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Morrison & Foerster, LLP

Supreme Court Grants Certiorari in Two Antitrust Cases, but Denies a Third
Yesterday the Supreme Court agreed to hear appeals in two significant antitrust cases — Bell Atlantic v. Twombley, Case No. 05-1126 (2006), and Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., Case No. 05-381 (2006) — but denied the Federal Trade Commission’s petition for certiorari in its case against pharmaceutical manufacturer Schering-Plough. FTC v. Schering-Plough, Case No. 05-273 (2006).

In Bell Atlantic v. Twombley, the Court will decide whether allegations of parallel conduct by defendants, coupled with a simple assertion that such conduct is the result of a conspiracy, states a claim under Section 1 of the Sherman Act. In the decision below, the Second Circuit held that it does, despite the fact that it is settled law that parallel conduct alone does not entitle the plaintiff to relief.

The Second Circuit’s holding conflicts with decisions of the First, Sixth, and Tenth Circuits, which require plaintiffs pleading a claim under Section 1 to allege facts that, if true, would support a claim of conspiracy. According to the law of the other Circuits, in the absence of direct evidence of a conspiracy, a plaintiff seeking damages for a violation of Section 1 based on parallel conduct must present evidence that tends to exclude the possibility that the alleged conspirators acted independently. Such additional facts — commonly known as “plus factors” — usually involve a showing that the defendants’ behavior would not be rational if they were not acting collusively. Under the “plus factor” standard, a plaintiff is not required at the pleading stage to describe every aspect of the asserted conspiracy, but it must allege some facts suggesting conspiracy before it can proceed to the discovery process. The Bell Atlantic defendants, as well as many amici, contend that the Second Circuit’s lowered pleading standard will invite frivolous litigation and impose significant burdens on the courts and private businesses.

Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co. concerns conduct known as “predatory bidding” — deliberately bidding up the price of inputs in order to prevent competitors from procuring sufficient supplies to manufacture finished products. The question presented by the case is whether the legal standard for predatory pricing claims under Section 2 of the Sherman Act also applies to “predatory bidding” claims. The standard for predatory pricing was set by the Supreme Court in Brook Group Ltd. v. Brown & Williamson Tobacco Corp., where the Court held that a plaintiff alleging predatory pricing must prove (1) that the defendant suffered a short term loss by virtue of its pricing, and (2) that it had a dangerous probability of recouping its loss in the long term once competition was eliminated.

In its decision below, the Ninth Circuit concluded that predatory bidding cases were distinguishable from predatory pricing cases because, unlike predatory pricing, predatory bidding does not result in lower prices to the end consumer. Therefore, the Ninth Circuit held that the two-part Brook Group test was inapplicable to predatory bidding claims and instead created its own test. Under the Ninth Circuit’s rule, a defendant engages in anticompetitive predatory bidding if it pays “a higher price than necessary” in order to prevent a plaintiff from obtaining necessary inputs “at a fair price.” The Ninth Circuit test has been criticized for its lack of objective standards and the increased likelihood that beneficial, aggressive, legal competition will be confused with anticompetitive conduct.

The Supreme Court declined to accept the more controversial case of FTC v. Schering-Plough, in which the Court was asked to evaluate the legality of certain types of patent litigation settlements between branded and generic drug manufacturers. The FTC had appealed a decision of the Eleventh Circuit holding that an agreement requiring Schering-Plough to pay Upshur-Smith significant royalties in exchange for Upshur’s forbearance from marketing a generic version of Schering’s patented heart medication did not violate Section 1.

The case involved a rare disagreement between the FTC and the Solicitor General, who recommended against certiorari. Although the Solicitor General agreed that the FTC raised “important and complex issues concerning the antitrust treatment of settlements in patent cases, particularly settlements that provide for delayed entry into the market combined with a ‘reverse’ payment from the patent holder to the alleged infringer,” the case did not present an appropriate opportunity for the Court to determine the proper standards for distinguishing legitimate patent settlements from settlements that impermissibly restrain trade in violation of the antitrust laws. Despite the denial of certiorari in this case, the FTC is expected to continue to pursue investigations of patent litigation settlements involving generic drug manufacturers.

07-05-2006

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Morrison & Foerster, LLP

Do Employers Have A Duty To Monitor Employees' Internet Activities?
In a case with potential national implications, a New Jersey court recently held in a case of first impression that employers have a legal obligation to investigate an employee’s activities when they know or have reason to know that the employee is using a workplace computer to access child pornography. Doe v. XYC Corporation, 382 N.J. Super. 122 (App. Div. 2005). The court also held that an employer is required to report the employee’s activities to the proper authorities and to take “effective internal action” to stop the employee’s activities. Based on the facts of the case, the court also ruled that “no privacy interest of the employee stands in the way of this duty on the part of the employer.”1

This ruling may have far-reaching implications for employers because it imposes duties on employers to: (1) ensure that their employees’ illegal work conduct does not cause injury to third parties, and (2) report an employee’s potentially illegal conduct to the proper authorities. The XYC Corporation case may be the beginning of a trend in which other courts adopt a similar analysis in situations involving serious public policy issues such as child pornography or child abuse.2 The case also highlights the risk that third parties can sue employers for the criminal acts of their employees. Although the ruling in the XYC Corporation case is limited to the context of child pornography, it may be expanded in the future to impose liability on employers for their employees’ use of work computers for other criminal activities.

This Commentary will discuss the facts and ruling of the XYC Corporation case. It will also provide employers with practical suggestions for complying with the obligations imposed by the XYC Corporation case.

Factual Background of the XYC Corporation Case

The employee in XYC Corporation was an accountant for XYC Corporation (the “Employer”). The Employer was put on notice a number of times between approximately 1998 and 2001 regarding the employee’s accessing pornographic Internet sites.

The employee’s co-workers reported to management that they observed the employee suddenly minimizing his computer screen in order to hide what had been on his screen and that they were uncomfortable with the employee’s activities. As a result, in February 2001, the Director of Network and PC Services reviewed the websites that the employee had been visiting and concluded that they were pornographic. In March 2001, the employee’s direct supervisor accessed the employee’s computer to find out which websites the employee had visited. The direct supervisor discovered that the employee had visited discussion groups with graphic names and pornographic websites, including one specifically about children – “Teenflirts.org: The Original Non Nude Teen Index.”

The court noted that the Employer’s managers never opened any of the websites the employee accessed to further investigate the websites’ contents. The only actions the Employer took against the employee were in 1998 or 1999 and on March 6, 2001, when the employee was told to stop his inappropriate computer use. The employee said that he would stop. In early June 2001, the employee’s supervisor discovered that the employee started accessing pornographic websites again. However, for reasons not explained in the case, the supervisor did not tell anyone and left on a business trip. He returned after the employee’s arrest on child pornography charges on June 19, 2001.

In connection with the employee’s arrest, the Employer searched the employee’s computer on June 20, 2001. The Employer discovered e-mails that the employee sent to pornographic websites and interactions with others (outside the XYC Corporation) regarding child pornography. The computer contained a folder of seventy downloaded pornographic photographs, including those of young females.

The employee admitted to downloading over 1,000 pornographic images while working for the Employer. The employee also admitted that he stored on his work computer nude photographs of his ten-year-old stepdaughter. The employee had transmitted three of these pictures over the Internet from his work computer to gain access to a child pornography website.

The ten-year-old girl’s mother discovered the transmitted photographs of her daughter, and brought suit against the Employer, claiming that her daughter suffered severe and permanent harm because the Employer negligently failed to report the employee’s unlawful conduct to the police.

The Court’s Ruling

The court imputed knowledge to the Employer that the employee had married a woman with a young child because his stepdaughter had attended company outings and had been at the Employer’s headquarters for “Take Your Daughter To Work Day.” The court also determined that the Employer had actual or constructive notice that the employee was accessing child pornography on his work computer. Therefore, the Employer had a legal duty to act by terminating the employee and/or reporting the employee’s conduct to law enforcement authorities.

In imposing this legal duty on the Employer, the court recognized that both state and federal laws prohibit the possession or viewing of child pornography, and that public policy “favors exposure of crime.” The court also cited the federal law that requires electronic communication service providers to report suspected violations of the federal law that prohibits interstate distribution of child pornography.3

In its analysis, the court also referred to Section 317 of the Restatement (Second) of Torts, which imposes a duty on a “master” (i.e., employer) under certain circumstances to control its “servant” (i.e., employee), even when the servant is acting outside the scope of his employment, to prevent the servant from “intentionally harming others or from so conducting himself as to create an unreasonable risk of bodily harm to them.” In the XYC Corporation case, the court ruled that the Employer had knowledge that the employee was engaging in activities that posed the threat of harm to others.

The court emphasized that the Employer possessed and could have implemented software to monitor the employee’s Internet activities. In addition, the Employer maintained website log files by date and could have easily determined which websites the employee visited on any given day. The Employer also implemented and distributed to employees a policy that recognized the Employer’s right to monitor employee website activity and e-mails. The policy made it clear that e-mails were not confidential. The court also suggested that the policy’s reporting requirement was intended to trigger an investigation to determine if, according to the policy, the offending employee needed to be disciplined. The court held that the Employer failed to effectively implement the procedures set forth in its own policies, to the detriment of the employee’s stepdaughter.

The court also determined that, based in part on the Employer’s policy, the employee had no legitimate expectation of privacy that would prevent the Employer from accessing his computer to determine if he was using it to view pornography. The policy permitted the Employer to access all e-mails sent over its system “as deemed necessary by and in the sole discretion of the [Employer].” In addition, the employee’s computer was in a cubicle located on a wall that had no doors and opened into a hallway.

Finally, the court rejected the Employer’s argument that it owed no duty to the employee’s stepdaughter. The court noted that employers have a duty to prevent their employees from harming others, such as committing a crime. When an employer has knowledge that an employee is engaging in activities that pose a threat of harm to others, the employer has a “duty to report [the] [e]mployee’s activities to the proper authorities and to take effective internal action to stop those activities, whether by termination or some less drastic remedy.”

Lessons from the XYC Corporation Case

The Employer’s failure to act in XYC Corporation is unusual.4 It was put on notice multiple times that the employee was accessing pornographic websites on his work computer. Given the disturbing facts and the number of times management was put on notice, it is not surprising that the court ruled that the Employer had a duty to investigate and take action. In a sexual harassment case, for example, an employer likely would be found liable if it were put on notice of the harassment a number of times but conducted only limited investigations and did not take effective action.

The unusual aspect of the XYC Corporation case is that the Employer’s failure to effectively investigate the employee’s activities resulted in liability for injuries to a third party, not just a co-worker of the employee. Another notable aspect is the court’s imposition of a duty on employers to report an employee’s conduct to law enforcement authorities in addition to taking appropriate steps to stop the harmful conduct.

The court was not clear regarding when an employer’s duty to investigate is triggered. Therefore, once an employer has any information that an employee has used a work computer to view or e-mail pornography, it should take immediate action to determine whether the employee violated a child pornography or other law and, if so, report it to the proper authorities.

Practical Suggestions

The XYC Corporation case emphasizes how important it is for employers to have an effective electronic media and services policy that addresses the use of work computers, the use of the company’s e-mail system, and access to the Internet using the employer’s network systems. At a minimum, such a policy should:

inform employees that they should have no expectation of privacy when using the company’s e-mail system or when accessing the Internet using the company’s network systems;
put a user of the company’s electronic media and services on notice that private, non-business-related activities are done at the employees’ own risk and are subject to monitoring; and
clearly state that a password is not an indicator of personal privacy.
Once a policy is implemented, an employer should conduct training and inform employees of monitoring and its purposes.

The XYC Corporation case demonstrates that having an electronic media and services policy is not enough. Employers must implement and enforce this policy as well. For example, when an employer suspects or becomes aware of an employee’s misuse of the Internet or e-mail system, the employer should undertake a prompt and thorough investigation. If the investigation reveals inappropriate Internet and/or e-mail use, the employer should take effective remedial action. Depending on the circumstances, this may include terminating the employee’s employment and/or reporting the employee’s conduct to the appropriate authorities.

Last, employers should conduct regular audits to ensure that their policies are in compliance with applicable law and are being followed by employees. Multi-national employers should keep in mind that many countries outside of the United States prohibit or strictly regulate employee monitoring. Such laws also typically prohibit employers from disclosing information about an employee’s use of the Internet or e-mail.

Footnotes

1 XYC Corporation filed notice that it was petitioning the New Jersey Supreme Court to review the decision. However, the parties settled the matter, and XYC Corporation withdrew its petition.

2 In fact, the California Supreme Court has held that three school districts were potentially liable to a thirteen-year-old girl who had been sexually molested by a former employee. See Randi W. v. Muroc Joint Unified School Dist., 14 Cal. 4th 1066 (1997). The former employers had unconditionally praised the former employee in their letters of recommendation, even though they knew of charges or complaints of his prior sexual misconduct with students.

3 Employers that provide an internal e-mail system to employees (as opposed to the public) are not considered “electronic communication service providers” under this law. See, e.g., Andersen Consulting LLP v. UOP, 991 F. Supp. 1041 (N.D. Ill. 2001).

4 According to a recent survey, in the past twelve months, nearly one-third of U.S. companies (31.6 percent) have terminated an employee and more than half of U.S. employers (52 percent) have disciplined an employee for violating e-mail policies. Outbound Email and Content Security in Today’s Enterprise, 2006 (commissioned by Proofpoint, Inc.).

07-05-2006

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McGuireWoods LLP

New Requirements for Phase I Environmental Site Assessments Effective November 1, 2006
Beginning November 1, 2006, purchasers of real property seeking to establish the innocent purchaser, bona fide prospective purchaser or contiguous property owner defenses under the Comprehensive Environmental Response, Compensation and Liability Act must comply with the Environmental Protection Agency's new "All Appropriate Inquiries" standard ("AAI").

07-05-2006

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Epstein Becker & Green, P.C.

NLRB Rules Employer Found to Have Bargained in Bad Faith May Still Lawfully Withdraw Recognition in Light of Union's Loss of Majority Status
On May 31, 2006, the National Labor Relations Board (the "NLRB" or "Board") issued an opinion in Garden Ridge Management, Inc., (347 NLRB No. 13) (i) affirming an administrative law judge's ("ALJ") findings that the employer failed unlawfully to bargain in good faith when it summarily refused requests by the union to meet more frequently, (ii) reversing the ALJ's findings that the employer engaged in unlawful "surface bargaining," (iii) reversing the ALJ's findings that the employer committed an unfair labor practice ("ULP") by insisting on both the union's waiver of its right to organize other units of the employer's employees and a broad management rights clause, and (iv) establishing that an employer's unlawful failure to meet at reasonable times to bargain with a union does not necessarily require a remedy that the employer continue to recognize and bargain with the union where subsequent to the employer failing to meet with the union as often as the union requested, the employer withdrew recognition of the union based upon a good faith belief that the union had lost the support of the majority of the bargaining unit for unrelated reasons.

07-05-2006

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Duane Morris, LLP

Supreme Court Expands Scope of Unlawful Retaliatory Conduct
As employers well know, it is often management's response to a complaint of discrimination, rather than the underlying action complained of, which can lead to liability under the anti-discrimination statutes. In such cases, liability is founded on a claim of ""retaliation"" as the result of a supervisor taking an adverse action against an employee because she complained of discrimination. After a complaint of discrimination is made, management is always faced with the challenge of balancing its right to ensure continued productivity and discipline in the workplace with the employee's right to oppose discrimination without being the subject of retaliatory conduct. The U.S. Supreme Court's latest decision in Burlington Northern and Santa Fe Railway Co. v. White has made management's job more difficult in these circumstances, as it has considerably widened the standard for what constitutes retaliatory conduct.

Anti-discrimination statutes, such as Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act (""ADA"") and the Age Discrimination in Employment Act (""ADEA""), specifically prohibit retaliation against employees who ""opposed"" unlawful discrimination or ""made a charge, testified, assisted, or participated in . . . an investigation, proceeding, or hearing"" regarding unlawful discrimination. The federal courts of appeals, however, have been unsettled on the issue of what could constitute actionable ""retaliation"" against an employee. In some Circuits, actionable retaliation was limited to acts that directly affected an employee's ""terms and conditions of employment,"" such as hiring, firing, promoting, demoting and reducing pay. Other Circuits have held that retaliatory conduct could include less obvious forms of adverse employment actions, such as filing false criminal charges against an employee, modifying an employee's work schedule to a less desirable shift, assigning an employee to less desirable tasks or precluding an employee from participating in workplace training that could help his or her career.

In Burlington Northern, the Supreme Court attempted to resolve the split in the lower courts by adopting a broad standard for retaliation. The Court stated:

We conclude that the anti-retaliation provision does not confine the actions and harms it forbids to those that are related to employment or occur at the workplace. We also conclude that the provision covers those (and only those) employer actions that would have been materially adverse to a reasonable employee or job applicant. In the present context that means that the employer's actions must be harmful to the point that they could well dissuade a reasonable worker from making or supporting a charge of discrimination.
The new standard then is - the retaliation provisions of Title VII are violated when a materially adverse employment action is taken in retaliation for protected activity that might deter a reasonable person from making or supporting a charge of discrimination.

In Burlington Northern, White was the only female employee in a track maintenance department, and performed work repairing train tracks. As a result of her prior experience, White primarily drove the forklift, which was considered a better job than the ""more arduous and dirtier"" work that White's male co-workers performed. During the period that she primarily operated the forklift, White complained about sexual harassment by a male supervisor. White was quickly reassigned to the other work that her co-workers performed, and a male employee was assigned to operate the forklift. Less than two weeks after her reassignment, White was suspended without pay for insubordination. After proceeding through the company's internal grievance process, White was reinstated with back pay for the 37 days during which she had been suspended.

White sued for discrimination and retaliation. White's retaliation claims were based on the company's modification of her duties (i.e., reassigning her from the forklift to less desirable duties) and the 37-day suspension. After a trial, White received a jury verdict in her favor for $43,500 for her claims of retaliation. On appeal, the Sixth Circuit agreed that the company's acts could constitute unlawful retaliation under Title VII.

The Supreme Court agreed and determined that, unlike the anti-discrimination provisions in Title VII, the language in the statute's anti-retaliation provision was not limited to certain kinds of adverse employment actions. The Court noted that Title VII's anti-retaliation provision broadly states, ""It shall be an unlawful employment practice for an employer to discriminate against any of his employees . . . because [they engaged in protected activity]."" The phrase ""to discriminate against"" is not limited, whereas Title VII's anti-discrimination provisions state:

It shall be an unlawful employment practice for an employer -

(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual's race, color, religion, sex, or national origin; or

(2) to limit, segregate, or classify his employees or applicants for employment in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect his status as an employee, because of such individual's race, color, religion, sex, or national origin.
The Court stated that the italicized portions of the anti-discrimination provisions set out limitations to the types of ""unlawful employment practices."" The Court then determined that the lack of any similar limiting descriptions in the anti-retaliation provision meant that the types of conduct that were to be protected from retaliation were to be construed more broadly.

The Supreme Court held that in order to establish a claim for retaliation, a plaintiff must show that a reasonable employee would have considered the retaliatory conduct to be materially adverse, ""which in this context means it well might have 'dissuaded a reasonable worker from making or supporting a charge of discrimination.'"" The Court specified that ""materially adverse"" conduct does not include such things as ""petty slights or minor annoyances that often take place at work and that all employees experience."" To illustrate the point, the Court distinguished between a supervisor's refusal to invite an employee to lunch, which would normally be trivial, and the supervisor's exclusion of an employee from a lunch meeting where training or career development activities were to take place. The Court also specified that ""materially adverse"" conduct ""extends beyond workplace-related or employment-related retaliatory acts and harm."" Thus, while every claim must be considered on a case-by-case basis, adverse action taken in response to protected activity may constitute unlawful retaliation even when it does not directly result in a tangible employment action, such as a discharge, a pay cut or a demotion.

What This Means for Employers

Although the Burlington Northern case was analyzed under Title VII, claims under other anti-discrimination statutes, such as the ADA and ADEA, are generally analyzed similarly. As a result of the Supreme Court's decision in this case, employers should be even more vigilant in the subsequent treatment of any employee who engages in protected conduct under one of the various anti-discrimination statutes. Before taking adverse action against an employee who has recently opposed discrimination or engaged in protected conduct, employers should think through the planned action carefully, diligently document their reasons and consult with employment counsel in order to ensure that they will be able to successfully defend against a possible claim of retaliation.

07-05-2006

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Duane Morris, LLP

IRS Releases Interim Guidelines for Section 179D Energy-Efficient Commercial Buildings Deduction
The IRS recently released interim guidelines pertaining to the deduction for energy-efficient commercial buildings under Section 179D of the Tax Code. This deduction was made available to building owners and leaseholders pursuant to the Energy Policy Act of 2005, enacted on August 8, 2005. The interim guidelines supplement Section 179D and are expected to be incorporated as regulations.

Specifically, the interim guidelines address the process by which a taxpayer obtains certification that installed energy-efficient property qualifies under Section 179D for the full deduction, and establish the total annual energy savings required for obtaining a partial deduction. The interim guidelines also provide information about the software programs that must be used in calculating power and energy expenditures.

Qualifying Energy-Efficient Commercial Building Property and Potential Deductions

Section 179D provides commercial building owners and leaseholders with a deduction for implementing energy-efficient commercial building property in their buildings between December 31, 2005, and January 1, 2008. The deduction is available whether the respective space is new construction or previously existed and applies in the year in which the energy-saving property was made ready for its intended use.

As defined in the Tax Code, ""energy efficient commercial building property"" is property: (a) with respect to which depreciation (or amortization) is allowable; (b) installed in a building located in the United States and within the scope of Standard 90.1-2001 of American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America; and (c) installed as part of the interior lighting systems, heating, cooling, ventilation and hot water systems, or as part of the building envelope. Further, the installed interior lighting, heating, cooling, ventilation, hot water systems and building envelope must either reduce the total annual energy and power costs by fifty percent (50%) or more, or be part of a taxpayer's overall plan, which includes the subsequent installation of the same, and which will reduce the total annual energy and power costs by fifty percent (50%) or more, as compared with a ""Reference Building,"" which is compliant with the minimum requirements of Standard 90.1-2001. For taxpayers meeting this threshold, the maximum deduction available to them is $1.80 per square foot, less the aggregate amount of the Section 179D deductions allowed with respect to the building for all prior taxable years.

Section 179D also provides for a partially qualifying commercial property deduction, which applies to property that would otherwise qualify as energy-efficient commercial building property but results in reductions in the total annual energy and power costs of less than fifty percent (50%) but greater than or equal to sixteen and two-thirds percent (16.66%). For taxpayers meeting this threshold, the maximum deduction available to them is $0.60 per square foot, less the aggregate amount of the Section 179D deductions allowed with respect to the building for all prior taxable years. Section 179D also provides interim guidelines encouraging and providing a deduction for improvements made to lighting systems.

Certification of Qualified Property

Section 179D requires that, before a taxpayer may claim a deduction, the property must be certified as energy-efficient commercial building property by a qualified individual. The requirements of a qualified individual include that the person may not be related to the taxpayer and must be an engineer or contractor that is properly licensed in the jurisdiction where the building is located. The certification does not need to be attached to the taxpayer's tax return, but taxpayers are required to maintain books and records that would satisfy investigation into the applicability of the deduction.

Approved Software Programs

Section 179D requires that certain software programs be used to identify energy expenditures for the purposes of the deduction. The Department of Energy is establishing a public list of software, which may be viewed at http://www.eere.energy.gov/buildings/info/tax_credit_2006.html.

07-05-2006

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Duane Morris, LLP

California Appellate Court Weighs In on Section 1800 and Federal Preemption
California Code of Civil Procedure allows an assignee under a general assignment for the benefit of creditors to recover what under the Bankruptcy Code would be called preferential transfers. However, the U.S. Court of Appeals for the Ninth Circuit called the validity of this statute into question (at least when it arises in federal court) when, in a 2-1 decision issued in early 2005 in Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198 (9th Cir. 2005), it held that Section 1800 is preempted by the federal Bankruptcy Code.

On May 31, 2006, the California Court of Appeal for the Second Appellate District took the first step in reviving the allegedly preempted statute (at least in state court), when it issued its opinion in Haberbush v. Charles and Dorothy Cummins Family Ltd. Partnership, Case No. B175947. Noting that ""[d]ecisions of the lower federal courts on federal questions are persuasive but not binding on state courts,"" the California Court in Haberbush took advantage of its freedom by disagreeing with the Ninth Circuit, and holding that Section 1800 is not preempted.

The central issue in both cases was the doctrine of field preemption, which generally means that where Congress has not expressly displaced state regulation in a certain area, that state regulation may nevertheless be preempted where it ""stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress."" The Congressional purpose allegedly encroached upon by Section 1800 is the Bankruptcy Code's goal of equitable distribution of a debtor's limited assets among its many creditors, where those assets may be insufficient to satisfy all creditors' claims in full.

After reviewing the ways in which the Bankruptcy Code seeks to accomplish an equitable distribution, and the ways in which the Sherwood Partners Court found that Section 1800 interfered with that goal, the Court in Haberbush found that it was ""impossible to conclude that Code of Civil Procedure section 1800 is inconsistent with 'the essential goals and purposes of federal bankruptcy law. . . .'"" (Ironic, given that two out of three judges on the Ninth Circuit Court of Appeals had just done so in Sherwood Partners.)

Responding to the Sherwood Partners decision on many of the same grounds cited in that decision's dissenting opinion, the Court in Haberbush first noted, as the Ninth Circuit had, that Congress intended for state laws governing voluntary assignments for the benefit of creditors (which sport a ""venerable common-law pedigree"") to coexist with the Bankruptcy Code. Second, the Court in Haberbush stated that where such state laws are permitted to coexist, the fact that they implicate the Bankruptcy Code's goal of equitable distribution is not sufficient to conclude that the state law ""stands as an obstacle"" to that goal. That conclusion was especially confounding to the Haberbush Court, which raised the same question asked by the dissenting judge in Sherwood Partners: How does the Section 1800 assignment law, which is virtually identical to the Bankruptcy Code's preferential transfer statute, stand as an obstacle to the goal of equitable distribution?

Where the statutes are virtually identical, it would seem that the Ninth Circuit's problem with Section 1800 is not what it does (equitably distribute a debtor's limited assets), but who does it (a debtor's hand-picked assignee, as opposed to a chapter 7 trustee appointed by the Office of the United States Trustee and subject to the disinterestedness and supervisory requirements imposed by the Bankruptcy Code).

The question now will be whether the U.S. Supreme Court steps in to resolve this turf war between the federal and state courts.

07-05-2006

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