By Scott Hall and Amber Leong

Despite (or possibly in reaction to) the recent court decision halting the enforcement of the regulations for the Consumer Privacy Rights Act (“CPRA”) by nine months, California regulatory authorities have made clear that they are still full speed ahead on privacy.

Immediately after the recent court decision on June 30, 2023, the California Attorney General’s Office issued a press release that it had sent notices to certain California employers regarding their compliance efforts in connection with employee privacy rights. Subsequently, the California Privacy Protection Agency (“CPPA”) released a statement on July 31, 2023 announcing its intent to review automakers’ data privacy practices for any “connected vehicle[s]” given these vehicles’ ability collect information “via built-in apps, sensors, and cameras, which can monitor people both inside and near the vehicle.” A few days later, on August 4, 2023, California Attorney General Rob Bonta and the CPPA filed a petition seeking to overturn the June 30, 2023 trial court decision delaying enforcement of the CPRA regulations.

Thus, in what has been a very busy past few weeks, California has clearly signaled its intent and willingness to move forward with the enforcement of privacy rights of California residents under the CPRA (which remains in effect despite the halt of regulations by court order). If companies have not already done so – they should, as soon as possible, assess whether they are subject to the CPRA, and if so, work with their legal teams to ensure their data collection practices, privacy policies, service provider agreements, and mechanisms to process consumer requests are all in place. Companies should also closely review areas of privacy that have been identified as enforcement priorities by regulators, including employee privacy rights, selling and sharing of consumer data, and connected vehicle data collection. California has shown it is not afraid to dole out fines in the millions. And with a new, dedicated California Privacy Protection Agency, in addition to the AG’s office, Federal Trade Commission, and other privacy enforcers, we can be sure to see a continued focus on privacy enforcement. If you have any questions or concerns, please do not hesitate to contact the Coblentz Data Privacy & Cybersecurity team.

By Scott Hall and Bina Patel

Although you are likely breathing a sigh of relief after just finishing compliance efforts for the California Privacy Rights Act (“CPRA”), don’t relax just yet. California has another new privacy law going into effect on July 1, 2024: The California Age-Appropriate Design Code Act (“CAADCA”). The new law is aimed at enhancing privacy, data, and safety protections for children and teens who use online platforms. Businesses subject to the CPRA should review the requirements of CAADCA closely to determine how their data protection measures should be updated, as the new law expands upon existing laws geared towards minors, such as California’s Parent’s Accountability and Child Protection Act and the federal Children’s Online Privacy Protection Act (“COPPA”).

Businesses Subject to CAADCA

CAADCA defines “business” the same way as CPRA.[1]  But, CAADCA only applies to businesses that provide online services, products, or features that are “likely to be accessed by children” who are under age 18. Still, this is a very broad scope, and much broader, for example, than COPPA, which is limited to operators of websites “directed to children” under 13, or with “actual knowledge” that a website is collecting personal information of children under 13.  CAADCA therefore expands both the age range (by 5 years) and the types of businesses and websites subject to regulation, since many online services, products, or features may be “likely to be accessed by children” under 18 even if they are not specifically directed at children or with actual knowledge of access by children. Whether a website is “likely to be accessed by children” will be determined based on various factors, including whether it is directed to children, routinely accessed by a significant number of children, has advertisements marketed to children, has design elements that are known to be of interest to children (i.e., games, cartoons, music, and celebrities who appeal to children), and has a significant audience that is determined to be children.

Affirmative Requirements of Covered Businesses

CAADCA requires covered businesses to implement the following affirmative actions:

• Perform a Data Protection Impact Assessment. Covered businesses must complete a Data Protection Impact Assessment (“DPIA”) before publicly launching a new online service, product, or feature that is “likely to be accessed by children.” The DPIA must include detailed information about a business’s online service, product, or feature, including its purpose, how it uses children’s personal information, and how it could harm children through its algorithms, design features, and targeted ads. The DPIA is confidential and exempt from public disclosure. Each business must retain documentation of the DPIA for as long as it provides the online service, product, or feature to children and provide a copy to the Attorney General upon request.
• Provide privacy by default. Covered businesses must configure all default privacy settings offered by the online service, product, or feature to offer a high level of privacy, unless the business can demonstrate a compelling reason that a different setting is in the best interest of children.
• Provide a privacy policy and terms. Covered businesses must provide privacy information, terms of service, policies, and community standards concisely, prominently, and using clear language suited to the age of the children that are likely to access their online service, product, or feature.
• Allow children to exercise privacy rights. Covered businesses must provide prominent, accessible, and responsive tools to help children or their parents/guardians exercise their privacy rights and report concerns.
• Identify tracking signals. Covered businesses must provide an obvious signal to a child when the child is being monitored or tracked by the online service, product, or feature.

Restrictions on Covered Businesses

CAADCA also prohibits covered businesses from engaging in the following actions:

• Using a child’s personal information in a way that is “materially detrimental to the physical health, mental health, or well-being of a child.”
• Collecting, selling, sharing, or retaining the personal information of children for any reason other than a reason for which the personal information was collected, unless the business can demonstrate a compelling reason that aligns with the best interests of children.
• Collecting, selling, or sharing any precise geolocation information of children, unless it is strictly necessary for the business to provide the service, product, or feature and only for a limited time.
• Using dark patterns, which are online experiences designed to encourage children to provide too much personal information.
• Profiling children, though this prohibition is subject to certain exceptions.
• Using personal information to estimate the age of a child for any other purpose or retaining that personal information longer than necessary to estimate age.

Enforcement of CAADCA

There is no private right of action under CAADCA, but the law authorizes the Attorney General to seek an injunction or civil penalty against any business that violates its provisions. The Attorney General can hold violators liable for a civil penalty of up to $7,500 per affected child. The new law gives companies an opportunity to cure any alleged violation within 90 days so that they can avoid these penalties.

Next Steps for California Businesses

While CAADCA does not go into effect until July 1, 2024, it is vital that California businesses take steps to ensure their compliance with the new law in advance of the effective date. These steps may include the following:

• Assess whether your business is subject to CAADCA. Determine if your business’s online products, services, or features are “likely to be accessed by children” under age 18 as defined under the new law.
• Start to prepare a Data Protection Impact Assessment. Familiarize yourself with the requirements of the DPIA and strategize how your business would perform such an assessment. For an online product, service, or feature that was launched before July 1, 2024, a DPIA must be completed by July 1, 2024. After that, a DPIA must be completed before launching any new online service, product, or feature that is “likely to be accessed by children.”
• Provide data privacy information in appropriate language for children. Revise your privacy information, terms of service, policies, and community standards so that they are accessible to the age group of children who are likely to access your online service, product, or feature.
• Start planning changes your business will need to make to ensure compliance. Businesses should consider how they can redesign their products, including those that have launched and those in development, to mitigate the risk of harm to children. For example, businesses will need to adjust their default privacy settings to accommodate a high level of privacy by default. A service, product, or feature should also provide an obvious signal to a child when their online activity is monitored or their location is tracked.
• Ensure that your business is not engaging in any prohibited activities. As described above, CAADCA imposes certain limitations on how and for what purpose a covered business may collect, sell, share, or retain a child’s personal information.

Please contact the Coblentz Privacy Team with any questions about CAADCA or other privacy issues.

To view a PDF version of this article, please click here.

[1] The CPRA defines a “business” as any for-profit entity operating in California that collects personal information of California residents and satisfies one of three requirements: (i) the company has annual gross revenues of more than $25 million; (ii) the company buys, sells, or shares personal information of at least 100,000 California residents; or (iii) the company derives at least 50% of its annual revenues from selling or sharing California residents’ personal information.

Wine trademarks have been the subject of recent decisions from the United States Patent and Trademark Office. In analyzing whether there is a likelihood of confusion between trademarks, these decisions illustrate the growing trend toward finding wine to be related to other types of alcohol, restaurant services, and even coffee, and fruit. Sabrina Larson and Bina Patel discuss the legal landscape of the vineyard and registering wine trademarks in the North Bay Business Journal article “Vine Notes: Relating wine to beer and spirits, restaurant services, even coffee and fruit.” To read the full article, please click here.

By Scott Hall, Mari Clifford, Sabrina Larson, Amber Leong, and Bina Patel

Now that July 1, 2023 has passed, and the California Privacy Rights Act (“CPRA”) is in effect, California Attorney General Rob Bonta has indicated his intent to ensure compliance with the new statute by sending out letters to certain California companies—particularly those with numerous California employees—to ascertain compliance with the CPRA’s requirements for employees and job applicants. Enforcement of these provisions may move forward even though enforcement of certain CPRA regulations has been postponed until early next year as detailed in our previous client alert.

Please contact Scott Hall at shall@coblentzlaw.com or Coblentz Data Privacy & Cybersecurity attorneys if you receive a letter regarding your privacy compliance practices and would like assistance in responding.

By Scott Hall, Mari Clifford, Sabrina Larson, Amber Leong, and Bina Patel

You are likely aware of headlines spreading the news of a recent Superior Court of California decision that has delayed the enforcement of the California Privacy Rights Act (“CPRA”) regulations until March 29, 2024. However, while the enforcement of the regulations has been delayed until March of next year, the CPRA itself remains in effect (since January 1, 2023) and is enforceable. 

On June 30, 2023—the eve of the July 1, 2023 enforcement date of the CPRA regulations—a California state court judge granted an injunction delaying enforcement of the CPRA regulations until March 29, 2024. The court found that the regulations could not be enforced on July 1, 2023 because this did not give the adequate one-year notice from March 29, 2023, when the regulations were published. See Cal. Chamber of Comm. V. Cal. Privacy Protection Agency, 34-2023-80004106-CU-WM-GDS (Cal. Sup. Ct. June 30, 2023). Specifically, the court found that the voters who enacted the CPRA by ballot initiative intended businesses to have a 12-month grace period between the adoption of final regulations and their enforcement. Id. Accordingly, the court held that enforcement of any final regulation under the CPRA must be stayed for a period of 12 months from the date that individual regulation becomes final. For the first set of CPRA regulations that became final on March 29, 2023, that means enforcement must wait until March 29, 2024.

Takeaway: While this may seem like a nine-month reprieve, this should not be the time for companies to halt or delay CPRA compliance efforts. The CPRA itself is still in effect and enforceable even if the regulations are not. If businesses have not already done so, they should use this opportunity to finalize compliance under the CPRA and its current regulations. Additionally, this decision indicates that businesses will have a year to put into place compliance processes for any new regulations promulgated in connection with the CPRA going forward (e.g., for automated decisionmaking, data impact assessments, and other regulations still forthcoming), which is good news for businesses and compliance officers. 

The landscape of data privacy laws is constantly changing—with new states enacting new data privacy laws each week. By staying on top of CPRA compliance needs now, businesses will be in a better position to pivot quickly to adjust to new applicable state laws and new regulations yet to be issued under the CPRA.  

If you have any questions about CPRA compliance or other privacy issues, please contact Scott Hall at shall@coblentzlaw.com or Coblentz Data Privacy & Cybersecurity attorneys.

By Sabrina Larson and Christopher Wiener

On June 8, 2023, the Supreme Court issued a unanimous decision in Jack Daniel’s Properties, Inc. v. VIP Products, limiting the scope of a parody defense to a trademark infringement claim.

The Takeaways

• The test for likelihood of confusion must be applied where an infringer uses a trademark as a trademark to identify the source of its goods, even if it claims that use is a parody, rather than the First Amendment analysis applicable to the use of marks in expressive or artistic works.
• The use of a mark as a parody does not shield an infringer from a dilution claim (alleged based on famous marks) where it uses the trademark as a trademark, to identify the source of its goods.

Background

VIP makes and sells a line of dog toys called “Silly Squeakers” designed to look like and to parody popular beverage brands, including toys named Dos Perros, Smella Arpaw, and Doggie Walker, to name a few. At issue here is VIP’s “Bad Spaniels” toy, designed to evoke the distinctive Jack Daniel’s brand and bottle:

In addition to the overall trade dress of the bottle and label, the Bad Spaniels toy mimics numerous specific elements of the Jack Daniel’s bottle, many of which are registered trademarks. For example:

• “Bad Spaniels” instead of “Jack Daniel’s”
• “The Old No. 2 On Your Tennessee Carpet” instead of “Old No. 7 Tennessee Sour Mash Whiskey”
• “43% poo by vol.” and “100% smelly” instead of “40% alc. by vol. (80 proof ).”

As the Supreme Court wryly summarized, the “jokes did not impress” Jack Daniel’s. It claimed both trademark infringement and dilution.

Use of Someone Else’s Trademark in Expressive Works: The Rogers Test

VIP defended its use of the Jack Daniel’s trademarks under the First Amendment—claiming that the Bad Spaniels toy is an “expressive work.” It claimed that the Rogers test applied to its use of the trademarks and that as protected speech, the typical analysis for trademark infringement, whether the use of the trademark creates a likelihood of confusion as to the source of the goods, did not apply to the Bad Spaniels toy.

The Rogers test dates to a 1989 case from the Second Circuit, Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989), and has since been applied by courts in many circuits to analyze use of trademarks in “expressive works,” where trademark rights and free speech rights under the First Amendment intersect. Rogers addressed potential infringement in the context of titles of expressive works—Ginger Rogers claimed Fellini’s film title incorporating her name was an infringement. The court disagreed, reasoning that the “expressive element of titles requires more protection than the labeling of ordinary commercial products.”

Although Rogers dealt with titles of creative works, the test has since been applied broadly to the use of trademarks within an artistic or expressive work. When it is applied, Rogers requires dismissal of infringement claims where the trademark is used in an expressive work—without turning to a likelihood of confusion analysis—unless (i) the use of the mark has no artistic relevance to the underlying work or (ii) the use of the mark explicitly misleads as to the source or content of the work. The lead-up to the Bad Spaniels decision involved extensive debate over whether the Rogers test should be stricken or modified.

Jack Daniel’s Trademark Infringement Claim

The Supreme Court did not overrule the Rogers test, but it clarified that the test does not apply when the alleged infringer uses the trademark as a trademark—i.e., as a source-identifier for its own goods. Rogers remains a “cabined doctrine” applying only when the defendant uses the mark in a non-source identifying way. Here, the Court concluded, VIP was using the Bad Spaniels trademarks as trademarks, to identify the source of the VIP dog toy products, a point that VIP had earlier conceded in the case. Accordingly, the only question that remains is whether the Bad Spaniels trademarks are likely to cause confusion with the Jack Daniel’s trademarks as to the source of each party’s products.

The Supreme Court remanded the case to determine the question of likelihood of confusion. The issue of parody was, however, not resolved. While it cannot be analyzed under the Rogers test, VIP’s claimed use of the marks as parody will be relevant to likelihood of confusion. A successful parody must conjure up the original work while also creating a contrast, to make the message of ridicule or humor clear. If parody is done successfully, it is typically not likely to create confusion.

Jack Daniel’s Dilution by Tarnishment Claim

Jack Daniel’s also claimed that the Bad Spaniels toy constituted dilution by tarnishment of its famous trademarks. Dilution applies where the asserted trademark is famous—widely recognized by the public as designating the source of goods. 15 U.S.C. § 1125(c). Dilution can occur where an infringer uses a famous trademark for unrelated goods, creating an association that harms the reputation of the famous trademark: that is, for Jack Daniel’s, the association of its whiskey with dog excrement.

A statutory exception to dilution is where the use of the trademark is “noncommercial.” VIP argued that its Bad Spaniels toy, despite being sold to consumers, was a noncommercial use because it parodied Jack Daniel’s. The Court held, however, that the use of a trademark is not necessarily noncommercial simply because it parodies another’s product. Instead, it again matters whether the trademark is being used as a trademark, to designate the source of goods.

The Takeaways Revisited

The Bad Spaniels decision narrows defenses that rely on the parodic nature of the use of the trademark. Instead, even if the intended use is a parody, the traditional trademark infringement analysis of likelihood of confusion will apply if the trademark is used to designate the source of the goods. Likewise, the noncommercial exception to a dilution claim cannot be invoked simply because the use is an intended parody. Parody is and remains, however, relevant to the likelihood of confusion analysis. Those who engage in parodies should carefully consider whether the parody is being used as a source identifier of their own goods or services—and if it is, to carefully consider whether it is likely to cause confusion. Meanwhile, the Rogers test remains intact, applying, as it traditionally has, in instances where the parody is not being used as a trademark.

To view a PDF version of this article, please click here.

A Comprehensive Look at New Developments in Data Privacy Laws

By Scott Hall, Mari Clifford, Sabrina Larson, Amber Leong, and Bina Patel

Download a PDF version of this report here.

It has been a busy start to 2023 on the data privacy front: from new privacy laws being passed in several states and going into effect in others, to increases in privacy litigation and data breaches. Businesses need to be aware of new developments, new legal requirements, and steps that should be taken to comply with these laws and reduce business risk.

Our Spring / Summer 2023 Privacy Law Report highlights some of the most important privacy developments to be aware of for the coming year.

What the report covers:

• New State Privacy Laws
• California’s Upcoming Age-Appropriate Design Code Act
• Comprehensive Federal Privacy Law?
• EU-US Privacy Framework Status
• Trends in Privacy Litigation and Enforcement
• Health Privacy
• Biometric Privacy Laws
• SEC Cybersecurity Rule
• Data Breach Response

You can download the full report here. If your company needs assistance with any privacy issues, Coblentz Data Privacy & Cybersecurity attorneys can help. Please contact Scott Hall at shall@coblentzlaw.com for further information or assistance.

By Kyle Recker

Additional developments relating to the Silicon Valley Bank and Signature Bank failures have occurred, and the situation continues to evolve. Upon the closure of Silicon Valley Bank the FDIC initially created the Deposit Insurance National Bank of Santa Clara, into which it immediately transferred all insured deposits. The FDIC has subsequently established Silicon Valley Bridge Bank, N.A. (SVBB), a temporary national bank that will continue operations as a full-service bank. This is the same form of bridge bank that the FDIC utilized at the outset for Signature Bank when it formed Signature Bridge Bank N.A. (SBB). The FDIC has now transferred all insured and uninsured deposits at Silicon Valley Bank, as well as substantially all of the bank’s other assets and obligations, to SVBB.

Both SVBB and SBB are continuing to perform their obligations under all contracts, which are backed by the FDIC and the full faith and credit of the United States, and all counterparties are likewise expected to continue fulfilling their contractual obligations to each bank.[1] Earlier this week, the FDIC appointed Tim Mayopoulos as CEO of SVBB. Mr. Mayopoulos subsequently released a statement assuring customers that the bank is open for business, opening new accounts, making new loans, and fully honoring existing credit facilities.[2] A statement on the Signature Bank website also states that SBB is still “providing a full suite of loan, deposit, and banking services.”[3]

At this time, it seems that the FDIC’s strategy is to keep operations at both banks as intact as possible so that the banks can either be recapitalized or sold whole. During a call with Silicon Valley Bank clients on Wednesday, Mr. Mayopoulos reportedly implored them to move deposits to SVBB, and indicated that if they keep their deposits with other institutions then “that clearly limits the range of options.”[4] If a recapitalization or sale does not materialize with respect to either bank, liquidation remains a possibility. As covered in our previous alert, the FDIC retains the authority to halt lending operations and repudiate contracts and leases, as it determines to be in the best interests of the receivership, and may dispose of the bank’s assets in a piecemeal fashion. Those with ties to either bank should continue to monitor the situation.

Also on the horizon is a potential bankruptcy or other liquidation or restructuring event for Silicon Valley Bank’s parent company, SVB Financial Group, in which the parent company’s non-bank businesses and assets may be sold or otherwise administered.

For questions regarding any potential claims, or assistance evaluating existing credit facilities, leases, and other contracts to determine whether any actions may be appropriate in connection with recent events, please contact Kyle Recker at krecker@coblentzlaw.com or another member of the Coblentz team.

To view a PDF version of this article, please click here.

 

[1] See FDIC Financial Institutions Letter FIL-10-2023.

[2] A copy of this statement is available here.

[3] See https://www.signatureny.com/home.

[4] See this article at CNBC.

By Kyle Recker

By now, most will have heard the news that all deposits at Silicon Valley Bank have been made available to depositors. The Federal Deposit Insurance Corporation (FDIC), in a series of joint statements issued with the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System, announced that all deposits at Silicon Valley Bank – both FDIC-insured and uninsured deposits – have now been transferred to the Deposit Insurance National Bank of Santa Clara, a newly-created bank established by the FDIC.¹ 

New York regulators also shut down Signature Bank on Sunday, March 12, 2023, and appointed the FDIC as receiver. Similar to Silicon Valley Bank, both FDIC-insured and uninsured deposits have been transferred to Signature Bridge Bank, N.A., which will be operated by the FDIC as a full-service bank while it is marketed for sale to potential buyers.

The Systemic Risk Exception

The protection of all deposits at Silicon Valley Bank and Signature Bank, rather than only FDIC-insured deposits, was made possible by the so-called “systemic risk exception” (SRE). The SRE was created by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDIC Improvement Act), which prohibited the protection of uninsured deposits if the cost of the resolution of a failed bank to taxpayers would be increased as a result.² The SRE allows the FDIC to bypass this limitation by invoking the SRE if the Secretary of the Treasury, with the recommendation of the boards of the FDIC and the Federal Reserve System, determines that there would otherwise be “serious adverse effects on economic conditions or financial stability.” On Sunday, the FDIC invoked the SRE for Silicon Valley Bank and Signature Bank.

Bank Term Funding Program

The recent invocations of the SRE specifically apply to Silicon Valley Bank and Signature Bank; it does not mean that uninsured deposits at other financial institutions would be fully protected in the future (unless similar actions are taken). To restore confidence in the liquidity of the U.S. banking industry, the Federal Reserve Board also announced that it is establishing a new program known as the Bank Term Funding Program.³ Any FDIC-insured deposit institution may borrow funds under the program by depositing certain eligible securities with the Federal Reserve Banks as collateral, which will be valued at par rather than current market value. Advances are available for terms of up to one year, in amounts equal to the par value of the collateral. This will allow financial institutions to temporarily access liquidity equal to the par value of their securities which have lost market value, and currently represent unrealized losses a bank would be forced to realize now if it needed to sell the securities on the market (which essentially is what caused the run on Silicon Valley Bank).

Implications for Non-Depositor Stakeholders

The invocation of the SRE provides relief to impacted depositors, but borrowers, landlords, and other stakeholders of these institutions remain in uncertain positions. Prior to passage of the FDIC Improvement Act in 1991, the typical practice of the FDIC was to retain and manage troubled assets of failed financial institutions itself. But this approach proved to be too costly and complex. Now, the FDIC strategy is to seek a buyer of a failed bank’s assets and liabilities as soon as possible, and before a bank actually fails, allowing a different financial institution to continue operations relatively seamlessly from the perspective of depositors and most other stakeholders.

In situations where an acquisition is not immediately possible, there are two key alternatives available to the FDIC. One option is to create a temporary national bank known as a “bridge bank” that can continue normal operations under the FDIC’s control while the FDIC markets the bank to potential bidders. The other option is to form a Deposit Insurance National Bank, which is a bridge bank but with more limited operations than a temporary national bank.⁴ The FDIC recently utilized both of these options in creating the Deposit Insurance National Bank of Santa Clara (in connection with Silicon Valley Bank) and Signature Bridge Bank, N.A. (in connection with Signature Bank).

It remains possible that the FDIC will find buyers of substantially all of the assets and liabilities of each bank, including their loan portfolios, in the coming days and weeks. As of the date of this publication, HSBC has already been lined up to acquire the operations of Silicon Valley Bank in the United Kingdom (for only £1). But what will it mean for non-depositor stakeholders if no buyers step up soon?

FDIC Servicing of Assets; Contract & Lease Repudiation

It is the FDIC’s responsibility to service the assets of a failed financial institution while under receivership until the assets are sold, and it has a number of operational mandates that apply to servicing those assets, such as maximizing the return from their sale, minimizing the amount of realized losses, and preserving availability and affordability of housing for those with low and moderate incomes.⁵ It also has broad latitude in determining liquidation strategies, and the power to repudiate contracts and leases entered into by the failed institution before entering receivership.⁶ This means the FDIC has the flexibility, within its operational mandates, to elect to terminate outstanding loan commitments, to dishonor letters of credit, and to terminate branch and office leases, among other things.

Borrower Concerns

As noted above, the FDIC is responsible for servicing the assets under receivership until those assets are sold. This includes servicing existing loans and outstanding loan commitments. It is FDIC policy to transfer day-to-day servicing of any retained loans to national servicers within 90 days of the financial institution’s failure while the FDIC continues efforts to fully liquidate the institution’s loan portfolio. A number of disposition strategies may be used by the FDIC in the liquidation process, including bulk sales and securitization.⁷ 

To be clear, borrowers should not expect any relief from fulfilling their contractual obligations owed under their credit facilities with a failed financial institution. But on the flipside, given the flexibility the FDIC has to cancel outstanding loan commitments, borrowers should also understand that advances may not be available under lines of credit or construction and development loans. The FDIC will analyze funding requests to determine if a requested advance is in the best interests of the receivership. For example, the FDIC may determine that it is necessary to fund all or a portion of the requested advance in order to preserve the value of collateral or maximize recovery. However, the FDIC’s role as receiver generally precludes it from continuing lending operations.⁸ 

Borrowers also should be aware that Signature Bank provided cash management services in connection with commercial real estate loans as the clearing bank and cash management bank. Lenders may soon be seeking a replacement to Signature Bank if a sufficiently creditworthy buyer does not assume the bank’s obligations under the relevant account control and cash management agreements. Some borrowers also may have selected Silicon Valley Bank as a clearing bank, and should also expect that replacement may be required.

Landlord Concerns

While the FDIC has the power to repudiate leases, that does not necessarily mean it will do so for all leases or that it will do so immediately. For example, all Silicon Valley Bank and Signature Bank branch locations are now open for business and operating as branches of the applicable bridge bank under the FDIC’s control and, so long as those branches remain open to the public, landlords remain entitled to contractual rent until such time as notice of repudiation is given. To the extent leases are actually repudiated, landlords will have a claim against the receivership estate for any unpaid rent due as of the date the FDIC was appointed receiver.⁹ The extent of recovery for claims for unpaid rent will depend on the extent of funds ultimately recovered by the FDIC from liquidation and made available to various classes of creditors.

Some landlords also may hold letters of credit delivered by tenants in lieu of cash security deposits. As with outstanding loan commitments, the FDIC has the ability to repudiate funding obligations under issued letters of credit. Unless the issuer’s obligations are assumed by a purchaser, landlords should not expect that attempts to draw on such letters of credit will be honored and should consider demanding replacements from tenants. Even if the issuer’s obligations are assumed, landlords should consider whether the buyer is of adequate credit quality before determining not to require a replacement letter of credit.

Other Stakeholders

Borrowers and landlords are not the only stakeholders aside from depositors that may be impacted by receivership of a failed bank. Other stakeholders include counterparties to swaps and other derivatives transactions, parties to purchase contracts (real property or otherwise), service providers, suppliers, and various other secured and unsecured creditors, as well as investors. But note that the actions being taken by the FDIC and the Federal Reserve in connection with the Silicon Valley Bank and Signature Bank failures are expressly not designed with the protection of investors and unsecured creditors in mind.

The FDIC will establish a process for submitting proofs of claims in the receivership proceedings sometime in the near future, and potential claimants should consult with counsel to preserve their positions within the receivership proceedings as they progress. FDIC receiverships typically are administered in ways that are similar to state court receiverships or bankruptcy cases, but they are not governed by state law or the bankruptcy code.

For questions regarding any potential claims, or assistance evaluating existing credit facilities, leases, and other contracts to determine whether any actions may be appropriate in connection with recent events, please contact Kyle Recker at krecker@coblentzlaw.com or another member of the Coblentz team.

To view a PDF version of this article, please click here.

 

[1] FDIC press releases may be accessed here.
[2] To read more about the history behind the passage of the Federal Deposit Insurance Corporation Improvement Act of 1991, refer to this 2013 article by Noelle Richards of the Federal Reserve Bank of Philadelphia.
[3] A copy of the term sheet for the program is available here.
[4] For a more complete discussion of the FDIC strategies, refer to Chapter 6 of Crisis and Response: An FDIC History, 2008-2013.
[5] See 12 USC §§ 1821(d)(13)(E) and 1823(d)(3)(D).
[6] See 12 USC § 1821(e).
[7] See Crisis and Response, linked in footnote 4, above.
[8] See A Borrower’s Guide to an FDIC Insured Bank Failure.
[9] See 12 USC § 1821(e)(4)(B).

By Jessica Wilson

Structuring a family’s investment activities can be complex. Across assets, activities, relationships and the particular circumstances of each family member-investor, a family office will typically provide a spectrum of services. While the role of the family office is, in part, to substitute the range of independent advisors needed, structuring a family office in a tax-efficient manner can be difficult due to the limitations that the tax law places on related persons and managing one’s own investments. One such limitation has been the inability to deduct trade or business expenses related to the family office. However, recent court cases offer new guidance to family offices that may entitle taxpayers to a deduction for trade or business expenses if the family office is structured properly.

Background

Lender Management, LLC v. Commissioner of Internal Revenue, T.C. Memo. 2017-246 (2017), provides family offices with a potential way to obtain trade or business expense deductions under Internal Revenue Code (the “Code”) Section 162 in connection with rendering investment management services.

Prior to tax reform legislation enacted in December of 2017 (the “2017 Tax Act”), Code Section 212 allowed taxpayers to deduct expenses incurred for the production or collection of income, to the extent such expenses exceeded 2% of the taxpayer’s adjusted gross income. The 2017 Tax Act suspended miscellaneous itemized deductions under Code Section 212 from 2018 through 2025.

Code Section 162, on the other hand, has not been suspended. Section 162 allows a taxpayer to claim as a deduction all of the ordinary and necessary expenses paid or incurred by the taxpayer during the taxable year in carrying on a “trade or business.” For example, payment of salaries and other compensation is deductible as a trade or business expense. However, it has long been held that an investor is not, by virtue of activities undertaken to manage and monitor his or her own investments, engaged in a trade or business.

Therefore, given the suspension of deductions under Section 212, it would be beneficial for the owners of income-producing activities if those activities were treated as a trade or business expense for tax purposes rather than as an investment activity engaged in for the production and collection of income.

Lender Facts

A recent case that many taxpayers and practitioners have been relying on to work around the suspension of Code Section 212 is Lender Management, LLC v. Commissioner. The Lender case involved a family business consisting of multiple LLCs. Every LLC at issue in Lender was co-owned, whether individually or through an entity, by the child, grandchild or great-grandchild of the family patriarch, or by the spouse of one of those people. Lender Management, LLC (“Management LLC”) directed the investment and management of assets owned by three investment LLCs, each of which were owned by Lender family members. Management LLC was also owned indirectly by two Lender family members. Management LLC owned only a minority interest in the investment LLCs.

The operating agreements of the investment LLCs provided Management LLC with a profits interest as compensation for its services to the extent that it successfully managed its clients’ investments. While Management LLC was owned by, and provided services to, Lender family members, it also held itself out as an active management entity to various governmental authorities, clients, investment banks, hedge funds and private equity funds. While each investor in the investment LLCs was in some way a member of the Lender family, Management LLC’s clients did not act collectively. The Tax Court noted that they were geographically dispersed, and some of them were even in conflict with each other. Thus, it did not simply make investments on behalf of the Lender family group. It provided investment advisory services and managed investments for each of its clients individually, regardless of the clients’ relationship to each other.

The Tax Court found that Management LLC was engaged in a trade or business for purposes of the deduction under Code Section 162. The Tax Court focused its attention on the activities of Management LLC and the family relationship among the investors. While family relationships are generally subject to heightened scrutiny, Lender Management’s activities and the positive facts in this case satisfied the Tax Court and the deduction under Section 162 was allowed.

Hellmann

About a year after the Lender decision, the Hellmann family petitioned the Tax Court for a similar issue. However, the Hellmann family had less favorable facts.

The Hellmanns were a group of family members who owned and operated GF Family Management, LLC (“GFM”). Like Lender, the issue raised in Hellmann was whether GFM was engaged in a trade or business within the meaning of Section 162, which would entitle it to claim ordinary business expense deductions for its operating costs. The IRS, as it did in Lender, argued that GFM was not engaged in a trade or business.

The Hellmann case eventually settled without a ruling, so it cannot be certain how the Court would have ruled. Prior to settlement, however, the Tax Court issued an order outlining some of its preliminary thoughts, which highlighted the differences between Hellmann and Lender:

• There were four Hellmann family members related to the court case; they all resided in the same city, had a good relationship, and the family office made investment decisions for the group as a whole. While the Lender family members, on the other hand, were geographically dispersed, in some cases did not get along or did not know each other at all, and the family office made decisions for each family member separately.
• The Hellman family members owned 99% of the relevant investment partnerships, and each of the four family members held a 25% interest in the family office. In contrast, the Lender family office did not own a significant portion of the LLCs it managed, and most of the family members who invested in the LLCs did not have an ownership interest in the family office.

Concluding Thoughts

While the Lender case does provide a helpful look at what the Tax Court views as a valid trade or business for purposes of deducting expenses under Code Section 162, it is important to keep in mind that the facts are key. The structure in Lender may not be the typical family office structure, but for clients with the appropriate expertise and family structure, Lender potentially provides an avenue for deducting family office expenses under Section 162.

Each family office attempting to deduct expenses under Section 162 should analyze its unique circumstances in connection with these cases. This article was authored by Jessica Wilson. If you are interested in establishing a family office, restructuring an existing family office to fit within this guidance, or would like to learn more about ways to maximize value to your family, please contact Jessica Wilson at jwilson@coblentzlaw.com or James Mitchell at jmitchell@coblentzlaw.com.

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