Tayman Lane Chaverri Congratulates Attorneys on SuperLawyers Recognition

We are pleased to announce that David Lee Tayman and Katie Lane Chaverri, Founding Partners at Tayman Lane Chaverri LLP, have been selected to the 2017 Washington, DC Super Lawyers list. This is an exclusive list, recognizing no more than five percent of attorneys in the District.

In addition, TLC Partner Erin L. Webb has been selected to the 2017 Washington, DC Rising Stars list. Each year, no more than 2.5 percent of the lawyers in the District under 40 or with less than 10 years in practice are selected by the research team at Super Lawyers to receive this honor.

Super Lawyers, part of Thomson Reuters, is a research-driven, peer influenced rating service of outstanding lawyers who
have attained a high degree of peer recognition and professional achievement. Attorneys are selected from more than 70
practice areas and all firm sizes, assuring a credible and relevant annual list.

Puerto Rico Restructuring Has Widespread Financial Impact

On Wednesday, Puerto Rico’s Governor declared that the commonwealth would seek protection under Title III, a court-supervised bankruptcy-like restructuring process. The restructuring of Puerto Rico’s $70 billion in outstanding debt would be the largest in the history of the U.S. municipal bond market and will have widespread implications in the equity and bond markets, as well as with bond debt insurers.

The filing comes after several lawsuits were filed on Tuesday after a stay on litigation expired as the commonwealth failed to reach a restructuring agreement with its bondholders.  The stay allowed for negotiations between Puerto Rico and its bondholders as mandated by The Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA, which was enacted into law on June 30, 2016, the day before the island defaulted on nearly $1 billion of principal and interest owed to its creditors — including holders of the island’s general obligation bonds, which carry a constitutional guarantee on payment.

Leading the creditors’ efforts is Ambac, one of the largest insurers of debt issued by Puerto Rico.  In addition to opposing Puerto Rico’s entitlement to bankruptcy protection, Ambac seeks a legal declaration that the commonwealth’s fiscal plan is unconstitutional. Analysts from trading firm BTIG, Mark Palmer and Giuliano Bologna, told CNBC that they believe Ambac’s “lawsuits represent the beginning of the municipal bond insurers’ pushback against Puerto Rico’s efforts to force its creditors to accept severe haircuts, and we would not be surprised to see similar litigation filed by Assured Guaranty and MBIA in the coming days.”  (MBIA, Inc. provides services including financial guarantee insurance.)

Wildfire Insurance Coverage Issues: Physical Damage and Prevailing on Claims for Business Interruption, Lost Profits, and Indirect Losses

The wildfires which recently raged in and around the Great Smoky Mountains have caused substantial damage to communities and businesses throughout Eastern Tennessee and Western North Carolina.  Wildfires in this area  destroyed hundreds of structures, burned well over a hundred thousand acres, caused substantial casualties, and displaced thousands of people.  These communities are strong and they will recover, but that recovery will take time and resources.  One important source of support for that recovery will be the insurance policies owned by those affected.  While some losses, such as direct fire damage, will likely be covered with little dispute, claims for more complex losses, such as business interruption and the lost profits resulting from delays and disruption caused by the fire and its aftermath are more likely to be the subject of coverage disputes.

These kinds of complex claims are likely to be of particular importance to the region around the Great Smoky Mountains as it seeks to recover from the wildfires.  Tourism is one of the main industries in this area.  Tourism revenues are likely to be heavily impacted both by the delays and shutdowns necessary for tourism-related businesses to rebuild infrastructure and from a decline in the number of people who want to travel to the region.  The wildfires have had an actual and perceived impact on the wilderness environment that has historically drawn so many visitors year after year.

One important consideration for policyholders seeking to recover under their insurance policies is the presence of exclusions from coverage.  While less common in the Appalachian region, wildfires regularly cause damage which results in insurance coverage litigation in other parts of the country.  A recent court decision addressing insurance coverage in the context of wildfire on the West Coast  gives some insight into how these exclusions might be addressed.  In Oregon Shakespeare Festival Assoc. v. Great American Insurance Co., 2016 WL 3267247 (D. Or. 2016), the United States District Court for the District of Oregon recently issued an opinion discussing policy exclusions in the context of wildfire-caused business interruption and property losses.

The plaintiff in that case was the organization in Ashland, Oregon which hosts the annual Oregon Shakespeare Festival.  At issue was property damage and lost business income associated with smoke from a nearby wildfire which took place during the summer of 2013.  The damage was caused not by the fire itself, but by smoke and associated soot and ash which permeated the festival theater.  The Festival also suffered wildfire-related air quality issues which caused the Festival to have to cancel a number of performances.  The property damage did not include any permanent or structural damage to the Festival’s facilities.  For the policyholder to be entitled to business interruption coverage for  losses associated with the cancelled performances, the “suspension” of the Festivals’ “operations” had to be “caused by direct physical loss of or damage to property” at the insured location.  Whether physical damage had occurred was a central question to determining coverage for the business interruption losses.

The Court followed a two step approach to determining whether the Festival was entitled to insurance coverage:  First, the Festival had to show that the loss fell within the scope of the policy’s coverage grant.  Second, assuming the loss was within that scope, the insurer, Great American, had the burden to establish that the loss was excluded by specific language in the policy.  Here the insurer unsuccessfully contested whether the damage was within the scope of the policy based on an argument that the damage was to the “air” in the Festival’s premises and that “air” did not constituted damaged “property.”  The court rejected this argument and found the damage was within the scope of the policy.  Noting that “while air may often be invisible to the naked eye, surely the fact that air has physical properties cannot reasonably be disputed,” the court found that Great American’s argument equated “physical damage” with “structural damage.”  With no support in the policy language for such an interpretation, the court rejected this argument.

After finding for the insured on the issue of whether the damage was within the scope of the policy, the Court next considered three exclusions, for (1) “delay, loss of use, loss of market,” (2) for “smog” or “smoke,” and (3) for “pollutants.”  The Court gave short shrift to the insurer’s argument regarding the “delay, loss of use, loss of market” exclusion and found that if the policy was read to exclude damages resulting from a delay, loss of use, or loss of market caused by a covered casualty it would unreasonably void the entire purpose of the policy, as most, if not all, first party losses involving physical damage also give rise to some type of delay, loss of use, or loss of market.

In addressing the “smog” and “smoke” exclusions, the court focused in on the specific definitions of these terms.  The term “smog” was not defined in the policy itself, so the court looked to the Oxford Dictionary to interpret that term, finding that the presence of both smoke and fog was necessary to form “smog.”  The court concluded that the insurance company had not presented evidence that any fog was present to combine with the smoke from the wildfire.  In addition, the court noted that “smoke” was specifically excluded elsewhere in the policy, it would not read the “smog” exclusion to bar coverage for any loss involving smoke, despite the insurer’s argument that the term “smog” included smoke damage.  Because the policy’s separate “smoke” exclusion was limited by its own terms to “smoke, vapor, or gas from agricultural smudging or industrial operations,” the court found that the smoke exclusion also did not apply.

The court similarly parsed the language of the pollution exclusion to determine that it did not apply.  While the policy identified smoke as a potential “pollutant,” the court found that “[i]f the policy drafters wanted to exclude smoke other than smoke ‘from agricultural smudging or industrial operations,’ they could have done so.”  In addition, for the pollution exclusion to apply, the losses to be excluded had to be incurred as a result of delay or increased time caused by complying with a government or legal requirement to “test for, monitor, clean up, remove, contain, treat, detoxify, or neutralize” the pollutant.  Since there was no such government or legal requirement associated with the smoke from the Oregon wildfires, the Court found that the pollution exclusion did not allow the insurer to escape paying the claim.

The Oregon Shakespeare court also held that established case law favored coverage.  The court analyzed cases considering what is and is not “physical” damage in the insurance context.  The cases included ones which found a pervasive odor, lead contamination of a furnace that was otherwise still usable, and the release of chemical gases to be physical damage, and a case holding that physical damage can occur on a molecular level and be undetectable “from a cursory inspection” of the property.  The court also made the point that the theatre had been made unusable for its intended purpose.  Thus, pervasive structural damage was not necessary to give rise to coverage.  The court showed that, in making the determination of what is or is not physical damage, consideration of the nature and intended use of the property in question and the purpose of the insurance policy are also relevant inquiries.

While the holdings of Oregon Shakespeare are specific to the policy and facts of that case, it does present us with several important things to consider with respect to wildfire-related insurance claims, whether connected to the recent Tennessee and North Carolina fires or otherwise:

  1. The policyholder bears the initial burden of proving that the loss falls within the policy;
  2. If the policyholder meets its burden, the insurer then bears the burden of showing that exclusions apply to bar coverage;
  3. The specific language of the policy is important and will be closely scrutinized and compared to the facts of the situation; and
  4. To determine whether a particular loss constitutes “physical” damage, courts will look to the nature and intended use of the property at issue and the purpose of the insurance policy.

Perhaps the most important takeaway from Oregon Shakespeare and the other cases in which courts consider coverage issues relating to the impact of wildfire is that, given the right insurance policy, strong arguments exist in favor of making insurance companies pay for claims relating to business interruption, lost profits, and disruption caused by the wildfire.

The U.S. District Court for the District of Maryland Emphasizes Need for Narrow Tailoring of Non-compete Provisions

Non-compete agreements have long been a part of the employment terms of executives and senior employees.  More recently, non-compete agreements have also become more and more typical for lower level employees as well.  As these kinds of agreements have become more common, questions about their enforceability have grown in relevance.  While determining the enforceability of such a provision requires a highly fact intensive analysis, the law provides some general rules and standards which guide this analysis.

A recent decision by Judge Roger W. Titus of the United States District Court for the District of Maryland, Seneca One Finance, Inc. v. Bloshuk, __ F.Supp.3d ____, 2016 WL 5851626 (D. Md. 2016), gives a well articulated summary of the legal standard for determining the enforceability of these agreements.  The case summarizes Maryland law on this issue, which is similar to, but not quite the same as, the law of other jurisdictions.  In Seneca One, a financial services firm involved in the business of financing structured annuities and other deferred payment plans sought to enforce a non-compete agreement against an employee who worked as an “annuity specialist,” a position in which the employee was responsible for managing the day-to-day  relationships with customers and building new relationships with prospective  customers.  As part of her employment, the defendant in this case signed an agreement which provided that she would neither compete with her employer nor solicit any potential or existing customers during her employment and for a year after leaving.

After about two and a half years of employment at the plaintiff, the defendant quit her job and joined a competitor where she worked in a very similar role and allegedly solicited customers of her prior employer.  In response, her former employer brought an action to enforce the non-compete agreement which resulted in Judge Titus’ decision.

Under Maryland law, a non-compete provision will only be enforced if it meets four requirements:

  • the employer must have a legally protected interest in the activity being restricted;
  • the restrictions of the provision must be no broader than is necessary to protect the employer’s interest;
  • the provision must not impose an undue hardship on the employee to be bound; and
  • the provision cannot violate public policy.

Although these criteria are the basic standard, what meets or does not meet the standard is not a hard and fast rule – evaluating the enforceability of a particular provision is highly dependent on the specific circumstances of the given situation.

With respect to the first requirement, courts recognize that an employer has a legally protected interest in preventing departing employees from taking the employer’s customer goodwill, even if the employee helped to create that goodwill.  The particular non-compete provision at issue in Seneca One prohibited the departing employee from engaging, directly or indirectly, in the same or similar business as the plaintiff employer.  Similarly, the non-solicitation provision prohibited the departing employee from soliciting existing and potential “customers” of the employer, a term defined to include all persons who had “been in contact” with the employer.  The provisions at issue in this case did not contain industry or geographic limitations.

The Court held that this broad restriction on post-employment competition was unenforceable because it was not limited to the work or type of work previously done for the employer.  Instead, the non-compete in this case blocked the former employee’s post-employment activities in a way that was far broader in scope than was necessary to protect the employer’s customer goodwill.  The non-compete provision was also found to be improper because it was designed to stop employees from working for any competitor of the employer, rather than to prevent employees from taking advantage of the first employer’s customer goodwill.  The Court also found the non-solicitation aspects of the provision too broad and, in particular, found the restriction against soliciting potential customers “breathtaking” (and not in a good way).

While it speaks more directly to what should be avoided, this case provides good guidance and specific factors to consider and think through with respect to the enforceability of non-compete provisions, both from a drafting and dispute perspective.  One basic watchword is “tailoring” – in order to be enforceable a non-compete provision should be specifically tailored to protect the employer’s interest in the customer goodwill which the employee is involved with managing or creating while employed.  Similarly, the non-solicitation aspects of such a provision are more likely to be enforceable if they focus on customer relationships that the employee actually interacted with, or was involved in developing, during the course of employment.  Putting an industry or a geographic limitation on the restrictions of a non-compete provision is another way to more narrowly tailor the provision.  But this is not foolproof or even necessary in all instances – the Seneca One decision acknowledges that non-competes without an industry or geographic limitation may be enforceable in certain circumstances, such as where the provision is otherwise narrowly tailored to protect the employer’s legally protected interest.

At its core, determining whether a non-compete provision is enforceable or not requires careful parsing of the factual details specific to each particular employer/employee situation.  That being said, Seneca One (and the cases like it) are very helpful because these decisions can be used to inform and guide this analysis.

Politics and Commercial Law – Trump’s Immigration Stance as Constructive Eviction?

For all the talk of big money and big business and their role in national politics, it’s actually relatively rare for national political issues to intersect with the mundane world of commercial law. That changed last week when a development entity controlled by (and named after) Donald Trump, the poll-leading republican presidential candidate and reality TV star, filed suit against entities controlled by D.C.’s own celebrity chef, José Andrés.

The case, Trump Old Post Office LLC v. Topo Atrio LLC and ThinkFoodGroup LLC, Case No. 15-1238 in the U.S. District Court for the District of Columbia, stems from Trump’s redevelopment of the Old Post Office Pavilion, a Washington, D.C. landmark, into a luxury hotel and conference center. As people familiar with the D.C. business community will likely recall, in November 2014, the Trump organization announced that it had entered into an agreement with world renowned chef José Andrés, pursuant to which Andrés would enter into a sublease for close to 10,000 square feet for the development of a “flagship restaurant” in the “Grand Cortile” of the Old Post Office Pavilion. In short, Andrés’ restaurant was to be a focal point and a key component of Trump’s luxury re-development of the Old Post Office Pavilion.

As is often the case with business relationships, this one seems to have started on a rosy-enough basis – the complaint quotes José Andrés as saying, in the January 2015 press release announcing the deal, that he has “long respected Donald Trump for his business acumen and [I] am proud to partner with him to create a truly remarkable, fine dining restaurant in the city I have called home for many years, right in the heart of the historic Post Office.” Andrés’ restaurant entity, Topo Atrio LLC, was to commence building out its restaurant space, pursuant to a sublease between the parties and, by the end of June 2015, was to submit documents to Trump Old Post Office LLC indicating that the build out was 90% complete. According to the Complaint, however, that never happened.

Instead, on July 8, 2015, the Washington Post quoted Andrés, who emigrated from Spain and became a U.S. citizen in 2013, stating that it was impossible for Andrés or his company to open his restaurant given Trump’s statements with respect to illegal immigration made during Trump’s June 16, 2015 presidential campaign announcement speech. Shortly thereafter, the relationship and the deal between the two men spiraled further downward, as Trump’s organization sent a notice of default to Topo Atrio LLC for failure to tender the 90% completion documents. Two days later, Topo Atrio LLC countered that the Trump organization had constructively evicted Topo Atrio through Trump’s statements and demanding that Trump recant those statements and somehow ensure that those statements “not be repeated, restated, or further disseminated.” Two days after that, the Trump organization rejected Topo Atrio LLC’s default notice because, among other things, Donald Trump himself was not a party to the sublease. Topo Atrio LLC then sent a notice of termination of the sublease. On that same day, the Trump organization fired back with a denial that the tenant had a right under the sublease to terminate and giving Topo Atrio LLC until July 30, 2015 to tender the required 90% completion documents. When that did not occur, on July 31, 2015, the Trump organization sent a notice exercising its right to terminate and cancel the sublease. The Complaint was filed that same day.

Trump Old Post Office Pavilion LLC is suing Topo Atrio LLC, as the principal obligor under the sublease, and ThinkFoodGroup LLC, as guarantor, on three discrete counts: (i) Breach of the sublease; (ii) enforcement of the guarantee; and (iii) attorneys’ fees. Under its breach of sublease count, the Trump organization is seeking lost rent (defined to include base rent, percentage rent, and additional rent) and damages related to the “reprogramming” of the space to be occupied by Andres’ restaurant. The complaint does not quote the rent provision of the sublease so it is not clear whether the Trump organization is alleging that termination caused the acceleration of all rents due through the full term of the sublease (a typical commercial lease provision). These damages are “in an amount to be proven at trial” but are estimated to exceed $10 million. By the guarantee count, the Trump organization is seeking to tag ThinkFoodGroup LLC with full liability for all damages due under the sublease. Under the attorneys’ fee count, the Trump organization has isolated and is pleading separately the attorneys’ fee provision in the sublease.

Andrés has not yet responded to the Trump organization’s complaint (nor is he required to at this point), so this article is based on the court filing of only one side of the dispute. That being said, however, and with acknowledgement that there is at least a second side to every story, it appears that Trump’s claims against Andrés stand on a solid legal foundation while Andrés’ position ventures into uncharted legal territory. A brief search of precedent, both within the District of Columbia and elsewhere, failed to reveal even a single instance of a court finding constructive eviction caused by the public words of a nonparty to the transaction, even when the offending nonparty is a principal/affiliate of a party. Moreover, Trump’s comments on illegal immigration, objectionable or not, were political speech, protected by the First Amendment. While I might change my mind after I read Andrés response, at this point I would advise him to get back to what he knows best – building great restaurants – and to choose his business partners carefully.

 

Slam Dunk for Donut Franchisor in Preliminary Injunction Ruling: The US District Court for the District of Columbia Enjoins Dunkin’ Donuts Franchisee from Operating Pending Underlying Breach of Contract Action

By: Alan J. Schaeffer

The U.S. District Court for the District of Columbia recently granted Dunkin’ Donuts Franchising, LLC a preliminary injunction, enjoining a franchisee from using Dunkin’ Donuts’ trademarks, or operating a competing business within 5 miles during the pendency of Dunkin’ Donuts’ action against the franchisee for breach of contract and trademark infringement. Dunkin’ Donuts Franchising, LLC v. 14th Street Eatery, Inc., et al., 2015 WL 209041 (D. DC May 5, 2015). This case is another example in a long history of franchise disputes where a franchisor succeeds in enjoining its franchisee from continuing to operate after being terminated, either by enforcing trademark rights, non-compete covenants, or both. Franchisees ultimately must abide the franchise agreements they sign and their operating rights are only valid as long as they are in good standing under those agreements.

But the real lesson of this case is that a franchisee should never ignore the franchisor when a a formal dispute process is initiated. Ignorance is not bliss and will lead to a bad outcome that will be difficult to reverse and which, in many cases, might sound the death knell for the franchisee’s future business prospects. In this case, the franchisee would have been well served to respond to the Franchisor’s notice of breach. With some discussion of the non-payment problem, the parties might have found a workable solution, whether it involved a payment plan or some remedial conduct on the part of Dunkin’ Donuts in response to some complaint by the franchisee. Instead, the franchisee let Dunkin’ Donuts terminate the franchise agreement without objection, essentially admitting its wrongdoing under the franchise agreement. The case probably was already lost by the time it reached the court and the franchisee’s continued failure to respond assured the outcome for Dunkin’ Donuts.

The underlying contract dispute arose when the franchisee failed to pay Dunkin’ Donuts the royalties and advertising fees that were required under the Dunkin’ Donuts franchise agreement. Dunkin’ Donuts issued a notice of breach to the defendants and demanded payment. After the prescribed cure period expired without a response from the defendants, Dunkin’ Donuts issued a second notice. The result was the same: no response or payment. This occurred over a four month period during which time the defendants continued to operate their franchised store. Dunkin’ Donuts finally terminated the defendants’ franchise agreement and their right to continue operating the Dunkin’ Donuts store. But the defendants nonetheless remained open and operating as a Dunkin’ Donuts store.

Injunctive Relief is an “Extraordinary and Drastic Remedy”

In addition to filing suit for trademark infringement and breach of contract, Dunkin’ Donuts moved for a preliminary injunction to prevent the defendants from continuing to operate the Dunkin’ Donuts store. Injunctive relief is a powerful enforcement tool and obtaining it can be very difficult. The Dunkin’ Donuts Franchising court explained just how difficult: “A preliminary injunction is an ‘extraordinary and drastic remedy’ that is ‘never awarded as of right’.” In order to prevail on a motion for injunctive relief, the movant “must demonstrate [1] that he is likely to succeed on the merits, [2] that he is likely to suffer irreparable harm in the absence of the preliminary relief, [3] that the balance of equities tips in his favor, and [4] that an injunction is in the public interest.”

How did Dunkin’ Donuts meet this extraordinary 4-part burden? First, the franchisor had to demonstrate a likelihood of success on the merit of its claims. Because the underlying facts that led to Dunkin’ Donuts terminating the franchise agreement and the fact that the franchisee continued to operate the store as an unauthorized Dunkin’ Donuts following termination were not contested, establishing likelihood of success on the merits was not difficult.

After addressing the likelihood of success on the merits, the court then addressed the “irreparable harm” element and found that Dunkin’ Donuts would be irreparably harmed if the injunction was not granted because “trademark infringement raises the presumption of irreparable harm.” Trademark infringement may lead to dilution of the distinctiveness of a trademark, loss of control of reputation and diminishment of goodwill, all of which cause irreparable harm. In this case, the defendants would irreparably harm the franchisor by continuing to operate a store using Dunkin’ Donuts marks without authorization and depriving Dunkin’ Donuts of the ability to control the use of its trademarks and ensure the quality control necessary to protect the goodwill associated with the brand.

The court then briefly addressed the last two elements necessary for granting a preliminary injunction: balance of equities and public interest. For the public interest element, the court reiterated the fact that the defendants were confusing (and deceiving) the public by operating an unauthorized Dunkin’ Donuts store and the quality and integrity of the product the public expected could suffer without the oversight of the franchisor.

The Court Delivered a Well-Reasoned Opinion but it was the Franchisee’s Total Failure to Respond or Defend Against the Breach of Contract Claims that Led to the Inevitable Result.

In the court’s discussion of the “balance of equities” element, it becomes clear that beyond the legal analysis of the various criteria necessary to grant injunctive relief, possibly the determining factor for the court decision in granting Dunkin’ Donuts’ motion was that the franchisee defendants were no-shows. They did not contest the termination by Dunkin’ Donuts and did not at any time respond to or appear during the legal proceeding. The court explained: “Based on the uncontested facts, Defendants brought this fate upon themselves by not paying contractually obligated fees.” Had the defendants contested the original breach, or at least approached Dunkin’ Donuts in response to the notice or to try to resolve the matter, they might have had the chance to make a claim for wrongful termination or franchisor breach. And when the franchisee totally ignored the legal action, the defendants left the court no choice but to accept Dunkin’ Donuts’ termination as justified and correct. And once the termination was accepted as the proper course of conduct by Dunkin’ Donuts, it did not seem so drastic or extraordinary for the court to find the elements necessary to grant the preliminary injunction.

This decision is a stark reminder of the power of injunctive relief – in this case that relief literally put the defendant out of business at the outset of litigation. Even if the defendant in this case is able to fund the fight on an ongoing basis, they may never recover the amounts lost due to their interrupted business operations. More than that, though, this case stands for the proposition that business owners/senior management need to take disputes seriously. The plaintiff in this case had to carry a very heavy burden in order be awarded an injunction. But the plaintiff was helped in this regard by a defendant that failed to assert a defense, at both the demand stage before litigation and once in court when the plaintiff sought injunctive relief.

Keeping Your Priorities Straight: The District of Columbia’s Split Priority Statute Allows Condominium Assessments To Prime And Potentially Extinguish First Priority Liens

The District of Columbia Court of Appeals recently confirmed the extensive reach of D.C.’s condominium assessment lien statute, D.C. Code § 42-1903.13 (a) (2001), which empowers a condominium association to foreclose its lien when a unit owner becomes six months behind in payment of condo assessments.  See Chase Plaza Condominium v. JPMorgan Chase Bank, N.A., (D.C. Apr. 17, 2014).  What makes the statute so unusual, and what can be a real surprise for unsuspecting secured lenders, is that the statute permits a condo association to foreclose its lien without satisfying prior liens and, therefore, could result in extinguishment of liens that are senior and prior to the condo association’s lien.  This is precisely what happened in Chase Plaza, which now serves as a powerful reminder that secured lenders active in the D.C. condominium market must be vigilant and take steps to protect themselves against liens for unpaid condo fees.

The D.C. Condo Statute Grants Condo Associations Powerful Super- Priority Lien Rights

While many state legislatures have enacted statutory liens for past due condo assessments, the District of Columbia’s statute contains a powerful tool that, in theory, could permit a lucky buyer to purchase a condominium unit for the cost of six months’ worth of condo fees.  Known as a “super-priority” lien, D.C. Code § 42-1903.13 (a) (2001) authorizes a condo association, to the extent of the sum that equals six months’ of past due condominium assessments, to prime senior, preexisting liens—including first priority UCC and purchase money security interests.  While condo fees in excess of the six-month sum are relegated to their ordinary position in the hierarchy of priorities, the statute creates an incentive for the condo association to initiate a foreclosure sale.  Because of its “super priority” status, the condo lien comes before all other liens regardless of its size, thereby relieving the condo association from raising the cash that ordinarily would be necessary to foreclose the senior lien interest(s).  Unless the purchase price is adequate to satisfy the senior liens, the statute extinguishes any and all senior and prior liens.

The D.C. Court of Appeals Upheld an Auction Sale that Extinguished a Six Figure Lien

In Chase Plaza, the borrower, Brian York, purchased his home in 2005 for $280,000 pursuant to a deed of trust that was later assigned to JP Morgan Chase.  By 2008, Mr. York had defaulted on his mortgage and was six months behind on his condo association fees.  The condo association commenced proceedings to foreclose its super-priority lien, asserting a whopping $9,415 in past due condo fees.  The condo association published a sale notice and notified all parties to the deed of trust that the sale would not be subject to the first deed of trust.  JP Morgan and its nominees failed to object.  A lone bidder showed up at the auction and purchased the condominium unit for $10,000.  Despite having a market value of approximately $200,000, after satisfaction of the condo association’s lien, all that was left of the proceeds to be remitted to JP Morgan was $478.  The foreclosure had the effect of extinguishing JP Morgan’s lien as well as a $60,000 second mortgage—both of which were duly recorded against the property.  In other words, the lucky buyer scored a condo for less than ten percent of its value.  In April 2010, when JP Morgan realized what had happened, it brought a complaint against the condo association and the buyer, arguing that the foreclosure should be set aside and its first priority lien should be reinstated.  The D.C. Court of Appeals upheld the sale and lien extinguishment, but remanded the case to determine whether the purchase price was unconscionable.

How Secured Lenders Can Protect Themselves

Chase Plaza serves as a painful reminder to financial institutions and other lenders of both the power that D.C. law gives condo associations and the downside risk of letting condo fees go unpaid, something that virtually every defaulting mortgage borrower does.  There are some things that secured lenders may do to try to protect themselves.  First, they could treat condo association fees the same way many lenders treat insurance and property taxes and require the borrower to escrow at least six months’ worth of condo fees and assessments.  A second option would be to require the borrower to include condo assessments in its monthly loan payment to permit the lender to make direct payments to the condo association.  Additionally, because condo fees and assessments are often subject to change at the condo association’s discretion, to the extent practicable, secured lenders should consider taking steps to stay apprised of the status of condo fee rates and the existence or likelihood of special assessments.

Tayman Lane Chaverri LLP Achieves Substantial Victory in Landmark Human Rights Case at the Intersection of Family and Immigration Law

Tayman Lane Chaverri LLP is pleased to announce that it prevailed at trial on behalf of its client, a minor child from Honduras, who escaped persecution by fleeing the country alone to seek reunification with her birth mother.  In a landmark family law and immigration case, TLC partner Katie Lane Chaverri overcame the procedural and practical roadblocks that often arise at the intersection of civil law and federal immigration law and obtained rulings and written orders from the Superior Court of the District of Columbia that granted custody to the child’s mother and served as the predicate for the child’s relief before U.S. Citizenship and Immigration Services.   Tayman Lane Chaverri LLP represented the minor child and her mother on a pro bono basis.

Owner Financing – Debt, Equity, or What?

From paying business expenses out of personal funds, to credit card advances, to cutting a check from a personal account to cover payroll in advance of a progress payment, business owners, particularly owner-operators, often serve as the financing source of first recourse when there is a cash flow deficit.  All other things being equal, an owner’s advancement of funds to his or her business from time to time is not a problem.  If everything works out, these transactions typically resolve themselves in the ordinary course of the business’ life.  If something goes wrong, however, these transactions may be subject to scrutiny by co-owners, lenders, creditors, or other parties-in-interest.  If this happens whether the owner contribution will be treated as debt or equity is much more situationally-dependent than the owner may realize when making the advance.

Because this issue is most likely to arise when the business that received the advanced funds is troubled, and because debt generally takes priority over equity in the divvying up of the spoils of a business gone bad, the party challenging the characterization of an advance is much more likely to seek to characterize what the owner considers to be debt as equity, rather than the other way around.  In most traditional businesses, there is usually no advantage to be gained by seeking to characterize equity as debt.

When push comes to shove and the matter is made the subject of litigation, courts are not required to simply accept the label of “debt” or “equity” placed upon a particular transaction.  A court will inquire into the actual nature of a transaction rather than accept the original parties’ characterization.  The primary factor considered when evaluating whether funds advanced by a shareholder are the result of an equity contribution or a loan is whether the transaction bears the earmarks of an arm’s length negotiation.  The more the supposed debt transaction reflects the characteristics of an arm’s length negotiation, the more likely such transaction will be treated as debt.

In making this determination, courts consider a variety of factors, including: (1) the names given to the certificates or documents evidencing the indebtedness; (2) the presence or absence of a fixed maturity date; (3) the source of payments; (4) the right to enforce payment of principal and interest; (5) participation in management flowing as a result of the funds advanced as part of the original transaction; (6) the status of the contribution in relation to regular (i.e., third-party) corporate creditors; (7) the intent of the parties; (8) ‘thin’ or inadequate capitalization; (9) identity of interest between creditor and stockholder; (10) source of interest payments; (11) the ability of the corporation to obtain loans from outside lending institutions; (12) the extent to which the advance was used to acquire capital assets; and (13) the failure of the debtor to repay on the due date or to seek postponement.

A critical group of these factors concern the formality of the alleged loan agreement.  The more specific and complete the parties are in identifying and codifying the terms of the alleged loan, the more like debt the transaction appears, and the more likely a court will be to agree to characterize the advance as a loan.  On the other hand, if the terms of such an agreement are vague and non-specific, the alleged loan may be interpreted to be more like a shareholder contributing equity to sustain his investment.

Another important group of factors concern the financial situation of the business at the time the owner made the purported loan.  If investing in the company appears to have been particularly risky (e.g., it was thinly capitalized), or the source of repayment of the “loan” was not made clear when the funds were advanced, then the transaction may be more readily characterized as an equity contribution.  The final group of factors is the relationship between the business’ equity owners, their respective interests in the business, and the identity of the parties’ participating in the making of the loan.  Where control of the business appears to be dependent upon the making of the loan, the loan is more likely to be characterized by the court as equity.

Uncharacterized fund advances happen all the time.  All too often, business owners fail to properly structure these transactions to withstand adverse scrutiny after the fact.  Business owners would be well-advised to take the long-term view and structure these transactions with an eye to the factors identified in this article.  Doing so may short circuit disputes before they have a chance to grow to the point where they cost the company and parties-in-interest unnecessary attorneys’ fees or even threaten the company’s health or well-being.

Binding Means Binding (Most of the Time Anyway)

Businesspeople ask for binding arbitration provisions to be worked into their contracts in the belief that arbitration is preferable to traditional litigation in terms of speed, cost, and efficiency of dispute resolution.  Whether or not that belief proves true is usually a function of the facts and circumstances of the particular situation.  However, as Judge Royce C. Lamberth of the U.S. District Court for the District of Columbia reminds us in his recent opinion, FBR Capital Markets & Co. v. Hans, — F.Supp.2d —- (D.D.C. 2013), certain things about arbitration are fairly predictable.  In particular, arbitrations conducted pursuant to binding arbitrations will result, in most instances, in arbitral awards that will be binding on the parties to the arbitration.

The case before Judge Lamberth was initiated under the Federal Arbitration Act (the “Act”) (9 U.S.C., § 1, et al.) following the award of a Financial Industry Regulatory Authority (“FINRA”) arbitration panel.  The Act is a body of federal law that provides a vehicle for the facilitation of arbitration, and for the recognition of the decisions resulting from private arbitrations.  Below the federal level, many states have enacted arbitration laws that are similar to the Act.  These state laws are often so similar that many states’ judiciaries look to federal caselaw for assistance in interpreting the state statutes.

FINRA is an independent, Congressionally-authorized, nonprofit organization that regulates the financial services industry.  In addition to promulgating rules to regulate the conduct of member organizations and their associated brokers and financial advisors, and enforcing those rules, FINRA provides an arbitration forum for the resolution of certain disputes.  Unless there is a written agreement requiring arbitration, FINRA arbitration of disputes between investors/customers and FINRA-member firms and/or their associated brokers and financial advisors is optional.  FINRA arbitration is mandatory for disputes between FINRA-member firms or between FINRA-member firms and “associated persons,” such as FINRA-registered brokers employed by or otherwise associated with a FINRA-member firm, when the dispute arises out of the non-insurance business of the FINRA-member firm or associated person.  The dispute at issue in FBR v. Hans stemmed from allegations by Hans that FBR, an investment bank and brokerage house based in Arlington, Virginia, failed to pay Hans brokerage commissions due under Hans’ agreement with FBR Capital Markets & Co. (“FBR”).

FBR initiated the case before Judge Lamberth by filing a petition under the Act to vacate the arbitration award entered by FINRA against FBR and in favor of the counterparty, a former broker for FBR.  The dispute at issue in the underlying arbitration was whether FBR had an obligation to pay its broker a commission on a transaction.  Judge Lamberth began his opinion by noting that judicial review of the findings of an arbitration panel is sharply limited by the Act and that Sections 10 and 11 of the Act provide the only grounds by which a federal court may vacate an arbitration award.  Only egregious departures from the parties’ agreed-upon arbitration are subject to judicial review:  corruption, fraud, evident partiality, misconduct, misbehavior, exceeding powers, evident material miscalculation, evident material mistake, and awards based upon a matter not submitted.  The only ground with any softer focus is imperfections, and a judge may review those only if they go to a matter of form not affecting the merits.  Because in promulgating the Act Congress clearly expressed an intentional national policy favoring arbitration as a dispute resolution venue, to vacate an arbitration order a petitioner must clear a high hurdle.

In its challenge to the arbitration decision, FBR argued that the FINRA panel manifestly disregarded the law.  Judge Lamberth disagreed and found that the FINRA arbitration panel had not manifestly disregarded the law but, on the contrary, had hear the arguments of both sides on the issues and made the legal decisions that the panel saw fit given those arguments.  Judge Lamberth then cited to D.C. Circuit precedent holding that courts reviewing arbitration decisions must confirm an arbitration award if a justifiable ground for the arbitration decision can be inferred from the facts of the case.  Finding that there were justifiable grounds for the FINRA arbitration panel to have reached its decision, Judge Lamberth then concluded that FBR had failed to meet its heavy burden and further admonished the petitioner that it should not continue to use the courts to re-litigate disputes it has settled, albeit not in its favor, through arbitration.

Judge Lamberth’s opinion in FBR Capital Markets & Co. v. Hans should serve as a reminder to everyone that, at least in the arbitration context, binding almost always means binding, and that one must meet a very high bar to vacate the decision of an arbitration panel that does its job properly.  Before businesses rush to put binding arbitration provisions in their commercial agreements the decision-makers should spend some time considering the kind of disputes that may spring from the transaction at issue.  Before opting to include binding arbitration provisions in commercial agreements, businesses should understand that, at a minimum, the parties must overcome a very high bar to overturn, seek higher review of, or otherwise “appeal” the result of a contractually binding arbitration.