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Morrison & Foerster, LLP

New Law Streamlines Release of Subdivision Bonds
A new law, effective January 1, 2006, makes it easier and quicker for many developers to secure the release of bonds used to guarantee subdivision improvements and the performance of other work.

Assembly Bill 1460, sponsored by Assemblyman Tom Umberg (D-Orange County), amended section 66499.7 of the Subdivision Map Act to include specific procedures and timelines for agencies to release performance security given by developers for subdivision improvements. Most notably, the law includes a “partial release” provision, which can be helpful to developers who are paying the high cost of large bonds over a long period. These provisions do not apply to any warranty security or guarantee.

In general, the new law provides:
Performance security must be released within 45 days of “final completion and acceptance of the required work.”
When a subdivider believes that the required improvements are complete, the subdivider may notify the agency of that belief in writing.
Within 45 days of receiving the subdivider’s notice, the agency must review and comment on, or approve, the statement that the work is complete. The 45 days runs from the date the agency receives the notice, not the date of the notice itself. The statute does not provide for the event that the agency fails to timely respond, although presumably this is a mandatory duty under the statute and a writ could be sought to compel the agency to comply.

If the agency determines that the work is not complete, it may provide for partial release of the security. The partial release procedure is described below.

If the agency disagrees that the work is complete, it must provide a “punch list” of deficiencies.

Within 45 days of receiving the list, the subdivider may, at its option, pursue the “partial release” procedure and provide cost estimates for the remaining work.

Within 45 days of receiving the cost estimates, the agency must comment on, approve, modify, or disapprove the cost estimates.
If the cost of the remaining work does not exceed 20 percent of the total original cost of the work, and if the agency approves the cost estimate for the remaining work, the agency must return all security except for that necessary to secure up to 200 percent of the cost estimate for the remaining work. (Alternatively, the agency may release the entire security upon the subdivider’s provision of substitute security in the necessary (partial) amount.)

An agency may only be compelled to engage in this partial release process one time per security, but it may engage in additional rounds of partial release if it desires. In other words, the developer may only seek the partial release process once (if at all – see below), although the agency may, at its own option, allow for other releases.

Within 45 days of the subdivider’s completion of the remaining improvements, the agency must notify the subdivider in writing whether it deems the improvements completed. There appears to be a gap in the statute here because there is no express provision for the subdivider to first notify the agency that it believes the remaining work is complete and compelling the agency to review and comment or approve within a certain time period. Arguably, the earlier steps in the process supply those procedures, but that is not clear.

Within 45 days of issuing the notice that the remaining work is complete, the agency must release the remaining security.
These new provisions have the potential of providing more certainty as to the time frame for bond releases, as well as streamlining the process and even providing earlier access to secured funds. In addition, the new partial release procedure should operate to limit an agency’s “punch list” of improvements that must be completed before the bond can be released; in other words, the agency should be held to that first list of deficiencies and cannot add on during the process.

Nonetheless, the new law appears to have a few weaknesses. In particular, the agency holding the security may be able to waive the partial release provisions. Although some of the statutory language indicates that the agency must participate in the partial release procedure if the subdivider elects to pursue it, other language in the bill indicates that this procedure may be optional for the agency, regardless of the subdivider’s election. Moreover, the statute does not provide procedures in the event that the agency fails to respond or disagrees with the cost estimate. Further, the statute does not contain any retroactivity provision, so that it appears to only apply to security given after its effective date, January 1, 2006, rather than earlier bonds. It does not appear that the date of the subdivision improvement agreement pursuant to which the improvements are being provided and secured in the first instance is relevant to this analysis of the new statute’s applicability.

While the new law is a step in the direction of clarifying the release of improvement security and of compelling agencies to hold security no longer than necessary, it appears to potentially fall short of those objectives. In any event, it is imperative for developers to take the necessary steps to make the best use of the new law, as the more far-reaching changes in the law are left to the developer’s option.

07-19-2006

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Morrison & Foerster, LLP

Potential for "Urban Decay" Must Be Analyzed Under CEQA
Water contamination and air pollution, now recognized as very real environmental problems, initially were thought to be nothing more than the exaggerated concerns of overly enthusiastic environmentalists. Similarly, experts are now warning about land use decisions that may cause a chain reaction of store closures and long-term vacancies, ultimately creating social and economic impacts that can destroy, or cause severe deterioration in, existing neighborhoods.

Typically, social and environmental effects caused by a project are not subject to review under the California Environmental Quality Act (CEQA) because the Act applies only to a project’s environmental effects. However, two recent cases reviewing “big-box” retail projects have held that when there is evidence that the social and economic effects caused by a project could result in a reasonably foreseeable environmental impact, such as urban decay, this indirect effect must be analyzed under CEQA.

In the first case, Bakersfield Citizens for Local Control v. City of Bakersfield, the City of Bakersfield prepared Environmental Impact Reports (EIRs) for two shopping centers located 3.6 miles apart. Both shopping centers were to contain Wal-Mart Supercenters (a Wal-Mart store combined with a supermarket that generally is open seven days a week, 24 hours a day), plus a variety of other large and small retail businesses.

The Fifth District Court of Appeal rejected the EIRs for both shopping centers because, among other deficiencies, they failed to evaluate potential urban decay impacts. The court stated that a proposed new shopping center does not trigger a presumption that decay will occur as a result of other businesses being closed. However, evidence – including a professional report – had been introduced suggesting that the economic impact of the shopping centers would trigger the environmental effect of urban decay. The court held that when such evidence is introduced, an EIR must evaluate that issue. The Bakersfield EIRs did not include even short statements indicating why decay impacts would be less than significant.

The Third District took a similar approach in Anderson First Coalition v. City of Anderson, which involved a challenge to an EIR for a 26.5-acre retail shopping area that also included a Wal-Mart Supercenter. Repeating the tactic used in the Bakersfield case, project opponents submitted studies and asserted that the project would cause urban decay in the City’s central business district. However, the court concluded that the EIR fully evaluated this claim and determined that it had no factual basis. The EIR reached this conclusion by relying on an economic analysis that evaluated the project’s impacts on other businesses, thus determining that the City’s downtown contained smaller stores typically serving local residents, while the Wal-Mart Supercenter would be geared toward the regional market and would also attract customers who are currently shopping in other towns. The EIR also explained that a redevelopment district had been established to control blight in the area, and that the downtown might actually be improved due to the tax increment monies derived from the project, which could be used to revitalize the area.

The Anderson court distinguished the Bakersfield case, where the lead agency had addressed urban decay studies and comments in the record by claiming such impacts were merely social and economic and, thus, outside the realm of CEQA. Whereas Bakersfield merely held that the EIR was inadequate due to the failure to consider the effects of urban decay, the Anderson case actually studied and responded to the claims, thus providing valuable insight into what a lead agency must do to evaluate urban decay impacts in order to satisfy CEQA.

The Bakersfield court also held, distinguishing several prior cases, that the end user of a “big-box” facility must be identified in the EIR. The court explained that when the particular type of retail business – such as a Supercenter – will have unique or additional adverse impacts, then disclosure of the type of business is necessary in order to accurately recognize and analyze the environmental effects of the proposed project. Further, the Bakersfield case established, even though a project may already be substantially completed, this does not render the issue of CEQA compliance moot. The court acknowledged that the completed portion of the construction generated substantial economic and psychological pressures to allow the shopping centers to complete all of the previously approved construction. The court declined this option for several reasons, including the developers’ express recognition that they were proceeding at their own risk when they relied on contested project approvals, and the City’s discretion to reject either or both of the shopping centers after further environmental study.

These two decisions illustrate a fundamental principle about the preparation of environmental documents for “big-box” stores and other large retail projects. Where a lead agency is presented with credible evidence of potential environmental impacts due to urban decay, the agency must evaluate that issue in an EIR. Moreover, the project proponent, in preparing the EIR, should provide a factual basis for the EIR evaluation, rather than merely a legal basis. Reviewing courts generally defer to lead agencies on factual determinations, while they are more likely to independently review legal conclusions. An EIR that includes a factual evaluation as part of its analysis of impacts and in its responses to comments is more likely to survive a litigation challenge.

07-19-2006

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Morrison & Foerster, LLP

Seawater Desalination: Urban Myth or Urban Supply?
Large-scale seawater desalination in California has almost achieved the status of urban myth. The idea of turning saltwater into freshwater is not new. Julius Caesar’s men turned the salty Mediterranean into drinking water; Thomas Jefferson promoted desalination within the fledgling United States Navy; and John F. Kennedy was quoted as saying, “[i]f we could produce fresh water from salt water at a low cost, that would indeed be a great service to humanity, and would dwarf any other scientific accomplishment.”

For a long time, however, California’s unquenchable thirst has not overcome a more powerful force – economics. Cost, more than anything else, has preserved large-scale seawater desalination’s mythological status in California. In the 1950s, the cost to treat seawater was estimated at $12 to $14 per 1,000 gallons of water. In 1990, with the advancement of desalination technology, that estimate fell to $6 per 1,000 gallons of water. Still, that cost dwarfed the price from other sources – the same amount of water from the State Water Project or the Colorado River was less than $1.

In other areas of the world, where economically viable alternative sources are not available, desalination has already been implemented on a massive scale. For example, Saudi Arabia produces more than 1 billion gallons of water per day through desalination, meeting 70% of the kingdom’s drinking water needs. However, in California the cost of desalination historically could not be justified. But time and technology have marched on, and desalination is becoming feasible. The current technology of choice, reverse osmosis – where seawater is pressed through membrane filters to produce freshwater – can now be implemented at an approximate cost of $2 to $3 per 1,000 gallons. On the horizon, the Lawrence Livermore National Laboratory is working on nanotechnology that may decrease that cost by as much as 75 percent. At the same time, alternative sources are becoming more scarce and, in turn, more expensive. The time now seems ripe for large-scale seawater desalination in California, but it is still by no means assured.

Some desalination facilities exist on California’s coast – presently capable of producing approximately three million gallons of water per day. The wave of new proposals rolling out, however, would increase this capacity to 240 million gallons per day. Among these proposals, two projects in Huntington Beach and Carlsbad have garnered the bulk of recent attention. Each proposed facility is designed to produce 50 million gallons of water per day – double the size of the largest desalination facility ever built in the United States (the largest existing facility, in Tampa Bay, Florida, was designed to produce 25 million gallons per day, but it has been plagued with operational problems and has yet to consistently achieve the designed capacity).

The proposed facility in Huntington Beach looks as though it may be the first test case to see whether California really is ready to turn the desalination myth into reality. The estimated $250 million project would be privately built and operated by Poseidon Resources, a relatively small, privately-held corporation based in Connecticut. The project has already roiled controversy over whether California’s ocean water should be made available for private profit.

A more technical objection has been over the project’s use of a seawater intake and outfall pipe, called a “once-through cooling” system, that is already in place for the adjacent power plant. This co-location of the desalination project with the power plant’s existing seawater cooling system is intended to minimize environmental impacts by avoiding the construction of a new separate water intake and outfall. The design has appeal – no additional water is drawn out of the sea that hasn’t already been taken in for the power plant. The problem is that the existing once-through cooling systems are themselves the focus of a growing opposition. The systems are falling into disfavor because they cause the entrainment and impingement of fish and aquatic organisms. Opponents of the desalination project argue that the project will perpetuate these impacts by creating an additional dependent use of the intake and outfall system. Thus, even if the power plant could convert to a different cooling system, the desalination project would still need to keep the system in operation.

The argument against once-through cooling has gained traction with a number of governmental entities in California, including the California Coastal Commission. In a May 26, 2005 letter from the Commission commenting on the Huntington project, the Commission indicated that the project should not simply assume that it can rely upon the neighboring power plant’s cooling system. What if the power plant is decommissioned? What if the power plant designs a different cooling treatment system? Moreover, the State Lands Commission recently adopted an agency resolution on April 17, 2006, that identifies the environmental impacts caused by once-through cooling systems, provides that no leases will be granted for new power facilities that use such cooling systems, and places certain requirements on existing power facilities before they can obtain lease extensions or renewals. (Currently, there are 21 coastal power plants with once-through cooling systems in California.) The California Ocean Protection Council, within the California Resources Agency, adopted a similar resolution on April 20, 2006, calling for the phasing out of once-through cooling systems in the state.

In response, proponents of the Huntington desalination project have insisted that environmental review is only required for existing or reasonably foreseeable future conditions, and that the power plant does not have any plans to reduce or change its cooling water needs. Notwithstanding the once-through cooling system controversy, on February 28, 2006, the Huntington Beach City Council narrowly approved the desalination project by one vote. Shortly thereafter, two Coastal Commissioners and the local chapter of the Surfrider Foundation appealed the City’s approval, and the Commission has now assumed jurisdiction over the project. At the time of this article, the Coastal Commission staff had not issued a report and recommendation, but the once-through cooling system problem looks as though it may be insurmountable. The outcome of the Huntington Beach project may also dictate the fate of the Carlsbad project, which also proposes reliance on an adjacent power plant’s once-through cooling system. Nevertheless, the Carlsbad City Council gave its unanimous approval on June 13, 2006.

Even if the Huntington Beach and Carlsbad projects are not built, large-scale desalination may still be in California’s future. The Metropolitan Water District has conducted preliminary studies for a large-scale facility at Dana Point. Rather than co-locating with a power plant’s infrastructure, the Dana Point project design calls for an underground intake that would lie below the sea floor. This underground design avoids the entrainment and impingement impacts that have generated such controversy in Huntington Beach and Carlsbad. The Coastal Commission approved a small- scale study project for Dana Point, using the underground design, with little fanfare. In a similar vein, the Commission approved other small projects using underground intakes in Sand City and Long Beach.

In Northern California, a number of San Francisco Bay Area water districts are engaged in a joint effort to explore their own large-scale project (possibly more than double the size of the Huntington Beach project). In initial studies, that project identified a preference for co-locating with a Pittsburgh power plant. However, in light of the obstacles faced by the Huntington Beach and Carlsbad projects, the Bay Area utilities would be wise to reconsider that location.

If seawater desalination can be successfully implemented in California on a large-scale, it promises a reliable, consistent water supply that would not be vulnerable to dry-year shortages. This option is attractive, particularly given recent water supply legislation, such as SB 610 and SB 221, that requires the demonstration of an available water supply for development. California’s population growth, and the concomitant demand for water, should lead to desalination projects of a much greater magnitude than have been built in the past. Based on the experience of current proposals, anyone hoping to draw water from the ocean would be smart to first bury their straws underground.

07-19-2006

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Morrison & Foerster, LLP

Settlements May Be Available in New Mexico and Oklahoma
In both New Mexico and Oklahoma, recent court decisions have upheld the states’ efforts to impose income tax on companies that are licensing intangibles to affiliates doing business in those states. While this issue is still being litigated in many states, and the United States Supreme Court has yet to address it, many companies may be interested in taking advantage of opportunities that may be available in New Mexico and Oklahoma to resolve potential liabilities and avoid lengthy audits and assessments.

In Kmart Corp. v. Taxation & Revenue Dep’t of New Mexico, 131 P.3d 22 (N.M. 2005), the New Mexico Supreme Court quashed the review it had previously granted, thereby upholding the Court of Appeals’ determination allowing the Department to assert nexus over an out-of-state trademark licensing company despite the lack of physical presence. However, the Supreme Court also held that gross receipts tax could not be imposed on the licensing company under the New Mexico statute.

In the wake of Kmart, the New Mexico tax authorities are interested in settling income and franchise tax liabilities, both for companies that have already been assessed (whose cases were on hold pending the determination in Kmart), and for those companies who have not been audited on this issue. For assessed companies or those already under audit, the State’s offer is to accept a reduced payment of tax, along with statutory interest, and to waive all penalties. Gross receipts tax will be eliminated in accordance with the court’s decision in Kmart. Details are still being worked out on such issues as the apportionment percentage that must be applied and the type of return that must be filed. For those companies that have not yet been identified by New Mexico, and that wish to come forward and identify themselves under New Mexico’s “Managed Audit Program,” in addition to the reduction of tax, and the waiver of penalties, interest would also be waived, and the “look back” period would be limited to seven years. The window of opportunity for these settlements is expected to close by August 1, both for companies with pending cases and those which have not yet been approached by New Mexico’s auditors but who wish to come forward.

In Oklahoma, the Oklahoma Court of Civil Appeals reached a decision similar to that in Kmart, and upheld the imposition of Oklahoma corporate income tax against a trademark licensing company, finding that it had “substantial nexus” with the State, and that the physical presence nexus requirement under Quill was limited to sales and use taxes. Geoffrey, Inc. v. Oklahoma Tax Comm’n, 132 P.3d 632 (Okla. Civ. App. 2005), cert. denied, No. 99,938 (Okla. Mar. 20, 2006).

Oklahoma may be willing to allow companies that have been licensing intangible property to affiliates doing business in Oklahoma and have not been audited yet to come forward and enter into Voluntary Disclosure Agreements. The terms of these agreements are still being addressed by the Oklahoma Tax Commission, but are expected to include waiver of all penalties.

The Departments in both Oklahoma and New Mexico have stated that they are in the process of compiling lists of companies to pursue for audit, so companies with potential exposure may want to consider coming forward if they have not yet been approached. We have been advised that, as is usually the case, the voluntary disclosure offers may no longer be available once a company has been identified and selected for audit.

07-19-2006

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Morrison & Foerster, LLP

Sizing Up "Big Box" Development: The Constitutionality of Size-Based Zoning Ordinances
The debate over so-called “big box” or “superstore” retail centers has dominated local land use politics in recent years. The “not in my backyard” opponents of big box development champion land use regulations limiting superstore development, citing the industry’s high-volume, deep-discount business model as a cause of the perceived demise of Main Street America. Other communities welcome large retail businesses and have relaxed land use restrictions to attract the sales tax revenues and employment opportunities such projects offer. Both often advocate special zoning and land use treatment for such stores. However, a local government’s ability to regulate such large retail development is not unlimited, as California’s Fifth District Court of Appeal recently concluded in two published cases discussed below.

Wal-Mart v. City of Turlock: Anti-Big Box Okay
In 2003, the City of Turlock enacted a zoning ordinance prohibiting development of retail “superstores” that exceed 100,000 square feet and devote more than 5 percent of sales-floor area to nontaxable items such as groceries. In doing so, the city found that superstores pose an unreasonable economic threat to the continued vitality of the city’s neighborhood commercial centers. Wal-Mart challenged the city’s action, claiming, among other things, that the city’s ban on superstores was not reasonably related to the public welfare and, therefore, exceeded the city’s land use authority. The lower court rejected the argument, and Wal-Mart appealed.

The Court of Appeal upheld the lower court decision, concluding that the city’s superstore restrictions are a valid exercise of the city’s police power to prevent economic harm to its local economy. The court explained that “a land use restriction is valid if it is fairly debatable that the restriction in fact bears a reasonable relation to the general welfare.” In the court’s view, substantial evidence appeared in the record to support the city’s conclusion, in adopting the ordinance, that big box grocers present a “unique threat” to Turlock’s neighborhood commercial centers because of their inclusion of discount retail and full-service grocery under a single roof. The court rejected Wal-Mart’s argument that the ordinance served to control economic competition, concluding that the anticompetitive effect was incidental to the ordinance’s purpose of addressing urban/suburban decay. In sum, the court held that the city could legitimately choose to manage development within its borders by using neighborhood shopping centers and the ordinance was related to protecting that land use choice.

Hernandez v. City of Hanford: Big Box Exemption Invalid
The City of Hanford regulated retail activity in its Planned Commercial Zoning District (PC zone) through an ordinance that prohibited the sale of furniture in the PC zone by stores smaller than 50,000 square feet in size, but specifically permitted such sales in larger stores, provided the total floor space area dedicated to such sales did not exceed 2,500 square feet. Based on this ordinance, the City cited the Country Hutch Home Furnishings and Mattress Gallery (Country Hutch) with a zoning violation when it sold furniture in a portion of its 4,000 square feet of leased retail space.

In 2002, Country Hutch sued the City on the claim that the ordinance violated the equal protection clause, which prohibits discriminatory treatment of similarly situated persons without a rational relationship to a legitimate state purpose. The trial court rejected the argument, concluding the City had a legitimate interest in (1) preserving the vitality of the City’s downtown commercial district, and (2) not discouraging large retailers from locating in the PC zone. Moreover, the trial court determined that the zoning ordinance did not violate equal protection guarantees because, by virtue of its size, the relatively small Country Hutch was not similarly situated to the much larger big box stores. Accordingly, the trial court upheld Hanford’s zoning ordinance. Country Hutch appealed.

The Court of Appeal disagreed with the trial court’s determination that, based on size, Country Hutch was not similarly situated to the PC zone’s large retail operations. The Court of Appeal reasoned that Country Hutch and the PC zone’s big box retailers both desired to sell furniture in the PC zone and, therefore, were similarly situated. Accordingly, to be valid, the PC zone’s size restrictions must bear a rational relationship to the statute’s legislative purpose. According to the court, “with the blanket 2,500 square foot restriction on furniture sales in the PC zone, the small retailer poses the same potential threat, if any, to the downtown merchants as the larger store. Thus, limiting the furniture sales exception to stores with more than 50,000 square feet is arbitrary.” In the court’s view, a rational relationship between the ordinance’s size classification and the goal of protecting downtown did not exist.

The Hernandez court was not persuaded by the City’s argument that the statute’s size restrictions were justified on the basis that they were rationally related to the City’s legitimate interest in preserving the economic viability of the PC zone by encouraging big box development. As explained by the court, since there was no evidence in the record indicating that small furniture retailers were detrimental to the PC zone, prohibiting such businesses from selling furniture was not reasonably related to the city’s goal of promoting the economic viability of the PC zone. On this basis, the court invalidated Hanford’s size restrictions on furniture sales in the PC zone.

Conclusion
While these recent cases may suggest that anti-big box ordinances will find more support in the courts than zoning that allows for large-scale retail development, that is not the case. In deciding these cases, the Court of Appeal determined that a city may regulate big box retail development on the basis of store size, provided such classification is reasonably related to the public welfare. Wal-Mart is clear that it is within a city’s police power to enact store size zoning restrictions for the purpose of protecting the economic viability of that city’s commercial districts. Hernandez, however, is equally clear that such restrictions will be overturned if the city cannot articulate a reasonable justification for limiting retail activity on the basis of store size. The California Supreme Court recently granted review of Hernandez, but declined to take up Wal-Mart. This could suggest a willingness by the Court to afford local governments broad authority in regulating the size of businesses within their jurisdictions. In any event, both decisions will undoubtedly be cited frequently by opponents and proponents of big box development.

07-19-2006

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Manatt, Phelps & Phillips, LLP

Delaware Chancery Court Rules that Purchase Price Dispute Must be Settled by Legal, Not Accounting, Arbitration
The Delaware Chancery Court recently ruled in OSI Systems Inc. v. Instrumentarium Corp. that a purchaser seeking to reduce the price of a corporate acquisition by more than half, in this case from $46.6 million to $21.0 million, may not do so by way of the closing price adjustment accounting process set forth in the purchase agreement, but rather the dispute must be submitted to a legal arbitrator.

In 2004, OSI purchased Spacelabs, a medical products business, from Instrumentarium for $46.6 million. The purchase price calculation provision in the purchase agreement provided for an unadjusted purchase price of $57.4 million, followed by a closing adjustment based on Spacelabs’ modified working capital statement as of June 30, 2003, and a final modified working capital statement as of the closing date. The initial estimated working capital was $85.1 million and the unadjusted purchase price of $57.4 million was to be increased or decreased, based on the final modified working capital statement.

Instrumentarium arrived at a final working capital calculation of $82.2 million, which would have lowered the purchase price by $7.8 million (the purchase price was furthered decreased pursuant to other adjustment provisions that were not at issue in the case). OSI also had the right to make its own working capital calculation and it arrived at a working capital calculation of $54.2 million, which would have reduced the purchase price by $25.3 million, over 54%, to $21.0 million.

The purchase agreement provided for two types of arbitration: closing price adjustment arbitration before an independent accounting firm and indemnification claims before a legally trained commercial arbitrator. If the parties disagreed on the final working capital calculation, the dispute was to be submitted to an independent accounting firm for a final and binding determination. Disputes over the representations and warranties contained in the purchase agreement were to be submitted to a legal arbitrator.

OSI sought to have the dispute resolved by the closing price adjustment arbitration process. Instrumentarium, on the other hand, argued that OSI’s claim was really a claim for indemnification due to a breach of representations and warranties in the purchase agreement and therefore should be submitted to a legal arbitrator. Both parties sued.

The court agreed with Instrumentarium and ruled that the dispute was to be settled by a legal arbitrator. The court ruled that OSI’s claim was, in essence, that Spacelabs’ financial statements and Instrumentarium’s initial calculation of working capital were not prepared in accordance with GAAP. OSI claimed that Instrumentarium’s initial $85.1 million working capital calculation did not conform to GAAP, whereas OSI’s final calculation of $54.2 million did conform to GAAP. Instrumentarium argued, and the court agreed, that such a claim is a claim for breach of representations and warranties and thus should be settled by legal arbitration.

Further, Instrumentarium noted that the accounting firm arbitrator would be required to use the same accounting method to calculate the final working capital amount as was used to calculate the initial working capital amount. Instrumentarium contended that to the extent that OSI sought to have different accounting principles apply to the initial and final working capital calculations, OSI would have to go to the legal arbitrator and prove that the initial calculation was not in accordance with GAAP, which would amount to proving that Instrumentarium breached a representation and warranty. Thus, Instrumentarium argued, and the court agreed, the claim belongs in legal arbitration.

The court stated that the closing adjustment arbitration provision in the purchase agreement “appears on its face to simply contemplate the use of an Independent Accounting Firm if there are differences of opinion about the amount of Modified Working Capital as of the Closing Date....OSI’s current position involves the Independent Accounting Firm in an entirely different and ambitious role: that of determining that the [accounting principles] used in the [initial] reference statement were not compliant with U.S. GAAP.”

Finally, the court noted “another reality – the fact that a ruling for OSI would undermine the limitations on liability and the core dispute resolution mechanism in the Purchase Agreement.” The purchase agreement, the court pointed out, limits damages to 25% of the purchase price for any claims of breach of representations or warranties. “OSI cannot bypass the contractual Indemnification process, ignore the contractual requirement to prepare its [working capital calculation] using accounting principles consistent with those used in the Reference Statement, and then seek a gigantic Closing Adjustment by attempting to convince the Independent Accounting Firm that Instrumentarium’s Reference Statement was materially inaccurate and infected by improper accounting.

07-19-2006

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Manatt, Phelps & Phillips, LLP

How Many Mistakes Can a Single Notice of Appeal Contain?
A notice of appeal is one of the simplest documents a lawyer can prepare. Usually the only serious attention paid to preparing a notice of appeal is to ensure a timely filing, because as a jurisdictional document, a tardy filing precludes an appeal. Hohn v. United States, 524 U.S. 236 (1998) (timely notice of appeal is mandatory and jurisdictional).

Sometimes deeper analysis is needed to confirm that the order or judgment at issue is appealable, or to address calendaring complexities introduced by tolling motions. But apart from these questions, simply filing a notice of appeal is about as easy as it gets.

In federal practice, a notice of appeal typically takes the form of a single sentence on a single page. It need only specify three items: who is appealing (i.e. the appellants must be named in either the case caption or body of the notice); what order or judgment is being appealed; and the court to which the appeal is being taken. Federal Rule of Appellate Procedure 3(c). That's it. And these three items are liberally construed, too, to ensure no appeal is lost on a technicality in the notice of appeal. Thus, errors in notices of appeal typically have no substantive effect.

For example, consider the following true story from last year. A copyright infringement action is pursued in federal district court in the Northern District of California. The plaintiff prevails on summary judgment. The defendants had 30 days after entry of judgment to file a notice of appeal. Federal Rules of Appellate Procedure 4(a)(1)(A). The plaintiff eagerly monitors the district court docket sheet for a notice of appeal, but more than 30 days elapse and no notice appears. Is the plaintiff's judgment necessarily in the clear? Actually, no.

Mistake 1: Apparently, on the last possible day, a notice of appeal was filed - but was filed in a Court of Appeals. It therefore did not show up on the district court docket. Notices of appeal, of course, are supposed to be filed in the district court. Federal Rules of Appellate Procedure 3(a)(1) and 4(a)(1)(A). But the mistake of filing in the appeals court has no substantive effect.

In fact, the Federal Rules of Appellate Procedure contemplates precisely this error. Rule 4(d), captioned ""Mistaken filing in the Court of Appeals,"" expressly provides that if a notice of appeal is ""mistakenly filed in the court of appeals,"" the appellate court clerk must note the date it was received and send it to the district court clerk. When it reaches the district court, it is then considered filed as of the date it reached the appellate court. Thus, this mistake was harmless, although it did inject delay in processing while the appellate and trial courts sent the documents back and forth. The lesson, of course, is to file the notice of appeal in the district court.

Mistake 2: A filing fee must accompany a notice of appeal. In this instance, the defendants included a check for $250. But the fee (at the time) was $255. (The filing fee now is $455.) This mistake was harmless too. Although Rule 3(e) requires that an appellant pay the filing fee when the notice of appeal is filed, under Supreme Court precedent a notice of appeal is considered timely even if the fee is paid late. Parissi v. Telechron Inc., 349 U.S. 45 (1944). Again, sound practice dictates following the rules and including the filing fee, in the correct amount, with the notice of appeal.

Mistake 3: There is a further procedural wrinkle to this tale. After the Court of Appeals returned the erroneously filed notice of appeal to the district court, the district court docketed the notice and then sent it back to the Court of Appeals for processing. A notice of appeal must indicate the name of the court to which the appeal is taken. Federal Rules of Appellate Procedure 3(c)(1). In this case, the notice of appeal stated that the defendants appealed to the Court of Appeals for the Federal Circuit. The Federal Circuit is a specialized appellate court in Washington, D.C., that has limited jurisdiction to hear certain types of matters, including patent and trademark cases. 28 U.S.C. Section 1295. But this was a copyright action. No patent, trademark or other claim that could give rise to Federal Circuit jurisdiction existed.

Accordingly, any appeal had to be to the circuit embracing the district court, which in this case was the 9th U.S. Circuit Court of Appeals. 28 U.S.C. Section 41. Surely purporting to appeal to the wrong court of appeals invalidates the notice, right? Nope. Again, appealing to the wrong court of appeals is not substantive. Dillon v. United States, 184 F.3d 556 (6th Cir. en banc 1999) (where only one proper avenue of appeal exists, a notice of appeal need not name the appellate court); United States v. Musa, 946 F.2d 1297 (7th Cir. 1991) (notice of appeal valid despite appealing to wrong circuit).

The only negative consequence was yet more delay and procedural hassle in getting the appeal properly docketed in the correct court. Meanwhile, docketing an appeal in the Federal Circuit requires the filing of several additional forms, from all parties: an entry of appearance form, a certificate of interest and a mediation docketing statement. All of these procedural steps were a wasted effort, given that the Federal Circuit lacked jurisdiction from the outset. In this case, it took almost three months from the time the notice of appeal originally reached the Federal Circuit for that court to order the appeal transferred to the 9th Circuit under the ""Transfer to cure want of jurisdiction"" statute, 28 U.S.C. Section 1631.

Mistake 4: One might suspect that the error of filing in the Federal Circuit arose because the defendants' lawyer was unfamiliar with the distinctions between the intellectual property doctrines of patents and trademarks on one hand and copyrights on the other hand. In fact, however, the defendants specifically had hired an intellectual property specialist as counsel to file the appeal. But this lawyer, admitted to the patent bar, apparently specialized in patent and trademark matters. Further, this lawyer was not admitted to practice in the Northern District of California or the 9th Circuit. Again, admission status is a technical irregularity the courts are inclined to excuse. Republican National Committee v. Taylor, 299 F.3d 887 (D.C. Cir. 2002) (appeal would not be dismissed for technical violation that notice of appeal was not signed by member of district court bar); cf. Cove/Mallard Coalition v. U.S Forest Service, 67 Fed. Appx. 426 (9th Cir. 2003) (notice of appeal void where signed by lawyer whose district court pro hac vice admission had been revoked). The lesson: hiring a specialist is a good idea, but make sure the right sort of specialist is retained - preferably one admitted to practice, and with experience, in the relevant court.

Then there is the content of the notice of appeal itself. The defendants used a form notice of appeal, which has only three blanks to fill in. The first is a spot to ""name all parties taking the appeal."" Federal Rules of Appellate Procedure 3(c)(1)(A). In this instance, the blank was filled in with ""the Defendants,"" instead of specifically naming the appellants, and the caption to the notice read simply ""XYZ Inc., et al.""

Thus, the only defendant named anywhere on the notice was XYZ Inc., with no indication of who the ""et alia"" parties might be. The rules and case law do allow an attorney representing more than one party to describe those parties as a group such as ""the Defendants."" Federal Rules of Appellate Procedure 3(c)(1)(A); National Center For Immigrants' Rights Inc. v. INS, 892 F.2d 814 (9th Cir. 1999). But this ability to be imprecise came only with the 1993 amendments to Rule 3(c), designed to liberalize the rule after Torres v. Oakland Scavenger Co., 487 U.S. 312 (1988), held that using ""et al."" in a notice of appeal was fatal to the unspecified parties' appeal. Even so, the better practice is to name the parties.

Next, the form had a blank to fill in to explain what the appeal was from, e.g., a final judgment or appealable order. The form parenthetically, but specifically, states ""describe the order."" Nonetheless, the defendants completed this blank with only the unhelpful word ""order.""

This entry is problematic, and not simply because it is entirely undescriptive. Recall that the plaintiff won a summary judgment motion and judgment thereafter was entered. Technically then, the appeal should be taken from the final judgment that was entered, not the order granting summary judgment. Again, however, the federal courts do not consider this error significant.

Ultimately, the defendants' appeal ended up where it belonged: at the 9th Circuit. Once docketed there - a process that took more than a month - the defendants were required to file a civil appeals docketing statement. The defendants failed to do so (despite an express order), forcing the court to issue another order setting a final deadline either to file a civil appeals docketing statement or a voluntary dismissal.

Again, the defendants ignored the court's order. The reason, presumably, was that the case had settled. While the respectful course of action would have been to alert the court to the settlement and then file a dismissal under Rule 42(b), instead the defendants simply abandoned their appeal - which had taken so long to properly docket in the right court - by ignoring it. Eventually - nearly a month later - the 9th Circuit got around to dismissing the appeal on its own.

As recounted above, the notice of appeal at issue crossed the country several times: first it was erroneously filed in the Federal Circuit in Washington, D.C. Next, it was returned to California for proper filing in the district court. Then it was sent back to Washington for appellate docketing. Finally, it was sent back to California again, this time to the 9th Circuit in San Francisco, for docketing in the correct appellate court.

One lesson from this saga could be that the courts are very forgiving of errors - even elementary mistakes - in a notice of appeal. A more valuable moral, however, is that even a simple notice of appeal can cause tremendous procedural hassles if the basics are overlooked. A lawyer can get away with making mistakes, but no serious practitioner wants to be that lawyer.

07-19-2006

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