Banking & Finance Law Report

High Risks of Banking with “Legal” Marijuana Businesses

Twenty-three states and the District of Columbia now permit the use and possession of marijuana to some degree under state law, and public support for legalization is at an all-time high. Despite the growing number of states legalizing marijuana, however, it remains a Schedule 1 controlled substance under the federal Controlled Substances Act (CSA). President Trump’s appointment of Alabama Senator Jeff Sessions, a long-time cannabis critic, as attorney general, brings even more uncertainty to currently hazy federal enforcement efforts. For banks and other financial institutions interested in providing loans or other banking services to the “legal” marijuana industry, the current federal prohibition and related regulatory challenges continue to result in risks that most institutions will find too high to overcome.

Federal Law and Current Guidance.

Because the manufacture, distribution, and dispensation of marijuana remains illegal under the CSA, banks and other financial institutions providing services to marijuana-related businesses risk violation of federal anti-money laundering statutes (18 U.S.C. §§ 1956 and 1957), the unlicensed money-remitter statute (18 U.S.C. § 1960) and the Bank Secrecy Act (BSA). These statutes can impose criminal liability for engaging in certain financial and monetary transactions with the proceeds of a “specified unlawful activity” and for failing to identify or report financial transactions that involve the proceeds of marijuana-related violations of the CSA. Continue Reading

Location is Not Everything When Perfecting a Security Interest

Most of us are familiar with that old saw “location, location, location”. While location might enhance the value of real estate, including the location as part of the collateral description in the UCC financing statement can limit the protections provided to a secured creditor and may provide a strategy for attack by a bankruptcy trustee.  First Niagara Bank learned this valuable lesson but only after spending substantial legal fees to protect a security interest where perfection should have been routine.

In the case of Ring v. First Niagara Bank, NA (In Re: Sterling United, Inc.),____F.3d ____, 2016 U.S. App. LEXIS 23009 (2d Cir. Dec. 22, 2016) (No. 15-4131-bk.), the Chapter 7 Bankruptcy Trustee for Sterling United, Inc., (“Debtor”) sued First Niagara Bank (“First Niagara”) asserting that First Niagara’s security interests in Debtor’s assets were avoidable under 11 U.S.C. § 547.  Under U.S.C. § 547(b)(4)(A), a trustee may avoid any “transfer of an interest of the debtor in property … made … on or within 90 days before the date of the filing of the petition” for bankruptcy, provided that those interests are not perfected security interests pursuant to 11 U.S.C. § 547(c)(3). Continue Reading

Liquidated Damages Provisions Are Enforceable Despite As Applied Inequities

Bankers and other business persons should carefully consider a significant change this year to the state’s law regarding contractual default clauses. The change was made by a little-noticed Ohio Supreme Court decision that requires the fairness of such clauses to be assessed from the perspective of the relationship of the parties at the beginning of the contract.  In the case at issue this led to enforcement of an extreme damages claim.

These clauses are commonly called “liquidated damages clauses” because they impose a definite economic cost on the defaulting party when a contract is breached. Such clauses are ubiquitous.  They are most frequently found in construction contracts and in public construction contracts they are often required by the law applicable to governmental bodies.  The clauses are also found in other types of business contracts frequently encountered by bankers such as IT vendor contracts, consulting contracts, contracts for the supply and delivery of equipment, and other contracts for the sale of goods and services where time is of the essence. Continue Reading

Website Accessibility Regulations Delayed Until 2018 but Banks Should Not Table the Issue

Long awaited Guidelines from the federal Department of Justice (DOJ) for website accessibility under the Americans with Disabilities Act (ADA) are now expected sometime in 2018. But, as discussed below, that does not mean that financial institutions transacting business with the public through websites and mobile applications should ignore web-based accessibility entirely until 2018. Law firms and the DOJ are attempting to enforce the ADA on website owners in the absence of mandatory regulatory guidelines.

The ADA and public accommodation

By way of background, the ADA requires that “places of public accommodation” be accessible to the disabled. Most financial institutions operating some form of physical facility open to the public understand their obligations to make those physical facilities accessible. Public accommodations are generally businesses that are open to the public and fall into one of 12 categories listed in the ADA, including “service establishments” which includes banking and financial institutions. Disabled persons can sue under the ADA alleging that they were denied full and equal access to the goods and services at a “place of public accommodation.” The DOJ also can bring suit for alleged ADA violations. There is a set of very specific and largely objective criteria for accessibility of physical locations.

Is your website or “app” a place of public accommodation?

This brings us to websites and mobile applications. Beginning in 2006, private litigants and the DOJ began filing or threatening to file legal action based on allegedly inaccessible websites (and eventually also including mobile applications). The law is unsettled as to whether websites and mobile applications are “places of public accommodation” under the ADA. Some courts have held that they are, and others have ruled otherwise. Some courts apply the ADA only to websites that have a connection to goods and services available at a physical location, like a retail store. The theory is that the store is a place of public accommodation, and “shopping there” online requires accessibility of the website. Other courts apply the ADA more broadly to include all websites that offer direct sale of goods or services, even those that lack “some connection to physical space.” Since web-based businesses can be sued anywhere they are regularly transacting business, litigants can select their forum based on which has the most favorable law.

Mobile banking websites and mobile applications are a way that a bank transacts its services with its customers. The argument would be that it is possible to fully enjoy the services offered by the bank without having access to the mobile banking website and mobile applications.

If the website or app is a place of public accommodation, what has to be done to make it accessible?

There are no current laws or regulations which define what is required. There are voluntary guidelines developed by W3C, an international consortium that develops web standards. The most recent version is the Web Content Accessibility Guidelines (WCAG) 2.0. Even within WCAG 2.0, there are degrees of accessibility: A, AA, and AAA. The lack of formal rules on accessibility has not stopped private litigants and their lawyers and the DOJ from attempting to enforce the ADA against businesses transacting business through websites and mobile applications. The DOJ has been insisting (without any statutory or regulatory basis) that websites and mobile applications be brought into compliance with WCAG 2.0 AA.

At the most basic level, an accessible website would have these (and other) accessible elements:

  • Provides text alternatives for any non-text content;
  • Provides alternatives for time-based media;
  • Includes content that can be presented in different ways without losing information or structure;
  • Is easy to see and hear, including separating foreground from background;
  • Permits all functionality from a keyboard (as opposed to a cursor);
  • Permits sufficient time to read and use content;
  • Is not designed in a way that is known to cause seizures;
  • Includes ways to help users navigate, find content, and determine where they are;
  • Includes text content that is readable and understandable;
  • Operates and appears in predictable ways;
  • Helps users avoid and correct mistakes; and
  • Is compatible with current and future user agents, including assistive web technologies.

What should businesses do?

Law firms representing private litigants have become increasingly aggressive in recent months in pursuing online accessibility. A typical approach involves a letter from a law firm asserting that the website or app is not accessible and offering to discuss an “agreed plan” for bringing the website into compliance. The threat typically also insists on payment of significant attorney’s fees and sometimes alleged damages as terms to settle. Even more importantly, businesses are potentially missing out on e-commerce with disabled customers who are unable to navigate their websites or mobile applications. Bottom line: You would be wise to evaluate the costs and potential benefits of incorporating website accessibility designs sooner rather than later, especially if a website or mobile application revamp is in your near-term business plans.

Ohio Bank Tax Legislation

On September 26, 2016, Rep. Armstutz introduced two pieces of legislation in the Ohio House that could impact the tax rate of the Ohio financial institutions tax (“FIT”) that is paid by banks and other financial institutions doing business in Ohio. These bills are H.B. 599 and H.B. 600.  These bills are alternatives.  Both would not be enacted.

The FIT took effect starting in 2014 and replaced the Ohio corporate franchise tax and dealers in intangibles taxes on financial institutions. Sometimes when a new tax is introduced to replace an existing tax, there are tax rate adjuster provisions in the legislation that are designed to “right-size” the tax rate over time to generate approximately the same amount of revenue as the old tax generated, or to generate a certain targeted amount of revenue for budgeting purposes.

H.B. 599 would delete the future rate adjuster provisions entirely that are set to be calculated during 2016 that would either increase or decrease the rates for years 2017 and thereafter.  Under H.B. 599, the current rates would continue indefinitely.

H.B. 600, alternatively, would use $212 million as the “2016 target” for the amount of revenue raised by the FIT.  It would increase the tax rate for 2017 and thereafter on the largest financial institutions if the total amount collected in 2016 is less than 90% of $212 million.  It would decrease the tax rate across-the-board for 2017 and thereafter if the total amount collected in 2016 is more than 110% of $212 million.

Sixth Circuit Underscores Importance Of Moving For A Stay After Entry Of Judgment In Foreclosure Proceedings

 

On September 9, 2016, the United States Court of Appeals for the Sixth Circuit issued a decision that parties in foreclosure proceedings should read carefully. In MSCI 2007-IQ16 Granville Retail, LLC v. UHA Corporation, LLC, Case No. 15-3524, the court addressed whether the sale of foreclosed property during the pendency of an appeal moots the appeal.  The court’s answer?  Yes, at least under the facts of this case.

Facts

MSCI obtains a judgment

Plaintiff MSCI 2007-IQ16 Granville Retail, LLC (“MSCI”) obtained summary judgment in this commercial foreclosure case that was filed in federal court because of diversity of citizenship between the parties and the fact that the four commercial properties at issue were located in three different counties.  The United States District Court for the Southern District of Ohio (the “District Court”) issued an in rem judgment entry and decree in foreclosure, finding that Defendant UHA Corporation, LLC (“UHA”) owed MSCI more than $13 million on the defaulted loan at issue.  UHA timely appealed, alleging a number of errors by the District Court.

The properties are sold

During the pendency of the appeal—because UHA failed to move for a stay of execution on the judgment in the District Court—the court-appointed special master placed the properties at issue up for sale. The properties were sold, and the sale and distributions were ultimately confirmed by the District Court.  Deeds to the properties were then executed and recorded.

The Sixth Circuit’s Analysis

Is there a final decision?

After merits briefing concluded, the Sixth Circuit requested supplemental briefing on whether the judgment entry and decree in foreclosure was a final decision within the meaning of 28 U.S.C. § 1291. The court concluded that it was, writing that “[b]ecause the judgment entry and decree determined the rights and obligations of the parties and lienholders; fixed a certain amount to be paid to MSCI that would be supplemented with future interest accrued, advances made, and other contractual obligations; and identified the property to be sold in satisfaction of that debt, it is a final decision.”  Accordingly, the court had appellate jurisdiction.

Is the appeal moot?

MSCI moved to dismiss the appeal as moot, arguing that the Sixth Circuit was powerless to grant any effectual relief to UHA. The court agreed that “[b]ecause UHA did not seek a stay, and MSCI enforced the judgment by selling the property and distributing the proceeds, satisfaction of the judgment renders this appeal moot.”  The court found that the version of Ohio Revised Code § 2329.45 in effect during the course of the litigation did not allow a restitution remedy for UHA because the cases interpreting that statute all presumed that the appellant at least sought a stay, whereas here UHA failed to move for a stay.  Moreover, the court reasoned, even if restitution was theoretically available to UHA, its debt to MSCI so far exceeded the appraised values of the foreclosed properties that any restitution award would simply be offset against the unpaid balance of the loan.

Accordingly, the Sixth Circuit granted MSCI’s motion to dismiss the appeal as moot, agreeing that it could no longer grant any effectual relief to UHA.

Takeaway

In this case of first impression, the Sixth Circuit joined its sister circuits—including the Fifth, Seventh, and Ninth Circuits—in finding that dismissal is appropriate where the property at issue is sold during the pendency of the appeal. The decision suggests that property owners facing an adverse judgment in foreclosure proceedings should at least move the trial court for a stay of execution on the judgment.  In fact, the court implied that simply moving for a stay—even where such a motion would be unsuccessful due to the property owner’s inability to post a supersedeas bond—may be enough to preserve the remedy of restitution afforded by Ohio law.

 

 

 

Legal mistakes, Good Faith Errors and the Fair Debt Collection Practices Act

Things looked bad for an Illinois law firm in 2014 when a consumer complaint was filed in federal district court against it. It was accused of violating the Fair Debt Collection Practices Act. The firm’s purported violation: Not anticipating when an appellate court would overrule established precedent.

And an opinion of United States Supreme Court overruled the firm’s best defense: that it had made a good faith legal error.

The matter began in 2013 when the law firm filed a consumer collection action. The FDCPA requires the filing of collection actions in the “judicial district” where the debtor lives or signed the contract.  The law firm reasoned that if the debtor lived in the Cook County judicial district, filing the suit would be proper there.  Its choice of venue was the First Municipal District of the Circuit Court of Cook County.

But there was a complication. There are many municipal districts in Cook County and the consumer did not actually live in the First Municipal District (although he did live in Cook County).

So should the law firm file the suit in the municipal district where the debtor lived? Or was it enough to file in the “judicial” district of Cook County?

The firm consulted its law books. It found a decision in 1996 of the federal Seventh Circuit Court of Appeals right on point.  And Cook County is in the Seventh Circuit.  That case was well known and had been followed in other cases.  That seemed to be the end of the matter until a few weeks after the filing of the collection action.

Then the Court of Appeals in a split decision overruled the older decision. The case should have been filed in the municipal district where the debtor lived.

Now it was clear that the law firm had filed the collection suit in the wrong place. The firm voluntarily dismissed the case, without prejudice to refiling in the correct venue.

And was the consumer happy? No. He turned the table on the firm and became a plaintiff under the FDCPA.

Under the FDCPA, a debt collector (in this case the law firm) is responsible for its errors. And consumers can enforce the FDCPA.

It was clear in this case, of course, there had been an error even if there was a good justification for it. But a U.S. Supreme Court decision under the FDCPA refuses to permit debt collectors to assert a good faith error defense when the error at issue is a legal mistake.  The consumer argued filing in the venue was no doubt a legal mistake.  So it didn’t matter whether the law firm acted in good faith.

The law firm argued it was unfair to impose liability against it in these circumstances. It had followed a clear judicial precedent, in good faith.  There was no dispute about that.

The law firm argued that it should not be required to predict when previous legal precedent would be overruled. If that was the case, then how would anyone know which cases to follow and which to disregard?  The Seventh Circuit Court of Appeals ultimately agreed, affirming a decision of the lower court that did not impose liability on the law firm.

Under the bona fide error defense, a debt collector is shielded from liability under the FDCPA, if it can show by preponderance of the evidence the violation was unintentional and resulted from a bona fide error notwithstanding procedures put in place to avoid the error. There was no assertion the law firm’s violation was intentional or that the law firm did not maintain procedures designed to avoid errors.

The only issue was whether the firm could rely on precedent and still be in “good faith.” At the time of the decision, the previous decision was almost eighteen years old. While the decision may have been criticized, it was clear the previous decision permitted the law firm to file the lawsuit where the lawsuit was filed.

The debtor asserted, however, that a recent U.S. Supreme Court decision, Jeremy v. Carlisle, 559 U.S. 573 (2010), held that the bona fide error defense was not intended to apply to a mistake in interpretation of legal requirements.  Debt collectors must follow the law and the good faith defense was intended by Congress to cover other kinds of errors.

But the Seventh Circuit Court of Appeals held the law firm had in fact made no mistake in legal interpretation because the existing precedent permitted the law firm to file where it did. The Court reasoned the law firm correctly interpreted the law that existed at the time the lawsuit was filed.

The Court of Appeals concluded that it was not the law firm’s mistake. Instead, it was the Court of Appeal’s mistake in its previous interpretation of the law that led to the misfiling of the collection action.

The Court of Appeals noted that the filing of the lawsuit was indeed a violation of the FDCPA. Yet that result was under the new precedent.  The retroactive change of law was entirely outside of the law firm’s control.  Hence, the bona fide error of defense applied.

The Court made specific mention of two aspects of record of the case. The Court may have found these persuasive in reaching its view of the case.

First, as soon as the older court decision was overruled, the law firm voluntarily dismissed its collection action.

Second, during the consumer’s deposition he was asked if where the collection suit was filed mattered to him. He responded, “I would say it only matters to me because it matters to my lawyer.”

Oliva v. Blatt, Hasenmiller, Leibsker & Moore, LLC, U.S. Court of Appeals, Seventh Circuit, No. 15 -2516 (June 14, 2016).

Expanding the Defense of Ordinary Course and Widening the Range of Acceptable Payments During the Historical Period

The Seventh Circuit Court of Appeals in Unsecured Creditors Committee of Sparrer Sausage Co., Inc. v. Jason’s Foods, Inc., 2016 WL 3213090 (7th Cir. June 10, 2016) expanded the scope of the ordinary course defense in a bankruptcy preference action.  This case provides an excellent road map for a creditors’ rights attorney defending a preference suit and suggests arguments for increasing the payments a creditor can retain even if those payments were made during the 90-day preference period.

Here are the facts in Jason’s Foods.  During the 90-day preference period, the debtor paid invoices it received from Jason’s Foods totaling about $587,000.00.  The Unsecured Creditors’ Committee filed suit asking the bankruptcy court to avoid all payments made within the 90-day preference period.  The bankruptcy court ruled that prior to the preference period, the debtor generally paid the invoices to Jason’s Foods within 16 to 28 days.  Accordingly, of the 23 invoices paid during the preference period, 12 were within the range and 11 were outside the range.  Thus, the bankruptcy court concluded that $306,110.23 of the payments were not made in the ordinary course.  The issue for the Seventh Circuit was whether the bankruptcy court set the range of ordinary course (within 16 to 28 days) too narrowly.  Jason’s Foods challenged the bankruptcy court’s decision in two ways.  First, it challenged the court’s use of an abbreviated historical period rather than the company’s entire payment history.  Second, it argued that the baseline comprises a too-narrow range of days surrounding the average invoice age during the historical period. Continue Reading

Supreme Court Enhances Creditor’s Right to Bar Debtor’s Discharge of Debts-Expanding Reach of Actual Fraud and Shareholder’s Liability

Until the recent U. S. Supreme Court’s decision in Husky International Electronics, Inc. v. Ritz, __ U.S. __, 136 S.Ct. 1581, 194 L.Ed.2d 655, 84 U.S. L.W. 4270 (2016),  there was disagreement in the circuit courts regarding whether a debtor in bankruptcy could be denied a discharge under 11 U.S.C. § 523(a)(2)(A) where the evidence of wrongdoing proved the debtor committed actual fraud, but there was no evidence that the debtor made a misrepresentation to the creditor seeking to bar the discharge.  For example, assume you represent a supplier who has a judgment against an insolvent company.  Assume further that you discover that the company’s major shareholder fraudulently transferred assets of the company to other entities which resulted in the company’s insolvency.  Accordingly, you file a piercing-the-corporate-veil claim against the shareholder and obtain a judgment.  However, before you can collect on the piercing claim, the shareholder files for bankruptcy protection.  You file an adversary proceeding seeking an order denying the discharge of the shareholder’s debt based on the fraudulent transfer scheme and the piercing-the-corporate-veil claim.  The shareholder counters and argues that the debt is nevertheless subject to discharge because § 523(a)(2)(A) requires evidence that the debt was obtained by actual fraud.  In the normal piercing case, a creditor will be hard pressed to present evidence that the debt was obtained by actual fraud, because the evidence usually is limited to showing that the ability of the company to pay its legitimate debt was hindered or delayed by the fraudulent acts of the shareholder.  Thus, the District Court of Texas and the Fifth Circuit Court ruled in favor of the shareholder and allowed the piercing debt to be discharged in bankruptcy.  This decision was in direct conflict with the Seventh Circuit’s decision in McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000) and the First Circuit’s decision in In Re Lawson, 791 F.3d 214 (1st Cir. 2015).  In McClellan and Lawson, the Courts followed the contrary rule holding that § 523(a)(2)(A) is not limited to misrepresentations and misleading omissions, but includes deliberate fraudulent-transfer schemes.  Such was the conflicting state of the law until the Supreme Court rendered its decision in Husky.

On May 16, 2016, the Supreme Court resolved the conflict and thereby enhanced the rights of creditors to prohibit a debtor in bankruptcy (including a shareholder liable based on piercing) from walking away from a debt arising from a fraudulent transfer scheme. The Court held that the term “actual fraud” in § 523(a)(2)(A) encompasses fraudulent conveyance schemes, even when those schemes do not involve a false representation.

Here are seven take-aways from the Husky case:

  1. There is a presumption that Congress did not intend “actual fraud” in § 523(a)(2)(A) to mean the same thing as a false representation;
  2. Actual fraud has long encompassed the kind of conduct involving a transfer scheme designed to hinder the collection of a debt;
  3. Anything that counts as fraud and is done with wrongful intent is “actual fraud” under § 523(a)(2)(A);
  4. Fraudulent conveyances, although fraudulent, do not require a misrepresentation from the debtor to the creditor;
  5. Fraudulent conveyances are not inducements based on fraud, but typically involve a transfer to a close relative, a secret transfer, a transfer of title without a transfer of possession, or a transfer based on grossly inadequate consideration;
  6. The fraudulent conduct is not in dishonestly inducing a creditor to extend the credit, but in the act of concealment and hindrance; and
  7. Nothing in the text of § 523(a)(2)(A) supports the position that the phrase “obtained by . . . actual fraud” requires not only that the relevant debts result from or be traceable to fraud, but also that the debts result from fraud at the inception of a credit transaction.

The Husky case will become an invaluable tool for creditors-rights attorneys who are able to establish sufficient evidence supporting a piercing-the-corporate- veil claim against a shareholder.  Even if the shareholder were to file for bankruptcy protection, a debt based on actual fraud, without a misrepresentation, will survive the bankruptcy discharge, because it is now understood that a false representation is not a necessary element of actual fraud and the Supreme Court in Husky refused to adopt such a requirement.

Federal Reserve Expresses Openness to Relaxation of HVCRE Regulations on Community Banks

Last year, as noted by this blog, the FDIC, OCC, and Federal Reserve imposed harsher capital requirements on certain “high volatility commercial real estate,” or HVCRE, exposures, in accordance with the Basel III international banking standards. These new requirements were opposed not only by the real estate industry but also by banking associations, particularly the Independent Community Bankers of America (ICBA). The ICBA argues that the Basel III rules were intended to apply only to large, internationally active banks, and that the rules place too great a regulatory burden on smaller institutions. A recent report by the Federal Reserve Bank of Philadelphia notes that CRE regulations disproportionately affect smaller banks, as “CRE represents approximately 50 percent of small bank loan portfolios, compared with just over 25 percent of large bank portfolios.” The report goes on to state that loans that might be classified as HVCRE under the new rules represent approximately 5% of total loans for the median commercial bank with total assets below $10 billion, “a modest, but certainly not insignificant, portion of small banks’ CRE portfolios.” Continue Reading

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