Transcript Slide 1

Emerging Issues for In-House Counsel 2006
Presented by:
The Corporate Litigation Practice Group of
Blank Rome LLP
November 3, 2006
© 2006, Blank Rome LLP
Arbitration: Is It Arbitrary?
Presented by:
Edward N. Cahn, Blank Rome LLP
Hirsh N. Cogan, Blank Rome, LLP, Moderator
LeRoy Lambert, Blank Rome LLP
Michael D. Young, JAMS,Inc.
Arbitration

Is it arbitrary?
3
Typical Clause

Any controversy or claim arising out of or relating to
this contract, or the breach thereof shall be settled by
arbitration administered by the American Arbitration
Association in accordance with its Commercial [or
other] Arbitration Rules [including the Optional Rules
for Emergency Measures of Protection], and judgment
on the award rendered by the arbitration may be
entered in any court having jurisdiction thereof.

Source: American Arbitration Association,
Drafting Dispute Resolution Clauses, A Practical Guide
4
Selection of Arbitrators




Specific Qualifications
Industry Specific
Number of Arbitrators
Party-Neutral Arbitrators
5
Particular Provisions




Locale
Time Periods
Choice of Law
Reasoned Opinion
6
“Baseball” Arbitration

When is it advisable?
7
Mediation

Typical Clause
– If a dispute arises out of or relates to this contract,
or the breach thereof, and if the dispute cannot be
settled through negotiation, the parties agree first to
try in good faith to settle the dispute by mediation
administered by the American Arbitration
Association under its Commercial Mediation
Procedures before resorting to arbitration, litigation,
or some other dispute resolution procedure.
Source: American Arbitration Association, Drafting
Dispute Resolution
Clauses, A Practical Guide
8
Mediation

Is mediation ever too early?
– Obtaining the necessary documents for
mediation
9
Arbitration –
Pleadings and Procedures




Narrative, Descriptive Pleadings
Preliminary Conference
Scheduling Order
Motion Practice
10
Discovery in Arbitration

Contractual Agreement on:
– Number of depositions
– Document production
– Interrogatories
11
Discovery from Out of
State Witnesses

Generally subpoenas calling for the
production of documents do not need to
comply with FRCP 45(b)(2)’s territorial
limit.
Hay Group, Inc. v. E.B.S. Acquisition
Corp., 360 F.3d 404 (3d Cir. 2004)
In re Security Life Ins. Co., 228 F.3d 865
(8th Cir. 2000)
12

The Second Circuit disagrees with the recent trend
that subpoenas for the production of documents do
not need to comply Rule 45(b)(2)’s territorial limit.
Dynegy Midstream Services LP v. Trammochem,
2006 WL 1612722 (2d Cir. 2006)
13
Injunctive Relief



Under the FAA, arbitrators can grant preliminary injunctive relief. See
Advisors Inc. v. Thorley, 147 F.3d 229, 230-31 (2d Cir. 1998);
Commercial Arbitration Rules and Mediation Procedures, at R-31(b).
Under Pennsylvania law, arbitrators can grant any form of equitable relief.
See 1980 Uniform Arbitration Act, 42 Pa.C.S.A. §§ 7301; Dickler v.
Shearson Lehman Hutton, Inc., 408 Pa. Super. 286 (Pa. Super. Ct. 1991)
N.Y. C.P.L.R. 7502(c) grants the court only the limited authority to issue
an order of attachment or a preliminary injunction in connection with an
arbitrable controversy and does not, despite petitioners' contentions,
endow the court with broad discretionary powers to fashion other
injunctive orders "in aid of arbitration." Salvano v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., 85 N.Y.2d 17 (1995)
14
Punitive Damages



Under the FAA, if contracting parties agree to include
claims for punitive damages within the issues to be
arbitrated, the Federal Arbitration Act ensures that their
agreement will be enforced. 9 U.S.C.S. §§ 3, 4,
Mastrobuono v. Shearson Lehman Hutton, 514 U.S. 52
Under Pennsylvania law, if an agreement is silent as to
remedies, arbitrators can award punitive damages.
Phillips v. Babcock & Wilcox, 349 Pa. Super. 351
(Pa. Super. Ct. 1985)
Under New York law, an arbitrator cannot award
punitive damages. Garrity v. Lyle Stuart, Inc., 40 N.Y.2d
15
354 (1976)
The “Manifest Disregard of Law”
Standard of Review for
Arbitration Awards
16
Manifest Disregard of Law
under the FAA?

In order to overturn an award for “manifest
disregard,” a court must determine that:
– the law that was allegedly ignored was clear, and in
fact explicitly applicable to the matter before the
arbitrators;
– the law was improperly applied, leading to an
erroneous outcome and
– arbitrator knew of the law’s existence and that it
should have been applied to the case before him.
17
New York and Pennsylvania

Under CPLR 7511, “manifest disregard of the law” is not a standard
under which a court can overturn an arbitrator’s decision.
Banc of Am. Secs. v. Knight,
2004 NY Slip Op 24232 (N.Y. Sup. Ct. 2004)

Recently, there has been an indication that New York may adopt
the “manifest disregard of the law” standard.
Wien & Malkin LLP v. Helmsley-Spear, Inc.,
6 N.Y.3d 471 (2006)

Pennsylvania law recognizes "manifest disregard of the law" as a
ground for vacating an arbitration award.
Republic W. Ins. Co. v. Legion Ins. Co.,
2001 Phila. Ct. Com. Pl. LEXIS 58
18
Arbitration Clauses


Are they always advisable?
When should they be utilized?
19
The Society of Maritime
Arbitrators, Inc. (“SMA”)

Formed in 1963 to provide a way for
companies in the industry to have disputes
resolved by commercial peers without resort
to the courts. Membership consists of
approximately 80 commercial persons
(including non-practicing lawyers).
20


Awards are published. There are presently in
excess of 3800 awards. Awards are available
on Lexis, ADMRTY Library, USAWDS File. There
are SMA Rules for Arbitration, for Mediation,
and for Conciliation.
Healy & Baillie (now Blank Rome) was attorney
of record in more than 600 of the published
awards (more than any other firm) and of
course in hundreds of other disputes subject to
arbitration which were resolved prior to award.
21
An SMA Panel


Most forms of charter parties call for
disputes arising under the charter to be
resolved by arbitration in London or New
York.
Typically, disputes are heard by threeperson panels. Each party appoints an
arbitrator and those two select a chairman.
22
Proceedings in an SMA
Arbitration (i)



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Compared to court, VERY informal, and compared
to most other arbitral bodies, informal.
No administration. Essentially, an ad hoc
arbitration, subject, of course, to the SMA Rules.
No pleadings, but parties often exchange
statements of their respective cases or present their
cases orally at an organizational hearing.
Limited discovery. Depositions are the exception,
not the rule, and only if parties agree. Extent of
document production depends on the parties, their
counsel, the issues, and the panel. “Any and all”
requests are not favored.
23
Proceedings in an SMA
Arbitration (ii)




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Claimant presents its case in chief.
Respondent presents its defense.
Cases are typically presented in stages, at different
times, not at one sitting. This is a consequence of
not having discovery.
Once parties have presented their evidence, they
exchange main and reply briefs.
Panel issues its award.
The award is subject to review by the district court
in accordance with Federal Arbitration Act and/or
applicable Conventions. It is very difficult to vacate
an award.
24
Arbitration with a difference?

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Consolidation of disputes between parties to
different contracts if issue involves “common
questions of fact or law and/or arise in
substantial part from the same maritime
transactions or series of related transactions,
provided all contracts incorporate SMA Rules.”
Section 2.
Section 30 authorizes an award of attorney’s fees
to the prevailing party, and SMA arbitrators
typically award them.
SMA arbitrators may award punitive damages in
maritime cases, but rarely do so.
25
Emerging Issues in Delaware Law
Presented by:
Alisa E. Moen, Blank Rome LLP
Craig A. Damast, Blank Rome LLP
Thomas P. Preston, Blank Rome LLP, Moderator
Once Upon a Disney The Evolution of the Fiduciary Duty of Good Faith
Trenwick America Litigation Trust v. Ernst &
Young, L.L.P.
2006 WL 2434228 (Del. Ch. Aug. 10, 2006)
- Fiduciary duties to creditors of a subsidiary
27
Once Upon a Disney –
The Evolution of the Duty
of Good Faith
Common law origin – the Triad



Duty of Care
Duty of Loyalty
Duty of Good Faith - maybe
Cede & Co v. Technicolor,
634 A.2d 345, 381 (Del. 1993)
28
What Is Good Faith?

good faith, n. A state of mind consisting in
(1) honesty in belief or purpose,
(2) faithfulness to one’s duty or obligation,
(3) observance of reasonable commercial
standards of fair dealing in a given trade or
business, or (4) absence of intent to defraud
or to seek unconscionable advantage…
Black’s Law Dictionary (2004)
29

bad faith, n. The opposite of “good faith,”
generally implying or involving actual or
constructive fraud, or design to mislead or
deceive another, or a neglect or refusal to
fulfill some duty or some contractual
obligation, not prompted by an honest
mistake as to one’s rights or duties, but by
some interested or sinister motive.
Black’s Law Dictionary (2004)
30

scienter. n. Lat. Knowingly. The term is used
in pleadings to signify an allegation … setting
out the defendant’s previous knowledge of
the cause which led to the injury complained
of, or rather his previous knowledge of a state
of facts which it was his duty to guard
against, and his omission to do which has led
to the injury complained of.
Black’s Law Dictionary (2004)
31
The Duty of Good Faith



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Is it a free-standing duty?
 (Disney Ft. n. 112)
Is it a state of mind?
Is it a standard of conduct?
Is it a catch-all?
Is it a gap-filler?
32
Is It a Gap Filler?
Duty of Care
Duty of Loyalty
“perform management
functions with the care
that an ordinary
prudent person would
reasonably be
expected to exercise in
a like position and
under similar
circumstances.”
Self-dealing or
conflict of interest
where best
interests of
corporation and
shareholders take
precedence over
interests of
director, officer or
controlling
shareholder. Guth
v. Loft, 5 A.2d 503
(Del. 1939)
Duty of Good Faith
Graham v. AllisChalmers Mfg. Co.,
188 A.2d 185, 130
(Del. 1963)
33
Is It a Standard of
Conduct?
Good Faith
Duty of Loyalty
Self-dealing or conflict
of interest where best
interests of corporation
and shareholders take
precedence over
interests of director,
officer or controlling
shareholder. Guth v.
Loft, 5 A.2d 503 (Del.
1939)
Duty of Loyalty
Duty of Care
34
According to Disney….

“To act in good faith, a director must act at
all times with an honesty of purpose and in
the best interests and welfare of the
corporation … a true faithfulness and
devotion to the interests of the corporation
and its shareholders…”
In re the Walt Disney Company,
2005 WL 2056651 (Del. Ch. 2005)
35
Bad Faith

An “intentional dereliction of duty, a
conscious disregard for one’s responsibilities
… deliberate indifference and inaction in the
face of a duty to act … conduct that is
clearly disloyal to the corporation. It is the
epitome of faithless conduct.”
In re the Walt Disney Company,
2005 WL 2056651 (Del. Ch. 2005)
36
How is “Good Faith”
different from Loyalty?


No allegation of breach of duty of loyalty in
Disney – just bad faith
The only way to rebut the business judgment
rule presumption is to demonstrate that the
conduct was in bad faith
37

Breach of Duty of Care
– Directors are protected by the BJR, unless
Plaintiffs can demonstrate gross
negligence or bad faith.
No Indemnification
§145
No Exculpation
§102(b)(7)
38

Breach of Duty of Loyalty
– may be authorized and ratified by the majority
of disinterested directors;
– may survive the entire fairness test
– no protection of the BJR, no indemnification, no
exculpation, probably no D&O
(See §145(g) permits purchase of D&O regardless of whether the
conduct can be indemnified, but not willful, deliberate, or criminal
conduct)
39
Statutory Framework
Delaware General Corporation Law



good faith is not defined
no liability imposed
finding of bad faith negates statutory
exculpation and indemnification
40
8 Del. C. § 101 et seq.
The term “good faith” appears nine times
-
102(b)(7) – exculpation clause
103(i) – filling error (“good faith effort”)
125 – conferring academic or honorary degrees
141(e) reliance on corporate records and third party reports
144 – ratification of conflict transactions by shareholders
145 – indemnification
162(c) – transfer of stock
172 – reliance on corporate records and third party reports
203 – business with interested stockholders
41
Fiduciary Duties in
Alternative Entities

The policy of alternative entities is to “give
maximum effect to the principle of freedom
of contract and to the enforceability of
[alternative entity’s] agreements.”
§ 17-1101(c); § 18-1101(b)
42
Contractual Abrogation

“To the extent that, at law or in equity, a member
or manager or other person has duties (including
fiduciary duties) to a limited liability company or to
another member or manager or to another person
that is party to or is otherwise bound by a limited
liability company agreement, the member’s or
manager’s or other person’s duties may be
expanded or restricted or eliminated by provisions
in the limited liability company agreement;
provided, that the limited liability company
agreement may not eliminate the implied
contractual covenant of good faith and fair dealing.”
6 Del. C. § 18-1101(c)
43
Why Do We Care?

§ 102(b)(7)
“a provision eliminating or limiting the personal liability of a
director to the corporation or its stockholders for monetary
damages for breach of fiduciary duty … shall not eliminate or
limit the liability … for acts or omissions not in good faith…”

§ 145
“a corporation shall have power to indemnify any person … by
reason of the fact that the person is or was a director, officer,
employee or agent of the corporation … if the person acted in
good faith…”
44
Business Judgment Rule

a presumption that in making a business
decision, directors of a corporation act on
an informed basis, in good faith, and in an
honest belief that the action taken was in
the best interest of the company.
45
Application of the BJR

“[b]usiness judgment rule protects the
directors of solvent, barely solvent, and
insolvent corporations, and … the creditors
of an insolvent firm have no greater rights
to challenge a disinterested, good faith
business decision than the stockholders of a
solvent firm.”
Trenwick Am. Litig. Trust,
2006 WL 2333201, at *22 n. 75, see also North Am.
Catholic Education programming Foundation, Inc. v.
Ghewalla, et al. 2006 WL 2588971, at *11 (Del. Ch.
Sept. 1, 2006).
46
Trenwick

The complaint set forth eight counts, all centered
on one idea – Trenwick’s expansion and acquisition
of Chartwell and LaSalle was “irrational” and
resulted from “gross negligence”. Such expansion
and subsidiary reorganization resulted in the
creation of a large insurance holding company with
inadequate reserves and assets to cover the claims
that were ultimately made against it rendering it
insolvent and leaving it with too few assets to
satisfy its creditors.
47
Defendants



Trenwick Group Inc.’s directors (parent
corporation)
Trenwick America Corp’s directors
(wholly-owned subsidiary - Debtor)
Former third-party advisors – Ernst &
Young, PWC, Baker & McKenzie and
Milliman, Inc.
48
Plaintiff


Litigation Trust
- created by the Litigation
Trust Agreement pursuant to
Trenwick America’s chapter 11 plan of
reorganization.
The Court dismissed claims of Debtor’s creditors to
the extent those claims could not have been
assigned to the Litigation Trust and did not
represent claims of the Debtor.
49
Consequences of
Trenwick….if any…



Does it raise the bar on pleading
insolvency?
Does it change the application of 102(b)(7)
to protect directors of insolvent
corporations?
Does the BJR rule change when the
company is insolvent?
50
Delaware law vs. New
York law

Unlike other jurisdictions, including New
York, 102(b)(7) under Delaware law
exculpates directors for actions that take
place when the company is insolvent.
51
Delaware vs. New York
Fiduciary Duties


DE – duty of care, loyalty and good faith
NY – duty of care, loyalty and obedience
(“the obligation of directors and officers to
act within the organization’s purposes and
ensure that the corporation’s mission is
pursued” State v. Grasso)
52
State v. Grasso: New Trend or
New York Non-Profit Outlier?
“This entire case rises and falls on the
issue of whether the NYSE acted ultra
vires in awarding Mr. Grasso excessive
compensation and benefits.”
53
Who is responsible for
excessive compensation?


Have directors hijacked the NYSE and
siphoned off the NYSE’s funds to pay Grasso?
Who is responsible for the ultra vires actions?
– directors? CEO? – Who is pay?
54
Trouble with Boilerplate
How Standard Clauses Stand Up In Court
Presented by:
Ann B. Laupheimer, Blank Rome LLP, Moderator
Faith Greenfield, Campbell Soup Company
Richard P. McElroy, Blank Rome LLP
Robert J. Stillman, Aetna Inc.
Agreements to Negotiate
in Good Faith
The parties agree to negotiate in good faith to
resolve expeditiously any controversies, claims or
disputes between the parties that may arise from
time to time under this Agreement or otherwise
relating to the Joint Venture. . . .
This letter agreement is not intended to be binding
upon the parties unless and until the parties sign a
final written agreement. The parties agree to
negotiate in good faith to enter into a final
agreement by 90 days from today.
56
Why Include These Terms?

Preliminary Duty to Negotiate In Good Faith?
– naïve belief in positive thinking
– aversion to litigation (belief in the power of
“business solutions”)
– inability to decide on firm outcome, time limits or
critical deal terms
– weak alternative to a carefully tailored mediation
and arbitration clause

Effective leverage between business persons
to get to a final agreement
57
Problem: How do I know when I
have negotiated in good faith?

Consider one litigant’s unsuccessful argument to
the federal court in New York that the court imply a
duty to:
– Disclose information material to party’s ability to formulate
offer
– Make offers and counteroffers
– Continue negotiations for a sufficient minimum period of
time before signing with other suitor to permit party a fair
opportunity to compete with alternative offer
Candid Productions, Inc. v. International
Skating Union, 530 F. Supp. 1330 (S.D.N.Y.
1982).
58
Will a Court Enforce a “Good Faith
Negotiation” Duty and if So, How?

New York law: probably not.
See, e.g., JillcyFilm Enterprises, Inc. v. Home
Box Office, Inc., 593 Supp. 515 (S.D.N.Y.
1984); Candid Productions, Inc. v.
International Skating Union, 530
F. Supp. 1330 (S.D.N.Y. 1982)

Pennsylvania law: probably if sufficiently definite.
See e.g., Channel Home Centers v. Grossman,
795 F.2d 291, 299 (3d Cir. 1986).



Illinois law: maybe yes
Minnesota: maybe no
New Hampshire: probably yes, and reserves for another day
the appropriate remedy (maybe none).
See Howtek, Inc. v. Relisys, 958 F. Supp. 46,
48 (D.N.H. 1996) (collecting cases).
59
No Jury Please
With respect to any judicial proceeding
commenced by either party to this Agreement
relating to a disputes, controversies, or issues
arising under or relating to this Agreement,
matter, both parties agree to waive their
rights, if any, to a jury trial.
60
To Waive or Not to Waive

Reasons to waive
– Belief that juries are not as intelligent as a judge
– Belief that subject matter lends itself to
emotional bias and you are on the wrong side
– Belief that Judge has better judgment or ability
to understand and study complex issues

Reasons not to waive
– Avoid “jury of one”
– Avoid judicial lottery
– Believe your client has the equities
61
Elements of a Successful
Jury Waiver




Think Big Scope: Some cases have made subtle distinctions in
the language of the waiver and Supreme Court requires that jury
waivers be construed narrowly. Aetna Ins. Co. v. Kennedy, 302
U.S. 389, 393 (1937).
Think Big Government: most federal courts enforce a clear
waiver.
Think Big Apple: New York case law is good and plentiful. A
broad jury waiver applies to torts and contracts, may be
enforced even in the face of fraud in the inducement claim.
Fraudulent Inducement: Most jurisdictions have embraced
Telum, Inc. v. E.F. Hutton, 859 F.2d 835, 837-38 (10th Cir. 1988),
requiring proof that jury waiver clause induced by fraud. See
Gurfein v. Sovereign Group, 826 F. Supp. 890, 921 (E.D. Pa.
1993).
62
“Don’t Look At Me!”:
Limiting Your Liability
Neither party will be liable to the other for
consequential, indirect or punitive damages for any
cause of action, whether in contract, tort or
otherwise, except for any grossly negligent, willful
or fraudulent act or omission.
Consequential damages include, but are not limited
to, lost profits, lost revenues and lost business
opportunities, whether or not the other party was or
should have been aware of the possibility of these
damages.
63
Protect Your Client With
Broad Limitation Language





Tort and Contract – make sure you include tort
and contract claims, as economic loss doctrine is
unreliable.
Lost Profits - Think about “consequential” in terms
of direct or indirect lost profits.
Punitive Damages – are they available for willful
breach of contract – trap for the unwary.
No Exceptions -- Think twice before including the
“gross negligence, willful or fraudulent conduct”
carve-out.
Damage Cap - Consider a monetary damages cap
-- ordinarily enforceable between sophisticated
parties.
64
Can The Parties Eliminate the
Recovery of Lost Profits and What
Are “Consequential Damages”?


Most courts will permit a clear waiver of lost
profits
Does elimination of “consequential
damages” avoid all claims for lost profits
– Ordinary benefit of the bargain damages for
breach of contract look a lot like “lost profits.”
– Most Courts distinguish between “direct” and
“indirect” lost profits.
65
Punitive Damages for
“Intentional” Breach of Contract





Conventional wisdom: punitive damages are available only
for torts
New York: punitive damages available for willful or
egregious breach of contract claims that include element of
public wrong. Rocanova v. Equitable Life Assur. Soc’y, 83
N.Y.2d 603, 613 (N.Y. 1994)
Minority of jurisdictions: punitive damages available for
“intentional breach of contract” under specific circumstances
Caution: exclude punitive damages, at the very least for
contract claims.
Fraud: hornbook law that a party may not, consistent with
public policy, insulate itself from any claim of fraud, but you
can likely limit the damage. Restatement (Second) of
Contracts § 195 (1981)
66
Contractually Shortened
Limitations Periods

Parties frequently provide for expiration of
warranties in a shorter timeframe than
statute of limitations or other mechanism to
shorten limitations period.
–
–
–
–
–
–
New York: Ok
Pennsylvania: Ok
Illinois: Ok
Missouri: against public policy by statute
Kentucky: Ok
California: Ok
67
Drafting an Integration
Clause That Sticks
This Agreement, including Appendices
attached to this Agreement and the Recitals
set forth herein, constitutes the entire
agreement between the parties pertaining
to the subject matter hereof, and all prior
representations, discussions and
negotiations between the parties and/or
members or Groups pertaining to the
subject matter of this Agreement are
superseded.
68
Preventing Claims of Fraud Based
On Pre-Contractual Negotiations

Boilerplate Integration Clauses Often Fail to prevent
claims of reliance on pre-contractual information
exchange
– New York: a general merger or integration clause does
not bar a claim for fraud or fraud in the inducement. Gizzi
v. Hall, 754 N.Y.S.2d 373, 376 (N.Y. App. Div. 2002).
– Delaware: simple integration clause traditionally not
enough to bar fraud in the inducement. Norton v. Poplos,
443 A2d 1 (Del. 1982).
– Pennsylvania: “We, too, have attempted to find
consistency in Pennsylvania parol evidence cases where
fraud is alleged. Our examination of the pertinent cases
has led us reluctantly to conclude that no intellectually
sound analysis of the cases can yield a perfectly consistent
set of principles.” 1721 Cherry St. Partnership v. Bell
Atlantic Properties, 439 Pa. Super. 141 (1995) (Beck, J.).
69
Favorable Trend in Sophisticated
Business Transactions

Delaware Chancery Court: ABRY Partners V, L.P. v. F&W
Acquisition LLC, 891 A.2d 1032, 1057 (Del. Ch. 2006):
“a party cannot promise, in a clear integration clause of a
negotiated agreement, that it will not rely on promises and
representations outside of the agreement and then shirk its
own bargain in favor of a ‘but we did rely on those other
representations’ fraudulent inducement claim.”

Southern District New York: DynCorp v. GTE Corp., 215 F.
Supp. 2d 308 (S.D.N.Y. 2002):
“A party to a contract cannot allege that it reasonably relied
on a parol representation when, in the same contract, it
"specifically disclaims reliance upon [that] particular
representation." See also MBIA Insurance Corp. v. Royal
Indemnity Co., 426 F.3d 204, 218 70(3d Cir. 2005) (Alito, J.)1
Draft Detailed Integration/AntiReliance Provision



Be Specific: Describe the representations or
information upon which the parties may not and did
not rely, such as sales information or forecasts,
reserves, omission of proprietary information,
projected income, budgets
Be detailed: disclaim accuracy of all data
exchanged, have parties specifically agree that they
did not rely on particular types of information.
Waive any right to allege fraud in the inducement
based on anything not included in the final written
agreement.
71
What About Parole Evidence?



Will a court look outside the four corners of contract for
“meaning” and “intent of the parties” where a term is found
ambiguous?
Will the integration clause prevent this?
Pennsylvania: “Parol evidence of representations concerning a
subject dealt with in an integrated written agreement and
made prior to or contemporaneous with the execution of the
agreement is admissible to modify or avoid the terms of that
agreement only where it is alleged that the parties agreed
that those representations would be included in the written
agreement but were omitted by fraud, accident, or mistake.
This is commonly referred to as ‘fraud in the execution’. . . .”
1721 Cherry St. Partnership v. Bell Atlantic Properties, 439 Pa.
Super. 141 (1995) (Beck, J.).
72
Indemnify This!
Each Indemnifying Group shall be responsible for and shall
indemnify the other Group against any and all Losses arising in
connection, directly or indirectly, with
–
–
–
–
–
–
any material breach of any material representation or warranty made
by an Indemnifying Group in this Agreement or in any document
contemplated by this Agreement;
any material breach of any material covenant made by an
Indemnifying Group in this Agreement or in any document
contemplated by this Agreement;
Products made and sold by or on behalf of such Indemnifying Group or
its predecessors prior to the Effective Date;
Breaches of contract, negligent acts or omissions, or breaches of law,
perpetrated or caused by such Indemnifying Group or its predecessors
prior to the Effective Date;
Employee claims (including, without limitation, due to dismissal by
reason of redundancy, conduct or otherwise) made by employees of
such Indemnifying Group or its predecessors prior to the Effective
Date; and
Any acts or omissions occurring prior to the Effective Date arising out
73
of or relating to (i) such Group’s Transferred
Assets, or (ii) such
Group’s business which are the subject of this Agreement.
Indemnification for Claims of
Intentional Wrongful Conduct



Prohibited in most jurisdictions where there is a finding of
intentional wrongful conduct, with jurisdictions less clear on
whether a “finding” of is required.
New York: permits (with clear language) contractual
indemnification so long as no finding of intentional wrongful
conduct. See Gibbs-Alfano v. Burton, 281 F.3d 12, 19-22 (2d
Cir. 2002).
Delaware: scant law but general observations critical of
indemnity contracts “which indemnify one against the
consequences of his own negligence” or where party found
liable for conduct more egregious than negligence. See e.g.,
Alten v. Ellin & Tucker, 854 F. Supp. 283, 288 – 289 (D. Del.
1994), citing Howard, Needles, Tammen & B v. Steers, Perini
& P, 312 A.2d 621, 624 (Del. 1973).
– BUT: see Delaware has highly developed law of
indemnifying officers and directors
so long as they acted
74
in good faith.
Indemnification for Punitive
Damages?

Punitive damages: usually awarded only
in cases of malicious, fraudulent, intentional
or willful misconduct, but in some
jurisdictions available for “reckless” conduct.
– insurance coverage cases permit indemnification
for vicariously imposed punitive damages
– Include special choice of law, modeled after
insurance policies or a promise by the parties
not to invoke public policy or challenge
enforceability
75
Indemnification for Cost to
Comply With Non-Monetary Relief

Non-monetary loss: if contract includes specific
language and method of calculating value, freedom
of contract should permit indemnification. See
National Casualty Co. v. Newtown Township, 2000
U.S. Dist. LEXIS 10747 (E.D. Pa. 2000) (Fullam, Sr.
J.) (insurer may contract to avoid indemnity
obligation for non-monetary loss, implying that
contract would govern this question) Outboard
Marine Corp. v. Liberty Mutual Ins. Co., 607 N.E.2d
1204 (Ill. 1993) (costs to comply with equitable
relief qualify as “damages” subject to
indemnification).
76
Indemnification for Party’s
Own Negligence


Illinois and New Jersey: prohibited by statute in
construction contracts:
“With respect to contracts or agreements, either public or
private, for the construction, alteration, repair or maintenance
of a building, structure, highway bridge, viaducts or other
work dealing with construction, or for any moving, demolition
or excavation connected therewith, every covenant, promise
or agreement to indemnify or hold harmless another person
from that person's own negligence is void as against public
policy and wholly unenforceable.” 740 ILCS 35/1. See N.J.
Stat. § 2A:40A-1 (same).
Pennsylvania: while such contracts are disfavored, party
may be indemnified against its own negligence if it uses “clear
and unambiguous language” with burden on party seeking
indemnity and ambiguities resolved against. See Amquip
Corp. v. Delaware Valley Erectors, 1999 U.S. Dist. LEXIS
18276 (E.D. Pa. 1999), aff’d, 265 77F.3d 1054 (3d Cir. 2001).
Special Rule in Securities
Fraud Cases

Most jurisdictions find indemnification
(implied or contractual) for securities
violations unavailable based on public policy
concerns, regardless of degree of fault.

– Eichenholtz v. Brennan, 52 F.3d 478 (3d Cir.
1995).
– Globus v. Law Research Service, Inc., 418 F.2d
1276 (2d Cir. 1969).
– In re Olympia Brewing Co. Sec. Lit., 674 F. Supp.
597, 611 (N.D. Ill. 1987) (collecting cases
concerning implied right to indemnification)
78
Developments in Database Security Law
Presented by:
Kit Applegate, Blank Rome LLP
Jordana Cooper, Blank Rome LLP, Moderator
Developments In Database
Security Law: Outline



Federal privacy law directed to financial
institutions: Gramm-Leach-Bliley
New state privacy statutes broadly directed
to businesses that conduct business within
the state and/or own or license personal
information of residents of the state
Enforcement
– State Attorney General activity
– Private litigation and class actions
– Federal agencies: FTC 80
Gramm-Leach-Bliley and
State Statutes: Introduction

G-L-B: 15 U.S.C. § 6801 et seq.:
– “It is the policy of Congress that each financial
institution has an affirmative and continuing
obligation to [1] respect the privacy of its
customers and [2] to protect the security and
confidentiality of those customers’ nonpublic
personal information.” 15 U.S.C. § 6801.
– Regulatory authority to reside with the federal
banking agencies, National Credit Union
Administration, Secretary of the Treasury, SEC,
and FTC, which regulate the financial institutions
81
subject to their jurisdiction,
and enforce G-L-B.
Gramm-Leach-Bliley and
State Statutes: Introduction

State Statutes
– At least 30 states presently have security
breach notification laws
– Statutes are similar, but far from uniform
– Cover a variety of topics



Notification of security breach
Use of Social Security numbers
Destruction of records that contain “personal
information”
82
G-L-B: Who Is Covered?


G-L-B: Any institution the business of which is
engaging in “financial activities” as defined by
Section 4(k) of the Bank Holding Co. Act of 1956.
15 U.S.C. § 6809(3)(A).
“Financial activities” include, inter alia:
– Lending, investing for others, or safeguarding money or
securities;
– Insuring or issuance of annuities or acting as an agent or
broker for such activities;
– Providing financial, investment, or economic advisory
services;
– Underwriting or making a market in securities. 12 U.S.C. §
83
1843(k)(4)(C).
G-L-B: Who Is Covered?



Generally, “financial institution” is defined “very
broadly under G-L-B and includes several entities
not traditionally recognized as financial institutions.”
65 Fed.Reg. 33646 (FTC). But FTC Rule contains a
“significantly engaged” modifier. Id.
Overlap between financial institutions covered by GL-B and entities covered by HIPAA. 65 Fed.Reg.
33646.
Colleges and universities are not exempted – may
be double-regulated by FERPA; compliance with
FERPA adequate to FTC. 65 Fed.Reg. 33646.
84
State Statutes:
Who Is Covered?

Apply to both businesses and individuals who:
– conduct business in that state; and/or
– own or license personal information of a resident of that
state


Also apply to third-party vendors that compile or
maintain personal information on behalf of other
businesses
“Financial institutions” covered under G-L-B are also
subject to the state statutes
– Exceptions exist for those that maintain procedures for a
breach of security system pursuant to federal or state
regulations
85
G-L-B:
What Information Is Covered?

“Nonpublic personal information.” With certain
exceptions, “a financial institution may not, directly
or through any affiliate, disclose to a nonaffiliated
third party and nonpublic personal information,
unless such financial institution provides or has
provided to the consumer a notice” that complies
with the statute and that gives the consumer a
reasonable opportunity to “opt out” of the
disclosure before it occurs. 15 U.S.C. § 6802; 65
Fed.Reg. 35162.
86
G-L-B:
What Information Is Covered?

“Nonpublic personal information”: In addition to
lists or groupings of consumers, this means
“personally identifiable financial information,”
excluding “publicly available information”
(information the financial institution has a
reasonable basis to believe is lawfully made
available to the general public from certain
specified sources). 65 Fed.Reg. 33646.
87
G-L-B:
What Information Is Covered?

“Personally available financial information” broadly
includes information a consumer provides to you on
an application, not just account balance
information, payment history, and credit/debit
purchase information. The FTC believes that “any
information should be considered financial
information if it is requested by a financial
institution for the purpose of providing a financial
product or service.” (Addresses, phone numbers.) It
also includes the fact that the individual has been
one of your customers. 65 Fed.Reg. 33646.
88
State Statutes:
What Information Is Covered?


Computerized data that include “personal
information”
“Personal information”
– Individual’s name
– Linked to any of the following:



Social Security number;
Driver’s license number or state identification card
number; or
Account, credit, or debit card number in combination
with any security code, access code, or password that
would permit access to the individual’s financial
account
89
G-L-B: Privacy Policies

G-L-B: Among other things, a financial
institution’s privacy policy contains a
description in general terms of who is
authorized to have access to the information
and states whether the institution has
security practices and procedures in place to
ensure the confidentiality of the information
in accordance with the policy. 65 Fed.Reg.
33646.
90
G-L-B:
Standards For Safeguarding
Customer Information


G-L-B: Regulators confer on institutions the
discretion to determine the levels of protection
necessary for different categories of information.
66 Fed.Reg. 8616.
Each institution must implement a comprehensive
written information security program that includes
administrative, technical, and physical safeguards
appropriate to the size and complexity of the
institution and the nature and scope of its activities.
66 Fed.Reg. 8616.
91
G-L-B:
Standards For Safeguarding
Customer Information

The information security program should be
designed to ensure the security and confidentiality
of customer information, protect against any
anticipated threats to the security of such
information, and protect against unauthorized
access to or use of such information that could
result in substantial harm or inconvenience to any
customer. 66 Fed.Reg. 8616.
92
State Law:
Standards For Safeguarding
Customer Information

The state statutes generally do not require the
formulation of information security protocols
– California is a notable exception. Companies that own or license
unencrypted personal information about California residents are
required to “implement and maintain reasonable security
procedures and practices” for that data

Destruction of records
– “A business . . . shall destroy, or arrange for the destruction of, a
customer’s records [paper or electronic] within its custody or
control containing personal information, which is no longer to be
retained by the business . . . by shredding, erasing, or otherwise
modifying the personal information in those records to make it
unreadable, undecipherable or nonreconstructable through
generally available means.” N.J.S.A. 56:8-162.
93
State Law:
Standards For Safeguarding
Customer Information

Limitations on use of Social Security
numbers
– Shall NOT:



Publicly post or display any four or more consecutive
numbers of an individual’s Social Security number
Print an individual’s Social Security number on any
materials mailed to the individual
Print an individual’s Social Security number on any card
required for the individual to access products or
services provided by the entity
94
State Law:
Standards For Safeguarding
Customer Information

Limitations on use of Social Security
numbers
– Shall NOT:


Intentionally communicate or otherwise make available
to the general public an individual’s Social Security
number
Require an individual to transmit his Social Security
number over the internet, unless the connection is
secure or the Social Security number is encrypted
95
G-L-B: What Is A Breach
Triggering Statutory Notification?


G-L-B: An incident involving unauthorized access
to or use of “sensitive customer information.” 70
Fed.Reg. 15736.
“Sensitive customer information”: a customer’s
name, address, or telephone number in conjunction
with social security, driver’s license, account, credit
or debit card number, or a personal identification
number or password that would permit access to
the customer’s account. Also any combination of
components that would allow someone to log onto
or access the customer’s account, such as user
name and password. 70 Fed.Reg. 15736.
96
State Law: What Is A Breach
Triggering Statutory Notification?


State statutes are not uniform in their definition of
“breach of security”
Access
– Unauthorized access of unencrypted computerized data
that compromises the security, confidentiality, or integrity
of personal information maintained by the business

Acquisition
– Unauthorized acquisition of unencrypted computerized
data that compromises the security, confidentiality, or
integrity of personal information maintained by the
business

Access and Acquisition
97
G-L-B:
When Must You Notify Customers?

G-L-B: When a financial institution
becomes aware of an incident of
unauthorized access to sensitive customer
information, it must investigate reasonably.
If the institution determines that “misuse of
its information about a customer has
occurred or is reasonably possible,”
notification is triggered. 12 C.F.R. Pt. 30,
App. B.
98
State Law: When Must
You Notify Customers?

Generally, duty to notify arises when a
business:
– Becomes “aware,” “discovers,” or receives
“notification” of a breach of security; and
– Ascertains that a customer’s personal
information “was, or is reasonably believed” to
have been acquired/accessed by an
unauthorized person
99
G-L-B: Which Customers
Must Be Notified?


G-L-B: Notice to “affected customers.” “If a financial
institution, based upon its investigation, can determine from
its logs or other data precisely which customers’ information
has been improperly accessed, it may limit notification to
those customers with regard to whom the institution
determines that misuse of their information has occurred or is
reasonably possible.”
“However, there may be situations where the institution
determines that a group of files has been accessed
improperly, but is unable to identify which specific customers’
information has been accessed. If the circumstances of the
unauthorized access lead the institution to determine that
misuse of the information is reasonably possible, it should
notify all customers in the group.”100 12 C.F.R. Pt. 30, App. B.
State Law: Which Customers
Must Be Notified?


Notification must be provided to those
customers whose “personal information”
“was, or is reasonably believed” to have
been acquired/accessed
Risk of harm exception in some statutes
– Disclosure not required if business establishes
that “misuse” of information not reasonably
possible
– Determination must be documented in writing
and retained for five years
101
G-L-B: How Soon Do Affected
Customers Have To Be Notified?

“[A]s soon as possible.” 12 C.F.R. Pt. 30,
App. B., Supp. A, III.A.
102
State Law: How Soon Do Affected
Customers Have To Be Notified?

Generally, notice must be made “in the most
expedient time possible and without
unreasonable delay”
– Florida mandates notice within 45 days

Notification may be delayed:
– to determine the scope of the breach and
restore the integrity of the data system
– if requested by law enforcement
103
G-L-B:
Notification To Law
Enforcement

G-L-B: Response program should contain
procedures for notifying appropriate law
enforcement authorities. Customer notice
may be delayed if an appropriate law
enforcement agency determines that
notification will interfere with a criminal
investigation and provides written request
for a delay. 12 C.F.R. 30, App. B, Supp. A.
104
State Law: Notification
To Law Enforcement



Delaware, New York, and
Pennsylvania do not require that law
enforcement be notified first
New Jersey does require that law
enforcement be notified before
disclosure is made to the customer
As a practical matter, law
enforcement should be notified
105
G-L-B And State Law:
Details Of Customer Notice

G-L-B: Detailed requirements for notice,
including:
– Description of the incident in general terms and
the type of customer information involved
– Description generally of what the institution has
done to protect from further unauthorized access
– Telephone number for further information.
– Remind customers to remain vigilant over 12-24
months and to promptly report incidents of
suspected identity theft.
106
G-L-B And State Law:
Details Of Customer Notice
– When appropriate:





A recommendation that the customer review account
statements and immediately report any suspicious
activity
A description of fraud alters
A recommendation that the customer periodically
obtain credit reports
How the customer may obtain a credit report free of
charge
Information about the ftc’s online guidance. 12 C.F.R.
30, App. B, Supp. A, iii.B.1
107
State Law:
Details Of Customer Notice


Delaware, New Jersey, and Pennsylvania do
not specify the contents of the notice
New York
– Contact information for the business making the
notification
– The personal information that was or believed to
have been acquired

Means of providing notice
– Written notice
– Electronic notice
108
State Law:
Details Of Customer Notice

Means of providing notice
– Telephonic notice
– Substitute notice

If the business can demonstrate that (1) the cost of
providing notice will exceeds a certain dollar amount,
or (2) that the affected class of customers exceeds a
certain number, or (3) that the business does not have
sufficient contact information to provide notice,
substitute notice may be made by:
– E-mail;
– Posting the notice on business’s web site; and
– Notifying major statewide media
109
G-L-B: Regulator Notice?

G-L-B: Response program should contain
procedures for notifying primary federal
regulator as soon as possible. 12 C.F.R. 30,
App. B, Supp. A, II.A.1
110
State Law:
Regulator Notice?

New York
– New York Attorney General
– New York Consumer Protection Board
– New York Office of Cyber Security and Critical
Infrastructure Coordination
111
G-L-B: Notice To Credit
Reporting Agencies?

G-L-B: Institutions are “encouraged” to
notify nationwide consumer reporting
agencies prior to sending notices to a large
number of customers that include contact
information for the reporting agencies. 12
C.F.R. 30, App. B, Supp. A, III.B.2.
112
State Law: Notice To Credit
Reporting Agencies?

Generally, where a large number of
customers are affected, a business must
notify, without reasonable delay, all
consumer reporting agencies that compile
or maintain files on consumers on a
nationwide basis of the timing, distribution,
and content of the notices
– New Jersey: 1,000
– New York: 5,000
– Pennsylvania: 1,000
113
G-L-B: Consequences -Regulator Action




G-L-B: Enforcement by OCC, Federal Reserve,
FDIC, OTS, National Credit Union Administration,
SEC, state insurance regulators, FTC as to persons
within their respective jurisdictions. Penalties not
enumerated. 15 U.S.C. § 6805
Agencies clarify (OCC) that existing authority is
“preserved.” 12 C.F.R. Pt. 30, App. B
Under existing authority, agencies may impose
fines. e.g., OCC: 12 U.S.C. § 1818
Most active regulator enforcement: FTC!
114
State Law: Consequences -Regulator Action

State AGs vested with authority to
prosecute violations
115
G-L-B And State Law:
Consequences! -- AG Actions


State AGs have been active in consumer privacy
before the new state statutes and before G-L-B based
on their authority under state consumer fraud and
other statutes.
1999: Minnesota AG action against a large financial
institution: Sale of customer information to a
third-party marketer in violation of its privacy policy.
Settlement over $3 million.
Led to charges by 38 other state AGs.
Led to class action lawsuit funded by several
million dollars in settlement, plus attorney’s
116
fees.
G-L-B And State Law:
Consequences! -- AG Actions


[1] Inadvertent disclosures of [2] nonsensitive
information prosecuted.
Alta Vista: NY AG action. $70,000 settlement
(2001). Involved names and addresses only –
input by consumers into Alta Vista Yellow Pages
directory to narrow searches to businesses nearby
and promised privacy; programming error led to
inadvertent disclosure to a third party company.
No one profited and third-party company did not
use the information.
117
G-L-B And State Law:
Consequences! -- AG Actions

Lesson: You must follow your privacy policies.

Elliot Spitzer on privacy policies (March, 2006):
– “Personal information secured through a promise of
confidentiality must always remain confidential.”
– “Companies must adhere to known privacy policies
and promises. Failing to do so constitutes a clear
consumer fraud.”
118
G-L-B And State Law: Consequences!
-- Private And Class Actions

Suits under G-L-B: Most courts have
determined no private right of action.
– e.g.,





Menton v. Experian Corp., 2003 WL 21692820
(S.D.N.Y. July 21, 2003);
Dunn v. First Nat’l Bank, 111 P.3d 1076
(Kan. App. 2005);
Borninski v. Williamson, 2004 WL 433746
(N.D. Tex. March 1, 2004);
Briggs v. Emporia State Bank and Trust, 2005 WL 2035038
(D. Kan. Aug. 23, 2005);
American Family Mutual Ins. Co. v. Roth, 2005 WL 3700232
(N.D. Ill. Aug. 5, 2005).
119
G-L-B And State Law: Consequences!
-- Private And Class Actions

“Back door”: Negligence claims, esp. negligence per se,
based on G-L-B standards:
– Dunmire v. Morgan Stanley, 2005 WL 1005993
(W.D. Mo. April 7, 2005):
Refuses to dismiss complaint asserting a claim for negligence per se
based on allegations that Morgan Stanley delivered account
information to account-holder’s soon-to-be-ex wife, premised on
violation of G-L-B and implementing regulations.
– Guin v. Brazos Higher Ed. Service Corp., 2006 WL 288483
(D. Minn. Feb. 7, 2006):
Employee maintained unencrypted personal customer information on
a laptop kept at home; burglary; defendant not able to tell which
customer information was active on laptop and sent 550,000
customer notices. No identity fraud appeared to have occurred.
Negligence claim analyzed on sj under G-L-B standards; defendant
prevailed.
120
G-L-B And State Law: Consequences!
-- Private And Class Actions

Negligence claims: Best-case scenario:
lost data.
– Giordano v. Wachovia Securities, 2006 WL
2177036 (D.N.J. July 31, 2006).
UPS package containing personal financial data
was lost in transit. Mere fear of misuse in future
– fear of injury – insufficient to create Article III
standing.
121
G-L-B And State Law: Consequences!
-- Private And Class Actions


Negligence claims: More risk: Burglary of
equipment without known interest in data.
Stollenwerk v. Tri-West Healthcare Alliance, 2005
WL 2465906 (D. Ariz. Sept. 6, 2005). Class action.
Burglary of computer hard-drives. Summary judgment
granted on negligence claims. “Absent evidence that the
data was actually targeted or accessed, there is no basis
for a reasonable jury to determine that sensitive personal
information was significantly exposed.”
122
G-L-B And State Law: Consequences!
-- Private And Class Actions


Negligence: Worst-case scenario: Save money;
poor security protocols; data theft.
Richardson v. DSW, Inc., 2006 WL 163167 (N.D. Ill.
Jan. 18, 2006): Suit under state consumer fraud
statute alleging retailer, on notice by credit card
company of its contractual obligations regarding the
proper handling and disposal of credit card
information, failed to follow the specified
procedures. Complaint states a claim where alleges
protocols ignored to save money, and hacking
ensured.
123
G-L-B And State Law: Consequences!
-- Private And Class Actions


Second “back door”: Suit for breach of contract based – privacy
policy as contract.
Best defense: Contract claims require damages. Loss of privacy
held not to satisfy requirement of economic losses flowing directly
from the breach. See In re Jetblue Airways Corp. Privacy Lit., 379
F.Supp.2d 299 (E.D.N.Y. 2005); In re Northwest Airlines Privacy
Lit., 2004 WL 1278459 (D. Minn. 2004).
– Note: This defense has application in negligence context as well.
Forbes v. Wells Fargo Bank, N.A., 420 F.Supp.2d 1018 (D. Minn. 2006)
(theft of computers containing unencrypted customer information;
negligence for failing to adequately secure data; no damages – the
“threat of future harm, not yet realized, will not satisfy the damage
requirement.”)


Additional defense: Privacy policy a “unilateral” undertaking but
not a unilateral contract – no offer and acceptance. In re
Northwest Airlines.
124
Untested defense: Preemption by G-L-B.
G-L-B And State Law: Consequences!
-- Private And Class Actions



Common law claims for common law duty of bank
confidentiality.
Usual defense: Banks not liable for acts of third
party wrongdoers or criminal acts of insiders as
beyond scope of employment. e.g., Roth v. First
Nat’l State Bank of NJ, 169 N.J. Super. 280 (App.
Div. 1979). Perhaps can augment defense with
good G-L-B protocols. Also, preemption???
On the other hand, may lose this legal defense as
G-L-B contemplates insider abuse and institution
responsible for limiting opportunities for abuse and
developing means to detect 125
and contain it.
G-L-B And State Law: Consequences!
-- Private And Class Actions



Private consumer fraud suits – typically class actions.
Breach of state statutes automatically qualifies as a
consumer fraud violation in many states. e.g., NJCFA –
willful, knowing or reckless failure to comply with notice
requirements is a NJCFA violation; attorney’s fees,
treble damages. N.J.S.A. 56:8-166.
Lack of damages defense. Before new state statutes,
we have argued “ascertainable loss” requirement for
private CFA claims not met by a data security breach in
and of itself. Will this defense survive the new
statutes???
126
Best Defense: Good Privacy
And Security Practices

Materials:
– April 2006 California Dept. of Consumer
Affairs “Recommended Practices on
Notice of Security Breach Involving
Personal Information”

Covers protection and prevention as well
127
The Federal Trade Commission’s
Privacy Enforcement Initiative

The FTC has the power to protect personal
information pursuant to:
– Section 5 of the Federal Trade Commission Act
(“FTC Act”); and
– The Gramm-Leach-Bliley Act
128
Section 5 of the FTC Act



Prohibits “unfair or deceptive act” or practices in or
affecting commerce. 15 U.S.C. 45(a)
Unfair practices: those that cause or are likely to
cause substantial injury to consumers which is not
reasonably avoidable by consumers themselves and
not outweighed by countervailing benefits to
consumers or to competition
The FTC Act allows the FTC to initiate federal
district court proceedings to enjoin violations and to
secure equitable relief including, but not limited to
restitution and disgorgement.
129
Section 5 of the FTC Act


Although Section 5 does not grant the FTC
specific authority to protect privacy, over the
last several years it has been construed to
prohibit certain privacy invasions based on
deception.
Generally applies to persons, partnerships,
or corporations.
130
Examples of Cases
Brought by the FTC:

In the Matter of Nations Title Agency, Inc.
(GLB)

In the Matter of CardSystems Solutions, Inc.
(FTC Act)

Federal Trade Commission v. ChoicePoint
Inc. (FTC Act)
131
Ethics/Internal Investigations
Presented by:
Jerry D. Bernstein, Blank Rome LLP
Timothy D. Katsiff, Blank Rome LLP
William H. Roberts, Blank Rome LLP, Moderator
Joseph G. Poluka, Blank Rome LLP
A. Internal Investigations:
A Brief Historical Perspective
133
B. The Purpose, Structure
and Mechanics of the
Internal Investigation
134
What is the impetus for the
investigation?
– A request of the Board
– Employee complaint of alleged
misconduct
– Commercial third party assertion
– Individual whistleblower
– Governmental assertion
– Governmental enforcement agency
inquiry or investigation
135
Evaluate the possible end results that
may occur and tailor all aspects of the
investigation accordingly
– Architecture should fit the objective.
– Is there an applicable/industry voluntary
disclosure program?
136
Evaluate the possible end results that
may occur and tailor all aspects of the
investigation accordingly (cont.)
– What are the nuances of the program?
e.g., DOJ Antitrust Division amnesty
program
– What are the requirements of the
program?
– What are the benefits of the program,
e.g., nonprosecution agreement, reduced
fines, lifting of debarment from receiving
U.S. Government contracts, etc.?
137
Evaluate the possible end results that
may occur and tailor all aspects of the
investigation accordingly (cont.)
– Will a waiver of privilege be required under the
program?
– Is there something less than the waiver that will
satisfy the government?
– Negatives of amnesty program or other
corporate cooperation?
– What is the impact of the waiver as it relates to
other potential adversaries of the client?
– Fight or flight? Should you disclose at all –
decide as early as possible.
138
Need for Quick Completion

Generally, investigations should be
conducted swiftly with the objective of
evaluating the scope of the
impropriety and stopping any
misconduct immediately while
concurrently gathering all the facts so
the best possible defenses may be
asserted, including voluntary
disclosure.
139
Is There an Ongoing
Governmental Investigation?
– Have the government investigators
contacted employees?
– Give guidance to employees to attempt to
protect corporation without creating
obstruction of justice issues.
– Encourage employees to be interviewed
at work with counsel present.
140
Is There an Ongoing Governmental
Investigation? (cont.)
– Do not advise that they are prohibited
from speaking with the government
investigators.
– Attempt to contact the agency to discover
focus of inquiry.
– Be sensitive to issues of multiple
representation of company and
employees.

We will discuss this issue in detail during the
ethics segment of the 141
program.
Who Should Conduct the
Investigation – Inside or
Outside Counsel?
– Is there a need for independence?
– Is there a possibility that internal counsel
may become a witness?
– Internal counsel’s ability to give legal
advice in local jurisdiction?
142
Is There a Corporate Compliance
Department/Officer?
– Degree of involvement?
– Is there a corporate compliance policy?
– Generally ensure that any investigation by
corporate compliance is done at the written
direction of Legal in support of its objective of
providing legal advice to the client.
– Is there an opportunity for a dual investigation?
Compliance Department and Legal Department
(to protect work product)
143
Who is the Client?
– The dominant CEO syndrome?
– Must Legal circumvent management and
go directly to the Board?
– Shareholders
144
Specific Objective of the
Investigation
– Determination of the standard of
care/due inquiry as required by the law,
regulation, contract, etc.
– Is it a case of “don’t ask, don’t tell”?
– Is finding “red flags” the objective? (FCPA
issues)
145
Other Practical
Investigation Issues
– Interviews of employees and need for
witnesses to such interviews
– Counseling of such employees about the
confidential nature of the investigation
and the duty not to disclose same
146
Other Practical
Investigation Issues (cont.)
– Document retention/recovery – processes
& capabilities
– “Litigation holds” – preservation
obligations and sanctions
– Forensic information technology
– Duty to maintain anonymity (ethics
hotlines)
– No retaliation against whistle blower
147
Insurance Issues
– Duty to disclose to trigger coverage?
– Impact of disclosure?
148
C. Ethical Considerations for
Internal Investigations
149
Define Your Role




Clearly define the scope of your engagement at
each stage
Clearly identify the client or clients you are
representing
Communicate your role with clarity to those to be
interviewed
Be clear whether the representation extends to
the individual directors, officers, employees,
former employees of the corporation, as well as
the corporation itself.
150
Can I Do It…How ?



What factors should be considered in deciding
on a simultaneous representation of the
company and some of its officers or
employees?
What are the dangers of later withdrawing
from one of the representations and
attempting to continue the representation of
the other party or parties?
What disclosures and consents are required?
151
When may a simultaneous
representation be undertaken?


There is no per se bar to simultaneous
representation.
Three limitations on multiple representation (see
dr 5-105; similar to PA and NJ and DEL RPC
1.7(b)):
– Must be able to conclude that a disinterested lawyer (DR 5105) would regard multiple representation as in the interest of
corporate client and employee client.
– Must obtain consent of both clients after full disclosure.
– Must be alert to changes in circumstances that render
continuation of multiple representation no longer permissible.
152
Basic Test


Basic Test : “[i]f the exercise of independent
professional judgment on behalf of a client
will be or is likely to be adversely affected” or
“if it would be likely to involve the lawyer in
representing differing interests” [NY]
Then consider the “Disinterested Lawyer
Standard”
153
Basic Test

Conflicts Subject To Disclosure And Consent
– If the attorney’s exercise of independent
professional judgment will be or is likely to be
adversely affected, then the second part of the
test must be satisfied: a disinterested lawyer
would conclude that the lawyer can competently
represent both the corporation and the
constituent.



immaterial conflicts--remote or unlikely to affect the lawyer’s
judgment
non-consentable conflicts
consentable conflicts
154
Basic Test
– The “disinterested lawyer”: an objective,
hypothetical lawyer whose only aim
would be to give the best advice possible
about whether the client should consent
to the conflicted representation.
155
Easy Cases

Example: Disinterested Lawyer Test Not
Satisfied:
Case 1: The government is investigating securities law
violations in the filing of false or misleading statements
and the employee has admitted wrongdoing in
connection with the financial statements under
investigation.
– Corporation would have strong interest in avoiding or limiting
liability by cooperating fully with the government and
providing any information sought by the government
regarding preparation of the financial statements.
156
Easy Cases
– The individual would have to consider a
variety of factors before deciding
whether it was in his interest to
cooperate with the government and
would need counsel able and willing to
negotiate a resolution of the matter.
– (See New York City Bar Formal Opinion
2004-02)
157
More Easy Cases…

Example: Disinterested Lawyer Test Satisfied
Case 2: Same investigation as Case 1 above, except
maintenance employee only overheard comments
regarding need to alter the corporation’s financial
statements but would have no concern about personal
liability for wrongdoing. No need for counsel to
negotiate independently with government.
Therefore, lawyer could represent individual as well as
the Company.
158
Closer Cases …
Case 3: Employee is in accounting
department but not involved in the
preparation of the financial statements under
investigation.
Case 4: Employee is in accounting
department of division, whose statement is
under investigation, but had limited
discretion to decide how to account for the
transactions giving rise to the investigation.
159
Closer Cases …
Case 5: Employee is in accounting division involved in
preparation of statement, but had no decision-making
authority with respect to how to account for the
transaction, but nonetheless participated in booking
the transaction.
These closer cases will depend on the specific of
knowledge possessed by the employee, and the
specific laws or regulations implicated by the conduct
and the perceived scope of the
government’s investigation.
160
Getting The Facts

Obtaining The Relevant Facts
In determining whether the Disinterested
Lawyer Test is satisfied, the lawyer will require
a detailed grasp of the relevant facts. How can
this be done before making the judgment to
engage in a multiple representation?
– Initial Interview with Employee: The
“Miranda Warning”

The lawyer is representing only the corporation
161
in this interview.
Getting The Facts

Advise the employee/director/officer:
– “I represent the corporation and do not represent you.”
– “Any information you provide is privileged under the
attorney-client privilege but the privilege is held by the
corporation and not you.”
– “It is up to the corporation and not you whether to waive
that privilege and share that information with third parties
[and the corporation may decide to do that without asking
you or informing you].”
162
“Should I Get My Own
Lawyer? Are You My Lawyer?”

What if the employee asks whether he should
consult with his own counsel?
– Suggested response: “I represent the corporation
and cannot advise you one way or the other on
that.”
– Should corporate counsel recommend getting
counsel? No, that potentially acts against the
interest of the corporation, the lawyer’s client.
163
“Should I Get My Own
Lawyer? Are You My Lawyer?”

What if prior to the interview the employee
asks corporate counsel to represent him/her?
– Corporate counsel should ordinarily decline to represent
the employee at this stage.
– In most cases, the lawyer will not have sufficient facts at
this stage to make a determination that the
Disinterested Lawyer Test is satisfied and a multiple
representation can be undertaken, subject to
disclosure and consent of both clients. It will be the
exceptional case where this will be permissible or
appropriate.
164
Later Retention
– The Later Request for Multiple Representation.

If the government requests an interview with the employee
who has already been interviewed by company counsel, and
this triggers a request that corporate counsel represent the
employee, then the lawyer should determine whether
he/she has enough information to make the determination
called for by the Disinterested Lawyer Test.
– If the lawyer does not, how can this information be obtained?
– In further interviews of the employee, the lawyer must always
make it clear that the lawyer represents only the corporation, not
the employee, and that any information received will be provided
to the corporation.
165
Later Retention
– If this is not done, then since information
received from a prospective client is subject to
the lawyer's duty of confidentiality,
 the lawyer’s corporate client will be
disadvantaged by this restriction on the
lawyer's ability to share this information.
 in some cases, the lawyer who fails to handle
the interview in this manner may be precluded
from continuing to represent the corporation.
Restatement (Third) of the Law Governing
Lawyers, § 15 (2000).
166
Full Disclosure


What Disclosures Must Be Made To Render
Multiple Representation Permissible?
If the lawyer determines that the
Disinterested Lawyer Test has been satisfied,
the lawyer must then make a full disclosure
to both clients and obtain their knowing
consent.
167
Full Disclosure
– What is involved in a “full disclosure”?



information reasonably sufficient, giving due regard
for the sophistication of the client, to permit the
client to appreciate the significance of the potential
conflict.
disclosure of any and all defenses and arguments
that a client will not have because of the joint
representation and the lawyer's fair and reasoned
evaluation of those defenses and arguments, and
the possible effect of failing to raise them.
risks and advantages of the joint representation.
168
Risks….Advantages
– Usual advantages

Avoiding expense of other counsel

Broad and detailed knowledge of the relevant facts
– Usual risks


a conflict may arise in the future that will disable corporate
counsel from continuing for the corporation--prejudice to
the corporation from the need to switch counsel; similar
risk to employee
need to obtain a prospective consent
169
Risks….Advantages



the loss of credibility to the investigating agency
limitation on the lawyers’ ability to pass on to the
corporation confidences and secrets that are not germane
to the matter--less of a risk where the employee has been
fully interviewed, but always present
possible complications for the corporation in crippling or
preventing the corporation’s full ability to cooperate with
the government. The corporation may have in its
possession information which its counsel obtained from
the employee that would help the corporation cooperate
with the government to its advantage, but be unable to
share this information because the employee does not
wish to waive the attorney-client privilege
170
Structuring and Getting
Consents

Steps include obtaining prospective
consents and consents to withdrawal:
– Prospective Waivers



Should be accompanied by full disclosure
Should be in writing signed by the client
Should advise of the types of conflicts that may arise to
the extent possible--who the conflicted parties would be,
and the source of the potential conflict
171
Structuring and Getting
Consents

Subjects of waivers:
– the possibility of future litigation
– client’s waiver of objection to former lawyer’s right to
cross examine former client
– potential need to revisit the scope of the waiver and
the conflict that actually did arise
– contractual limitations of the scope of the
representation, e.g. representation through
investigatory stage only, to a single interview, or to a
series of interviews with the government or on
designated topics
172
Agreements On Privilege And
Separate Shadow Counsel
– Understandings on privileged information



whether and what kind of confidential information will be
shared with the two clients
who will control the privilege
what will happen in the event of a dispute between the
clients
– Shadow Counsel and Co-counsel


Middle ground representation for attorney who is involved
to take over in the event of withdrawal and to provide
independent advice at times where conflict arises
Adds to cost but reduces risk of potential conflicts and
their resolution
173
1.
The Thompson Memorandum
174
2.
Selective Waiver
175
1. Payment of Attorney Fees for employees
2. Thompson Memorandum and DOJ’s
consideration of payments of an
employee’s legal fees when determining
whether to indict the corporation.
a. U.S. v. Stein, No. S1 05 Crim. 0888, 2006
WL 1735260 (S.D.N.Y. June, 2006)
176
E. Enron: A Case Study
177
Whose Privilege Is It Anyway?
Presented by:
Lesli C. Esposito, Blank Rome LLP
John D. Kimball, Blank Rome LLP
Jeremy A. Rist, Blank Rome LLP, Moderator
Daniel L. Stackhouse, Blank Rome LLP
The Privilege Is Under Attack!
The attorney-client privilege is, more than ever, subject to
increasing challenge:
1.
2.
3.
4.
Aggressive government investigatory techniques
Increasingly insistent transaction partners
Technology changing conditions and frequency of
communication
Heightened auditor independence and demand for
information
Each of these phenomena places the exercise of the
attorney-client privilege at a higher risk than ever before.
179
Special Topics



Waiver of the privilege through transaction
disclosures
Waiver of the privilege through disclosure
to the government
Waiver of the privilege through disclosure
to insurers and auditors
Bonus Topic: “Opinion-Shopping”
180
I. Transactional Disclosures
Whether a company waives the attorneyclient privilege through due diligence or
other disclosures to a transaction partner is
a question that arises frequently, and
increasingly often.
Examples: Patent opinions; attorney
memoranda on litigation exposure;
unredacted board minutes
181
Disclosure Destroys Privilege




Basic Rule: A disclosure of privileged information
to a potential transaction partner waives the
privilege, as the confidential nature of that
information has been destroyed.
“Confidentiality Agreement” irrelevant.
Privilege waived even if disclosure is required by
law (e.g., “material information”).
Waiver of certain privileged information may waive
privilege as to all communications on same
subject.
182
Waiver of
Privilege Identified

Oaks Industries, Inc. v. Zenith Industries,
Inc., 1998 WL 79614 (N.D. Ill. July 27, 1988):
“We decline to expand the coverage of the attorneyclient privilege to information which a party freely
shares with other business persons. Such an
expansion – to all persons with whom the party may
enter or consider entering into a business transaction
– would quickly swallow up the general rule that
disclosure waives the attorney-client privilege.
Moreover, it would do little to promote the underlying
purpose of the privilege, that of encouraging open
discussions between clients and their attorneys.”
183
Waiver of
Privilege Identified

Libbey Glass, Inc. v. Oneida, Ltd., 197 F.R.D. 342,

Intl’l Honeycomb Corp. v. Transtech Serv. Network,
347-49 (N.D. Ohio 1999) (client waived privilege as
to attorney’s opinion on trade dress infringement
issues by disclosing it during negotiations to
representatives of an entity with whom a joint
venture was eventually formed)
1992 WL 314897 (E.D.N.Y. Oct. 9, 1992) (decision
to reveal privileged information to potential
investors for “legitimate business purposes” was
rational, yet entailed consequence of waiver)
184
Waiver of
Privilege Identified

Cheeves v. Southern Clays, Inc., 128 F.R.D. 128,

AMCA Int’l Corp. v. Phipard, 107 F.R.D. 39, 43 (D.

Paul R. Rice, Attorney-Client Privilege in the United
States (2d ed.) (2003) § 9:90
131 (M.D. Ga. 1989)
Mass. 1985) (client’s disclosure of counsel’s
memorandum explaining royalty payments waived
privilege on that memorandum and on all other
communications with any attorneys regarding such
payments)
185
Privilege
Deemed Preserved

Hewlett-Packard Co. v. Bausch & Lomb, Inc., 115 F.R.D.
308 (N.D. Cal. 1987) (disclosure of counsel’s
confidential opinion letter in negotiations over sale of
subsidiary did not waive privilege).
Three factors identified:
– party had duty to disclose possibility that patent
litigation could arise
– disclosure made only after special confidentiality
agreement to protect this specific information
– “real possibility” that potential purchaser would
purchase the business
186
Privilege
Deemed Preserved

Tenneco Pck’g Specialty and Consumer Prods., Inc.
v. S.C. Johnson & Sons, Inc., 1999 WL 754748
(N.D. Ill. Sept. 14, 1999) (also stressed late stage
of disclosure and extremely limited confidentiality
agreement as to the specific information in
question)

Rayman v. Am. Charter Fed. Savings & Loan Ass’n,

Cavallaro v. United States, 153 F. Supp.2d 52, 62
148 F.R.D. 647 (D. Neb. 1993)
(D. Mass. 2001) (dicta) (erroneously stating that
disclosure of information during merger
negotiations does not pose problems for privilege)
187
Can a Common Interest
Agreement Preserve Privilege?


Answer generally “no” in negotiation context.
A “community of interests exists among . . . separate
corporations where they have an identical legal interest
with respect to the subject matter of a communication
between an attorney and a client concerning legal
advice . . . The key consideration is that the nature of
the interest be identical, not similar, and be legal, not
solely commercial.”
–

Duplan Corp. v. Deering Milliken, Inc., 397 F. Supp. 1146, 1172 (D. S.C.
1975).
Transaction-related interests are usually deemed
“commercial,” at least until final stages where regulatory
scrutiny may be at hand.
188
When Privilege May Be
Preserved Despite Disclosure





Legal duty to disclose
Transaction is near closing
Transaction is a merger or a stock
transaction (i.e., not an asset sale)
Special precautions are taken to ensure the
confidentiality of the privileged information
in question
Formal regulatory inquiry has begun or is
imminent
189
II. Waiver Through Disclosure
to the Government



Incentives to produce privileged information
to the government in connection with an
investigation
Effects of such disclosure
Attempts to ameliorate consequences of
disclosure or refusal to disclose
190
Incentives to Produce
Privileged Information


Intense pressure
Required for favorable treatment
–
Thompson Memorandum: “one factor a
prosecutor may weigh in assessing the
adequacy of a corporation’s cooperation is the
completeness of its disclosure, including, if
necessary, a waiver of the attorney-client and
work product protections.”
191
The Effects of
Voluntary Disclosure



Effect on communications with attorneys
Does the disclosure to the government
constitute a waiver with respect to the
materials produced?
With respect to all materials on the same
subject matter?
192
Waiver of the Privilege With
Respect to the Materials
Produced

The law regarding “selective waiver” is in a “state of hopeless
confusion.”
–

Cir. 2002).
Most of the Courts of Appeals have held voluntary disclosure to
the government to constitute a waiver with respect to the
materials produced.
–

See, e.g., Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289 (6th
See, e.g., Permian Corp. v. United States, 665 F.2d 1214 (D.C. Cir. 1981).
However, the Eighth Circuit has accepted the theory that
disclosure taking place in a “non-public” setting may preserve the
privilege, with or without special confidentiality agreement.
–
See, e.g., Diversified Indus. v. Meredith, 572 F.2d 596, 611 (8th Cir. 1978). A party
may “selectively” waive the privilege as to the government, but preserve it against
outsiders. Most other courts have rejected this.
193
Waiver of the Privilege With
Respect to the Materials
Produced

Some courts, however, have noted that
special confidentiality agreements may
be effective in preserving the privilege.
– See, e.g., Enron Corp. v. Borget, 1990 WL 144879 (S.D.N.Y. Sept.
22, 1990)

Confidentiality agreements are generally
ineffective.
– See, e.g., Columbia/HCA
194
3 Basic Positions as to
Selective Waiver



Selective waiver never permissible
Selective waiver permissible
Selective waiver permissible where
government agrees to special confidentiality
protections
The first position is dominant
195
Waiver of the Privilege with
Respect to all Materials on the
Same Subject Matter

Some courts have determined that “partial waiver”
of some privileged information waives privilege as
to all other privileged communications related to
the same subject.
– See, e.g., In re Sealed Case, 676 F.2d 793, 818 (D.C. Cir. 1982); In re
Martin Marietta Corp., 856 F.2d 619 (4th Cir. 1988).



Probably only triggered at a certain point after a
significant quantum of privileged information
related to the subject has been disclosed.
May not apply where partial information is not put
into public record.
“What does fairness dictate?”
196
Efforts to Preserve
the Privilege



H.R. 2179 (2004) would have limited waiver of
privilege to any information disclosed to the S.E.C.
pursuant to a written confidentiality agreement.
Sentencing Commission: April 5, 2006, Commission
voted to remove language from 8C2(g), cmt. 12,
which required waiver of privilege as prerequisite
for finding “full cooperation.”
Proposed F.R.E. 502: would preserve privilege and
work product protections where information is
disclosed to a “federal, state, or local government
agency during an investigation by that agency, and
is limited to persons involved in the investigation.”
197
III. Waiver of the Privilege Through
Disclosures to Insurers and Auditors
Insurers



Insurance policy “cooperation clauses” may require
the insured to share privileged information with the
insurer.
Disclosure of privileged or work product information
to an insurer may waive the privilege as to other
parties.
The issue of waiver will often turn on whether the
insured and insurer share a “common interest” in
the underlying suit.
198
Location, Location, Location:
Know What States’ Laws May Apply



A majority of insurance disputes are litigated
in federal court based on diversity
jurisdiction.
State law is not uniform regarding attorneyclient privilege in the insurance context.
As a result, disclosure to an insurer may
result in a waiver in one jurisdiction, but not
in another.
199
The “Common Interest” Doctrine

Insurer providing a defense: The “common interest”
doctrine is most likely to preserve the privilege where
the insurer has retained counsel to defend the insured.
–
See e.g., Metropolitan Life Ins. Co. v. Aetna Cas. & Surety Co., 730 A.2d 51, 65
(Conn. 1999); Lectrolarm Custom Sys., Inc. v. Pelco Sales, Inc., 212 F.R.D. 567,571
(E.D. Cal. 2002).

Reservation of rights: The doctrine is less likely to apply
if the insurer has reserved its rights or the scope of any
identity of interest is uncertain.
–

See e.g., North River Ins. Co. v. Philadelphia Reinsurance Corp., 797 F.Supp. 363
(D.N.J. 1992); Lectrolarm, supra.
Separate counsel: Most courts will not find a “common
interest” if the insurer declines coverage or the insured
has its own counsel and acts independently of the
insurer.
–
See e.g., Lectrolarm, supra; Metropolitan Life, supra at 65 n. 33.
200
Common Interest:
Sword and Shield

In a coverage dispute, insurers may use the
“common interest” doctrine to seek access
to the insured’s privileged materials from
the underlying case.
– The unity of interest eliminates any expectation
of confidentiality for communications relating to
the defense of the underlying case.
– Privilege may still attach to communications
related to coverage because the interests of the
insurer and its insured are adverse.
– See, e.g., Nationwide Mut. Fire Ins. Co. v.
Bourlon, 617 S.E.2d 40, 47 (N.C. Ct. App. 2005).
201
Little Clarity From the Courts

Several courts have found that a “common interest”
eliminates a claim of privilege between the insured
and insurer.
– See, e.g., Waste Mgmt., Inc. v. Int’l Surplus Lines Ins. Co., 579
N.E.2d 322, 328 (Ill. 1991); Dendema v. Denbur, Inc., 2002 U.S.
Dist. LEXIS 3804 (N.D. Ill. Mar. 8, 2002); Metro Wastewater
Reclamation Dist. v. U.S. Fire Ins. Co., 142 F.R.D. 471 (D. Col.
1992)

Other courts have rejected this approach.
– See, e.g., N. River Ins. Co. v. Columbia Cas. Co., 1995 WL 5792
(S.D.N.Y. Jan. 5, 1995); Int’l Ins. Co. v. Newmount Mining Corp.,
800 F. Supp. 1195 (S.D.N.Y. 1992); Owens-Corning Fiberglass
Corp. v. Allstate Ins. Co., 660 N.E.2d 755 (Ohio Ct. Com. Pl.
1993).
202
Privilege and Insurance Policy
Cooperation Clauses

Insurers have argued, and some courts have
agreed, that the insured’s contractual duty to
cooperate waives the privilege with respect to
materials in the underlying case.
– See, e.g., Waste Mgmt., Inc. v. Int’l Surplus Lines Ins. Co., 579
N.E.2d 322, 328 (Ill. 1991).

Most courts have rejected the cooperation clause
waiver argument.
– See, e.g., Bituminous Cas. Corp. v. Tonka Corp., 140 F.R.D. 381,
386 (D. Minn. 1992); Metropolitan Life, supra at 63-64.
203
Disclosures to
Accountants & Auditors
Auditors

In general, the attorney-client privilege does not
apply to communications that are intended to be
disclosed to third parties, or that are in fact so
disclosed.
– See, e.g., U.S. v. Rockwell Intern., 897 F.2d 1255 (3d Cir.) 1990).

“[N]o accountant-client privilege exists under
federal law, and no state-created privilege has been
recognized in federal cases.”
– United States v. Arthur Young & Co., 465 U.S. 805, 817 (1984).
204
State Law All Over the Map on
Accountant-Client Privilege



At least 31 states have codified some form of
accountant-client privilege, but the statutes and the
protection afforded thereunder vary considerably.
Only about 12 states provide a “meaningful
privilege.” Many others have merely codified
accountants’ existing ethical obligations.
– The Accountant-Client Privilege: A Prescription
for Confidentiality or Just a Placebo?,” New Eng.
L. Rev. 697, 735 (2000).
Statutory accountant-client privilege is often strictly
construed.
205
An Exception to Every Rule:
Accountants as Translators

Accountant may be deemed privileged agent where
the accountant serves as a translator to facilitate
communications between counsel and client for the
purpose of obtaining legal advice.
– See, e.g., United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).

This exception does not apply where the
accountant is providing accounting services or
information that is not necessary to counsel’s
provision of legal advice to the client.
– See, e.g., United States v. Ackert, 169 F.3d 136, 139 (2d Cir.
1999); In re G-I Holdings, Inc., 218 F.R.D. 428, 436-37 (D.N.J.
2003); United States v. Chevron Texaco Corp., 241 F. Supp. 2d
1065, 1072 (N.D. Cal. 2002).
206
Disclosures to Auditors

Generally, disclosure of privileged information to auditors will
waive the privilege.
– S.E.C. v. Brady, 2006 WL 2880444 (N.D. Tex. Oct. 6, 2006)
(disclosure of confidential information to auditors for purposes
other than seeking legal advice destroys the right to claim the
privilege).
– First Fed. Savs. Bank v. United States, 55 Fed. Cl. 263, 269-70
(Fed. Cl. 2003) (disclosure of unredacted board minutes during
annual audits waived the privilege, because the disclosure did
not have a legal purpose).
– United States v. El Paso Co., 682 F.2d 530, 540 (5th Cir. 1982)
(disclosure of tax pool analysis and underlying documentation to
outside accountants for tax purposes waived the privilege).

Where counsel retains an auditor to assist in providing legal
advice, the auditor acts as a privileged agent.
– See U.S. ex rel. Robinson v. Northrop Grumman Corp., 2002 WL
31478259 (N.D. Ill. Nov. 5, 2002).
207
Privilege v. Work Product:
An Important Distinction

Waiver of the attorney-client privilege is not necessarily a
waiver of the work product protection for the same
documents.
– See S.E.C. v. Brady, supra at *10.

Most courts find work product waived only when it is disclosed
to an “adversary” or potential “adversary”.
– See, e.g., Lawrence E. Jaffe Pension Plan v. Household Int’l, Inc.,
237 F.R.D. 176, 183 (N.D. Ill. July 6, 2006); United States v.
Stewart, 287 F. Supp.2d 461 (S.D.N.Y. 2003).

Generally, waiver of opinion work product will not result in a
broad subject matter waiver.
– See, e.g., S.E.C. v. Brady, supra at *14; Chambers v. Allstate Ins.
Co., 206 F.R.D. 579, 589 (S.D. W. Va. 2002).
208
Is An Auditor an “Adversary”?

The fact that an auditor must remain independent
does not establish that it is adversarial to the
company it audits.
– See, e.g., Lawrence Jaffe Pension Plan, supra at 183.

Some courts have suggested that auditors and the
companies they audit share a common interest in
the information shared by the company.
– See Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc., 229 F.R.D.
441 (S.D.N.Y. 2004). But see Medinol Ltd. V. Boston Scientific
Corp., 214 F.R.D. 113 (S.D.N.Y. 2002) (in view of recent
accounting scandals, it is “crystal clear” that “in order for
auditors to properly do their job, they must not share common
interests with the company they audit”) (emphasis added).
209
Privilege Threat Increased in
Post-Enron Environment



The enactment of the Sarbanes-Oxley Act of 2002 in the wake
of Enron and other corporate scandals has broadened the
scope of information requested by auditors and increased
potential threats to the privilege.
Areas of inquiry include liabilities and contingency/litigation
reserves, results of internal investigations, and legal advice
regarding regulatory and transactional matters.
In response, the ABA recently adopted a resolution urging the
SEC and other governmental and professional organizations to
adopt standards, policies, practices and procedures to ensure
that the privilege and work product protections are preserved
throughout the audit process
– See ABA Aug. 7-8, 2006 Resolution and Report of ABA Task Force
on the Attorney-Client Privilege, available at
http://www/abanet.org/buslaw/attorneyclient/home.shtml.
210