The Tort of Appropriation: Consequences and Avoidance Strategies

In the age of the internet, successful marketing and advertising requires businesses to be able to immediately capture the attention of potential customers. Often, this can be accomplished by using a familiar face or voice in advertising material. Whether it is a celebrity talking about their favorite hamburger or an NBA player’s picture on a box of cereal, such endorsements tend to play a role in the marketing success of a product or service. However, when a person’s identity is used without their permission, what may have seemed like an innocent use of someone’s image can quickly turn into a lawsuit.

Misappropriation and the Right of Publicity

The “right to privacy” and its protection from government intrusion was a foundational tenet of America’s inception; its protection from private actor’s intrusion has been a fundamental legal principle in the United States since as early as the late 19th century.[1] Embedded in such principle is the tort of “misappropriation”, or the unauthorized use of a person’s identity for another’s benefit.[2] Although this right to privacy typically applies to any person,[3] those who are arguably most harmed from such practices are celebrities and public figures. In the context of celebrities, public figures and others who generate economic value from their identity, the “right of publicity” is the legal principle which aims to protect such valuable traits from unauthorized uses.[4] In protecting such assets, various states have passed right of publicity statutes, such as California’s Celebrities Rights Act which also affords posthumous rights for deceased celebrities and public figures.[5]

What is Protected?

Attributes such as a person’s name, voice, signature, photograph, and likeness are those traits which are specifically protected under law.[6] However, courts often analyze the use of any of these features in a wide-reaching manner. For instance, the use of a person’s name applies not just to someone’s legal name, but also to pseudonyms and aliases.[7] Additionally, of these characteristics, courts often interpret “likeness” using the broadest of definitions. In one instance, using the “readily identifiable” standard, a court found that a sufficiently detailed drawing could fall under the “likeness” category.[8] This “readily identifiable” test is included in California’s Celebrities Rights Act and provides that “a person shall be deemed to be readily identifiable from a photograph when one who views the photograph with the naked eye can reasonably determine that the person depicted in the photograph is the same person who is complaining of its unauthorized use.”[9]

What is Prohibited?

Misappropriation is the unauthorized use of a person’s identity for “exploitative purposes”, which is generally defined as “advertising purposes or for the purposes of trade.”[10] Such exploitative purposes are further laid out in California’s right of publicity statute, which prohibits the unauthorized use of another’s identity in connection with “products, merchandise, or goods, or for purposes of advertising or selling, or soliciting purchases of, products, merchandise, goods or services.”[11]

Whether a use is for “exploitative purposes” is often a subject of contention between parties. As was the case when Jewel Foods ran a full-page advertisement congratulating Michael Jordan on being inducted in the Naismith Memorial Basketball Hall of Fame in 2009 which resulted in Jordan subsequently suing Jewel Foods for violations of his right of publicity.[12] The court sided with Jordan in finding that the inclusion of the “Jewel-Osco” logo along with the conspicuously placed marketing slogan in the congratulatory advertisement was sufficient to be considered a commercial or exploitative use.[13] In yet another contentious use in 2019, a lawsuit was brought against Fiji Water for a right of publicity violation.[14] In this case, Fiji Water had posted a meme[15] which featured a cardboard cutout of Kelly Steinbach, who was seen holding a tray of Fiji Water bottles throughout the 2019 Golden Globe Awards.[16]


In addition to the risk of being dragged into a potentially costly and lengthy litigation proceeding, remedies for misappropriation and the violation of one’s right of publicity can have substantial consequences. One such example occurred in the In re NCAA Student-Athlete Name & Likeness Licensing[17] class action, where college athletes had sued a videogame developer for the unauthorized use of the athletes’ names and likenesses, which ultimately purportedly settled for $40 million in favor of the college athletes.[18]

One key form of recovery in a misappropriation action is the disgorgement of the defendant’s wrongfully earned profits.[19] Additional types of remedies are often available, particularly in California where the right to publicity is a paramount concern to celebrities and public figures alike. In support of the significance of such assets, California law provides that plaintiffs are not only permitted to pursue and recover damages for violations of both the common law and statutory right of publicity,[20] but in cases where the defendant is found to have engaged in fraudulent or malicious conduct punitive damages and attorneys’ fees may also be recoverable.[21]

Avoidance Strategies

Using a person’s identity without their consent can result in considerable liability. However, there are certain types of uses which fall outside the scope of misappropriation. One of the key misappropriation exemptions or exceptions is a use that is made in connection with a newsworthy or public interest matter.[22] Particularly, uses that are made in connection with news, public affairs, sports and political campaigns are ones that, in some jurisdictions, do not require consent.[23] Although such uses may not be immune from defamation or other potential causes of action.[24]

Another form of use which often arises in misappropriation claims are certain types of creative uses which tend to be protected by the First Amendment.[25] In some jurisdictions, commentary, criticism, satire, and parodies fall under such exempted uses.[26] Meanwhile, some courts have ruled that a creative use of another’s identity may not constitute misappropriation if such use is transformative, looking to whether the new work merely supersedes the objects of the original creation, or instead adds something new with a further purpose or different character which alters the first with new expression, meaning, or message.[27] However, the ideal situation is likely to avoid having to support an argument for “transformation” altogether and maintain originality in advertising.


[1] See U.S. Const. amend. IV; see also, Samuel D. Warren & Louis D. Brandeis, The Right to Privacy, 4 Harv. L. Rev., 5 (1890). [2]  See, Ross v. Roberts, 222 Cal. App. 4th 677 (2013). [3] Fla. Stat. § 540.08 (2020). [4] See, Timed Out, LLC v. Youabian, Inc., 229 Cal. App. 4th 1001, 1006 (2014). [5] Cal. Civ. Code § 3344.1 (2020). [6] Cal. Civ. Code § 3344 (2020). [7] See, Faegre & Benson, LLP v. Purday, 367 F. Supp. 2d 1238 (D. Minn. 2005). [8] See, Newcombe v. Adolf Coors Co., 157 F.3d 686, 692-93 (9th Cir. 1998). [9] Cal. Civ. Code § 3344(b)(1) (2020). [10] N.Y. Civ. Rights Law § 51 (2020). [11] Cal. Civ. Code § 3344(a) (2020). [12] See, Jordan v. Jewel Food Stores, Inc., No. 12-1992 (7th Cir. 2014) [13] Id. [14] See, Steinbach v. The Wonderful Company LLC, et al. (LASC 19STCV03256)[15] Merriam-Webster defines “meme” as “an amusing or interesting item (such as a captioned picture or video) or genre of items that is spread widely online especially through social media.” [16] Id. [17] See, Keller v. Elec. Arts Inc., 724 F.3d 1268 (9th Cir. Cal. 2013). [18] See, Maureen A. Weston, Gamechanger: NCAA Student-Athlete Name & Likeness Licensing Litigation and the Future of College Sports, 3 Miss. Sports L. Rev. 77, 98 (2014). [19] Cal. Civ. Code § 3344(a). [20] Cal. Civ. Code § 3344(g) (2020). [21] Cal. Civ. Code § 3294 (2020). [22] See, Montana v. San Jose Mercury News, 34 Cal. App.4th 790, 793 (1995). [23] Cal. Civ. Code § 3344(d) (2020). [24] See, Eastwood v. Superior Court, 149 Cal. App. 3d 409, 421-26 (1983) [25] U.S. Const. amend. I. [26] Wash Rev. Code § 63.60.070(1) (2020). [27] See, Comedy III Prods., Inc. v. Gary Saderup, Inc., 25 Cal. 4th 387 (2001).

What’s in a Name? Avoiding Promoter Liability in Pre-Incorporation Contracts in Presley v. Ponce Plaza

A corporation must file the necessary paperwork with the Secretary of State to be incorporated. The incorporation process might take some time, and while this process is pending, the individuals forming the corporation may need to sign purchase orders, leases, or other necessary contracts. The individual who signs any of these contracts lists the corporation’s name, but the corporation is not technically in existence and will not be liable until the corporation adopts the contract.

Any contract entered into prior to the incorporation of a business entity is a possible liability for the “promoter.” A promoter is a person or entity acting on behalf of the corporation not yet formed.[1]  Presley v. Ponce Plaza Assocs., is an appellate case that involved a final summary judgment imposing personal liability upon the appellant for accelerated rent due under a lease agreement in which the appellant supposedly executed on behalf of a professional association.[2] The court reasoned that “[a]lthough the named professional association utilized by the appellant on the lease agreement was not a duly incorporated entity, the appellant maintained that the parties understood that it was merely an abbreviated name for appellant’s duly incorporated entity.”[3] The appellee, however, countered that, at all times, its lease agreement was with the appellant solely as an individual and that, in any event, where the appellant knowingly executed a contract on behalf of a non-incorporated entity, the appellant was individually liable as a matter of law.”[4] The court found that this created a sufficient dispute of material fact to preclude summary judgment and thus summary judgment was in error.[5] The lesson in this case is to avoid potential liability as a promoter, parties to a contract and contract drafters should always use the exact name of the entity already formed to avoid the accusation that the agreement was a pre-incorporation contract with a yet to be formed entity.

The promoter remains personally liable for pre-incorporation contracts he enters into, even after corporate adoption, unless and until there has been a novation.[6] A novation is a legal agreement between the promoter, the corporation, and at least one other contracting party in which each party agrees that the other contracting party that the corporation will replace the promoter under the contract.[7] Therefore, without a novation, if a corporation is formed and the contract is adopted by the business, both the promoter and the business will be liable on the contract. A corporation will become liable on a contract when it adopts the contract by either an express board of directors’ resolution or an implied adoption through knowledge of the contract and acceptance of its benefits.[8] This is known as ratification.[9]

Promoters are personally liable for pre-incorporation contracts because at the time of the formation of a pre-incorporation contract the corporation was non-existent. One strategy is to avoid contracting as a promoter altogether and simply to wait until the corporation is officially formed to enter into agreements on its behalf.  However, there may be situations in which pre-incorporation contracts are unavoidable. Determining the possible liability for pre-incorporation contracts is something that should be discussed with an attorney and the promoter and all liabilities should be analyzed thoroughly before signing on the dotted line. Such contracts should be carefully drafted to limit the danger that the promoter will be held personally liable.

According to Presley v. Ponce Plaza Assocs., in Florida, a creditor seeking to recover from an individual who has supposedly acted on behalf of a nonexistent corporation, the creditor must prove that the individual knew or should have known of the corporation’s nonexistence when he or she so acted.[10] It is, therefore, advisable to consult with an attorney and inquire about the possibility of including in pre-incorporation contracts a novation clause. This would include an explicit acknowledgement by the other contracting party that it understands it is contracting with an individual and the not yet formed corporation and that the contracting party will look only to the corporation, not the promoter, for performance if and when the corporation adopts the contract. Including such a provision in a true pre-incorporation contract can help avoid misunderstanding and save contracting parties, creditors, and debtors alike a great deal of money and frustration.


[1] Promoter, Black’s law dictionary (11th ed. 2020). [2] Presley v. Ponce Plaza Assocs., 723 So. 2d 328 (Fla. 3d DCA 1998). [3] Id at 329. [4] Id. [5] Id. [6] Electro-Protective Corp. v. Creative Jewelry by Kempf, 513 So. 2d 190, 192 (Fla. 5th DCA 1987). [7] Id. [8] Spurrier v. United Bank, 359 So. 2d 908, 910 (Fla. 1st DCA 1978). [9] Id. [10] Presley v. Ponce Plaza Assocs., 723 So. 2d 328, 329 (Fla. 3d DCA 1998).

Can a Business Sue for a Bad Review?

The Confluence of Free Speech and Free Enterprise

In the digital age, the culture surrounding how a business is “reviewed” by a customer or patron has become one of the most determining factors of a businesses’ success. The growing popularity of websites such as Yelp, Google, Bing, and other services which allow people to rate and review businesses has in turn resulted in a surge in the importance and impact that these reviews can have. With reviews now becoming the driving force behind influencing where consumers choose to take their business to, it is more essential than ever to understand what options a business has after receiving a negative review.


One of the more common causes of action which businesses bring forth against the poster of a negative review is for defamation. Although the definition of “defamation” varies from state to state, it generally encompasses a false and unprivileged publication which “exposes a person to hatred, contempt, ridicule, or which is injurious to such person’s occupation.”[1] Defamation can be in the form of a written publication, known as libel, or a spoken publication, known as slander.[2] In the context of reviews that are published about a business, the applicable form of defamation is “libel.” Although bringing a libel case against someone typically requires a plaintiff to show damages which result from the libelous statement, such as showing is not required if the statement is defamation per se.[3] Examples of libel per se are statements that: “(i) relate to the person’s business or profession to the person’s detriment; (ii) falsely claim that the person committed a crime of moral turpitude; (iii) imputes unchastity on the person; or (iv) claim that the person suffers from a loathsome disease.”[4]

Often, a negative review that is published about a customer’s experience with a business could constitute defamation per se, as such a review would relate to the plaintiff’s business or profession. However, there are several privileges and defenses that a defendant has available with regards to defamation claims making an effective defamation case difficult. In the context of a negative review, statements that are merely one’s opinion, hyperbole or which are understood as mere ridicule, rather than an allegation of fact, are subject to the “Opinion and Fair Comment Privileges” and are therefore not deemed to constitute a defamatory statement.[5] Additionally, truth and the substantial truth are absolute defenses against a finding that a statement is defamatory.[6]

Despite the potential availability of certain privileges or defenses, in cases where the person who published statement had fabricated the events surrounding the review or had otherwise falsified parts of the review, there is a greater likelihood that an injured business owner may prevail in a defamation claim against the reviewer. One such example occurred in 2016 when Florida’s Fourth District Court of Appeal awarded a business owner $350,000 for a negative review in which the business owner was able to prove that the reviewer had falsified information related to the review.[7]

First Amendment Protection

The First Amendment to the Constitution of the United States prohibits the making of any law which abridges the freedom of speech.[8] When one party sues another in response to a party’s publication of speech, such suit is often referred to as being a “strategic lawsuit against public participation” or “SLAPP”. In an effort to defend the citizen’s right to the exercising of their freedom of speech, states across the country have in turn passed what are generally referred to as “Anti-SLAPP” statutes, which are intended to provide protection in cases where a lawsuit has been brought against a party primarily to chill the valid exercise of the constitutional rights of freedom of speech.[9] In such cases, where a defendant is able to prevail on an Anti-SLAPP motion, the plaintiff would in turn be liable for the defendant’s attorney’s fees, court costs, and other expenses.[10]

The Consumer Review Fairness Act of 2016

Considering the increased vulnerability that businesses had become exposed to as a result of negative reviews, businesses have often turned to including or embedding non-disparagement clauses within certain agreements and licenses. The intent and effect of such clauses are to restrict a consumer’s ability to publicize negative and disparaging statements against a business. As a response to such oppressive actions against consumers, the Consumer Review Fairness Act of 2016 (CRFA)[11] was passed which solidified consumers’ “right to Yelp” and effectively invalidated non-disparagement clauses in certain “form contracts.”[12] Additionally, the CRFA makes it unlawful for a person to offer or enter into a form contract containing a non-negotiable non-disparagement clause.[13] The CRFA further empowers the Federal Trade Commission (FTC) with investigating and enforcing the act by providing the FTC with the ability to bring forth an action against a party who has violated the CRFA with causes of action such as unfair or deceptive acts or practices.[14]

Dealing with the Review Platforms

Besides dealing with the actual poster of a negative review, another common avenue that business owners looked to are the platforms in which the review is published on. Before the CRFA was passed, certain business review platforms such as Yelp had begun taking matters into their own hands. In 2012, Yelp starting issuing “Consumer Alerts” through it’s “Yelp’s Consumer Protection Initiative” which alerted visitors to a businesses’ profile that the business owner had previously threatened a reviewer with legal action.[15]

Additionally, business owners had often sought out to obtain the identity of anonymous negative review posters through subpoenaing records which would reveal such poster’s identity. Although ultimately reversed on jurisdictional issues, the Court of Appeals of Virginia held that the anonymity of the poster of a review can in fact be upheld if the reviews were in fact lawful.[16] However, such anonymity may not be upheld in cases where a plaintiff has a legitimate, good faith belief that such reviews are defamatory, such as is the case when the reviewer had not actually been a customer of the business.[17]

Lastly, have been the attempts for business owners to sue the review platforms themselves for having the published defamatory statements against them. However, after years of litigation, the California Supreme Court held in the landmark case Hassel v. Bird[18] that review platforms, such as Yelp in this case, are not liable for defamatory statements posted on their service due to the immunity granted to content service providers under Section 230 of the Communications Decency Act.[19]

Ultimately, it is an uphill battle for businesses to sue for a bad review. While some have been successful, case law, the burden of proof, and the level of anonymity make it difficult to sustain even a bona fide claim for defamation as a result of a falsified bad review.

[1] Cal. Civ. Code §§ 45-46. [2] Cal. Civ. Code § 44. [3] See Yow v. National Enquirer, Inc. 550 F.Supp.2d 1179, 1183 (E.D. Cal. 2008). [4] Restatement (2nd) of Torts, §§570-574. [5] See Leidholdt v. L.F.P. Inc., 860 F.2d 890 (9th Cir. 1988). [6] See Time Inc. v. Hill, 385 U.S. 411 (1967). [7] See Blake v. Giustibelli, Case No. 4D14-3231 (Florida 4th DCA, January 6, 2016). [8] U.S. Const. amend I. [9] California Code of Civil Procedure § 425.16. [10] Id. [11] 15 U.S. Code § 45(b). [12] 15 U.S. Code § 45(b)(a)(3). [13] 15 U.S. Code § 45(b)(c). [14] 15 U.S. Code § 45(b)(d). [15] Vince Sollitto, Protecting Free Speech: Why Yelp is Marking Businesses That Sue Their Customers, Yelp Official Blog (July 25, 2016) [16] See Yelp, Inc. v. Hadeed Carpet Cleaning, Inc., 752 S.E.2d 554 (2014). [17] Id. at 560. [18] Hassell v. Bird, 420 P.3d 776 (Cal. 2018). [19] 47 U.S.C. § 230.

McConville v. SEC: Widening the Net through Falsities and Scienter

McConville v. United States involved a petition for review of an order of the Securities and Exchange Commission (“SEC”) finding violations of several sections of the Securities Exchange Act of 1934 by the chief financial officer of Akorn Incorporated.[1] Akorn Incorporated manufactured and sold diagnostic and therapeutic pharmaceuticals to wholesalers and end-use consumers.[2] Akorn would process and keep track of its orders using various rates, corporate credits, and payment schedules (e.g. current, thirty to sixty days past due, etc.).[3] Akorn used a system that involved three different financing offices and used different computer programs and record-keeping mechanisms to track its orders and payments.[4] Akorn tried using a new system to improve its record keeping but the system was incapable of tracking all of Akorn’s data.[5] The company switched to another software and it did not transfer the data from the previous software system to the new one.[6]

Between February 28, 1997 and March 20, 2001, Rita McConville (“Petitioner”) worked as chief financial officer (“CFO”) of the company and was responsible for (1) supervising the finance departments, (2) working with Akorn’s auditor, and (3) filing documents with the SEC.[7] In 2000, problems with the company’s financial records came to light.[8] First, Akorn’s auditor alerted the board of problems with the company’s financial record-keeping, e.g. misapplication of credits, failure to review accounts receivables, etc.[9] Second, a dispute arose between Akorn and one of its customers as a result of billing discrepancies amounting to close to $5 million.[10]

Despite these problems, Petitioner assured the auditor that the accounts were being reconciled.[11] Petitioner also participated in the drafting of financial documents during her time as CFO, including the 2000 Form 10-K.[12] Petitioner also signed two letters essentially stating that the financial statements did not need to be adjusted because no events had occurred after December, 2000 and after February, 2001 that had a material effect on the statements.[13] In 2002, Akorn restated its financial statements for the years 2000 and 2001.[14] Akorn reported that it had some errors in their financial statements, among other concerns, that the company had in fact sustained a net loss of $2.4 million in 2000 instead of the gain of $2 million it had initially reported.[15]

In 2003, the SEC started proceedings against Petitioner and the current CFO of Akorn alleging that Petitioner’s mismanagement of the financial department caused the company to file documents that were in violation of the federal securities laws.[16] The SEC found that Petitioner’s conduct violated Sections 10(b), 13(b)(2), and 13(b)(5) of the Securities Act of 1934 (“Act”), among others.[17] After the SEC’s findings, Petitioner filed a petition for review with the United States Court of Appeals for the Seventh District.[18]

Under Section 10(b) of the Act, the Commission must show that Petitioner “(1) made a false statement or omission (2) of material fact (3) with scienter[19] (4) in connection with the purchase or sale of securities.”[20]  The issue was whether there was substantial evidence to support the Commission’s finding.[21]

Petitioner argued that the Commission did not prove the first and third elements by substantial evidence.[22] However, the appellate court found that the Commission proved the first element because Petitioner not only drafted Akorn’s financial statements, but she also reviewed and approved them, including the Form 10-K.[23] She also assured auditors that the documents were accurate and that no events had occurred that would make the documents misleading.[24] Therefore, the court concluded that Petitioner’s substantial involvement in the making of the documents and her statements to the auditors established that she made a false statement or omission.[25]

The court also found that the Commission proved the third element of scienter.[26] The court stated that “the requisite for scienter is an ‘extreme departure from the standards of ordinary care, which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.’”[27] Here, the court found that Petitioner was aware of the problems in Akorn’s financial department and that she failed to disclose them in the financial statements.[28] For example, Petitioner stated that all customer accounts would be reconciled by a specific date, but this was not accomplished.[29] Despite this, Petitioner told auditors that nothing had occurred that would have made the financial statements misleading.[30] Therefore, the court concluded that Petitioner’s conduct occurred with recklessness and that the Commission proved the third element.[31] In addition, the appellate court found that there was substantial evidence that Petitioner violated SEC rules 13(b)(2) and 13(b)(5) of the Act.[32] As a result, the appellate court denied the petition for review.[33]

McConville highlights the importance of good record keeping. Purposely submitting inaccurate or false information in documents filed with the SEC is not the only method of running afoul with the commission. Bad tracking and recordkeeping that causes inaccurate reports, even if not intentional, may also lead to violations and charges with the SEC. It is also not necessary for a person to sign a document for it to be attributed to them, it is enough that the person was substantially involved in the process of making the document, e.g. drafting, reviewing, or affirming the document’s accuracy and content.

[1] McConville v. United States, 465 F.3d 780 (7th Cir. 2006). [2] Id. at 782. [3] Id. [4] Id.  at 783. [5] Id. [6] McConville, 465 F.3d at 783. [7] Id. [8] Id. [9] Id. [10] Id. [11] McConville, 465 F.3d at 784. [12] Id. at 785 (A 10-K Form is a document reporting a corporation’s financial health to the SEC.).  [13] Id. [14] Id.  [15] Id. at 786.  [16] McConville, 465 F.3d 786 (Petitioner was the CFO during the preparation of the documents filed with the SEC but was removed shortly before the company filed its financial statements with the SEC. She continued to work gathering information for the financial statements in her new position as corporate controller.). [17] Id. [18] Id. [19] While not defined in the regulations, the United States Supreme Court has described the term “scienter” as proscribing conduct evinced by an intent to deceive, manipulate, or defraud; see, Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). [20] Id. [21] Id. at 787. [22] McConville, 465 F.3d at 787. [23] Id. [24] Id. at 788. [25] Id. [26] Id. [27] McConville, 465 F.3d at 788 (quoting Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 600 (7th Cir. 2006)). [28] Id.  [29] Id.  [30] Id. [31] Id. at 789. [32] McConville, 465 F.3d at 789-90 (The opinion also explains how Petitioner violated rules 13(b)(2) and 13(b)(5) but the focus of this article was on rule 10(b)).  [33] Id. at 790.

OCIE Risk Alert Cautions Registered Funds to Address Deficiencies

Recently, the Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert listing the deficiencies and weaknesses found most often by the agency while examining registered investment companies (“funds”).[1] The Risk Alert also includes observations that focus on money market funds and target-date funds.[2] According to the Risk Alert, the most common deficiencies and weaknesses are those related to the fund compliance rule, disclosure to investors, the board approval process involving advisory contracts, and the fund code of ethics rule.[3]

The Fund Compliance Rule

Under this rule, a fund is required to “adopt and implement written policies and procedures reasonably designed to prevent violations of the federal securities laws by the fund.”[4] The rule also requires that the fund board approve the policies and procedures of the fund’s service providers and annually review the adequacy and effectiveness of the policies and procedures. The most common deficiencies or weaknesses regarding the fund compliance rule are:

  • That funds’ compliance programs did not consider the nature of the business activities or risks specific to the fund;[5]
  • That funds did not follow or enforce their compliance policies and procedures;[6]
  • That funds did not “adopt and implement policies and procedures” to monitor compliance by service providers;[7]
  • That some funds did not “conduct annual reviews of their policies and procedures,” and others had so little documentation that it was unclear whether the reviews had been completed at all;[8] and
  • That certain funds conducted annual reviews but did not address how effective and adequate the fund’s policies and procedures were.[9]

Disclosure to Investors

“The federal securities laws make it unlawful to make untrue statements of material fact or omit material information necessary to make other statements not misleading in registration statements, reports, and other documents filed with the Commission or otherwise provided to investors.”[10] The most common deficiencies or weaknesses observed involved:

  • Funds that provided “incomplete or potentially materially misleading information in their prospectuses, statements of information, or shareholder reports when compared to the funds’ actual activities.”[11]

Some examples of incomplete or misleading information include not disclosing the payment of fees made to service providers and not disclosing changes to an investment strategy.[12]

1940 Act Section 15(c) Process

Section 15(c) “requires a majority of the fund’s independent directors to approve the fund initially entering into, or renewing, a contract or agreement with a person who undertakes regularly to serve or act as an investment adviser of or a principal underwriter for such fund.”[13] Among other considerations, board members of the fund have a duty to request and asses the information needed to evaluate the terms of the contract and to preserve the documents considered by the board when approving the terms or renewal of the contract.[14] The most common deficiencies or weaknesses involving the Section 15(c) process are:

  • That some fund boards may not have requested or considered information necessary to evaluate the fund’s investment advisory agreement, while others may have received incomplete information and did not request the missing information.[15]
  • That funds’ shareholder reports that did not “discuss adequately the material factors and conclusions that formed the basis for the board’s approval of an investment advisory contract”;[16] and
  • That, in some cases, the funds’ advisory contract review process did not comply with section 15(c).[17]

Fund Code of Ethics

The fund code of ethics requires funds and other entities “to adopt a written code of ethics containing provisions reasonably necessary to prevent their ‘access persons’ from engaging in fraudulent, deceptive, or manipulative acts in connection with the purchase and sale of securities held or to be acquired by the fund.”[18] The most common deficiencies and weaknesses related to the fund code of ethics rule are:

  • Funds that failed to implement procedures necessary to prevent violations of their codes of ethics or had procedures that were inadequate;[19]
  • Funds that failed to follow, enforce or “use reasonable diligence to prevent violations of their codes of ethics”;[20] and
  • Funds that failed to comply with their approval and reporting obligations.[21]

In addition, OCIE conducted an examination focusing on Money Market Funds (“MMF”) and Target Date Funds (“TDF”) and found some deficiencies and weaknesses as well.

Money Market Funds

  • When it comes to “eligible securities” and minimal credit risk determinations some MMFs did not maintain adequate records and in their credit files, did not include information required under Rule 2a-7;
  • When it comes to “eligible securities” and minimal credit risk determinations some MMFs did not have policies and procedures that addressed, among other things, filling accurate and timely information with the Commission, and testing for issuer diversification to ensure that no more than 5% of the funds’ assets were invested in any one issuer.[22]
  • Some MMFs provided stress test results that “did not include the required summary of significant assumptions used in the stress tests”;[23]
  • Some MMFs had not adopted and implemented policies and procedures to comply with Rule 2a-7;[24] and
  • MMFs did not disclose on their websites information required under Rule 2a-7 and/or the information was inaccurate.[25]

Target Date Funds

The OCIE noted that most of the TDF’s were following the 1940 Act in the areas reviewed, but there were still some deficiencies and weaknesses related to their disclosures and compliance programs.[26] “Some TDS had incomplete and potentially misleading disclosures in their prospectuses and advertisements.”[27] For example, some information in the TDFs marketing materials was different than the TDFs’ prospectus disclosures.[28] In addition, TDFs had incomplete or missing policies and procedures.[29] Some of the missing or incomplete policies and procedures involved monitoring asset allocations and overseeing advertisements and sales literature.[30]

The key takeaway from this risk alert is that boards of funds need to take a more active role in ensuring compliance with securities regulations. In particular, to avoid non-compliance, funds should review the fund compliance rule, expand disclosure to investors,  improve the board approval process involving advisory contracts, and ensure the thorough implementation of the fund code of ethics rule.

[1] Top Compliance Topics Observed in Examinations of Investment Companies and Observation from Money Market Fund and Target Date Fund Initiatives, Office Compliance Inspection & Examinations (Nov. 7, 2019), [hereinafter Top Compliance Topics]. [2] Id. [3] Id. [4] Id. [5] Id. at 5. [6] Top Compliance Topics, supra note 1, at 5. [7] Id. [8] Id. [9] Id. [10] Id. at 3. [11] Top Compliance Topics, supra note 1, at 3. [12] Id. [13] Id. [14] Id. [15] Id. [16] Top Compliance Topics, supra note 1, at 3. [17] Id. at 3-4. [18] Id. at 4. [19] Id. [20] Id. [21] Top Compliance Topics, supra note 1, at 4. [22] Id. at 5. [23] Id. [24] Id. at 6. [25] Top Compliance Topics, supra note 1, at 6. [26] Id. [27] Id. [28] Id. at 7. [29] Id.  [30] Top Compliance Topics, supra note 1, at 7.  

Racing Against the Clock: How Somers Forces Whistleblowers into Silence or Premature SEC Reporting

On February 21, 2018, the Supreme Court in Digital Realty Trust, Inc. v. Somers[1] narrowly construed the definition of “whistleblower” in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act” or “Act”) and thus limited who qualifies for the anti-retaliation protections afforded by the Act. The Court narrowly interpreted the Dodd-Frank Act, holding that a whistleblower is entitled to the anti-retaliation protections of the Act only if the employee reports alleged securities law violations directly to the Security Exchange Commission (SEC) while still employed by the issuer[2].[3]

The Supreme Court’s decision in Digital Realty arose after it granted certiorari[4] to resolve a conflict in the courts highlighted in the Ninth Circuit Court of Appeal’s decision in Somers v. Digital Realty Trust (2017) .[5] Paul Somers (Somers) worked as Vice President of Digital Realty Trust from 2010 to 2014.[6] Somers’s complaint asserted that Digital Realty terminated him only after he reported potential violations of the securities laws internally to company management.[7] Somers did not provide this information to the SEC while employed.[8] Somers subsequently brought a whistleblower retaliation claim under the Dodd-Frank Act against Digital Realty for his termination.[9] The company moved to dismiss the claim on the grounds that Somers did not qualify as a whistleblower under the Dodd-Frank Act because he had not reported the alleged securities law violations to the SEC before his termination.[10] The district court denied the motion, reasoning that the whistleblower provisions under Dodd-Frank were ambiguous and, as a result, the SEC’s broader Rule 21F-2, which accorded protection to internal reports, was entitled to Chevron deference.[11] The Ninth Circuit affirmed, concluding that adoption of the statutory definition of whistleblower, as the company urged, would narrow the anti-retaliation provisions to protect only active employees who report possible violations of securities laws both internally and to the SEC, which was unlikely to occur.[12]

On review, the Supreme Court held that a plain reading of Dodd-Frank’s definition of “whistleblower” in conjunction with its anti-retaliation provision, as well as the intent of Congress in enacting the statute, cut against the Ninth Circuit’s expansive reasoning. The issue before the Supreme Court in Digital Realty was the language of the Dodd-Frank Act, which defines “whistleblower” as “any individual who provides . . . information relating to a violation of the securities laws to the Commission, in a manner established . . . by the Commission.”[13] The Supreme Court unanimously, with two concurrences, overturned the Ninth Circuit’s holding and concluded that Mr. Somers’s failure to make a report to the SEC while employed was fatal to his case.[14]

First, the Court pointed to the explicit statutory language of Dodd-Frank, noting that the specific text of the statute defined a whistleblower as someone who reported to the SEC, and the statutory definition of whistleblower applied to govern the anti-retaliation provisions under the Act.[15] The Court also reasoned that Congress must have intended to use a government-reporting requirement because it incorporated such a requirement into the whistleblower definition but not elsewhere in the statute.[16] Second, the Court relied on the legislative intent, holding that the “core objective” of Dodd-Frank was “to prompt reporting to the SEC” and interpreting Dodd-Frank’s definition of whistleblower strictly furthered that goal, even if it narrowed the field of eligible employees.[17]  Since Congress had directly spoken to the precise question before it, the Court saw no need to accord deference to a contrary view adopted by the SEC in Rule 21F-2.[18]

The Court therefore held that individuals not meeting the threshold requirement of providing pertinent information to the SEC cannot benefit themselves of Dodd-Frank’s anti-retaliation protections; the Court noted that such a requirement is by statutory design.[19] The Court stressed that Congress enacted Dodd-Frank “to motivate people who know of securities law violations to tell the SEC,” and, in connection with this purpose, Congress granted such individuals “immediate access to federal court, a generous statute of limitations . . .  and the opportunity to recover double backpay.”[20] The Court, however, found that the reason for such incentives was to effectuate Dodd-Frank’s narrow objective of motivating individuals to “tell the SEC,” and not to “disturb the ‘corporate code of silence’” and embolden employees to report fraudulent behavior “not only to the proper authorities . . . but even internally.”[21]

In sum, Digital Realty determines an employee is entitled to no anti-retaliation protections if the employee only reports such purported violations internally, utilizing the employer’s internal compliance processes. Time will tell whether the Supreme Court’s ruling will deter or increase the number of whistleblower actions. Employees may either fail to report altogether for fear of unprotected retaliation, or, to ensure protection against retaliation, simultaneously report to both the regulators and internal compliance departments before those teams have a chance to review, investigate, and remediate as necessary. The decision is limited to the Dodd-Frank whistleblower statute involving securities laws and does not appear to affect or mention the numerous other whistleblower protection statutes. In the wake of Digital Realty ruling, employers should review their whistleblower policies frequently, in conjunction with legal counsel, to ensure that employees have multiple avenues to report suspected illegal and/or unethical conduct. Likewise, whistleblower polices should assure employees that such reports will not be met with retaliation.

[1] Dig. Realty Tr., Inc. v. Somers, 138 S. Ct. 767 (2018). [2] “Issuer” is a term which refers to an organization offering one or more securities for investment. [3] Id. at 778. [4] The Supreme Court grants certiorari when a party challenges the decision of a lower court and the Court decides to review the case. It’s effectively like asking for a manager and having the manager decide to closely review the subordinate’s work. [5] See, Somers v. Digital Realty Tr., Inc., 850 F.3d 1045 (9th Cir. 2017). [6] Id. [7] Id. at 1047. [8] Id. [9] Id. [10] Somers, 850 F.3d at 1047. [11] The scope of the Chevron deference doctrine is that when a legislative delegation to an administrative agency on a particular issue or question is not explicit but rather implicit, a court may not substitute its own interpretation of the statute for a reasonable interpretation made by the administrative agency; see, generally, Thomas W. Merrill & Kristin E. Hickman, Chevron’s Domain, 89 Geo. L.J. 833 (2001); see also, Chevron U.S.A. Inc. v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984). [12] Somers v. Digital Realty Tr. Inc., 850 F.3d 1045 (9th Cir. 2017). [13] 15 U.S.C. § 78u-6 (a)(6). [14] Dig. Realty Tr., 138 S. Ct. at 772. [15]Id. at 775. [16] Id. at 777. [17] Id. at 780. [18] Id. at 781-82. [19] Dig. Realty Tr., 138 S. Ct. at 781-82. [20] Id. at 778. [21] Id.

A No-Brainer: Protecting Your Website Under the DMCA

In the United States copyrights are federally protected under the Copyright Act of 1976.[1] Unaddressed under the Copyright Act of 1976,  exponential advances in technology in the nineties led to the proverbial “opening of the floodgates” for a deluge of a variety of infringing activity. To address these activities and to expand upon the rights of copyright owners in the modern age, the Digital Millennium Copyright Act[2] (DMCA) was passed in 1998.

In light of the liability several provisions of the DMCA imparted upon certain parties, such as online service providers, Congress further embedded the Online Copyright Infringement Liability Limitation Act[3] within the DMCA. The Online Copyright Infringement Liability Limitation Act, which is commonly referred to as the “Safe Harbor” provisions of the DMCA, provides immunity to online service providers from being liable for copyright infringement so long as the requirements and criteria of the Safe Harbor provisions are adhered.

The Safe Harbor provisions are divided into separate sections to address different circumstances.[4] For instance, the Safe Harbor provisions address Transitory Digital Network Communications,[5] System Caching,[6] Information Location Tools,[7] and Information Residing on Systems or Networks At Direction of Users.[8] However, only the “Information Residing on Systems or Networks At Direction of Users” provision requires that service providers designate an agent in order to receive DMCA takedown requests.[9]

DMCA Takedown Requests

Within the Copyright Act, the term “service provider” is defined as a party who, upon a user’s request, facilitates the transmission of requested material without modifying the content that is being transmitted, as well as those individuals or organizations who provide online or network service access.[10] This includes most websites that allow users to post or store material on a service provider’s systems, such as search engines and directories, as well as internet service providers.

In order for a service provider to be exempt from liability from copyright infringement, the service provider must not have actual knowledge or be aware of the circumstances surrounding the allegedly infringing material or activity or, upon obtaining knowledge or awareness of such infringing material or activity, must expeditiously remove or disable access to the material.[11] One of the most common methods a service provider gains knowledge or awareness of infringing material or activities is through what is referred to as the “notice and takedown system” or a “DMCA takedown notice.”

DMCA Takedown Notice Requirements

The requirements for a valid takedown notice are set forth in § 512 of the Copyright Act[12] and include:

  1. A physical or electronic signature of the owner of the allegedly infringed material, or an authorized agent of such owner;
  2. Identification of the material that that is allegedly being infringed;
  3. Identification of the allegedly infringing material or activity that is sufficient to allow the service provider to locate the material;
  4. Contact information of the complaining party;
  5. A statement that the complaining party has a “good faith belief that use of the material in the manner complained of is not authorized by the copyright owner, its agent, or the law”; and
  6. A statement that “the information in the notification is accurate, and under penalty of perjury, that the complaining party is authorized to act on behalf of the owner…”[13]

Notably, where a service provider is in receipt of a takedown notice which does not meet all of the notice requirements but at least identifies the protected work that is allegedly being infringed, the infringing material, and the complaining party’s contact information, the service provider is under a duty to take reasonable steps to contact the complaining party to obtain a proper notice in order for the Safe Harbor immunity to apply in such situations.[14]

Defective DMCA Takedown Notices

Within the Safe Harbor provisions, the requirements for preparing a valid DMCA takedown notice are meticulously set out.[15] Additionally, the Safe Harbor provisions provide that a defective notice, one which fails to substantially comply with the takedown notice requirements, shall not be considered as providing the service provider with knowledge or awareness of the infringing material or activities.[16] The result of such a defective notice is that it rends from the notice any power it would have had to put an infringer on notice of that infringement. In essence, despite receipt of a defective notice, in the eyes of the law a service provider is regarded as not having actual knowledge or awareness of such infringing activities or material, which in turn provides the service provider with immunity from liability.[17]

Misrepresentations in DMCA Takedown Notices

However, in instances where a sender has knowingly sent a takedown notice which materially misrepresents the infringing nature of the material or activity, then such sender shall be liable to the service provider “for any damages, including costs and attorneys’ fees, incurred . . . as the result of the service provider relying upon such misrepresentation.”[18] Such “misrepresentation” can arise in many different circumstances, including when a sender of a DMCA takedown request fails to consider the “fair use” defense, acknowledged in the landmark case Lenz v. Universal Music Corp., where Universal Music had wrongfully sent a takedown request for a video of a child who was dancing to Prince’s song “Let’s Go Crazy” without considering whether such activity was protected under the fair use defense.[19]

DMCA Registered Agent

The Safe Harbor provisions further provide that “[t]he limitations on liability established in this subsection apply to a service provider only if the service provider has designated an agent to receive notifications of claimed infringement.”[20] Furthermore, service providers must make the designated registered agent’s name, physical address, phone number, and email address publicly accessible as well as to provide the U.S Copyright Office with such information.[21]

It is required that a service provider appoint a DMCA registered agent in order to be able to avail itself of the DMCA Safe Harbor protection. Indeed, courts have held that service providers were unable to invoke the section 512 Safe Harbor with respect to any infringing conduct occurring until it has a designated agent registered with the Copyright Office.[22] A service provider may only designate one DMCA agent, who may be an individual, a person or position within the service provider’s organization or an independent third-party entity.

In an effort to further facilitate the ease of appointing and managing a service provider’s designated DMCA agent, in 2016 the U.S Copyright Office launched the DMCA Designated Agent Directory which allows service providers to designate a DMCA agent and to pay the requisite fees online.[23] With the potential substantial consequences of failing to designate DMCA registered and the affordability and ease in which a service provider can register a designated DMCA agent, it is imperative that any website owner fully comply with the DMCA Safe Harbor requirements so as to ensure protection from potential liability for infringing material or activities that are made available through your website.

[1] 17 U.S.C. §§ 101-810 (1998). [2] 17 U.S.C. §§ 512, 1201–1205, 1301–1332 (2020); 28 U.S.C. § 4001 (2020). [3] 17 U.S.C. § 512. [4] Id. [5] 17 U.S.C. § 512(a). [6] 17 U.S.C. § 512(b). [7] 17 U.S.C. § 512(d). [8] 17 U.S.C. § 512(c). [9] Id. [10] 17 U.S.C. § 512(k)(1). [11] 17 U.S.C. § 512(c)(1)(A). [12] 17 U.S.C. § 512(c)(3)(A). [13] Id. [14] 17 U.S.C. § 512(c)(3)(B)(1). [15] 17 U.S.C. § 512(c)(3)(A). [16] 17 U.S.C. § 512(c)(3)(B)(1). [17] See, e.g., UMG Recordings v. Shelter Capital, 667 F.3d 1022 (9th Cir. 2011), modified at 718 F.3d 1006 (9th Cir. 2013). [18] 17 U.S.C. §§ 512(f). [19] See, Lenz v. Universal Music Corp., 801 F.3d 1126 (9th Cir. 2015). [20] 17 U.S.C. §§ 512(c)(2). [21] Id. [22] See, e.g., Oppenheimer v. Allvoices, Inc., 2014 3:14-cv-00499-LB (N.D. Cal., June 10, 2014) (indicating that “Section 512(c)(2) ‘plainly specifies that a registered agent is a predicate, express condition’ that must be met and that ‘the safe harbor will apply “only if” such agent has been designated and identified to the Copyright Office for inclusion in the directory of agents.’” citing Perfect 10, Inc. v. Yandex N.V., No. C 12-01521 WHA, 2013 U.S. Dist. LEXIS 65802, 2013 WL 1899851, at *8 (N.D. Cal. May 7, 2013)). [23] 37 C.F.R. § 201.3 (2020).

Permanent Establishment through Agent: Dangers of Unintentionally Submitting to Foreign Jurisdiction

Businesses with global operations often pursue and maintain relationships by relying on their globally mobile employees to initiate and sustain relationships with their foreign customer bases. These practices may have developed over a number of years in line with the growth of the business and frequently without any consideration being given to the potential tax consequences of such assignments. Where such employees are regularly conducting business in other jurisdictions, there is a risk of the business creating a permanent establishment and therefore becoming liable for local taxes.

Permanent establishment is a concept defined by a country’s tax laws or by their international treaties. The Organisation for Economic Co-operation and Development (OECD) has published a model convention on income tax entitled “Model Tax Convention on Income and on Capital 2014” (Convention). The Convention defines permanent establishment as “a fixed place of business through which the business of the enterprise is wholly or partly carried on.”[1]  This definition is simply a model, and every income tax treaty has its own variation on this concept. This definition is simply a model, and every income tax treaty has its own variation on this concept. Under the 2014 treaty[2] definition of permanent establishment, the threshold of activity of an enterprise in one jurisdiction that results in the creation of a permanent establishment in another jurisdiction is determined by two forms of presence.[3] The first form of presence is the fixed place of business test. An enterprise has a permanent establishment in another territory if it has a fixed place of business there through which it carries on its business, subject to several specific activity exemptions.[4] The second form of presence is the dependent agent test. Currently, a permanent establishment arises when an agent, acting on behalf of a foreign enterprise, habitually exercises authority to conclude contracts in the name of the enterprise, unless the agent is an independent agent (legally and economically independent from its principal) acting in the ordinary course of its business.[5]  Since the previous definition was limited to the formal conclusion of contracts, the OECD widened the scope of the definition to also include situations in which an agent habitually plays the principal role leading to the conclusion of contracts that are then routinely concluded without material modification by the enterprise.[6]

To determine whether the presence of a representative abroad creates a permanent establishment in another country, the scope of activities undertaken by the representative for that business are essential. Not every activity carried out on behalf of the company will result in the creation of permanent establishment. Activities carried out by a potential dependent agent must be of regular and permanent character. The Convention provides that concluding contracts on behalf of the company does not include only the final stage of signing a contract, but also includes determining terms and conditions of a contract.[7] Therefore, negotiating powers given by a company may be sufficient to recognize such a person as a dependent agent for tax purposes. An important issue is that the person acting on behalf of the foreign enterprise must maintain independence and autonomy. If the agent does not fall into the self-employed category, the agent does not bear the risk arising from contracts concluded, and if the employer is entitled to issue binding instructions and commands, the risk of the foreign establishment is largely reduced.

In Action 7 of the Base Erosion and Profit Shifting (BEPS) Project, the OECD attempts to tackle common tax avoidance strategies used to prevent the existence of a permanent establishment, including through agency or commissionaire arrangements instead of establishing related distributors.[8] Action 7 also aims to prevent the misuse of specific exceptions to the permanent establishment definition, which relate to activities of a preparatory and supporting nature.[9] A company’s supporting activities, such as preparatory work that does not generate revenue does not trigger permanent establishment status.[10] The burden of proof is with the company to demonstrate that the activities are auxiliary and do not warrant a permanent establishment status.[11]

What makes permanent establishment a risk?

The presence of a permanent establishment in the territory of a state is the “combination to the safe” in taxing the business profits of a foreign enterprise. The activities of an agent in a foreign country, can unintentionally trigger permanent establishment.   When a business has permanent establishment in a country and some of its employees working there becomes taxable in that country.[12] Without permanent establishment, some of its employees would not be taxed. The exponential rise in controversy over permanent establishment is the subject of frequent disputes between taxpayers and tax administrations.

Depending on the jurisdiction and the specific terms of the income tax treaty, in the event of noncompliance, companies and some of their employees may be subjected to additional taxation, and there is the possibility that employees could be stopped at the border and prohibited from entering the country, resulting in a lost opportunity or loss of business.[13] In addition, companies may be subject to fines, penalties, and other legal action from a foreign government. This could be a costly result and may also negatively impact reputations and status with other business partners as well as customers.

Permanent establishment rules vary across jurisdictions and it would be necessary to obtain advice locally in order to ensure compliance. To prepare for new regulations, employers with a global footprint should review their existing structures or planned procedures. Particularly, enterprises should review the activities performed by their foreign agents determine whether their roles and responsibilities may lead to permanent establishment in a foreign jurisdiction.

[1]Org. for Economic Co-operation and Dev., Article 5 Permanent Establishment in Model Tax Convention on Income an on Capital 2014 (full version) OECD Publishing, Paris (2014). [2]The most recent version, as of the date of this article, was published on April 25, 2019 and is entitled “Model Tax Convention on Income and on Capital 2017”. [3] Id. [4] Id. [5] Id. [6] Org. for Economic Co-operation and Dev., Article 5 Permanent Establishment in Model Tax Convention on Income an on Capital 2014 (full version) OECD Publishing, Paris (2014). [7] Id. [8] Org. for Economic Co-operation and Dev., Additional Guidance on the Attribution of Profits to Permanent Establishments, BEPS Action 7 (2018). [9] Id. [10] Id. [11]Org. for Economic Co-operation and Dev., Multilateral Convention To Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, (2016). [12] Org. for Economic Co-operation and Dev., Article 5 Permanent Establishment in Model Tax Convention on Income an on Capital 2014 (full version) OECD Publishing, Paris (2014). [13]Id.

The Consequences of Misrepresentations in the Sale of a Tech Company

Whether it’s a company buying out its competition or a corporate tech giant purchasing a business so as to integrate its assets with another company’s assets, the sale and acquisition of tech companies is a massive part of the technology industry with billions of dollars on the line.[1] While many of the major acquisitions that are successful become newsworthy, such transactions aren’t always as easy and straightforward as they may seem. Particularly, when a seller of a company has made material misrepresentations to the purchaser.

The Second Edition of the Restatement of Contracts broadly defines a misrepresentation as “an assertion that is not in accord with the facts.”[2] Within this definition lies a variety of different circumstances which give rise to the occurrence of a misrepresentation. In the context of a tech company sale, a misrepresentation can generally be classified as either being fraudulent or negligent. A misrepresentation is fraudulent when it is consciously false and is intended to mislead the other party.[3] In the case of fraudulent misrepresentation, “one becomes liable for breaching the general duty of good faith or honesty.”[4] However, where a party has failed to “exercise reasonable care or competence in supplying correct information,” such a party is liable for negligent misrepresentation.[5] As can be expected, the consequences that a misrepresentation can have are greatest in instances where a party has purposefully provided the other party with false information.

Representations and Warranties

While the details and arrangements concerning the sale of a business may vary greatly from one transaction to another, the commonality in all such dealings is that the buyer typically relies on the seller’s representations and warranties regarding the business affairs of the company. Often, such representations and warranties are supplemented with supporting documentation. However, this may not always be the case for every transaction or for every representation and warranty that is made concerning the business. Knowing the meaning behind such assurances as well as the consequences of relying on false assertions can be essential in avoiding potentially harmful deals.

Organization, Standing, and Power

A common preliminary assertion made by the seller is that the company actually exists and is in good standing in the jurisdiction that it was formed in. Additionally, the person signing on behalf of the company will often represent that they have authority to bind the company to the terms of the sale agreement.

Litigation, Compliance with Laws, Permits, and Business Restrictions

Whether there is, or has been, any claim, action, audit, litigation, proceeding or investigation against a company can make or break a deal. Similarly, a seller’s assurance to a buyer that the company is under no restrictions of doing business and that the company validly holds all necessary permits and licenses is likely to be an essential prerequisite for a buyer to be willing to enter into a transaction for the purchase of a tech company.

Financial Statements, Liabilities, and Tax Matters

The financial status of a business is often among the most important aspects that a purchaser would consider in connection with buying a company. Considering such importance, a potential buyer will typically require the seller to furnish supporting documentation concerning a company’s finances as a condition to closing the deal.

Assets, Intellectual Property, and Customers

Besides the financial condition of a business, another vital component of the purchase of a tech company revolves around the company’s assets. Assets can come in various forms including physical property, intellectual property and the company’s goodwill. Certain aspects such as physical assets and intellectual property can be well documented through records, ledgers and registrations. However, intangible assets such as a company’s goodwill, are not easily documentable and, as such, a buyer must typically rely on the representations made by the seller with respect to such assets.

Types of Remedies Available

The consequences of a misrepresentation concerning a matter in one of these sections can be catastrophic for the purchasing party. In such instances, the buyer may be unknowingly purchasing a company with legal and regulatory issues or entering a deal with a business that doesn’t rightfully hold title to what it warrants to be its intellectual property.


In the event a party is harmed by another party’s breach of an agreement, courts will look to compensate the injured party in an amount that’s equal to the injury sustained through what’s referred to as “compensatory damages.”[6] In some jurisdictions the court will award an injured party with the “benefit of the bargain” whereby the injured party receives the difference between the value of what was expected less the value of what was actually received.[7] While other jurisdictions compensate an injured party based on “out-of-pocket loss” whereby the injured party receives the difference between the amount that the party paid less the value of what was received.[8] Additionally, where there has been a finding of fraud, courts may potentially award punitive damages to punish the intentional conduct of the breaching party.[9]

Equitable Relief

In addition to the different types of monetary damages that may be available to a party that has been injured by another party’s fraudulent misrepresentations, other forms of remedy, such as equitable relief, may also be available. The availability of certain forms of equitable relief may be dependent on the particular misrepresentations that have been made, while others are general forms of equitable relief which may be available as a result of a party’s reliance on a fraudulent misrepresentation.[10]

Rescission, as an equitable form of relief, allows the injured party to rescind, or cancel, the agreement and further restores the parties to the position that they were in prior to having entered into the agreement.[11] This type of remedy is particularly useful in cases where the seller’s misrepresentation results in the buyer having purchased something that was not contractually agreed to.[12]

As applied to specific misrepresentations that may have been made, an agreement can also be voided or cancelled if the other party has made a misrepresentation that the company had been validly formed or that the company was in good standing at the time that the agreement is entered into.[13] Ultimately, the availability of equitable relief as a remedy depends on the facts of a particular case. For instance, in a case where the person signing on behalf of a company lacked the actual authority to do so, the consequences would depend if the signatory had the express, apparent or inherent authority to do so.[14]

Parties who have been wronged as a result of a misrepresentation in a company sale may pursue compensatory relief, punitive relief, or other equitable relief as applicable in the jurisdiction. Although certain relief and redress may be available for a party that has been injured as a result of another’s fraudulent misrepresentation in a tech company sale, best practice is to try and avoid ending up in such situations in advance of the sale. Prior actions such as performing the requisite due diligence and having a carefully crafted sales agreement are some of the most important steps that can be taken to help mitigate the risk of falling victim to misrepresentations before they happen.

[1] See generally, M&A Statistics, Thomson Financial, Institute for Mergers, Acquisitions and Alliances (IMAA) analysis, (2020). [2] Restatement (Second) of Contracts §159. [3] Restatement (Second) of Contracts §162. [4] See, Gibb v. Citicorp Mortgage, 246 Neb. 355, 371 (1994). [5] Id. [6] See McKnight v. Denny, 198 Pa. 323 (1901). [7] See Damon v. Sun Co., 87 F.3d 1467 (1st Cir. 1996). [8] See Strouth v. Wilkinson, 224 N.W. 2d 511 (Minn. 1974). [9] See Jugan v. Friedman, 646 A.2d 1112 (N.J. 1994). [10] Restatement (Second) of Contracts § 345. [11] RESCISSION, Black’s Law Dictionary (11th ed. 2019). [12] See, United States v. Jones, 176 F.2d 278 (9th Cir. 1949). [13] See, White Dragon Prods. v. Performance Guars., 196 Cal. App. 3d 163, 168-169 (1987). [14] See, 3 Business Organizations with Tax Planning § 48.02 (2020).

Avoiding the Unauthorized Practice of Law in Florida: The Basics

Like most jurisdictions, the unlicensed practice of law (“UPL”) is prohibited in Florida.[1] Therefore, distinguishing lawful services from those which are unlawful is crucial.  The unauthorized practice of law is the practice of law by a person who is not a lawyer licensed to do so.[2] Specifically, it is the performance of acts or duties that are restricted to the members of the legal profession.[3]

Every state has its own interpretation of what constitutes UPL.[4] In Florida, a person who is not licensed or otherwise authorized to practice law in the state, and practices law in the state commits a felony of the third degree.[5] The Supreme Court of Florida has inherent jurisdiction to prohibit the unlicensed practice of law.[6] On the other hand, the Florida Bar Association is the entity in charge of considering, investigating, and seeking the prohibition of matters pertaining to the unlicensed practice of law and the prosecution of alleged offenders.[7] However, while traditional legal services like representing a client in court are easily defined as UPL, determining whether a service constitutes the unauthorized practice of law can be tricky and difficult. In fact, even the Supreme Court of Florida has expressed that defining what constitutes the practice of law can be difficult.[8]

There is a general societal understanding that the performance of services in representing another before the court is the practice of law.[9] The supreme court explained that the practice of law also includes giving legal advice and counsel to people as to their rights and obligations under the law and preparation of legal documents, although such matters may not then or ever be the subject of proceedings in court.[10] However, the court has provided some guidance in distinguishing benign advice or services from the unauthorized practice of law. The Supreme Court of Florida has stated that:

if the giving of such advice and performance of such services affect important rights of a person under the law, and if the reasonable protection of the rights and property of those advised and served requires that the persons giving such advice possess legal skill and a knowledge of the law greater than that possessed by the average citizen, then the giving of such advice and the performance of such services by one for another as a course of conduct constitute the practice of law.[11]

In other words, for a person’s conduct to constitute the practice of law two things need to be present. First, the person is giving advice or performing services that affect important rights of a person under the law. Second, to protect those rights, the type of advice given is that which requires legal skill and knowledge greater than what an average citizen would have.

To provide context, an effective strategy is to review examples of which types of conduct the supreme court has found to constitute the “unauthorized practice of law” and which types of conduct it has  not. The Florida Supreme Court has expressed that the drafting of living trusts and related documents by a corporation or other nonlawyer constitutes the unlicensed practice of law.[12] The supreme court stated that the assembly, drafting, execution, and funding of a living trust document constitutes the practice of law.[13] The court also stated that a lawyer must make the determination as to the client’s need for a living trust and identify the type of living trust most appropriate for the client.[14] The supreme court explained that because a living trust document involves the disposition of property at death, it requires legal expertise and must be performed by a lawyer.[15] However, the simple gathering of the necessary information for the living trust does not constitute the practice of law, and therefore, nonlawyers may perform this activity.[16]

On the other hand, the Supreme Court of Florida has stated that it is not the unlicensed practice of law for nonlawyers to engage in communications with clients for the purposes of completing the “Notice to Owner” forms and preliminary notice forms.[17]  The supreme court explained that the forms required only a minimum amount of information that could be easily obtained from the customer or the public records.[18] The court also stated that there had been no showing that the public was being harmed by the preparation of these forms by nonlawyers.[19] However, the supreme court noted that nonlawyers may not give legal advice in connection with the preparation and service of the notices.[20]

In addition, there are instances in which a person who is not licensed in Florida may practice in law within the state.[21] For example, attorneys licensed in another state may represent someone in a court proceeding in Florida with the court’s permission and in arbitration proceedings in the state.[22] The Florida Bar’s Foreign Legal Consultancy Rule allows a foreign attorney to advise clients on the laws of the country under which the attorney is admitted to practice.[23]

Avoiding the unauthorized practice of law boils down to avoiding two pitfalls: (1) avoid providing consulting or other advice which may affect the ultimate rights of another person or entity; and (2) don’t give advice which requires advanced legal knowledge or skill.

[1] Fla. Stat. § 454.23 (2012); [2] Unauthorized Practice of Law, The Wolters Kluwer Bouvier Law Dictionary (2012). [3] Id.  [4] See, e.g., Unauthorized Practice of Law, The State Bar of Cal., (last visited June 3, 2020). [5] Fla. Stat. § 454.23 (2012). [6] Unlicensed Practiced of Law, Fla. Dep’t of State: Div. of Library & Info. Services, (last visited June 3, 2020). [7] Id.  [8] The Florida Bar v. Brumbaugh, 355 So. 2d 1186, 1191 (Fla. 1978). [9] State ex rel. Florida Bar v. Sperry, 140 So. 2d 587, 591 (Fla. 1962). [10] Id. [11] Id. [12] See Fla. Bar Re Advisory Op.-Nonlawyer Preparation of Living Trs., 613 So. 2d 426 (Fla. 1992). [13] Id. at 428. [14] Id. at 427-28. [15] Id. at 428. [16] Id. [17] See Fla. Bar re Advisory Opinion-Nonlawyer Preparation etc., 544 So. 2d 1013, 1016 (Fla. 1989); Fla. Stat. § 713.06(1) (2020) (A “Notice to Owner” is a written notice from a laborer (who is not dealing with the owner directly) that advises the owner of improved real property that the laborer has a right to place a lien on the property for any money that is owed to him (the laborer) for labor, services or materials furnished and that remains unpaid). [18] Fla. Bar re Advisory Opinion-Nonlawyer Preparation etc., 544 So. 2d 1013, 1016 (Fla. 1989). [19] Id. [20] Id. at 1016-17. [21] Unlicensed Practice of Law, The Fla. Bar, (last visited June 3, 2020). [22] Id. [23] Id.