koppe’s order on summary judgment may be granted. See id. at 249-50. defendants’ motion for spoliation sanctions for destruction of text messages and Facebook posts, (doc. # 56), where the B. Constructive Discharge court noted:

″Employees in Nevada are presumed to be employed at-will Plaintiff’s counsel argued . . . that those Facebook unless the employee [*7] can prove facts legally sufficient posts were not relevant because Plaintiff has already to show a contrary agreement was in effect.″ Dillard Dep’t admitted to enjoying working for Defendant Dr. Stores, Inc., v. Beckwith, 115 Nev. 372, 989 P.2d 882, 884-85 Atwood and because her constructive discharge (Nev. 1999) (internal citations and quotations omitted). ″The claim is based entirely on the alleged May 2011 at-will rule gives the employer the right to discharge an incident. employee for any reason, so long as the reason does not violate public policy.″ Id. (Doc. # 75 p. 9). Defendants mistakenly characterize the above summation of plaintiff’s counsel’s arguments as the ″ An action in tort for constructive discharge has been held ″law of the case″ to argue that plaintiff’s constructive to exist when an employer creates working conditions so discharge claim rests entirely on the May 29, 2011 incident. intolerable and discriminatory that a reasonable person in (See doc. # 109 p. [*9] 13). Therefore, defendants argue ″ the employee’s position would feel compelled to resign. plaintiff’s claim for constructive discharge fails because a Martin v. Sears Roebuck & Co., 111 Nev. 923, 899 P.2d 551, single isolated incident is not sufficient as a matter of law to 553 (Nev. 1995). Under Nevada law, a tortious discharge is support a finding of constructive discharge. (Doc. # 109 p. shown to exist upon proof that: 13) (citing Sanchez v. City of Santa Ana, 915 F.2d 424, 431 (9th Cir. 1990)). (1) the employee’s resignation was induced by action and conditions that are violative of public Defendants’ argument is without merit. First, Federal Rule policy; (2) a reasonable person in the employee’s of Evidence 201 provides for judicial notice of adjudicative position at the time of resignation would have also facts. Under Rule 201(b)(2), the court may ″judicially notice resigned because of the aggravated and intolerable a fact that is not subject to reasonable dispute because it . . employment actions and conditions; (3) the . can be accurately and readily determined from sources employer had actual or constructive knowledge of whose accuracy cannot reasonably be questioned.″ Fed. R. the intolerable actions and conditions and their Evid. 201(b)(2). The court’s summary of plaintiff’s argument impact on the employee; and (4) the situation could is not a finding of fact. have been remedied. Moreover, the court expressly rejected plaintiff’s argument Beckwith, 989 P.2d at 885. Thus, ″[o]ne of the elements that certain destroyed Facebook posts were not relevant necessary to prove constructive or tortious discharge is that precisely because plaintiff’s claims are not based exclusively the action by the employer was in violation of public on the May 29, 2011, incident, but on the environment at policy.″ Id. at 886. Public [*8] policy exceptions in the Atwood Urgent as a whole.2 Therefore, the court declines to tortious discharge or constructive discharge context ″are take judicial notice as requested by defendants. Accordingly, severely limited to those rare and exceptional cases where plaintiff’s claim for constructive discharge does not fail as a the employer’s conduct violates strong and compelling matter of law as based solely on the May 29, 2011 incident. public policy.″ Sands Regent v. Valgardson, 105 Nev. 436, 777 P.2d 898, 900 (Nev. 1989). Previously in this action, this Next, defendants argue plaintiff’s claim for constructive court held that rape and sexual assault are violative of public discharge fails as a matter of law due to lack of evidence. policy for purposes of proving constructive discharge. See (See doc. # 89 p. 5). Defendants point out that plaintiff never

2 ″Plaintiff’s Facebook comments . . . are directly relevant to this litigation. Plaintiff’s entire lawsuit centers [*10] around her assertion that the work environment at Defendant Dr. Atwood’s dental practice was sexual in nature.″ (Doc. # 75 p. 9). 10 Recent Decisions Every Page 119 of 309 Attorney Should Know

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complained to Dr. Atwood about his unwanted advances, Under Nevada law, ″[f]alse imprisonment is an unlawful did not look for other employment, and voluntarily quit her violation of the personal liberty of another, and consists in job at Atwood Urgent. (See doc. # 89 p. 6). Defendants confinement or detention without sufficient legal authority.″ further argue that even if sexual assault qualifies as a public NRS 200.460. An actor is subject to liability to another for policy exception to the at-will doctrine, there is no evidence false imprisonment if (1) he acts intending to confine the Dr. Atwood attempted to rape or sexually assault plaintiff. other within boundaries fixed by the actor, and (2) his act Defendants point out that plaintiff did not ″hit, scratch, or directly or indirectly results in such a confinement of the punch Dr. Atwood in an effort to escape,″ clocked out after other, and (3) the other is conscious of the confinement or is the alleged attack, and accepted a ride home from Dr. harmed by it. See Restatement (Second) of Torts § 35 Atwood even though plaintiff could have entered a gym (1965). next door ″or crossed the street and entered a Von’s [sic] grocery store.″ (Doc. # 109 p. 11-12). Additionally, plaintiff Defendants argue plaintiff’s claim for false imprisonment did not file a police report and apologized to Dr. Atwood the fails because plaintiff voluntarily entered Dr. Atwood’s day after the alleged assault via text message for not being office, Dr. Atwood’s office door [*13] remained open, able to help with an after-hours appointment the following Atwood Urgent’s front door was unlocked, and plaintiff did ″ ″ [*11] evening. Id. at 12. not hit, scratch, or punch Dr. Atwood. (Doc. # 89 p. 7). Additionally, plaintiff took the time to punch out on the time Plaintiff responds that sexual assault is violative of public clock following the incident and accepted a ride home from policy and thus qualifies as an exception to the at-will Dr. Atwood. Id. doctrine. Further, whether a reasonable person would feel compelled to resign under the circumstances is a question of Plaintiff responds that all elements of a claim for false material fact precluding summary judgment. (see doc. # 98 imprisonment have been met. Dr. Atwood pulled plaintiff p. 20). onto his lap and used his strength to keep her there, thus, plaintiff was confined within boundaries fixed by Dr. The court finds that whether a reasonable person in plaintiff’s Atwood. Plaintiff’s subsequent resignation evidences that situation would have felt compelled to resign is a genuine she was harmed by this confinement. issue of material fact precluding summary judgment. This court’s December 12, 2012, order specifically addressed Defendants have not presented evidence sufficient to negate whether rape or sexual assault qualify as public policy an essential element of plaintiff’s claim for false exceptions to the at-will doctrine. (See doc. # 12). Finding imprisonment or demonstrated that plaintiff failed to that rape and sexual assault are violative of public policy, establish an essential element to such claim. According to this court denied defendants’ motion to dismiss plaintiff’s plaintiff, Dr. Atwood pulled her onto his lap, used physical constructive discharge claim. Defendants’ argument that strength to keep her there, and she was temporarily so there is insufficient evidence to support plaintiff’s claim of confined. (See doc. # 98 p. 24). Dr. Atwood admits that he alleged sexual assault causing her resignation is without pulled plaintiff onto him, but that it was to ″tickle her and merit. Defendants have not negated any element of plaintiff’s play with her in a playful manner.″ (See id. at 23). Thus, a constructive discharge claim or demonstrated that plaintiff genuine issue of material fact remains as to whether Dr. has failed to make a showing sufficient to establish an Atwood intended to confine plaintiff when [*14] he pulled essential element of that claim. Specifically, defendants her onto his lap. Accordingly, this court denies defendants’ [*12] have not proved that the alleged sexual assault of motion for summary judgment with regard to plaintiff’s plaintiff on May 29, 2011 did not occur or did not induce false imprisonment claim. plaintiff’s subsequent resignation. D. Intentional Infliction of Emotional Distress(″IIED″) Additionally, defendants have not offered any evidence to show that Dr. Atwood did not have actual or constructive To state a claim for IIED, a plaintiff must show: (1) knowledge of the impact of his actions on plaintiff. There is defendant acted in an extreme and outrageous manner; (2) conflicting evidence as to whether Dr. Atwood was aware defendant intended to or recklessly disregarded the that plaintiff was upset by his conduct. Therefore, the court probability that his conduct could cause plaintiff emotional denies defendants’ motion for summary judgment with distress; (3) plaintiff actually suffered extreme or severe regard to plaintiff’s constructive discharge claim. emotional distress; and (4) defendant’s conduct caused plaintiff’s distress. See Miller v. Jones, 114 Nev. 1291, 970 C. False Imprisonment P.2d 571, 577 (Nev. 1998). A claim for IIED operates on a 10 Recent Decisions Every Page 120 of 309 Attorney Should Know

Page 5 of 6 2014 U.S. Dist. LEXIS 153342, *14

continuum: the less extreme the outrage, the greater the that plaintiff did not suffer emotional distress. Therefore, the need for evidence of physical injury or illness from the court denies defendants’ motion for summary judgment as emotional distress. See Chowdhry v. NLVH, Inc.., 109 Nev. to intentional infliction of emotional distress. 478, 851 P.2d 459, 462 (Nev. 1993). ″Liability is only found in extreme cases where the actions of the defendant go E. Breach of Contract beyond all possible bounds of decency″ and are atrocious A party to a contract may seek rescission of that contract and utterly intolerable. Alam v. Reno Hilton Corp., 819 F. based on fraud in the inducement. J.A. Jones Constr. Co. v. Supp. 905, 911 (D. Nev. 1993) (citing Restatement (Second) Lehrer McGovern Bovis, Inc., 120 Nev. 277, 89 P.3d 1009, of Torts § 46 cmt. d (1965)). 1018 (Nev. 2004). Thus, fraudulent inducement is an Defendants argue Dr. Atwood’s conduct was not extreme or affirmative defense to a suit for breach of contract. To prove outrageous because plaintiff apologized for not being able fraudulent inducement, a plaintiff must prove: (1) a false to assist with a subsequent after-hours appointment. (See representation made by the party defendant; (2) defendant’s Doc. # 89 p. 25). Further, plaintiff has not shown she [*17] knowledge or belief that the representation was false; suffered severe emotional distress because she [*15] returned (3) intention to therewith induce plaintiff to consent to the to work on May 31, 2011; did not immediately seek formation of the contract; (4) plaintiff’s justifiable reliance treatment; began dating someone new shortly after the upon the misrepresentation; and (5) damage to plaintiff incident; and eventually became pregnant, despite reporting resulting from such reliance. See Id. at 1018. Thus, under ″ that she was experiencing avoidance of sexual contact. See Nevada law, [t]o establish fraud in the inducement of a Id. contract, a party must prove, among other things, that the other party made a false representation that was material to Plaintiff responds that Dr. Atwood’s hyper-sexual behavior the transaction.″ Awada v. Shuffle Master, Inc., 123 Nev. which culminated in the May 29, 2011, incident qualifies as 613, 173 P.3d 707, 713 (Nev. 2007) (internal citation extreme and outrageous conduct. (See doc. #98). omitted). Additionally, plaintiff points out that her delay in seeking Plaintiff filed an answer to defendants’ counterclaims in counseling is not dispositive, as there is no requirement that which she alleged, among other things, that Dr. Atwood a plaintiff alleging emotional distress seek any counseling. fraudulently induced her to enter into the promissory note Defendants have failed to provide sufficient evidence to with the Atwoods. (See doc. # 31 p. 5). Plaintiff alleges that negate plaintiff’s IIED claim. Attempted rape or sexual as Dr. Atwood’s sexual advances became more aggressive, assault is clearly extreme and offensive conduct. According he induced her to take the loan from him in February 2011 to plaintiff, Dr. Atwood climbed on top of her with his pants to impede her from asserting her rights. (See doc. # 98 p. undone and held her down. She feared that he was going to 28). Defendants argue plaintiff’s assertion of fraudulent rape her. (See doc. #98 p. 17). Dr. Atwood disputes inducement was discounted by her own deposition testimony. plaintiff’s recollection of events. During his deposition, he Specifically, plaintiff admitted she asked the Atwoods for stated that he was only attempting to tickle plaintiff and that the loan and did not claim she had been fraudulently their relationship was consensual. (See doc. #75 p. 1). induced during her deposition. (See doc. # 109 p. 8). Whether Dr. Atwood did attempt to rape or sexually assault Plaintiff [*18] points out that counsel for Kelli Atwood plaintiff is a disputed issue [*16] of material fact. failed to ask plaintiff a single question about her fraudulent inducement defense at her deposition. (See doc. # 98 p. 28). Plaintiff has also provided competent evidence that she Dr. Atwood’s intent in entering into the promissory note suffered extreme emotional distress sufficient to survive with plaintiff is a question of material fact precluding summary judgment. That plaintiff briefly returned to work summary judgment. Plaintiff’s admission that she asked the at Atwood Urgent following the May 29, 2011 incident, Atwoods for the loan and failure to mention her fraudulent called in sick to subsequent after-hours appointments, started inducement defense during her deposition do not negate a new relationship, and eventually bore a child does not plaintiff’s fraudulent inducement defense. Therefore, the prove that she did not suffer extreme emotional distress. court denies defendants’ motion for summary judgment as Notably, plaintiff did not report she was pregnant until to breach of contract. February 10, 2012, approximately nine months after the alleged sexual assault. That plaintiff allegedly began a IV. Conclusion relationship shortly after resigning from Atwood Urgent and became pregnant some nine months later does not establish Accordingly, 10 Recent Decisions Every Page 121 of 309 Attorney Should Know

Page 6 of 6 2014 U.S. Dist. LEXIS 153342, *18

IT IS HEREBY ORDERED, ADJUDGED, AND DECREED /s/ James C. Mahan that defendants/counterclaimants’/third-party plaintiff’s renewed motion for partial summary judgment, (doc. #89), JAMES C. MAHAN is DENIED. UNITED STATES DISTRICT JUDGE DATED THIS 23rd day of October 2014. Commercial Real Estate Panel - Page 122 of 309 Legal UPdates and Financing Trends

Page 1

1 of 1 DOCUMENT

*** This document is current through the November 24, 2014 *** *** issue of the Federal Register ***

TITLE 26 -- INTERNAL REVENUE CHAPTER I -- INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY SUBCHAPTER A -- INCOME TAX PART 1 -- INCOME TAXES NORMAL TAXES AND SURTAXES DETERMINATION OF TAX LIABILITY RULES FOR COMPUTING CREDIT FOR INVESTMENT IN CERTAIN DEPRECIABLE PROPERTY

Go to the CFR Archive Directory

26 CFR 1.45D-1

§ 1.45D-1 New markets tax credit.

(a) Current year credit. The current year general business credit under section 38(b)(13) [26 USCS § 38(b)(13)] includes the new markets tax credit under section 45D(a) [26 USCS § 45D(a)].

(b) Allowance of credit -- (1) In general. A taxpayer holding a qualified equity investment on a credit allowance date which occurs during the taxable year may claim the new markets tax credit determined under section 45D(a) [26 USCS § 45D(a)] and this section for such taxable year in an amount equal to the applicable percentage of the amount paid to a qualified community development entity (CDE) for such investment at its original issue. Qualified equity investment is defined in paragraph (c) of this section. Credit allowance date is defined in paragraph (b)(2) of this section. Applicable percentage is defined in paragraph (b)(3) of this section. A CDE is a qualified community development entity as defined in section 45D(c) [26 USCS § 45D(c)]. The amount paid at original issue is determined under paragraph (b)(4) of this section.

(2) Credit allowance date. The term credit allowance date means, with respect to any qualified equity investment --

(i) The date on which the investment is initially made; and

(ii) Each of the 6 anniversary dates of such date thereafter.

(3) Applicable percentage. The applicable percentage is 5 percent for the first 3 credit allowance dates and 6 Commercial Real Estate Panel - Page 123 of 309 Legal UPdates and Financing Trends

Page 2 26 CFR 1.45D-1

percent for the other 4 credit allowance dates.

(4) Amount paid at original issue. The amount paid to the CDE for a qualified equity investment at its original issue consists of all amounts paid by the taxpayer to, or on behalf of, the CDE (including any underwriter's fees) to purchase the investment at its original issue.

(c) Qualified equity investment -- (1) In general. The term qualified equity investment means any equity investment (as defined in paragraph (c)(2) of this section) in a CDE if --

(i) The investment is acquired by the taxpayer at its original issue (directly or through an underwriter) solely in exchange for cash;

(ii) Substantially all (as defined in paragraph (c)(5) of this section) of such cash is used by the CDE to make qualified low-income community investments (as defined in paragraph (d)(1) of this section); and

(iii) The investment is designated for purposes of section 45D [26 USCS § 45D] and this section as a qualified equity investment or a non-real estate qualified equity investment (as defined in paragraph (c)(8) of this section) by the CDE on its books and records using any reasonable method.

(2) Equity investment. The term equity investment means any stock (other than nonqualified preferred stock as defined in section 351(g)(2) [26 USCS § 351(g)(2)]) in an entity that is a corporation for Federal tax purposes and any capital interest in an entity that is a partnership for Federal tax purposes. See §§ 301.7701-1 through 301.7701-3 of this chapter for rules governing when a business entity, such as a business trust or limited liability company, is classified as a corporation or a partnership for Federal tax purposes.

(3) Equity investments made prior to allocation -- (i) In general. Except as provided in paragraph (c)(3)(ii) of this section, an equity investment in an entity is not eligible to be designated as a qualified equity investment if it is made before the entity enters into an allocation agreement with the Secretary. An allocation agreement is an agreement between the Secretary and a CDE relating to a new markets tax credit allocation under section 45D(f)(2) [26 USCS § 45D(f)(2)].

(ii) Exceptions. Notwithstanding paragraph (c)(3)(i) of this section, an equity investment in an entity is eligible to be designated as a qualified equity investment or a non-real estate qualified equity investment under paragraph (c)(1)(iii) of this section if--

(A) Allocation applications submitted by August 29, 2002.

(1) The equity investment is made on or after April 20, 2001;

(2) The designation of the equity investment as a qualified equity investment is made for a credit allocation received pursuant to an allocation application submitted to the Secretary no later than August 29, 2002; and

(3) The equity investment otherwise satisfies the requirements of section 45D [26 USCS § 45D] and this section; or

(B) Other allocation applications.

(1) The equity investment is made on or after the date the Secretary publishes a Notice of Allocation Availability (NOAA) in the Federal Register;

Page 3 26 CFR 1.45D-1

(3) The equity investment otherwise satisfies the requirements of section 45D [26 USCS § 45D] and this section.

(iii) Failure to receive allocation. For purposes of paragraph (c)(3)(ii)(A) of this section, if the entity in which the equity investment is made does not receive an allocation pursuant to an allocation application submitted no later than August 29, 2002, the equity investment will not be eligible to be designated as a qualified equity investment. For purposes of paragraph (c)(3)(ii)(B) of this section, if the entity in which the equity investment is made does not receive an allocation under the NOAA described in paragraph (c)(3)(ii)(B)(1) of this section, the equity investment will not be eligible to be designated as a qualified equity investment.

(iv) Initial investment date. If an equity investment is designated as a qualified equity investment in accordance with paragraph (c)(3)(ii) of this section, the investment is treated as initially made on the effective date of the allocation agreement between the CDE and the Secretary.

(4) Limitations -- (i) In general. The term qualified equity investment does not include --

(A) Any equity investment issued by a CDE more than 5 years after the date the CDE enters into an allocation agreement (as defined in paragraph (c)(3)(i) of this section) with the Secretary; and

(B) Any equity investment by a CDE in another CDE, if the CDE making the investment has received an allocation under section 45D(f)(2) [26 USCS § 45D(f)(2)].

(ii) Allocation limitation. The maximum amount of equity investments issued by a CDE that may be designated under paragraph (c)(1)(iii) of this section by the CDE may not exceed the portion of the limitation amount allocated to the CDE by the Secretary under section 45D(f)(2) [26 USCS § 45D(f)(2)].

(5) Substantially all -- (i) In general. Except as provided in paragraph (c)(5)(v) of this section, the term substantially all means at least 85 percent. The substantially-all requirement must be satisfied for each annual period in the 7-year credit period using either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe harbor calculation under paragraph (c)(5)(iii) of this section. For the first annual period, the substantially-all requirement is treated as satisfied if either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe-harbor calculation under paragraph (c)(5)(iii) of this section, is performed on a single testing date and the result of the calculation is at least 85 percent. For each annual period other than the first annual period, the substantially-all requirement is treated as satisfied if either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe harbor calculation under paragraph (c)(5)(iii) of this section, is performed every six months and the average of the two calculations for the annual period is at least 85 percent. For example, the CDE may choose the same two testing dates for all qualified equity investments regardless of the date each qualified equity investment was initially made under paragraph (b)(2)(i) of this section, provided the testing dates are six months apart. The use of the direct-tracing calculation under paragraph (c)(5)(ii) of this section (or the safe harbor calculation under paragraph (c)(5)(iii) of this section) for an annual period does not preclude the use of the safe harbor calculation under paragraph (c)(5)(iii) of this section (or the direct-tracing calculation under paragraph (c)(5)(ii) of this section) for another annual period, provided that a CDE that switches to a direct-tracing calculation must substantiate that the taxpayer's investment is directly traceable to qualified low-income community investments from the time of the CDE's initial investment in a qualified low-income community investment. For purposes of this paragraph (c)(5)(i), the 7-year credit period means the period of 7 years beginning on the date the qualified equity investment is initially made. See paragraph (c)(6) of this section for circumstances in which a CDE may treat more than one equity investment as a single qualified equity investment.

(ii) Direct-tracing calculation. The substantially-all requirement is satisfied if at least 85 percent of the taxpayer's investment is directly traceable to qualified low-income community investments as defined in paragraph (d)(1) of this section. The direct-tracing calculation is a fraction the numerator of which is the CDE's aggregate cost basis determined under section 1012 [26 USCS § 1012] in all of the qualified low-income community investments that are directly traceable to the taxpayer's cash investment, and the denominator of which is the amount of the taxpayer's cash Commercial Real Estate Panel - Page 125 of 309 Legal UPdates and Financing Trends

Page 4 26 CFR 1.45D-1

investment under paragraph (b)(4) of this section. For purposes of this paragraph (c)(5)(ii), cost basis includes the cost basis of any qualified low-income community investment that becomes worthless. See paragraph (d)(2) of this section for the treatment of amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment.

(iii) Safe harbor calculation. The substantially-all requirement is satisfied if at least 85 percent of the aggregate gross assets of the CDE are invested in qualified low-income community investments as defined in paragraph (d)(1) of this section. The safe harbor calculation is a fraction the numerator of which is the CDE's aggregate cost basis determined under section 1012 [26 USCS § 1012] in all of its qualified low-income community investments, and the denominator of which is the CDE's aggregate cost basis determined under section 1012 [26 USCS § 1012] in all of its assets. For purposes of this paragraph (c)(5)(iii), cost basis includes the cost basis of any qualified low-income community investment that becomes worthless. See paragraph (d)(2) of this section for the treatment of amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment.

(iv) Time limit for making investments. The taxpayer's cash investment received by a CDE is treated as invested in a qualified low-income community investment as defined in paragraph (d)(1) of this section only to the extent that the cash is so invested within the 12-month period beginning on the date the cash is paid by the taxpayer (directly or through an underwriter) to the CDE.

(v) Reduced substantially-all percentage. For purposes of the substantially-all requirement (including the direct-tracing calculation under paragraph (c)(5)(ii) of this section and the safe harbor calculation under paragraph (c)(5)(iii) of this section), 85 percent is reduced to 75 percent for the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section).

(vi) Examples. The following examples illustrate an application of this paragraph (c)(5):

Example 1. X is a partnership and a CDE that has received a $ 1 million new markets tax credit allocation from the Secretary. On September 1, 2004, X uses a line of credit from a bank to fund a $ 1 million loan to Y. The loan is a qualified low-income community investment under paragraph (d)(1) of this section. On September 5, 2004, A pays $ 1 million to acquire a capital interest in X. X uses the proceeds of A's equity investment to pay off the $ 1 million line of credit that was used to fund the loan to Y. X's aggregate gross assets consist of the $ 1 million loan to Y and $ 100,000 in other assets. A's equity investment in X does not satisfy the substantially-all requirement under paragraph (c)(5)(i) of this section using the direct-tracing calculation under paragraph (c)(5)(ii) of this section because the cash from A's equity investment is not used to make X's loan to Y. However, A's equity investment in X satisfies the substantially-all requirement using the safe harbor calculation under paragraph (c)(5)(iii) of this section because at least 85 percent of X's aggregate gross assets are invested in qualified low-income community investments.

Example 2. X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On August 1, 2004, A pays $ 100,000 for a capital interest in X. On August 5, 2004, X uses the proceeds of A's equity investment to make an equity investment in Y. X controls Y within the meaning of paragraph (d)(6)(ii)(B) of this section. For the annual period ending July , 2005, Y is a qualified active low-income community business (as defined in paragraph (d)(4) of this section). Thus, for that period, A's equity investment satisfies the substantially-all requirement under paragraph (c)(5)(i) of this section using the direct-tracing calculation under paragraph (c)(5)(ii) of this section. For the annual period ending July 31, 2006, Y no longer is a qualified active low-income community business. Thus, for that period, A's equity investment does not satisfy the substantially-all requirement using the direct-tracing calculation. However, during the entire annual period ending July 31, 2006, X's remaining assets are invested in qualified low-income community investments with an aggregate cost basis of $ 900,000. Consequently, for the annual period ending July 31, 2006, at least 85 percent of X's aggregate gross assets are invested in qualified low-income community investments. Thus, for the annual period ending July 31, 2006, A's equity investment satisfies the substantially-all requirement using the safe harbor calculation under paragraph (c)(5)(iii) of this section. Commercial Real Estate Panel - Page 126 of 309 Legal UPdates and Financing Trends

Page 5 26 CFR 1.45D-1

Example 3. X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On August 1, 2004, A and B each pay $ 100,000 for a capital interest in X. X does not treat A's and B's equity investments as one qualified equity investment under paragraph (c)(6) of this section. On September 1, 2004, X uses the proceeds of A's equity investment to make an equity investment in Y and X uses the proceeds of B's equity investment to make an equity investment in Z. X has no assets other than its investments in Y and Z. X controls Y and Z within the meaning of paragraph (d)(6)(ii)(B) of this section. For the annual period ending July 31, 2005, Y and Z are qualified active low-income community businesses (as defined in paragraph (d)(4) of this section). Thus, for the annual period ending July 31, 2005, A's and B's equity investments satisfy the substantially-all requirement under paragraph (c)(5)(i) of this section using either the direct-tracing calculation under paragraph (c)(5)(ii) of this section or the safe harbor calculation under paragraph (c)(5)(iii) of this section. For the annual period ending July 31, 2006, Y, but not Z, is a qualified active low-income community business. Thus, for the annual period ending July 31, 2006 --

(1) X does not satisfy the substantially-all requirement using the safe harbor calculation under paragraph (c)(5)(iii) of this section;

(2) A's equity investment satisfies the substantially-all requirement using the direct-tracing calculation because A's equity investment is directly traceable to Y; and

(3) B's equity investment does not satisfy the substantially-all requirement because B's equity investment is traceable to Z.

Example 4. X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On November 1, 2004, A pays $ 100,000 for a capital interest in X. On December 1, 2004, B pays $ 100,000 for a capital interest in X. On December 31, 2004, X uses $ 85,000 from A's equity investment and $ 85,000 from B's equity investment to make a $ 170,000 equity investment in Y, a qualified active low-income community business (as defined in paragraph (d)(4) of this section). X has no assets other than its investment in Y. X determines whether A's and B's equity investments satisfy the substantially-all requirement under paragraph (c)(5)(i) of this section on December 31, 2004. The calculation for A's and B's equity investments is 85 percent using either the direct-tracing calculation under paragraph (c)(5)(ii) of this section or the safe harbor calculation under paragraph (c)(5)(iii) of this section. Therefore, for the annual periods ending October 31, 2005, and November 30, 2005, A's and B's equity investments, respectively, satisfy the substantially-all requirement under paragraph (c)(5)(i) of this section. For the subsequent annual period, X performs its calculations on December 31, 2005, and June 30, 2006. The average of the two calculations on December 31, 2005, and June 30, 2006, is 85 percent using either the direct-tracing calculation under paragraph (c)(5)(ii) of this section or the safe harbor calculation under paragraph (c)(5)(iii) of this section. Therefore, for the annual periods ending October 31, 2006, and November 30, 2006, A's and B's equity investments, respectively, satisfy the substantially-all requirement under paragraph (c)(5)(i) of this section.

(6) Aggregation of equity investments. A CDE may treat any qualified equity investments issued on the same day as one qualified equity investment. If a CDE aggregates equity investments under this paragraph (c)(6), the rules in this section shall be construed in a manner consistent with that treatment.

(7) Subsequent purchasers. A qualified equity investment includes any equity investment that would (but for paragraph (c)(1)(i) of this section) be a qualified equity investment in the hands of the taxpayer if the investment was a qualified equity investment in the hands of a prior holder.

(8) Non-real estate qualified equity investment. If a qualified equity investment is designated as a non-real estate qualified equity investment under paragraph (c)(1)(iii) of this section, then the qualified equity investment may only satisfy the substantially-all requirement under paragraph (c)(5) of this section if the CDE makes qualified low-income community investments that are directly traceable (including investments made through one or more CDEs) to non-real estate qualified active low-income community businesses (as defined in paragraph (d)(10) of this section). The proceeds of a non-real estate qualified equity investment cannot be used for transactions involving a qualified active low-income Commercial Real Estate Panel - Page 127 of 309 Legal UPdates and Financing Trends

Page 6 26 CFR 1.45D-1

community business that is not a non-real estate qualified active low-income community business.

(d) Qualified low-income community investments -- (1) In general. The term qualified low-income community investment means any of the following:

(i) Investment in a qualified active low-income community business or a non-real estate qualified active low-income community business. Any capital or equity investment in, or loan to, any qualified active low-income community business (as defined in paragraph (d)(4) of this section) or any non-real estate qualified active low-income community business (as defined in paragraph (d)(10) of this section).

(ii) Purchase of certain loans from CDEs -- (A) In general. The purchase by a CDE (the ultimate CDE) from another CDE (whether or not that CDE has received an allocation from the Secretary under section 45D(f)(2) [26 USCS § 45D(f)(2)]) of any loan made by such entity that is a qualified low-income community investment. A loan purchased by the ultimate CDE from another CDE is a qualified low-income community investment if it qualifies as a qualified low-income community investment either --

(1) At the time the loan was made; or

(2) At the time the ultimate CDE purchases the loan.

(B) Certain loans made before CDE certification. For purposes of paragraph (d)(1)(ii)(A) of this section, a loan by an entity is treated as made by a CDE, notwithstanding that the entity was not a CDE at the time it made the loan, if the entity is a CDE at the time it sells the loan.

(C) Intermediary CDEs. For purposes of paragraph (d)(1)(ii)(A) of this section, the purchase of a loan by the ultimate CDE from a CDE that did not make the loan (the second CDE) is treated as a purchase of the loan by the ultimate CDE from the CDE that made the loan (the originating CDE) if --

(1) The second CDE purchased the loan from the originating CDE (or from another CDE); and

(2) Each entity that sold the loan was a CDE at the time it sold the loan.

(D) Examples. The following examples illustrate an application of this paragraph (d)(1)(ii):

Example 1. X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. Y, a corporation, made a $ 500,000 loan to Z in 1999. In January of 2004, Y is certified as a CDE. On September 1, 2004, X purchases the loan from Y. At the time X purchases the loan, Z is a qualified active low-income community business under paragraph (d)(4)(i) of this section. Accordingly, the loan purchased by X from Y is a qualified low-income community investment under paragraphs (d)(1)(ii)(A) and (B) of this section.

Example 2. The facts are the same as in Example 1 except that on February 1, 2004, Y sells the loan to W and on September 1, 2004, W sells the loan to X. W is a CDE. Under paragraph (d)(1)(ii)(C) of this section, X's purchase of the loan from W is treated as the purchase of the loan from Y. Accordingly, the loan purchased by X from W is a qualified low-income community investment under paragraphs (d)(1)(ii)(A) and (C) of this section.

Example 3. The facts are the same as in Example 2 except that W is not a CDE. Because W was not a CDE at the time it sold the loan to X, the purchase of the loan by X from W is not a qualified low-income community investment under paragraphs (d)(1)(ii)(A) and (C) of this section.

(iii) Financial counseling and other services. Financial counseling and other services (as defined in paragraph (d)(7) of this section) provided to any qualified active low-income community business, or to any residents of a low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). Commercial Real Estate Panel - Page 128 of 309 Legal UPdates and Financing Trends

Page 7 26 CFR 1.45D-1

(iv) Investments in other CDEs -- (A) In general. Any equity investment in, or loan to, any CDE (the second CDE) by a CDE (the primary CDE), but only to the extent that the second CDE uses the proceeds of the investment or loan --

(1) In a manner --

(i) That is described in paragraph (d)(1)(i) or (iii) of this section; and

(ii) That would constitute a qualified low-income community investment if it were made directly by the primary CDE;

(2) To make an equity investment in, or loan to, a third CDE that uses such proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) of this section; or

(3) To make an equity investment in, or loan to, a third CDE that uses such proceeds to make an equity investment in, or loan to, a fourth CDE that uses such proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) of this section.

(B) Examples. The following examples illustrate an application of paragraph (d)(1)(iv)(A) of this section:

Example 1. X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On September 1, 2004, X uses $ 975,000 to make an equity investment in Y. Y is a corporation and a CDE. On October 1, 2004, Y uses $ 950,000 from X's equity investment to make a loan to Z. Z is a qualified active low-income community business under paragraph (d)(4)(i) of this section. Of X's equity investment in Y, $ 950,000 is a qualified low-income community investment under paragraph (d)(1)(iv)(A)(1) of this section.

Example 2. W is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On September 1, 2004, W uses $ 975,000 to make an equity investment in X. On October 1, 2004, X uses $ 950,000 from W's equity investment to make an equity investment in Y. X and Y are corporations and CDEs. On October 5, 2004, Y uses $ 925,000 from X's equity investment to make a loan to Z. Z is a qualified active low-income community business under paragraph (d)(4)(i) of this section. Of W's equity investment in X, $ 925,000 is a qualified low-income community investment under paragraph (d)(1)(iv)(A)(2) of this section because X uses proceeds of W's equity investment to make an equity investment in Y, which uses $ 925,000 of the proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) of this section.

Example 3. U is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On September 1, 2004, U uses $ 975,000 to make an equity investment in V. On October 1, 2004, V uses $ 950,000 from U's equity investment to make an equity investment in W. On October 5, 2004, W uses $ 925,000 from V's equity investment to make an equity investment in X. On November 1, 2004, X uses $ 900,000 from W's equity investment to make an equity investment in Y. V, W, X, and Y are corporations and CDEs. On November 5, 2004, Y uses $ 875,000 from X's equity investment to make a loan to Z. Z is a qualified active low-income community business under paragraph (d)(4)(i) of this section. U's equity investment in V is not a qualified low-income community investment because X does not use proceeds of W's equity investment in a manner described in paragraph (d)(1)(iv)(A)(1) of this section.

(2) Payments of, or for, capital, equity or principal -- (i) In general. Except as otherwise provided in this paragraph (d)(2), amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment must be reinvested by the CDE in a qualified low-income community investment no later than 12 months from the date of receipt to be treated as continuously invested in a qualified low-income community investment. If the amounts received by the CDE are equal to or greater than the cost basis of the original qualified low-income community investment (or applicable portion thereof), and the CDE reinvests, in accordance with this paragraph (d)(2)(i), an amount at least equal to such original cost basis, then an amount equal to such original cost basis will be treated as continuously invested in a qualified low-income community investment. In addition, if the amounts received by the CDE are equal to or greater than the cost basis of the original qualified low-income community Commercial Real Estate Panel - Page 129 of 309 Legal UPdates and Financing Trends

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investment (or applicable portion thereof), and the CDE reinvests, in accordance with this paragraph (d)(2)(i), an amount less than such original cost basis, then only the amount so reinvested will be treated as continuously invested in a qualified low-income community investment. If the amounts received by the CDE are less than the cost basis of the original qualified low-income community investment (or applicable portion thereof), and the CDE reinvests an amount in accordance with this paragraph (d)(2)(i), then the amount treated as continuously invested in a qualified low-income community investment will equal the excess (if any) of such original cost basis over the amounts received by the CDE that are not so reinvested. Amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment during the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section) do not have to be reinvested by the CDE in a qualified low-income community investment in order to be treated as continuously invested in a qualified low-income community investment.

(ii) Subsequent reinvestments. In applying paragraph (d)(2)(i) of this section to subsequent reinvestments, the original cost basis is reduced by the amount (if any) by which the original cost basis exceeds the amount determined to be continuously invested in a qualified low-income community investment.

(iii) Special rule for loans. Periodic amounts received during a calendar year as repayment of principal on a loan that is a qualified low-income community investment are treated as continuously invested in a qualified low-income community investment if the amounts are reinvested in another qualified low-income community investment by the end of the following calendar year.

(iv) Example. The application of paragraphs (d)(2)(i) and (ii) of this section is illustrated by the following example:

Example. On April 1, 2003, A, B, and C each pay $ 100,000 to acquire a capital interest in X, a partnership. X is a CDE that has received a new markets tax credit allocation from the Secretary. X treats the 3 partnership interests as one qualified equity investment under paragraph (c)(6) of this section. In August 2003, X uses the $ 300,000 to make a qualified low-income community investment under paragraph (d)(1) of this section. In August 2005, the qualified low-income community investment is redeemed for $ 250,000. In February 2006, X reinvests $ 230,000 of the $ 250,000 in a second qualified low-income community investment and uses the remaining $ 20,000 for operating expenses. Under paragraph (d)(2)(i) of this section, $ 280,000 of the proceeds of the qualified equity investment is treated as continuously invested in a qualified low-income community investment. In December 2008, X sells the second qualified low-income community investment and receives $ 400,000. In March 2009, X reinvests $ 320,000 of the $ 400,000 in a third qualified low-income community investment. Under paragraphs (d)(2)(i) and (ii) of this section, $ 280,000 of the proceeds of the qualified equity investment is treated as continuously invested in a qualified low-income community investment ($ 40,000 is treated as invested in another qualified low-income community investment in March 2009).

(3) Special rule for reserves. Reserves (not in excess of 5 percent of the taxpayer's cash investment under paragraph (b)(4) of this section) maintained by the CDE for loan losses or for additional investments in existing qualified low-income community investments are treated as invested in a qualified low-income community investment under paragraph (d)(1) of this section. Reserves include fees paid to third parties to protect against loss of all or a portion of the principal of, or interest on, a loan that is a qualified low-income community investment.

(4) Qualified active low-income community business -- (i) In general. The term qualified active low-income community business means, with respect to any taxable year, a corporation (including a nonprofit corporation) or a partnership engaged in the active conduct of a qualified business (as defined in paragraph (d)(5) of this section), if the requirements of paragraphs (d)(4)(i)(A), (B), (C), (D), and (E) of this section are met (or in the case of an entity serving targeted populations, if the requirements of paragraphs (d)(4)(i)(D), (E), and (d)(9)(i) or (ii) of this section are met). Solely for purposes of this section, a nonprofit corporation will be deemed to be engaged in the active conduct of a trade or business if it is engaged in an activity that furthers its purpose as a nonprofit corporation. Commercial Real Estate Panel - Page 130 of 309 Legal UPdates and Financing Trends

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(A) Gross-income requirement. At least 50 percent of the total gross income of such entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within any low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). An entity is deemed to satisfy this paragraph (d)(4)(i)(A) if the entity meets the requirements of either paragraph (d)(4)(i)(B) or (C) of this section, if "50 percent" is applied instead of 40 percent. In addition, an entity may satisfy this paragraph (d)(4)(i)(A) based on all the facts and circumstances. See paragraph (d)(4)(iv) of this section for certain circumstances in which an entity will be treated as engaged in the active conduct of a trade or business. See paragraph (d)(9) of this section for rules relating to targeted populations.

(B) Use of tangible property -- (1) In general. At least 40 percent of the use of the tangible property of such entity (whether owned or leased) is within any low-income community. This percentage is determined based on a fraction the numerator of which is the average value of the tangible property owned or leased by the entity and used by the entity during the taxable year in a low-income community and the denominator of which is the average value of the tangible property owned or leased by the entity and used by the entity during the taxable year. Property owned by the entity is valued at its cost basis as determined under section 1012 [26 USCS § 1012]. Property leased by the entity is valued at a reasonable amount established by the entity. See paragraph (d)(9) of this section for rules relating to targeted populations.

(2) Example. The application of paragraph (d)(4)(i)(B)(1) of this section is illustrated by the following example:

Example. X is a corporation engaged in the business of moving and hauling scrap metal. X operates its business from a building and an adjoining parking lot that X owns. The building and the parking lot are located in a low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). X's cost basis under section 1012 [26 USCS § 1012] for the building and parking lot is $ 200,000. During the taxable year, X operates its business 10 hours a day, 6 days a week. X owns and uses 40 trucks in its business, which, on average, are used 6 hours a day outside a low-income community and 4 hours a day inside a low-income community (including time in the parking lot). The cost basis under section 1012 [26 USCS § 1012] of each truck is $ 25,000. During non-business hours, the trucks are parked in the lot. Only X's 10-hour business days are used in calculating the use of tangible property percentage under paragraph (d)(4)(i)(B)(1) of this section. Thus, the numerator of the tangible property calculation is $ 600,000 (4/10 of $ 1,000,000 (the $ 25,000 cost basis of each truck times 40 trucks) plus $ 200,000 (the cost basis of the building and parking lot)) and the denominator is $ 1,200,000 (the total cost basis of the trucks, building, and parking lot), resulting in 50 percent of the use of X's tangible property being within a low-income community. Consequently, X satisfies the 40 percent use of tangible property test under paragraph (d)(4)(i)(B)(1) of this section.

(C) Services performed. At least 40 percent of the services performed for such entity by its employees are performed in a low-income community. This percentage is determined based on a fraction the numerator of which is the total amount paid by the entity for employee services performed in a low-income community during the taxable year and the denominator of which is the total amount paid by the entity for employee services during the taxable year. If the entity has no employees, the entity is deemed to satisfy this paragraph (d)(4)(i)(C), and paragraph (d)(4)(i)(A) of this section, if the entity meets the requirement of paragraph (d)(4)(i)(B) of this section if "85 percent" is applied instead of 40 percent. See paragraph (d)(9) of this section for rules relating to targeted populations.

(D) Collectibles. Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles (as defined in section 408(m)(2) [26 USCS § 408(m)(2)]) other than collectibles that are held primarily for sale to customers in the ordinary course of business.

(E) Nonqualified financial property -- (1) In general. Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property. For purposes of the preceding sentence, the term nonqualified financial property means debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities, and other similar property except that such term does not include -- Commercial Real Estate Panel - Page 131 of 309 Legal UPdates and Financing Trends

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(i) Reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less (because the definition of nonqualified financial property includes debt instruments with a term in excess of 18 months, banks, credit unions, and other financial institutions are generally excluded from the definition of a qualified active low-income community business); or

(ii) Debt instruments described in section 1221(a)(4) [26 USCS § 1221(a)(4)].

(2) Construction of real property. For purposes of paragraph (d)(4)(i)(E)(1)(i) of this section, the proceeds of a capital or equity investment or loan by a CDE that will be expended for construction of real property within 12 months after the date the investment or loan is made are treated as a reasonable amount of working capital.

(ii) Proprietorships. Any business carried on by an individual as a proprietor is a qualified active low-income community business if the business would meet the requirements of paragraph (d)(4)(i) of this section if the business were incorporated.

(iii) Portions of business -- (A) In general. A CDE may treat any trade or business (or portion thereof) as a qualified active low-income community business if the trade or business (or portion thereof) would meet the requirements of paragraph (d)(4)(i) of this section if the trade or business (or portion thereof) were separately incorporated and a complete and separate set of books and records is maintained for that trade or business (or portion thereof). However, the CDE's capital or equity investment or loan is not a qualified low-income community investment under paragraph (d)(1)(i) of this section to the extent the proceeds of the investment or loan are not used for the trade or business (or portion thereof) that is treated as a qualified active low-income community business under this paragraph (d)(4)(iii)(A).

(B) Examples. The following examples illustrate an application of paragraph (d)(4)(iii) of this section:

Example 1. X is a partnership and a CDE that receives a new markets tax credit allocation from the Secretary. A pays $ 1 million for a capital interest in X. Z is a corporation that operates a supermarket that is not in a low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). X uses the proceeds of A's equity investment to make a loan to Z that Z will use to construct a new supermarket in a low-income community. Z will maintain a complete and separate set of books and records for the new supermarket. The proceeds of X's loan to Z will be used exclusively for the new supermarket. Assume that Z's new supermarket in the low-income community would meet the requirements to be a qualified active low-income community business under paragraph (d)(4)(i) of this section if it were separately incorporated. Pursuant to paragraph (d)(4)(iii)(A) of this section, X treats Z's new supermarket as the qualified active low-income community business. Accordingly, X's loan to Z is a qualified low-income community investment under paragraph (d)(1)(i) of this section.

Example 2. X is a partnership and a CDE that receives a new markets tax credit allocation from the Secretary. A pays $ 1 million for a capital interest in X. Z is a corporation that operates a liquor store in a low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). A liquor store is not a qualified business under paragraph (d)(5)(iii)(B) of this section. X uses the proceeds of A's equity investment to make a loan to Z that Z will use to construct a restaurant next to the liquor store. Z will maintain a complete and separate set of books and records for the new restaurant. The proceeds of X's loan to Z will be used exclusively for the new restaurant. Assume that Z's restaurant would meet the requirements to be a qualified active low-income community business under paragraph (d)(4)(i) of this section if it were separately incorporated. Pursuant to paragraph (d)(4)(iii) of this section, X treats Z's restaurant as the qualified active low-income community business. Accordingly, X's loan to Z is a qualified low-income community investment under paragraph (d)(1)(i) of this section.

Example 3. X is a partnership and a CDE that receives a new markets tax credit allocation from the Secretary. A pays $ 1 million for a capital interest in X. Z is a corporation that operates an insurance company in a low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]). Five percent or more of the average of the aggregate Commercial Real Estate Panel - Page 132 of 309 Legal UPdates and Financing Trends

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unadjusted bases of Z's property is attributable to nonqualified financial property under paragraph (d)(4)(i)(E) of this section. Z's insurance operations include different operating units including a claims processing unit. X uses the proceeds of A's equity investment to make a loan to Z for use in Z's claims processing operations. Z will maintain a complete and separate set of books and records for the claims processing unit. The proceeds of X's loan to Z will be used exclusively for the claims processing unit. Assume that Z's claims processing unit would meet the requirements to be a qualified active low-income community business under paragraph (d)(4)(i) of this section if it were separately incorporated. Pursuant to paragraph (d)(4)(iii) of this section, X treats Z's claims processing unit as the qualified active low-income community business. Accordingly, X's loan to Z is a qualified low-income community investment under paragraph (d)(1)(i) of this section.

(iv) Active conduct of a trade or business -- (A) Special rule. For purposes of paragraph (d)(4)(i) of this section, an entity will be treated as engaged in the active conduct of a trade or business if, at the time the CDE makes a capital or equity investment in, or loan to, the entity, the CDE reasonably expects that the entity will generate revenues (or, in the case of a nonprofit corporation, engage in an activity that furthers its purpose as a nonprofit corporation) within 3 years after the date the investment or loan is made. This paragraph (d)(4)(iv) applies only for purposes of determining whether an entity is engaged in the active conduct of a trade or business and does not apply for purposes of determining whether the gross-income requirement under paragraph (d)(4)(i)(A), (d)(9)(i)(B)(1)(i), or (d)(9)(ii)(C)(1)(i) of this section is satisfied.

(B) Example. The application of paragraph (d)(4)(iv)(A) of this section is illustrated by the following example:

Example. X is a partnership and a CDE that receives a new markets tax credit allocation from the Secretary on July 1, 2004. X makes a ten-year loan to Y. Y is a newly formed entity that will own and operate a shopping center to be constructed in a low-income community. Y has no revenues but X reasonably expects that Y will generate revenues beginning in December 2005. Under paragraph (d)(4)(iv)(A) of this section, Y is treated as engaged in the active conduct of a trade or business for purposes of paragraph (d)(4)(i) of this section.

(5) Qualified business -- (i) In general. Except as otherwise provided in this paragraph (d)(5), the term qualified business means any trade or business. There is no requirement that employees of a qualified business be residents of a low-income community.

(ii) Rental of real property. The rental to others of real property located in any low-income community (as defined in section 45D(e) [26 USCS § 45D(e)]) is a qualified business if and only if the property is not residential rental property (as defined in section 168(e)(2)(A) [26 USCS § 168(e)(2)(A)]) and there are substantial improvements located on the real property. However, a CDE's investment in or loan to a business engaged in the rental of real property is not a qualified low-income community investment under paragraph (d)(1)(i) of this section to the extent a lessee of the real property is described in paragraph (d)(5)(iii)(B) of this section.

(iii) Exclusions -- (A) Trades or businesses involving intangibles. The term qualified business does not include any trade or business consisting predominantly of the development or holding of intangibles for sale or license.

(B) Certain other trades or businesses. The term qualified business does not include any trade or business consisting of the operation of any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.

(C) Farming. The term qualified business does not include any trade or business the principal activity of which is farming (within the meaning of section 2032A(e)(5)(A) or (B) [26 USCS § 2032A(e)(5)(A) or (B)]) if, as of the close of the taxable year of the taxpayer conducting such trade or business, the sum of the aggregate unadjusted bases (or, if greater, the fair market value) of the assets owned by the taxpayer that are used in such a trade or business, and the aggregate value of the assets leased by the taxpayer that are used in such a trade or business, exceeds $ 500,000. For Commercial Real Estate Panel - Page 133 of 309 Legal UPdates and Financing Trends

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purposes of this paragraph (d)(5)(iii)(C), two or more trades or businesses will be treated as a single trade or business under rules similar to the rules of section 52(a) and (b) [26 USCS § 52(a) and (b)].

(6) Qualifications -- (i) In general. Except as provided in paragraph (d)(6)(ii) of this section, an entity is treated as a qualified active low-income community business for the duration of the CDE's investment in the entity if the CDE reasonably expects, at the time the CDE makes the capital or equity investment in, or loan to, the entity, that the entity will satisfy the requirements to be a qualified active low-income community business under paragraph (d)(4)(i) of this section throughout the entire period of the investment or loan.

(ii) Control -- (A) In general. If a CDE controls or obtains control of an entity at any time during the 7-year credit period (as defined in paragraph (c)(5)(i) of this section), the entity will be treated as a qualified active low-income community business only if the entity satisfies the requirements of paragraph (d)(4)(i) of this section throughout the entire period the CDE controls the entity.

(B) Definition of control. Control means, with respect to an entity, direct or indirect ownership (based on value) or control (based on voting or management rights) of more than 50 percent of the entity. For purposes of the preceding sentence, the term management rights means the power to influence the management policies or investment decisions of the entity.

(C) Disregard of control. For purposes of paragraph (d)(6)(ii)(A) of this section, the acquisition of control of an entity by a CDE is disregarded during the 12-month period following such acquisition of control (the 12-month period) if --

(1) The CDE's capital or equity investment in, or loan to, the entity met the requirements of paragraph (d)(6)(i) of this section when initially made;

(2) The CDE's acquisition of control of the entity is due to financial difficulties of the entity that were unforeseen at the time the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this section was made; and

(3) If the acquisition of control occurs before the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section), either --

(i) The entity satisfies the requirements of paragraph (d)(4) of this section by the end of the 12-month period; or

(ii) The CDE sells or causes to be redeemed the entire amount of the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this section and, by the end of the 12-month period, reinvests the amount received in respect of the sale or redemption in a qualified low-income community investment under paragraph (d)(1) of this section. For this purpose, the amount treated as continuously invested in a qualified low-income community investment is determined under paragraphs (d)(2)(i) and (ii) of this section.

(7) Financial counseling and other services. The term financial counseling and other services means advice provided by the CDE relating to the organization or operation of a trade or business.

(8) Special rule for certain loans -- (i) In general. For purposes of paragraphs (d)(1)(i), (ii), and (iv) of this section, a loan is treated as made by a CDE to the extent the CDE purchases the loan from the originator (whether or not the originator is a CDE) within 30 days after the date the originator makes the loan if, at the time the loan is made, there is a legally enforceable written agreement between the originator and the CDE which --

(A) Requires the CDE to approve the making of the loan either directly or by imposing specific written loan underwriting criteria; and

(B) Requires the CDE to purchase the loan within 30 days after the date the loan is made. Commercial Real Estate Panel - Page 134 of 309 Legal UPdates and Financing Trends

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(ii) Example. The application of paragraph (d)(8)(i) of this section is illustrated by the following example:

Example. (i) X is a partnership and a CDE that has received a new markets tax credit allocation from the Secretary. On October 1, 2004, Y enters into a legally enforceable written agreement with W. Y and W are corporations but only Y is a CDE. The agreement between Y and W provides that Y will purchase loans (or portions thereof) from W within 30 days after the date the loan is made by W, and that Y will approve the making of the loans.

(ii) On November 1, 2004, W makes an $ 825,000 loan to Z pursuant to the agreement between Y and W. Z is a qualified active low-income community business under paragraph (d)(4) of this section. On November 15, 2004, Y purchases the loan from W for $ 840,000. On December 31, 2004, X purchases the loan from Y for $ 850,000.

(iii) Under paragraph (d)(8)(i) of this section, the loan to Z is treated as made by Y. Y's loan to Z is a qualified low-income community investment under paragraph (d)(1)(i) of this section. Accordingly, under paragraph (d)(1)(ii)(A) of this section, X's purchase of the loan from Y is a qualified low-income community investment in the amount of $ 850,000.

(9) Targeted populations. For purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] , targeted populations that will be treated as a low-income community are individuals, or an identifiable group of individuals, including an Indian tribe, who are low-income persons as defined in paragraph (d)(9)(i) of this section or who are individuals who otherwise lack adequate access to loans or equity investments as defined in paragraph (d)(9)(ii) of this section.

(i) Low-income persons --(A) Definition --(1) In general. For purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9), an individual shall be considered to be low-income if the individual's family income, adjusted for family size, is not more than--

(i) For metropolitan areas, 80 percent of the area median family income; and

(ii) For non-metropolitan areas, the greater of 80 percent of the area median family income, or 80 percent of the statewide non-metropolitan area median family income.

(2) Area median family income. For purposes of paragraph (d)(9)(i)(A)(1) of this section, area median family income is determined in a manner consistent with the determinations of median family income under section 8 of the Housing Act of 1937, as amended. Taxpayers must use the annual estimates of median family income released by the Department of Housing and Urban Development (HUD) and may rely on those figures until 45 days after HUD releases a new list of income limits, or until HUD's effective date for the new list, whichever is later.

(3) Individual's family income. For purposes of paragraph (d)(9)(i)(A)(1) of this section, an individual's family income is determined using any one of the following three methods for measuring family income:

(i) Household income as measured by the U.S. Census Bureau,

(ii) Adjusted gross income under section 62 [26 USCS § 62] as reported on Internal Revenue Service Form 1040. Adjusted gross income must include the adjusted gross income of any member of the individual's family (as defined in section 267(c)(4) [26 USCS § 267(c)(4)] ) if the family member resides with the individual regardless of whether the family member files a separate return,

(iii) Household income determined under section 8 of the Housing Act of 1937, as amended.

(B) Qualified active low-income community business requirements for low-income targeted populations --(1) In general. An entity will not be treated as a qualified active low-income community business for low-income targeted populations unless--

(i) Except as provided in paragraph (d)(9)(i)(D)(2) of this section, at least 50 percent of the entity's total gross Commercial Real Estate Panel - Page 135 of 309 Legal UPdates and Financing Trends

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income for any taxable year is derived from sales, rentals, services, or other transactions with individuals who are low-income persons for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9);

(ii) At least 40 percent of the entity's employees are individuals who are low-income persons for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9); or

(iii) At least 50 percent of the entity is owned by individuals who are low-income persons for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9).

(2) Employee. The determination of whether an employee is a low-income person must be made at the time the employee is hired. If the employee is a low-income person at the time of hire, that employee is considered a low-income person for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9) throughout the time of employment, without regard to any increase in the employee's income after the time of hire.

(3) Owner. The determination of whether an owner is a low-income person must be made at the time the qualified low-income community investment is made, or at the time the ownership interest is acquired by the owner, whichever is later. If an owner is a low-income person at the time the qualified low-income community investment is made or at the time the ownership interest is acquired by the owner, whichever is later, that owner is considered a low-income person for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9) throughout the time the ownership interest is held by that owner.

(4) Derived from. For purposes of paragraph (d)(9)(i)(B)(1)(i) of this section, the term derived from includes gross income derived from:

(i) Payments made directly by low-income persons to the entity; and

(ii) Money and the fair market value of property or services provided to the entity primarily for the benefit of low-income persons, but only if the persons providing the money, property, or services do not receive a direct benefit from the entity (for this purpose, a contribution that benefits the general public is not a direct benefit).

(5) Fair market value of sales, rentals, services, or other transactions. For purposes of paragraph (d)(9)(i)(B)(1)(i) of this section, an entity with gross income that is derived from sales, rentals, services, or other transactions with both non low-income persons and low-income persons may treat the gross income derived from the sales, rentals, services, or other transactions with low-income persons as including the full fair market value even if the low-income persons do not pay fair market value.

(C) 120-percent-income restriction --(1) In general --(i) In no case will an entity be treated as a qualified active low-income community business under paragraph (d)(9)(i) of this section if the entity is located in a population census tract for which the median family income exceeds 120 percent of, in the case of a tract not located within a metropolitan area, the statewide median family income, or in the case of a tract located within a metropolitan area, the greater of statewide median family income or metropolitan area median family income (120-percent-income restriction).

(ii) The 120-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is not located in a metropolitan area.

(iii) The 120-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is located in a metropolitan area and more than 75 percent of the tract is zoned for commercial or industrial use. For this purpose, the 75 percent calculation should be made using the area of the population census tract. For purposes of this paragraph (d)(9)(i)(C)(1)(iii), property for which commercial or industrial use is a permissible zoning use will be treated as zoned for commercial or industrial use.

(2) Population census tract location --(i) For purposes of the 120-percent-income restriction, an entity will be Commercial Real Estate Panel - Page 136 of 309 Legal UPdates and Financing Trends

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considered to be located in a population census tract for which the median family income exceeds 120 percent of the applicable median family income under paragraph (d)(9)(i)(C)(1)(i) of this section (non-qualifying population census tract) if at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more non-qualifying population census tracts (non-qualifying gross income amount); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts (non-qualifying tangible property usage); and at least 40 percent of the services performed for the entity by its employees are performed in one or more non-qualifying population census tracts (non-qualifying services performance).

(ii) The entity is considered to have the non-qualifying gross income amount if the entity has non-qualifying tangible property usage or non-qualifying services performance of at least 50 percent instead of 40 percent.

(iii) If the entity has no employees, the entity is considered to have the non-qualifying gross income amount and non-qualifying services performance if at least 85 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts.

(D) Rental of real property for low-income targeted populations --(1) In general. An entity that rents to others real property for low-income targeted populations and that otherwise satisfies the requirements to be a qualified business under paragraph (d)(5) of this section will be treated as located in a low-income community for purposes of paragraph (d)(5)(ii) of this section if at least 50 percent of the entity's total gross income is derived from rentals to individuals who are low-income persons for purposes of section 45D(e)(2) [26 USCS § 45D(e)(2)] and this paragraph (d)(9) or rentals to a qualified active low-income community business that meets the requirements for low-income targeted populations under paragraphs (d)(9)(i)(B)(1)(i) or (ii) and (d)(9)(i)(B)(2) of this section.

(2) Special rule for entities whose sole business is the rental to others of real property. If an entity's sole business is the rental to others of real property under paragraph (d)(9)(i)(D)(1) of this section, then the gross income requirement in paragraph (d)(9)(i)(B)(1)(i) of this section will be considered satisfied if the entity is treated as being located in a low-income community under paragraph (d)(9)(i)(D)(1) of this section.

(ii) Individuals who otherwise lack adequate access to loans or equity investments --(A) In general. Paragraph (d)(9)(ii) of this section may be applied only with regard to qualified low-income community investments made under the increase in the new markets tax credit limitation pursuant to section 1400N(m)(2) [26 USCS § 1400N(m)(2)]. Therefore, only CDEs with a significant mission of recovery and redevelopment of the Gulf Opportunity Zone (GO Zone) that receive an allocation from the increase described in section 1400N(m)(2) [26 USCS § 1400N(m)(2)] may make qualified low-income community investments from that allocation pursuant to the rules in paragraph (d)(9)(ii) of this section.

(B) GO Zone Targeted Population. For purposes of the targeted populations rules under section 45D(e)(2) [26 USCS § 45D(e)(2)], an individual otherwise lacks adequate access to loans or equity investments only if the individual was displaced from his or her principal residence as a result of Hurricane Katrina or the individual lost his or her principal source of employment as a result of Hurricane Katrina (GO Zone Targeted Population). In order to meet this definition, the individual's principal residence or principal source of employment, as applicable, must have been located in a population census tract within the GO Zone that contains one or more areas designated by the Federal Emergency Management Agency (FEMA) as flooded, having sustained extensive damage, or having sustained catastrophic damage as a result of Hurricane Katrina.

(C) Qualified active low-income community business requirements for the GO Zone Targeted Population --(1) In general. An entity will not be treated as a qualified active low-income community business for the GO Zone Targeted Population unless--

(i) At least 50 percent of the entity's total gross income for any taxable year is derived from sales, rentals, services, Commercial Real Estate Panel - Page 137 of 309 Legal UPdates and Financing Trends

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or other transactions with the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof;

(ii) At least 40 percent of the entity's employees consist of the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof; or

(iii) At least 50 percent of the entity is owned by the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof.

(2) Location --(i) In general. In order to be a qualified active low-income community business under paragraph (d)(9)(ii)(C) of this section, the entity must be located in a population census tract within the GO Zone that contains one or more areas designated by FEMA as flooded, having sustained extensive damage, or having sustained catastrophic damage as a result of Hurricane Katrina (qualifying population census tract).

(ii) Determination --For purposes of the preceding paragraph, an entity will be considered to be located in a qualifying population census tract if at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more qualifying population census tracts (gross income requirement); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more qualifying population census tracts (use of tangible property requirement); and at least 40 percent of the services performed for the entity by its employees are performed in one or more qualifying population census tracts (services performed requirement). The entity is deemed to satisfy the gross income requirement if the entity satisfies the use of tangible property requirement or the services performed requirement on the basis of at least 50 percent instead of 40 percent. If the entity has no employees, the entity is deemed to satisfy the services performed requirement and the gross income requirement if at least 85 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more qualifying population census tracts.

(D) 200-percent-income restriction --(1) In general --(i) In no case will an entity be treated as a qualified active low-income community business under paragraph (d)(9)(ii) of this section if the entity is located in a population census tract for which the median family income exceeds 200 percent of, in the case of a tract not located within a metropolitan area, the statewide median family income, or, in the case of a tract located within a metropolitan area, the greater of statewide median family income or metropolitan area median family income (200-percent-income restriction).

(ii) The 200-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is not located in a metropolitan area.

(iii) The 200-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is located in a metropolitan area and more than 75 percent of the tract is zoned for commercial or industrial use. For this purpose, the 75 percent calculation should be made using the area of the population census tract. For purposes of this paragraph (d)(9)(ii)(D)(1)(iii), property for which commercial or industrial use is a permissible zoning use will be treated as zoned for commercial or industrial use.

(2) Population census tract location --(i) For purposes of the 200-percent-income restriction, an entity will be considered to be located in a population census tract for which the median family income exceeds 200 percent of the applicable median family income under paragraph (d)(9)(ii)(D)(1)(i) of this section (non-qualifying population census tract) if--at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more non-qualifying population census tracts (non-qualifying gross income amount); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts (non-qualifying tangible property usage); and at least 40 percent of the services performed for the entity by its employees are performed in one or more non-qualifying population census tracts (non-qualifying services performance).

(ii) The entity is considered to have the non-qualifying gross income amount if the entity has non-qualifying Commercial Real Estate Panel - Page 138 of 309 Legal UPdates and Financing Trends

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tangible property usage or non-qualifying services performance of at least 50 percent instead of 40 percent.

(E) Rental of real property for the GO Zone Targeted Population. The rental to others of real property for the GO Zone Targeted Population that otherwise satisfies the requirements to be a qualified business under paragraph (d)(5) of this section will be treated as located in a low-income community for purposes of paragraph (d)(5)(ii) of this section if at least 50 percent of the entity's total gross income is derived from rentals to the GO Zone Targeted Population, rentals to low-income persons as defined in paragraph (d)(9)(i) of this section, or rentals to a qualified active low-income community business that meets the requirements for the GO Zone Targeted Population under paragraph (d)(9)(ii)(C)(1)(i) or (ii) of this section.

(10) Non-real estate qualified active low-income community business --(i) Definition. The term non-real estate qualified active low-income community business means any qualified active low-income community business (as defined in paragraph (d)(4) of this section) whose predominant business activity does not include the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate. For purposes of the preceding sentence, predominant business activity means a business activity that generates more than 50 percent of the business' gross income. The purpose of the capital or equity investment in, or loan to, the non-real estate qualified active low-income community business must not be connected to the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate.

(ii) Payments of, or for, capital, equity or principal with respect to a non-real estate qualified active low-income community business --(A) In general. For purposes of paragraph (d)(2)(i) of this section, a portion of the amounts received by a CDE in payment of, or for, capital, equity, or principal with respect to a non-real estate qualified active low-income community business after year one of the 7-year credit period (as defined by paragraph (c)(5)(i) of this section) may be reinvested by the CDE in a qualifying entity (as defined in paragraph (d)(10)(ii)(D)). Any portion that the CDE chooses to reinvest in a qualifying entity must be reinvested by the CDE no later than 30 days from the date of receipt to be treated as continuously invested in a qualified low-income community investment for purposes of paragraph (d)(2)(i) of this section. If the amount reinvested in a qualifying entity exceeds the maximum aggregate portion of the non-real estate qualified equity investment, then the excess will not be treated as invested in a qualified low-income community investment. The maximum aggregate portion of the non-real estate qualified equity investment that may be reinvested into a qualifying entity, which will be treated as continuously invested in a qualified low-income community investment, may not exceed the following percentages of the non-real estate qualified equity investment in the following years:

(1) 15 percent in Year 2 of the 7-year credit period.

(2) 30 percent in Year 3 of the 7-year credit period.

(3) 50 percent in Year 4 of the 7-year credit period.

(4) 85 percent in Year 5 and Year 6 of the 7-year credit period.

(B) Seventh year of the 7-year credit period. Amounts received by a CDE in payment of, or for, capital, equity, or principal with respect to a non-real estate qualified active low-income community business (as defined in paragraph (d)(10)(i) of this section) during the seventh year of the 7-year credit period do not have to be reinvested by the CDE in a qualified low-income community investment to be treated as continuously invested in a qualified low-income community investment. Commercial Real Estate Panel - Page 139 of 309 Legal UPdates and Financing Trends

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(C) Amounts received from qualifying entity. Except for the seventh year of the 7-year credit period under paragraph (d)(10)(ii)(B) of this section, amounts received from a qualifying entity must be reinvested by the CDE no later than 30 days from the date of receipt to be treated as continuously invested in a qualified low-income community investment.

(D) Definition of qualifying entity. For purposes of paragraphs (d)(10)(ii) and (d)(10)(iii) of this section, a qualifying entity is--

(1) A certified community development financial institution (certified CDFI) that is a CDE under section 45D(c)(2)(B) [26 USCS § 45D] (as defined by 12 CFR 1805.201), which is unrelated to the CDE making the investment in the certified CDFI within the meaning of section 267(b) [26 USCS §267(b)] or section 707(b)(1) [26 USCS § 707(b)(1)]; or

(2) An entity designated by the Secretary by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter).

(e) Recapture -- (1) In general. If, at any time during the 7-year period beginning on the date of the original issue of a qualified equity investment in a CDE, there is a recapture event under paragraph (e)(2) of this section with respect to such investment, then the tax imposed by Chapter 1 of the Internal Revenue Code for the taxable year in which the recapture event occurs is increased by the credit recapture amount under section 45D(g)(2) [26 USCS § 45D(g)(2)]. A recapture event under paragraph (e)(2) of this section requires recapture of credits allowed to the taxpayer who purchased the equity investment from the CDE at its original issue and to all subsequent holders of that investment.

(2) Recapture event. There is a recapture event with respect to an equity investment in a CDE if --

(i) The entity ceases to be a CDE;

(ii) The proceeds of the investment cease to be used in a manner that satisfies the substantially-all requirement of paragraph (c)(1)(ii) of this section; or

(iii) The investment is redeemed or otherwise cashed out by the CDE.

(3) Redemption -- (i) Equity investment in a C corporation. For purposes of paragraph (e)(2)(iii) of this section, an equity investment in a CDE that is treated as a C corporation for Federal tax purposes is redeemed when section 302(a) [26 USCS § 302(a)] applies to amounts received by the equity holder. An equity investment is treated as cashed out when section 301(c)(2) [26 USCS § 301(c)(2)] or section 301(c)(3) [26 USCS § 301(c)(3)] applies to amounts received by the equity holder. An equity investment is not treated as cashed out when only section 301(c)(1) [26 USCS § 301(c)(1)] applies to amounts received by the equity holder.

(ii) Equity investment in an S corporation. For purposes of paragraph (e)(2)(iii) of this section, an equity investment in a CDE that is an S corporation is redeemed when section 302(a) [26 USCS § 302(a)] applies to amounts received by the equity holder. An equity investment in an S corporation is treated as cashed out when a distribution to a shareholder described in section 1368(a) [26 USCS § 1368(a)] exceeds the accumulated adjustments account determined under § 1.1368-2 and any accumulated earnings and profits of the S corporation.

(iii) Capital interest in a partnership. In the case of an equity investment that is a capital interest in a CDE that is a partnership for Federal tax purposes, a pro rata cash distribution by the CDE to its partners based on each partner's capital interest in the CDE during the taxable year will not be treated as a redemption for purposes of paragraph (e)(2)(iii) of this section if the distribution does not exceed the CDE's operating income for the taxable year. In addition, a non-pro rata de minimis cash distribution by a CDE to a partner or partners during the taxable year will not be treated as a redemption. A non-pro rata de minimis cash distribution may not exceed the lesser of 5 percent of the CDE's operating income for that taxable year or 10 percent of the partner's capital interest in the CDE. For purposes of this Commercial Real Estate Panel - Page 140 of 309 Legal UPdates and Financing Trends

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paragraph (e)(3)(iii), with respect to any taxable year, operating income is the sum of:

(A) The CDE's taxable income as determined under section 703 [26 USCS § 703], except that --

(1) The items described in section 703(a)(1) [26 USCS § 703(a)(1)] shall be aggregated with the non-separately stated tax items of the partnership; and

(2) Any gain resulting from the sale of a capital asset under section 1221(a) [26 USCS § 1221(a)] or section 1231 [26 USCS § 1231] property shall not be included in taxable income;

(B) Deductions under section 165, [26 USCS § 165] but only to the extent the losses were realized from qualified low-income community investments under paragraph (d)(1) of this section;

(C) Deductions under sections 167 and 168 [26 USCS §§ 167 and 168], including the additional first-year depreciation under section 168(k) [26 USCS § 168(k)];

(D) Start-up expenditures amortized under section 195 [26 USCS § 195]; and

(E) Organizational expenses amortized under section 709 [26 USCS § 709].

(4) Bankruptcy. Bankruptcy of a CDE is not a recapture event.

(5) Waiver of requirement or extension of time -- (i) In general. The Commissioner may waive a requirement or extend a deadline if such waiver or extension does not materially frustrate the purposes of section 45D [26 USCS § 45D] and this section.

(ii) Manner for requesting a waiver or extension. A CDE that believes it has good cause for a waiver or an extension may request relief from the Commissioner in a ruling request. The request should set forth all the relevant facts and include a detailed explanation describing the event or events relating to the request for a waiver or an extension. For further information on the application procedure for a ruling, see Rev. Proc. 2005-1 (2005-1 I.R.B. 1) or its successor revenue procedure (see § 601.601(d)(2) of this chapter).

(iii) Terms and conditions. The granting of a waiver or an extension to a CDE under this section may require adjustments of the CDE's requirements under section 45D [26 USCS § 45D] and this section as may be appropriate.

(6) Cure period. If a qualified equity investment fails the substantially-all requirement under paragraph (c)(5)(i) of this section, the failure is not a recapture event under paragraph (e)(2)(ii) of this section if the CDE corrects the failure within 6 months after the date the CDE becomes aware (or reasonably should have become aware) of the failure. Only one correction is permitted for each qualified equity investment during the 7-year credit period under this paragraph (e)(6).

(7) Example. The application of this paragraph (e) is illustrated by the following example:

Example. In 2003, A and B acquire separate qualified equity investments in X, a partnership. X is a CDE that has received a new markets tax credit allocation from the Secretary. X uses the proceeds of A's qualified equity investment to make a qualified low-income community investment in Y, and X uses the proceeds of B's qualified equity investment to make a qualified low-income community investment in Z. Y and Z are not CDEs. X controls both Y and Z within the meaning of paragraph (d)(6)(ii)(B) of this section. In 2003, Y and Z are qualified active low-income community businesses. In 2007, Y, but not Z, is a qualified active low-income community business and X does not satisfy the substantially-all requirement using the safe harbor calculation under paragraph (c)(5)(iii) of this section. A's equity investment satisfies the substantially-all requirement of paragraph (c)(1)(ii) of this section using the direct-tracing calculation of paragraph (c)(5)(ii) of this section because A's equity investment is traceable to Y. However, B's equity investment fails the substantially-all requirement using the direct-tracing calculation because B's equity investment is Commercial Real Estate Panel - Page 141 of 309 Legal UPdates and Financing Trends

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traceable to Z. Therefore, under paragraph (e)(2)(ii) of this section, there is a recapture event for B's equity investment (but not A's equity investment).

(f) Basis reduction -- (1) In general. A taxpayer's basis in a qualified equity investment is reduced by the amount of any new markets tax credit determined under paragraph (b)(1) of this section with respect to the investment. A basis reduction occurs on each credit allowance date under paragraph (b)(2) of this section. This paragraph (f) does not apply for purposes of sections 1202, 1400B, and 1400F [26 USCS §§ 1202, 1400B, and 1400F].

(2) Adjustment in basis of interest in partnership or S corporation. The adjusted basis of either a partner's interest in a partnership, or stock in an S corporation, must be appropriately adjusted to take into account adjustments made under paragraph (f)(1) of this section in the basis of a qualified equity investment held by the partnership or S corporation (as the case may be).

(g) Other rules -- (1) Anti-abuse. If a principal purpose of a transaction or a series of transactions is to achieve a result that is inconsistent with the purposes of section 45D [26 USCS § 45D] and this section, the Commissioner may treat the transaction or series of transactions as causing a recapture event under paragraph (e)(2) of this section.

(2) Reporting requirements -- (i) Notification by CDE to taxpayer -- (A) Allowance of new markets tax credit. A CDE must provide notice to any taxpayer who acquires a qualified equity investment in the CDE at its original issue that the equity investment is a qualified equity investment entitling the taxpayer to claim the new markets tax credit. The notice must be provided by the CDE to the taxpayer no later than 60 days after the date the taxpayer makes the investment in the CDE. The notice must contain the amount paid to the CDE for the qualified equity investment at its original issue and the taxpayer identification number of the CDE.

(B) Recapture event. If, at any time during the 7-year period beginning on the date of the original issue of a qualified equity investment in a CDE, there is a recapture event under paragraph (e)(2) of this section with respect to such investment, the CDE must provide notice to each holder, including all prior holders, of the investment that a recapture event has occurred. The notice must be provided by the CDE no later than 60 days after the date the CDE becomes aware of the recapture event.

(ii) CDE reporting requirements to Secretary. Each CDE must comply with such reporting requirements to the Secretary as the Secretary may prescribe.

(iii) Manner of claiming new markets tax credit. A taxpayer may claim the new markets tax credit for each applicable taxable year by completing Form 8874, "New Markets Credit," and by filing Form 8874 with the taxpayer's Federal income tax return.

(iv) Reporting recapture tax. If there is a recapture event with respect to a taxpayer's equity investment in a CDE, the taxpayer must include the credit recapture amount under section 45D(g)(2) [26 USCS § 45D(g)(2)] on the line for recapture taxes on the taxpayer's Federal income tax return for the taxable year in which the recapture event under paragraph (e)(2) of this section occurs (or on the line for total tax, if there is no such line for recapture taxes) and write NMCR (new markets credit recapture) next to the entry space.

(3) Other Federal tax benefits -- (i) In general. Except as provided in paragraph (g)(3)(ii) of this section, the availability of Federal tax benefits does not limit the availability of the new markets tax credit. Federal tax benefits that do not limit the availability of the new markets tax credit include, for example:

(A) The rehabilitation credit under section 47 [26 USCS § 47];

(B) All deductions under sections 167 and 168 [26 USCS §§ 167 and 168], including the additional first-year depreciation under section 168(k) [26 USCS § 168(k)], and the expense deduction for certain depreciable property under section 179 [26 USCS § 179]; and Commercial Real Estate Panel - Page 142 of 309 Legal UPdates and Financing Trends

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(C) All tax benefits relating to certain designated areas such as empowerment zones and enterprise communities under sections 1391 through 1397D [26 USCS §§ 1391 -- 1397D], the District of Columbia Enterprise Zone under sections 1400 through 1400B [26 USCS §§ 1400 -- 1400B], renewal communities under sections 1400E through 1400J [26 USCS §§ 1400E --1400J], and the New York Liberty Zone under section 1400L [26 USCS § 1400L].

(ii) Low-income housing credit. If a CDE makes a capital or equity investment or a loan with respect to a qualified low-income building under section 42 [26 USCS § 42], the investment or loan is not a qualified low-income community investment under paragraph (d)(1) of this section to the extent the building's eligible basis under section 42(d) [26 USCS § 42(d)] is financed by the proceeds of the investment or loan.

(4) Bankruptcy of CDE. The bankruptcy of a CDE does not preclude a taxpayer from continuing to claim the new markets tax credit on the remaining credit allowance dates under paragraph (b)(2) of this section.

(h) Effective/applicability dates. (1) In general. Except as provided in paragraphs (h)(2), (h)(3), and (h)(4) of this section, this section applies on or after December 22, 2004, and may be applied by taxpayers before December 22, 2004. The provisions that apply before December 22, 2004, are contained in § 1.45D-1T (see 26 CFR part 1 revised as of April 1, 2003, and April 1, 2004).

(2) Exception. Paragraph (d)(5)(ii) of this section as it relates to the restriction on lessees described in paragraph (d)(5)(iii)(B) of this section applies to qualified low-income community investments made on or after June 22, 2005.

(3) Targeted populations. The rules in paragraph (d)(9) of this section and the last sentence in paragraph (d)(4)(iv)(A) of this section apply to taxable years ending on or after December 5, 2011. A taxpayer may apply the rules in paragraph (d)(9) of this section to taxable years ending before December 5, 2011 for designations made by the Secretary after October 22, 2004.

(4) Investments in non-real estate businesses. Paragraphs (c)(8) and (d)(10) of this section apply to equity investments in CDEs made on or after September 28, 2012.

HISTORY: [Treas. Dec. 9171, 69 FR 77625, 77627, Dec. 28, 2004; Treas. Dec. 9171, 70 FR 4012, Jan. 28, 2005; 76 FR 75774, 75778, Dec. 5, 2011, Treas. Dec. 9560; 77 FR 59544, 59546, Sept. 28, 2012, Treas. Dec. 9600]

AUTHORITY: AUTHORITY NOTE APPLICABLE TO ENTIRE PART: 26 U.S.C. 7805.

NOTES: Section 1.45D-1 also issued under 26 U.S.C. 45D(i) Section 1.45D-1 also issued under 26 U.S.C. 45D(e)(2) and (i). [EFFECTIVE DATE NOTE: 76 FR 75774, 75778, Dec. 5, 2011, amended this section, effective Dec. 5, 2011; 77 FR 59544, 59546, Sept. 28, 2012, amended this section, effective Sept. 28, 2012.]

NOTES APPLICABLE TO ENTIRE CHAPTER: EDITORIAL NOTE: IRS published a document at 45 FR 6088, Jan. 25, 1980, deleting statutory sections from their regulations. In Chapter I, cross references to the deleted material have been changed to the corresponding sections of the IRS Code of 1954 or to the appropriate regulations sections. When either such change produced a redundancy, the cross reference has been deleted. For further explanation, see 45 FR 20795, March 31, 1980. [The OMB control numbers for title 26 appear in §§ 601.9000 and 602.101 of this chapter.]

NOTES APPLICABLE TO ENTIRE SUBCHAPTER: Supplementary Publications: Internal Revenue Service Looseleaf Regulations System, Alcohol and Tobacco Tax Commercial Real Estate Panel - Page 143 of 309 Legal UPdates and Financing Trends

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Regulations, and Regulations Under Tax Conventions. EDITORIAL NOTE: Treasury Decision 6091, 19 FR 5167, Aug. 17, 1954, provides in part as follows: PARAGRAPH 1. All regulations (including all Treasury decisions) prescribed by, or under authority duly delegated by, the Secretary of the Treasury, or jointly by the Secretary and the Commissioner of Internal Revenue, or by the Commissioner of Internal Revenue with the approval of the Secretary of the Treasury, or jointly by the Commissioner of Internal Revenue and the Commissioner of Customs or the Commissioner of Narcotics with the approval of the Secretary of the Treasury, applicable under any provision of law in effect on the date of enactment of the Code, to the extent such provision of law is repealed by the Code, are hereby prescribed under and made applicable to the provisions of the Code corresponding to the provision of law so repealed insofar as any such regulation is not inconsistent with the Code. Such regulations shall become effective as regulations under the various provisions of the Code as of the dates the corresponding provisions of law are repealed by the Code, until superseded by regulations issued under the Code. PAR. 2. With respect to any provision of the Code which depends for its application upon the promulgation of regulations or which is to be applied in such manner as may be prescribed by regulations, all instructions or rules in effect immediately prior to the enactment of the Code, to the extent such instructions or rules could be prescribed as regulations under authority of such provision of the Code, shall be applied as regulations under such provision insofar as such instructions or rules are not inconsistent with the Code. Such instructions or rules shall be applied as regulations under the applicable provision of the Code as of the date such provision takes effect. PAR. 3. If any election made or other act done pursuant to any provision of the Internal Revenue Code of 1939 or prior internal revenue laws would (except for the enactment of the Code ) be effective for any period subsequent to such enactment, and if corresponding provisions are contained in the Code, such election or other act shall be given the same effect under the corresponding provisions of the Code to the extent not inconsistent therewith. The term "act" includes, but is not limited to, an allocation, identification, declaration, agreement, option, waiver, relinquishment, or renunciation. PAR. 4. The limits of the various internal revenue districts have not been changed by the enactment of the Code. Furthermore, delegations of authority made pursuant to the provisions of Reorganization Plan No. 26 of 1950 and Reorganization Plan No. 1 of 1952 (as well as redelegation thereunder), including those governing the authority of the Commissioner of Internal Revenue, the Regional Commissioners of Internal Revenue, or the District Directors of Internal Revenue, are applicable to the provisions of the Code to the extent consistent therewith. Commercial Real Estate Panel - Page 144 of 309 Legal UPdates and Financing Trends

Page 1

1 of 1 DOCUMENT

*** Current through PL 113-185, approved 10/6/14 ***

INTERNAL REVENUE CODE SUBTITLE A. INCOME TAXES CHAPTER 1. NORMAL TAXES AND SURTAXES SUBCHAPTER A. DETERMINATION OF TAX LIABILITY PART IV. CREDITS AGAINST TAX SUBPART D. BUSINESS RELATED CREDITS

IRC Sec. 45D

§ 45D. New markets tax credit

(a) Allowance of credit. (1) In general. For purposes of section 38 [IRC Sec. 38], in the case of a taxpayer who holds a qualified equity investment on a credit allowance date of such investment which occurs during the taxable year, the new markets tax credit determined under this section for such taxable year is an amount equal to the applicable percentage of the amount paid to the qualified community development entity for such investment at its original issue. (2) Applicable percentage. For purposes of paragraph (1), the applicable percentage is-- (A) 5 percent with respect to the first 3 credit allowance dates, and (B) 6 percent with respect to the remainder of the credit allowance dates. (3) Credit allowance date. For purposes of paragraph (1), the term "credit allowance date" means, with respect to any qualified equity investment-- (A) the date on which such investment is initially made, and (B) each of the 6 anniversary dates of such date thereafter.

(b) Qualified equity investment. For purposes of this section-- (1) In general. The term "qualified equity investment" means any equity investment in a qualified community development entity if-- (A) such investment is acquired by the taxpayer at its original issue (directly or through an underwriter) solely in exchange for cash, (B) substantially all of such cash is used by the qualified community development entity to make qualified low-income community investments, and (C) such investment is designated for purposes of this section by the qualified community development entity. Such term shall not include any equity investment issued by a qualified community development entity more than 5 years after the date that such entity receives an allocation under subsection (f). Any allocation not used within such Commercial Real Estate Panel - Page 145 of 309 Legal UPdates and Financing Trends

Page 2 IRC Sec. 45D

5-year period may be reallocated by the Secretary under subsection (f). (2) Limitation. The maximum amount of equity investments issued by a qualified community development entity which may be designated under paragraph (1)(C) by such entity shall not exceed the portion of the limitation amount allocated under subsection (f) to such entity. (3) Safe harbor for determining use of cash. The requirement of paragraph (1)(B) shall be treated as met if at least 85 percent of the aggregate gross assets of the qualified community development entity are invested in qualified low-income community investments. (4) Treatment of subsequent purchasers. The term "qualified equity investment" includes any equity investment which would (but for paragraph (1)(A)) be a qualified equity investment in the hands of the taxpayer if such investment was a qualified equity investment in the hands of a prior holder. (5) Redemptions. A rule similar to the rule of section 1202(c)(3) [IRC Sec. 1202(c)(3)] shall apply for purposes of this subsection. (6) Equity investment. The term "equity investment" means-- (A) any stock (other than nonqualified preferred stock as defined in section 351(g)(2) [IRC Sec. 351(g)(2)]) in an entity which is a corporation, and (B) any capital interest in an entity which is a partnership.

(c) Qualified community development entity. For purposes of this section-- (1) In general. The term "qualified community development entity" means any domestic corporation or partnership if-- (A) the primary mission of the entity is serving, or providing investment capital for, low-income communities or low-income persons, (B) the entity maintains accountability to residents of low-income communities through their representation on any governing board of the entity or on any advisory board to the entity, and (C) the entity is certified by the Secretary for purposes of this section as being a qualified community development entity. (2) Special rules for certain organizations. The requirements of paragraph (1) shall be treated as met by-- (A) any specialized small business investment company (as defined in section 1044(c)(3) [IRC Sec. 1044(c)(3)]), and (B) any community development financial institution (as defined in section 103 of the Community Development Banking and Financial Institutions Act of 1994 (12 U.S.C. 4702)).

(d) Qualified low-income community investments. For purposes of this section-- (1) In general. The term "qualified low-income community investment" means-- (A) any capital or equity investment in, or loan to, any qualified active low-income community business, (B) the purchase from another qualified community development entity of any loan made by such entity which is a qualified low-income community investment, (C) financial counseling and other services specified in regulations prescribed by the Secretary to businesses located in, and residents of, low-income communities, and (D) any equity investment in, or loan to, any qualified community development entity. (2) Qualified active low-income community business. (A) In general. For purposes of paragraph (1), the term "qualified active low-income community business" means, with respect to any taxable year, any corporation (including a nonprofit corporation) or partnership if for such year-- (i) at least 50 percent of the total gross income of such entity is derived from the active conduct of a qualified business within any low-income community, (ii) a substantial portion of the use of the tangible property of such entity (whether owned or leased) is within any low-income community, (iii) a substantial portion of the services performed for such entity by its employees are performed in any low-income community, (iv) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is Commercial Real Estate Panel - Page 146 of 309 Legal UPdates and Financing Trends

Page 3 IRC Sec. 45D

attributable to collectibles (as defined in section 408(m)(2) [IRC Sec. 408(m)(2)]) other than collectibles that are held primarily for sale to customers in the ordinary course of such business, and (v) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property (as defined in section 1397C(e) [IRC Sec. 1397C(e)]). (B) Proprietorship. Such term shall include any business carried on by an individual as a proprietor if such business would meet the requirements of subparagraph (A) were it incorporated. (C) Portions of business may be qualified active low-income community business. The term "qualified active low-income community business" includes any trades or businesses which would qualify as a qualified active low-income community business if such trades or businesses were separately incorporated. (3) Qualified business. For purposes of this subsection, the term "qualified business" has the meaning given to such term by section 1397C(d) [IRC Sec. 1397C(d)]; except that-- (A) in lieu of applying paragraph (2)(B) thereof, the rental to others of real property located in any low-income community shall be treated as a qualified business if there are substantial improvements located on such property, and (B) paragraph (3) thereof shall not apply.

(e) Low-income community. For purposes of this section-- (1) In general. The term "low-income community" means any population census tract if-- (A) the poverty rate for such tract is at least 20 percent, or (B) (i) in the case of a tract not located within a metropolitan area, the median family income for such tract does not exceed 80 percent of statewide median family income, or (ii) in the case of a tract located within a metropolitan area, the median family income for such tract does not exceed 80 percent of the greater of statewide median family income or the metropolitan area median family income. Subparagraph (B) shall be applied using possessionwide median family income in the case of census tracts located within a possession of the United States. (2) Targeted populations. The Secretary shall prescribe regulations under which 1 or more targeted populations (within the meaning of section 103(20) [IRC Sec. 103(20)] of the Riegle Community Development and Regulatory Improvement Act of 1994 (12 U.S.C. 4702(20))) may be treated as low-income communities. Such regulations shall include procedures for determining which entities are qualified active low-income community businesses with respect to such populations. (3) Areas not within census tracts. In the case of an area which is not tracted for population census tracts, the equivalent county divisions (as defined by the Bureau of the Census for purposes of defining poverty areas) shall be used for purposes of determining poverty rates and median family income. (4) Tracts with low population. A population census tract with a population of less than 2,000 shall be treated as a low-income community for purposes of this section if such tract-- (A) is within an empowerment zone the designation of which is in effect under section 1391 [IRC Sec. 1391], and (B) is contiguous to 1 or more low-income communities (determined without regard to this paragraph). (5) Modification of income requirement for census tracts within high migration rural counties. (A) In general. In the case of a population census tract located within a high migration rural county, paragraph (1)(B)(i) shall be applied by substituting "85 percent" for "80 percent". (B) High migration rural county. For purposes of this paragraph, the term "high migration rural county" means any county which, during the 20-year period ending with the year in which the most recent census was conducted, has a net out-migration of inhabitants from the county of at least 10 percent of the population of the county at the beginning of such period.

(f) National limitation on amount of investments designated. (1) In general. There is a new markets tax credit limitation for each calendar year. Such limitation is-- (A) $ 1,000,000,000 for 2001, (B) $ 1,500,000,000 for 2002 and 2003, (C) $ 2,000,000,000 for 2004 and 2005, (D) $ 3,500,000,000 for 2006, and 2007, Commercial Real Estate Panel - Page 147 of 309 Legal UPdates and Financing Trends

Page 4 IRC Sec. 45D

(E) $ 5,000,000,000 for 2008, (F) $ 5,000,000,000 for 2009 [, and] (G) $ 3,500,000,000 for 2010, 2011, 2012, and 2013. (2) Allocation of limitation. The limitation under paragraph (1) shall be allocated by the Secretary among qualified community development entities selected by the Secretary. In making allocations under the preceding sentence, the Secretary shall give priority to any entity-- (A) with a record of having successfully provided capital or technical assistance to disadvantaged businesses or communities, or (B) which intends to satisfy the requirement under subsection (b)(1)(B) by making qualified low-income community investments in 1 or more businesses in which persons unrelated to such entity (within the meaning of section 267(b) or 707(b)(1) [IRC Sec. 267(b) or 707(b)(1)]) hold the majority equity interest. (3) Carryover of unused limitation. If the new markets tax credit limitation for any calendar year exceeds the aggregate amount allocated under paragraph (2) for such year, such limitation for the succeeding calendar year shall be increased by the amount of such excess. No amount may be carried under the preceding sentence to any calendar year after 2018.

(g) Recapture of credit in certain cases. (1) In general. If, at any time during the 7-year period beginning on the date of the original issue of a qualified equity investment in a qualified community development entity, there is a recapture event with respect to such investment, then the tax imposed by this chapter [IRC Sections 1 et seq.] for the taxable year in which such event occurs shall be increased by the credit recapture amount. (2) Credit recapture amount. For purposes of paragraph (1), the credit recapture amount is an amount equal to the sum of-- (A) the aggregate decrease in the credits allowed to the taxpayer under section 38 [IRC Sec. 38] for all prior taxable years which would have resulted if no credit had been determined under this section with respect to such investment, plus (B) interest at the underpayment rate established under section 6621 [IRC Sec. 6621] on the amount determined under subparagraph (A) for each prior taxable year for the period beginning on the due date for filing the return for the prior taxable year involved. No deduction shall be allowed under this chapter [IRC Sections 1 et seq.] for interest described in subparagraph (B). (3) Recapture event. For purposes of paragraph (1), there is a recapture event with respect to an equity investment in a qualified community development entity if-- (A) such entity ceases to be a qualified community development entity, (B) the proceeds of the investment cease to be used as required of subsection (b)(1)(B), or (C) such investment is redeemed by such entity. (4) Special rules. (A) Tax benefit rule. The tax for the taxable year shall be increased under paragraph (1) only with respect to credits allowed by reason of this section which were used to reduce tax liability. In the case of credits not so used to reduce tax liability, the carryforwards and carrybacks under section 39 [IRC Sec. 39] shall be appropriately adjusted. (B) No credits against tax. Any increase in tax under this subsection shall not be treated as a tax imposed by this chapter [IRC Sections 1 et seq.] for purposes of determining the amount of any credit under this chapter [IRC Sections 1 et seq.] or for purposes of section 55 [IRC Sec. 55].

(h) Basis reduction. The basis of any qualified equity investment shall be reduced by the amount of any credit determined under this section with respect to such investment. This subsection shall not apply for purposes of sections 1202, 1400B, and 1400F [IRC Sections 1202, 1400B and 1400F].

(i) Regulations. The Secretary shall prescribe such regulations as may be appropriate to carry out this section, including regulations-- (1) which limit the credit for investments which are directly or indirectly subsidized by other Federal tax benefits Commercial Real Estate Panel - Page 148 of 309 Legal UPdates and Financing Trends

Page 5 IRC Sec. 45D

(including the credit under section 42 [IRC Sec. 42] and the exclusion from gross income under section 103 [IRC Sec. 103]), (2) which prevent the abuse of the purposes of this section, (3) which provide rules for determining whether the requirement of subsection (b)(1)(B) is treated as met, (4) which impose appropriate reporting requirements, (5) which apply the provisions of this section to newly formed entities, and (6) which ensure that non-metropolitan counties receive a proportional allocation of qualified equity investments.

HISTORY: (Added Dec. 21, 2000, P.L. 106-554, § 1(a)(7) (Title I, § 121(a)), 114 Stat. 2763, 2763A-605; Oct. 22, 2004, P.L. 108-357, Title II, Subtitle C, §§ 221(a), (b), 223(a), 118 Stat. 1431, 1432; Dec. 20, 2006, P.L. 109-432, Div A, Title I, § 102(a), (b), 120 Stat. 2934; Oct. 3, 2008, P.L. 110-343, Div C, Title III, § 302, 122 Stat. 3866; Feb. 17, 2009, P.L. 111-5, Div B, Title I, Subtitle E, § 1403(a), 123 Stat. 352; Dec. 17, 2010, P.L. 111-312, Title VII, Subtitle C, § 733(a), (b), 124 Stat. 3317; Jan. 2, 2013, P.L. 112-240, Title III, § 305(a), (b), 126 Stat. 2329.)

HISTORY; ANCILLARY LAWS AND DIRECTIVES

Explanatory notes: In subsec. (f)(1)(F), ", and" has been inserted in brackets to indicate the probable intent of Congress to include it.

Amendments:

In 2013, P.L. 112-240, Sec. 305(a), (b) (applicable to calendar years beginning after 12/31/2011, as provided by Sec. 305(c) of P.L. 112-240, which appears as a note to this section), amended subsec. (f) by substituting "2010, 2011, 2012, and 2013" for "2010 and 2011" in para. (1)(G), and by substituting "2018" for "2016" in para. (3).

In 2010, P.L. 111-312, Sec. 733(a), (b) (applicable to calendar years beginning after 2009, as provided by Sec. 733(c) of P.L. 111-312, which appears as a note to this section), amended subsec. (f), in para. (1), by deleting "and" at the end of subpara. (E), deleting a period at the end of subpara. (F), and adding subpara. (G), and in para. (3), by substituting "2016" for "2014".

In 2009, P.L. 111-5, Sec. 1403(a), amended subsec. (f)(1) by deleting "and" at the end of subpara. (C), substituting "and 2007," for ", 2007, 2008, and 2009." in subpara. (D), and adding subparas. (E) and (F).

In 2008, P.L. 110-343, Sec. 302, amended subsec. (f)(1)(D) by substituting "2008, and 2009" for "and 2008".

In 2006, P.L. 109-432, Sec. 102(a), (b) (effective on enactment, as provided by Sec. 102(c) of P.L. 109-432, which appears as a note to this section), amended subsec. (f)(1)(D) by substituting ", 2007, and 2008" for "and 2007"; and amended subsec. (i) by deleting "and" at the end of para. (4), substituting ", and" for a period in para. (5), and adding para. (6).

In 2004, P.L. 108-357, Sec. 221(a) (applicable to designations made by the Secretary of the Treasury after 10/22/2004, Commercial Real Estate Panel - Page 149 of 309 Legal UPdates and Financing Trends

Page 6 IRC Sec. 45D

as provided by Sec. 221(c)(1) of P.L. 108-357, which appears as a note to this section), amended subsec. (e) by substituting para. (2) for one which read: "(2) Targeted areas. The Secretary may designate any area within any census tract as a low-income community if-- "(A) the boundary of such area is continuous, "(B) the area would satisfy the requirements of paragraph (1) if it were a census tract, and "(C) an inadequate access to investment capital exists in such area.". --P.L. 108-357, Sec. 221(b) (applicable to investments made after 10/22/2004, as provided by Sec. 221(c)(2) of P.L. 108-357, which appears as a note to this section), amended subsec. (e) by adding para. (4). --P.L. 108-357, Sec. 223(b) (effective as if included in the enactment of this section, pursuant to Sec. 223(b) of P.L. 108-357, which appears as a note to this section), amended subsec. (e) by adding para. (5).

In 2000, P.L. 106-554, Sec. 1(a)(7) (enacting into law Sec. 121(a) of Subtitle C of Title I of H.R. 5662, as introduced on Dec. 14, 2000 (applicable as provided by Sec. 121(e) of such H.R. 5662, which appears as a note to Code Sec. 38)), added Code Sec. 45D.

Other provisions: Guidance on allocation of national limitation. Act Dec. 21, 2000, P.L. 106-554, § 1(a)(7), 114 Stat. 2763 (enacting into law § 121(f) of Subtitle C of Title I of H.R. 5662 (114 Stat. 2763A-610), as introduced on Dec. 14, 2000), provides: "Not later than 120 days after the date of the enactment of this Act, the Secretary of the Treasury or the Secretary's delegate shall issue guidance which specifies-- "(1) how entities shall apply for an allocation under section 45D(f)(2) of the Internal Revenue Code of 1986, as added by this section; "(2) the competitive procedure through which such allocations are made; and "(3) the actions that such Secretary or delegate shall take to ensure that such allocations are properly made to appropriate entities.". Audit and report. Act Dec. 21, 2000, P.L. 106-554, § 1(a)(7), 114 Stat. 2763 (enacting into law § 121(g) of Subtitle C of Title I of H.R. 5662 (114 Stat. 2763A-610), as introduced on Dec. 14, 2000), provides: "Not later than January 31 of 2004, 2007, and 2010, the Comptroller General of the United States shall, pursuant to an audit of the new markets tax credit program established under section 45D of the Internal Revenue Code of 1986 (as added by subsection (a)), report to Congress on such program, including all qualified community development entities that receive an allocation under the new markets credit under such section.". Application of amendments made by § 221 of Act Oct. 22, 2004. Act Oct. 22, 2004, P.L. 108-357, Title II, Subtitle C, § 221(c), 118 Stat. 4131, provides: "(1) Targeted areas. The amendment made by subsection (a) [amending subsec. (e)(2) of this section] shall apply to designations made by the Secretary of the Treasury after the date of the enactment of this Act. "(2) Tracts with low population. The amendment made by subsection (b) [adding subsec. (e)(4) of this section] shall apply to investments made after the date of the enactment of this Act.". Application of amendment made by § 223 of Act Oct. 22, 2004. Act Oct. 22, 2004, P.L. 108-357, Title II, Subtitle C, § 223(b), 118 Stat. 1432, provides: "The amendment made by this section [adding subsec. (e)(5) of this section] shall take effect as if included in the amendment made by section 121(a) of the Community Renewal Tax Relief Act of 2000 [adding this section].". Effective date of Dec. 20, 2006 amendments. Act Dec. 20, 2006, P.L. 109-432, Div A, Title I, § 102(c), 120 Stat. 2934, provides: "The amendments made by this section [amending subsecs. (f)(1)(D) and (i) of this section] shall take effect on the date of the enactment of this Act.". Special rule for allocation of increased 2008 limitation. Act Feb. 17, 2009, P.L. 111-5, Div B, Title I, Subtitle E, § 1403(b), 123 Stat. 352, provides: "The amount of the increase in the new markets tax credit limitation for calendar year 2008 by reason of the Commercial Real Estate Panel - Page 150 of 309 Legal UPdates and Financing Trends

Page 7 IRC Sec. 45D

amendments made by subsection (a) shall be allocated in accordance with section 45D(f)(2) of the Internal Revenue Code of 1986 [subsec. (f)(2) of this section] to qualified community development entities (as defined in section 45D(c) of such Code [subsec. (c) of this section]) which-- "(1) submitted an allocation application with respect to calendar year 2008, and "(2) (A) did not receive an allocation for such calendar year, or "(B) received an allocation for such calendar year in an amount less than the amount requested in the allocation application.". Application of Dec. 17, 2010 amendments. Act Dec. 17, 2010, P.L. 111-312, Title VII, Subtitle C, § 733(c), 124 Stat. 3318, provides: "The amendments made by this section [amending subsec. (f) of this section] shall apply to calendar years beginning after 2009.". Application of Jan. 2, 2013 amendments. Act Jan. 2, 2013, P.L. 112-240, Title III, § 305(c), 126 Stat. 2329, provides: "The amendments made by this section [amending subsec. (f) of this section] shall apply to calendar years beginning after December 31, 2011.".

NOTES:

Code of Federal Regulations: This section is referred to in 26 CFR 1.45D-1, 1.181-1T.

Related Statutes & Rules: This section is referred to in IRC Sections 38, 39, 181, 196.

Research Guide:

Forms: 11 Rabkin & Johnson, Current Legal Forms, § 9.02, Irrevocable Trusts.

Federal Taxation: 2 Rabkin & Johnson, Federal Income, Gift and Estate Taxation (Matthew Bender), ch 1, The Individual § 1.11. 3B Rabkin & Johnson, Federal Income, Gift and Estate Taxation (Matthew Bender), ch 50D, Limitations on Losses From Real Estate § 50D.01.

Texts: 3 Banking Law (Matthew Bender), ch 62, Tax Treatment of Bank Income § 62.14. Cohen's Handbook of Federal Indian Law (Matthew Bender), ch 8, Taxation § 8.02. Cohen's Handbook of Federal Indian Law (Matthew Bender), ch 21, Economic Development § 21.02. 1 Environmental Law Practice Guide (Matthew Bender), ch 2, Historic Preservation § 2.06.

Emerging Issues Analysis Commercial Real Estate Panel - Page 151 of 309 Legal UPdates and Financing Trends

Page 8 IRC Sec. 45D

New Markets Tax Credit

The Internal Revenue Code contains a number of tax incentives to taxpayers making investments and loans in low-income communities. IRC Section 45D, adds to these incentives by providing a new tax credit for qualified equity investments made to acquire stock in a selected community development entity. This article provides an overview of the new markets tax credit. Commercial Real Estate Panel - Page 152 of 309 Legal UPdates and Financing Trends

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-01 (2014)

122:22-1-01. Definitions.

(A) "Allocation agreement" means a written agreement between the director and a state allocatee specifying the terms and conditions associated with the receipt of the credit allocation pursuant to sections 5725.33, 5729.16, and 5733.58 of the Revised Code and rules 122:22-1-01 to 122:22-1-08 of the Administrative Code.

(B) "Allocation date" means the effective date of an allocation agreement.

(C) "Applicant" means a qualified CDE that applies to the director to receive a credit allocation from the new market tax credit program.

(D) "Application period" means each time period established by the director during which qualified CDE's may apply for a credit allocation.

(E) "Authorized representative" of an entity means an officer or other individual who has the actual authority to sign for, and make representations on behalf of, the entity.

(F) "CDE" means community development entity.

(G) "Control" means (1) ownership, control or power to vote more than fifty percent of the outstanding shares of any class of voting securities of an entity, directly or indirectly or acting through one or more persons; (2) control in any manner over the election of a majority of the directors, trustees, managers, or general partners (or individuals exercising similar functions) of any other entity; or (3) power to exercise, directly or indirectly, a controlling influence as determined by the director over the management policies or investment decisions of another entity.

(H) "Credit Allocation" means the amount of new market tax credit authority allocated by the director to a state allocatee pursuant to an allocation agreement.

(I) "Credit Allowance Period" means the seven-year period during which a taxpayer may claim new market tax credits for qualified equity investments made in a qualified CDE. Commercial Real Estate Panel - Page 153 of 309 Legal UPdates and Financing Trends

Page 2 OAC Ann. 122:22-1-01

(J) "Director" means the director of the department of development of the state of Ohio.

(K) "Fiscal year" means the fiscal year of the state of Ohio.

(L) "Issuer," as that term is used in section 5725.33 of the Revised Code, means a state allocatee.

(M) "NMTC claimant" means an entity that may claim a new market tax credit as provided in section 5725.33, 5729.16, or 5733.58 of the Revised Code.

(N) "Principal user" means the entity which occupies for the conduct of its business more than fifty percent of the rentable square footage in a building subject to a lease or other rental agreement for a term not less than the credit allowance period.

(O) "Principally owned" means ownership, directly or by a person that controls the principal user, of at least eighty per cent of the outstanding shares or other equity interest and the power to exercise, directly or indirectly, a controlling influence over the management policies of the special purpose entity.

(P) "Program guidelines" means the guidelines for the Ohio new markets tax credit program issued by the director.

(Q) "Qualified community development entity" has the meaning given that term in division (A)(5) of section 5725.33 of the Revised Code.

(R) "State allocatee" means a qualified CDE that is selected by the director to receive a credit allocation and enters into an allocation agreement. "State allocatee" includes any subsidiary applicant that is a signatory to the allocation agreement.

(S) "Subsidiary" means with respect to a CDE any legal entity that is owned or controlled, directly or indirectly, by the CDE.

(T) "Superintendent" means the superintendent of the department of insurance of the state of Ohio.

(U) "Tax commissioner" means the commissioner of the department of taxation of the state of Ohio.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 154 of 309 Legal UPdates and Financing Trends

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-02 (2014)

122:22-1-02. Allocation of new markets tax credit authority.

(A) To comply with the limitation set forth in division (C) of section 5725.33 of the Revised Code, the aggregate amount of credit allocations made by the director to all state allocatees each fiscal year shall not exceed ten million dollars.

(B) The director shall make credit allocations to qualified CDE's through a competitive process. The director shall establish and announce by public notice application periods during which qualified CDE's may submit applications for credit allocations. Qualified CDE's may request credit allocations by completing an application in the form published by the director for the relevant application period. Applications must be signed by an authorized representative of the applicant and submitted so as to be received by the director not later than the closing time for the application period as announced by the director. Applications will be evaluated based on scoring criteria published by the director in the program guidelines in advance of the relevant application period. The director may review applications for completeness and request that applicants provide information to complete any identified omissions. Except for responses to specific requests for information as part of the completeness review, an applicant may not amend its application. If the application period has not closed, an applicant may withdraw its application and submit a new application. The director shall set forth in the program guidelines the schedule of events for each application period.

(C) Each award of a credit allocation by the director to a qualified CDE will be made subject to the execution and delivery of an allocation agreement in form and substance acceptable to the director. If an applicant selected to receive a credit allocation fails to execute and deliver an allocation agreement within thirty days after receipt of the allocation agreement from the director, the award will be deemed to have been rejected by the applicant. If an applicant declines an award of a credit allocation for any reason or is deemed to have rejected the award as described in the preceding sentence, the director may award the credit allocation to another applicant.

(D) In order for a state allocatee to transfer its allocation authority to a subsidiary, the state allocatee must demonstrate, at a minimum, that it exercises and will maintain a controlling influence over the investment decisions of the subsidiary. Commercial Real Estate Panel - Page 155 of 309 Legal UPdates and Financing Trends

Page 4 OAC Ann. 122:22-1-02

(E) On or after the allocation date, the state allocatee may designate qualified equity investments as to which new market tax credits may be claimed with respect to equity investments made on or after that date. A state allocatee may not designate equity investments as qualified equity investments in an amount that would cause aggregate new market tax credit claims in excess of the state allocatee's credit allocation for the period in which the qualified equity investments are made. A state allocatee may not designate any equity investment that it issues as a qualified equity investment if such investment is issued by the state allocatee more than twelve months after the allocation date unless such expiration is extended by the director in writing as provided in the following sentence. The director may extend the period of time during which an investment may be made upon the written request of a state allocatee made at least thirty days, but not more than sixty days, before the scheduled expiration date if the state allocate demonstrates that an investment commitment has been made but will not be closed prior to the scheduled expiration of the credit allocation award.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 156 of 309 Legal UPdates and Financing Trends

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-03 (2014)

122:22-1-03. Qualified active low-income community business.

(A) Within sixty days after closing each qualified low-income community investment made in this state for which a new market tax credit is to be allowed, the state allocatee shall notify the director of such investment and certify to the director that the investment has been made in a qualified active low-income community business as that term is defined in division (A)(4) of section 5725.33 of the Revised Code. The notice shall be in a form approved by the director and shall contain the amount paid to the state allocatee for the qualified equity investment at its original issue.

(B) The state allocatee shall include with the certification described in paragraph (A) of this rule supporting documentation evidencing that the qualified active low-income community business does not derive or project to derive fifteen percent or more of its annual revenue from the rental or sale of real property or that the exception provided in division (A)(4) of section 5725.33 of the Revised Code applies. If the qualified active low-income community business is a special purpose entity as described in division (A)(4) of section 5725.33 of the Revised Code, the supporting documentation must include (1) organizational documents for the business showing that it was formed solely for the purpose of renting, either directly or indirectly, or selling real property back to the principal user; (2) evidence of ownership of the special purpose entity and that the principal user principally owns the special purpose entity; (3) a lease or rental agreement evidencing that the principal owner of the special purpose entity is a principal user of the subject real property; and (4) evidence that the principal user does not derive fifteen per cent or more of its annual revenue from the rental or sale of real property.

(C) For purposes of determining whether a business is a qualified active low-income community business as defined in section 5725.33 of the Revised Code, "annual revenue" will be applied consistently to refer to gross annual revenue of the business.

(D) The state allocatee may request from the director a written determination whether or not, based on the certification and supporting documentation provided by the state allocatee pursuant to this rule, a business is a qualified active low-income community business as that term is defined in division (A)(4) of section 5725.33 of the Revised Code. Such determination shall be final provided that the certification of the state allocatee on which the director relies and the supporting documentation which accompanies the certification is true, correct, and complete. Commercial Real Estate Panel - Page 157 of 309 Legal UPdates and Financing Trends

Page 6 OAC Ann. 122:22-1-03

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 158 of 309 Legal UPdates and Financing Trends

Page 7

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-04 (2014)

122:22-1-04. Notices and reporting.

(A) The state allocatee shall submit an annual report to the director with respect to each allocation agreement to which the state allocatee is a party. The annual report shall include a complete copy of any report submitted by the state allocatee to the community development financial institutions fund (or any successor fund or agency administering the federal new markets tax credit program) for the corresponding reporting period, together with an Ohio annual report supplement. The state allocatee shall submit its annual report no later than one hundred eighty days following the end of the CDE's fiscal year each year beginning the year after the allocation date and continuing through the year following the expiration of the last credit allowance period for any qualified equity investment designated by the state allocatee based on the credit allocation made in the allocation agreement.

(B) The Ohio annual report supplement shall be in the form required by the director. Among other information that may be required by the director, the state allocatee shall report for each qualified equity investment the purchase price for the equity investment, the adjusted purchase price for the equity investment, the first credit allowance date, all NMTC claimants (including name, address, and federal employer identification number for each NMTC claimant) whether or not the NMTC claimant is then a holder of the qualified equity investments, the amount of the adjusted purchase price attributable to each NMTC claimant, the status of each NMTC claimant as the original holder or a transferee of the qualified equity investment, and the effective date of each transfer of the qualified equity investment. The state allocatee shall also show in the Ohio annual report supplement its calculation of the adjusted purchase price, as that term is defined in division (A) of section 5725.33 of the Revised Code.

(C) The state allocatee shall notify the director of any notice of recapture or any potential event of recapture pursuant to section 45D(g) of the Internal Revenue Code and section 1.45D-1(e)(2) of Title 26 of the Code of Federal Regulations, as such federal laws and regulations exist on the effective date of the enactment of section 5725.33 of the Revised Code, October 16, 2009. Such notice shall be given in writing and submitted to the director promptly, but in any event within thirty days of the recapture event.

(D) The director may also require the state allocatee to report from time to time such information about its qualified low-income community investments as may be necessary or useful for the director to evaluate the new market tax Commercial Real Estate Panel - Page 159 of 309 Legal UPdates and Financing Trends

Page 8 OAC Ann. 122:22-1-04

credits program.

(E) Each report and notice required by this rule shall contain a certification signed by an authorized representative of the state allocatee that the information reported is true, correct, and complete.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 160 of 309 Legal UPdates and Financing Trends

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-05 (2014)

122:22-1-05. Monitoring and recapture.

(A) The director will monitor compliance of state allocatees with the terms and conditions of allocation agreements and program guidelines. If subsidiary CDE's are parties to an allocation agreement, the director will monitor compliance on a consolidated basis for the total amount of the credit allocation made pursuant to the allocation agreement.

(B) In the event of any recapture pursuant to section 45D(g) of the Internal Revenue Code and section 1.45D-1(e)(2) of Title 26 of the Code of Federal Regulations, as such federal laws and regulations exist on the effective date of the enactment of section 5725.33 of the Revised Code, October 16, 2009, all new market tax credits claimed by any taxpayer in respect of each equity investment subject to recapture of federal new market tax credits shall also be subject to recapture by the state of Ohio. Following receipt of notice by the state allocatee of a recapture event of federal new market tax credits, the director shall notify the tax commissioner and the superintendent and request that taxes be assessed against each NMTC claimant subject to the jurisdiction of the tax commissioner and the superintendent, respectively, in the aggregate amount of new market tax credits claimed by each such taxpayer in respect of the affected equity investments and all applicable interest.

(C) In addition to recapture under the circumstances described in paragraph (B) of this rule, new market tax credits shall be subject to recapture if the director determines that more than fifteen per cent of the proceeds of an investment for which the tax credit is claimed were used other than for qualified low-income community business investments. The director shall notify the state allocatee in writing if the director identifies any circumstance indicating potential recapture under this paragraph. The state allocatee shall have thirty days after the date of the director's notice to respond in writing. The director shall issue a preliminary written determination, which shall state the director's findings and conclusion on which the recapture determination is based. The state allocatee shall have the right to request within thirty days after the date of the preliminary determination a hearing with the director to refute any of the director's findings and conclusions. Thereafter, the director shall issue a final written determination. If the director determines that a recapture event has occurred, the director shall notify the tax commissioner and the superintendent and request that taxes be assessed against each NMTC claimant subject to the jurisdiction of the tax commissioner and the superintendent, respectively, in the aggregate amount of new market tax credits claimed by each such taxpayer in respect of the affected equity investments and all applicable interest. Commercial Real Estate Panel - Page 161 of 309 Legal UPdates and Financing Trends

Page 10 OAC Ann. 122:22-1-05

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 162 of 309 Legal UPdates and Financing Trends

Page 11

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-06 (2014)

122:22-1-06. Fees.

(A) Each applicant shall submit with its application for a credit allocation an application fee in an amount established annually by the director in a schedule of new market tax credit program fees. An application will not be considered by the director unless the application fee is paid. Application fees are non-refundable even if an application is withdrawn or incomplete.

(B) Each state allocatee shall pay a servicing fee in an amount established annually by the director in a schedule of new market tax credit program fees. The servicing fee will be payable in full upon execution and delivery of the allocation agreement. No allocation agreement shall be effective unless the servicing fee has been paid.

(C) A request for a determination described in paragraph (D) of rule 122:22-1-03 of the Administrative Code shall be subject to payment of a non-refundable processing fee in an amount established annually by the director in a schedule of new market tax credit program fees. Such a determination will not be issued by the director unless the processing fee is paid.

(D) The director shall establish the schedule of new market tax credit program fees for each fiscal year. The schedule of new market tax credit program fees shall be published by the director on the department of development website.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 163 of 309 Legal UPdates and Financing Trends

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-07 (2014)

122:22-1-07. Delegation of functions.

Except as provided in this rule, each and any of the powers and duties of the director under this chapter, including the making, signing and issuance of allocation agreements and determinations, accepting or refunding of fees, and exercise of recapture, may be performed by the assistant director of development or such other officers and employees of the department of development as may be designated in writing by the director or such assistant director. Any such designation under this chapter shall continue to be effective unless and until it is terminated or superseded in writing, notwithstanding any succession in the office of director or assistant director. Any reference in this chapter to the director includes the assistant director or such other designated officers or employees.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 164 of 309 Legal UPdates and Financing Trends

Page 13

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*** This document is current through the Ohio Register for the week of September 22, 2014 through September 25, 2014 ***

122:22 New Markets Tax Credit Program Chapter 122:22-1 New Markets Tax Credit Program

OAC Ann. 122:22-1-08 (2014)

122:22-1-08. Severability.

If any clause, provision or application of any of the rules in rules 122:22-1-01 to 122:22-1-08 of the Administrative Code is determined to be invalid or unenforceable, such determination shall not affect the remainder of such rule, other application of the rule, or application of other rules of this chapter, which shall be applied as if the invalid or unenforceable portion, application or references to the invalid or unenforceable portion did not exist.

History:Effective: 11/29/2010.

R.C. 119.032 review dates: 11/29/2015.

Promulgated Under: 119.03.

Statutory Authority: 5725.33.

Rule Amplifies: 5725.33, 5729.16, 5733.58. Commercial Real Estate Panel - Page 165 of 309 Legal UPdates and Financing Trends

Page 1

1 of 4 DOCUMENTS

Current through Legislation passed by the 130th General Assembly and filed with the Secretary of State through File 140 (SB 143)

TITLE 57. TAXATION CHAPTER 5725. FINANCIAL INSTITUTIONS; DEALERS IN INTANGIBLES; INSURANCE COMPANIES DOMESTIC INSURANCE COMPANIES

Go to the Ohio Code Archive Directory

ORC Ann. 5725.33 (2014)

§ 5725.33. Nonrefundable tax credit for holding qualified low-income community investments; new markets tax credit operating fund

(A) Except as otherwise provided in this section, terms used in this section have the same meaning as section 45D of the Internal Revenue Code, any related proposed, temporary or final regulations promulgated under the Internal Revenue Code, any rules or guidance of the internal revenue service or the United States department of the treasury, and any related rules or guidance issued by the community development financial institutions fund of the United States department of the treasury, as such law, regulations, rules, and guidance exist on October 16, 2009.

As used in this section:

(1) "Adjusted purchase price" means the amount paid for qualified equity investments multiplied by the qualified low-income community investments made by the issuer in projects located in this state as a percentage of the total amount of qualified low-income community investments made by the issuer in projects located in all states on the credit allowance date during the applicable tax year, subject to divisions (B)(1) and (2) of this section.

(2) "Applicable percentage" means zero per cent for each of the first two credit allowance dates, seven per cent for the third credit allowance date, and eight per cent for the four following credit allowance dates.

(3) "Credit allowance date" means the date, on or after January 1, 2010, a qualified equity investment is made and each of the six anniversary dates thereafter. For qualified equity investments made after October 16, 2009, but before January 1, 2010, the initial credit allowance date is January 1, 2010, and each of the six anniversary dates thereafter is on the first day of January of each year.

(4) "Qualified active low-income community business" excludes any business that derives or projects to derive fifteen per cent or more of annual revenue from the rental or sale of real property, except any business that is a special Commercial Real Estate Panel - Page 166 of 309 Legal UPdates and Financing Trends

Page 2 ORC Ann. 5725.33

purpose entity principally owned by a principal user of that property formed solely for the purpose of renting, either directly or indirectly, or selling real property back to such principal user if such principal user does not derive fifteen per cent or more of its gross annual revenue from the rental or sale of real property.

(5) "Qualified community development entity" includes only entities:

(a) That have entered into an allocation agreement with the community development financial institutions fund of the United States department of the treasury with respect to credits authorized by section 45D of the Internal Revenue Code;

(b) Whose service area includes any portion of this state; and

(c) That will designate an equity investment in such entities as a qualified equity investment for purposes of both section 45D of the Internal Revenue Code and this section.

(6) "Qualified equity investment" is limited to an equity investment in a qualified community development entity that:

(a) Is acquired after October 16, 2009, at its original issuance solely in exchange for cash;

(b) Has at least eighty-five per cent of its cash purchase price used by the qualified community development entity to make qualified low-income community investments, provided that in the seventh year after a qualified equity investment is made, only seventy-five per cent of such cash purchase price must be used by the qualified community development entity to make qualified low-income community investments; and

"Qualified equity investment" includes any equity investment that would, but for division (A)(6)(a) of this section, be a qualified equity investment in the hands of the taxpayer if such investment was a qualified equity investment in the hands of a prior holder.

(B) There is hereby allowed a nonrefundable credit against the tax imposed by section 5725.18 of the Revised Code for an insurance company holding a qualified equity investment on the credit allowance date occurring in the calendar year for which the tax is due. The credit shall equal the applicable percentage of the adjusted purchase price of qualified low-income community investments, subject to divisions (B)(1) and (2) of this section:

(1) For the purpose of calculating the amount of qualified low-income community investments held by a qualified community development entity, an investment shall be considered held by a qualified community development entity even if the investment has been sold or repaid, provided that, at any time before the seventh anniversary of the issuance of the qualified equity investment, the qualified community development entity reinvests an amount equal to the capital returned to or received or recovered by the qualified community development entity from the original investment, exclusive of any profits realized and costs incurred in the sale or repayment, in another qualified low-income community investment within twelve months of the receipt of such capital. If the qualified low-income community investment is sold or repaid after the sixth anniversary of the issuance of the qualified equity investment, the qualified low-income community investment shall be considered held by the qualified community development entity through the seventh anniversary of the qualified equity investment's issuance.

(2) The qualified low-income community investment made in this state shall equal the sum of the qualified low-income community investments in each qualified active low-income community business in this state, not to exceed two million five hundred sixty-four thousand dollars, in which the qualified community development entity invests, including such investments in any such businesses in this state related to that qualified active low-income community business through majority ownership or control. Commercial Real Estate Panel - Page 167 of 309 Legal UPdates and Financing Trends

Page 3 ORC Ann. 5725.33

The credit shall be claimed in the order prescribed by section 5725.98 of the Revised Code. If the amount of the credit exceeds the amount of tax otherwise due after deducting all other credits in that order, the excess may be carried forward and applied to the tax due for not more than four ensuing years.

By claiming a tax credit under this section, an insurance company waives its rights under section 5725.222 of the Revised Code with respect to the time limitation for the assessment of taxes as it relates to credits claimed that later become subject to recapture under division (E) of this section.

(C) The amount of qualified equity investments on the basis of which credits may be claimed under this section and sections 5726.54, 5729.16, and 5733.58 of the Revised Code shall not exceed the amount, estimated by the director of development, that would cause the total amount of credits allowed each fiscal year to exceed ten million dollars, computed without regard to the potential for taxpayers to carry tax credits forward to later years.

(D) If any amount of the federal tax credit allowed for a qualified equity investment for which a credit was received under this section is recaptured under section 45D of the Internal Revenue Code, or if the director of development services determines that an investment for which a tax credit is claimed under this section is not a qualified equity investment or that the proceeds of an investment for which a tax credit is claimed under this section are used to make qualified low-income community investments other than in a qualified active low-income community business, all or a portion of the credit received on account of that investment shall be paid by the insurance company that received the credit to the superintendent of insurance. The amount to be recovered shall be determined by the director of development services pursuant to rules adopted under division (E) of this section. The director shall certify any amount due under this division to the superintendent of insurance, and the superintendent shall notify the treasurer of state of the amount due. Upon notification, the treasurer shall invoice the insurance company for the amount due. The amount due is payable not later than thirty days after the date the treasurer invoices the insurance company. The amount due shall be considered to be tax due under section 5725.18 of the Revised Code, and may be collected by assessment without regard to the time limitations imposed under section 5725.222 of the Revised Code for the assessment of taxes by the superintendent. All amounts collected under this division shall be credited as revenue from the tax levied under section 5725.18 of the Revised Code.

(E) The tax credits authorized under this section and sections 5726.54, 5729.16, and 5733.58 of the Revised Code shall be administered by the department of development services. The director of development services, in consultation with the tax commissioner and the superintendent of insurance, pursuant to Chapter 119. of the Revised Code, shall adopt rules for the administration of this section and sections 5726.54, 5729.16, and 5733.58 of the Revised Code. The rules shall provide for determining the recovery of credits under division (D) of this section and under sections 5726.54, 5729.16, and 5733.58 of the Revised Code, including prorating the amount of the credit to be recovered on any reasonable basis, the manner in which credits may be allocated among claimants, and the amount of any application or other fees to be charged in connection with a recovery.

(F) There is hereby created in the state treasury the new markets tax credit operating fund. The director of development services is authorized to charge reasonable application and other fees in connection with the administration of tax credits authorized by this section and sections 5726.54, 5729.16, and 5733.58 of the Revised Code. Any such fees collected shall be credited to the fund. The director of development services shall use money in the fund to pay expenses related to the administration of tax credits authorized under sections 5725.33, 5726.54, 5729.16, and 5733.58 of the Revised Code.

HISTORY:

153 v H 1, § 101.01, eff. 10-16-09; 2012 HB 510, § 1, eff. Mar. 27, 2013.

NOTES: Commercial Real Estate Panel - Page 168 of 309 Legal UPdates and Financing Trends

Page 4 ORC Ann. 5725.33

Section Notes

EFFECT OF AMENDMENTS

The 2012 amendment substituted "October 16, 2009" for "the effective date of the enactment of this section by H.B. 1 of the 128th general assembly" in the first paragraph of (A); substituted "October 16, 2009" for "the effective date of this section" in the second sentence of (A)(3); substituted "October 16, 2009" for "the effective date of the enactment of this section" in (A)(6)(a); substituted "sections 5726.54, 5729.16, and 5733.58" for "sections 5729.16 and 5733.58" in (C), the first and second sentences of (E), and the second sentence of (F); inserted "services" wherever it appears in (D) through (F); substituted "and under sections 5726.54, 5729.16, and 5733.58" for "division (D) of section 5729.16, and section 5733.58" in the last sentence of (E); inserted "5726.54" in the sections list of the last sentence of (F); and made a stylistic change.

LexisNexis 50 State Surveys, Legislation & Regulations

Business & Development Tax Credits & Incentives Commercial Real Estate Panel - Page 169 of 309 Legal UPdates and Financing Trends

Page 5

2 of 4 DOCUMENTS

Current through Legislation passed by the 130th General Assembly and filed with the Secretary of State through File 140 (SB 143)

TITLE 57. TAXATION CHAPTER 5726. TAX ON FINANCIAL INSTITUTIONS

Go to the Ohio Code Archive Directory

ORC Ann. 5726.54 (2014)

§ 5726.54. Tax credit for person holding qualified equity investment on credit allowance data

(A) Any term used in this section has the same meaning as in section 5725.33 of the Revised Code.

(B) A taxpayer may claim a nonrefundable credit against the tax imposed by this chapter for each person included in the annual report of the taxpayer that holds a qualified equity investment on a credit allowance date occurring in the calendar year immediately preceding the tax year for which the tax is due. The credit shall be computed in the same manner prescribed for the computation of credits allowed under section 5725.33 of the Revised Code.

By claiming a tax credit under this section, a taxpayer waives its rights under section 5726.20 of the Revised Code with respect to the time limitation for the assessment of taxes as it relates to credits claimed under this section that later become subject to recapture under division (D) of this section.

A taxpayer may claim against the tax imposed by this chapter any unused portion of the credits authorized under sections 5725.33 and 5733.58 of the Revised Code, but only to the extent of the remaining carry forward period authorized by those sections.

The credit shall be claimed in the order prescribed by section 5726.98 of the Revised Code. If the amount of the credit exceeds the amount of tax otherwise due after deducting all other credits preceding the credit in the order prescribed in section 5726.98 of the Revised Code, the excess may be carried forward for not more than four ensuing tax years.

(C) The total amount of qualified equity investments on the basis of which credits may be claimed under this section and sections 5725.33, 5729.16, and 5733.58 of the Revised Code is subject to the limitation of division (C) of section 5725.33 of the Revised Code.

(D) If any amount of a federal tax credit allowed for a qualified equity investment for which a credit was received Commercial Real Estate Panel - Page 170 of 309 Legal UPdates and Financing Trends

Page 6 ORC Ann. 5726.54

under this section is recaptured under section 45D of the Internal Revenue Code, or if the director of development services determines that an investment for which a tax credit is claimed under this section is not a qualified equity investment or that the proceeds of an investment for which a tax credit is claimed under this section are used to make qualified low-income community investments other than in a qualified active low-income community business, all or a portion of the credit received on account of that investment shall be paid by the taxpayer that received the credit to the tax commissioner. The amount to be recovered shall be determined by the director pursuant to rules adopted under section 5725.33 of the Revised Code. The director shall certify any amount due under this division to the tax commissioner, and the commissioner shall notify the taxpayer of the amount due. The amount due is payable not later than thirty days after the day the commissioner issues the notice. The amount due shall be considered to be tax due under section 5726.02 of the Revised Code, and may be collected by assessment without regard to the limitations imposed under section 5726.20 of the Revised Code for the assessment of taxes by the commissioner. All amounts collected under this division shall be credited as revenue from the tax levied under section 5726.02 of the Revised Code.

HISTORY:

2012 HB 510, § 1, eff. Mar. 27, 2013; 2013 HB 59, § 101.01, eff. Sept. 29, 2013.

NOTES:

Section Notes

EFFECT OF AMENDMENTS

The 2013 amendment made a stylistic change. Commercial Real Estate Panel - Page 171 of 309 Legal UPdates and Financing Trends

Page 7

3 of 4 DOCUMENTS

Current through Legislation passed by the 130th General Assembly and filed with the Secretary of State through File 140 (SB 143)

TITLE 57. TAXATION CHAPTER 5729. FOREIGN INSURANCE COMPANIES

Go to the Ohio Code Archive Directory

ORC Ann. 5729.16 (2014)

§ 5729.16. Nonrefundable tax credit for holding qualified low-income community investments

(A) Terms used in this section have the same meaning as in section 5725.33 of the Revised Code.

(B) There is hereby allowed a nonrefundable credit against the tax imposed by section 5729.03 of the Revised Code for a foreign insurance company holding a qualified equity investment on the credit allowance date occurring in the calendar year for which the tax is due. The credit shall be computed in the same manner prescribed for the computation of credits allowed under section 5725.33 of the Revised Code.

The credit shall be claimed in the order prescribed by section 5729.98 of the Revised Code. If the amount of the credit exceeds the amount of tax otherwise due after deducting all other credits in that order, the excess may be carried forward and applied to the tax due for not more than four ensuing years.

By claiming a tax credit under this section, an insurance company waives its rights under section 5729.102 of the Revised Code with respect to the time limitation for the assessment of taxes as it relates to credits claimed that later become subject to recapture under division (D) of this section.

(C) The total amount of qualified equity investments on the basis of which credits may be claimed under this section, section 5725.33, and section 5733.58 of the Revised Code is subject to the limitation of division (C) of section 5725.33 of the Revised Code.

(D) If any amount of a federal tax credit allowed for a qualified equity investment for which a credit was received under this section is recaptured under section 45D of the Internal Revenue Code, or if the director of development services determines that an investment for which a tax credit is claimed under this section is not a qualified equity investment or that the proceeds of an investment for which a tax credit is claimed under this section are used to make qualified low-income community investments other than in a qualified active low-income community business, all or a portion of the credit received on account of that investment shall be paid by the insurance company that received the Commercial Real Estate Panel - Page 172 of 309 Legal UPdates and Financing Trends

Page 8 ORC Ann. 5729.16

credit to the superintendent of insurance. The amount to be recovered shall be determined by the director of development services pursuant to rules adopted under section 5725.33 of the Revised Code. The director shall certify any amount due under this division to the superintendent of insurance, and the superintendent shall notify the treasurer of state of the amount due. Upon notification, the treasurer shall invoice the insurance company for the amount due. The amount due is payable not later than thirty days after the date the treasurer invoices the insurance company. The amount due shall be considered to be tax due under section 5729.03 of the Revised Code, and may be collected by assessment without regard to the time limitations imposed under section 5729.102 of the Revised Code for the assessment of taxes by the superintendent. All amounts collected under this division shall be credited as revenue from the tax levied under section 5729.03 of the Revised Code.

HISTORY:

153 v H 1, § 101.01, eff. 10-16-09; 2013 HB 59, § 101.01, eff. Sept. 29, 2013.

NOTES:

Section Notes

EFFECT OF AMENDMENTS

The 2013 amendment inserted "services" in the first and second sentences of (D); and made a stylistic change. Commercial Real Estate Panel - Page 173 of 309 Legal UPdates and Financing Trends

Page 9

4 of 4 DOCUMENTS

Current through Legislation passed by the 130th General Assembly and filed with the Secretary of State through File 140 (SB 143)

TITLE 57. TAXATION CHAPTER 5733. CORPORATION FRANCHISE TAX

Go to the Ohio Code Archive Directory

ORC Ann. 5733.058 (2014)

§ 5733.058. Adjustments due to exempted investment in certain public utilities

(A) As used in this section, an "exempted investment" is a direct or indirect investment in the equity of, or the direct or indirect ownership of, a person satisfying divisions (A)(1) and (2) of this section for the person's entire fiscal or calendar year ending within or with the corporation's taxable year ending immediately prior to the tax year.

(1) The person is a limited liability company not treated as a separate C corporation for federal income tax purposes, or the person is a pass-through entity.

(2) The person owns and operates a public utility in this state and as such is required by law to file reports with the tax commissioner and pay an excise tax upon its gross receipts.

(B) Except as provided in division (C) of this section, each corporation directly or indirectly owning or directly or indirectly having an equity investment in an exempted investment shall make the adjustments required by divisions (B)(1) to (4) of this section.

(1) The corporation shall deduct from its net income the distributive share of net income and gain attributable to the corporation's exempted investment, but only to the extent such net income and gain are included in the corporation's net income without regard to this section.

(2) The corporation shall add to its net income the distributive share of expenses and losses attributable to the exempted investment, but only to the extent such expenses and losses have been deducted in calculating the corporation's net income without regard to this section.

(3) (a) The corporation shall exclude from the calculation of its property, payroll, and sales factors, as defined in divisions (B)(2)(a) to (c) of section 5733.05 of the Revised Code, the corporation's proportionate share of the property, payroll, and sales attributable to the exempted investment, but only to the extent the corporation's proportionate share of Commercial Real Estate Panel - Page 174 of 309 Legal UPdates and Financing Trends

Page 10 ORC Ann. 5733.058

the property, payroll, and sales attributable to the exempted investment would be included in the calculation of the corporation's property, payroll, and sales factors under section 5733.057 of the Revised Code without regard to this section.

(b) Division (B)(3)(a) of this section does not apply to division (B)(2)(d) of section 5733.05 of the Revised Code.

(4) Notwithstanding section 5733.98 of the Revised Code to the contrary, a corporation shall not be allowed any nonrefundable credit or nonrefundable credit carryforward listed in that section to the extent the credit is attributable to the corporation's direct or indirect ownership of or equity investment in an exempted investment and such credit directly relates to the owning and operating of a public utility in this state by a person described in divisions (A)(1) and (2) of this section.

(C) (1) The adjustments provided by division (B) of this section shall be allowed and required only to the extent that such adjustments directly relate to the owning and operating of a public utility in this state by a person described in divisions (A)(1) and (2) of this section.

(2) To the extent that any gross receipts of a person described in divisions (A)(1) and (2) of this section are not for business done by such person from the direct or indirect operation of, or the direct or indirect ownership of, a public utility in this state, then such gross receipts and related property and payroll shall not be subject to the adjustment otherwise provided by division (B) of this section.

(3) Division (B) of this section does not apply to the corporation, and section 5733.057 of the Revised Code shall apply to the corporation's computation of its net income, its property, payroll, and sales factors, and its credits to the extent that the person described in divisions (A)(1) and (2) of this section directly or indirectly owns or directly or indirectly has an equity investment in any other person described in division (A)(1) of this section but not described in division (A)(2) of this section.

(D) Section 5733.057 of the Revised Code applies for purposes of the ownership and investment criteria set forth in this section.

(E) This section is effective for taxable years ending after September 28, 1997.

HISTORY:

147 v H 770. Eff 9-16-98.

NOTES:

Related Statutes & Rules

Cross-References to Related Statutes

Determination of net income of corporations, RC § 5733.05.

Effect of ownership interest in pass-through entity, RC § 5733.057.

Net income defined; exception, RC § 5733.04. Commercial Real Estate Panel - Page 175 of 309 Legal UPdates and Financing Trends

Page 11 ORC Ann. 5733.058

Order in which credits to be claimed; credits not to exceed tax due; carry forward of excess; exception, RC § 5733.98.

LexisNexis 50 State Surveys, Legislation & Regulations

Franchise Tax Ethics Panel - Supervision and Page 176 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 177 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 178 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 179 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 180 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 181 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 182 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 183 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 184 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 185 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 186 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 187 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 188 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 189 of 309 Legal Outsourcing Ethics Panel - Supervision and Page 190 of 309 Legal Outsourcing Ethics Panel - 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Coaching Supervision

Deborah Pearce Pearce Communications Group LLC www. pearce-communications.com Providing Effective Leadership in our Page 282 of 309 Supervisory Roles

If you manage or supervise others…

You are being watched!

What kind of relationships are you creating? Providing Effective Leadership in our Page 283 of 309 Supervisory Roles

The role of Supervisor is directly linked to the retention of talented associates…

¢ It's not that younger workers don't embody loyalty — it's actually the opposite. Millennials are very loyal — they're just not loyal to a company; they're loyal to their bosses. Marston, author of the book " Motivating the 'What's In It For Me' Workforce ," says that effective bosses are the number one reason why Millennials stay at a job.

¢ Furthermore, the number one reason Millennials quit their jobs is because they're dissatisfied with their bosses.

Business Insider September 2012 Vivian Giang Providing Effective Leadership in our Page 284 of 309 Supervisory Roles

COACHING SUPERVISION DEFINED…

Definition:

“A relational approach to managing and supporting employees that helps them to develop problem-solving skills – i.e. the ability to think through options, prioritize and communicate effectively.” Providing Effective Leadership in our Page 285 of 309 Supervisory Roles

What are the skills and characteristics of a Coaching Supervisor?

¢ Self-awareness ¢ Self management ¢ Active listening ¢ Problem solving ¢ Giving and receiving effective feedback ¢ Understanding motivation ¢ Conflict management ¢ Appropriate recognition and praise ¢ Co-creating a high performance team Providing Effective Leadership in our Page 286 of 309 Supervisory Roles

What a Coaching Supervisor Does

• Creates a relationship with the employee • Helps develop an employee’s skill set • Is effective in addressing employee issues: • Clearly presents the problem • Gathers information from the employee’s perspective • Engages in problem solving with the employee • Models effective communication practices Providing Effective Leadership in our Page 287 of 309 Supervisory Roles

They build a feedback-rich culture.

¢ How’s your week going? ¢ Is there anything you’re working on that you think I need to know more about? ¢ Where do you need more of me right now? ¢ Is there anything I’m doing that’s making your job more difficult? ¢ What else do we need to talk about? Providing Effective Leadership in our Page 288 of 309 Supervisory Roles

True/False question for the audience…

Your current organization is feedback rich. There’s a lot of feedback to each member and few surprises.

a. True b. False Providing Effective Leadership in our Page 289 of 309 Supervisory Roles

They build a “Thinking Team.”

“What are the options you see?” “What are your ideas about what we can do?” “What would it take to keep this situation from repeating itself?” “What might happen if we follow that plan?” “How will others feel about this decision?” “What’s your best thinking about what we can do?” Providing Effective Leadership in our Page 290 of 309 Supervisory Roles

They build a High Performance Team. Providing Effective Leadership in our Page 291 of 309 Supervisory Roles

So how do you know if you are creating a high performance team?

You are getting results!

People hold themselves and others to high expectations; there is personal and collective accountability. Providing Effective Leadership in our Page 292 of 309 Supervisory Roles

So how do we know if you are creating a high performance team?

You are getting results!

People understand and embrace change. Providing Effective Leadership in our Page 293 of 309 Supervisory Roles

So how do you know if you have created a high performance team?

You are getting results!

People operate within an open communication system – one that does not avoid conflict. Providing Effective Leadership in our Page 294 of 309 Supervisory Roles

True/False question for the audience…

Your organization manages employee conflicts in a timely and effective way.

a. True b. False Providing Effective Leadership in our Page 295 of 309 Supervisory Roles

So how do you know if you have created a high performance team?

You are getting results! People interact from a foundation of trust.

(vulnerability-based trust: judgment and pride morph into support, compassion and empathy.) Providing Effective Leadership in our Page 296 of 309 Supervisory Roles

So how do you know if you have created a high performance team?

You are getting results!

People share the vision; they know that their work has purpose. Providing Effective Leadership in our Page 297 of 309 Supervisory Roles

So how do you know if you have created a high performance team?

You are getting results!

People celebrate success; they are recognized. Providing Effective Leadership in our Page 298 of 309 Supervisory Roles

How does a person become a Coaching Supervisor?

¢ Start with yourself. Watch what you do!

¢ Solicit feedback!

¢ Get trained in the skills of Coaching Supervision.

¢ Commit to new behaviors! Providing Effective Leadership in our Page 299 of 309 Supervisory Roles Providing Effective Leadership in Page 300 of 309 our Supervisory Roles

Average Leadership Is Ruining Business

July 20,, 2014 inShare 1,378D

This is Part 3 of the series: Shoddy Workmanship: Why 90% Of Leaders Are Average Or Worse The epidemic of average leaders

Average leadership is strangling the workplace. In many organizations we find leaders who act only as caretakers. They maintain the organization but they do not enhance it. The reason average leadership is so prevalent is because it is rarely recognized as problematic. Consider:

1. Most leaders who think they are high achieving are really average and only about 18% of leaders are truly high achieving (Jay Hall, Teleometrics International). 2. A workforce requires a 10:1 ratio of managers to staff. For the U.S. workforce of 100 million to be perfectly managed 10 million great supervisors and an additional 1 million great managers of those supervisors are required. There are approximately 3 million great U.S. supervisors (27% of what is needed). (Gallup) 3. Nearly one in five (18%) of those currently in management roles demonstrate a high level of talent for managing others, while another two in 10 show a basic talent for it. Companies fail to choose the candidate with the right talent for the job 82% of the time . As a result, time and resources are wasted attempting to train bad managers to be who they're not. Nothing fixes a bad leadership selection. http://thechairmansblog.gallup.com/2014/04/nothing-fixes-bad-manager.html 4. 26 % of sergeants and staff sergeants and 23 % of lieutenants and captains surveyed planned to leave the Army after completing their current service obligations. Of those, 35% of enlisted and 26 % of officers cited the quality of leadership at their duty stations as a reason for leaving. ( Army Research Institute) The impact of average leaders 1. 63% of employees worldwide are not engaged in their jobs. They don’t hate their jobs, and aren’t necessarily negative --- they’re just there (Gallup). And that applies to managers also. Average! 2. Better leaders make a difference and the most significant impact is in their ability to teach workers how to be more productive , i.e. capability building. (The National Bureau of Economic Research Working Paper) 3. Average managers ruin great performers as quickly as poor managers. Average is the enemy of excellent. http://blogs.hbr.org/2012/10/the-coming-collapse-of-average/

In the words of Pogo, the old-time cartoon character “We have met the enemy and he is us”.

The cause of average leadership

The root causes of average leadership can best be described by assessing the foundational leadership building blocks.

Providing Effective Leadership in Page 301 of 309 our Supervisory Roles

Competence There are two competency issues that lead to average leadership. The first, is a person who could not perform the tasks if their life depended on it. ( Robert Mager)The solution to this situation is immediate removal of that person from leadership because he or she will never be successful and will continue to do harm if left in a leadership position. The second issue is the leader who knows the terms and language of leadership but either cannot recognize when to use those skills or cannot skillfully apply those skills in day to day situations. The solution to this issue is first, leadership development and then removal if skills still cannot be performed. Character The second reason for average performance is lack of character. This leader knows what to do and could perform if they choose to do so but the leader is unwilling to put forth the effort required to fulfill their leadership responsibilities.. This is the “good enough for government work” mentality. Cut corners, meet the letter of the law and be just good enough. This is a performance management problem (KITA motivation needed) and then removal of the person from leadership if skills are not utilized. Philosophy The third reason for average performance is an inadequate leadership philosophy. If we refer back to Douglas McGregor’s work (Part 2 of this series), the key leadership philosophy question is “Do people and productivity mix?” Part 2 of this series reviewed the three styles that answer that question “No”.

The average manager answers this question yes, but feels people and productivity must be separated. He or she looks at people and agrees that people are critical to high performance. The average leader agrees that high performance is critical to an organization. The average leader does not believe that in the real world high productivity and high people concerns can be integrated. Therefore they share the same Theory X leadership philosophy with the autocrat, the placator and the mentally retired leader. Average leaders believe people and productivity do not mix and must be managed separately.

Providing Effective Leadership in Page 302 of 309 our Supervisory Roles

There are two major ways the average manager attempts to addresses the people-productivity mix. Both are less than adequate.

First the average manager attempts to keep the concern for people and productivity balanced. This is probably the most common leadership philosophy today because it is viewed as realistic or pragmatic. This manager believes that if a tough decision or action has to be taken for productivity then it must be balanced with a people action. One will see an average leader “chew out” an employee for poor performance, and then be sure to meet with that employee by the end of the day to insure the employee is ok, to joke with them or to discuss their family (being sensitive and concerned are always good people skills!). Balance the scales. Make one tough decision for results and balance it with one action for people (throw a pizza party!)

The second way an average manager operates is by watering down actions from optimal to workable. The average manager believes optimal exists in theory only but the real world is pragmatic. Since the average manager wants everyone's buy-in, a solution is devised to incorporate items that are important to each person or group. The result is a workable (not optimal) solution that consumes more time and resources to implement but produces only average results. This is the way the government political process works in most instances - workable (never optimal) solutions produced at high cost.

Today organizations yearn for innovation. The greatest opportunities reside right under the nose of the average manager who instead of settling for adequate could strive for optimal. Today many schools of thought present this concept as clever. Thus management techniques (being political and pragmatic_ are presented as appropriate..

Consequences of the average management team.

The average style of leadership is the most dangerous of all because it produces just enough to meet day to day demands but not enough to become better. This leadership style is represented by the equation, 1 + 1=2.

With the average leader, there is no significant growth in capability, innovation or synergy that moves the company to the next plateau. Employees realize they are becoming stagnant;

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they feel they have learned all there is to know. Eventually they use the knowledge they have gained as a stepping stone to move to a company where their skills will be optimized. The average organization and leader will be stunned at how well their ex-employees do at new companies and they will bemoan the environment and the new generation for failure to retain talent.

Over time the average company, its managers and its people stay basically the same. While there is a facade of success, this organization will be basically the same in five years as it is today.

If you can't beat them, join them: adapting to the average manager

Organizations often try to adapt when they find that the majority of their managers are average. Many organizations feel they are clever (or practical) in using these approaches, but adaptive actions solve the symptoms of a problem, not the root cause. As a result, a deep foundation for growth is never built.

Adaptive strategy 1: Organizations follow the Jack Welch motto, “Whip your thoroughbreds.” Companies believe they can gain greater value by working their best people harder than by pushing their multitude of “average” managers to work at a higher level. http://blogs.hbr.org/2012/10/the-coming-collapse-of-average/ . While there is fact to support the productivity implications of this approach, significant motivation and morale problems can result. Adaptive strategy 2: Another approach is used by organizations which adapt by assigning their best workers to the best bosses, believing that this strategy results in the largest productivity gains. "The Value of Bosses," Edward P. Lazear, Kathryn L. Shaw, and Christopher T. Stanton, National Bureau of Economic Research Working Paper No. 18317 (August) .

The problem with both these approaches is that in an age of engagement and collaboration only a few people are actually touched by great managers. Organizations work around mediocrity rather than build great leaders.

The problem will get worse

Organizations face an increasing deterioration of capabilities in new employees graduating from an ineffective educational system. The ability to find and hire high achieving talent will become more difficult. Therefore organizations must build high achieving managers and employees as the highest priority of a sound talent management system. Most will probably not be succesful.

Is there a solution?

Moving from average leadership to excellent is not easy but it is necessary. Building a high achieving leadership team is one of the most significant achievements of any manager. This

Providing Effective Leadership in Page 304 of 309 our Supervisory Roles

accomplishment produces results long after that leader has departed. To be successful on an organizational level requires several actions:

1. It requires the obsessive attention of the senior leader. 2. Leaders must learn how to lead with the what and the why ans engage with the how. 3. Leaders must recognize average performance when they see it. 4. Leaders must never reward or recognize average as exceptional. 5. Leaders must remove average managers as soon as it is recognized that the person is not capable or willing of practicing high achieving leader behaviors. 6. Leaders must learn to say “This is not your best work and is not optimal. Come back to me with a better alternative to meet our objectives.” The danger for all of us • Most of us reading this article think we are great leaders but are really average. • Great leaders and great organizations can become average when they fail to sustain their focus.

Next: Part 4: The Philosophy of the High Achieving Leader

Doug Wilson 9By9Solutions

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Mark Graban Influencer Speaker, Consultant, Blogger, Author of "Lean Hospitals" & "Healthcare Kaizen," VP of Customer Success at KaiNexus

What Bad Managers, Good Managers, and Great Managers Do Sep 11 2014

A key thing I've learned in my career and my own work experience:

Bad managers tell employees what to do, good managers explain why they need to do it, but great managers involve people in decision making and improvement."

There might be more to management to that, but I think that's a pretty good start. " Lean management ," or the Toyota management style, encourages leaders to live in that "good to great" range (with apologies to Jim Collins ). Bad managers bark orders. They are directive and tell employees what to do, without any explanation or context. I saw that style of management quite often during my first two years at General Motors ( read my previous post about that experience ) and the workplace was incredibly dysfunctional as a result.

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There are top-down, "command and control" managers in every type of workplace, unfortunately. Managers who are controlling and have all the answers want their employees to " check their brains at the door ," and often say so quite explicitly — or they spread that message in more subtle ways. At GM, front-line employees complained that they were "hired for their backs and their arms, not their brains." In hospitals, healthcare professionals (even those with master's degrees) have complained, "They just want us to do what we're told." This is not a recipe for quality, productivity, or good customer service.

A friend of mine lives in a high-rise condo building. One example of "telling" was the general manager telling employees that the doors to the resident gym must now be kept closed at all times. For years, previously, the doors had been left open unless a resident wanted privacy and chose to close them.

My friend asked one of the employees, "Why are the doors closed all of the time now?" The employee replied, "I don't know, [the manager] just told us to."

It's disrespectful to just give directives without letting people understand the reason(s) why. There might have very well been a good reason why the doors were now to be kept closed. Had the manager taken just a few minutes to share a reason why, the employees would feel better about themselves and would more likely keep the doors closed. If employees are following directives out of a fear of being "written up," they aren't in a position to provide great service.

A good condo manager would explain why the doors now need to be closed. And, if there wasn't a good reason why, they wouldn't force the change on a whim.

A great condo manager would involve the employees in coming up with solutions to whatever problem is being solved by keeping the doors closed. The employees, when being posed with the problem, might come up with the idea of "close the doors" or they might come up with something better. Either way, they would feel a greater sense of ownership over the idea since they were involved in its creation.

Providing Effective Leadership in Page 307 of 309 our Supervisory Roles

During my time at GM, the better of the two plant managers I worked for taught us that Lean leaders (in the style of Toyota leaders) will always explain why something must be done, in those rare instances when they have to give a directive. The dynamic changes from "thou shalt wear safety gloves (because I'm the boss and I told you so)" to "you must wear safety gloves (because it's necessary for your safety and we don't want you to get hurt, even though you might think there is little risk)." Bad managers tell. Good managers explain why. Great managers go beyond this.

Great managers might engage the employees in figuring out how to reduce the safety risk that makes gloves necessary in the first place. Maybe an employee would suggest that a different, but equally effective, chemical be used. We don't know unless we engage our employees.

In 90% of workplace situations, I'd guess, the manager shouldn't be telling people what to do, even if they are making the effort to explain why. Great managers engage people in designing their work and they continue to engage them in ongoing improvement. As I learned from former Toyota employees and the books of Taiichi Ohno , work procedures "should not be forced down from above but rather set by the production workers themselves ." This mindset and approach requires that leaders set aside their egos and century-old habits. of top-down management. Managers won't have all of the answers. Instead of dictating how things get done (and expecting obedience and compliance), managers need to work together with employees to define how the work is done. Managers need to ask employees what ideas they have for improving the workplace, through the practice of "Kaizen ." Our employees are adults and they deserve our respect. They deserve great leaders who can work together to help everybody succeed and do what's best for their customers (or residents).

Mark Graban (@MarkGraban ) is a consultant , author , and speaker in the “Lean healthcare” methodology. Mark is author of the Shingo Award-winning books Lean Hospitals and Healthcare Kaizen . His latest, The Executive Guide to Healthcare Kaizen is now available. He is also the VP of customer success for the technology company KaiNexus . Mark blogs most weekdays at www.LeanBlog.org . He is also helping organize a "Lean healthcare" study tour to Japan in November .

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Building a High-Trust Culture, #2: Invest in Respect

January 09, 2014

• inShare 304 Joel Peterson Chairman, JetBlue Airways. Stanford Business School

Personal integrity is the foundation of trust in any organization. It’s the pervasive sense that people will do what they say they're going to do, and that their actions consistently reflect their principles and character. Integrity, then, is an internal cornerstone of trust. But leaders should also be looking to spur the outward growth of trust across an organization. The way to do that is by practicing the art of respect.

Respect is, in some sense, the currency of trust – the way it’s exchanged and circulated among people. It’s any easy concept to pay lip service to, but like any facet of behavior and attitude, respect requires focus, awareness, and practice. Leaders show and encourage respect when they empower team members, celebrate their contributions, and help them learn from missteps.

You'll know you've got a high-trust organization when you find leaders showing respect to people at every level, especially those from whom they stand to gain the least. Does a CEO view a receptionist as “help,” or as a team member who may rise through the ranks with the memory of being treated well by the chief? Do vice presidents seek out feedback from people well outside their inner circle – and act on it? Do executives remember colleagues’ names, and the names of their partners and children – not because they've memorized them to score points, but because they actually care?

With these ideas in mind, here are a few guidelines for creating an atmosphere of respect, where trust can grow and thrive.

1) Positive always beats negative. Steer clear of attacks, sniping, and even trash-talking the competition. Going negative reveals a general lack of respect and self-control. Your culture will be better served by celebrating what your own team is doing than by tearing down the competition. If you talk behind someone’s back, your team will start to wonder what you’re saying about them when they're not around. Honoring those not present is a good way to show respect for those who are. As described below, it’s not that you have to be all smiles all the time, but that when things get tough, you don't give in to the devil on your shoulder. Even firing, handled properly , can be done in a way that demonstrates respectful treatment of those who will do better elsewhere. 2) Respect is an investment. Nothing yields greater dividends in team coherence, employee satisfaction, and organizational momentum than advancing the best interests of the people you work with. Leaders know that as an organization’s reputation for respecting everyone expands, so will general trust levels. More trust means fewer politics and

Providing Effective Leadership in Page 309 of 309 our Supervisory Roles

personal agendas – and without those, people are more productive, more satisfied, and more likely to come up with and execute new ideas. 3) Root out disrespect. Just as respect can be contagious, disrespect can be a contagion: once it breaks out in a few places, it can begin to spread. You can lose key team members and organizational stability, leaving the business limping for years to come. Vigilant leaders are always looking to nip disrespectful practices in the bud. That means no tolerance for talking behind people’s backs, letting problems fester, or failing to give people the feedback they need to improve . 4) Respect isn’t the same as being nice. Showing respect means far more than being polite or deferential. Indeed, disagreement is key to great decision-making , and people in high-trust organizations feel secure in their ability to disagree – in part because they know how to disagree with respect. There’s an art to expressing a contrary viewpoint without making it personal or petty.

One of the most effective leaders I've worked with used this principle by starting any disagreement with a “capture” of the other person’s point of view. He would begin by stating, “If I understand what you’re saying…” and then describe the opposing viewpoint to that person's satisfaction (he could often say it better than they had). Then he'd continue, graciously, “But another way to look at this is…” He knew it was respectful to listen carefully to his interlocutor so he could summarize the person's position – but he also knew it was an effective way to disagree.

A vibrant atmosphere of trust is one in which colleagues are constantly showing respect to, and earning it from, one another. Respect starts with the example of an organization’s leaders, but it isn't a ‘trickle down’ system; in a trust-driven culture, respect is prized at every level. If it sounds difficult, that’s because it is. Building a culture of respect is a long-term commitment. But it’s one that will pay off big – on the bottom line, the top line, and every line in between.