A New Year – A New Order
As we embark on a New Year, take a journey with me and “envision” what can and may well be. Let your mind expand and free yourself of traditional thinking. What will the New Order look like in, say, 2020?

Cyber Banking Is Upon Us
Oh, how we wistfully remember the days of tellers, personal service, and physical money. The cyber cell manufactured by Looney Tunes, Inc. is the hottest new “go to” device to do everything, including banking, accessing your home and car, and online shopping. In the paperless and cashless society we will be accustomed to in 2020, coin of the realm will no longer be accepted, even at McDonalds!

Community Banking Reinvented
Lo and behold, a small group of community banks, about 5,000 to be precise, have survived the further consolidation of our industry. Ten banks control more than 90% of the deposits and 100 control 95%. Walbank is giving Citibank, Chase and Bank of America a run for their money with its integrated, multipurpose “chip” account, based on state-of-the-art micro technology. Those remaining hardcore community banks will dabble in non-interest income activities and continue to emphasize their primary (and only real) advantage – service and responsiveness. Branches will be reduced in number and size, reflecting cost considerations and the impact of electronic banking.

The Return of M&A
And now back to the near-term future. Everyone asks me when M&A activity will return, following a 20-year low in 2011. I don't know and I doubt anyone else does either. But, let's speculate. There should be some activity in 2012, provided bank stock prices move north, real estate values finally stabilize, and unemployment continues to recede. However, I don't think we will see substantial M&A activity until 2013 or 2014.

When that inevitably occurs, we will see the natural anticipated consolidation of the industry for all the reasons we know – board and management fatigue, shareholder frustration, increasing regulatory (i.e., compliance) burden, and a nudge in that direction by regulators.

The Survival of the Dual Banking System
I firmly believe community banking will continue, but wonder if the dual banking system will survive. Realistically, it takes a certain critical mass of “assets under management” for state banking agencies to function in a meaningful way. How consolidation of the industry impacts that is yet to be seen. Perhaps they will simply partner up with the FDIC on exams. However, I do think that there is some risk of survivability of state banking agencies in certain states. This, of course, would be unfortunate in my view.

Why Community Banking?
As I have said before, quoting my former colleague Mark Lewington, “Community banking is part of the fabric of this country.” I still believe that. It is why I have built my practice and career around representing community banks. They are special and an integral part of the communities they serve.

On to the Future
It looks like the worst is over for most of the surviving community banks. It is now time to get new business, make some money, and look toward the future. I look forward to this next chapter and the new challenges that lie ahead during the remainder of this decade.

2011 in Review
As we approach a New Year and close 2011, it seems like a good time to reflect on this past year. In short, it was a mixed bag. We took a few steps forward and a few steps back, but there was clearly no rhythm or consistency in the economy, stock market, capital raises, or mergers and acquisitions.

Deals Still On Hold
FDIC-assisted deals diminished as the failures seem to be winding down. Meanwhile, there have been random deals here and there with private equity still playing a key role as bank stock prices preclude active deal making. The continued uncertainty in real estate values and asset quality make whole bank deals challenging. Toward that end, we have seen real estate appraisals, particularly for raw land, plummet in sometimes shocking fashion.

Random Stock Offerings
There have been random stock offerings, but mostly in the form of private equity, private placements, and community/shareholder offerings. The public offerings have been sparse, as below book value stock prices (even for relatively healthy banks) have put a damper on offerings.  The disfavor of the banking sector by investors has really hurt efforts by marginal banks to successfully recapitalize.

The 2012 Crystal Ball
Given the erratic economy the past three years, it is risky business indeed to speculate about 2012. However, as the stock market recently had a positive spurt, let's be optimistic and hope that we will finally turn the corner in 2012. The upcoming Presidential election could unfortunately delay the recovery. If, and only if, real estate values finally stabilize, will we start to see a true recovery. The underlying issue is a lack of confidence in the economy and the ability to have sustained economic growth and improved employment numbers.

It is likely that M&A activity will start to tick up in 2012 and really heat up by 2013. There is enormous pent up demand by both buyers and sellers. Given skinny margins, slow growth, increasing regulatory burden and pressure to consolidate, tired boards and management, and impatient shareholders, mergers inevitably will occur over time. The only question is, “When?”

Some Overdue Thanks
As we conclude this year, I realize it is long past due for me to thank a lot of folks. I would like to take this opportunity.  To our amazing clients in Hawaii, Montana, Idaho, Nevada, California, Alaska, Wyoming, Arizona, Utah, and, of course, Oregon and Washington (that means you Melanie, Mick, Curt, Cheryl, Rich and Landon, and so many, many more), thank you for your loyalty and friendship.  To my former and present colleagues from Jim Gallagher, Mark Lewington, Jill Myers, Mark Finkelstein, Shauna Vernal, Christi Muoneke and Kim Stephan to Kumi Baruffi, John John, Steve Miller, Casey Nault, Bart Bartholdt, Mark Northrup, Denise McDermott, Amy Fleetwood, Maggie Kinsella and Sylvia Brougham, a sincere thank you for your support and friendship. And to my great kids Sara and Dan, terrific grandkids Emily and Jack, my cousin Irwin, and my dear friends, especially Claire, I say I love you all.  Lastly, I pay tribute to my heroes, my parents Rose and Carl.  As a son of an immigrant butcher, I truly appreciate the many blessings that have come my way.

Thank you all for the opportunity to share my thoughts, ideas, humor and feelings with you. It is a privilege. I am a lucky man indeed.

And so on that positive note, I wish you all a happy holiday season and healthy New Year – próspero año nuevo for sure!

Pac Man is Dormant
“Where have all the deals gone?” a colleague of mine asked. Well, so far in 2011 there have been just 140 whole bank deals and 88 FDIC-assisted deals done. The much ballyhooed consolidation of the banking industry predicted in the beginning of the year has yet to materialize … and Pac Man is asleep.

Why Are We Treading Water?
There is no doubt in my mind that there are willing buyers and sellers, but four major impediments have limited the whole bank deals this year. One, bank stocks are simply undervalued, making it too expensive for acquirers to use stock as currency. For instance, one bank stock index is down 100% since 2007. Two, uncertainties continue to linger about the economy, real estate values, and asset quality as a whole. Three, purchase accounting marks can be significant. And, four, securing regulatory approval is still a challenge.

What is it Going to Take to Move the Needle?
I think that until the world economic situation is stabilized, a plan is in place to reduce the U.S. budget deficit, and bank stocks return to some reasonable price level, whole bank deals will continue to be sparse. Probably, only private equity groups who still have about a third of the $20 billion they raised available in “powder” will be significant players until this changes.

It is clear that the larger, healthier banks see acquisitions as a means of growth in a stagnant economy. It is equally clear that many smaller banks, particularly those that are stressed, are looking for a liquidity event. To get down to the 5,000 bank figure prognosticated by many, it would take 165 deals a year through 2020. With 90% of bank assets already held by billion dollar or larger companies, this trend is inevitable. It is just a matter of time.

History as Our Predictor
It is no great surprise that whole bank deals are down. For instance, when we had 475 mergers in 1998, bank stocks were trading at well over twice tangible book value. They are trading at less than tangible book value now, making bank stock a very pricy currency. Not surprisingly, merger premiums have tracked bank stock trading prices with current deal multiples at an average of 91.7% of tangible book value. However, the forces that have been driving consolidation in the industry from a peak of approximately 14,500 banks are more prevalent now than ever, with regulatory burden and operational fatigue at all-time highs.

What is a Bank to Do?
Ironically, both buyers and sellers need to be patient as deal obstacles recede over the coming year. Obviously, the conditions of sellers may dictate their ability to be patient. For the sellers, clean up your balance sheet. For the buyers, keep your war chest and regulatory relations strong. We have never experienced the environment we have all navigated since 2007, but we seem to be learning. So, as we approach this Thanksgiving season, many of you will be thinking “Gobble, Gobble” beyond the turkey context. The good news is that you can be thankful you are still part of the conversation.

The Seattle City Council recently passed an ordinance (Council Bill No. 117216) requiring most employers operating in Seattle to provide their employees with paid sick leave and paid “safe leave” (related to domestic violence, sexual assault, stalking, and other safety concerns) by September 1, 2012. 

While the ordinance is incredibly long and detailed, this Cyber-Graham summarizes the key provisions of Seattle's new sick and safe leave law.

Employers and Employees Covered by the Ordinance
The ordinance covers employees who work at least 240 hours in Seattle per calendar year, and employers with five or more employees.  Employers are divided into tiers based on their size, and all employees count for purposes of determining an employer's tier (regardless of whether they perform any work in Seattle).
 
• Tier 1 employers have between five and 49 employees, and must provide at least five days of paid sick or safe leave per year. 

• Tier 2 employers have between 50 and 249 employees, and must provide at least seven days of paid sick or safe leave per year. 

• Tier 3 employers have at least 250 employees and must provide at least nine days of paid sick or safe leave per year. 

Accrual of Paid Sick and Safe Leave
Employees currently working in Seattle will begin to accrue paid sick and safe leave upon the effective date of the ordinance.  Employees hired after the effective date will begin to accrue paid sick and safe time upon the commencement of their employment, but will not be permitted to use such leave until their 180th day of work.

• Tier 1 employers are permitted to cap paid sick and safe leave at 40 hours per calendar year.
 
• Tier 2 employers are permitted to cap paid sick and safe leave at 56 hours per calendar year.

• Tier 3 employers are permitted to cap paid sick and safe leave at 72 hours per calendar year. 

While employees must be permitted to carry over some accrued but unused paid sick and safe leave from year-to-year, the amount may be capped at 40 hours for Tier 1 employees, 56 hours for Tier 2 employees, and 72 hours for Tier 3 employees. Employers with existing universal paid time off (“PTO”) programs, that combine sick and vacation time, need not provide Seattle employees with additional paid sick and safe leave, so long as it can be used for the same purposes and accrues and carries over at the rates provided in the ordinance.

Use of Paid Sick or Safe Leave
Paid sick leave may be used for absences resulting from the employee's own health needs, or to care for the health condition or medical needs of an eligible family member.  For purposes of sick leave, an eligible “family member” is defined to include children, grandparents, parents, parents-in-law, spouses, and registered domestic partners.

Paid safe leave may be used for the following reasons:

• “When the employee's place of business has been closed by order of a public official to limit exposure to an infectious agent, biological toxin or hazardous material.”

• “To care for a child whose school or place of care has been closed by order of a public official for such reason.”

• In “situations of domestic violence, sexual assault or stalking affecting the employee or a family member.” 

When possible, requests for paid sick or safe leave must be made at least ten days in advance of the absence (unless the employer's normal policy requires less notice), or as soon as possible.  However, when the need for leave is unforeseeable, “the employee must provide notice as soon as is practicable and must generally comply with an employer's reasonable normal notification policies and/or call-in procedures, provided that such requirements do not interfere with the purposes for which the leave is needed.” 

Record Keeping Requirements
Employers must provide a record of the amount of paid sick or safe leave each employee has available on each Seattle employee's pay stub.  Employers must also retain records of the hours worked and the amount of paid sick or safe leave used by each eligible employee. These records must be kept for a period of two years in a file separate from personnel files.

While the ordinance does not take effect until September 1, 2012, businesses with employees working in Seattle should begin to consider how they will be affected by this new law.  Employment counsel should be consulted to ensure proper compliance.

For more information, contact attorney Adam S. Belzberg by phone at 206.340.9654 or e-mail at abelzberg@grahamdunn.com.

Anything is Possible
With the recent passing of Apple icon Steve Jobs and all the articles and insights on this visionary, it made me think of what is possible.  Steve Jobs' biggest legacy may not be Apple, or the Mac, or the iPhone or iPad. His legacy may very well be his belief that anything is possible – with vision, imagination and persistence.

What Does This Mean for Us?
Jobs changed the way virtually everyone worked, lived and interacted.  His influence transcended the technology.  It was life-changing and culture-changing.  Beyond the technology that he brought us, didn't he really bring us dreams of the future?  How can we make things, our lives, and the lives of others better?  Did we learn to think “outside the box” and imagine?  Now the trick is to successfully apply these important lessons to our everyday lives.

Making Our Industry Better
Technology may very well be the key to maintaining the banking industry.  Imagine a world of all-electronic transfers of money.  Imagine the ultimate smart phone that lets you handle all of your banking needs in one interactive device.  It's here.  Just as printed books, newspapers and magazines will soon be relics, over time traditional banks as we know them also will be archaic. While some customers may still prefer to visit branches, those numbers will dwindle significantly over the years, rendering traditional branches virtually obsolete.

Imagine
Imagine a totally paperless world of banking, with all transactions handled electronically and remotely.  It will revolutionize branches and the whole delivery system.  For those who come into the bank, think of kiosks with Mac-like devices expediting customer transactions.  Much like the airline industry with online booking, check-in and even baggage check-in, banking is headed in the same direction.

The Challenge
The real challenge is to take the lessons learned from Steve Jobs and apply them effectively to the banking industry.  While there will still be a segment of customers who desire personal service, the reality is that the future is filled with technology, whether we love it or not.  The trick for a community bank is to retain some semblance of personal service, while still embracing technology.  It will allow them to compete on a more cost-effective basis and offer a broader array of products and services competitively.

Embrace the Future
We as a country and an industry are going through a metamorphosis.  Many other parts of the world have actually passed us in terms of creative technology and embracing cutting-edge alternatives.  Like it or not, we must all adapt or perish, so let's embrace it and think creatively and proactively.  We should all be asking ourselves what consumers will want or demand in the next three to five years, and then go about repositioning ourselves for the inevitable changes. Let's embrace the possibilities, instead of resisting them.  Welcome to the future!

Capital is Still King
Even in these battered financial markets, several of our clients are in the midst of community/shareholder stock offerings.  Capital remains essential as banks return to profitability.  With historically low interest rates, eroding margins and increasing securities portfolios, capital is critical to future growth and meaningful profitability.

The Best Defense is a Good Offense
Through the economic debacle since 2008, most banks have played defense, cleaned up their portfolios and waited out the storm.  Well, I think it is time to play some offense.  While traditional loan growth is still tough, SBA lending and offering expanded products and services is one way to combat narrowing margins.

Stop Worrying About the Regulators
Yes, this is me speaking!  While recognizing their enormous power and respecting their mission, we can no longer live in fear of the regulators.  The best way is to have strong capital, some healthy growth, improved efficiencies and profitability.  While questions still persist about the regulators' view of community banks, being proactive (not confrontational) seems appropriate.  My sense is the “fear factor” the regulators operated under the last several years has dissipated as the pace of bank failures has slowed.

Confidence is Critical
Just like the economy, the lion's share of our challenge is restoring confidence in the banks.  I think we should all work together to make this a top priority.  As an industry, notwithstanding the current concern about a “double dip” recession, the vast majority of community banks have withstood the storm.  Community banks remain a part of the fabric of this country and it is time they started to hold their heads proud again.  Truly, the future is now, if we make it happen.

On September 29, 2011, the Washington Supreme Court issued an important Public Records Act case, Neighborhood Alliance of Spokane County v. County of Spokane (No. 84108-0).  In this case the Court resolved several murky issues that have plagued PRA litigation, and soundly admonished public agencies to conduct “adequate” searches in response to PRA requests.

The case involved a PRA request brought pursuant to RCW Ch. 42.56 from a Spokane-based community organization that, among other things, investigated illegal hiring practices in the Spokane County Building and Planning Department (BPD). 

The Alliance had received an anonymous copy of an undated BPD office seating chart placing “Ron and Steve” into cubicles; however, Ron and Steve had not yet been hired.  The chart had been generated by a computer of a BPD employee.  Subsequently “Ron” was hired as was “Steve”, a son of a county commissioner.  The Alliance sent a PRA request to the County for all iterations of the seating chart and received three charts.  The one that the Alliance had been provided anonymously was not dated, making it impossible to prove that the hiring of “Ron and Steve” was preordained.  The Alliance sought to obtain a document that would show when the important seating chart was created.  It was told that the computer that generated the chart in question had been replaced and therefore it was impossible to tell the original date of the chart's creation, but the County did not search for the original hard drive that remained in the county's control. 

The Alliance sued under the PRA and the County claimed that it was not subject to normal discovery procedures because of the nature of a PRA suit.  Justice Johnson, writing for the Court held that normal discovery rules under the Civil Rules of Procedure apply in PRA litigation, particularly to discover relevant information such as why documents were withheld, destroyed, or lost.  These facts have a significant bearing on penalty determinations which depend heavily upon evidence of an agency's bad faith.  In doing so, Justice Johnson differentiated Washington State's PRA actions from federal actions under the Freedom of Information Act (“FOIA”) where discovery is limited.

However, Justice Johnson returned to the FOIA for the second holding of the case, which was that the adequacy of a search for records under the PRA is the same as under FOIA, which focuses on whether the search itself was “adequate” depending upon the circumstances of a case.  Under an “adequacy” test, agencies are required to perform more than a perfunctory search and to follow obvious leads as they are uncovered, but they only have to search those places where public records are reasonably likely to be found.  The Court refused to find that an agency's inadequate search constitutes a new cause of action under the PRA.  Rather, it found that a failure to perform an adequate search was considered as an aggravating factor in determining any daily penalty amount. 

Finally, the Court resolved the question of whether a requestor can be deemed a “prevailing party” in PRA litigation when such litigation is not necessary to ultimately obtain the records for question.  Only a prevailing party is entitled to penalties and attorney's fees under the PRA.  The Court found that a party is determined to be prevailing if the party can show that the record should have been disclosed upon the party's request, but was not.  It held that “litigation need not be the cause of a disclosure and a party is entitled to the PRA's remedial provisions when an agency wrongfully refuses to disclose a produced requested record.”

In summary, this case makes it more difficult for public agencies to avoid PRA obligations and increases potential liability for penalties and attorney's fees if an agency search is “inadequate.”  Further, litigation costs may increase because agencies will be obligated to respond to discovery requests that investigate why an agency withheld a record, and the sufficiency of an agency search.  The case also clarifies that an agency cannot avoid liability by disclosing records once the PRA litigation has started.

Flying High
As I return from a brief vacation from guess where, I am reflecting back on the past year, the present and the future. While things are far from rosy in our economy, at least some positive things are happening.

Play the Hand You're Dealt
As former Seahawks Coach Chuck Knox (a/k/a Ground Chuck) used to say, “You've gotta play the hand you are dealt.” We are on the verge of announcing one whole bank deal (yes they are rare in the Northwest, but possible) and closing another significant capital raise. So forgive my upbeat mood and cautious optimism. Both of these transactions have taken time and reflect the parties' willingness to play the cards they were dealt.

What's Up Now?
Clearly there are many challenges for banks in the next few years, with making money not the least of them. Fears of a “double dip” recession have surfaced. Hopefully this doesn't become a self-fulfilling prophecy, for confidence is at the root of our economic recovery. With these uncertainties and a depressed bank stock market, it pretty much looks like most deals will have to wait until next year. This is unfortunate, since we sense that there are plenty of willing buyers and sellers, but for reasonable terms.

Where Art Thou Regulators?
Honestly, it's been a mixed bag. We have seen a significant shift in the level of cooperation by the regulators. However, whenever Washington, D.C. gets involved, all bets (and time frames) are off. As I have quoted one of my old D.C. buddies in the past, “Washington D.C. is an island surrounded by reality.” This has never been truer than now. It really can be frustrating for our clients and the regional offices of the regulators as well. While I respect that they have a tough job to do, we all must be held accountable. It is time!

Aloha and Mahalo
I would like to take this opportunity to thank our many loyal and terrific clients. Your patience and support in dealing with the regulators and the many challenges you face is indeed appreciated and admired. I am inspired by the will and strength of our clients. That is what truly drives me and nourishes me. MAHALO!!!

Yesterday, our client Viking Bank, Seattle, WA, announced that it will merge with AmericanWest Bank, Spokane, WA, in an all cash transaction. Viking had approximately $400 million in assets at June 30, 2011. Click here to see the news release announcing the transaction.

This transaction marks the third whole bank merger announced in the Northwest this year, after a long dry spell. Viking, like many other banks in its market area, has struggled with the effects of the lingering economic downturn, but has an attractive branch network and franchise.

We would be pleased to discuss your comments and questions about this transaction and its implications for your institution and other banks in the Northwest.

The following provides an inside perspective on these issues from Graham & Dunn attorney Estera Gordon, an approved foreclosure mediator who has participated in developing foreclosure mediation forms and procedures, and presented at the King County foreclosure mediation training.

* * *

By Estera Gordon
August 18, 2011

The Foreclosure Fairness Act (FAA) allows homeowners at risk of foreclosure to require their lenders to mediate about foreclosure issues, including reinstatement, loan modification, debt restructuring, and other workout arrangements.[1]

On Friday, July 22, 2011, the day the FFA became effective, I was at the King County Dispute Resolution Center for Day 3 of my training as a Washington State Foreclosure Mediator.  By the end of the day, the Washington State Department of Commerce (“DOC”) had received at least 30 mediation referrals.  The approved mediator list was posted and DOC began assigning mediations the following week.  Mediation notices are going out, and the first mediations will probably take place in late August or early September.

The FFA makes the lender's failure to participate in good faith in the mediation a defense to foreclosure.[2]  Another possible defense is the lender's refusal to agree to a loan modification that has a net present value higher than the net present value of the anticipated recovery from the foreclosure.[3]  These defenses will hinge on the mediator's post-mediation certification.

Who are the foreclosure mediators?

A large majority of the approved foreclosure mediators are employees or volunteers of non-profit community-based dispute resolution centers (DRCs).[4]  About half are attorneys with substantial mediation experience.  Some, like me, are both.  There are also a few retired judges and a few housing counselors. 

How were the foreclosure mediators selected?

The DOC worked with the DRCs and other mediation organizations to identify qualified mediators[5] who had (a) at least 200 hours of mediation experience or (b) at least 60 hours of mediation experience and 40 hours of mediation training.  About 250 potential foreclosure mediators and DRC personnel[6] were chosen to attend a three-day training program.

Attendees at the two-day statewide training in late June 2011 submitted applications for approval as foreclosure mediators.  The applications required us to document our mediation training and experience, and provide detailed background information and references.  In July, Day 3 experiential trainings were hosted by DRCs around the state.

DOC reviewed the applications, verified training attendance, and checked references.  In addition to the 200 or so approved mediators, there are about 25 “conditional co-mediators.”  These are less experienced mediators who will not be assigned mediations initially, but may co-mediate with an approved mediator.[7]

What do they know about residential real estate foreclosures?

Given the wide variety of backgrounds among the approved foreclosure mediators, it's hard to generalize.  In selecting the initial panel of approved mediators, DOC emphasized mediation training and experience (process expertise) over subject matter expertise.  In addition, some of us have a background in commercial law, real estate, consumer law, or collections.  But we all spent an intense two days learning about foreclosures and alternatives to foreclosure, including the loan modification and net present value calculations required under various federal programs.  We should all understand the concepts behind those programs and be able to facilitate productive discussions about all the issues involved.

How will they decide whether the parties are mediating in good faith?

DRC mediators usually define good faith as consisting of four components:
      • willingness to speak openly about the situation;
      • willingness to listen and try to understand the other party's perspective;
      • some flexibility about possible solutions; and
      • a commitment to keep any agreements made in the mediation.
Although I don't usually use the term “good faith,” I (and all the DRC mediators I know) ask the parties before the mediation begins if they will agree to approach the mediation this way.

Since most of the approved foreclosure mediators are DRC mediators, these four components will likely form the baseline for the mediator's good faith certification.  In addition, the FAA says that violation of the duty of good faith “may include” (a) failure to timely participate in mediation without good cause; (b) the lender's failure to timely provide required documents; (c) the borrower's failure to timely provide required documents; (d) failure to pay the required mediation fee; (e) failure to designate a representative with adequate settlement authority; and (f) the lender's request that the borrower waive future claims as a condition of loan modification.[8]

The FFA requires the lender (or authorized agent), the borrower, and the mediator to meet in person for the mediation session, but it allows the lender's representative with settlement authority to attend by phone or video conference.[9]  The statute is unclear whether telephone or video participation by a representative with settlement authority is instead of or in addition to participation in person by someone on the lender's behalf.  I think most mediators will expect the lender to send someone to mediate in person, and failing to do so may put the mediator's good faith certification atrisk.

What will happen at the mediation?

The FFA requires the mediating parties to “address the issues of foreclosure” that may enable them to reach resolution, including “reinstatement, modification of the loan, restructuring of the debt, or some other workout plan.” The mediator is required to make sure that the parties consider: (a) the borrower's economic circumstances; (b) the net present value of payments under a modified loan versus the anticipated recovery after foreclosure; (c) loan modification and net present value calculations established by the FDIC or other applicable federal programs; and (d) other applicable loss mitigation guidelines for federally insured loans.[10]

While the FFA prescribes the content of the mediation, it does not adopt any particular mediation process.  The DRC-hosted third day of training focused on mediation process.  Through role-plays and group discussions, we had the opportunity to practice mediation in a residential foreclosure setting and reach some consensus about anticipated mediation issues and challenges under the FFA.  We also have a fairly active online discussion group.  Nonetheless, different mediators will conduct the mediations differently, depending on their individual background and mediation style.  DOC is intentionally leaving process details to the individual mediators, relying on a pool of experienced mediators to apply their own style to develop their own foreclosure mediation process.

DRC mediators are likely to emphasize face-to-face discussion and negotiation.  The process will probably begin with an opening statement by the mediator, describing the mediation process, good faith, and the mediator's role.  This will be followed by statements by the borrower, then the lender, describing the situation from their perspective and identifying their mediation goals.  The mediator uses these statements to help the parties focus their discussion, discuss the issues, explore options, and negotiate towards resolution.  The mediator may meet individually with each party, but most of the mediation will take place with the parties in the same room, communicating and negotiating directly with each other. 

Attorney mediators who come from a commercial litigation background will probably conduct the mediation differently.  They are more likely to rely on private conversations with each party separately to elicit that party's perspective and generate proposals, which the mediator will communicate to the other party.  This is known as a “shuttle” style.  The mediator might not make an opening statement to the parties jointly, relying instead on individual or joint pre-mediation communications.

If a housing counselor or attorney refers a borrower to foreclosure mediation,[11] DOC will assign an approved foreclosure mediator based on location and availability.  DOC will notify the lender, borrower, deed of trust trustee, and referring housing counselor or attorney of the referral, and identify the assigned mediator.[12]  The mediator must schedule the mediation to take place within 45 days (unless the parties agree in writing to an extension), and provide written notice.[13]

Many of the mediations, especially at the outset, will have two mediators.  DOC has expressed a preference for co-mediation, and some DRCs are requiring their mediators to co-mediate, at least at the outset.  For DRC mediators, co-mediation is familiar and comfortable, and should not significantly impact the individual mediation.  Over time, though, co-mediation should result in a more uniform mediation process and greater consensus on best practices.  The assigned mediator (or the DRC through which they mediate) will choose the co-mediator.[14]
Based on Nevada's foreclosure mediation experience, most foreclosure mediations will take one to three hours.  The mediation will end when the parties reach a resolution or conclude that they cannot do so.  At the end of the mediation, the mediator will write up (or assist the parties in writing up) the basic terms of any resolution.  After the mediation, the mediator will provide the FFA-required certification on a standardized DOC form.[15]

One last thought.

Mediation is, by definition, a flexible, organic, process that allows the mediator to accommodate the parties' individual needs and preferences.  Mediators are used to adapting their process to fit the parties and their circumstances.  That skill will be in full play for all of us as we learn from our own experience and party feedback, and develop our own preferred foreclosure mediation process within the FFA's unique parameters.  While the lack of predictability may be frustrating at the outset, the result over the long term should be a mediation foreclosure program that works for lenders and borrowers in general, and for each party individually.
________________
[1] FFA  §7(7)
[2] FFA  §7(11)(a)
[3] FFA  §7(11)(c)
[4] RCW ch. 7.75 is the enabling act for DRCs.
[5] FAA §10(1) requires all foreclosure mediators to be either (a) attorneys, (b) housing counselors, (c) DRC employees or volunteers, or (d) retired judges.
[6] DRCs will administer the foreclosure mediations assigned to their non-attorney employees and volunteers and other foreclosure mediators (attorneys, housing counselors, retired judges) who have elected to participate through the DRCs.
[7] DRCs routinely use a co-mediation model (two mediators working together, often as part of a mediation training or practicum program).  DOC has expressed a preference for co-mediation in foreclosure mediations as well.
[8] FFA  §7(8)
[9] FFA  §7(6)
[10] FFA  §7(7)
[11] FFA  §7(1)-(2)
[12] FFA  §7(3)
[13] FFA  §7(4)-(5)
[14] Co-mediation will not increase the parties' fees, which may not exceed $400 ($200 per party) for a one to three hour mediation.  Additional fees may be authorized by DOC for mediations that take longer.  FFA §7(14)
[15] FFA §7(9); the “certification of mediation form” is available on the DOC website at http://www.commerce.wa.gov/site/1367/default.aspx.
________________________________________
If you should have any questions or wish to discuss issues specific to condemnation, please contact any of the following members of the Graham and Dunn Condemnation Team:
 
Marisa V. Lindell (206.340.9639 or mlindell@grahamdunn.com),
Jeffrey A. Beaver (206.340.9652 or jbeaver@grahamdunn.com),
Matthew R. Hansen (206.340.9595 or mhansen@grahamdunn.com),
Zachary R. Hiatt (206.340.9635 or zhiatt@grahamdunn.com),
or Larry J. Smith (206.340.9645 or lsmith@grahamdunn.com).

If you would like to talk about mediation under the FFA, please contact Estera Gordon (206.340.9630 or egordon@grahamdunn.com).

On July 5, 2011, we let you know about a new .xxx top level domain name (“.tld”) that ICANN created for the adult entertainment industry.  Nothing seems to get brand owners up in arms faster than finding that their brand is associated with an adult website.  So, if you want to keep your valuable brand from being registered as a new adult entertainment .xxx domain name, now is the time to act.

The new register for the .xxx tld is ICM Registry.  For brand owners, you may preemptively register your brand during a “sunrise” period that begins September 7, 2011 and ends October 28, 2011.  The sunrise period has been designed to both permit domain registration from members of the adult entertainment industry and to assist brand managers from other industries who want to protect their trademarks.  ICM Registry will work alongside individual domain registrars during this period to ensure the Web addresses are not registered by others at a later date. This service is without annual fees and will only be available to rights owners during the restricted sunrise period.

November 8, 2011 marks the beginning of a “Land Rush” that will run for 18 days.  During this time, businesses from the adult entertainment industry will have access to the remaining .xxx Web addresses.  If a competition arises over a particular domain name, a closed-auction will be held for those applicants at the end of the Land Rush period.  On December 7, 2011, the .xxx domains will be available to the general public - at which point any domain name speculator will be able to register a .xxx domain name and put it to use or hold it for sale to another party.

If you miss the sunrise period and you find your brand prominently used as a .xxx adult industry domain, you will be forced to deal with this post-registration, by means of an administrative domain name dispute resolution process or a lawsuit.  Both post-registration options can be expensive and a plaintiff would have to meet legal standards for claims of cybersquatting or trademark infringement or dilution.

The pre-reservation process that we mentioned in our earlier Cyber-Graham is now closed, but over 900,000 showed signs of interest during the pre-reservation period.  However, ongoing inquiries are being handled by ICANN accredited registrars.

For more information, we invite you to contact us.  You may also sign up for updates from the ICM Registry or simply see http://www.icmregistry.com.

*Research assistance credit (and appreciation) goes to Graham & Dunn summer associate Jonathan Smith.

______________________

Bob Cumbow and Kathleen Petrich are shareholders with Graham & Dunn and counsel their clients regarding trademarks and domain names, among other forms of Intellectual Property creation, protection, management, commercialization, and enforcement.  For more information about this CyberGraham or questions pertaining to the new domain name challenges/opportunities and trademark management, please contact them or other Graham & Dunn IP team members:  Mike Atkins and Jessica Hoerschelmann.

Hindsight Is 20/20

As I reflect back over the last 3+  years, it is clear that most of us missed the boat on (i) the recession; (ii) the length of the recession and (iii) the depth of the recession.  While it would have been virtually impossible to predict (ii) and (iii), in hindsight we should have seen the makings of a serious economic slowdown.  After more than a decade of sustained growth, history has taught us most good things must eventually come to an end – and they did – with a resounding thud.

Fingerprints Galore

If we are to be honest with ourselves, the carnage in the banking industry could have been tempered by a more proactive approach.  Pretty much everyone involved with the industry, including Congress, the Administration, the regulators, the bankers and the professionals who served the industry mostly ignored the signals.  It's time everyone admitted there is shared responsibility for this debacle.  Hopefully, we all learn from this painful experience and avoid repeating our mistakes.

The Imbalance in the System

Because of the fallout of the recent financial crisis, everyone is extremely guarded and cautious.  Bankers, in particular, often feel frustrated dealing with the ultra-conservative regulatory environment.  While it is clear that it has been no picnic for the banking regulators, some balance must return to the industry-regulatory relationship.  What I have seen most vividly since I started my career with the Comptroller of the Currency ages ago is the apparent and troubling lack of respect and tolerance between the regulators and the bankers.  To generalize would be unfair and irresponsible.
But all too often we have seen or heard about the apparent lack of respect and trust that should be at the foundation of a healthy bank regulatory environment.  In order for banks to fully recover and lead our economic recovery, that healthy balance must be rebuilt.  Recognizing that all of us in the industry are in it together is an important first step.

The Absence of M&A and Consolidation

Given the current earnings and stock price environment for banks and the apparent regulatory hurdles in getting deals done, it is really no surprise that the predicted wave of consolidation has not commenced yet.  Until bank stock prices move up, I don't think we will see the activity predicted.  In addition, the level of capital expectations by regulators and the depth of loan and other due diligence by buyers are also having a chilling effect on deals.  At some point, that all will gradually change, driven in part by the desire of buyers to grow earnings and sellers to find an exit strategy.

Moving Forward

It is my sincere hope that, while we should learn from our recent experience, we all move forward together, the regulators and the banks (I have largely given up on the Administration and Congress) to rehabilitate our industry and help end this endless recession.  As one of my old regulatory buddies used to say “Washington DC is an island surrounded by reality.”  That never has been more true than now.  In the spirit of Aretha Franklin, building mutual R*E*S*P*E*C*T between the banks and their regulators should be an admirable and mutually productive goal.

________________________________________
If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:
 
Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com). 

Evolution

Over the past three years during the financial crisis, the role of the Board of Directors has evolved to address changing times.  In our frequent meetings with Boards of all sizes throughout the West, it is clear that there is some confusion on the appropriate role of directors in today's environment.  A combination of economic, investor and regulatory pressures has reshaped that role.  The purpose of this article is to provide some perspective and guidance to directors in these uncertain times.

The Basics

In layman's terms, directors have certain basic fiduciary duties to their company and its shareholders.  These include the duties of care and loyalty.  What this means is that directors need to exercise the judgment that an ordinary prudent person would use in similar circumstances.  In English, directors need to make informed, thoughtful decisions.  They need to get meaningful reports and information in advance of meetings, carefully review such materials, attend meetings and ask good questions.  While the Board needs to trust management (or replace management if that trust is lost), directors still need to ask probing questions and test management's recommendations in a respectful, constructive manner.  While directors' expectations have been raised in these challenging times, they must provide healthy oversight but rely on management to run day-to-day operations.

The Pressure From Regulators

With all due respect to the banking regulators, who have a difficult job in tough economic times, the Board should not take on the task of running the Bank on a day-to-day basis.  With administrative actions very common, Boards no doubt will have enhanced involvement, more frequent and lengthier meetings and a greater commitment of time and effort.  However, that oversight is not a substitute for Bank management.  Given the regulatory scrutiny and exploration of mergers and recapitalizations, Boards must strike a fine balance between enhanced oversight and day-to-day management. 

“So-Called” Executive Sessions

As an outgrowth of Bank failures and economic stress and related pressures from regulators, there has evolved the more common practice of “Executive Sessions” of independent directors.  The most recent roots of this practice come from the Sarbanes-Oxley Act for public companies.  However, it appears there is confusion as to the purpose of these meetings.  Many of our clients, both public and private, have simply adopted a practice of providing for executive sessions of outside directors on a monthly or quarterly basis.  They are often just part of the regular agenda and the Board can exercise the right to have an “executive session” or not depending on need.  This seems to work well since calling of such meetings on an ad hoc basis creates unnecessary suspicions by, and tensions with, management.  Such executive sessions should have one purpose – to discuss the performance of the “inside directors,” i.e. the President and CEO.  Following the session, the chairman should meet with any inside directors and summarize the Board's discussions.  Please remember inside directors have the same fiduciary duties as outside directors.  All other discussions about the Bank should involve them.  The purpose of such executive sessions is simple – to create a convenient forum to discuss the performance of the CEO/President without the CEO/President being present.

Finding a Balance

Ultimately, things will settle down to some semblance of normalcy and Boards can return to a more balanced role.  However, the lessons learned over the past three years should not be lost.  During the good times, we all tend to be a little less involved and focused.  Going forward, Boards will have to raise the bar a bit and provide thoughtful, meaningful oversight, while avoiding micromanagement.

Takeaways

If anything, recent times have shown that many Boards were unprepared for the challenges their Banks faced.  While the depth and breadth of the financial crisis were unforeseeable, we all should learn from the experience.  Meaningful and continuous director education is a must.  This can come from a variety of sources – trade association meetings, periodic updates by your CPAs, investment advisors, counsel, compensation consultants and independent loan reviewers.  Last but not least, the Board should never be afraid of asking thoughtful questions in a respectful manner.  All this assumes of course that directors are prepared for Board meetings and review their Board packets in advance.  Our world has changed and we all must change with it, including directors.

If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:
 
Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
or Casey M. Nault (206.340.4808 or cnault@grahamdunn.com).

In 1987, Washington's legislation granted design professionals, and their employees, immunity from claims of professional negligence brought by workers injured during the course of a construction project, unless the design professional contractually assumed responsibility for job-site safety or actually exercised control over the portion of the site where the injury occurred.  The statute does not apply to the design professional's negligence in preparing design plans and specifications which result in job-site injuries.

Last week, in the first opportunity to interpret the statute, the Washington Supreme Court held that since the injuries in the case did not occur at a location where actual construction work was taking place, the statute did not apply to protect the design professional against job-site safety claims.  Michaels v. CH2M Hill (Wash. S. Ct., May 2011) The facts of the case were as follows.

In 1998, the City of Spokane hired CH2M Hill for a 10-year capital improvement project to upgrade and retrofit the City's waste water treatment plant.  In 2003, CH2M Hill modified its contract with the City to provide that, in addition to managing the design of upgrades to the plant, it would provide “on-call” services during the upgrades to assist the City in operating the plant.  As part of its services, CH2M Hill proposed changes to the recirculation system of the City's digesters.  The City's operators were unaware of how the changes would affect the over-filling of one of the digesters, and during operations to relieve sludge building up in the roof of the digester it collapsed, killing one operator and injuring two others.

The survivors sued CH2MHill for negligence, and CH2MHill argued it was immune under the design professionals statute because its services related to the construction of improvements to the City's plant.  Focusing on CH2M Hill's on-call services, the Washington Supreme Court disagreed and held that the statute only applies to injuries arising from services directly related to actual construction work.  The court narrowly construed the statutory terms “construction site” as meaning the “space of ground occupied or to be occupied by a building that is or will be put together to form a complete integrated object” and “construction project” as the “overarching plan and process of so completing the building.”  Thus, if a design professional's services are not performed on the site of actual construction or directly related to the construction process, such services may not be protected by the statute for job-site safety claims.

The court also rejected CH2M Hill's argument that the advice it had given to the City to improve the operation of its digesters did not fall within the statute's exception for claims related to the negligent preparation of design plans and specifications.  CH2M Hill argued that the exception only applied to written plans and specifications which are ordinarily prepared for construction projects.  The court held that the exception was not so limited and that it applied to verbal advice as well as written plans and specifications.

The following are steps design professionals, contractors and owners should consider in light of the court's ruling:

• Design professionals should make sure contract documents clearly identify who is responsible for job-site safety, and if the design professional is not responsible the documents should explicitly disclaim such responsibility. 
• The party most capable of managing job-site safety should be made responsible for safety, and the contract documents should clearly express that understanding. On most projects this responsibility resides with the general contractor, as it is usually most capable of managing safety. 
• Industry forms of owner-architect contracts often provide that the architect is the owner's site representative.  In light of the court's ruling, owners may want to consider using more limiting language to express the architect's responsibilities and relationship with the owner.
• Owner-contractor agreements and sometimes owner-architect agreements include flow-down indemnity and insurance provisions that provide limited liability protection for the architect or engineer.  Owners and contractors should make sure such provisions are appropriately drafted to meet statutory requirements and are complied with in the construction process.  Owners or contractors who fail to add an architect or engineer to a policy when required by an agreement may find themselves insuring the design professional. 

________________________________________

If you should have any questions or wish discuss this issue further, please contact the following members of Graham & Dunn's construction group:
 
Michael K. Fandel at  206.340. 9693 or mfandel@grahamdunn.com
Stephen H. Goodman at 206.340.9607 or sgoodman@grahamdunn.com
Zachary R. Hiatt at 206.340.9635 or zhiatt@grahamdunn.com

The Landscape

Get ready for another domain name gold rush!  New generic and branded domain names will soon be available--but this time there will be new challenges and significant costs associated with the process.

All businesses now know that having a Web presence and often directly offering goods/services through the business Web site is a must in the 21st century.  Instead of accessing a specific business owner's Web site by typing in a formal and convoluted Internet protocol (IP) address, such as 207.68.166.247, domain names enable consumers look for a specific business by typing in a user-friendly character-string (e.g., microsoft.com) to enable a computer on the Internet to find another computer.

Back in the mid 1990s we saw a rush to grab everything .com, .org, and .net (other early top level domains or .tlds included .edu for universities and .gov for the U.S. government).  ICANN, (Internet Corporation for Assigned Names and Numbers), the organization that oversees the huge and complex interconnected network of unique identifiers that allows computers on the Internet to find one another, continued to pump out new generic .tlds (such as .aero, .pro, .coop, .biz and .info), country codes (such as .ca for Canada), and regional codes (such as .eu for the European Union).  There are or will be soon about 306 tlds available, including the new .tld .xxx for the adult entertainment industry approved last March.

New Peril .xxx?

Nothing seems to get brand owners up in arms faster than finding that their brand is associated with a porn site.  Trademark owners were up in arms over past .tld expansions as they created cyber opportunities for others to filch their trademarks, but became generally pacified by ICANN's adopting a uniform domain name dispute resolution proceeding (UDRP) to help legitimate trademark owners get back their domains when used illegitimately and in bad faith by others.  In addition to post registration, ICANN also adopted sunrise periods in which legitimate trademark owners could object or block (through registration) objectionable use of a trademark in a new .tld domain pre-registration.  In the case of the new .xxx tld, trademark owners can essentially co-opt their trademark from being on the .xxx registry by reserving their trademarks in the sunrise period beginning in September 2011.  As an extra precaution, trademark owners can pre-reserve on sites such as http://domains.icmregistry.com/.  So, brand owners who want to block their brands from use as porn site domains will want to take action in the sunrise period beginning in September or early “pre-registration” now.

New Opportunities or Expensive Cyber Vanity Plate?

Now, ICANN has thrown open all generic domain extensions ? and the granddaddy of them all: “.brand” ? (in other words, your own private brand or name) ? but for a fee, and a whopper of a fee at that.  Here are the highlights, which are subject to a fair amount of continued tinkering:

• Established corporations, organizations, or institutions in good standing may apply (individuals or sole proprietorships are prohibited from filing)
• Potential applicants must become registered users of the TLD Application System (TAS) and pay a $5000 deposit to receive access to a full application form (containing 50 sections or about 100 pages!)
• At time of filing a full application, the applicant must pay $180,000 ($185,000 less the $5,000 deposit)
• Application window period is January 12, 2012 through April 12, 2012
• Applications require proof of legal establishing and copies of financial statements for the most recently completed fiscal year
• Financial information will be kept confidential by ICANN agents
• In some cases, refunds for a portion of the evaluation fee may be available for applications that withdraw an application before the evaluation process is complete
• Additional fees may be required in the event that a formal objection is lodged, for priority evaluation, for referring an application to the Registry Services Technical Evaluation Panel

Bottom line:  this is a big expensive process.  Some in the legal community are bandying about a number in the $500,000 range for the entire process, not including the business resource allocation time to assist with the preparation of the application and assembling requested documents, such as financial reports.

This raises the question:  Should a business pay the outrageous sum of $185,000 for the initial application filing fee (not to mention the very large legal fee that could accompany the 100-or-so-page application) when they can get a .com domain name for $11.99 (bulk price) from GoDaddy?  Is this the equivalent of an expensive “vanity vehicle license plate”?

Most businesses would likely say the cost isn't worth it.  In these days of increasingly sophisticated and reliable Web search technology, few consumers type a domain name into a browser to find a particular business, but rely more heavily on search engines, such as Google, to reach a particular business or brand.  Further the technical requirements will be much more strenuous to operate a “private registry” than merely registering a single domain on a .com registry.  ICANN will want to know that an applicant has the technical expertise to meet the requirements.  To date, only one business has publicly stated its intent to go after the “.brand” domain extension, and that is Canon (wanting.canon).  Presumably Canon has the technical savvy to meet the requirements, in addition to having the necessary funding.

But what if the goal is to get a bigger share of the online market space?  What if the business plan adopts the use of distributors that can more easily be tracked/managed or a way to better police counterfeits?  What if customers can immediately feed into the .brand account for a myriad of goods/services?  Then, the prospect of a $500,000 or so expense may well be worth it in comparison to extensive and expensive online marketing and advertising and as a means to more cost effectively deliver the business's goods and services to online consumers.

Once Canon obtains its .canon registration and others trickle in, will there be a sufficient interest for legitimate businesses/organizations to jump in?  In other words, will Coca Cola, the holder of the most valuable trademark (estimated in some reports to be worth over $70 Million in 2010 by Interbrand) really want to sit on the sideline and not register .coke or .cocacola?

And what about entire industries, developing or not?  What would it be worth to have .bank or .software or .smartgrid top level domain?  How could information and goods/services be distributed to consumers/potential consumers under vast new swaths of cyber real estate?

Finally, will the availability of these new “name your own” .tlds provide an attractive alternative to battling with competitors and cybersquatters for similar second-level domains in the .com and other existing generic .tlds?  Or will businesses still have to spend time and money policing their trademarks in the older .tlds even after spending big bucks to adopt one of their own?

Many of these questions will likely be resolved over the next year.  But for those with strong financial backing and good Web business plan/marketing plan, the opportunity to get an exclusive .tld (generic or branded) may be very attractive and more than a mere “vanity plate.”

________________________________________
If you should have any questions or wish to discuss issues specific to Intellectual Property please contact any of the following members of the Graham and Dunn Intellectual Property Team:
 
Kathleen T. Petrich 206.340.9672 or kpetrich@grahamdunn.com
Robert C. Cumbow 206.340.9619 or rcumbow@grahamdunn.com
*Research assistance credit (and appreciation) goes to Graham & Dunn summer associate Jonathan Smith

Deals Are Fragile

As we slowly attempt to recover from the throes of the economic debacle in the West, it has become increasingly apparent that deals – whether they be mergers or financings – are fragile creatures.  For every deal done, there are many that never get completed.  Frustration among both buyers and sellers, investors and targets is running very high these days.  We all hear about the successes, but rarely about the misses.

Why Are Deals So Fragile?

Actually, this is a complicated phenomenon.  First, lingering asset quality concerns are still the primary reason buyers or investors walk away.  They simply can't get the numbers to pencil out and provide the returns on investment they are seeking.  Also, relatively low bank stock prices make it challenging for more traditional acquirors (read that not private equity) to use their currency to do acquisitions.  Then add the social and regulatory factors to the mix and the results are not so surprising.

Diminishing FDIC Deals

There are fewer attractive (size and location) FDIC-assisted deals remaining.  It appears this number has peaked and down the road we will eventually return to whole bank transactions as the norm, with the occasional FDIC-assisted deal.  Those “stuck in the middle,” i.e. not yet ready for receivership, but significantly wounded banks, are finding a mixed bag out there.  Private equity has shown an interest at the right price in selective deals; again size and location being important.  Traditional buyers have been less inclined to participate in the arena – perhaps reflecting the reporting demands placed on public companies for NPAs and the like.  One interesting play is two damaged banks combining and creating enough critical mass to attract investors.  However, most of these deals fall apart in the talking stages.  They often resemble “strategic alliances” or so-called “mergers of equals,” with all the attendant social issues.

The Regulatory Hurdles

While the regulators have selectively allowed private equity into the game, it still remains a costly and time consuming process.  Further, mergers will continue to be carefully scrutinized by the regulators for fear of approving a deal which could later implode.  And, let's face it, private equity is generally a different breed of cat, learning to adapt to a heavily regulated world foreign to them.  Only time will tell how all these private equity deals will play out.  Lastly, it's clear that high capital levels – i.e. 10% Tier 1 capital –  will be expected by the regulators for dealmakers for the next 2-3 years.

Supply and Demand

I suppose in a nutshell, everything comes down to supply and demand.  There is money out there waiting to be invested in either recapitalizing or buying banks and buyers are anxious to employ that capital and grow their franchises.  As we have all seen and heard, there are a number of boards and management teams simply fatigued by the events of the past three years and discouraged by the prospects for small community banks going forward.  This suggests a pick-up of whole bank M&A..  While discussions continue, relatively little activity has occurred, especially in the West.  So, when considering a deal, whether a merger/sale or recapitalization, it would be worthwhile to recognize how fragile deals are due to asset quality, expected premiums/returns or regulatory requirements, not to mention the all important human element. Indeed, these deals must be handled with special care if they are to be successfully completed.

If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:
 
Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
or Casey M. Nault (206.340.4808 or cnault@grahamdunn.com).

The American economy and indeed American notions of what freedom means are heavily built upon the concept of private property.  Private property as it has been known in the United States is unique in much of the world – it is unlike the feudal background of European property laws, certainly unlike the state control of property in Communist countries, even countries like China that are in transition to something approximating a free market, and unlike property laws in much of South America where the property rights of indigenous people often overlap and are diametrically opposed to the property rights of corporate interests in the same piece of real estate.  And so the Fifth Amendment's injunction that private property shall not be taken for public use without the payment of just compensation has been viewed in American civics courses for generations as a bulwark of American law. 

On the other hand, as the country became more populated, more industrialized, and as we have come to understand the importance of things like wetlands, tidelands and channel migration zones to the public welfare as a whole, the scope of the police power and government's regulatory authority necessarily increased.  Government regulations that would have been considered unthinkable in the Nineteenth Century became accepted as essential in the Twentieth Century.¹   The courts, and particularly the United States Supreme Court, was extremely cautious about potentially overstepping its bounds in protecting private property and thereby inappropriately chilling the efforts of local governments to respond to changing conditions.

The result was that for most of the last half of the Twentieth Century the task for a property owner's lawyer attempting to determine whether their client had a viable regulatory taking claim was to read cases where the property owner lost and tried to decide whether anything about their client's case made it more likely that they would win.  The United States Supreme Court spent years avoiding reaching the merits of regulatory takings cases based on ripeness and jurisdiction arguments.  See, e.g., Williamson County Reg'l Planning Comm'n v. Hamilton Bank of Johnson City, 473 U.S. 172, 105 S. Ct. 3108, 87 L. Ed. 2d 126 (1985)(holding that a developer's taking claim was not ripe because it had not obtained a final administrative decision as to what would be permitted on its property and because it had not sought compensation for any taking under state law); MacDonald, Sommer & Frates v. Yolo County, 477 U.S. 340, 106 S. Ct. 2561, 91 L. Ed. 2d 285, reh'g denied, 478 U.S. 1035 (1986)(holding that just because a “relatively intensive” use of land is turned down does not mean that a takings case is ripe if a less intense development might be approved and would still allow economically viable use of land).  And when the Supreme Court actually addressed a regulatory taking claim, it more often than not decided that the property owner before it had not suffered a taking requiring compensation – even though in dicta it indicated that a regulatory taking under similar circumstances might be possible.

A. Penn Central outlines the bounds of the conversation on regulatory taking.

One such case was Penn Cent. Transp. Company v. City of New York, 438 U.S. 104 (1978).  There the Court held that New York City's landmarks preservation law did not create a compensable taking of Penn Central's rights in Grand Central Station by prohibiting the construction of a 50-story building cantilevered above the terminal. 

The Court in Penn Central can be credited with at least “fessing up” to the difficulty it was having in figuring out how to distinguish a regulation that was within the police power of the government to prohibit uses of property that are harmful to the public health, safety and welfare or require uses that are conducive to the health safety and welfare, and those regulations that require compensation.

The question of what constitutes a “taking” for purposes of the Fifth Amendment has proved to be a problem of considerable difficulty.   While this Court has recognized that the “Fifth Amendment's guarantee . . . [is] designed to bar Government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole, this Court, quite simply, has been unable to develop any “set formula” for determining when “justice and fairness” require that economic injuries caused by public action be compensated by the government, rather than remain disproportionately concentrated on a few persons.  Indeed, we have frequently observed that whether a particular restriction will be rendered invalid by the government's failure to pay for any losses proximately caused by it depends largely “upon the particular circumstances [in that] case.”

438 U.S. at 123-124 (authorities omitted).  The Court went on to describe what has been called “the Penn Central test.”  In the ordinary parlance of a “test,” it is not a “test” at all, but at most a discussion of things that a court should evaluate in considering a regulatory taking claim.  How the Court should think about those factors depends on the particular case.

In engaging in these essentially ad hoc, factual inquiries, the Court's decisions have identified several factors that have particular significance.  The economic impact of the regulation on the claimant and, particularly, the extent to which the regulation has interfered with distinct investment-backed expectations are, of course, relevant considerations.  See Goldblatt v. Hempstead, supra, 369 U.S. at 594, 82 S.Ct., at 990.  So, too is the character of the governmental action.  A “taking” may more readily be found when the interference with property can be characterized as a physical invasion by government.  See, e.g., United States v. Causby, 328 U.S. 256, 66 S. Ct. 1062, 90 L.Ed. 1206 (1946), than when interference arises from some public program adjusting the benefits and burdens of economic life to promote the common good.

Id.  at 124. 

 B. Palazzolo holds that Penn Central has meaning, but doesn't elucidate that meaning.

While subsequent cases almost immediately started referring to that as the “three-part” Penn Central test (dividing “economic impact of the regulation” and “extent to which the regulation has interfered with distinct investment-backed expectations” into two parts of the “test”), it was not until Palazzolo v. Rhode Island, 533 U.S. 606, 121 S. Ct. 2448, 150 L. Ed. 2d 592, on remand, 785 A.2d 561 (2001), 23 years later, that the Supreme Court demonstrated that in fact, a regulatory taking might be found based on an ad hoc evaluation of the Penn Central factors, even where the regulation did not take all economically viable use of the property and did not include a physical invasion of the property.²  

Palazzolo involved a regulation preventing the filling of salt marsh tidelands.  Palazzolo had acquired his property in 1959, at a time when many similarly situated beach properties in his community had been filled or were being filled.  Palazzolo had owned the property in various forms over time – first with other investors, in a corporate form, and later, after he bought out the other investors and the corporation was dissolved, as a private individual.  He had made various attempts to develop the property as a private beach club over time, which the Court described as “sporadic.”  Each of his proposals ran into objections, and each resulted in a scaling back from the previous proposal.  Eventually though it was clear that he was not going to be able to fill the wetlands and thus he wasn't going to be able to build the beach club, and because the property was overwhelmingly wetland, he claimed it had no economically viable use.  The Rhode Island Supreme Court found that Palazzolo's case was not ripe, that because he took individual ownership of the property after the wetland regulation was already in place he did not have “reasonable investment-backed expectations” that were affected by the regulation, and that because there was one small corner of the property that was upland, upon which a single house could be built, he was not deprived of all economically viable use of the land.

The U.S. Supreme Court reversed the Rhode Island Court.  It found his case ripe – there was no remaining question as to whether he could fill the wetland.  It also found that the fact that when he obtained sole ownership of the property the wetland regulation was already in place did not bar Palazzolo's claim.

The State may not put so potent a Hobbesian stick into the Lockean bundle. The right to improve property, of course, is subject to the reasonable exercise of state authority, including the enforcement of valid zoning and land-use restrictions. . . . The Takings Clause, however, in certain circumstances allows a landowner to assert that a particular exercise of the State's regulatory power is so unreasonable or onerous as to compel compensation. Just as a prospective enactment, such as a new zoning ordinance, can limit the value of land without effecting a taking because it can be understood as reasonable by all concerned, other enactments are unreasonable and do not become less so through passage of time or title. Were we to accept the State's rule, the postenactment transfer of title would absolve the State of its obligation to defend any action restricting land use, no matter how extreme or unreasonable. A State would be allowed, in effect, to put an expiration date on the Takings Clause. This ought not to be the rule. Future generations, too, have a right to challenge unreasonable limitations on the use and value of land.

Nor does the justification of notice take into account the effect on owners at the time of enactment, who are prejudiced as well. Should an owner attempt to challenge a new regulation, but not survive the process of ripening his or her claim (which, as this case demonstrates, will often take years), under the proposed rule the right to compensation may not be asserted by an heir or successor, and so may not be asserted at all. The State's rule would work a critical alteration to the nature of property, as the newly regulated landowner is stripped of the ability to transfer the interest which was possessed prior to the regulation. The State may not by this means secure a windfall for itself.

533 U.S. at 627.  The Supreme Court agreed with the Rhode Island Supreme Court, however, that the fact that the property retained $200,000 in value as the site for a single home meant that the regulation did not cause a Lucas taking.  As a result, the Supreme Court reversed and remanded the case for a determination of whether there was a regulatory taking under Penn Central. 

The upshot is that the Court necessarily concluded that Penn Central could provide a basis for a regulatory taking, even where the property has continuing economic value.  That squarely presents, however, the question left completely undiscussed by Penn Central, which is how in an “essentially ad hoc factual inquiry” a court should evaluate those “factors” Penn Central set forth.  The Supreme Court's decision in Palazzolo does not answer that question, but left it to the lower court on remand. 

 C. Recent federal cases are ad hoc and fact-specific, but shed light on some parts of the Penn Central test.

 1. Florida Rock Industries V – after 15 years, the fifth decision is a judgment for the property owner.

Regulatory taking cases are not for the faint of heart.  Through most of the time when the United States Supreme Court was developing its current regulatory taking jurisprudence, a company called Florida Rock Industries was litigating the issues in the Federal Court of Claims.  Florida Rock Industries bought 1,560 acres of largely wetland in 1972 for the purpose of mining limestone from beneath the wetland.  That purpose, if at least as disruptive as most mining, was entirely legal in 1972.  The 1974 amendments to the Clean Water Act prohibited the dredging or filling of wetlands without a Section 404 permit, however, and because Florida Rock's proposed activities did not meet the standards for the issuance of a 404 permit, it had been foreclosed from using the vast majority of its property based on its investment-backed expectations.  The case has resulted in five major federal decisions between 1985 and 1999.  (Florida Rock Indust. Inc. v. United States, 8 Cl.Ct. 160 (1985)(Florida Rock I), rev'd and remanded, Florida Rock Indus., Inc. v. United States, 791 F.2d 893 (Fed. Cir. 1986), cert denied, 479 U.S. 1053 (1987)(Florida Rock II), on remand, Florida Rock Indus., Inc. v. United States, 21 Cl.Ct. 161 (1990)(Florida Rock III); Florida Rock Indus. Inc. v. United States, 18 F.3d 1560(Fed. Cir. 1994), cert denied, 513 U.S. 1109(1995)(Florida Rock IV), and Florida Rock Indus., Inc. v. United States, 45 Fed. Cl. 21 (1999)(Florida Rock V).  The Court's discussion in Florida Rock V finally addressed the Penn Central test, and found a taking requiring compensation.

 The Federal Circuit's decision in Florida Rock IV had found that there was a “speculative market for property comparable to Florida Rock's land,” 45 Fed.Cl. at 31, and therefore Florida Rock V started with the proposition  that economically viable use of the land remained after the Clean Water Act amendments.³   There was no categorical taking of Florida Rock's land.  Nonetheless, Florida Rock V found a 73% diminution in value from the regulation.

 The court found a 73% reduction in value to be a substantial diminution in value, but then had to deal with cases that have said that “mere diminution in value” is not enough to constitute a taking.  Courts have found no taking where a regulation included mere diminution in value than the court found Florida Rock would suffer.  See, e.g., Euclid, 272 U.S. 365 (1926)(no taking despite 75% diminution; Hadacheck v. Sebastian, 239 U.S. 394, (1915)(no taking despite 87 1/2% diminution).  Those cases have led some governmental bodies to posit that if they can leave a landowner with some minor value, their regulation could not be a taking.  The Florida Rock V court explained that “mere diminution” is not a quantitative evaluation – it means that “diminution alone,” in the absence of other factors, does not constitute a taking. 

The police power may necessarily limit or reduce the value of some property owners' property.  But all citizens and all property owners also benefit from the police power.

The economic impact of certain land use controls, when shared by other members of the community, has been held to be non-compensable.  “When there is reciprocity of advantage, paradigmatically in a zoning case . . . then the claim that the Government has taken private property has little force: the claimant has in a sense been compensated by the public program ‘adjusting the benefits and burdens of economic life to promote the common good.”  “Mere diminution' occurs when the property owner has received the benefits of a challenged regulation, such that an ‘average reciprocity of advantage' results from it.  . . .

A ‘partial taking occurs when a regulation singles out a few property owners to bear burdens, while benefits are spread widely across the community,'

45 Fed. Cl. at 36-37 (authorities omitted).  Although that discussion necessarily brushes over into the second test – the “character of the governmental action” – what it suggests is that as with any 3-factor test, the weight to be given to different factors will vary depending on the facts of the case, but diminution in value alone is not sufficient to constitute a taking. 

 The Florida Rock V case also clarified a point that is implicit but not explicit in Lucas.  In Florida Rock V the government proved that there was a market for the land consisting of speculators who were prepared to buy it for a quarter of its unregulated value, intending to hold the land for some indefinite period until the Clean Water Act regulations were removed, and it could be used to mine limestone.  There was also an argument that “Florida Rock could also use its land for the observation of wildlife or maybe even for hunting.”  That, however, was not a use that would prevent a taking.  “However, these are not commercially valuable uses.”  45 Fed. Cl. at 37. 

 Turning to Florida Rock's “reasonable investment-backed expectations,” the court rejected the argument that state and local regulations would have precluded the mining, and therefore federal regulations did not impair Florida Rock's investment-backed expectations.  “The mere presence of such regulatory programs does not affect our analysis.”  But it did not have to deal with the situation where a landowner buys land knowing that regulations in place would restrict its use.  Florida Rock bought its land in 1972, at a time when its proposed mining was entirely legal.  The court did note that unlike the regulation in Penn Central, which did not interfere with the use the owner had made of the property for decades – a train station – the regulation here directly prohibited the primary purpose for which the company had purchased the property.  These were “distinct investment-backed expectations,” squarely rendered impossible by the regulation.

 Turning finally to the “character of the governmental action,” the court focused on two things. 1) The regulation was not to address a health or safety risk.  It was to protect the environment.  2) It not only provided widespread public benefit, at considerable cost to Florida Rock, it was not even applied equally to all owners of similarly situated properties.  The government had apparently drawn a line, to the east of which it would allow similar operations to occur, and to the west of which it would protect the wetlands.  Florida Rock was on the west side of the line.  But the very fact that the activity was permitted elsewhere suggested that the government action did not fall into the category of nuisances or other activities that may have been prohibited under the common law. 

The government made a permissible policy choice that this land should benefit the public's supply of wetlands.  This court cannot review or scrutinize or second guess this policy choice.  Plaintiff does not ask the court to do this anymore than in a condemnation proceeding a court could review or second guess a need for a road or a school.  The court must, however, decide whether this action has taken the plaintiff's property as effectively as if it had been condemned.

45 Fed.Cl. at 40.

Having reviewed each part of the 3-part Penn Central test, the court found that all three put together constituted a regulatory taking.  The court only had before it 98 acres of the total property, for which an actual permit had been denied.⁴   The court awarded $752,444 in damages for the taking of the right to mine the 98 acres, plus interest from October 2, 1980, when the permit was denied, plus attorneys fees, and encouraged the parties to settle the claims as to the remaining 1462 acres, which the court now presumed would suffer a comparable fate.

 2. Guggenheim v. City of Goleta – the Ninth Circuit finds a facial taking under Penn Central, then changes its mind.

 Guggenheim v. City of Goleta, 582 F.3d 996 (2008) was a facial challenge to a mobile home park rent-control ordinance.  Under the ordinance, the owner of a mobile home park was prohibited from raising rental rates to mobile home owners more than a fixed percentage of the CPI, with a rigid additional formula for recovering the cost of improvements to the park.  The City of Goleta was facing skyrocketing increases in housing prices, and the regulation was intended to protect low-income housing.  But because a mobile home owner could sell their unit to someone else with the rent-controlled rent in place, the effect was that the mobile home would sell for more than if the new owner would be subject to rent increases from the mobile home park owner.  As a result of the ordinance, a mobile home that might sell for $12,000 based on its intrinsic value, instead sold for over $100,000, with the difference being the capitalized value of the rent increases that the ordinance protected the new owner from.  The result of the ordinance was a one-time wealth transfer from the mobile home park owner to the owners of the mobile home when the ordinance went into effect. 

 In a split decision the Ninth Circuit initially reversed the trial court and found a facial taking.  It was clearly impressed by two factors in particular – first the extent to which the ordinance took significant value from the park owners and transferred the value to the mobile home owners at the time the ordinance was adopted.  “It has long been accepted that the sovereign may not take the property of A for the sole purpose of transferring it to another private party B, even though A is paid just compensation.” 582 F.3d at 1021 (quoting Kelo v. City of New London, 545 U.S. 469, 477 (2005))  Second, the ordinance put a burden on a very limited number of property owners – the people who own mobile home parks – to address a broad societal problem of the lack of low income housing.  The court found it was a classic case where government was “forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.⁵”  582 F.3d at 1028. 

 There were two unique issues that the court had to address in Goleta, however.  The first was, in a facial challenge, what evidence can a court actually consider?  Both parties had offered economic expert testimony about the impact of the ordinance on the owners.  But was that proper?  In an “as applied” challenge to an ordinance the court can clearly consider all sorts of evidence about how the ordinance impacts the property.  But does a “facial” challenge mean you can only look at the face of the ordinance and that a court cannot receive evidence about its impact.  The Court's resolution was to hold that the court can receive evidence that shows that the “mere enactment” of the ordinance constitutes a taking.

The proper inquiry in a facial challenge is not whether the property owners can demonstrate that property has been taken without providing evidence beyond the text of the regulation; the inquiry is whether the ‘mere enactment' of the regulation constitutes a taking.  Thus, in a takings claim we must look not only at what the statute says, but also at what its mere enactment does.  At a minimum, we must look to the general economic principles that allow us to interpret the statute's effect, so that we may understand the regulation's general scope and dominant features.  In addition, there must be a way to understand the economic impact on the complaining property owner.  A property owner who is not permitted at least to present evidence that proves that he has actually suffered the kind of economic harm of which he complains would be precluded from even proving his own standing to bring the claim- the property owner must be permitted to adduce evidence that he has suffered the injury for which he seeks redress.

582 F.3d at 1017. 

 The second issue was how the court should analyze the “distinct investment-backed expectations” of the plaintiffs, who purchased their property at a time when it was in the county, before Goleta was incorporated, and who bought when the county had a similar ordinance in place.  The court struggled with the fact that on one level, the park owners got what they expected to get.  On the other hand, Palazzolo had held that the fact that Palazzolo did not acquire sole interest in the property until the regulations he challenged were in place did not bar his claim.  The three-judge panel held that Palazzolo meant that the owners who took ownership after a rent control ordinance was in place could bring the suit that their predecessors could have brought.

On rehearing, 638 F.3d 1111, cert. denied, 2011 WL 884881 (U.S. May 16, 2011), an en banc panel vacated the three-judge panel's decision and affirmed the trial court's grant of summary judgment for the City.  The en banc panel, with a 3-judge dissent, found that the property owners, who purchased the property while it was subject to rent control, could have no “distinct investment-backed expectation” that the rent control ordinance would be repealed.

A landlord buys land burdened by lease-holds in order to acquire a stream of rents and the possibility of increased rents or resale value in the future.  The stream already suffered a reduced flow when the Guggenheims bought it, so what they paid would reflect the flow that the law allowed.  The Guggenheims might conceivably have paid a slight speculative premium over the value that the legal stream of rent income would yield, on the theory that rent control might someday end, either because of a change of mind by the municipality or court action.  But that premium could be no more than a speculative possibility, not an “expectation.”  Speculative possibilities of windfalls do not amount to “distinct investment-backed expectations,” unless they are shown to be probable enough materially to affect the price

Id. at 1120-21.  The Court went on to note that the people who really did have investment-backed expectations were the mobile home owners who had paid a premium for their mobile home after the rent control ordinance had been adopted.  Ending rent control would create a windfall for Guggenheim at their expense.

 It is fair to assume that this will be an area of continuing development of the law of regulatory taking.  Although the en banc panel's reasoning is hard to argue with, the three-judge panel also made strong arguments in the opposite direction.  And, the en banc panel left the law where the regulatory taking claim depends on when a property owner bought their property, implying that the ordinance might take property from one owner, requiring compensation, but not from another owner.

 3. Rose Acre Farms, Inc. v. United States – protection of public health and safety doesn't result in a taking.

 The most recent Federal Circuit case coming out of the Court of Claims is Rose Acre Farms, Inc. v. United States, 559 F.3d 1260, cert. denied, 130 S.Ct. 1501 (2010) (Fed. Cir. 2009).  There the Federal Circuit reversed a takings judgment, and held that no taking had occurred. 

 Rose Acre Farms is a major producer of fresh eggs, with 112,000 laying hens in three farms, producing several million eggs annually.  It suffered injury when for a period of about two and a half years some of its flocks were subject to regulations that allowed their eggs to be sold only to the pasteurized market as a result of salmonella being found in the flocks.  Rose Acre claimed its eggs and its hens were “taken.”

 The Federal Circuit's decision is significant for two reasons.  First, its discussion of the measure of the “economic impact of the regulation” will affect property owners who want to claim lost profits as a result of the government's action.  The court rejected lost profits as a measure of impact. 

 Second, having addressed at length the economic impact and reversed the Court of Claims decision that the impact was significant, the Court went on to address what was probably the larger problem with Rose Acres' claim.  That is that while we have seen a huge increase in the scope of government regulation during the Twentieth Century that has spawned the whole concept of regulatory taking, government regulation to protect the health of food being sold goes back to at least the Twelfth Century.  See, 559 F.3d at 1279.  The “character of the governmental action” factor was simply overwhelming under the facts of Rose Acre to any of the other factors.

 D. Practice Thoughts, in Somewhat Random Order.

 Regulatory taking law remains the area of law concerning protection of constitutional rights where the courts are the most tone deaf to actually protecting constitutional rights.  Very few property owners can undertake decades of litigation to vindicate their rights, with multiple trips not just through the administrative process but up and down from trial court to appellate court and back.  Most landowners suffering a regulatory taking will have no protection because they cannot afford the cost of vindicating their rights.  That phenomenon fuels the property rights movements and leads to arguably much more serious outcomes than if government would figure out how to pay people when it takes their property.

 Understand that “precedent” is only modestly helpful in regulatory taking cases.  The single most universal thing the Court said in Penn Central is that whether or not a regulation requires compensation because of a taking “depends largely upon the particular circumstances of that case.”  438 U.S. at 124.  So the differences of the case in front of you from the cases previously decided will be more important than the similarities.  The challenge is to properly figure out how to generalize from the prior ad hoc decision to the one you have to address.

 The problem, of course, is that the intersection between the proper, uncompensated scope of the police power or other government regulation and the Fifth Amendment's requirement of just compensation for the taking of property is not subject to a bright line test.  There are no Miranda warnings that can be spelled out.

 In the end, the three part test of Penn Central is perhaps less instructive than what the Court said before laying out those three factors.  The issue is “fairness and justice.”  What sorts of burdens should be borne by the public as a whole and what sorts of burdens is it appropriate to assume each property owner should bear because they also receive a “reciprocity of advantage” from the regulations?  What did the property owner have a right to expect, not just when they bought the property, but over the period that they have owned it?

 Regulatory taking law needs to recognize the different characteristics of property owners.  There remain in the world long-term property owners, who husband their property over decades or even generations.  Their investment-backed expectations may (or may not) evolve over time, but the expectations tend to be very long-term.  On the other hand, there are developers whose entire business model is premised on holding any piece of real estate for the shortest possible time.  Government attorneys tend to want to paint both property owners with the same brush, the result of which is to favor developers with short-term interests.  Regulatory taking law should not be allowed to develop to the prejudice of land owners who hold their property over long periods.  It would be helpful if an “important” court would say that.  It is tragic to see an 84 year-old man assailed as being a “developer” who was “too stupid” to have developed his property when everyone else did – as happened in the last regulatory taking case I had.  There also – at least in the state of Florida – may be investors who are willing to buy land that they know to be highly regulated, on the speculative hope that the regulation will someday be repealed.  Those owners should not be able to come in later and complain – but exactly how to reconcile their situation with the Palazzolo situation will be a subject of future litigation.

 Most taking cases need to be settled, because the government has lawyers on the payroll and property owners usually don't.  That means that the task for a plaintiff's lawyer is to 1) only take good cases, and 2) focus on the equities early, often and vigorously.  At the same time, government lawyers who view regulatory taking plaintiffs as being in the same category as mass-murders – to be beaten at all costs or at the very least kept in litigation until they die – need to recognize that they fuel the extremes of the property rights movement.  Regulatory taking cases are like other cases; good lawyers should settle them before the whole purpose of bringing the case has become moot.

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 ¹ The Court in Village of Euclid v. Ambler Realty  Co., 272 U.S. 365, 386-87 (1926), which first sustained a local zoning ordinance, put it this way:

Building zone laws are of modern origin.  They began in this country about 25 years ago. Until recent years, urban life was comparatively simple; but, with the great increase and concentration of population, problems have developed, and constantly are developing, which require, and will continue to require, additional restrictions in respect of the use and occupation of private lands in urban communities.  Regulations, the wisdom, necessity, and validity of which, as applied to existing conditions, are so apparent that they are now uniformly sustained, a century ago, or even half a century ago, probably would have been rejected as arbitrary and oppressive.  Such regulations are sustained, under the complex conditions of our day, for reasons analogous to those which justify traffic regulations, which, before the advent of automobiles and rapid transit street railways, would have been condemned as fatally arbitrary and unreasonable.  And in this there is no inconsistency, for, while the meaning of constitutional guaranties never varies, the scope of their application must expand or contract to meet the new and different conditions which are constantly coming within the field of their operation.  In a changing world it is impossible that it should be otherwise.

² In the interim the Court had formulated “rules” for at least two simpler kinds of takings. 

In Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419(1982) the Court held that where an ordinance forced a building owner to submit to the “actual physical invasion” of their property in the form of allowing cable TV companies to attach wires to the exterior of the building without compensation, that was a regulatory taking.  The fact that the injury to the property was de minimis, and indeed may have increased the market value of the building, because without it tenants could not get cable TV, was deemed irrelevant.

In Lucas v. South Carolina Coastal Council, 505 U.S. 1003, 112 S. Ct. 2886, 120 L. Ed.2d 798 (1992) the Court held that where a regulation deprives a property of all economically viable use, it is a taking.  Significantly, Lucas did not hold that the property must have no “value.”  The property at issue was a residential lot on the South Carolina coast.  All other lots in the subdivision, including lots similarly situated, had been built upon, but the Coastal Council adopted a rule that would prohibit construction of a house on the Lucas lot.  Nonetheless, the dissent argued vigorously that the lot had a market – someone would buy it to picnic or camp on it, and the neighbors might well be willing to buy it to expand their own properties.  Both points were probably true, but the fact that the majority held a taking had occurred necessarily rejects the notion that the fact that a parcel of land has some sort of “salvage value” – as most land will have – prevents a regulatory taking.  The Lucas Court found one circumstance under which a regulation depriving property of all economically viable use is not a taking.  That is if “background principles” of common law would have precluded the use of the property anyway.  Thus a nuisance or certain interference with navigation on navigable waters would never have been allowed under the common law, so a regulation spelling out the fact that it cannot be done is not a taking.  
 
³  That speculative market is apparently based on the assumption that eventually the Clean Water Act will be amended to permit the dredging and filling of wetlands, and there are people willing to pay quite a lot of money now for property that they will have to hold until the Clean Water Act is amended or repealed.  But then there were also people who apparently were paying to get their affairs in order prior to the Rapture that was predicted for last month.  It is unfortunate that the Federal Circuit allowed such a speculative market to be treated as a “viable economic use” of the property – particularly because once the government is forced to pay for an easement precluding any dredging of the land, the speculators are likely to vanish, leaving the property owner only partly compensated.

⁴ One of the earlier remands in the Florida Rock saga was based on the fact that until Florida Rock had applied for a permit and been denied, the court did not know what might be allowed.  Following that, Florida Rock applied for a permit, and as expected, the permit was denied. 

⁵ Interestingly the court found the  benefits of the ordinance applied not just to people in need of low-income housing, but also to another group: “those who would like to support affordable housing initiatives  without paying for it themselves, for example, owners and developers of other forms of housing such as apartments that might otherwise be forced to provide subsidized housing, and taxpayers who want to subsidize affordable housing without actually increasing their own tax liability to pay for it.  582 F.3d at 1021.

Businesses are buying up competitors' brands as internet search terms or keywords (think Google “Ad Words” program) to get prominent search engine placement.  We see this all the time where a consumer keys a branded search term into a search engine and gets a list of competitors under “sponsored links.”   Brand owners do not like the practice because they believe that allowing competitors to buy their trademarks (brands) as keywords in order to get “vaunted cyber placement space” and comparative advertising placement on the same Internet web page as that of the brand owner's products/services is trademark infringement.   The competitors claim that the Internet is no different than staking out “shelf space” in a retail store where competitors' products are often placed side-by-side on shelf or on the same store aisle and consumers have no trouble distinguishing between the two competitors and their brands.

And search engines like Google are laughing all the way to the bank because this tension has created real “value per click” and an expensive bidding war for everyone's brands.

So, is it trademark infringement or is it fair play?

There are not enough court cases that give a complete picture, plus what little cases we have caused more confusion than clarity.  That said, there has been some recent court activity in the Ninth Circuit (the court of appeals for federal courts that covers Washington, Oregon, California, Arizona, Nevada, Idaho, Montana, Alaska, and Hawaii) and federal district courts within the Ninth Circuit that can help us arrive at a snapshot of the potential risks and a way to minimize risk if competitors plan to continue the practice.

On one hand, there is the extreme:  trademark infringement was found in the Binder v. Disability Group case .  There, the defendants were liable for the plaintiff's lost profits ($146,117.60) and such lost profits were doubled ($292,235.20) because the federal trial court found willful behavior.  In that case, the court found it significant that the defendants knew or should have known that they chose the keywords that they did because such words were the number one hit for that purchaser's business.  Further, the court awarded the plaintiff its attorneys' fees and costs for bringing the suit.  While the plaintiff's attorneys' fees were not yet determined, it is likely that the amount will be above “six figures.”  Also of note, one of the individual defendants (an officer of the defendant business) was personally assessed liability because he directed the selection and purchase of the brand owner's brand as a keyword.  Ouch.

If that scares you, the next development should provide you an opportunity to exhale.  The Ninth Circuit Court of Appeals more recently in Network Automation v. Advanced Systems Concepts, ,   pronounced that the test for infringement (likelihood of confusion) for Internet keywords should be flexible and put more emphasis on confusion factors pertaining to whether there was sufficient labeling and the level of sophistication of the online consumer business and less on the so called “Internet Troika or Trinity” that placed key emphasis on the similarity of the two trademarks, the proximity of the goods/services, and the simultaneous use of the Internet as a marketing channel.  Since any person or business buying a direct competitor's trademark and using it simultaneously on the Internet would run afoul of a rigid application of the “Internet Troika,” the Ninth Circuit moved away from a mechanical or rigid application of the likelihood of confusion factors and emphasized flexibility along with a new factor (evidence of labeling/other appearance factors).  If the consumer is a sophisticated one, the degree of care is likely to be higher which cuts away from a likelihood of confusion. 

In the Network Automation case, the Ninth Circuit reversed the lower trial court's grant of a preliminary injunction against the competitor and instructed the trial court to review other likelihood of confusion factors, including an evaluation of the labeling used and the overall appearance of the competitor's use of the brand owner's keyword, as well as the sophistication level of the consumer.  Because the case will then be decided by the trial court, we do not yet know what the outcome will be. 

But again we are given clues as to the kind labeling that seems to be ok.   The Network Automation case suggests that clear labeling of the competitor's purchased advertising space such as defined by terms like “paid advertisements” and “paid ad” or even “sponsored link ” seems to do the trick.  Further, the more heightened the distinction between the paid ad space from the “organic” ad space, such as through different color or shading or other graphic distinctions, the less likely confusion would exist.  Flexibility of the confusion factor test is mandated by the Ninth Circuit and much of the analysis will be on a case-by-case basis.  But the Network Automation case suggests a blueprint for legally moving forward with the practice of acquiring competitor's brands as keywords. 

Of course, even if someone can legally do something, it does not necessarily mean that they should do so.  Our laws and boundaries of “what's ok and what's not” are strongly derived by codes of conduct and customs that develop over time.  Businesses that tout their respect for others' trademarks and demand such respect for their own brands in return risk a PR scandal if they are known to actively buy up their competitor's brands as keywords.  In the age of the Internet, bad press can spread fast (hence the term “viral”). 

Further, just because one may have a good legal defense, there is the possibility that one would have to spend valuable time and money defending itself in a lawsuit for trademark infringement/false designation of origin/false advertising, and possibly state claims of unfair competition/consumer protection act violations.  In the U.S., the usual rule is both parties pay unless there is particular statute that applies, there is a contractual obligation to shift fees, or the claims of the lawsuit are baseless or design to harass.

So, where does that leave us? 

I believe that the safe bet at the present time is not to buy your competitor's brands through search engine keyword programs.  Yes, you lose valuable online real estate.  But the current risk can be costly (ask Mr. Miller, a defendant in the above cited Binder case).  Further, if you buy a competitor's keywords specifically because such brand is highly ranked and well-regarded and will move you up in the search engine rankings, you have set yourself up for a willfulness claim in the event you lose.  Such willfulness can be costly:  a court can double or even triple your liabilities and shift the burden of defending the action to you.   At a minimum, there are significant legal fees, hard costs, and resource time required to mount a defense of such a legal action.  Further, the PR backlash can quickly unravel perceived benefit acquired through the acquisition of competitors' brands in search engine keyword programs.

For those more risk-tolerant and are going to go forward and adopt their competitors' brands as keywords (hey, everyone is doing it (!) and advertising on the Internet is the only way to succeed in today's climate), then at least make sure that your can prove that your consumers are sophisticated enough to be able to distinguish the two businesses online when they show up on the same search engine page and label, label, label!

And if you are the brand owner, you might want to consider buying your own brand as part of keyword advertising so that when a consumer keys your brand into the search term, it comes up with your website under “sponsored links” and presumably in the organic search, as well. 

1. Binder v. Disability Group, Inc., --F.Supp.2d--, 2011 WL 284469 (C.D. Cal. Jan. 25, 2011)
2. Network Automation, Inc. v. Advanced Systems Concepts, Inc., --F.3d --, 2011 WL 815806 (9th Cir. March 8, 2011)
3. This case was decided only two months after the California district court Binder decision.  Because of the emphasis on a legal standard that has been cast into doubt by the Ninth Circuit, the Binder case judgment may be in jeopardy if appealed.  However, it is noted that the Binder case introduced evidence of actual consumer confusion.
4. There is some disagreement in legal circles whether “sponsored ad” is truly sufficient (e.g., does the word “sponsor” actually represent “sponsorship” in the trademark sense?).  But I leave that to another article.

________________________________________
If you should have any questions or wish to discuss issues specific to Intellectual Property please contact any of the following members of the Graham and Dunn Intellectual Property Team:
 
Kathleen T. Petrich 206.340.9672 or kpetrich@grahamdunn.com
Robert C. Cumbow 206.340.9619 or rcumbow@grahamdunn.com
Michael G. Atkins 206.340.9614 or matkins@grahamdunn.com
________________________________________
Cyber-Graham® is published by Graham & Dunn as a service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorneys listed above or the attorney whom you normally consult.
Graham & Dunn PC • 2801 Alaskan Way • Suite 300 • Seattle • Washington • 98121

Overview

New rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act continue to be proposed on a rolling basis, including two recent rule proposals on compensation.  The following is a summary of these proposals and a look ahead at the timeline for future compensation and governance rulemaking.   

Compensation Committee and Advisor Independence

On March 30, 2011, the Securities and Exchange Commission proposed rules under Section 952 of Dodd-Frank to require the national securities exchanges to adopt listing standards governing the independence of compensation committees and their advisors.  The proposed rule essentially covers the same ground as Section 952, which leaves it to the stock exchanges to adopt substantive requirements for the independence of compensation committee members.  As noted in our prior alert, available here, Section 952 of the Act requires the stock exchanges to consider certain factors when adopting independence requirements, including the source of all forms of compensation paid to committee members and their various affiliations with the company.  However, specifics are left for the exchanges to determine. 

The Act and the rules also will require compensation committees to consider independence factors before retaining advisors, including legal counsel, also covered in our prior alert.   The rules do not prohibit retaining advisors who are not independent; they only require considering independence factors.

In addition, the proposed rule would revise the proxy disclosure rules on compensation consultant involvement in compensation-setting and conflicts of interest, expanding the scope of disclosure to cover any consultant who provided advice, whether or not resulting from a formal engagement, and eliminating the current carve-out for advice on broad-based plans or providing non-customized benchmarking data.

Interagency Proposed Rule on Incentive Compensation at Financial Institutions

Also on March 30, 2011, seven federal agencies  announced a joint proposed rule under Section 956 of Dodd-Frank, covering incentive compensation practices at financial institutions with assets of $1 billion or more.  The proposed rule is subject to public comment, with the final rule becoming effective six months after it is published.  The proposed rule would prohibit incentive arrangements for directors, executives and employees that encourage inappropriate risks by providing excessive compensation or that could lead to a material financial loss.  Institutions with assets of $50 billion or more are subject to heightened requirements, including mandatory three-year deferral and loss adjustment of at least 50% of executive officer incentive compensation.   The framework for institutions with less than $50 billion in assets is principles-based, requiring boards and compensation committees to apply standards and factors contained in existing rules and guidance, and recognizing that appropriate policies and procedures will vary by the size of the institution and the complexity and scope of its incentive arrangements.  

The factors for assessing whether pay is excessive are those contained in the Federal Deposit Insurance Act, and include (among others) the total level of compensation, the financial condition of the institution and peer practices.  The factors and guidance for guarding against material financial loss are those contained in the June 2010 interagency guidance issued by the key federal banking regulators, which focuses on ensuring that risk and reward are properly balanced, risk management personnel are involved in structuring incentive arrangements, and incentive structures and arrangements are supported by strong internal controls and corporate governance. 

A key substantive requirement for all covered institutions is a new annual report.  The specific form of the annual report will be prescribed by each agency, but would describe the structure of incentive arrangements and the policies and procedures governing those arrangements, and explain why those arrangements do not create incentives that could lead to a material financial loss or result in excessive compensation.

Institutions that participated in the Treasury's Capital Purchase Program (CPP) under the Troubled Asset Relief Program will be familiar with many key elements of the policies and procedures required.  In particular, the procedures and disclosure required for the new annual report appear similar to the board-level incentive compensation risk assessments and certifications required under the CPP rules.  This should give institutions who participated in the CPP a head start on compliance with the new rules.

The Road Ahead

The SEC has revised its anticipated rulemaking schedule to implement Dodd-Frank compensation and governance provisions.  It currently forecasts rulemaking in the August-November 2011 timeframe regarding, among other things, disclosure of pay-for-performance, CEO/Median Employee pay ratios, hedging company stock by employees and directors and recovery (clawback) of executive compensation.  In addition, while it is difficult to predict which proposals will gain any traction, there are proposals in Congress to repeal aspects of Dodd-Frank, such as the requirement for CEO/Median Employee pay ratio disclosure, which would impose a significant administrative burden on many public companies who would have to calculate and track “total compensation” for all employees as defined by the SEC's proxy rules, which is not the same as W-2 compensation for IRS purposes.

What Should Companies Do Now?

• Financial institutions with assets over $1 billion should begin to understand and map compliance against the interagency proposed rule on incentive compensation.  This will be particularly important for institutions that did not participate in the CPP, as the processes and reporting to be required under the new rule will be less familiar to them than to CPP participants.
• Compensation committees of exchange-listed companies may want to begin assessing whether the proposed independence rules for the committee and its advisors raise any concerns, although the specific standards for committee independence will not be known until the stock exchanges issue proposed rules within 90 days after the SEC rule goes final.
• Non-exchange listed companies may want to consider which aspects of the proposed rules apply.

Conclusion
 
We are somewhere midstream on the process of Dodd-Frank rulemaking on compensation and corporate governance.  Several key rules have been proposed and, in some cases, adopted, but several others are still to come.  We are assisting the management and boards of a variety of companies with these requirements, will continue to closely follow emerging trends, and will publish further updates as developments warrant.  In the meantime, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) should you have any questions or wish to discuss these issues further.

The good news on the federal estate tax front is that a person who dies in 2011 or 2012 can have a $5,000,000 estate and pay no federal estate tax.

Washington residents, however, may need to review their estate plans because the Washington state estate tax is no longer tied to the federal estate tax system. This unlinking of the tax systems means that estates of Washington residents may face unanticipated tax liabilities.  Read More >>

Rachel Carson published Silent Spring in 1962, motivated by the death of birds from the spraying of DDT to control mosquitoes, and in doing so became a founder of the environmental movement.  The National Environmental Policy Act (NEPA) of 1969, the Coastal Zone Management Act of 1972, the Marine Mammals Protection Act of 1972, the Endangered Species Act (ESA) of 1973, the 1974 amendments to the Clean Water Act, and numerous other major federal environmental laws followed.  For most of the last nearly 40 years the agriculture and forest industries have assumed that the Federal Insecticide, Fungicide & Rodenticide Act (FIFRA), 7 U.S.C. §§ 136 – 136y, enacted in 1972, was the environmental movement's response to the concern about pesticides and that compliance with FIFRA meant that they were complying with the law regarding use of pesticides.  Click here to see full article>>

Overview

On January 25, 2011, the Securities and Exchange Commission adopted final rules for “Say on Pay” and “Say on Frequency” votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act, providing shareholders with an up-or-down non-binding vote on executive compensation and a separate non-binding vote whether to hold “Say on Pay” every one, two or three years. Our prior memo describing the SEC's initial proposed rules is available here. A major change in the final rules from the proposed rules is that “smaller reporting companies” (those with a public float of less than $75 million) have been given a two-year reprieve.

Effective Date

The new rules will be effective in late March or early April (depending on when they are published in the Federal Register). However, under the Dodd-Frank legislation, all proxy statements relating to annual meetings of shareholders to be held after January 20, 2011 must include a non-binding Say on Pay proposal and a non-binding Say on Frequency proposal for shareholders to vote on whether the Say on Pay proposal should be included every one, two or three years. To the extent there are differences between the final rules and the legislation, companies should be able to rely on the new rules; for example, smaller reporting companies can rely on the two-year reprieve effective immediately (unless they are required to hold Say on Pay under the Troubled Asset Relief Program, a requirement unaffected by Dodd-Frank or the new rules).

Key Differences from Proposed Rules

Key differences in the final rules compared to the proposed rules include:

• Smaller Reporting Company Reprieve. Smaller reporting companies were not exempted from Say on Pay/Say on Frequency, but implementation has been deferred until annual meetings occurring after January 20, 2013. In addition, SEC Chair Mary Schapiro stated that the two-year deferral period will enable the SEC to consider whether the rules will disproportionately burden small issuers and adjust the rules, if appropriate, before they apply to smaller reporting companies.
• Reporting Frequency Determination. The location and timing of reporting a company's determination of how frequently to hold a Say on Pay vote has shifted, and is now required to be reported on a Form 8-K by the earlier of (i) 150 days or (ii) 60 days before the deadline for shareholder proposals for the next annual meeting as published in the most recent proxy statement. Under the proposed rules, the frequency determination would have been required in the 10-Q or 10-K for the quarter during which the annual meeting was held.
• Effect of Frequency Determination on Future Shareholder Proposals. Future shareholder proposals relating to Say on Pay or frequency may be excluded as being substantially implemented only if the company has adopted a frequency chosen by a majority of votes cast in the most recent Say on Frequency vote. This is a higher standard than the proposed rules, which required acting only in accordance with the plurality vote.

Application to TARP Companies

Companies with outstanding preferred stock under TARP are required to hold an annual Say on Pay vote under the TARP rules. The TARP requirements effectively supersede the SEC and Dodd-Frank requirements. As a result, until their TARP obligations have been repaid, TARP companies cannot choose to hold the Say on Pay vote less frequently than annually, and need not provide a Say on Frequency vote.

What Should Companies Do Now?

• Smaller reporting companies not subject to TARP rules can now move forward with their proxy and annual meeting planning knowing Say on Pay and Say on Frequency will not be required until 2013.
• All public companies other than smaller reporting companies should prepare to include a Say on Pay and Say on Frequency vote in their 2011 proxy statements (assuming the 2011 annual meeting occurs after January 20, 2011).
• Boards of companies subject to the rules for 2011 should consider whether to make a recommendation on Say on Frequency, and if so, what to recommend. In this regard, early data is now available regarding the number of companies recommending one, two, or three years, or providing no recommendation, and the common rationales for each approach. Since the first Say on Pay and Say on Frequency votes have already occurred, early data also is available on voting outcomes. As noted in our prior memo, companies may want to consider whether an annual vote offers some benefits, including more timely feedback from shareholders on compensation policies and practices, higher ratings from proxy advisory firms such as Institutional Shareholder Services (ISS), and the possibility that including a Say on Pay opportunity provides shareholders a non-binding way to register a protest vote, rather than voting against board or compensation committee members and/or compensation plans that may be submitted for shareholder approval.

Conclusion

The SEC has granted a welcome reprieve to smaller reporting companies, but all other public companies must include Say on Pay and Say on Frequency proposals in their 2011 annual meeting proxy statements. We are assisting a variety of companies with these requirements, will continue to closely follow emerging trends and voting outcomes, and will publish further updates on Say on Pay and other Dodd-Frank corporate governance and executive compensation provisions as developments warrant. In the meantime, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) should you have any questions or wish to discuss these issues further.

Passages

Last Friday I attended a memorial service for Pat Redmond, who was President and CEO of Viking Bank. The memorial service was an amazing celebration of Pat's life – he was one of the “good guys” and the ceremony reflected that. The speakers were eloquent and poignant and made me think about what is important in life.

Reflections

As we as a country and an industry work our way back towards some semblance of normalcy and stability, Pat's passing seemed to put everything in perspective. Despite the challenges most of us have faced professionally, the most important things are still life, health, family and friends. Often our priorities get confused, especially as we go through particularly stressful periods.

Lessons Learned

In meeting the challenges we are presented, we cannot lose sight of what's really important. We need to look to our family and friends for support and strength. Often, we tend to internalize problems and isolate ourselves from the ones that matter most. The lesson learned from Pat is to rely on family and friends and not close down. They will be there after the storm.

An Industry In Transition

Last week I also attended another client's Board meeting. The CEO made a great comment: “It is the unwritten agenda of the federal banking agencies to shrink the banking system.” Upon reflection, I realized how powerful a statement that is as it explains otherwise inconsistent and seemingly unreasonable actions. Raise capital, merge, sell or fail seems to be the regulatory mantra with the not so subtle goal of reducing the number of banks as soon as possible.

Surviving In Today's Environment

It seems crystal clear that in order to survive today a bank must have lots of capital. Without it, you may fall prey to aggressive regulatory enforcement actions, loan and asset classifications and write downs and an overall unfriendly environment. Those banks that have been able to raise or at least maintain strong capital seem to be in the best position to minimize regulatory ire and to survive.

Size Does Matter

Unfortunately, we have seen a discrepancy in the way regulators treat banks depending on their size. Generally speaking, those banks with over $1 billion in assets seem to get more time and tolerance to address issues than the smaller community banks. Perhaps it's merely the potential impact on the system of the failure of a larger bank, but size does seem to matter. More time, more tolerance, and quicker upgrades after recapitalization all are common characteristics for the larger banks.

Crystal Ball Gazing

2011 will be a year of continued consolidation, some capital formation and more whole bank deals. Clearly, before the end of the decade, there will be fewer than 5,000 banks.

People

When the smoke clears, life is just a journey and it's about the people we meet and the experiences and memories we accumulate along the way that matter most. The premature passing of Pat Redmond should serve as a stark reminder of that.

Traveling Man 

As I return from an amazing trip to South Africa, including the experience of a safari, I can't help but make the comparison between the world of community banking and the jungle.  Obviously, the Kings of the Jungle are the regulators who roared very loudly in 2010 with their bank closures and administrative actions.  Many bankers must feel like they are lost in the jungle and are prey for regulators and others.  It truly is survival of the fittest.

2010 in Perspective

Last year continued to be a very difficult and challenging year for community banks.  Even those that managed to survive and avoid Consent Orders, found their earnings challenged, with good loan demand soft and some level of asset quality issues.  Whole bank M&A was almost at a standstill, as FDIC-assisted deals still seemed to be the focus of most acquirors.  The one bright spot was capital raises, ranging from private equity to community offerings to public offerings.  The industry continued to consolidate with failures, some mergers and virtually no new bank formations.

What Lies Ahead

There appears to be a beacon of light at the end of this 3-year tunnel.  Those community banks that survive will see a new order of banking.  Back to basics banking, with sound lending practices funded by core deposits will be highly valued.  At the same time, bankers will have to think a bit out of the box without taking undue risk.  The pace of whole bank mergers should accelerate sometime in 2011, including some so-called “strategic alliances,” aka, little or no premium deals.  Creative deal making, with holdbacks based on sellers' asset performance over some period of time gaining wider acceptance.  

The Uncertain World We Live In

I am hopeful that as the economy recovers and real estate values stabilize, the overall relationship between banks and their regulators will gradually improve and return to some level of normalcy.  The fear of failures and Inspector General Reports should dissipate, allowing more flexibility and tolerance as banks work their way through the aftermath of the down economic cycle.

When Will We Smile Again?

I am optimistic that the enormous pressure that banks have felt will be relieved a bit and that some enjoyment will return to banking.  We all aspire to job satisfaction and to enjoying our work with a smile on our face and the sense of a job well done knowing that the Lion is not nipping at our feet.

On December 16, 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“TRUIRJCA”), which was signed into law by President Obama on December 17, 2010. The new - but temporary - tax law makes several important changes to the estate, gift and generation-skipping transfer (“GST”) tax regime.

The highlights of the new law are as follows:

• Reunification of Estate and Gift Taxes. The new law creates a single, graduated rate schedule for both the estate and gift tax, providing a single exemption to be used for lifetime taxable gifts and/or bequests made after December 31, 2010.
• Higher Exemption and Lower Rates. The new federal exemption is now set at $5 million per person and, with proper planning, $10 million per couple (indexed for inflation in 2012) with a top rate of 35% for estate, gift and GST taxes. The new law is effective as of January 1, 2010, but allows estates arising after January 1, 2010 and before January 1, 2011 to elect to use the old law (no estate tax and modified carryover basis) or the new provisions. The GST tax exemption is set at $5 million with a 0% rate for 2010 and a 35% rate beginning in 2011.
• Portability. Under the new law, the executor of a deceased spouse's estate (dying after December 31, 2010) may transfer any unused estate tax exemption to the surviving spouse to shelter assets from estate taxes on the surviving spouse's death.

You should review your current Will to consider updates to reflect these changes. Reviewing your current Will is particularly important if you have not revised your Will since 2005, when the State of Washington enacted a state estate tax that is decoupled from the federal estate tax

We hope you find this information helpful. Please feel free to call us with any questions you may have.

Recent Observations

During the past week, I attended a meeting with the OCC and the Oregon Bankers Association Winter Conference. One of the open themes of both meetings was “what is the future of community banking?” When the smoke clears, it seems clear that one of the most lasting legacies of the past 3-year financial debacle will be the consolidation of the banking industry, most heavily impacting community banks.
 
The Whys and Wherefores

First of all many banks, management and shareholders are simply tired of the battle. Between the obvious regulatory challenges and the continued economic struggle, folks just are looking for an exit strategy. Just as importantly, the business model for most community banks, particularly in the West, will need to change dramatically. No more heavy real estate based lending funded by brokered deposits. A more diversified mix of C&I and SBA loans will be a must for survival. Also size, especially with additional compliance burdens on the horizon, will become a significant factor. The guess is $150-200 million is the new minimum critical mass necessary to absorb growing operating costs. Further, for most community banks, holding companies will become a useless tool, with no more trust preferred or double leveraging – what's the point of another regulator and corporate entity without any tangible benefits?

Technology, Technology, Technology

Clearly, while there will be some need for brick and mortar, banks will need to continue to invest heavily in technology as the demographics of their customer base continue to change and demands dictate. I think the physical presence of community banks will change, with fewer and smaller branches and more forms of online and remote banking – who knows what the next new age Blackberry or iPhone will look like and allow customers to do remotely? However, community banks must never forget that personal service is their big advantage over the larger banks and must preserve that even in a changing delivery system.  

Value, Value, Value

The wild card in community banking is what will be community banks' long-term value. Let's face it, a successful community bank will do 1% ROAA and 10% ROE, especially if capital requirements are stiff. Realistically, even assuming demand to purchase community banks recovers, how much can buyers pay for lower returns using less valuable currency?

The Survivors

I still believe that community banks are part of the fabric of this country. However, it is clear that the government would prefer a consolidated industry, and the battle to make money and attract talented bankers will be a challenge. To that end, I doubt there will be even 5,000 banks by the end of this decade. By the mere fact of consolidation, those who choose to survive should gain the benefits of a smaller, less competitive marketplace. Capital will be a key component for those survivors who successfully navigate the changing marketplace and gain critical market

Overview

Boards and Compensation Committees of publicly-traded companies always have much to consider as they approach year-end and the upcoming proxy season. This year, there are some notable new issues arising from the Dodd-Frank Act, but there are also a variety of issues under long-existing rules that can fall through the cracks. The following are some of the matters Boards and Compensation Committees should attend to as part of the year-end cycle.

• Say on Pay and Say on Frequency. Details of the new requirements under Dodd-Frank are covered in our prior Cyber-Graham. Compensation Committees would be well advised to require management to begin drafting the Say on Pay and Say on Frequency proposals sooner rather than later, and begin to consider what recommendation, if any, to make with respect to Say on Frequency, recognizing that influential stakeholders such as Institutional Shareholder Services (ISS), the Council of Institutional Investors and several large funds have come out in favor of an annual vote.
• ISS GRId Score and Proxy Voting Guidelines. As part of its year-end process, every public company should review their current ISS Governance Risk Indicators, or GRId, scores and also review the prior year's report and recommendations on the Company's proxy proposals. There may be actions the Board is willing to take that could improve the GRId ratings and reduce the chances of a negative recommendation on Say on Pay, the directors up for re-election and/or any compensation plans presented for shareholder approval. There is often low-hanging fruit to be picked when ISS reports are carefully reviewed.
• CD&A. As always, Compensation Committees should require early work on the upcoming Compensation Discussion & Analysis, and should consider the disclosure implications of year-end compensation decisions. This is not to suggest that decisions should be made to conform to desired disclosure, but early CD&A drafting can help management and the Committee accurately frame the rationale for decisions on matters such as discretionary bonuses, the selection of incentive plan performance criteria, and the selection of equity award vehicles. In addition, early drafting can allow time to evaluate whether it is appropriate not to disclose incentive-plan performance targets in CD&A, in light of SEC rules and guidance that they must be disclosed unless doing so would result in substantial competitive harm.
• Independence of Compensation Committee Members. Dodd-Frank requires new standards for Compensation Committee independence. The rules will not be effective in time for calendar-year company proxy season, but Boards may want to consider whether any Compensation Committee members have relationships with the company that would render them non-independent under applicable Audit Committee standards, since many have speculated that Compensation Committee standards may be similar.
• Independence of Compensation Committee Advisors. Another Dodd-Frank requirement that will not be effective in time for the upcoming proxy season is for Compensation Committees to consider independence factors to be set forth in SEC rules when retaining advisors. Although the SEC has not yet proposed rules, certain factors were specified in the legislation. Compensation Committees may wish to begin considering those factors and, where appropriate, discuss the independence of their advisors in the upcoming proxy statement.
• Section 16 “Non-Employee Director” Status. Under Section 16 of the Securities Exchange Act of 1934, equity awards are exempt from 6-month, short-swing matching if approved by a committee of “non-employee directors” or the full Board. Any director with a disclosable “related person transaction” does not qualify as a “non-employee director”, so companies whose equity awards are approved only by the Compensation Committee should ensure that none of its members has a “related person transaction” disclosed or required to be disclosed in the proxy statement. Annual director and officer questionnaires should cover “non-employee director” status in addition to “outside director” status under Internal Revenue Code Section 162(m) and general independence under applicable stock exchange rules.
• Five-Year Shareholder Approval of Performance Criteria. Under Section 162(m) of the Internal Revenue Code, performance-based compensation is excluded from the $1 million cap on deductible compensation for covered executives so long as the performance criteria used in the incentive plan are approved by shareholders at least every five years. Companies that could exceed the $1 million cap for any covered executive should assess whether shareholder approval of performance criteria is necessary or prudent at the upcoming annual meeting.
• Incentive Compensation Risk.
• Proxy Disclosure. SEC rules adopted before last proxy season require disclosure if risks arising from compensation practices and policies are reasonably likely to result in a material adverse effect. There should be a formal process leading to the conclusion, involving whichever Board-level body has oversight for compensation risk (typically the Compensation Committee). In addition, while the literal language of the rule requires no disclosure if the conclusion is negative, a common SEC comment in 2010 was to describe the process leading to the conclusion, and ISS favors “negative disclosure” and some discussion of the process.
• TARP Requirements. Financial institutions with outstanding obligations under the Troubled Asset Relief Program (TARP) must conduct prescribed compensation risk assessments at least every six months, and Compensation Committees must include their conclusions in their proxy reports (or in a separate report to Treasury and their primary banking regulator if not an SEC-reporting company).
• Bank Regulatory Guidance. Under joint guidance from the federal banking regulators (Fed, FDIC, OCC and OTS), financial institution Boards must ensure that incentive compensation policies do not compromise the safety and soundness of the institution by encouraging excessive risk-taking. Under this guidance, Boards must ensure risks and rewards in incentive programs are appropriately balanced, with mechanisms designed to mitigate risk. The regulators will take incentive compensation risk into account when assessing the overall safety and soundness of the institution.

Conclusion

The foregoing is not intended to be complete and represents some current issues public company Boards and Compensation Committees must attend to as year-end approaches. We hope that the above is helpful in your corporate governance compliance efforts. Please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) should you have any questions or wish to discuss these issues further.

• Climate Change and Reducing Greenhouse Gas Comes Home to Washington
• Addressing Greenhouse Gas Emissions Under the Washington State Environmental Policy Act
• It Will Take Focus and Money Just to Stay in the Game
• Farm Power: Skagit County Brothers Innovate in Sustainable Agriculture and Renewable Energy by Turning Manure into Power

Climate Change and Reducing Greenhouse Gas Comes Home to Washington

When we published our last newsletter, the 2009 Washington Legislature had just decided not to pass a state cap-and-trade program as part of the Western Climate Initiative. The draft legislation brought forth by the Department of Ecology was too ill-defined and left too much important discretion to future agency rule-making. There was also a new administration in the other Washington, which seemed far more interested than the Bush Administration in making climate change a national priority. There had always been good reasons why Washington would be disadvantaged by moving ahead of the rest of the nation with a cap-and-trade program.

Today, a year and a half later, it is pretty clear that there won't be a federal cap-and-trade program any time soon. It is unclear that Congress can adopt much of any significant legislation over the next two years. Beyond that is anyone's guess, but thought leaders on the left and the right seem to both be moving away from cap-and-trade as the mechanism to address climate change and are instead focusing on how government investment in research and development could help make breakthrough technologies cost competitive.

But while no solutions to climate change and greenhouse gases are likely to come from the other Washington, things are moving here. Increasingly businesses in Washington are both facing the need to address and report their greenhouse gas consequences, and are finding opportunities to make a difference. Here is a sampling of what is going on.

Addressing Greenhouse Gas Emissions Under the Washington State Environmental Policy Act

By Cynthia Kennedy

Climate change regulation is looming on the horizon for Washington businesses. And, while federal Clean Air Act limitations on greenhouse gas (“GHG”) limitations and cap and trade proposals initially are focusing on specific industries and large sources, here in Washington even the smallest businesses may soon be required to calculate and mitigate GHG emissions for all kinds of projects requiring review under the State Environmental Policy Act (“SEPA”) (Ch. 43.21C RCW; Ch. 197-11 WAC). read more »

It Will Take Focus and Money Just to Stay in the Game

By Elaine Spencer

The hallmark of a consultant's report is that when you read it, your first reaction is “I knew that.” The hallmark of a consultant's report that was worth the money is that your second reaction is, “It's about time someone said it out loud that clearly.”

So it was with the release last month of the Washington State Clean Energy Leadership Plan Report (Leadership Plan Report), authored by Navigant Consulting, Inc. Washington's 2009 Legislature created the Clean Energy Leadership Council, charged with developing a plan of actions to accelerate business growth and associated increased jobs in Washington as the world transitions to a clean energy economy. The Legislature also funded hiring a consultant to develop a plan to meet that objective. The Leadership Plan Report is the product of that legislation. read more »

Farm Power: Skagit County Brothers Innovate in Sustainable Agriculture and Renewable Energy by Turning Manure into Power

By Claire Molesworth

Skagit County brothers Kevin and Daryl Maas are leading the charge to turn manure into power with their innovative start-up company, Farm Power. Farm Power operates what's called an “anaerobic manure digester” that harvests methane gas from cow manure to create electricity. Farm Power currently operates a dairy digester near Rexville in Skagit County, Washington, and has plans for other facilities under way in Whatcom and King Counties. read more »

Airborne

Well, it seems to happen every time. Finally the boredom of a 14 hour flight to Sydney got to me. The title has a double meaning. First, it is a tribute to the recently passed Dave Niehaus, the long time voice of the Seattle Mariners. But it also reflects the feelings of many bankers I have spoken with in recent meetings, as the frustration of running a bank in today's environment bubbles to the surface.

When Will It End?

This is the $64 question, as bankers wonder when the economy will really turn, real estate values bottom out, solid loan demand returns and the regulators take their foot off of the accelerator. The frustration expressed to me by many long-term, successful bankers is widespread and troubling. In particular, the inconsistency of examiners and mostly negative regulatory attitude is disturbing. Bankers feel helpless, reluctant to ever defend their positions for fear of further regulatory retaliation. The fear of making a mistake, fueled by Inspector General reports of failed banks, seems to have paralyzed regulators from exercising discretion and showing tolerance. From my vantage point, while there are exceptions, they appear to be relatively rare.

Capital, Capital, Capital

Folks, I hate to be repetitive, but we told you so. Capital is the primary elixir with the regulators. Without it, you are likely to be earmarked for regulatory action. We have witnessed a clear point of no return, where once a bank evolves to a certain position – probably below 5% Tier 1 capital – it becomes almost impossible to successfully recapitalize. The recent bankruptcy filing by AmericanWest out of Spokane, Washington is an attempt to avoid a bank failure and potential FDIC repercussions, but will leave nothing for shareholders.  

The Banking World Going Forward

If there are any lessons to be learned, besides the obvious, identifying and attacking your problem assets sooner, rather than later, and recapitalizing or merging before it gets too late seem to be at the top of the list. Shareholder dilution is the lesser evil compared to the alternative. It is abundantly clear that further consolidation in the banking industry is inevitable. It is simply too costly to operate a smaller community bank in today's environment; and with the new consumer financial protection agency and the FDIC insurance fund bust, costs inevitably will spiral upward. Add to that the clear sense that most regulators would rather see fewer banks, the frustration of bankers, boards and shareholders, and the absence of new bank formations, and the deck seems stacked.

Hang In There

To all community banks that have survived the past three years, we say hang in there. Better times must be ahead. While painfully slow, historically the pendulum always swings. We all hope never to relive this experience, but hopefully we'll learn from it. Those who have the will (and capital) to survive should prosper from this consolidation.

What's Going On?

Since the beginning of the economic downturn, bank M&A activity nationally and particularly in the Northwest has continued to decline, except for FDIC-assisted transactions.  In fact, the last whole bank deal completed in the Northwest was Washington Federal's acquisition of First Mutual Bank in February 2008.  This is the biggest drought in memory.  While bank M&A is down nationally, there are some pockets of more activity.  The linchpin seems to be the availability of FDIC-assisted deals - obviously tied to the relative economic strength of the region.

The Uncertain Future

It appears that until most of the remaining assisted deals wend their way through the system, whole bank deals will still be the exception in the Northwest.  We might see some light at the end of the tunnel in the latter half of 2011, assuming the economy starts to recover and real estate values have bottomed out.

Opportunities for Buyers

For those banks that are relatively healthy, have capital and an appetite for expanding, selective whole bank transactions and attractive prices may be appealing.  While assisted deals are still the "cat's meow," they do present workout and accounting challenges for successful bidders.  The key to doing a whole bank deal will be for the buyer to get comfortable with the seller's loan portfolio and any OREO.

Opportunities for Sellers

While the last few years have been extremely challenging, particularly if you have been thinking of selling your bank, if you are a relatively healthy bank, things may soon change.  No doubt premiums will be lower than historically, but buyers may be ready to selectively acquire smaller banks.  Sellers have to determine how long they are willing to remain independent and what they think the M&A market will look like in the future.  The challenges for smaller community banks to make money and successfully deal with regulators are a big factor in this analysis.

Mergers of Equals/Strategic Alliances

Given the dearth of whole bank deals, many smaller banks have contemplated so-called MOEs or strategic alliances by partnering up with another similar sized bank to increase size, improve efficiency and attain critical mass to be competitive, become an acquirer or eventually be a more attractive acquisition candidate.  These deals also aid in management transitions and retirement strategies.

The Bottom Line 

Whole bank M&A activity in the Northwest has bottomed out during the economic downturn.  Eventually, M&A activity will increase as the failed banks diminish and the economy slowly rebounds.  This will be accelerated if players can craft creative and flexible deal structures.  Well-positioned acquirers with strong capital may be poised to take advantage of strategic opportunities at attractive prices, providing exit strategies for sellers.

Overview

On October 18, 2010, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission proposed rules to require all public companies to hold a periodic “Say on Pay” vote, providing shareholders with an up-or-down non-binding vote on the compensation of executives as disclosed in the proxy statement. In addition, also as required by Dodd-Frank, the SEC proposed rules regarding how frequently a Say on Pay vote must be held (so-called “Say on Frequency”) and regarding a non-binding shareholder vote on “golden parachute” compensation in merger proxies (“Say on Golden Parachutes”). This marks the SEC's first major rule proposal to implement the various corporate governance and executive compensation provisions of Dodd-Frank.

Effective Date

Under Dodd-Frank, all proxy statements relating to annual meetings of shareholders to be held after January 20, 2011 must include a non-binding Say on Pay proposal and a non-binding Say on Frequency proposal for shareholders to vote on whether the Say on Pay proposal should be included every one, two or three years. Regardless when the SEC adopts final rules, the rule proposal makes clear that companies must comply with the statute and include these proposals even if rules are not finalized before January 20, 2011. Going forward, and subject to special rules for TARP companies discussed below, the Say on Pay vote will be held at least every three years, and the Say on Frequency vote must be held at least every six years.

Scope

The legislation and the proposed rule require all SEC-reporting companies, including companies whose securities may be quoted on the over-the-counter bulletin board or pink sheets, to include proxy proposals for Say on Pay and Say on Frequency. For now, this includes “smaller reporting companies” as defined by SEC rules (companies with a public float of less than $75 million). However, the legislation gave the SEC authority to exempt certain categories of companies, and the SEC has specifically requested comment in the rule proposal whether smaller reporting companies should be exempt. Therefore, it remains possible that smaller reporting companies will not be subject to Say on Pay under Dodd-Frank or SEC rules (although TARP companies would still be required to include a Say on Pay proposal under TARP rules, as discussed below).

Requirements of Say on Pay and Frequency Proposals

Say on Pay

The proposed rule does not mandate any specific language that must be included in a Say on Pay proposal. The requirement is that shareholders be given an opportunity to approve the compensation of the named executive officers as disclosed under Item 402 of SEC Regulation S-K (the main executive compensation disclosure rule). Therefore, in order to ensure compliance, many companies will choose to parrot the language of the statute and the rule.

Frequency

Similarly, no specific language is mandated for the frequency of Say on Pay proposal. The rule proposal acknowledges that the board of directors may make a recommendation as to how frequently Say on Pay should be held, but the proposal language must make clear that shareholders are not voting up-or-down on the board's recommendation, they are voting on whether to hold it every one, two or three years.

No Preliminary Proxy Filing Required

As expected, the SEC has added Say on Pay and Say on Frequency to the list of matters for which no preliminary proxy statement filing will be required.

Disclosure Implications for the CD&A, 10-K and 10-Q

CD&A

Many companies may now choose to include a concise executive summary in Compensation Discussion & Analysis (CD&A) succinctly making the case for their executive compensation programs. The CD&A will be a critical advocacy piece in persuading shareholders to vote yes on Say on Pay, and perhaps as important, persuading proxy advisory services such as ISS/RiskMetrics and Glass-Lewis to recommend votes in favor. In addition, the proposed rule would require companies that include a CD&A in their proxy statements (i.e., all public companies other than “smaller reporting companies”) to discuss in the following year's CD&A whether, and if so how, they have taken the prior year's Say on Pay vote into account with respect to their executive compensation policies and decisions.

The SEC clarified that “smaller reporting companies” do not need to include a CD&A in their proxy statements solely due to the requirement to include a Say on Pay proposal (which specifically references CD&A as part of the named executive compensation disclosure shareholders are voting to approve).

Forms 10-K and 10-Q

Companies will need to disclose in the Form 10-Q covering the quarter during which a Say on Frequency vote occurred (or in the Form 10-K if the vote occurred during the fourth quarter) how frequently they will hold a Say on Pay vote after taking into account the results of the Say on Frequency vote that occurred.

Application to TARP Companies

Companies with outstanding preferred stock under TARP are required to hold an annual Say on Pay vote under the TARP rules. The TARP requirements effectively supersede the SEC and Dodd-Frank requirements. As a result, until their TARP obligations have been repaid, TARP companies cannot choose to hold the Say on Pay vote less frequently than annually, and need not provide a Say on Frequency vote.

Proxy Card Implementation for Say on Frequency

The rule proposal would require companies to provide four voting choices for Say on Frequency: 1) every year, 2) every two years, 3) every three years, or 4) abstain. However, many proxy service providers (such as Broadridge Financial Solutions) have systems that allow for only three choices (the traditional “for”, “against” or “abstain”). Therefore, the proposed rule allows three choices on a transitional basis if proxy cards must be finalized before final SEC rules become effective: one, two or three years. Shareholders wishing to abstain under the three-choice approach simply would not check any box.

Say on Golden Parachutes

Also as required by Dodd-Frank, the rule proposal requires a non-binding shareholder vote to approve “golden parachute” compensation disclosed in merger proxies. New disclosure rules would require more extensive disclosure of compensation triggered by the transaction shareholders are being asked to approve. Companies could avoid including a Say on Golden Parachute proposal in a merger proxy if they have previously included the golden parachute compensation in a regular Say on Pay vote (including the additional disclosure of compensation triggered by the transaction). However, this option may not be attractive, given the uncertainty of when an M&A transaction may take place, the actual amount of such payments and the possibility that “golden parachute” compensation arrangements may be amended before a transaction occurs, which would render the previous approval of such arrangements stale.

What Should Companies Do Now?

• All public companies, including smaller reporting companies, should prepare to include a Say on Pay and Say on Frequency Vote in their 2011 proxy statements (assuming the 2011 annual meeting occurs after January 20, 2011).
• Consider whether to include a board recommendation on Say on Frequency, and if so, what to recommend. Companies may want to consider whether an annual vote offers some benefits, including more timely feedback from shareholders on compensation policies and practices, higher ratings from proxy advisory firms such as ISS/RiskMetrics and Glass-Lewis, and the possibility that including a Say on Pay opportunity may give unhappy shareholders a non-binding way to register a protest vote, rather than voting against board or compensation committee members and/or compensation plans that may be submitted for shareholder approval.
• Consider whether to include the golden parachute disclosure in the annual proxy statement to avoid having to include it later in a merger proxy.
• Open dialogue with your proxy service provider to determine whether the 2011 Say on Frequency vote will involve three or four choices, so you can prepare your 2011 proxy card.

Conclusion

Say on Pay is now a reality for all public companies, although smaller reporting companies could still be exempted in the final rules. We will publish further updates on Say on Pay and other Dodd-Frank corporate governance and executive compensation provisions as developments warrant, including further SEC rulemaking. In the meantime, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) should you have any questions or wish to discuss these issues further.

The Future Is Now

It's hard to believe but 2010 is rapidly coming to a close. It has been another challenging year for banks in the West, but it appears that the worst may be over. While several banks still remain in jeopardy and others are struggling, the FDIC informally indicated that failures in the West have fallen short of their own projections – a good sign. Now, if the real estate and job markets could only stabilize, we would be on our way to a real recovery.

Looking Ahead

2010 has seen assisted transactions as the deals of choice, with few whole bank deals, lots of private and public offerings and negligible new bank startups. By contrast, 2011 could see the return of whole bank deals. There is clearly pent up demand on the part of sellers. With enhanced capital for buyers and more stable loan portfolios for sellers, the “lock-down” environment for whole bank mergers in 2010 may change. I think sellers, in particular, may be more realistic in their pricing expectations and anxious to get out of a very challenging business, with directors tiring of the process and the uncertain costs of regulation.

The Regulators Speak

For the first time in several years, I sense that the regulators will selectively and cautiously take their foot off the pedal. I think they finally see the proverbial light at the end of the tunnel. This shift in attitude could be critical in facilitating more whole bank mergers.

A Consolidating Industry

Through a combination of assisted deals, whole bank mergers and sparse new bank formations, the banking industry as we know it will continue to consolidate. What the magic number will be is anyone's guess, but 5,000 by the end of this decade seems like a real possibility.

Survival of the Fittest

Those banks which have exercised some degree of discipline and foresight will be the survivors. As always, capital will play a key role for the survivors and consolidators. As the pendulum slowly swings, 2011 will usher in the start of the next wave of consolidation in the banking industry.

Overview and Executive Summary

On August 25, 2010, the Securities and Exchange Commission adopted “proxy access” by a 3-2 vote, ending a process that had spanned several years and alternative rule proposals. Significant shareholders or groups of shareholders will now be able to use management's proxy statement to nominate director candidates to public company boards, rather than preparing and filing their own proxy statements and waging a traditional proxy contest. Neither the adoption nor the timing (i.e., in time for the 2011 proxy season) was a surprise, given comments earlier this year from SEC Chair Mary Schapiro that proxy access was high on the Commission's agenda.

As more fully described below, the new rules:

• Provide a “proxy access” right to shareholders who satisfy a “three percent for three years” test
• Limit shareholder nominees under the proxy access rule in any year to 25% of total board seats
• Require shareholder nominees under the proxy access rule to be independent under applicable stock exchange standards (but not independent of the nominating shareholder)
• Delay implementation of the proxy access right at “smaller reporting companies” for three years

Scope

The new proxy access rules apply to all companies with equity securities registered with the SEC, including companies whose securities are quoted on the over-the-counter bulletin board or pink sheets (i.e., not limited to companies listed on a major stock exchange). However, implementation of the proxy access right for “smaller reporting companies” as defined by SEC rules (generally those with public floats under $75 million) will be delayed for three years.

Key Elements

• General. Companies will be required to include the nominees of qualifying shareholders (or groups of shareholders) in the Company's proxy materials, subject to the conditions and limits on aggregate shareholder nominees under the rules.
  
• Threshold: Three Percent for Three Years. To be eligible, a shareholder must have continuously held at least three percent of the total voting power for at least three years. Shareholders can aggregate their holdings for the purpose of qualifying. Borrowed shares will not count toward the threshold; only shares over which the shareholder has investment control.
  
• The final rule differs from the prior rule proposal, which would have set thresholds of one, three and five percent depending on the size of the compa
  
• Shareholder Nominees Limited to 25% of Total Board Seats. The aggregate number of shareholder nominees cannot exceed 25% of the total board seats. Companies with classified or “staggered” boards should note that the limit is tied to total board seats, not the number of seats up for election in a given year. If the Company determines to support a nominee submitted by a shareholder through the new proxy access process, that nominee will count toward the 25% limit.
  
• Nominees Must Be Independent. Shareholder nominees must satisfy all objective independence criteria under applicable stock exchanges. However, nominees need not be independent of, and may be affiliated with, the nominating shareholder.
  
• Purpose Cannot Be Control. Shareholders cannot use the new proxy access system if they intend to seek control of the Company or a number of board seats in excess of the 25% threshold under the rule.
  
• New Shareholder Notice Filing. Nominating shareholders will need to submit a new notice to the Company and the SEC on Schedule 14N, providing relevant details and supporting statements, no later than 120 days before the anniversary of the prior year's proxy statement. Similar to the shareholder proposal process, companies will have the ability to seek to exclude nominees on procedural grounds.
  
• Shareholder Proposals Can Expand Proxy Access Right. The SEC also amended the shareholder proposal rules to permit shareholder proposals on proxy access, so long as the proposals do not conflict with the new proxy access rules. For example, companies could not exclude on substantive grounds a shareholder proposal that sought to expand the scope of proxy access (e.g., lowering the percentage ownership threshold below three percent). “Smaller reporting companies” should note that while implementation of the proxy access right has been deferred for three years, the change in shareholder proposal rules has not been deferred, so they will be subject to proxy access proposals, including binding proposals, in 2011.
  
• Effective Date. The new rules will be effective 60 days after publication in the Federal Register, or around November 1, 2010. The 120-day notice period for nominations will apply, but since most calendar-year companies filed their 2010 proxy statements after March 1, 2010, proxy access will apply to most companies for the 2011 proxy season (other than smaller reporting companies, as noted above).

What Should Companies Do Now?

Public companies other than “smaller reporting companies” should assess the likelihood that any shareholder, or group of shareholders, satisfying the “three percent for three years” test would run a slate of director nominees in the company's proxy statement. Outreach to major shareholders may be appropriate in some circumstances.

Conclusion

Proxy access has been much debated but, as we have discussed in prior alerts, has been widely expected in some form. The ultimate effect of proxy access remains to be seen, but it certainly gives large shareholders greater leverage over director elections and may result in an increase in negotiations between companies and large shareholders over board nominees. Should you have any questions or wish to discuss these issues further, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com).

Overview and Executive Summary

On August 25, 2010, the Securities and Exchange Commission adopted “proxy access” by a 3-2 vote, ending a process that had spanned several years and alternative rule proposals. Significant shareholders or groups of shareholders will now be able to use management's proxy statement to nominate director candidates to public company boards, rather than preparing and filing their own proxy statements and waging a traditional proxy contest. Neither the adoption nor the timing (i.e., in time for the 2011 proxy season) was a surprise, given comments earlier this year from SEC Chair Mary Schapiro that proxy access was high on the Commission's agenda.

As more fully described below, the new rules:

• Provide a “proxy access” right to shareholders who satisfy a “three percent for three years” test
• Limit shareholder nominees under the proxy access rule in any year to 25% of total board seats
• Require shareholder nominees under the proxy access rule to be independent under applicable stock exchange standards (but not independent of the nominating shareholder)
• Delay implementation of the proxy access right at “smaller reporting companies” for three years

Scope

The new proxy access rules apply to all companies with equity securities registered with the SEC, including companies whose securities are quoted on the over-the-counter bulletin board or pink sheets (i.e., not limited to companies listed on a major stock exchange). However, implementation of the proxy access right for “smaller reporting companies” as defined by SEC rules (generally those with public floats under $75 million) will be delayed for three years.

Key Elements

• General. Companies will be required to include the nominees of qualifying shareholders (or groups of shareholders) in the Company's proxy materials, subject to the conditions and limits on aggregate shareholder nominees under the rules.
  
• Threshold: Three Percent for Three Years. To be eligible, a shareholder must have continuously held at least three percent of the total voting power for at least three years. Shareholders can aggregate their holdings for the purpose of qualifying. Borrowed shares will not count toward the threshold; only shares over which the shareholder has investment control.
  
• The final rule differs from the prior rule proposal, which would have set thresholds of one, three and five percent depending on the size of the compa
  
• Shareholder Nominees Limited to 25% of Total Board Seats. The aggregate number of shareholder nominees cannot exceed 25% of the total board seats. Companies with classified or “staggered” boards should note that the limit is tied to total board seats, not the number of seats up for election in a given year. If the Company determines to support a nominee submitted by a shareholder through the new proxy access process, that nominee will count toward the 25% limit.
  
• Nominees Must Be Independent. Shareholder nominees must satisfy all objective independence criteria under applicable stock exchanges. However, nominees need not be independent of, and may be affiliated with, the nominating shareholder.
  
• Purpose Cannot Be Control. Shareholders cannot use the new proxy access system if they intend to seek control of the Company or a number of board seats in excess of the 25% threshold under the rule.
  
• New Shareholder Notice Filing. Nominating shareholders will need to submit a new notice to the Company and the SEC on Schedule 14N, providing relevant details and supporting statements, no later than 120 days before the anniversary of the prior year's proxy statement. Similar to the shareholder proposal process, companies will have the ability to seek to exclude nominees on procedural grounds.
  
• Shareholder Proposals Can Expand Proxy Access Right. The SEC also amended the shareholder proposal rules to permit shareholder proposals on proxy access, so long as the proposals do not conflict with the new proxy access rules. For example, companies could not exclude on substantive grounds a shareholder proposal that sought to expand the scope of proxy access (e.g., lowering the percentage ownership threshold below three percent). “Smaller reporting companies” should note that while implementation of the proxy access right has been deferred for three years, the change in shareholder proposal rules has not been deferred, so they will be subject to proxy access proposals, including binding proposals, in 2011.
  
• Effective Date. The new rules will be effective 60 days after publication in the Federal Register, or around November 1, 2010. The 120-day notice period for nominations will apply, but since most calendar-year companies filed their 2010 proxy statements after March 1, 2010, proxy access will apply to most companies for the 2011 proxy season (other than smaller reporting companies, as noted above).

What Should Companies Do Now?

Public companies other than “smaller reporting companies” should assess the likelihood that any shareholder, or group of shareholders, satisfying the “three percent for three years” test would run a slate of director nominees in the company's proxy statement. Outreach to major shareholders may be appropriate in some circumstances.

Conclusion

Proxy access has been much debated but, as we have discussed in prior alerts, has been widely expected in some form. The ultimate effect of proxy access remains to be seen, but it certainly gives large shareholders greater leverage over director elections and may result in an increase in negotiations between companies and large shareholders over board nominees. Should you have any questions or wish to discuss these issues further, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com).

Most copyright holders know they have to register their work before going to court to enforce their copyrights. The normal turn-around time for registration in the U.S. Copyright Office is six months (e-filing) to 22 months (paper filing). These time-frames can wreak havoc with copyright enforcement campaigns. For those in a rush, the only option in the past was to petition the Copyright Office for special handling for a rush approximately five-day turn around -- all for a relatively big fee (government fee and additional legal costs). Now, for copyright owners residing in states in the Ninth Circuit [1], that process may be less onerous, at least temporarily.

The Copyright Act requires a plaintiff to register a copyright before filing an infringement suit by submitting a complete application to the Copyright Office [2]. On May 25, 2010, a Ninth Circuit panel weighed in on an issue that has split the federal circuit courts: what it means to “register” [3]. The Tenth and Eleventh Circuits follow the “registration approach,” in which a copyright is not registered until a certificate of registration has been issued. The Fifth, Seventh and now Ninth Circuits use the “application approach,” in which a plaintiff can register by submitting a complete application to the Copyright Office.

Supporters of the “registration approach” argue that Congress intended the Copyright Office to maintain authority over which copyrights are protectable. Allowing an application alone to satisfy the registration requirement deprives the Copyright Office of the filtering role Congress intended. These supporters also regard the statute as clear and unambiguous: registration means registration, not application.

On the other side, defenders of the “application approach” note that the Copyright Office can join a suit that has already been filed if it determines that the copyright is not protectable. The application approach merely condenses the timeline and does not deprive the Office of its intended role. Furthermore, this approach arguably follows the spirit of the Copyright Act. As the Ninth Circuit panel stated, “we conclude that the application approach better fulfills Congress's purpose of providing broad copyright protection while maintaining a robust federal register” [4].

So what are the ramifications of this ruling and of the continuing circuit split?

• For prudent copyright holders, the ruling has little effect. The prevailing practice has long been to register one's copyright shortly after publication of the work to preserve the ability to claim statutory damages.
  
• In the Ninth Circuit, defendants in copyright litigation will now have one fewer defense to infringement claims.
  
• Copyright holders should be wary that this rule could change soon. The issue will likely be addressed by the Supreme Court and some jurisdictions will have to change their practices to comply.
  
• When rushed, plaintiffs in a Ninth Circuit copyright suit can file a registration application and go straight to court without waiting. Whenever possible, however, plaintiffs should consider paying the extra fee to expedite the copyright registration process.

This case came on the heels of, and partly relied on, a plaintiff-friendly Supreme Court ruling for copyright litigation [5]. In that case, the Court held that infringement claims by unregistered copyright holders cannot be dismissed on jurisdictional grounds suggesting that mere lack of registration doesn't divest a claim of its federal court jurisdiction. But is it enough to get into court in the first place? Only time and the Supreme Court will tell.

________________________________________
[1] Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, and Washington.

[2] 17 U.S.C. § 411

[3] Cosmetic Ideas, Inc. v. IAC/InteractiveCorp, 606 F.3d 612 (9th Cir. 2010).

[4] Id at 619.

[5] Reed Elsevier, Inc. v. Muchnick, 130 S. Ct. 1237 (2010)

Even before 2 ESSB 6143 was passed, the B&O tax laws were sufficiently broad so that (at least arguably) individuals should have been paying B&O tax all along on compensation that they received for their services as directors. According to the findings of the Legislature, however, there has been “a widespread misunderstanding among corporate directors that the business and occupation tax does not apply to the compensation they receive for services as a director of a corporation.”

Because of the widespread misunderstanding, the legislature found that it is appropriate “in this unique situation” to provide limited relief against retroactive assessment of B&O taxes. Therefore, the revenue bill states that the B&O tax does not apply to director compensation until July 1, 2010. The Legislature directs the Department of Revenue to take measures to ensure that corporate directors understand and comply with their B&O tax obligations.

Compensation received for services as a corporate director is subject to tax as income under the “services and other activities” B&O tax classification, which is normally taxed at the rate of 1.5%. However, 2 ESSB 6143 imposes a temporary three year 0.3% increase in the tax rate on all income in that classification. So between July 1, 2010 and June 30, 2013, the tax rate will be 1.8%.

Why Capital Is So Critical

This may seem obvious, but capital is the key to survival in today's economic and regulatory environment. It truly represents the wheels of the bus. As one client aptly put it – either you're on the bus or you're under the bus.

Capital is critical for a variety of reasons, including:

• It clearly improves all your key ratios.
• It allows you flexibility in negotiating with borrowers and disposing of troubled assets.
• It creates a more positive mindset for bank regulators, especially when they examine your bank.
• It increases your lending limit and provides additional resources to lend and grow again in the future.
• It provides a cushion for unforeseen challenges.

The Regulatory Mantra

Every administrative action, formal or informal, has a capital requirement. It is at the center of what bank regulators look for, along with accurately and timely identifying your credit issues. The optimum time to raise capital is before you absolutely need it and certainly before the examiners pay you a visit. Our experience is that once banks hit a certain point, raising capital becomes extremely challenging and massively dilutive.

The Dilution Dilemma

A year ago, I attended a banking conference in Denver and a senior Federal Reserve official stated on a panel that DILUTION was something banks had to accept if they expected to raise capital in today's environment. In essence, that person was saying “get over it.” I thought that was a bit harsh, but time has shown the truth to that statement. Just look at a number of high profile banks which have completed massively dilutive capital raises. Dilution beats the alternative – survival is the name of the game today.

What We Are Seeing Out There

The public capital market has been up and down, but several of our clients have successfully navigated these waters with substantial common stock raises. Several of our other clients have had successful private offerings and others are exploring that avenue as well. Another potential vehicle some have used with mixed success are so-called shareholder rights offerings. Those depend on the condition of the bank and the investment appetite of existing shareholders and the surrounding community. The good news is that a number of community banks have been able to bolster their capital during the past year.

The Crystal Ball

While, obviously, no one really knows what lies ahead, we expect additional bank failures in the Northwest, with a continuing stream of FDIC-assisted transactions. Until these end, I think examiners will still be very cautious and whole bank mergers will be limited. On the bright side, there does seem to be some stabilization in asset quality for many of the banks, reversing the downward trend experienced during the past two years. Hopefully, this positive trend will continue.

Conclusion

CAPITAL IS KING! Capital truly is the wheels of the bus – without it you're stuck in the mud. While not a cure-all, sufficient fresh capital should significantly improve relationships with regulators and let you operate your bank from an offensive rather than defensive standpoint. While concerns about shareholder dilution are valid, it is clear that it beats the alternative.

1. Say on Pay.  The Act requires every public company to hold a periodic “Say on Pay” vote, providing shareholders with an up-or-down non-binding vote on the compensation of executives as disclosed in the proxy statement.   The SEC will have discretion to exempt certain companies, so it remains to be seen whether smaller reporting companies will be covered.  In a surprise, the legislation requires companies to hold an annual, biennial or triennial vote, and to have shareholders vote at least every six years on whether the Say on Pay vote will be held every one, two or three years.  The first Say on Pay vote would be required for the first annual meeting occurring after January 20, 2011.  The SEC is expected to add Say on Pay as one of the proposals that does not trigger a preliminary proxy statement filing requirement.
   
   
2. Say on Golden Parachutes.  The Act requires a non-binding shareholder vote to approve “golden parachute” compensation disclosed in merger proxies.  The SEC has authority to exempt certain companies from this requirement.
   


3. Enhanced Compensation Committee Independence.  For listed companies, compensation committee members will be subject to heightened independence standards.  These new standards will be reflected in revised stock exchange listing standards, which must be adopted by July 2011.  It is widely believed that compensation committee members will now be subject to similar standards as audit committee members have been subject to since the adoption of Sarbanes-Oxley.  These enhanced standards will take into account indirect sources of compensation, such as consulting or advisory fees, which previously may not have violated applicable independence standards.  The stock exchanges have the authority to exempt small companies from these new requirements.
   


4. Compensation Committee Advisors and Conflicts.  Compensation committees of listed companies will be required to consider certain independence factors to be determined by the SEC before retaining consultants, legal counsel and other advisors.  The factors must include (i) other services provided, (ii) fees as a percentage of total revenue for the advisor, (iii) the advisor's internal conflicts of interest policies, (iv) relationships between committee members and the advisor, and (v) the advisor's holdings of client stock, if any.  In addition, proxy statements for annual meetings held after July 20, 2011 must include enhanced disclosure regarding compensation consultants and their independence.  The stock exchanges have the authority to exempt small companies from these new requirements.
   
   
5. Clawback of Previously Awarded Compensation.  The Act directs stock exchanges to require listed companies to adopt a policy to recover or “claw back” incentive compensation awarded to current or former executive officers (including equity awards) during a three-year look-back period if such compensation turns out to be unearned based on a restatement of financial results due to material noncompliance with financial reporting requirements, regardless whether the individual committed any misconduct.  The amount recovered would be the incremental amount resulting from the misstatement (not necessarily the entire award).  The SEC must clarify the treatment of equity awards in rulemaking; for example, whether only awards that vest based on achieving financial targets are included.  This clawback requirement is a narrower standard than applies to participants in the Treasury's Capital Purchase Program, which are required to recover compensation based on any erroneous data, regardless whether an accounting restatement occurred.
   
   
6. Enhanced Disclosure Obligations.  The Act requires the SEC to adopt rules providing for the following enhanced proxy disclosures:


• Ratio of CEO to Median Employee Pay.  Companies will be required to disclose the ratio of CEO total compensation to median total compensation of all employees other than the CEO (and also disclose the actual amounts).  “Total compensation” is to be calculated according to the SEC's proxy rules, a measure many companies may not currently track for the general employee population.
  
• Pay/Performance Link.  Disclosure of the relationship between company performance and compensation “actually paid” will be required.  Changes in the value of stock will be taken into account.
  
• Policy on Hedging Company Stock.  Disclosure will be required whether employees and directors are permitted to hedge company stock.

Corporate Governance Provisions

1. Proxy Access.    The Act provides the SEC with explicit authority to adopt rules granting shareholders access to management's proxy statement for the purpose of nominating directors to the board.  The SEC's most recent proxy access rule proposal would give a shareholder or a group of shareholders holding 1% (for large accelerated filers), 3% (for accelerated filers) or 5% (for non-accelerated filers) of outstanding shares the ability to include nominees in management's proxy statement.  After recently re-opening the comment period, the SEC reportedly will adopt proxy access in time for the 2011 proxy season.
   


2. Further Restrictions on Broker Discretionary Voting.  The Act further restricts the scope of matters on which brokers can exercise discretion in voting when they have not received specific instructions from beneficial holders.  Broker discretion to vote in director elections was prohibited for the first time in the 2010 proxy season, and now brokers will be restricted from exercising discretion on executive compensation or “any other significant matter” as determined by SEC rule.  The loss of broker discretionary voting could have a particularly significant impact on “Say on Pay” voting.
   


3. No Majority Voting Requirement.  One major item not included in the final legislation was majority voting.  However, we do not expect the momentum toward adoption of majority voting to subside, particularly for larger companies.

• Consider whether tools are in place to calculate the “total compensation” for all employees under the SEC's proxy rules, in order to meet the requirement to disclose median “total compensation” for all employees (and the ratio compared to CEO compensation).  This is an important new disclosure control and procedure.
  
• Consider whether executive compensation or corporate governance policies or practices are likely to draw negative recommendations from the major proxy advisory firms (such as RiskMetrics Group and Glass Lewis), since the loss of broker discretionary voting combined with Say on Pay could put directors at greater re-election risk.  We do not suggest that companies should blindly adhere to standards mandated by RiskMetrics, but do urge companies to be aware of which of their practices may draw negative attention so appropriate planning and communications can occur.
  
• Assess whether any compensation committee members may be at risk of not satisfying enhanced independence requirements, and what that would mean for stock exchange listing standards compliance (e.g., whether there would be enough other directors to fully populate the compensation committee).


• With proxy access likely to be adopted before next year's proxy season, companies may want to assess the likelihood that any shareholder, or group of shareholders, exceeding the applicable threshold (1%, 3% or 5%) would run a slate of director nominees in the company's proxy statement if given the opportunity.  Outreach to major shareholders may be appropriate in some circumstances.
  
• If insider trading policies do not currently address (or address but do not prohibit) hedging company stock, companies may want to review and possibly revise those policies before next year's proxy season so they won't have to disclose that they have no policy against hedging.

Conclusion 

It is no surprise that most of the proposed provisions survived in the final Act, given the current political environment.  We will publish further updates on these issues as developments warrant, including related SEC rulemaking.  In the meantime, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com) or Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) should you have any questions or wish to discuss these issues further.

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1. Majority Voting in Director Elections. Under the Senate bill, directors would be elected by majority vote in uncontested elections (a plurality standard would apply in contested elections). Any director nominee who does not receive a majority of votes cast in uncontested elections would be required to tender his or her resignation to the board. The board could reject the resignation, but would need to do so by unanimous vote and disclose, within 30 days of the election, its analysis as to why the resignation was not accepted and why its decision was in the best interests of the company and its shareholders. The Securities and Exchange Commission (SEC) would have the authority to exempt small companies from this rule.
• The House bill did not contain a majority voting provision.
• Although majority voting has become more common than not among S&P 500 companies, it remains the minority practice among all public companies.
2. Proxy Access. Both the House and Senate bills provide the SEC with explicit legislative authority to adopt rules granting shareholders access to management's proxy statement for the purpose of nominating directors to the board. There has been some question whether the SEC has such authority. The SEC's most recent proxy access rule proposal would give a shareholder or a group of shareholders holding 1% (for large accelerated filers), 3% (for accelerated filers) or 5% (for non-accelerated filers) of outstanding shares the ability to include nominees in management's proxy statement.
• Proxy access is high on the SEC's agenda and appears likely to be adopted.
3. Further Restrictions on Broker Discretionary Voting. The Senate bill would require further restrictions on the scope of matters on which brokers can exercise discretion in voting when they have not received specific instructions from beneficial holders. For the 2010 proxy season, for the first time brokers were not permitted to cast discretionary votes in director elections. The Senate bill would also restrict brokers from exercising discretion on executive compensation or “any other significant matter” as determined by SEC rule.
• The House bill did not contain a similar provision.

1. Say on Pay. Both the House and Senate bills include a “say on pay” provision requiring listed companies to provide shareholders with an up-or-down non-binding vote on the compensation of executives as disclosed in the proxy statement.
• In recent weeks, U.S. companies have lost “say on pay” votes for the first time, and it is somewhat noteworthy that none of those companies was a major Wall Street financial institution (Occidental Petroleum, Motorola, KeyCorp).
2. Say on Golden Parachutes. The House bill would require a non-binding shareholder vote to approve “golden parachute” compensation disclosed in merger proxies.
3. Enhanced Compensation Committee Independence. Under both bills, compensation committee members would be subject to heightened independence standards. In addition, enhanced proxy disclosure regarding compensation consultants and their independence would be required. The SEC would have the authority to exempt small companies from this rule.
4. Clawback of Previously Awarded Compensation. The Senate bill would require listed companies to adopt a policy to recover or “claw back” incentive compensation awarded to current or former executive officers (including stock options) during a three-year look-back period if such compensation turns out to be unearned based on a restatement of financial results due to material noncompliance with financial reporting requirements.
• In one respect this is a narrower standard than applies to CPP participants, which are required to recover compensation based on any erroneous data, regardless whether an accounting restatement occurred.
5. Enhanced Disclosure Obligations. The Senate bill would require the following enhanced proxy disclosures:
• Pay/Performance Link. Disclosure of the relationship between company performance and compensation actually paid would be required. Changes in the value of stock would be taken into account.
• Ratio of CEO to Median Employee Pay. Companies would be required to disclose the ratio of CEO total compensation to median total compensation of all employees other than the CEO (and also disclose the actual amounts). “Total compensation” would be calculated according to proxy rules, a measure many companies may not currently track for the general employee population.
• Policy on Hedging Company Stock. Disclosure would be required whether employees and directors are permitted to hedge company stock.

Potential Implications
The combined effect of several of the proposed reforms could be significant for many companies. For example, the combined effect of restrictions on broker discretionary voting, say on pay, and majority voting could put compensation committee members at heightened risk. The “for” vote on say on pay proposals likely would decline substantially if broker discretionary votes were prohibited, which could result in more negative say on pay votes, which could trigger “vote no” campaigns against compensation committee members by activists and proxy advisory firms. Under the new majority voting standard and the recent loss of broker discretionary voting for directors, compensation committee members at companies with significant negative say on pay votes could be at heightened risk in director elections.

Moreover, the SEC's proxy access proposal could create a significant distraction for boards and management as holders of a relatively small percentage of the outstanding shares insert their candidates in proxy statements and potentially on boards.

Finally, as noted above, there could be a significant additional compliance burden on companies to, for example, calculate “total compensation” under the SEC's proxy rules for all employees.

What Should Companies Do Now?

• Given the heightened re-election risk for directors, companies should consider whether any of their policies or practices are likely to draw negative recommendations from the major proxy advisory firms (such as RiskMetrics Group and Glass Lewis).
• CPP companies may want to assess whether the policies and practices they have adopted to comply with Treasury rules will satisfy the proposed new requirements.
• With proxy access likely to be adopted before next year's proxy season, companies may want to assess the likelihood that any shareholder, or group of shareholders, exceeding the applicable threshold (1%, 3% or 5%) would run a slate of director nominees in the company's proxy statement if given the opportunity. Outreach to major shareholders may be appropriate in some circumstances.
• Assess whether any compensation committee members may be at risk of not satisfying enhanced independence requirements, and what that would mean for stock exchange listing standards compliance (e.g., whether there would be enough other directors to fully populate the compensation committee).
• Consider whether tools are in place to calculate the “total compensation” for all employees under the SEC's proxy rules.

• Aggressively work your problem assets.
• Make capital raising a very high priority.
• Ensure you have a good and frequent (perhaps semi-annually) outside loan review.
• Communicate effectively and timely with all of your regulators – the “no surprise” rule is a good one.
• Involve and timely inform the Board on all material developments at the Bank.
• Utilize your professional advisors – lawyers, accountants, investment bankers, outside loan reviewers – properly, they can be valuable resources.
• Try to stay positive as we all work through these trying times.

On December 7, 2009, the U.S. Patent and Trademark Office (“PTO”) announced, in conjunction with the United Nations Framework Conference on Climate Change being currently held in Copenhagen, Denmark, an expedited procedure for pending “Green Technology” patent applications called the Green Technology Pilot Program (“Pilot Program”). This announcement was greeted with a bit of fanfare and eager anticipation, as the normal pendency for examination of the application can be up to 30 months. But the pilot program is limited to the first 3000 petitions. Here are the specifics:

• Must have a pending patent application as of December 8, 2009 (effective date of Pilot Program)
• The subject invention must be for a “Green Technology,” which includes applications pertaining to environmental quality, energy conservation, development of renewable energy resources or greenhouse gas emission reduction)
• The normal government petition fee of $130 is waived
• Do not need to meet all of the requirements to make the application “special for purposes of expedited
• All petitions must be filed by December 8, 2010 or until the first 3000 petitions are received
• The petition must be filed through the PTO's electronic filing system (PAIR)
• Petition must be filed meeting the following:
• Pending non provisional application (not a reissue)
• Must meet the technology classification
• Cannot contain more than 3 independent claims and a total of 20 claims
• No multiple dependent claims
• Can concurrently file a preliminary amendment to cancel claims to the required 3 independent/20 claims total limit
• Claims must be directed to a single invention
• Must include a statement regarding restriction practice
• Petition must state how the invention materially enhances the environment
• Petition must be filed at least one day prior to the date of an Office Action issuing (restriction requirement counts)
• Petition must be accompanied with a request for early publication and payment of publication fee (currently $300), but then publication fee not charged at Issue Fee time
• The PTO has suggested that the Pilot Program may be extended if successful.

The petition is a great thing if the invention clearly falls in the correct technology classifications, directed to a unitary invention, and has no greater than the maximum claim set allowed for the petition. If the petition to make special is approved, the Application will be examined out of turn on a fast track basis. This can cut a significant amount of time off an otherwise long few years of waiting for examination.

An applicant will need to contact its patent counsel as soon as possible to review the application and to see whether the application meets the requirements or if a preliminary amendment to cancel claims makes sense. While the U.S. Government has graciously waived the petition fee, the Applicant should expect a fair fee from counsel to review/counsel/prepare and file such a petition. Plus, there will be a government fee of $300 for the request of early publication, but this fee would have to be paid in any event. But under current practice, the Applicant is generally not hit with this fee until the Issue Fee is paid, thereby knowing that the application has been allowed. Thus, the PTO would get its publication fee early whether the patent application is allowed or not. Still, it may be a fair trade off for obtaining a patent in a green technology on a fast track.

For more information on the newly announced Pilot Program, go to: http://www.uspto.gov/news/pr/2009/09_33.jsp or http://www.uspto.gov/patents/law/notices/2009.jsp . For counseling regarding whether it makes sense to file a petition, contact your Patent Attorney.

The Proposed Restructure

Well, Senator Dodd, bless his heart, has come out with yet another proposal to restructure the financial regulatory system. If you haven't seen it, at its heart is a new oversight body called the “Financial Institutions Regulatory Agency” or “FIRA.” I think a more appropriate name would be the “Financial Institutions Regulatory Entity” or “FIRE."

While it probably has zero chance of passing as proposed, the bill is telling. By stripping the FDIC and Federal Reserve of their bank regulatory oversight functions – making the FDIC just an insurance agency and the Federal Reserve a monetary policy agency and eliminating the OCC and OTS as we know them, I interpret Senator Dodd to be saying “You all messed up – so we are going to start over again.”

Actually, the concept of a new, single financial regulatory agency is intriguing. At least it would centralize power and create some consistency. The downside is that word power – and the fear of its abuse.

Where Are We Anyway?

Unfortunately we are still in the middle of this mess. With real estate values still dropping in many locales, we are far from done. The implications are far reaching. Because of archaic accounting pronouncements, banks, steered straight off a cliff by the accountants, appraisers and regulators, are forced to write down “distressed” assets to fire sale values. Why no OTTI standards have been adopted for real estate is beyond me. We just continue to privatize the upside on real estate and publicly swallow the downside in large gulps.

The Scary Regulatory Environment

Folks, I am here to tell you things have only gotten worse. With each succeeding Inspector General Report, the regulators get more dogmatic and risk averse. Enforcement actions are flying. Three CAMELS ratings are embraced. The whole process and its aftermath are overwhelming to boards and management and the regulators themselves, who simply don't have the resources or necessary experience to properly address all the issues, many of which are self-created.

There is huge frustration on the part of management teams, including many good bankers just trying to survive this nightmare. Solutions that are an iota out of the box are shot down with no apparent thought or explanation. The mantra now is for common equity in capital raises, and failure is being considered over preferred stock injections.

Eliminating the Hostile Regulatory Environment

In hindsight, many banks took on too much risk and real estate concentrations. And, yes the regulators have a very tough job to do. However, the hostile environment we are operating under serves no one well.

The regulators , legislators, banks and their lobbyists must all take a step back and reconsider where we are at now, where we want to get and how best to get there without further scorching the earth.

The Irony of It All

The irony is that the banks are supposed to be at the heart of the economic recovery. However, with reduced lending limits, concentration ratios and tolerance for regulatory criticism, the banks just aren't lending much nowadays. Why a broad-based government guaranteed lending program has yet to be adopted is beyond me.

From the outside looking in on that “island surrounded by reality” which is known as Washington, D.C., Congress, the administration and the bank regulatory agencies all are on different C-SPAN channels. The disconnect is frightening.

Let's Put Out the Fire

So before adopting any new regulatory reform, let's figure out just what went wrong, put a meaningful plan together to fix it and go about the business of returning our banking system and economy to some semblance of stability. Otherwise, we truly are playing with FIRE!

Overview

On October 22, 2009, the Federal Reserve Board issued proposed guidance designed to ensure that incentive compensation practices and policies at Fed-regulated institutions, including U.S. bank holding companies, state member banks and certain other categories of institutions, do not undermine the safety and soundness of those institutions. The Fed explained its action in part by noting that corporate governance structures related to compensation practices may not be sufficient to protect the safety and soundness of institutions, since the federal “safety net” may lead shareholders to tolerate a degree of risk that is inconsistent with safety and soundness. Like the Treasury rules applicable to institutions participating in the Troubled Asset Relief Program (TARP) and recent proposed rules from the Securities and Exchange Commission (SEC), the proposed Fed guidance focuses on identifying and eliminating compensation practices that may encourage employees to take excessive risks. The Fed guidance does not impose pay caps or limit the forms of compensation, but rather imposes a framework of key principles within which Boards and management must design incentive compensation programs. In addition to the guidance, the Fed also announced two new supervisory initiatives to drive progress toward compensation practices that are better aligned with safety and soundness and to identify and spread best practices.

The proposed guidance is subject to a 30-day comment period, with final guidance potentially several months away. However, the Fed expects institutions covered by the guidance to immediately begin reviewing their incentive compensation policies and practices in light of the proposed guidance. In this regard, although the TARP rules and the Fed guidance are not entirely duplicative, there are substantial areas of overlap and institutions that have participated in TARP and are undertaking required risk assessments under the TARP rules should be able to leverage some of that work for purposes of beginning to implement the Fed guidance. In addition, although many banking institutions are not technically subject to the Fed guidance (e.g., state-chartered non-member banks whose federal regulator is the FDIC), we believe all banking organizations should become familiar with and prepare to implement the key tenets of the guidance in anticipation that their regulators will soon require similar measures. Further to this point, the Corporate and Financial Institution Compensation Fairness Act of 2009, recently passed by the House of Representatives, would require all federal banking regulators to regulate compensation with a focus on avoiding excessive risk.

Proposed Guidance

Key Principles

The guidance introduces three key principles designed to ensure that incentive compensation does not encourage employees to take excessive risks.

1. Incentives in compensation arrangements should be appropriately balanced with related risks. The guidance requires institutions to consider the full range of risks inherent in incentive compensation arrangements, including remote but potentially catastrophic risks, to ensure that the potential financial rewards from an employee's activities are appropriately balanced against the related risks. Examples of appropriate balance include (a) adjusting payouts for related risk, (b) aligning the risk horizon with the payout through deferred payments, clawbacks and/or longer performance periods, and (c) reducing the sensitivity of payouts to increases in short-term financial results. As a means of testing whether arrangements are appropriately balanced, the Fed encourages institutions, particularly large, complex institutions where incentive compensation is a major portion of total compensation, to employ both a backward-looking analysis of payments relative to risk outcomes, and a forward-looking “scenario analysis” to assess potential payments and risk outcomes under various scenarios. The Fed also suggests that safety and soundness concerns are lessened where, as is often the case at regional and community banks, incentive compensation comprises a relatively small portion of total compensation, since employees are less likely to take excessive risk when the corresponding payout is less significant.
2. Incentive compensation arrangements should be compatible with effective controls and risk management. The guidance requires institutions to develop and maintain appropriate controls around the design, implementation and monitoring of incentive compensation programs. Those controls should be subject to internal audit and designed by appropriate personnel (e.g., risk management, human resources, finance) whose incentive compensation should be tied primarily to the objectives of their work and not the financial performance of the institution or the business unit they review.
3. Programs should operate within a framework of strong corporate governance, including active Board oversight. The guidance encourages each institution's Board to exercise active oversight through a compensation committee of independent directors, which should work closely with the risk and audit committees (or the full Board if those functions are not delegated to a committee). The Fed expects at least an annual review of management's assessment of the effectiveness of the programs and related controls in providing balanced risk-taking incentives.

Covered Employees; Broad Scope

The preamble to the guidance states that problematic incentive compensation practices at all levels of financial institutions contributed to the financial crisis. Accordingly, the guidance applies not just to senior executives or other most highly-compensated employees, but also to employees who, either individually or as a group, may expose the institution to material risk. However, the guidance also acknowledges that the scope and complexity of each institution's business as well as the scope and prevalence of incentive compensation arrangements will be important factors in evaluating whether incentive compensation arrangements raise safety and soundness concerns. For example, it should be much simpler for community banks whose incentive compensation programs are neither rich nor weighted toward risky activities to implement and satisfy the Fed guidance than for large, diversified, global investment banks with thousands of employees deriving the majority of their compensation from incentive compensation tied to risky activities.

Supervisory Initiatives

The Fed is commencing two supervisory initiatives to promote better incentive compensation practices.

1. Large Complex Institutions. The first initiative involves a “horizontal” review of the incentive compensation arrangements at 28 large, complex banking organizations, designed to (a) better understand the arrangements, (b) assess the effectiveness of controls and whether payouts are balanced with related risks, (c) better understand the corporate governance framework around incentive compensation and (d) identify emerging best practices. Each institution will be required to submit a report detailing its practices and outlining its plans to enhance the effectiveness of controls and ensure their programs are consistent with safety and soundness and do not encourage excessive risk-taking.
2. Other Institutions. Incentive compensation programs and controls at other institutions will be reviewed as part of the regular, risk-focused supervisory process. These reviews will be tailored appropriately to reflect the scope and complexity of the institution's business and compensation programs. Findings will be incorporated into supervisory ratings and, where deficiencies exist, may result in supervisory action against the institution.

What Should Banks Do Now?

En Route Again

As I head down to San Francisco for yet another meeting with a federal banking regulator on behalf of a client, I ask myself, “What is happening in this crazy world of banking?” The past year has been littered with historical and severe financial crisis. Now we are facing the ravages that ensue – as bank after bank in the West suffers the consequences.

The New World of Bank Examinations

Our first hand experience is that bank examinations are now a frightening experience. Examiners, by and large, seem to come in loaded for bear looking under every rock, fearful of missing anything for which they could later be criticized. The ALLL calculation has become a nightmare, subject to arbitrary evaluation. Let's face it, as long as real estate values plummet and appraisers are afraid of their own shadows, collateral values will diminish and write downs will be mandated by examiners and accountants. With “1” rated banks becoming “3s” and “2s” becoming “4s”, a “3” CAMELS rating is now the new “1.” There rarely is a benefit of the doubt given to the banks. At the root of this evil are the FDIC's “Inspector General” reports which are mandated for all losses to the insurance fund of $25 million or more. Hindsight, using a telescope is 20/20!

The Enforcement Action Explosion

Enforcement Actions are being handed out like Advil. With 50% of the banks in the Northwest rated “3” or worse, MOUs and C&Ds are more common than not. While the regulators have a job to do, the language is often inflammatory and provisions dogmatic and unachievable. If the goal is to rehabilitate the banks, these actions are more like prison sentences. There is a lot of closing the barn doors after the horses have stampeded going on out there.

The Failures

It makes me sick to see banks we know or have worked with in some capacity fail. Without being cynical or paranoid, it seems when a bank gets in serious trouble, the regulators target them for euthanasia. Supporting the conspiracy theory that the FDIC would like to shrink the banking universe is their recent pronouncement extending the three year “lockdown” on new banks to seven years, virtually shutting down any new bank formations for the foreseeable future.

Thank Goodness for Capital

The only real ray of sunshine lately has been the ability of non-C&D banks to raise capital. With bank stock prices at decade low values, investors have shown a willingness to put new capital in selected banks that are seen as survivors and consolidators. This is critical to “refuel the tank.” However, the C&D banks have found the sledding far tougher. How long this capital window will remain open is a big unknown, but now clearly is the time to try to raise capital.

The FDIC Insurance Fund

As I predicted in prior CyberGrahams, the fund is now basically bust. Who would ever have thought of 3-year prepaid insurance or of “Reverse Tarp” with the FDIC actually borrowing from the very big banks Treasury just bailed out. It's beyond insanity. Further, the FDIC is finding fewer qualified bidders for failed banks and a sharply diminished appetite for failed bank acquisitions – not a good formula going forward.

Does Anyone Have Any Solutions?

Well, apparently restructuring banking regulation is going to solve a (hopefully) once in a lifetime financial crisis, fueled by easy credit and inflated real estate values. I don't think so. Let's face it, we are in triage now and the patients are falling fast and furiously. I have two simple suggestions: OTTI treatment for real estate collateral and OREO where the appraised value is at a “fire sale” level and the bank has the capacity to hold for a period of time and tolerance for good management teams that are proactively addressing their problems. This situation will be exacerbated as more banks fail and the FDIC as liquidator aggressively disposes of real estate acquired through these bank failures. Eventually, the real estate market and values will bottom out – and I think we are far closer to the end of the down cycle than the beginning. The banks just need some time to allow the cycle to turn. It's that simple! The FDIC can't afford to take down all the banks. Sanity must prevail at last.

The hotel industry is seeing an increased interest among hotel companies to provide hotel asset management services. What are the pressures that are driving this trend? What are the best practices for securing asset management engagements?

The Old Formulas for Success

In the heyday of easy money and brand consolidation, many qualified, experienced hoteliers opened new ownership and management shops. These new companies, often formed with just a few individuals, typically followed one of two different approaches for success.

In the first of these approaches, the hoteliers connected with one or more equity funds and formed joint ventures. The hoteliers brought to the table their experience as operators, including their industry connections and deal sources; the equity funds brought their experience in property acquisition and, of course, their equity. These “owner-operator” joint ventures used and repeated a simple template: the operator finds a hotel that can be repositioned through application of the operator's skills; the joint venture buys the hotel, using the fund's equity and leveraging it with debt financing; and the joint venture executes the repositioning plan, stabilizes the hotel, and sells it for a profit. Typically, these owner-operators had 10 to 20 hotels in their portfolios in various stages of the process, and they provided their equity owners a 12-20% IRR. The operators, as the “finders,” would usually also receive a “promote”. a special equity interest that could give the operator an extra return after certain success thresholds were met.

In the second approach, the hoteliers formed companies that focused exclusively on building a portfolio of management contracts. These “independent management” companies usually focused on a particular segment in which they could demonstrate special skill. By so doing, they presented owners with cost-effective and friendly alternatives to the big, branded management companies.

The Formulas Hit the Wall

Over the past year, several factors have challenged both of these formulas.

The most obvious challenge is the lack of debt financing for acquisition and development. Without credit, most owner-operators have limited ability to purchase, renovate and sell for a profit. Although some lenders are still making hotel loans, interest rates are high and recourse is often required. Additionally, the lenders are demanding much greater equity participation by the owner-operator. Now, the joint venture must put up equity of 40-60% of the hotel's value (rather than 15-30% in the heyday). Additionally, the operator's “sliver” is often expected to be as much as 20-30% of that total equity (rather than .05-5.0% in the heyday). This has temporarily blocked many owner-operators from acquiring hotels. Even the largest hotel companies are hesitant to invest these high levels of equity.

The lack of debt financing has impacted the independent management formula, as well. These companies depend on new development and sales of existing hotels, both of which create opportunities for new management contracts and relationships. Without financing, the fuel for this formula has been running dry.

A second challenge, of course, is the decline in RevPAR across the industry. Under both formulas, the operators' fees are directly tied to hotel performance, and so fee income has declined sharply. This decline has hurt the operators' ability to make the investments of time and money needed to find opportunities and expand market share. Additionally, the decline in performance has severely hurt the equity funds' income and balance sheets, particularly those that have relied on higher levels of leverage. Many no longer have the appetite. or even the ability. to fund new acquisitions.

A third challenge is the so-called “bid/ask” spread that separates buyers and sellers. With the evaporation of debt financing, the decline in RevPAR, and the increase in cap rates, hotel values have plummeted in the minds of buyers. Many owners, though, are in denial. Those that aren't certainly do not find the present time to be an appealing selling opportunity.

Industry observers have predicted that lenders would break the bid/ask stalemate by putting pressure on hotel owners as renewal dates approach and covenant or monetary defaults loom. So far, this prediction has not come to pass. Instead, the lenders appear to be in a surprising mode. we call it “extend, amend, and pretend.”

With the bid/ask spread at an all-time high, the deal flow levels are at an all-time low. The opportunities for hotel companies have been correspondingly scant.

What's a Hotel Company To Do. Buy Debt?

Most hotel companies have been revisiting their business plans and looking for ways to productively engage their underutilized management talent, shore up their income, and expand if possible. See Hotel Times “Three Point Plan to Thrive in 2009” December 2008.

Some owner-operators have felt that a key opportunity is to seek out and buy hotel paper. This opportunity assumes, of course, that the operator's equity partner has funds to invest or that the operator has found a new equity partner in a position to do so. Even so, the number of opportunities to buy hotel paper at deep discounts has been relatively few, as lenders continue to extend, amend and pretend. Anecdotal information suggests that discounts on hotel paper have mostly been less than 20%. At 20%, the discount has not been large enough to justify the additional risks inherent in buying paper. Not all hotel owners will give up their equity without a fight. Some will start lender liability suits or file for bankruptcy protection. Once in bankruptcy, the debt holder's position may be challenged, and the holder may confront unpleasant results. See Hotel Owners, Lenders and Stakeholders Square Off: Equitable Subordination May 2009. Thus the “hotel paper opportunity” has not been a panacea for owner-operators.

Still, the lenders' current frame of mind is unlikely to continue indefinitely. Few believe that RevPAR will increase substantially in 2010. 2011 looks better, but any RevPAR uptick in 2011 will be coming off a very low floor. As this reality takes hold, lenders will have to revalue their hotel loans. When they do, they will have to take their losses. Then, the motivation to extend, amend and pretend should evaporate and action should follow. At that time, perhaps, good opportunities to buy hotel paper may arise.

Asset Management for Lenders and Special Service Providers. A New Marketplace

Many believe that, as in the past, most lenders whose borrowers have defaulted will follow a more traditional route than marketing their paper. they will foreclose, stabilize, and sell their troubled hotel assets. If so, then these lenders will need help. See Hotel Loans in Trouble – Pointers for Lenders.

The Lenders' extend, amend and pretend approach has made it difficult for hotel companies to find lenders who want to engage the help they need. But, as indicated earlier, the lenders' approach is unlikely to continue indefinitely. Most hotel companies believe that, soon, lenders and special service providers will take action and will need help. asset management help.

Additionally, hotel companies are aware that the financing fads of the last five years have multiplied the number of stakeholders in the debt and capital stacks. Even as senior lenders extend, amend and pretend, junior stakeholders might (and should) be less patient. These subordinate parties have seen their interests erode more quickly and substantially than the senior lenders. They are likely to need their own asset managers. perhaps sooner than senior lenders will. to help them make wise choices and protect their investments. The multiplication of layers in the debt and capital stack should correspondingly multiply the needs and opportunities for asset management.

Accordingly, hotel companies are seeking to position themselves to serve these needs and profitably apply their underutilized resources and talent. This rush by hotel companies to re-identify and re-brand as asset management service providers is creating a new competitive market. The competition feels even more acute since there appear to be many hotel companies in the hunt, but the customers are still in hibernation.

Our sense is that hotel companies interested in expanding into this new, still-unfolding market do not yet feel they are on secure footing. Many do not yet know how to best approach lenders and have not really honed their value propositions. This uncertainty is creating confusion for lenders as they are barraged with solicitations. Within the hotel industry, we recognize names and can appreciate the special talents of these people and companies. However, what makes sense to us, as hotel industry insiders, may just be noise to an overwhelmed special service provider or loan credit specialist.

Suggestions for Success

The following are observations that we believe will be helpful in becoming a player in the emerging asset management market and will help your hotel company stand out.

   1. Find and exploit your sweet spot. Identify what it is that you do especially well. If your experience is unique, then initially build your marketing around this obvious point of distinction.

      For example, if you have owned and operated luxury resorts in the Caribbean, then you should target your marketing to lenders who have financed luxury resorts in that region. A lender holding paper on a distressed luxury Caribbean resort will want to give you fair consideration, based on your very targeted knowledge of that asset or asset class. If you were once with the brand, or even had direct experience operating the particular asset, you have a clear marketing advantage, as you will be able to immediately demonstrate where you can provide real value.

   2. Do not over sell. This seems like the same point as the previous one, but it really is different. There is a danger in trying to hold oneself out to be all things to all people. It dilutes your credibility and it undermines the value of your marketing efforts. No one wants to appear desperate. Even if you can asset manage an extended stay hotel and a luxury resort, you lose credibility by marketing for both. If you have no experience in a unique market such as Las Vegas or Hawaii, do not claim to be able to asset manage hotels there. Be honest about where your expertise is and capitalize on that segment. It makes little sense to over promise and under perform. Once you are engaged and have a relationship, then you can market internally to your client that you can cover other asset classes or have other unique capabilities of value. If you are not the right company, then recommend the company you feel is best for the job. In making the referral, you will gain credibility with the lender and are more likely to be trusted and hired by that lender for an engagement that is in your sweet spot. The party receiving the referral should reciprocate.

   3. Leverage your network. Many of you have existing relationships with equity funds and lenders. Let these companies know of your expanded services through the people you are working with. Speak with lawyers and accountants who work within the hotel industry. Lawyers and accountants are expected to provide independent and trustworthy recommendations. If the lawyers and accountants have a good knowledge of your sweet spot, then they can be confident that you will perform well.

   4. Target the right companies. The largest lenders and special service providers have strong barriers to entry. If you do not already have a relationship with a major lender or special service provider, then you have an uphill battle for acceptance. On the other hand regional and local lenders do not have the same institutional relationships and are more likely to engage a new asset management company. Local and regional lenders generally have smaller hotels in their loan portfolios, therefore, the engagements may not be as large or prestigious as with a national lender or special service provider, but there is money to be made while a reputation is developed.

   5. Team up. Be willing to create new alliances with similarly situated companies and with other service firms that might offer unique services. For example, if you do not have construction expertise, then you might consider teaming up with a group that is currently providing construction consulting to your targeted client. Then leverage the existing relationship and share the upside with your new partners. Although law firms, due to ethics rules, may not share fees with you, having a relationship with hospitality specialty counsel can help with your marketing. In this ever changing environment, it will help to demonstrate to potential clients that you have the wherewithal to anticipate needs and services outside of your specialty and have developed relationships with the best providers in the other fields.

   6. Educate the lending and investment community. These new customers need to be convinced that hiring an asset manager is a good investment of time and resources. Individually and collectively, at every opportunity, the lender and investor need to be advised why it is important to have an asset manager representing their piece in the asset. Many lenders and special service providers believe having an asset manager is redundant to their function. It is important that they understand the nuances of branding, market share, deferred capex and many other hotel-specific challenges that can quickly sink their asset and with it their equity.

With over fifty percent (50%) of all hotels anticipated to change hands over the next several years, there will be plenty of work for everyone. The burgeoning asset management community should look to maintain its high standards and credibility by providing the most effective service they can. Then, new and valuable business relationships will develop, the industry's reputation will be enhanced, and the lending community will gain a respect for the industry that will lead to even more opportunities.

Four months ago, the “Employee Free Choice Act”. which would have helped union organizers by eliminating secret ballot elections in favor of accepting signed union cards, increased penalties for employers for misconduct in union organizing campaigns, and provided for arbitrator-dictated terms of an employer's first union contract if bargaining failed. fell short of the votes required to break a filibuster in the U.S. Senate. In Olympia, the “Worker Privacy Act”. which would have limited the ability of employers to tell their side of the unionizing issue. was killed after inappropriate lobbying by organized labor was uncovered by the Seattle Times. See Graham & Dunn Cyber-Graham, March 26, 2009.

In the news this past week are developments on both fronts.

To overcome objections to the effective elimination of secret ballot elections, Democrats in D.C.. in collaboration with organized labor. have reportedly decided to drop the card-check provision in order to capture enough votes to defeat a filibuster. A revised bill is in the works. The bill would drop card-check . . . but would still contain enhanced penalties for employers accused of wrongdoing in opposing union organizing campaigns, and provide for the imposition by a government arbitrator of the terms of a collective bargaining agreement, if an agreement is not promptly reached between the parties. Critics of the proposed legislation, on the management-side of the aisle, argue that the prospect of a government-imposed contract will inflate union demands at the bargaining table, and be a big boost in union organizing to begin with, because a union would then be in a position to promise not just the right to negotiate, but that a contract will actually be obtained (and on terms not dictated by an employer's bargaining leverage).

In Olympia, reports the P-I Online on Monday, July 13, the State Labor Council is turning up the heat on Democrats in state government, again threatening to cut off campaign financing for politicians who oppose passage of legislation supported by organized labor, specifically, the Workers Privacy Act. A key provision in that legislation would prevent employers from making “captive audience speeches”. holding discussions on company time about the pros-and-cons of unions.

A revised federal Employee Free Choice Act is not in final form, but its drafters are reported to be considering giving union organizers access to company property for campaigning, and, like the Washington State labor bill, barring employers from requiring employees to attend “captive audience” meetings.

1. Broker Voting in Director Elections. The SEC approved the New York Stock Exchange's proposed change to Rule 452 to re-classify director elections as “non-routine” matters and thereby prohibit brokers from voting shares for which they receive no voting instructions from the beneficial holder. This rule change impacts all public companies, not just NYSE-listed companies, because the rule applies to all NYSE member brokers; the exchange on which a particular company's stock is listed is irrelevant for purposes of applying the rule. Historically brokers have typically voted uninstructed shares according to the board's recommendations. More recently, some brokers have adopted a “proportional voting” model, under which they vote uninstructed shares in the same proportion as shares for which they receive instructions, which usually results in a strong majority of “retail” shareholder votes in line with the board's recommendations. The net effect of this rule change will be the loss of previously reliable block of voting support generally corresponding to the size of the company's retail shareholder base (since retail voting tends to be very low). Companies with a large retail shareholder base need to consider whether quorums will be threatened (which typically will not be an issue if a “routine” matter under Rule 452, such as ratification of auditors, is included on the ballot), and if they have a majority voting standard for director elections, whether the loss of broker votes may place directors at risk. The revised rule is effective for shareholder meetings occurring on or after January 1, 2010.
2. New Disclosure Rules. The SEC voted to propose new or revised disclosure rules in the following areas:
• Risk Analysis of General Employee Compensation Programs. If the risks arising from the incentives driven by general employee compensation policies and programs could have a material effect on the company, the Compensation Discussion & Analysis (CD&A) would need to discuss and analyze those programs on a company-wide basis (i.e., not limited just to the named executive officers).
• Compensation Consultant Conflicts of Interest. If the board or compensation committee retains a compensation consultant that also provides other services to the company, the company would need to disclose the fees for the board/compensation committee advice, the other services and related fees, management's role in retaining the consultant for other services and whether the board or compensation committee approved the other services.
• Equity Compensation Reporting. Equity compensation awards now would be reported in the Summary Compensation Table and the Director Compensation Table as the aggregate grant date fair value of awards granted during the fiscal year, as opposed to the amount expensed during the fiscal year for all outstanding awards.
• Board Leadership Structure. Companies would be required to discuss in their proxy statements the reasons for their particular board leadership structure (i.e., insider Chair separate from CEO, Chair/CEO combination, independent Chair), why that structure is appropriate for the company, and any impact of the board leadership structure on the board's risk management function.
• Director Qualifications. Director and nominee biographies in proxy statements would need to include disclosure of the experience, qualifications, attributes and skills that qualify the director or nominee to serve on the board and the committee(s) on which they serve. Biographies also would need to disclose all public company directorships held during the last five years, as opposed to only current directorships as is presently required.
• Form 8-K Reporting of Shareholder Meeting Results. Companies would be required to report voting results from shareholder meetings within four business days under a new Item of Form 8-K. Currently, voting results are not required to be reported until the Form 10-Q for the quarter during which the meeting occurred.
3. Proxy Solicitation Rule Changes. The SEC proposed amendments that would allow shareholders and other third parties to distribute unmarked copies of the company's proxy card, along with their own views, without having to file their own proxy statements. This would allow, for example, dissidents to send proxy cards with “vote no” literature.
4. Say on Pay for TARP Companies. The SEC proposed rules to require public companies that are TARP participants to include in their annual proxy materials a separate non-binding proposal to approve executive compensation, and disclose what effect the vote will have. This rule proposal was required by the stimulus bill and does not materially change public TARP companies' obligations in this area, which were already effective for the 2009 proxy season. Notably, the SEC clarified a point of ambiguity in the original legislation: that “smaller reporting companies”, which are not required to include a CD&A in their proxies, do not need to include one merely to satisfy the statutory language that the advisory vote be on executive compensation as disclosed in the proxy statement, including the CD&A (among other disclosures).

Treasury Actions

The Treasury Department issued “interim final” rules on executive compensation and corporate governance for TARP companies, which are immediately effective but also subject to public comment for 60 days and possible revision. The interim final rules clarified and expanded upon some provisions of the February 2009 stimulus bill, left other provisions vague and ambiguous and used the authority delegated to Treasury to impose some new requirements not contemplated by the original legislation. Some of the more notable provisions of the rules are:

• Golden Parachute Payment Restrictions. These restrictions cover the “senior executive officers” (the CEO, CFO and next three most highly compensated executives) (SEO's) and the next five most highly compensated employees (HCE's). Severance in any amount is prohibited for this group, as are any payments triggered by a change in control. In addition, there can be no acceleration of any vesting (such as under outstanding stock or option awards, or supplemental retirement benefits) as a result of termination or change in control.
• Bonus, Incentive and Retention Payment Restrictions. TARP companies may not accrue or pay any bonus, incentive or retention payment to a group of employees that depends on the amount of government investment. The rules provide an exception for restricted stock that cannot vest sooner than two years and otherwise becomes transferable in 25% increments as a like percentage of government investment is repaid. Another exception applies for grandfathered arrangements that existed on February 11, 2009 and provide a legally binding right to a specific payment. The definitions of bonus, incentive and retention awards are broad; for example, a supplemental retirement benefit subject to vesting can be considered a retention award.
• Gross-Ups. Tax gross-ups are prohibited for the SEO's and the next 20 HCE's. Like the restriction on golden parachute payments, there is no carve-out for pre-existing arrangements.
• Perquisites. Companies must not only disclose but also justify perquisites with a value over $25,000 provided to anyone covered by the bonus restriction.
• Clawback and Luxury Expenditures Policies. TARP companies must ensure that all incentive compensation to the SEO's and the next 20 HCE's is subject to clawback if the underlying performance metrics were inaccurate. TARP companies also must adopt a luxury expenditures policy covering expenditures for entertainment and events, transportation services, office renovations and other similar matters.
• Say on Pay for Non-Public Companies. It still remains unclear whether non-public TARP companies are required to include a Say on Pay proposal in their proxy statements. The original legislation, SEC rules and Treasury rules all tie the advisory vote to executive compensation disclosure provided under SEC rules. It seems reasonable for non-public TARP companies, which are not required to provide any executive compensation disclosure under SEC rules, to conclude that a Say on Pay vote is not required because it would be meaningless in the absence of anything to vote on, and that a requirement for Say on Pay tied to SEC disclosure does not bootstrap them into having to provide SEC-like executive compensation disclosure. This latter position is supported by analogy to the SEC's clarification that smaller reporting companies do not need to prepare a CD&A merely because the Say on Pay requirement references CD&A among other disclosures. This issue will need to be clarified.
• Special Master for Executive Compensation. Treasury has created the Office of the Special Master for TARP Executive Compensation. The Special Master is charged with carrying out Treasury's obligation to review prior compensatory payments by TARP companies to determine whether they were inconsistent with the purposes of TARP or contrary to the public interest. The Special Master also has authority to issue interpretive opinions on executive compensation, either upon the request of a TARP company or on his own volition.

Graham & Dunn Franchise Attorneys Douglas C. Berry, David M. Byers, and Daniel J. Oates authored the following article, published in Summer 2009 in the Seattle University Law Review, Vol. 32, Pg. 811.  Cited as Berry, Byers & Oates, State Regulation of Franchising; the Washington Experience Revisited, 32 Seattle U. L. Rev. 811 (2009).  Posted with permission.

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On June 12, 2009, Facebook, the online social networking site, began allowing its millions of users to create personalized URLs for their Facebook pages. These personalized "usernames" may incorporate trademarks that are already in use.

Allowing your trademark to be used as a Facebook username could dilute the value of the mark and your ability to protect it.  Facebook has recognized this, and is providing a method by which trademark owners can call their registered trademarks to Facebook's attention. While it is not yet clear how Facebook decides which trademarks are to be entitled to protection, the aim of the program is for qualifying trademarks to be protected from being registered as usernames by Facebook users.  Facebook also has a mechanism whereby a trademark owner who mark does get registered as a Facebook username can request that Facebook take corrective action.

Click here to view the Facebook trademark registration form.

For more information on protecting your trademark, contact one of our trademark attorneys: Robert Cumbow (rcumbow@grahamdunn.com); Kathleen Petrich (kpetrich@grahamdunn.com); and Michael Atkins (matkins@grahamdunn.com).

The hotel industry's year-over-year declines continued in the second quarter of 2009. Demand is leveling out at a lower baseline, and the hotel industry is adjusting to a new reality.

Hotel owners, lenders and stakeholders are now beginning to square off to determine who will take a haircut and who will be squeezed out altogether. This process will not be quick or easy. As this process lurches through its early stages, an issue has temporarily taken center stage: equitable subordination.

Earlier this month, In In re Yellowstone Mountain Club, the bankruptcy court subordinated Credit Suisse's $375 million secured loan. How did this happen? Will it happen again in other cases? What are the lessons?

The Yellowstone Mountain Club LLC

The Yellowstone Club development began in late 1999, touted as the world's only private ski and golf community. In 2005, Credit Suisse made a secured loan of $375 million to the then-owner of the development, Yellowstone Mountain Club, LLC (the “Debtor”). Credit Suisse made the loan under a “new loan product” referred to as a “syndicated term loan.” A Credit Suisse loan officer described it as akin to a “home-equity loan” for commercial real estate owners.

Last November the Debtor filed a Chapter 11 bankruptcy. The unsecured creditors committee and others faced off against Credit Suisse, attacking its secured claim on a number of grounds. Then, after motions and hearings, the bankruptcy court on May 13 entered an interim order subordinating Credit Suisse's $375 million loan to the claims of unsecured creditors. In other words, the unsecured creditors and post-petition lenders will be paid ahead of Credit Suisse, even though Credit Suisse has a first lien mortgage on the development.

A New Loan Product Built on Shaky Ground

Credit Suisse's “new loan product” did work much like a home equity loan. it allowed development owners to take equity out of their developments and use the proceeds freely for other purposes. As the Yellowstone bankruptcy court described it:

“[The product allowed] owners of luxury second-home developments the opportunity to take their profits up front by mortgaging their development projects to the hilt. Credit Suisse would loan the money on a non-recourse basis, earn a substantial fee, and sell most of the credit to loan participants. The development owners would take most of the money out as a profit dividend, leaving their developments saddled with enormous debt. Credit Suisse and the development owners would benefit, while their developments. and especially the creditors of their developments. bore all the risk of loss.”

The court believed that, like some securitized home equity loans in recent years, the Credit Suisse product was based on inflated and manipulated property valuations. The court noted that Credit Suisse, to support the product, had developed “a new form of appraisal methodology,” termed “Total Net Value” methodology. This new methodology “relied almost exclusively on the Debtors' future financial projections, even though such projections bore no relation to the Debtors' historical or present reality.” The court stated that the methodology did not comply with FIRREA, and then pointedly remarked that this fact “was not important to Credit Suisse because Credit Suisse was seeking to sell its syndicated loans ‘to non bank institutions'.” The court concluded that the product “enriched Credit Suisse, its employees and more than one luxury development owner, but it left the developments too thinly capitalized to survive…. [T]hey were doomed to failure once they received their loans from Credit Suisse.”

“Let the Chips Fall Where They May”

The Yellowstone court found that the Credit Suisse product had this same “dooming” effect on the Yellowstone Club development. Of the $375 million loan proceeds, “approximately $209 million was transferred out of the Yellowstone Club” to the Debtor's primary equity owner. The court obviously believed that Credit Suisse callously disregarded that the loan and the expected disbursements would leave the project without sufficient capital to survive. Credit Suisse “had not a single care how [the developer] used a majority of the loan proceeds.” It turned “a blind eye to Debtors' financial statements,” and its due diligence was “all but non-existent.” The only plausible explanation for Credit Suisse's actions, the court said, was that it “was simply driven by the fees it was extracting from the loans it was selling, and letting the chips fall where they may.”

Building to a crescendo, the court concluded:

“Unfortunately for Credit Suisse, those chips fell in this Court with respect to the Yellowstone Club loan. The naked greed in this case combined with Credit Suisse's complete disregard for the Debtors or any other person or entity who was subordinated to Credit Suisse's first lien position, shocks the conscience of this Court. While Credit Suisse's new loan product resulted in enormous fees to Credit Suisse in 2005, it resulted in financial ruin for several residential resort communities. Credit Suisse lined its pockets on the backs of the unsecured creditors. The only equitable remedy to compensate for Credit Suisse's overreaching and predatory lending practices in this instance is to subordinate Credit Suisse's first lien position to that of CrossHarbor's superpriority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors.”

Why “Equitable Subordination?”

Section 510(c) of the Bankruptcy Code states:

[T]he court may - (1) under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim… ; or (2) order that any lien securing such a subordinated claim be transferred to the estate.

The subordination of a claim based on equitable considerations generally requires three findings: “(1) that the claimant engaged in some type of inequitable conduct, (2) that the misconduct injured creditors or conferred unfair advantage on the claimant, and (3) that subordination would not be inconsistent with the Bankruptcy Code.” Benjamin v. Diamond (In re Mobile Steel Co.) 563 F.2d 692, 699-700 (5th Cir. 1977).

Although the general theory of equitable subordination appears to have a broad reach, its use has been rare and reserved for extraordinary circumstances. Normally, before a non-insider claim is subordinated, “egregious conduct” must be “proven with particularity.” Sharp dealings aren't enough. one must prove that the claimant “is guilty of gross misconduct tantamount to fraud, overreaching or spoliation to the detriment of others.” In re First Alliance Mortg. Co., 497 F.3d 977, 1006 (9th Cir. 2006).

The Yellowstone court obviously felt that Credit Suisse's conduct was egregious enough, finding that its actions “were so far overreaching and self-serving that they shocked the conscience of the Court.” What was so egregious? Boiling down the facts, Credit Suisse in essence: 1) made a loan knowing that a large part of the money would be taken out of the project and used elsewhere; 2) planned to syndicate the loan to others; 3) was motivated to ignore red flags because of the large fees it would earn; 4) based its loan on a questionable appraisal methodology; and 5) over-leveraged the project.

Will “Equitable Subordination” Happen in other Cases?

The Yellowstone court freely pointed out that Credit Suisse's “new loan program” has been marketed to other master-planned residential and recreational communities, “such as Tamarack Resort, Promontory, Ginn, Turtle Bay, and Lake Las Vegas.” Like the loan to the Yellowstone Club, each of those other developments “received a syndicated loan from Credit Suisse's Cayman Island branch, which allowed the equity holders in said entities to take sizeable distributions from all or part of the Credit Suisse loan proceeds.”

Those other well-known projects are obviously outside of the Yellowstone court's jurisdiction. The court, however, essentially invited stakeholders in those other developments to make similar attacks on the loans Credit Suisse made to those projects:

“Numerous entities that received Credit Suisse's syndicated loan product have failed financially, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay and Ginn. If the foregoing developments were anything like this case, they were doomed to failure once they received their loans from Credit Suisse.”

Clearly, whenever Credit Suisse's “new loan product” was involved in a project, stakeholders will now be able to attack the loan on the basis of equitable subordination.

But the argument likely will reach loans from other lenders. In the real estate bubble of recent years, many loans have the earmarks that “shocked the conscience” of the Yellowstone court. Under the court's holding, a loan will be susceptible to attack if it has the following attributes:

• It allowed the equity owner to take money out of the project;
• It was intended to be securitized;
• It allowed the lender to earn large fees;
• It was based on potentially questionable appraisals or appraisal methods; and
• It overleveraged the project.

These circumstances have a familiar ring to many in the hotel industry. The last two bullets might seem somewhat unique to the Yellowstone facts. Most loans in recent years likely were not based on Credit Suisse's “Total Net Value” methodology. But given the demand and value declines of the last nine months, 20-20 hindsight can make many appraisals look questionable. And at today's values, many. if not most. development projects look overleveraged.

What are the Lessons?

The industry will learn much as it works through the current extraordinary circumstances. The Yellowstone case can provide many lessons, some broad and philosophical, others practical and technical. A few of the more practical take-aways to consider:

• For principal owners: Did you take money out of your project and overleverage it? If so, investors and creditors may have a basis to recover the funds you received. They may also seek to subordinate the secured loan that served as the source of the distributions. Subordination may trigger certain of your guaranty obligations to the lender.
• For investors: If the principal owners took money out of your project and overleveraged it, you may have a basis to recover the money and subordinate the loans that funded the distributions.
• For lenders: If Credit Suisse's “new loan program” seems at all similar to loans in your portfolio, take into account the possibility of equitable subordination and other attacks. The banking industry is not popular at this time, and judges may be looking for ways to address what is viewed as “predatory lending practices” and other “abuses” that might be blamed for the financial meltdown. Be sensitive to these issues in the foreclosure process, and, if possible, seek ways to obtain a reasonable recovery outside of the free-fire zone of bankruptcy court.
• For buyers: Understand that, if you buy a loan from a lender at a discount, you must look carefully at the circumstances. A first lien mortgage may be susceptible to attack and may present unpleasant surprises.

Meeting the Needs of the Industry

The hotel industry faces daunting challenges in this time of stress. To help clients successfully address them, in January 2009 Graham & Dunn announced the formation of its Hotel Asset Resolution Task Force. See Graham & Dunn Establishes…. HART Force employs Graham & Dunn's nationally recognized Hospitality Industry Group. Its members have assisted the industry since 1990, and, in previous down-cycles, have successfully addressed many of the same legal issues and challenges facing the industry today. HART Force is further enhanced and combined with the extensive banking industry resources of Graham & Dunn's Financial Services Group and the firm's bankruptcy/insolvency, real estate, labor and employment, litigation, and construction practices.

HART Force is led by Hospitality Industry Group partners Irvin W. Sandman and Russell C. Savrann. It provides clients advice about, and access to, the Hospitality Industry Group's wide-ranging contacts and resources in the hotel industry. These resources include advisory, economic, and disposition services and companies that can assist with a broad range of segments and brands, as well as highly-regarded independent hotel management companies.

HART Force members continue to inform the industry with articles on relevant topics. Most recently Mr. Sandman and Mr. Savrann wrote on the special challenges for hotel lenders. See Hotel Loans in Trouble. Pointers for Lenders.

Introduction

As we make our way through and eventually out the other side of the financial crisis, Congress, the SEC, the Treasury Department and other governmental authorities are poised to implement, and expand beyond troubled financial institutions, major pillars of the shareholder activist agenda and new regulations on executive compensation. At the state level, Delaware has enacted, and many other states also can be expected to adopt, significant corporate governance reforms. The remainder of 2009 is likely to bring new rules and legislation with respect to some or all of the following major issues.

• Independent Board Chair. On May 19, 2009, Senators Charles Schumer and Maria Cantwell introduced the “Shareholder Bill of Rights Act of 2009”, which would require all public companies to have an independent Chair of the Board of Directors. On a separate track, SEC Chairman Schapiro has stated that the SEC will consider requiring proxy disclosure of the reasons for a company's particular Board leadership structure (i.e., insider Chair separate from CEO, Chair/CEO combination, independent Chair).
• Majority Voting and Declassified Boards. The proposed Shareholder Bill of Rights Act of 2009 would require public companies to adopt majority voting in uncontested elections, and to place the entire slate of directors up for election each year.
• Proxy Access. “Proxy access” refers to the ability of shareholders to include their own board nominees in the company's proxy statement. On May 20, 2009, the SEC approved the publication of proposed rules implementing proxy access for all public companies. Statements at the SEC's open meeting and the SEC's press release (available here) reveal the following core tenets of the new rule proposal:
  • To be eligible, a shareholder would need to own, for a minimum of one year, an amount of shares that varies depending on the size of the company: 1% for large accelerated filers ($700 million public float or more), 3% for accelerated filers (public float of $75-700 million) and 5% for non-accelerated filers (public float less than $75 million).
  • Shareholders could aggregate ownership to reach the required threshold.
  • Shareholder nominees in the aggregate could represent no more than the greater of one nominee or 25% of the company's board, with preference given to the earliest nomination, not the highest share ownership.
  • Nominees must be independent under applicable stock exchange requirements.
  • Nominating shareholders must file certain information on a new Schedule 14N, and certify that they are not seeking a change in control of the company or to gain more than minority representation on the board.
  
  The proposed rules have not yet been published and will be subject to public comment and revision, and it is important to remember that proxy access has twice been rejected by the SEC in the last decade. However, the recent change in SEC leadership combined with political pressure arising from the financial crisis suggests that proxy access in some form is likely to be implemented in time for the 2010 proxy season.
  
  Momentum behind proxy access is underscored by proposed federal legislation and recent state action. The proposed Shareholder Bill of Rights Act of 2009 directs the SEC to adopt rules establishing proxy access. Delaware enacted amendments to its General Corporation Law in April 2009 permitting the adoption of proxy access through bylaw amendments. Other states, including Washington, are currently studying the issue and are likely to follow Delaware's lead.
• Risk Committee of the Board. The proposed Shareholder Bill of Rights Act of 2009 would require public company boards to create a risk committee of independent directors with responsibility to establish and evaluate the company's risk management practices.
• Say on Pay. The February stimulus bill required all financial institutions participating in the U.S. Treasury's Troubled Asset Relief Program (TARP) to provide shareholders with an annual non-binding vote on executive compensation. The proposed Shareholder Bill of Rights Act of 2009 would extend that requirement to all public companies.
• Other Executive Compensation Issues. Treasury will soon release regulations implementing the executive compensation provisions of the February 2009 stimulus bill. SEC Chairman Schapiro has stated that the SEC is considering a number of changes to executive compensation disclosure rules. In addition, the White House, the Federal Reserve and the SEC reportedly are working on an initiative to broadly regulate compensation at a wide range of financial institutions, both public and private, and without regard to whether an institution has received federal assistance. Here are some of the issues reportedly being addressed.
  • Golden Parachutes. The stimulus bill defined the first dollar as “golden” by prohibiting any severance payments to executives of TARP participants, even several weeks or months of salary according to time-in-service formulas applicable to all employees. The language of the statute was vague, and we can expect the upcoming Treasury regulations to clarify its scope. The proposed Shareholder Bill of Rights Act of 2009 would require merger proxies to include a non-binding shareholder advisory vote for any type of compensation triggered by the underlying transaction.
  • Excessive Risk. TARP participants are already required to take a number of actions aimed at ensuring that compensation programs do not encourage excessive risk-taking. The upcoming Treasury regulations will clarify some of these requirements. The SEC may now require all public companies to disclose their risk management practices, both generally and in the context of setting compensation. The new White House-led initiative to reform compensation practices at financial firms reportedly will include restrictions on pay practices that are deemed to threaten the “safety and soundness” of the institution, such as paying loan officers on volume rather than loan quality. The risk committee that would be required by the proposed Shareholder Bill of Rights Act of 2009 conceivably could have some overlapping jurisdiction (with the compensation committee) over compensation practices.
  • Other Executive Compensation Disclosure. Chairman Schapiro has stated that the SEC will consider requiring proxy disclosure of a company's overall compensation approach, not just the approach for top executives, and disclosure related to compensation consultant conflicts of interest. The SEC reportedly also is considering amending the Summary Compensation Table to include the grant date fair value of awards granted during each year, rather than the aggregate compensation expense recognized for all awards during the year.
• Other State Law Governance Reforms. In addition to the proxy access amendments discussed above, Delaware enacted additional significant corporate law amendments which other states also can be expected to adopt. These other amendments include:
  • Separate Record Date for Voting Rights. Delaware corporations now may (but are not required to) provide for a record date for shareholders entitled to vote that is separate from the record date for shareholders entitled to notice of the meeting. This allows the voting record date to be closer to the meeting date, and thereby addresses concerns that some shareholders can influence the outcome of an election without holding any economic interest in the company.
  • Reimbursement of Proxy Contest Expenses. Delaware corporations now may (but are not required to) provide in their bylaws for the reimbursement of expenses incurred by shareholders in waging successful proxy contests, along with any conditions for reimbursement such as the percentage of the vote received by the shareholder nominee.
  • Director and Officer Indemnification. The Delaware amendments protect indemnification and related expense advancement rights provided under a company's charter documents from being stripped or reduced after an event giving rise to indemnification or expense advancement occurs.

Increasing Influence of Proxy Advisory Firms

A likely consequence of the implementation of some or all of the reforms described above is to increase the influence of proxy advisory firms such as ISS/RiskMetrics. For example, if all public companies are subject to Say on Pay, majority voting and declassified boards, all compensation committees could face increased pressure to conform executive compensation programs to ISS guidelines or risk being targeted for ouster at the next annual meeting. Nominating committee members similarly could face increased pressure with respect to governance issues.

Public Company Action Items

• Independent Board Chair. If they have not done so already, public companies with an executive Chairman should begin contingency planning for an independent Board Chair in case that provision of the proposed Shareholder Bill of Rights Act is enacted. If an independent Chair is not legislated, public companies should anticipate the need for proxy disclosure explaining their choice of Board leadership.
• Proxy Access. Public companies should assess their shareholder base to understand which shareholders, either alone or in combination with other large shareholders, would have a nomination right under the proposed proxy access rules, and whether any of those shareholders opposed incumbent directors in recent elections.
• Review Executive Compensation Programs. Public companies should conduct a fresh review of executive compensation programs and consider whether any may put compensation committee members at risk, particularly those that draw the heaviest criticism such as tax gross-ups, golden parachutes and perquisites.
• Compensation Consultant Conflicts. Public companies with a compensation consultant that serves both the compensation committee and management should anticipate new disclosure requirements regarding potential conflicts of interest.

Action Items for All Companies

• Banks and Other Financial Institutions: Review Compensation Programs. All banks and other financial institutions should review their compensation programs for practices that may be considered to promote excessive risk taking, such as paying loan officers based on volume, in light of the initiative reportedly underway at the White House, Federal Reserve and SEC.
• Consider Various State Law and Public Company Reforms. Many if not most states can be expected to follow Delaware's lead with respect to the governance reforms noted above. Both public and private companies should begin to consider how the reforms enacted in Delaware may affect them if enacted in their state. In addition, private companies that model public company governance structures as a best practice, or in anticipation of a public offering, may wish to implement some or all of the reforms applicable to public companies.

Conclusion

It is unclear whether, and in what form, each of the proposed corporate governance reforms discussed above ultimately may be implemented. However, significant momentum seems to be building toward the adoption of many if not all of them. We will publish further updates on these issues as developments warrant.

In the meantime, please contact your usual Graham & Dunn attorney or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com), Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com), or Bart E. Bartholdt (206.340.9647 or bbartholdt@grahamdunn.com) if you should have any questions or wish to discuss these issues further.

Washington residents may need to review their estate plans because of changes in estate tax laws. The current Washington state estate tax is no longer tied to the federal estate tax system. This unlinking of the tax systems means that estates of Washington residents may face unanticipated tax liabilities.

Many married couples still have Wills that were drafted when the two estate tax systems were integrated. Those Wills were designed so no estate tax would be due upon the death of the first spouse to die, but may now result in the surviving spouse paying up to $170,000 to the State of Washington. The Wills can be modified to delay that tax.

An unmarried person who passes away in 2009 with a taxable estate of $3,500,000 would pay no federal estate tax, but would pay up to $170,000 of State of Washington estate tax. If an individual is able to make lifetime gifts, this tax could be eliminated.

The chart below compares the amounts that can pass free of estate tax under both systems.

Year of Death	State of Washington Statutory Deduction	Federal Applicable Exclusion Amount
Between January 1, 2006 and December 31, 2008	$2,000,000	$2,000,000
2009	$2,000,000	$3,500,000
2010	$2,000,000	REPEAL FOR ONE YEAR ONLY
2011 and thereafter	$2,000,000	$1,000,000

Here are samples of the tax payable by the estate of an unmarried Washington resident who dies in 2009.

Federal Taxable Estate	State of Washington Estate Tax	Federal Estate Tax	Total Estate Tax
$3,500,000	$170,000	0	$170,000
$5,000,000	$390,000	$499,500	$889,500
$10,000,000	$1,255,000	$2,360,250	$3,615,250

Make sure that your estate plan takes into consideration the increases in the amounts that can pass free of estate tax and the coordination required because of the differences in the federal and State of Washington estate tax systems. Graham & Dunn's wealth management attorneys can review your current estate plan to make sure that it is flexible and works to your advantage.

If you have any questions or wish to discuss this issue further, contact Marcia K. Fujimoto at 206.340.9637 or mfujimoto@grahamdunn.com, Wendy S. Goffe at 206.340.9633 or wgoffe@grahamdunn.com or any of the members of Graham & Dunn's Wealth Management Team.

Jeffrey Beaver¹
May 5, 2009 

At one end of the spectrum regarding regulatory takings in the environmental context, regulations are treated as presumptively valid exercises of a government's police powers^.2  At the other end of the spectrum, you find regulations that clearly go “too far”³ and are invalid or amount to a taking.  For those of us practicing in the middle, we are more likely to face an environmental regulation that diminishes the land value but not to the level found in Lucas v. South Carolina Coastal Commission.⁴

From Police Power to Regulatory Takings

So why are some regulations that diminish value not treated as a compensable taking?  The simple answer is that regulations are considered within the scope of the slate's police powers.⁵  Early takings jurisprudence treated police powers as being limited to the regulation of nuisances.⁶  Generally such regulations were pro-active and aimed at preventing undesirable actions.  Since Village of Euclid v. Amber Realty Co.,⁷ the modern view of the state's police power is that the power is a broad regulatory power which encompasses any regulation aimed at the health, safety, and welfare of the state.  At its most extreme, this police power has been argued to be so broad that if the regulation is deemed valid then landowners are not entitled to compensation for their losses.  However, the common interpretation of police powers is that it amounts to the government's general regulatory power-so long as the government exercises this power for valid purposes.

On the other end of the spectrum, certain regulations are treated as a per se taking requiring compensation.  These regulations fall into two categories⁸:

1. Physical appropriation or invasion under Loretto v. Teleprompter Manhattan CATV Corp.⁹;
2. Total regulatory taking under Lucas.

We know that any regulation which requires a permanent and physical occupation of the property is a taking regardless of the actual dollar damage.¹⁰  Even if the regulation increases the value of the property it remains a taking, however, the amount of compensation due may be nominal.¹¹

Under the Lucas total regulatory taking rule, if the regulation denies all economically viable use of the property leaving the property “economically idle,” then the regulation amounts to a taking.¹²  In a 2002 opinion, the Court clarified that the per se rule applies to the parcel-as-a-whole and that the per se rule requires a 100% diminution of value, not 95%.¹³  Further, a regulation must be permanent and not temporary for the Lucas analysis to apply.¹⁴

While it is important to understand the outer limits of the police power and takings, most of our clients will face regulations that fall in the middle: someplace between a clearly valid exercise of the police power and a categorical taking.

Partial Takings: The Middle Ground

For regulations that result in a partial taking, Lingle v. Chevron U.S.A., Inc.¹⁵ affirmed the appropriateness of a Penn Central v. City of New York¹⁶ analysis.  Under Penn Central, courts are to review takings claims based on three well known factors:  (1) the economic impact of the regulation on the claimant; (2) the character of the government regulation; and (3) the regulation's interference with investment-backed expectations.¹⁷  The Penn Central Court rejected the landowner's claim that the landmark status caused a loss of value of air rights by citing that, in the evaluation of a takings claim, the Court will not segment the property but rather will evaluate the extent of the interference on the entire parcel.¹⁸  As for the landowners' claim that they are being forced to bear a public burden, the Court rejected this noting the city's landmark law is applied to several structures throughout the city.¹⁹  The purpose of these factors is similar to the Loretto and Lucas analyses in that the “focus [is] on the severity of the burden that the government imposes upon private property rights.²⁰

Lingle also settles that the “substantially advances a legitimate state interest” test from Agins v. City of Tiburon²¹ is not a valid method of determining whether a taking has occurred.²²  The reason behind disavowing the Agins test is that the courts should evaluate regulatory takings based on the “magnitude or character of the burden a particular regulation imposes upon private property rights.²³  Applying a Penn Central analysis avoids the circumstance where a landowner who is burdened by an effective regulation has not suffered a taking, while a landowner who is also burdened, but by an ineffective regulation, has suffered a taking.²⁴  As the Lingle court notes, it is untenable to decide whether a regulation “takes” by virtue of its ineffectiveness.²⁵

Most cases will be subject to the three-factor Penn Central analysis.  Cases involving a 100% diminution of value will be analyzed under Lucas.  Cases involving a physical invasion will be analyzed under Loretto.

For more information on Regulatory Takings or Litigation contact Jeffrey A. Beaver at jbeaver@grahamdunn.com or 206.340.9652.  This article is available for download as a .pdf.

Notes:

1. Jeffrey Beaver is a shareholder at Graham & Dunn PC in Seattle, Washington.  This article is adapted from remarks Mr. Beaver delivered in August 2007 at the ABA Annual Meeting in San Francisco.
2. See Village of Euclid v. Amber Realty Co., 272 U.S. 365 (1926). 
3. Penn. Coal Co. v. Mahon, 260 U.S. 393, 415 (1926).
4. 505 U.S. 1003, 1019 (1992).  Lucas reversed prior precedent that nuisance exception regulations were not a taking.  See 2A Nichols on Eminent Domain § 6.01[13][c] (Rev. 3d ed. 2004).
5. Penn Coal, 260 U.S. 393.
6. 2A Nichols on Eminent Domain §§ 6.01[7], 6.01 [2].
7. 272 U.S. 365 (1926).
8. Lingle v. Chevron, Inc., 544 U.S. 528, 538 (2005).
9. 453 U.S. 419 (1982).
10. Id.; Burke, Barlow, Understanding the Law of Zoning and Land Use Controls § 3.0I (2002).
11. Burke, Barlow. Understanding the Law of Zoning and Land Use Controls § 3.01 (2002).
12. Lucas, 505 U S. at 1019.
13. Tahoe-Sierra Preservation Council, Inc., v. Tahoe Regional Planning Agency, 535 U.S. 302 (2002).
14. Id.
15. 544 U.S. 528, 538 (2005).
16. 438 U.S. 104 (1978).
17. Penn Central, 438 U.S. at 124.
18. Id. at 130-31.
19. Id. at 134-35.
20. Lingle, 544 U.S. at 539.
21. 477 U.S. 225, 260 (1980).
22. Lingle, 544 U.S. at 542.
23. Id.
24. Id. at 543.
25. Id. While Lingle did away with the Agins test, Nollan v. California Coastal Commission, 483 U.S. 825 (1987) and Dolan v. City of Tigard, 512 U.S. 374 (1994) remain good law when analyzing exactions. The question posed by Nollan and Dolan was not did the regulation substantially advance some purpose but whether the exactions substantially advanced the same interests that the permit authority asserted were the grounds for denying the permits in the first place.  See 544 U.S. at 547-48.
    

An ongoing series on new emissions legislation brought to you by the Graham and Dunn Natural Resource and Manufacturing Team

Without question, the cutting-edge question in trademark law for the last several years has been whether keyword search advertising harms trademarks in a way that could sustain a lawsuit. A secondary issue is whether such a lawsuit may be brought against the advertiser only or against the search provider as well. These issues are the subject of a long-awaited opinion that the Second Circuit Court of Appeals handed down recently in the long-fought case of Rescuecom v. Google, 06-4881-cv (2d Cir., Apr. 3, 2009).
 
What is keyword search advertising?

Keyword search advertising is a form of advertising whereby a search engine sells advertising placement to an advertiser based on specific words or phrases that a user of the search engine enters as search terms. The advertiser who enters into this kind of arrangement with a search engine benefits by having its ad or sponsored link displayed whenever any of the search terms it has chosen are entered by a user. even if those search terms include the trademarks of the advertiser's competitors.

What is the dispute about?

At core, the dispute is about whether, in a keyword search advertising arrangement, the search engine or the advertiser or both are infringing the rights of competitors whose trademarks are on the list of keywords the advertiser has chosen to trigger its ads. Those who oppose this practice say that it infringes trademark rights because consumers who enter certain search terms and are then subjected to a search results display that also includes ads and sponsored links placed by others are likely to be confused as to the relationship between the party whose trademark they entered as a search term and the parties who placed the ads and links. Those who defend the practice say that it is nothing more than comparative advertising, similar to placing products on shelves next to competing products, or advertising that “if you are looking for this kind of product, take a look at ours.” Supporters further assert that consumers know the difference between search results and advertising, and are unlikely to be confused; indeed, the Federal Trade Commission has promulgated rules requiring search engines to make advertisements and sponsored links visually different from search results precisely to avoid such deception or confusion. Another argument is that, as a matter of economic policy, consumers searching for information on a particular type of product are likely to benefit from receiving information about similar competing products.

What have the courts held?

Thus far, no court has found a search provider liable for engaging in the practice of keyword search advertising, though individual advertisers have been found in some cases to be liable where the advertisements or links triggered by the chosen keywords were in themselves deceptive.

Why haven't search providers been found liable?

To be liable for trademark infringement under the Lanham Act (the trademark and unfair competition statutes of the United States), a defendant must be using the plaintiff's trademark, or a confusingly similar mark, in connection with an offering of goods or services in commerce. Search engines who have been sued by trademark owners over the practice of keyword search advertising have pointed out that a court may not consider the merits of the trademark owners' claims unless it is established that the defendant search engines are in fact “using” the plaintiffs' trademarks as the term “use” is meant in the Lanham Act. The issue of whether keyword search advertising is trademark infringement may not be addressed until the court is satisfied that the “use” requirement has been met. Keyword search advertising cases have thus been so far diverted into the question of whether or not this practice is a “use” of a trademark sufficient to trigger potential liability under the Lanham Act.

Most courts that have addressed the issue have found that it is a use of the plaintiff's trademark, and have moved on to consider likelihood of confusion, which is the test of trademark infringement. But even those courts that surmounted the “use” hurdle still have held that the practice of keyword search advertising is not, in itself, trademark infringement, and may result in liability only against an advertiser whose ads are themselves deceptive, either because they use the plaintiff's trademark or because they use no trademark at all, encouraging consumers to assume that the ads are associated with the company whose trademarks the consumer used as search terms.

However, until the recent Rescuecom ruling, the courts of the Second Circuit had held uniformly that keyword search advertising does not constitute a “use” of the plaintiff's trademark. Thus the new ruling resolves a disparity between the Second Circuit and the rest of the circuits.

Why did the Second Circuit courts find that keyword search advertising is not a “use” of a trademark?

In an earlier case, dealing not with keyword search advertising but with adware-triggered pop-up ads, the Second Circuit had held that the Lanham Act's “use” requirement was not satisfied because the purveyors of pop-up advertising did not display any trademarks of others in connection with an offering of goods or services in commerce, and that often the strings of keystrokes with which users triggered pop-up ads did not consist of or even contain the trademark of the aggrieved competitor. 1-800 Contacts v. WhenU, 414 F.3d 400 (2d Cir. 2005). Although the Second Circuit specifically distinguished its WhenU holding from the keyword search advertising type of situation, district courts of the Second Circuit began to apply the same analysis to keyword cases. One of those “no use” holdings, the Rescuecom case, was appealed. It was argued to the Second Circuit Court of Appeals in April of 2008, and ever since then, the trademark world has eagerly awaited the decision.

What did the Second Circuit decide?

The Second Circuit emphasized that its 1-800 Conacts v. WhenU opinion was particular to pop-up advertising, and had expressly distinguished itself from keyword search advertising. It then held that, contrary to the findings of Second Circuit district courts in a string of cases, a search provider does “use” a trademark in commerce when it offers that trademark as a suggested keyword search term to trigger a client's advertisements. Specifically, the court held that when Google's Keyword Suggestion Tool presents potential words and phrases to an advertiser as possible keyword choices for triggering ads, that constitutes a “display” of the trademark of any company whose trademark is among the suggested words, and thus is a “use” of the mark “in commerce.” The court specifically stated that:

First, in contrast to 1-800, where we emphasized that the defendant made no use whatsoever of the plaintiff's trademark, here what Google is recommending and selling to its advertisers is Rescuecom's trademark. Second, in contrast with the facts of 1-800 where the defendant did not “use or display,” much less sell, trademarks as search terms to its advertisers, here Google displays, offers, and sells Rescuecom's mark to Google's advertising customers when selling its advertising services. In addition, Google encourages the purchase of Rescuecom's mark through its Keyword Suggestion Tool. … Google uses and sells  Rescuecom's mark “in the sale . . . of [Google's advertising] services . . . rendered in commerce.”

The Second Circuit got this wrong in one respect. In a keyword search advertising arrangement, the search provider is not “selling” anyone's trademark to someone else. There is no purchase or sale of a trademark involved in such a relationship. What Google is selling is advertising placement. Specifically, it sold to Rescuecom's competitors the opportunity to have their ads appear when computer users searched for “Rescuecom” as a keyword. This is nowhere near the same thing as selling a trademark, and it is astonishing that such an august body as the Second Circuit Court of Appeals would think that it is.

Nevertheless, even if it had not said that Google was “selling” Rescuecom's trademark to its competitors, the Second Circuit persuasively found that Google had displayed that trademark in connection with an offering of services (namely Google's own advertising placement services), and thus had “used” the mark in commerce as required by the Lanham Act. In so holding, the Second Circuit decided that a search provider might, after all, be liable for trademark harm for engaging in a keyword search advertising program.

What did the Second Circuit not decide?

The Second Circuit's holding in Rescuecom did not decide that keyword search advertising is trademark infringement, nor that search engines are liable for this activity. It only decided that such programs are a “use” of the trademarks of others, satisfying the Lanham Act's use requirement. Rescuecom, and other plaintiffs, must still show that the practice is likely to cause consumer confusion in order to obtain relief or damages for trademark infringement.

So what happens next?

The Rescuecom case is remanded to district court, and Google must now face the plaintiff's claim of trademark infringement. The fact that Google's program does constitute “use” of a trademark in no way decides the case. For one thing, Google's first-line “no trademark use” defense is backed up by second-line trademark “fair use” defenses, including the assertion that they are not using the mark as a trademark for the specific goods or services they were offering, and that the use was a legitimate comparative-advertising use (which the Ninth Circuit acknowledges in its “Nominative Fair Use” doctrine). Only if Google's fair use defenses fail will the court consider whether there was a likelihood of confusion; and only if it finds a likelihood of confusion will Google be liable for trademark infringement.

One of the many problems presented by the likelihood of confusion analysis in this case is the fact that, if Google's suggestion of Rescuecom as a keyword search term to trigger ads for Rescuecom's competitors was a use in commerce of Rescuecom's trademark by Google, who was likely to be confused? The fact that a subsequent user of Google's search engine who keys in “Rescuecom” and ends up viewing ads for Rescuecom's competitors might be confused is irrelevant. Google's “use” of the Rescuecom trademark was in displaying it to Rescuecom's competitors as a prospective search term to trigger their competing ads. Therefore it is those advertisers, not the computer users who later enter “Rescuecom” as a search term, whose likelihood of confusion must be considered. Because Google displayed those trademarks as search terms, not as brands for its own advertising services, it is unlikely that Google's clients were likely to be confused. If later keyword searchers were confused because they saw ads for Rescuecom's competitors when they entered “Rescuecom” as a keyword, that is not the result of Google's display of Rescuecom's trademark to its advertising customers, but rather the result of the ads that were placed by Rescuecom's competitors and triggered by the keyword search.

But doesn't everyone already do this kind of thing? What's the big deal?

In truth, many advertisers routinely engage in keyword search advertising triggered by use of their competitors' trademarks, in the belief that this is simply comparative advertising and in no way illegal or likely to harm the competitor's trademark rights. It's also true that many companies whose trademarks are used in this way by their competitors do not sue, but instead simply engage in keyword search advertising of their own. If this were a universal practice (which it appears to be on the way to becoming), the result would be that a person who keyed in the trademark of one particular company would get search results for that company but would also get advertisements and sponsored links for both that company and some of its competitors. In terms of the consumer-information purposes that advertising serves, this is not necessarily a bad thing, and can in fact be a very good thing, since it furthers competition and broadens consumers' range of choice.

So where is all this headed?

I'll go out on a limb here and guess that it's headed toward vindication of the practice of keyword advertising as a form of comparative advertising that is unlikely to create consumer confusion and is therefore not trademark infringement (except in those cases where the triggered ads are themselves deceptive or confusing).  However, the courts have surprised me before, so I'll go out on a different limb and say this: If the court were to hold that Google's display of the “Rescuecom” trademark in the course of its keyword suggestion process is a use that is likely to cause confusion, what about words and phrases that have significance apart from being trademarks? If a distributor of fresh apples were to enter into a keyword search advertising agreement with Google to display its ads any time a consumer entered the search term “apple,” would that infringe the trademark rights of Apple Computer? It doesn't seem likely; in fact, such a result would be outrageous, and would upset the already delicate balance between the First Amendment and trademark law. So my guess is that if the court finds likelihood of confusion in the Rescuecom case, that holding would apply only to trademarks that are merely trademarks, and not to most trademarks, which have other meanings and non-trademark significance.

All right, then, what are the take-aways?

For now, if you're a search engine and you are offering advertising placement based on a user's input of keyword search terms that consist of or include someone's trademark, you might be liable for trademark infringement. though no court has as yet so held. If you are an advertiser entering into a keyword search advertising arrangement with a search engine, your best policy is to make sure your ads are clearly designated as coming from your company, and not likely to deceive or confuse consumers. Though, even if you do, the jury is still out on whether the practice of keyword search advertising, in and of itself, might constitute trademark infringement or unfair competition.

For more information contact Seattle Trademark Attorney, Robert Cumbow, or any of the member's of Graham & Dunn's Intellectual Property Law group.

The Changing Regulatory Environment

Over the past year, as the economy has continued to deteriorate, the bank regulatory environment has become more and more challenging. Many “experts” have predicted that as many as half the banks in the United States will be under some form of administrative action by year-end. Based on what we are seeing out there, that may become a reality.

As we get deeper into the recession, more current bank examinations uncover more problems, reflecting continuing credit deterioration. In part, this is purely a function of the economy, stressed borrowers and collateral values. In part, it probably reflects the increased scrutiny and caution of the bank examiners, who are concerned about missing any problems.

Plummeting Examination Ratings

As a result of this enhanced scrutiny and economic deterioration, exam ratings have continued to plummet. A “2” rating is the new “1” which is now the rating to embrace and be proud of. Double-downgrades from “1” to “3” and “2” to “4” from prior exams are commonplace. Offsite temporary downgrades between exams also are proliferating based on deterioration in Call Report numbers.

What does this mean? Well, a “3” rating gets you either a state action or Memorandum of Understanding (“MOU”). A “4” or”5” rating gets you a Cease and Desist Order (“C&D”), means you probably no longer meet “well-capitalized” status, and shuts you down from taking brokered deposits and significantly increases your deposit insurance premiums. As one of our clients points out, the difference between a “4” and “5” rating is worth fighting for since a “5” puts you in “distinguished” company status and under enhanced scrutiny.

The Best Defense is a Good Offense

How do you avoid a bad report card? Well, if your asset quality is bad, you have a problem. However, on the margin you can take a number of proactive steps to improve your rating, including:

• Identifying and properly classifying your problem assets.
• Enhancing your loan files and documentation.
• Ordering appraisals for property timely and as often as necessary.
• Strengthening collateral positions on problem loans.
• Being forthright and upfront with the regulators to build credibility.
• Aggressively restructuring and/or disposing of problem assets.
• Raising capital, if possible.
• Improving your balance sheet and off balance sheet liquidity.
• Understanding your liquidity position; stress test it; having a contingency funding plan.

While these steps are not a guarantee that you will avoid all regulatory pitfalls, they could, on the margin, make the difference in your overall “CAMELS” rating, whether you get an administrative action, the type and severity of such action, the tone of the exam report and the timeframe to get out from under such action.

What If You Get a Proposed Administrative Action?

Our research and experience shows that most administrative actions have certain “core” features. However, you can negotiate specific provisions and timeframes to reflect your particular bank's situation.

The regulators are anxious to get these administrative actions in place, particularly since they have been internally and externally criticized for not acting quickly enough. However, we advise our clients to try to negotiate terms that they believe they can live with and meet. Remember, the regulators have extensive powers to enforce violations of formal “written agreements”, including the assessment of civil money penalties, removal of officers and directors, and, in extreme cases, termination of deposit insurance. While few of these additional enforcement powers have been used recently, given the changing economic and regulatory environment, history may not be a good predictor of future action. So be careful to what you agree. Obviously, you should utilize experienced counsel to guide you through this foreign process.

Disclosure Considerations

C&D Orders are placed on the issuing federal bank regulator's website and are therefore public. Accountants will require their disclosure in your notes to financial statements. MOUs and state enforcement actions are not per se publicly disclosed. However, our recent experience is that accountants are typically requiring disclosure in financial statements, particularly if there are capital requirements or dividend restrictions. Also, many public companies are disclosing any form of administrative action as a matter of prudence and conservative practice in today's economic environment.

When Will It All End?

Most prognosticators suggest that the economy will not bottom out until year-end. If this is the case, more current exams will undoubtedly reflect this continued deterioration in credit portfolios and underlying collateral values. So, more administrative actions should be expected until the cycle ends and economic recovery begins. In the meantime, you will need to deal with a challenging regulatory environment, with overworked and highly stressed examiners trying to cope with an unprecedented environment.

While the regulatory environment has been difficult, we must admit it has not been hostile. However, with real estate values continuing to tumble and capital almost impossible to access, some of the demands by regulators seem unreasonable. We think everyone needs to adjust their sights and let things play out a bit and stabilize. Time should be everyone's ally.

If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:

Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
Casey M. Nault (206.340.4808 or cnault@grahamdunn.com),
or Jane H. Kaufman (206.340.9663 or jkaufman@grahamdunn.com).

Lenders who understand the unique and complex aspects of hotel collateral can avoid costly missteps and resulting losses. The “recession-turned-meltdown” has put intense pressure on the hotel industry. As the pressure continues to build, many hotel loans are in default or soon will be.

Beginning last fall, consumers, seeing their net worth and savings evaporate, cancelled vacations and travel plans. Entering the winter, businesses began layoffs to respond to shrinking demand, and travel continued to decline. Congress then piled on, claiming that business meetings and conferences were mostly boondoggles taken at taxpayer expense. Companies cancelled all “nonessential travel,” and group and transient business dried up. Hotel industry analysts, as recently as last June, had predicted a 2.8% RevPAR increase for 2009. Now they predict a 2009 decline of between 10% and 30%, depending on the region and segment, with the upscale segment taking the biggest hit. These RevPAR decreases convert to NOI decreases of 20% to 60% and, with increasing cap rates, a loss of hotel value of 50% or more.

Many. if not most. upscale hotels that have been financed within the last five years are now in loan covenant default. This year, so far, relatively few hotel loans have fallen into monetary default, as owners use up their reserves to meet debt service. This cannot last. By June, hotel lenders will see increasing monetary defaults.

What should lenders with hotel collateral do? In January, we responded by forming our Hotel Asset Resolution Task Force (HART Force), bringing the specialized legal and industry skills and resources to stakeholders involved with troubled hotel assets. Below are now some obvious. and not-so-obvious. pointers specifically for hotel lenders.

The Obvious

• Find out if you have any hotel loans. Because hotel loans typically are interspersed among a bank's other commercial real estate loans, the first task is to find out if your commercial loan portfolios include any hotel loans. If they do, then you can begin to make reasonable choices about them.
  
  
• Recognize that any hotel loan is at risk. If you have hotel loans that were funded in the last five years, expect that they are in trouble, even if there is no current monetary default. Most upscale hotels that are leveraged at 60% or more are using up and running out of reserves. The time to evaluate your alternatives is now, before you face a loan default or operational deficits that will require the bank's cash just to keep the hotel open.
  
  
• Understand that hotels are not like other collateral. Hotels are not like other commercial real estate. Although hotels are often housed in a box that looks deceivingly similar to an office building, they are complex, operating businesses within that box. A typical upscale hotel includes restaurant businesses, cocktail lounges, retail outlets, landlord operations, spa operations, laundry and housekeeping operations, recreational facilities, parking operations, and, of course, nightly rooms rental, all run by 100 or more on-site employees. The legal structures are complex, usually involving a national brand under a franchise agreement or a “branded hotel management contract”. a complex, industry-specific contractual relationship. Equity structures are often multi-layered. Residential components or even “condo hotel units” can be intertwined with reciprocal easements and other rights that impact the value of the hotel and its flexibility.
  
  
• Line up reputable, industry-knowledgeable legal and business advisors. The hotel industry is a tight-knit community, and hotel skill sets are specific, specialized, and held by people and companies dedicated to the industry for years or decades. Without access to industry knowledge and experience, you have little hope of achieving satisfactory results. To adequately exert control and then stabilize, manage, and market these complex assets, you will need the assistance of legal and other advisors who know the hotel industry, are experienced with all aspects of hotels, and can apply this industry, legal, and business knowledge for best advantage.
  
  

The Not-So-Obvious

• When a hotel goes dark, its value takes a nose-dive. If a borrower's business is losing money, the lender's ultimate recourse usually is to sweep the accounts, collect accounts receivable, force a liquidating “going-out-of-business” sale, and then sell any remaining real estate. This approach works with hotel collateral only if the hotel is such a poor performer that the property should just be scraped. If this is not the case, then the hotel facilities are usually worth money only as a hotel. hotel facilities are so specialized that they typically are worth very little for any other purpose. Then, your choice usually is either to sell the hotel as an operating hotel or as a “dark” hotel. Of these two choices, the second is almost always disastrous. The reason is that, when a hotel goes dark, two large capital investments are lost. The first is the capital outlay required to open the hotel after it is built. this is the cost of locating and hiring a capable work force and of outfitting the hotel with liquor, food, etc. The second is the large chunk of capital required to get through, typically, three years of deficits, while the hotel establishes its customer base, becomes efficient in its operations, and reaches “stabilization.” If a hotel is allowed to go dark, these capital investments vaporize. Any buyer of the hotel will then need to take into account the cost of making these investments again, as well as the risk that stabilization will not be achieved as planned. To avoid this impact on collateral value, you absolutely must be proactive. You must see any operational deficits coming well in advance and decide how to fund them, if necessary, to prevent the hotel from going dark.
  
  
• Consider receivership. Working with a cooperative, honest, and capable borrower to achieve a satisfactory resolution can be a sensible strategy. Other times, you may feel that the borrower is out of rope, especially if additional funds are required to avoid a hotel closure. Receiverships can provide a way to fund operations and run the hotel without leaving the borrower in control. Receivership laws vary from state to state, but most work very well for hotel assets. A key in using receivership laws is to successfully identify and put in place a receiver that knows hotels. Many reputable management companies are very interested in serving as a receiver, and some see receivership as an opportunity to “manage to own.” But conflicts of interest can arise. You need experienced counsel to help select the right receiver, formulate the receivership order, and establish the strategy for using the receivership to stabilize and dispose of the hotel.
  
  
• Rethink whether you have priority over unsecured creditors. It is true that secured lenders have priority over unsecured creditors, such as trade vendors and managers. Accordingly, you have the power to foreclose and not pay vendors, payroll, etc. As indicated above, however, a hotel's value is largely dependent on the hotel's operation. If you foreclose in a traditional way, the value of the operation will be so damaged that you typically will lose, many times over, any savings from foreclosing out unsecured creditors. As a result, rethink whether you can practically take priority over the hotel's unsecured creditors.
  
  
• Determine whether the SNDA should be enforced. The “Subordination and Nondisturbance Agreement,” between the lender and the hotel's management company, is an important document. If the management company was asleep at the wheel, you may have what appears to be the holy grail of SNDA's. it may state that you can sweep the operating accounts and leave the hotel management company to fund payroll and operating expenses. These rights often cannot be exercised, however, without seriously damaging the operation and the value of the collateral. Before you use these rights, take a well-considered look at the actual impact of doing so.
  
  
• Think like a hotelier. Your recovery will depend on how you preserve or improve the value of the hotel operation. This means that, like it or not, you have to begin to think like a hotelier. How is the hotel positioned? Is the hotel management company doing a good job? Is it the right company for the property? What can be done to improve the hotel's value as you exercise your rights? Obviously, you need advisors that can help with these choices, as well as legal counsel with industry contacts that can help you get to the right resources and steer clear of pretenders.
  
  
• Know the condition of the hotel. Many hotel owners are neglecting facility maintenance and putting off necessary repairs. Will you be inheriting assets with mold, façade issues, ineffective or dated HVAC, ADA or structural issues? Are there extraordinary liabilities that should be considered or handled before you move toward control or foreclosure? Require a Maintenance Enforcement Program survey (“MEP”) before embarking on your realization strategy.
  
  
• Review obligations to the brand. Most hotel assets will have a brand or flag. Does the brand hurt or help the hotel's value? If the brand impairs value, evaluate your legal rights to shed the brand, under the SNDA or otherwise. If the brand enhances value, review and understand the commitments made to the brand. For example, the brand may be engaged in repositioning efforts (for example IHG is in the midst of a brand repositioning for all Holiday Inn hotels and is requiring expensive signage changes and other upgrades). Or the hotel may be currently required by the brand to perform a major upgrade of the facility (known in hotel parlance as a “PIP”). Triage may be required to prevent the brand from imposing penalties or even terminating the right to fly the flag.
  
  
• Evaluate the leverage over the borrower. Because hotel collateral is fragile and dependent on the hotel's operation, there is considerable value in your ability to motivate the borrower to assist you in reaching your objectives. Do you have personal recourse against the borrower? Is the borrower facing a big tax bill if the borrower gives you a deed in lieu? Be up front with the borrower and his needs. A cooperative, well-motivated borrower can lead to enhanced collateral value and a successfully executed realization plan.
  
  
• Understand and anticipate special problems, such as liquor licenses. Every upscale hotel has liquor licenses that are essential for revenue. If a lender has a receiver appointed, takes a deed in lieu, or forecloses, the liquor license must be transferred. The transfer often requires several weeks and many detailed disclosures from the new licensee. Think ahead. being forced to close down the hotel's bars can be extremely costly. Make sure your counsel's team includes experienced liquor license attorneys that can address these issues.
  
  
• Beware of multi-faceted hotel assets. All hotels are complicated assets, but some are “over-the-top” for the uninitiated. A hot segment over the last six years is the “condo hotel.” Assets such as these present a myriad of complications See Troubled Condo Hotel Workouts. For example, if a foreclosing lender sells a condo hotel unit without following specific, well-considered procedures, the foreclosing lender may inadvertently violate federal or state securities laws.
  
  

Meeting the Needs

The challenges to hotel lenders are daunting. To help clients successfully address them, in January 2009 Graham & Dunn announced the formation of its Hotel Asset Resolution Task Force. See Graham & Dunn Establishes.... HART Force employs Graham & Dunn's nationally recognized Hospitality Industry Group. Its members have assisted the Industry since 1990, and, in previous down-cycles, have successfully addressed the very legal issues and challenges facing the industry today. The Task Force is further enhanced and combined with the extensive banking industry resources of Graham & Dunn's Financial Services Group and the firm's bankruptcy/insolvency, real estate, labor and employment, litigation, and construction practices.

The Hotel Resolution Task Force is led by Hospitality Industry Group partners Irvin W. Sandman and Russell C. Savrann, in close coordination with Financial Services Group and bankruptcy partner Mark D. Northrup, Real Estate Group partner Douglas J. Smart, and litigation partners Douglas C. Berry, Stephen H. Goodman and Steven A. Miller.

The Task Force provides advice to clients about, and access to, the Hospitality Industry Group's wide-ranging contacts and resources in the hotel industry. These resources include, among many others, the advisory, economic, and disposition services of CBRE Hotels and companies that can assist with a broad range of segments and brands, including highly-regarded independent hotel management companies.

Please contact Irvin W. Sandman (206.340.9641 or isandman@grahamdunn.com), Mark D. Northrup (206.340.9628 or mnorthrup@grahamdunn.com), Steven A. Miller (206.903.4806 or smiller@grahamdunn.com) or Russell C. Savrann (203.215.5186 or rsavrann@grahamdunn.com) if you have any questions about Graham & Dunn's Hotel Asset Resolution program and how it pertains to your holdings.

On Tuesday, March 10, the Employee Free Choice Act (“EFCA”) which was passed in the House in 2007 but fell short of the votes required to break a filibuster in the Senate, was reintroduced in Congress. A major promise when President Obama spoke to union groups during the presidential campaign was that he would sign it into law. There is little question that EFCA would assist union organizers because of its three key provisions:

1. Eliminating the current requirement for a secret ballot election, in which employees vote for or against union representation, instead accepting signed union cards as proof of the union's status as the employees' bargaining representative;
2. Increasing penalties against employers accused of pressuring or penalizing workers who support a union-organizing campaign;
3. Providing that if an employer and union do not agree on the terms of their first collective bargaining agreement within 90 days after bargaining begins, either party may refer the dispute to federal mediation to facilitate negotiations, and if mediation does not result in a settlement within 30 days, the dispute will be referred to a government-appointed arbitrator, who will set the terms of employment for two years.

Meanwhile in Olympia, a labor-backed bill, known as the “Worker Privacy Act,” was killed on Friday, March 13. by the Governor, along with the Senate Majority Leader and the House Speaker. after inappropriate lobbying by organized labor was uncovered by the Seattle Times. The Act would have let employees refuse to attend mandatory meetings in which employers tell their side of the unionizing issue. So-called “captive audience speeches”. mandatory meetings employees are paid for attending. can be an important avenue for communicating an employer's message about unions, but unions may speak with employees on working time under certain circumstances. Employers are not allowed to visit employees at their homes to share their message. Opponents argue that this law, if it had passed, would violate “free speech” rights of employers under the law, and upset a balance that allows both sides to reach workers with their message.

Card Check Versus Secret Ballot Election

Union organizing drives start with collecting signed “authorization cards,” which state that the employee signing the card wants that union to be his or her bargaining representative. Currently, an employer can demand a secret ballot election even if a majority of employees has signed authorization cards. Among reasons cited for the current requirement of a secret ballot election, in order to obtain informed, uncoerced votes, is the concern that authorization cards are gathered when only the union organizer's side has been heard, and card-signing may be influenced by peer pressure from fellow workers supporting the union. Under current law, employers may accept signed authorization cards as sufficient proof that a majority of employees want union representation, but may insist on a secret ballot election, conducted after a period of a few weeks of campaigning and typically after the employer has had time to get its message out. Most employers insist on an election. Union organizers contend that during a campaign, employers have better access to the employees for delivering their message, and can pressure employees or engage in reprisals which kill support for a union.

EFCA would not per se eliminate the election process, which can be initiated by cards collected from 30 percent of the bargaining unit employees; however, a union which has collected cards from over 50 percent of the employees (not just the 30 percent required to get a secret ballot election) could force unionization without one. As a practical matter, expect secret-ballot union elections to be eliminated. Although a union can obtain an election under current law if it has signatures from 30 percent, rarely does it file a petition without more than the 50 percent needed to win, because, as time passes, that percentage generally erodes with employer campaigning.

EFCA provides that the National Labor Relations Board will adopt regulations addressing how to establish the validity of signed authorization cards.

First Contract Mediation and Arbitration

In the public sector, “interest arbitration”. use of an arbitrator who does not just facilitate agreement on the terms but sets them himself. is not uncommon, under the laws of the various states. (Public employees' bargaining is not governed by the National Labor Relations Act, but rather by state law, if at all.) However, it is all but unheard of in private sector labor relations. In private sector bargaining, the Federal Mediation and Conciliation Service (FMCS) provides mediators to assist union and management in reaching agreement where bargaining has stalled. However, the FMCS is just a facilitator which does not have authority to dictate the terms of a contract if the parties can't reach agreement themselves. EFCA would radically change collective bargaining: unless the parties agree on a contract in the first 120 days, the FMCS will refer the dispute to an arbitration panel to dictate the employment terms.

Proponents of the legislation argue that current remedies against stonewalling employers are so weak that they can, in effect, win by “surface bargaining” instead of negotiating in good faith. The pressure is on a union to obtain a contract within the first year after it is certified as the employees' bargaining representative, because at the end of that “certification year,” the union loses its insulation against attempts to decertify it. Opponents of the legislation point out that there are already remedies for bargaining in bad faith and that, if workers believe they are not getting a fair offer, in the private sector they can strike.

As a practical matter, the provision for “interest arbitration” assures a union of getting a “first contract” on terms dictated, not by bargaining leverage, but by a government-appointed arbitrator. This also would help a union organize workers in the first place, because with EFCA the union could now make a guarantee it could not honestly make before. that it will get more than just negotiations, it will get a contract. without striking. the terms of which will not be dictated by their employer's bargaining leverage.

Increased Penalties for Unfair Labor Practices

EFCA would require the NLRB to seek an injunction when there is reasonable cause to believe that employers have pressured or penalized employees, or engaged in other conduct that significantly interferes with employee rights during an organizing drive or first contract negotiation. It also calls for increases in monetary penalties for employers who pressure or penalize employees during an organizing campaign or first contract negotiations, including triple lost pay, and civil fines of up to $20,000 per violation against an employer found to have willfully or repeatedly violated employee rights during an organizing campaign or first contract negotiation. Currently there are no civil fines for violations.

Prospects for Passage?

EFCA legislation died in Congress last time because, in the Senate, Democrats failed (by nine votes) to obtain the 60 votes needed to invoke cloture to end the opponents' filibuster. (A motion for “cloture” in parliamentary procedure is one aimed at bringing debate to an end.) In the U.S. Senate, to overcome a minority's filibuster, a super-majority of 60 out of the 100 senators suffices. Democrats hold 56 seats now, 57 if Al Franken is seated in Minnesota, and there are two independents who typically vote with the Democrats. Strong pressure can be expected from the business community to kill or revise EFCA. And on March 25, there were reports that Senator Arlen Specter, a moderate Republican, will vote against it, although he would consider an anti-business measure of this kind when the economy recovers.

Some Thoughts for Proactive Employers

If EFCA becomes law, the need to understand the often tricky rules about what is and what is not “unfair” conduct by employers in a union-organizing campaign or in contract negotiations will be even greater than it already is, and effective campaigning by employers, within the rules, will be required much earlier in the process. at the card-signing phase of organizing. Traditional pre-election campaigning will come too late. Awareness of do's and don'ts when discovering a union organizing campaign is underway, and dealing with it early, will be a must.

For more information, contact attorney Clemens H. Barns at

The following article was published in Landslide, Volume 1, Number 4, March/April 2009.  Copyright 2009 by the American Bar Association.  All rights reserved.

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Scared of getting sued for patent infringement in the Eastern District of Texas? That fear may no longer be warranted.

For several years, patent plaintiffs found a friendly forum in the so called “rocket docket” Eastern District of Texas. That district was considered so “plaintiff friendly” that rough estimates place patent infringement cases filed there at over 50%. Despite cases where neither party was incorporated, had an office or distribution in the Eastern district, but merely only sold product in the district, the Eastern District would routinely refuse to transfer venue in patent infringement cases. Given that patent infringement awards can routinely run in the many millions of dollars, defendants hauled into the Eastern District of Texas had reason for concern.

Concern about this unique district court willfully taking on all patent infringement cases even made its way into the patent reform bill that is was reintroduced before the Congress. The Senate counterpart of the bill (S. 1145 -110^th Congress) would prohibit judicial districts from taking cases where:

1. the defendant of a patent infringement case (or in a declaratory judgment action) does not have its principal place of business or is incorporate or formed;
2. the defendant has not committed substantial acts of infringement and does not have a regular and established physical facility that the defendant controls and that constitutes a substantial portion of the operations of the defendant; and
3. where the primary plaintiff does not reside.

A defendant may request the case be transferred where:

1. any of the parties has substantial evidence or witnesses that otherwise would present considerable evidentiary burdens to the defendant if such transfer were not granted;
2. transfer would not cause undue hardship to the plaintiff; and
3. venue would be otherwise appropriate under 28 U.S.C. §1391.

However, even the proposed change appears to be no longer necessary in order for the defendant to obtain relief from blatant forum shopping. At the very end of 2008, on a writ of mandamus, the Federal Circuit Court of Appeals ruled that the Eastern District of Texas had abused its discretion by failing to transfer a patent infringement case to a more convenient forum, namely the Southern District of Ohio. In re TS Tech USA Corporation, 551 F.3d 1315 (Fed. Cir. Dec. 29, 2008).

In the underlying litigation (Lear Corp. v. TS Tech, No. 2:07-CV-406), Lear, a Delaware corporation with its principal place of business in Southfield, Michigan, filed its patent infringement suit against TS Tech USA, an Ohio corporation with its principal place of business in Reynoldsburg, Ohio, in the Eastern District of Texas based on the allegation that TS Tech had been making and selling infringing pivotal headrest assemblies to Honda Motor Co., Ltd. and further that TS Tech knowingly and intentionally induced Honda to infringe the patent at issue by selling the headrest assemblies in Honda vehicles throughout the United States, including the Eastern District of Texas. When TS Tech filed a motion pursuant to 28 U.S.C. §1404(a) to transfer venue of the case to the Southern District of Ohio, the district court refused because several (Honda) vehicles with TS Tech's allegedly infringing headrest assembly had been sold in the district and that the citizens of that district has a substantial interest in having the case tried locally.

For those that feared being hauled into the plaintiff friendly Eastern District of Texas for patent infringement merely because they sell a product or provide a service that can be found in Eastern District of Texas, the Federal Circuit has signaled “enough is enough” and are willing to grant the extraordinary remedy of a writ of mandamus if the district court refuses to transfer the case and there is good reason to do so. This case may indeed have much greater impact across the country. at least with regard to patent infringement cases. Even though the Federal Circuit applied only 5^th Circuit law, the logic may be used for other blatant patent forum shopping cases. But for now, defendants can make a venue challenge with greater certainty in patent cases filed in the Eastern District of Texas where the parties have no offices in the district, do not do business (beyond mere conduit) in the district, and in which no key witnesses reside in the district and not merely because the plaintiff wishes the case to be there.

Preface

Well folks, we are now in the middle of the most incredible economic vortex any of us has ever seen or could have imagined. I say it is time to take some critical, concrete steps to stem the tide and stop us from drowning.

The FDIC Fund

Let's face it, at 40 basis points (even with a likely 10 basis point special assessment), the deposit insurance fund is probably going to be tapped out soon. If only those assessments had continued during the last decade of unparalleled prosperity and earnings. Oh well, one can dream. But back to reality. The FDIC, in this man's opinion, has to allow banks that have a reasonable chance of surviving to gradually wean themselves off brokered deposits and not go cold turkey and expire from lack of liquidity while still possessing adequate capital.

If we accept the premise that the fund is inadequate, we must move away from a liquidation to a going-concern mentality. Only time will heal the wounds we have inflicted on ourselves. This is especially the case now that the industry is too crippled to fully replenish the fund.

Mark-to-Market Accounting

The notion of mark-to-market accounting of assets in a true fire sale environment is ludicrous and becomes a self-fulfilling prophecy. Stop it! This is again a liquidation, not going concern approach. If you were to dump a huge amount of any product on the market all at once, of course prices would hit rock bottom. Has anyone in Washington, D.C. ever heard of supply and demand? How about reading Chapter 1 of Samuelson on Economics?

As my old D.C. friends remind me, “D.C. is an island surrounded by reality.” Out of touch is a true understatement. Allow banks to dispose of toxic assets in an orderly fashion or else we are just socializing the losses and privatizing the profits.

Government Guaranteed Loan Program

Finally, a small light went off with the recently announced Fed $200 billion lending program. It needs to be some multiple of that. The Stimulus package is an expensive bureaucratic, ill-conceived, time-consuming waste. Why not simply have a massive government guaranteed lending program similar to the SBA, allowing banks to lend to businesses and individuals? Isn't it better to keep these distressed small businesses alive and keep people in existing jobs than creating make work jobs and positions that will take forever to develop at $250,000 a pop? This will temper the awful unemployment trend and let people keep their dignity and stay engaged.

Conclusion

I realize that this is a very complicated problem, but taking concrete steps to rebuild consumer confidence in the economy and our banking system is a good way to start.

If you should have any questions or wish to discuss issues specific to your financial institution please contact Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com).

On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (the "Act") into law. The Act made changes to the provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") that will impact many employers. It provides a government subsidy for a portion of the COBRA premium payments that employees losing their jobs would otherwise have to pay in order to maintain medical insurance coverage. In addition, it provides a special COBRA extended election period for COBRA coverage so that employees who were involuntarily terminated from employment on or after September 1, 2008, but did not originally elect COBRA continuation coverage, can take advantage of the subsidy. The subsidy is available for periods of coverage beginning on or after March 1, 2009.

COBRA Premium Subsidy

COBRA provides that employers generally must offer "qualified beneficiaries" (generally, an individual covered by a group health plan, and the spouse and dependents of such individual) the option to elect to continue health coverage following involuntary termination of employment. Premiums for coverage must be paid by the qualified beneficiary. Under the Act, the federal government will subsidize 65 percent of the premiums for a period of up to nine months, if the qualified beneficiary is an "assistance eligible individual." An “assistance eligible individual" is a qualified beneficiary who:

• Is eligible for COBRA continuation coverage at any time during the period beginning September 1, 2008 and ending December 31, 2009;
• Elects COBRA coverage (when first offered or during the additional election period); and
• Has a qualifying event for COBRA coverage that is the covered employee's involuntary termination of employment during the period beginning September 1, 2008 and ending December 31, 2009.

Extended Election Period

The Act provides a special extended election period for COBRA coverage for an individual who does not have COBRA continuation coverage in effect as of February 17, 2009, the date of enactment of the Act, but who would have been an assistance eligible individual if such election were in effect. Such individuals may elect to receive COBRA coverage and participate in the subsidy program during the period that begins on February 17, 2009 and ends 60 days after the individual receives notice of the special extended election period. So, for example, an individual who was involuntarily terminated from employment after September 1, 2008 but did not elect COBRA continuation may now enroll in his former employer's health plan and receive the government's subsidy for the premiums. In the case of individuals who elect coverage during this special extended election period, coverage begins with the first period of coverage beginning on or after February 17, 2009 and not from the date of termination. Coverage will not extend beyond the period of coverage originally required had COBRA coverage been elected at the time of termination (generally 18 months from the date of termination).

Reimbursement of Premium Subsidy Through Payroll Taxes

The premium subsidy provision of the Act is implemented through the payroll tax system. The Act treats the 65 percent of premium amount otherwise payable by an assistance eligible individual as payroll taxes that were previously paid by the employer. The employer is allowed to credit that amount against its payroll tax obligations. If the amount treated as previously paid payroll taxes exceeds the employer's actual payroll tax obligations, the employer can claim a refund.

High-Income Individuals Not Eligible For Subsidy

An individual is not eligible for the premium subsidy if his modified adjusted gross income for the taxable year in which the subsidy is provided exceeds $145,000 ($290,000 for a joint return). In addition, the subsidy is phased out incrementally for individuals with modified adjusted gross income between $125,000 ($250,000 for a joint return) and $145,000 ($290,000 for a joint return). An individual who receives the premium subsidy, but is not entitled to all or part of it because his modified adjusted income exceeds a threshold amount, is subject to income taxes on the excess.

Notice Requirements

The Act imposes new notice requirements on employers, including the requirement to provide notice to those entitled to elect COBRA continuation coverage of the subsidized premium program; the option to enroll in a less expensive plan, if the employer permits this option; the extended election period; and the individual's requirement to notify the plan sponsor of his or her becoming eligible for health coverage under another plan. The Act requires the Secretary of Labor to publish model notices by March 19, 2009.

What You Need To Do

The notice described above must be given to the following individuals:

• In the case of involuntary terminations of employment of a covered employees between February 17, 2009 and December 31, 2009, all assistance eligible individuals; and
• In the case of involuntary terminations of employment of a covered employees between September 1, 2008 and February 17, 2009,
  • assistance eligible individuals who are currently receiving COBRA; and
  • individuals who did not elect COBRA continuation coverage, by are otherwise assistance eligible individuals.

Although model notices are not required to be published until March 19, 2009, employers should begin now to identify those individuals to whom notices must be sent. In the case of individuals who did not elect COBRA continuation coverage, but are otherwise assistance eligible individuals, the notice must be given by April 18, 2009, so prompt action is required.

If you have any questions or wish to discuss this issue further, please contact Denny F. Wong at 206.340.9612 or dwong@grahamdunn.com, or any of the members of Graham & Dunn's Labor and Employment Practice Group:

Clemens H. Barnes (206.340.9681 or cbarnes@grahamdunn.com)
Judith A. Endejan (206.340.9694 or jendejan@grahamdunn.com)
April Upchurch Olsen (206.340.9597 or aolsen@grahamdunn.com)

With the loss of 600,000 jobs in January alone, and unemployment rates soaring to 7.6%¹, many companies are doing everything they can to reduce operating expenses in light of the economic downturn. As a result, many businesses have significantly reduced their workforce by implementing layoffs, or by terminating select employees with substandard performance. Whether your company is considering an isolated termination, or a larger reduction-in-force, there are practical steps that you can (and should) take to reduce the risk of employment litigation.

Most employees are “at will” meaning they can be discharged for any reason or for no reason. There is one caveat to “at will” employment, and that is, that an employee may not be discharged for an illegal reason. With the many employment laws designed to protect employees from illegal conduct, most motivated employees can find a legal basis to sue their employer despite being employed at will. In fact, the Equal Employment Opportunity Commission, the federal agency responsible for processing discrimination claims, has reported a 15.2% increase in the number of discrimination charges filed against employers in 2008, and we predict an even larger increase in 2009². Although every employer incurs some legal risk simply because of its status as an employer, by following the steps outlined below you will minimize that risk, but also place yourself in the best position to defend any lawsuit or EEOC charge that may come your way.

Implement Good Personnel Policies
Every employer should have solid personnel policies. Personnel policies are designed to communicate expectations to employees, and to let employees know what is and is not appropriate at work. In turn, these policies frequently support the employer's reason for employee discipline and discharge. Additionally, Personnel policies often include important legal regulations, and may even be required by some laws. These types of policies (harassment/discrimination/no-retaliation, the Family Medical Leave Act, disability and religious accommodation, and meal and rest break requirements) demonstrate to plaintiff's counsel and to the court that you, as the employer, understand your legal requirements, that you communicated those requirements to employees, and that you took proactive steps to implement the law.

Routinely Counsel Employees Regarding Poor Performance
Employees with performance problems should receive honest feedback on an ongoing basis-not just at year end. Most employees want to do a good job, and assume they are doing a good job unless you tell them otherwise. Without this critical feedback, an employee's performance will continue to suffer, and you as the employer will continue to get frustrated. Employers who are reluctant to give true feedback frequently reach the proverbial “straw that broke the camel's back” and move straight to termination without first laying the groundwork. Any resulting termination is a surprise (and perhaps a complete shock) to the employee, who doesn't understand what happened. Although an employee's reaction to his or her termination is not our first concern, an employee's surprise is frequently what gets the employer into hot water because the employee starts looking for the “real” reason she has been terminated (i.e., is it because the employee is pregnant, requested FMLA leave, complained about perceived sexual harassment etc.). An employee ostensibly terminated for performance, but not given any information about his or her performance may end up at the EEOC, or worse yet, consulting with a lawyer. The problems can frequently be avoided if you, as the employer, have done your job and counseled the employee appropriately.

Document Misconduct and Performance Counseling
Documentation plays an important role in laying the groundwork for any employee termination whether it's a termination for misconduct or poor performance. If you have done the performance counseling suggested above, you should have documented the dates on which you spoke with the employee, the performance issues discussed, how the employee intended to resolve the issues, and the consequences if the employee does not improve. If a termination is based on misconduct, you will want to document the circumstances surrounding the misconduct, including any investigation you may have done into the incident. This documentation is critical for you, as the employer, to justify your reason for discharging the employee. If you've done this, you are in a much better position to defend yourself if you do end up in litigation.

Conduct A Risk Assessment For Each Employee Termination
Some employment terminations present increased legal risks simply because of the circumstances. To understand your risk, consider whether the individual is in a protected class, has complained about discrimination/harassment, has disclosed a pregnancy or otherwise requested time off under a federal or state leave law, or has made any wage and hour complaints. Assuming the motivations for the termination are legitimate, the answer to these questions may not make any difference. Nonetheless, you should still be aware of timing and whether the employee may perceive that the discharge is because of conduct that is protected by law. If there is increased risk of a lawsuit because of the proximity between an employee's protected conduct and the termination, it is more important than ever that you have taken precautions before the termination.

Treat Employees With Respect At All Times, But Especially on the Way Out
Terminations are difficult for everyone, but employees who are treated with respect are less motivated to find a reason to sue you. Unless you have a strong reason, such as employee theft or sabotage, it's perfectly appropriate to allow employees to collect their things, to say goodbye to co-workers, and to generally exit the workplace with dignity.

Carefully Plan and Document A Reduction in Force
A Reduction in Force (“RIF”) must be planned in advance with careful attention paid to the selection process. Employer engaging in this process should review layoff policies, identify criteria for layoff (i.e. by position or by employee), document criteria, and carefully select employees. It is also very important to document the selection process and to be able to articulate why a particular employee was selected. Lastly, keep in mind there may be some legal requirements applicable to a RIF, such as the Worker Adjustment Retraining and Notification Act, the Older Workers Benefit and Protection Act if you offer severance pay, and state law requirements.

All employers face some legal risk when terminating employees. Nonetheless, you can take proactive steps to minimize the risks you face, and to place your organization in the best position possible when it comes to defending a lawsuit. As many have said before, “an ounce of prevention is worth a pound of cure” and this is certainly true in employment law.

Recent Developments

The rumors of the FDIC “locking down” banks from brokered deposits are true. Here is how it happens. If you are not “well capitalized,” then under Prompt Corrective Action (“PCA”) (a leftover piece of legislative shrapnel from the thrift bailout 20 years ago), you are precluded from accepting or renewing any brokered deposits without receiving a waiver from the FDIC, which is rarely forthcoming and is granted only under limited circumstances. Paying more than 75 basis points above the average deposit rate in your market will be considered the same as taking a brokered deposit.

You can also find yourself in the same fix if you are rated a composite “4” or “5” bank or have a Cease and Desist Order (“C&D”). In that event, you are deemed to be just adequately capitalized (no matter your level of capital), and are subject to the same PCA brokered deposit restrictions.

The Dilemma

If you fall below “well capitalized” or are rated a “4” or “5” bank or get a C&D, you are effectively locked out of taking brokered deposits. If brokered deposits are a critical source of your funding, you could actually expire from a lack of liquidity, like WaMu and Bank of Clark County, even if you have adequate capital. In fact, you technically could be well capitalized and still become illiquid. Again, remember, if you are actually just adequately capitalized or are a “4” or “5” or have a C&D, you cannot even pay a premium for regular deposits in your market above 75 basis points. Further CDARS are also considered brokered deposits, even though they are held by existing customers.

Our discussions with the FDIC suggest that this is a bright line test and that waivers for brokered deposits are the exception (e.g. as a temporary bridge for a sale of the bank). To understand this hard-line approach, you have to realize that the FDIC believes that if a bank fails, the brokered deposits (which the FDIC inherits as a liability) will effectively be a total loss to the deposit insurance fund, based on their past experience. Hence, NO MAS!

What To Do

Clearly, any steps your bank can take now to avoid any of these PCA triggering mechanisms are absolutely critical. We realize that raising capital in today's environment can be challenging, but significant dilution is still better than the alternative. Ultimately, lowering your dependence on brokered deposits would be a good practice. Keep in mind that once you get in trouble, borrowing from the FHLB, the Fed, or bankers' banks becomes increasingly challenging, further drying up your secondary sources of liquidity.

Conclusion

We highly recommend that your bank focuses on this serious, potential liquidity situation and avoids getting yourself in this impossible dilemma. Whether the FDIC will soften its stance as the breadth of this crisis spreads, is hard to determine. Even arguments allowing you to renew or replace brokered deposits solely to support the steady disposal of toxic assets have fallen on unreceptive ears to date. So please be forewarned of the seriousness of this situation.

If you should have any questions or wish to discuss issues specific to your financial institution please contact any of the following members of the Graham and Dunn Financial Services Team:

Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com),
Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com),
Casey M. Nault (206.340.4808 or cnault@grahamdunn.com),
or Jane H. Kaufman (206.340.9663 or jkaufman@grahamdunn.com).

Yesterday, our client, Glacier Bancorp (Nasdaq: GBCI), headquartered in Kalispell, MT, announced a merger agreement whereby First National Bank & Trust, located in Powell, Wyoming, would become the newest member of the Glacier family of banks, in a combination stock and cash deal valued at $17.5 million. At December 31, 2008, First National Bank & Trust had $282 million and Glacier had $5.6 billion in total assets, respectively. Click here to see the news release announcing the transaction.

This transaction is Glacier's second foray into Wyoming and continues to broaden its footprint in the Rocky Mountain states. This acquisition reflects Glacier's continuing ability to add independent banks with seasoned management teams, even in today's challenging deal environment, by using its strong stock currency and capital position as consideration.

We would be pleased to discuss your comments and questions about this transaction and its implications for your institution and the industry in general.

For more information on this topic, please contact Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com) or Kumi Yamamoto Baruffi (206.340.9676 or kbaruffi@grahamdunn.com).

Introduction

Each year there are a number of important disclosure considerations for companies that file Annual Reports on Form 10-K under Securities and Exchange Commission (SEC) rules. These considerations have come into greater focus for the 2009 year-end reporting season given the severe challenges facing many companies in this extraordinarily difficult economic environment. The best way to communicate transparently with investors and protect your company during these uncertain and litigious times is to prepare a thorough and thoughtful 10-K Report with particular focus on the Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and Risk Factors sections.

Perhaps more than any other year in recent memory, this year special attention should be paid to MD&A and Risk Factors. In particular, we encourage 10-K drafters to undertake a fresh review of the SEC's interpretive releases on MD&A from May 1989, January 2002 and December 2003 (the “1989 Release”, “2002 Release” and “2003 Release”). The theme “looking through the eyes of management” may never have been more spot on than now. Drafters may find guidance in the prior releases that may be particularly relevant in the current economic crisis.

When preparing MD&A, companies should be mindful of the following:

• Overview. Most companies have taken the SEC's cue in the 2003 Release to include an overview or introductory section, as a means of fulfilling the key MD&A objective of providing a narrative explanation of the financial statements and a discussion of the business that enables investors to see the company through the eyes of management. This year perhaps more than ever, care should be taken to provide an overview that gives investors a frank assessment of the company's results and the road ahead.
• Not Just a “Mark-Up”. Senior SEC Staff have frequently reminded issuers that each year's MD&A, and particularly the overview, should not be simply a mark-up of the prior year's disclosure. The current environment in particular underscores the need for companies to take a fresh approach to the overview section, discussing the particular impacts of the current environment on the company's business and financial results. MD&A drafters would be well advised to begin the process of drafting the overview by sitting down with executive management and asking them how they would describe the company's results, challenges and prospects to a new board member or potential investor.
• Forward-Looking Disclosure May Be Mandatory. Executives and MD&A drafters should be mindful that forward-looking disclosure is not always optional. Disclosure is mandatory where there is a known trend or uncertainty that is reasonably likely to have a material effect on the company's financial condition or results of operations.
• Liquidity and Capital Resources. For many companies, this year's discussion of liquidity and capital resources will differ significantly from prior year disclosures, and even from the last quarter's Form 10-Q discussion. Among other issues, MD&A drafters should consider whether any known trends exist with respect to the company's debt instruments and facilities. For example, if current modeling shows a trend toward breach of a financial covenant or the failure to maintain ratings necessary to access debt facilities the company has traditionally relied upon, the company will need to consider appropriate disclosure related to the trend, steps the company is taking in response, its likely effects and whether any alternative sources of funding are available. As another example, companies with maturing debt instruments or facilities should consider appropriate disclosure regarding the expected cost and availability of replacement financing, if material. For the first time in recent memory, liquidity has become a widespread concern for many financial institutions and should receive appropriate and prominent disclosure in your MD&A, as well as Risk Factors, if applicable.
• Sources of Possible MD&A Disclosure. As part of sound disclosure controls and procedures, companies should ensure that material information, particularly forward-looking, that is shared internally among executives and the board of directors is considered for possible MD&A disclosure. In one prominent enforcement action, the SEC based its conclusion that material information had been omitted from MD&A in part on the fact that the matter was specifically brought to the attention of the company's board in meeting materials and was the subject of significant board discussion and concern.
• Update Forward-Looking Statement Paragraph. Companies should consider whether the risks and uncertainties noted in their cautionary statement regarding the use of forward-looking statements should be updated and re-ordered. The safe harbor applicable to forward-looking statements provides the greatest protection when the risks and uncertainties noted are as current as possible and correspond to the forward-looking statements actually included in the report. Accordingly, updating this language could be critical in protecting the company against future claims based on forward-looking statements.

When preparing Risk Factors, companies should be mindful of the following:

• Focus on Particular Risks to the Company. The current economic environment clearly presents a heightened risk profile for many if not all companies. The most effective risk factors will discuss the specific material risks to the company and its stock and bondholders, rather than simply discuss the current challenging economic conditions without explaining exactly how they translate into specific risks for the company. In other words, generic or industry risks may not be enough.
• Focus on Differential Risks to Stock and Bondholders. For companies with both publicly-traded stock and bonds, particular care should be taken to ensure that any differential impacts on stock and bondholders of material risks facing the company are discussed.

Copies of the SEC's 2003 Release, 2002 Release and 1989 Release can be found on the Commission's Web site here, here and here, respectively.

Conclusion

We hope this alert will help you in preparing your upcoming Form 10-K. Please feel free to contact your usual contact at Graham & Dunn, or Casey M. Nault (206.903.4808 or cnault@grahamdunn.com), Stephen M. Klein (206.340.9648 or sklein@grahamdunn.com), or Bart E. Bartholdt (206.340.9647 or bbartholdt@grahamdunn.com) if you should have any questions or wish to discuss issues specific to your financial institution.

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The forces of globalization continue to change our world, and with it the hotel industry.  In response, U.S. hotel developers, brand owners, and investors have continued to accelerate their efforts to extend their reach across borders and apply their skills in new, international markets.  As U.S. markets contract in the current, ongoing recession, the effort to reach new markets has become even more urgent.

Experienced hotel counselors have special industry knowledge and legal skills to help developers in the complex process of acquiring, developing, and stabilizing hotel projects.  As hotel clients cross borders, the U.S. lawyer faces a new set of challenges.
This article provides an approach to international hotel projects to allow both hotel companies and their counselors to understand the big-picture risks and objectives and to apply their skills without exceeding their limitations.  By approaching international hotel projects intelligently, the complexity, costs and risks can be reduced.

1. How Much Foreign Law Will You Need?
   
   All international hotel projects are not alike.   Some are more affected by the law of the foreign jurisdiction than others.  For example, an ordinary hotel franchise agreement that is governed by U.S. law and that has a strong arbitration clause may require little application of foreign law.  In contrast, a co-investment in foreign real property by citizens and entities of multiple countries will require extensive application of foreign law.
   
   Accordingly, the first step in approaching the international project is to inventory and understand the objectives of the legal documents and relationships.  To do this, it is important to bring back from the subconscious essential concepts that experienced lawyers take for granted in a domestic deal. 
   
   For example, when we enter into a contract, such as a hotel management agreement or franchise agreement, our ultimate objectives are usually the following:
   
   • We want the parties to understand and accept their promises.
   • If the other side breaches, usually we want to be able to take legal action in pursuit of damages or other bargained-for remedies.
   • We then want to be able to get to judgment, enter the judgment in appropriate jurisdictions, enforce the judgment, and collect.
   
   In contrast to the objectives in creating simple, contractual relationship, if we are investing in real estate, our ultimate objectives include the following:
   
   • We want to “own” the property and understand what the normal attributes of ownership are.
   • We want to know how to establish and protect our “ownership.”
   • We want to know what we have to do, legally and practically, to accomplish our development objectives.
   • We want to know how we will be able to protect our interests if things do not go according to plan.
     
   Hotel projects can involve dozens of different kinds of legal relationships and transactions.  In each relationship, the U.S. lawyer should bring to top-of-mind these basic objectives and fundamentals.  In contrast to a domestic deal, the U.S. lawyer must realize that these fundamentals cannot be assumed and will require specific attention.  Then the lawyer can begin to understand how deeply the lawyer will need to delve into foreign law and foreign issues to accomplish the expected results and have recourse to the expected remedies.
   
2. Arbitration:  The Most Important Cleavage Point for Drafting Contracts.
   
   In any contract, the most essential, ultimate legal concern is enforcement.  A contract accomplishes little if it cannot be enforced according to the parties' expectations.
   
   f the parties do not effectively establish the law and forum for enforcing the contract, then the possibility remains that a foreign court will be involved.  And if a foreign court will be involved, then local procedural or substantive law might govern the contract and what it means.  And if the foreign courts might decide those critical matters, then the deal lawyer will have to start from scratch in drafting the contracts so they conform to local law and can be enforced under it.  This slippery slope leads to very large local and U.S. legal bills.
   
   The answer usually does not lie in specifying venue in U.S. courts.  In general, courts in every country do not give much weight to the judgments entered by the courts of other countries.  This is even the case when, for example, a party attempts to enter and enforce in Canada a judgment obtained in a U.S. court.  Very often, the foreign court will reopen the facts and a new mini-trial or a retrial may occur.  This risk then leads back to the slippery slope.
   
   The answer usually does lie in arbitration.  Interestingly, although countries seldom give much deference to foreign courts' decisions, virtually all countries must give great deference to arbitration awards.  This is because most countries are bound by one or more treaties that require it.  More than 120 countries are now parties to the U.N. Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), 21 U.S.T. 2517 (1958).   These countries include, for example, Mexico, Canada, and the Peoples Republic of China.   A few South American countries that are not parties to the New York Convention are parties to the similar Inter-American Convention on International Commercial Arbitration, 14 I.L.M. 336 (1975), which the U.S. has also ratified. 
   
   These two treaties (the “Arbitration Enforcement Treaties”) are pivotal.  They allow the parties to effectively choose the applicable law, the venue, the trier of fact, and the procedures for the hearing process.  Then, when the arbitrator's judgment is obtained, the foreign court must enter and recognize the judgment as the equivalent of a final judgment in the foreign court.  The only exceptions to the obligation to do so are narrow defenses based on gross abuses of procedural rights or violation of public policy.
   


3. Making Choices About Arbitration:  Selecting the Arbitrator, Governing Law, and Venue.
   
   Even though the Arbitration Enforcement Treaties provide for only narrow defenses to recognition, those narrow defenses do exist.  Accordingly, a primary consideration in choosing the arbitrator, the governing law, and the venue is whether the choices will help steer clear of those narrow defenses.  A secondary consideration is the impact these choices will have on the objective of diminishing involvement of foreign law and foreign lawyers in the negotiation and documentation of the deal.
   
   
   1. Choosing the Arbitration Service. 
      An arbitration provision can call for arbitration with the assistance of an international arbitration organization.  This kind of arbitration is often called an administered arbitration.  Alternatively, the provision can identify a specific, independent arbitrator (often called an ad hoc arbitrator or a non-administered arbitration). 
      
      One of the defenses under the Arbitration Enforcement Treaties is that “the recognition or enforcement of the award would be contrary to the public policy of” the country where recognition is sought.  Another defense is that “the composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties.”
      
      These defenses suggest that the U.S. lawyer should make all aspects of the arbitration procedure as mainstream as possible.  Also, the lawyer should ensure that the arbitration service has a good deal of international arbitration experience.  By doing so, one can expect to reduce the risks that the procedure or the arbitrator will inadvertently trigger defenses under the Arbitration Enforcement Treaties. 
      
      The leading international arbitration organizations are:
      
      • The International Chamber of Commerce's Court of International Arbitration (ICC).  It is based in Paris but administers proceedings worldwide, with Switzerland being a particularly important site.
      • The American Arbitration Association.  Its International Center is based in New York, but it operates nationwide.
      • The LCIA Court of International Arbitration in London.  It is active in England and elsewhere, primarily in Commonwealth countries.
      • The International Centre for the Settlement of Investment Disputes (ICSID).  It is operated by the World Bank and is a specialized arbitration organization for disputes in transactions between private investors and foreign governments.
      
      All of these organizations have generally similar rules, typically available on their web sites.  They also all provide basically equivalent types of services.
      
      If an ad hoc or nonadministered arbitration process is chosen, then the arbitration clause will have to specify a governing set of rules.   The most commonly used rules in nonadministered arbitration are those published by the United Nations Commission on International Trade Law (UNCITRAL) Arbitration Rules.
      
      
      • Choosing the Governing Law. 
        Of course, any U.S. lawyer will want U.S. law to apply and, ideally, the law of the State in which the lawyer practices.  The closer to home the lawyer can keep the governing law, the less advice will be needed to make sure the laws of an unfamiliar jurisdiction will not unexpectedly override the intentions and expectations of the parties. 
        
        Also, one of the defenses to enforcement under the Arbitration Enforcement Treaties is that the parties' agreement “is not valid under the law to which the parties have subjected it.”  To the extent that the applicable law is familiar and accessible to the U.S. lawyer, the lawyer can more easily reach comfort that the agreement is valid under the applicable law and that an arbitration award based on the agreement will be enforceable under the Arbitration Enforcement Treaties.
        
        If, despite the U.S. lawyer's best efforts, the parties' negotiations lead them away from U.S. law, then normally a U.S. lawyer should fight hard to make sure the foreign law is based on common law and not civil law.
        
        The law in the U.S. and all its States (other than Louisiana) is based on common law.  Courts are responsible for creating and applying case law and resolving most civil disputes.  The system is borrowed, essentially, from English common law.  Many other countries around the world have also borrowed this system.  It is remarkable how similarly contractual issues and enforcement are handled in common law jurisdictions.  The familiarity and similarities help diminish the amount of foreign law advice and contractual modifications needed to make sure the documents do what they are supposed to do.
        
        The civil law system, in contrast, is based on the Napoleonic Code.  Under this system, almost everything that a U.S. lawyer knows is wrong.  If the governing laws are those of a civil law country, then foreign lawyers will need to be heavily involved, and the documents will need significant modification in form and substance to make sure they are enforceable and fulfill the parties' expectations.
      
      
      • Choosing the Venue.
        The New York Convention states that a country ratifying the Convention may “declare that it will apply the Convention to the recognition and enforcement of awards made only in the territory of another Contracting State.”  As a result, it is important that venue selected is in a country that is a party to the Convention.
        
        Also, one might reasonably conclude that arbitrators who are in, or close to, the governing law jurisdiction might have more experience with and knowledge about the governing law.  This experience and knowledge should help reduce costs and the chances of an aberrant ruling.  Accordingly, it is logical to select a venue that correlates to the governing law.
      
      
      • Other Choices.
        Sample arbitration clauses can be obtained from the websites of the leading arbitration organizations mentioned above, as well as UNCITRAL.  These clauses will help identify other choices.
        
        The choices will include, for example, the identification of the language to be used in the proceedings.  They also may suggest mediation as a step before arbitration.  The considerations in making these choices are rather obvious or are no different than those involved in usual, domestic transactions.
   
   
4. Considerations When Foreign Property Investments are Involved.
   
   If the international hotel project will involve the client in foreign ownership, then the lawyer and client will, by necessity, need to become heavily involved in local law.  Local counsel will be required and will be an essential part of the team.  The U.S. lawyer will need to apply all of his “issue spotting” skills and his/her ability to “think like a lawyer” to ferret out and understand the areas where local law impacts the client's normal expectations, and then the lawyer will need to skillfully communicate those variances and risks to the client.
   
   Even when ownership of foreign real estate is an essential part of the client's rights and expectations, however, the lawyer still can and should work to structure the deal so that application of foreign law will be minimized. 
   
   If, for example, multiple parties will have interests in the real estate, a single entity can be created to own the property.  Then, a separate entity can be created in a familiar jurisdiction under familiar laws.  The deal between the parties can then reside primarily in the documents governing that entity.  The documents can include an effective arbitration clause that follows the suggestions set forth in previous sections of this part II.  Obviously, tax considerations, the laws of the foreign jurisdiction, and the parties' expectations will affect the structure.  But the impact of foreign law can be minimized and costs and complexity can be reduced by isolating the real estate issues and then building the deal points into separate entities governed by familiar structures, documentation, and enforcement mechanisms.
   
   
5. Selecting And Working With Foreign Counsel.

Once the U.S. lawyer has taken inventory the objectives of the legal documents and relationships and has determined how much foreign law and lawyering will be needed, the U.S. lawyer must then select foreign counsel. 

As suggested above, every international hotel deal will have some foreign law to consider.  At a minimum, local counsel is usually needed to help evaluate and anticipate circumstances that could trigger enforcement defenses under the Arbitration Enforcement Treaties.  And if, for example, the U.S. party's main recourse upon a breach is to arbitrate to judgment, enter the judgment in the foreign jurisdiction, and execute on foreign assets, then the U.S. lawyer likely will need to learn from local counsel how effective that execution process will be and then steer the transaction to accommodate those considerations. 

At the other end of the spectrum, the project may involve acquisition and development of foreign real estate.  Then, local counsel will be an essential part of the team, as heavily involved as the local real estate/land use/construction lawyer in a domestic development project.

The choice of foreign counsel should be made with full understanding of these needs and roles.  Then, a number of considerations may weighed.


1. Factors in Selecting Foreign Counsel.

First, the U.S. lawyer should understand what kind of lawyers are available in the foreign jurisdiction and what they do.  In common law countries, one can expect barristers and solicitors.  They often have different roles and capacities.  In civil law countries, the notary is a distinct legal profession and may be required.   The U.S. lawyer may also encounter a “foreign legal consultant (FLC).  The FLC may not, for example, be permitted to advise on purely local-law matters.  If the U.S. lawyer is not aware of these limitations, the employment of the FLC may unknowingly build in an extra layer of expense.

Next, the U.S. lawyer can tap a number of sources to create a list of potential foreign counsel choices.  Personal experience and trust with the foreign lawyer is, of course, very useful.  One normally also seeks out recommendations from other lawyers, law firms, and other professionals whom the U.S. lawyer knows and trusts.  Research and verification on the Internet has its usual role, as well.

Once a list of potential foreign counsel has been compiled, U.S. counsel should contact and talk with each of them.  The process of coming to a final selection is essentially the same as the process of selecting local counsel in a domestic transaction. 

Ask:

• What skills and experience are needed for the engagement?
• Does the candidate have those skills?
• Does the candidate have a good reputation for honesty, service and integrity?  Does the candidate reflect these attributes in his contacts with you?
• Can you communicate with the candidate easily and without waste of time?
• Do you feel a comfortable connection with the way the candidate behaves and thinks?
• Do you believe that the candidate will be a team player?  Or do you sense the candidate be or driven by personal gain, fee generation, and ego?
• Will the candidate be able to work well with those he or she will needs to work with?
• Does the candidate have the technology needed to communicate effectively and accomplish the work?
• Are the fees and rates reasonable?


2. Special Factors and Hazards.
   
   U.S. lawyers take for granted and expect behavior and conduct mandated by ethical rules applicable to U.S. lawyers.  Do not assume that they apply in the foreign country. 
   For example, the foreign jurisdiction might not require that the lawyer treat your communications as confidential and privileged.  Obviously, if the project is not publically announced and confidentiality is important, the failure to recognize the absence of these protections can have grave consequences.
   
   Similarly, the foreign jurisdiction may not protect against conflicts of interest.  It is very annoying to hire a local lawyer only to find that he has a personal interest diametrically opposed to the client's objectives and is actively pursuing them to the client's detriment.
   


3. The Engagement Letter.
   
   As indicated above, the ethical rules, expectations, norms, and customs applicable in a foreign legal engagement may not line up with our normal expectations.  The engagement letter is a key document to help bring these expectations in line. 
   
   In addition to the usual terms of a typical engagement letter, the letter can provide for confidentiality, protections against conflicts of interest, provisions about service expectations and deadlines, billing expectations, and specific terms about the opinions or other work product expected from the foreign lawyer.  If these terms are critical, consider the advantages of employing arbitration provisions, as discussed earlier in this Section II.

Globalization will continue, both in good times and in times of recession and crisis.  To survive, hotel developers, brand owners, and investors will continue their efforts to access new, international markets. The need to approach the international hotel project intelligently has never been more important.  By understanding how much foreign law will be needed, taking full advantage of the Arbitration Enforcement Treaties, making the right choices on enforcement issues and structuring, and carefully considering and selecting foreign counsel, hotel industry stakeholders and their counsel will accomplish their objectives with reduced complexity and with increased success.

Responding to the impact of the financial crisis on the hotel industry, Graham & Dunn's Hospitality Industry Group has formed a Hotel Asset Resolution Task Force. The Task Force is an interdisciplinary team with the specialized legal and industry skills, experience, and resources to meet the needs of clients who own, hold, manage, or will take control of troubled hotel assets. The Task Force will assist hotel owners, lenders, special servicers, their asset management firms, and other stakeholders with the restructuring of hotel loans and the positioning, transition, and disposition of distressed or foreclosed hotel assets. The Task Force will also assist new investors seeking to acquire and reposition troubled hotel assets in anticipation of the eventual recovery.

The hotel industry is bracing for a predicted RevPar decline of 7.8% nationwide in 2009. Because the still-unfolding economic downturn has no recent historical equivalent, even this projection may be understated, and certain markets will certainly suffer greater damage than the nationwide average. The declines, combined with increasing cap rates, will result in a substantial reduction in the value of hotel assets. Leveraged hotels will face difficulty meeting debt service, and a significant percentage of all hotels will fail to satisfy debt ratio requirements and other loan covenants. Hotel owners with significant equity still at risk will need to employ a coherent strategy to protect their investments. Lenders, special servicers, and other stakeholders will need to do the same, and, if they inherit and assume direct responsibility for hotel assets, they will need to stabilize, manage, and market these complex businesses. New investors will need to exercise intelligence and diligence to navigate the hotel industry, make good choices, and avoid dangers as they seek to acquire and turn around troubled hotel assets.

Owners' Challenges

Hotel owners must take a hard look at their hotel assets and determine the effect of a substantial decline in RevPar and an increase in cap rates. They need to assess whether they potentially face monetary loan defaults. They also need to carefully evaluate their loan documents and determine whether there is a risk that their hotels may fail to satisfy debt coverage ratios or other loan covenants. In either event, they need assistance in establishing a business and legal strategy to protect their equity.

If defaults must be cured, or even if, more simply, loan renewal dates are imminent, owners need to understand the new realities of the lending environment. In many cases, an influx of significant new equity will be needed to protect existing investments, and owners need assistance to understand and access new sources of equity in the troubled national and global environment.

Owners also need to understand available legal rights and remedies, including insolvency laws, correctly weigh them, and, if necessary, pursue them.

Challenges facing Hotel Lenders and Investors

If, because of the declines in values and performance, a hotel owner's equity must be considered lost, or if the owner is unable to access new sources of equity or debt, then the hotel's lenders or investors will themselves need to assert control over the hotel.

Hotels are complicated assets in almost all respects. Without access to industry knowledge and experience, these new owners have little hope of achieving satisfactory results. To adequately exert control and then stabilize, manage, and market these assets, lenders and investors will need the assistance of legal and other advisors who know the hotel industry, are experienced with all aspects of hotels, can apply this industry, legal, and business knowledge for best advantage.

• Dealing with Partially Completed Hotel Projects. In some cases, a hotel project may be in a state of partial completion at the time of foreclosure. To determine forward progress to proceed, the foreclosing lender, special servicer, or investor will need to confront and understand the hotel's specific entitlements and structure. If a decision to complete the project is made, then doing so will also often require the settlement of lien claims, enforcement of warranties, and many other construction issues.
  
• Repositioning and Maximizing Realization of Operating Hotels. Other distressed hotels may be completed and operating, but may be performing poorly. The stakeholder considering foreclosure will need to address decisions and issues that are unique to the hotel business. Before foreclosure, the stakeholder will need to be fully aware of the unique aspects of the hotel business, including such things as the need to transfer the hotel's liquor licenses and the specialized state and local disclosure and licensing laws that must be addressed and satisfied. The use of receivership laws must be considered and understood, and, if this route is selected, a qualified, industry-experienced receiver must be engaged and authorized by court order that is informed by both legal and hotel-specific knowledge. The stakeholder will need to analyze the terms of any branded management contract, the relationship with the branded management company, the ability to change brands and the effect of doing so, the hotel's operating budget, and scheduled capital expenditures. The stakeholder will then need to position the hotel for a satisfactory disposition. All of these steps will require specialized, hotel-specific legal and business knowledge and access to resources in the hotel industry.
  
• Addressing Legal Risks of Hotel Operations. Stakeholders who lack hands-on hotel experience will face a number of legal issues they are not accustomed to addressing. These may include employment and union problems and issues, environmental law risks, specialized hotel contracts such as group contracts, intellectual property and e-commerce concerns, and litigation relating to guests, tenants, or contractor agreements.
  
• Handling Unique, Multi-faceted Hotel Assets. The foreclosing lenders, special servicers, or investors may also confront complex hotel assets, such as condo hotels. Condo hotels trigger special risks. See Trouble Condo Hotel Workouts – The Time Has Arrived. For example, if the foreclosing lender sells a condo hotel unit without following specific, well-considered procedures, the foreclosing lender may inadvertently violate federal or state securities laws.

Concerns for Branded Management Companies

Branded management companies' most valued assets are their portfolios of long-term, branded management contracts.

Managers must analyze their performance clauses to see if their contracts are at risk. They also need to review their Subordination and Nondisturbance Agreements (SNDA) to see what rights they have if a loan default occurs and the lender begins foreclosure. If the SNDA was not well-negotiated, the branded management company may have trouble accessing the hotel's revenues to meet payroll or perform brand-mandated capital improvements.

Branded managers need assistance in this analysis as well as experienced counsel to anticipate and address risks both inside and outside of receivership and bankruptcy.

Challenges for New Investors

In this diverse, complex global economy, there are those who are looking to invest. These investors will help initiate the economy's recovery by providing owners with equity or liquidity and allowing lenders to move assets off their books. These new investors include private equity sources (both foreign and U.S.). Also, pension and other equity funds will be in the process of revaluing their real estate portfolios. When that has occurred, they will need to rebalance their portfolios and, once again, will need to invest in real estate.

Real estate investors who become interested in hotels quickly learn that special, industry knowledge and skills are required to avoid costly investment and operational errors. Complexity and risks are multiplied in a troubled environment.

Special skills are required to determine which hotel assets are troubled because of the current economic environment and which will be troubled even when the environment improves. Once the good assets are identified, investors must adeptly handle a very broad range of industry-specific issues. These include the special due diligence and legal concerns of hotel acquisitions. In addition, the investor must understand how to handle multiple liens and claimholders and, potentially, receivership or bankruptcy procedures. Simultaneously, the investor needs to engage the industry resources to establish and execute the strategy to reposition the hotel assets and minimize losses while the recovery takes hold.

Meeting the Needs

To help clients successfully address these challenges, the Task Force employs Graham & Dunn's nationally recognized Hospitality Industry Group. Its members have assisted the industry since 1990, and, in previous down-cycles, have successfully addressed the very legal issues and challenges facing the industry today. The Task Force is further enhanced and combined with the extensive banking industry resources of Graham & Dunn's Financial Services Group and the firm's bankruptcy/insolvency, real estate, labor and employment, litigation, and construction practices.

The Hotel Resolution Task Force is led by Hospitality Industry Group partners Irvin W. Sandman and Russell C. Savrann, in close coordination with Financial Services Group and bankruptcy partner Mark D. Northrup, Real Estate Group partner Douglas J. Smart, and litigation partners Doug Berry, Stephen H. Goodman and