By Mark J. Fucile
Both academic research and the popular legal media have increasingly discussed the “wellness” challenges facing the legal profession.[i] At the same time, the organized bar both nationally and locally have undertaken significant initiatives to better address these challenges.[ii] Although precise statistics are not available, anecdotal evidence from case reports suggests that lawyer “impairment” in one form or another puts lawyers at disciplinary risk and firms at malpractice risk.[iii]
This article surveys two related questions for law firm risk management within the context of lawyer impairment: (1) what are a law firm’s supervisory responsibilities for lawyers[iv] who may be impaired? and (2) what are the reporting obligations of law firms for an impaired lawyer?[v] With each, the word “impairment” is used in the broadest sense of a condition—regardless of the cause—that affects a lawyer’s ability to competently represent clients.[vi]
Idaho Rule of Professional Conduct (“RPC”) 5.1(a) outlines the regulatory duties of law firm partners and others with “comparable managerial authority” for creating an ethical infrastructure within their firms. To account for variations in firm size, number of offices and practice fields, RPC 5.1(a) is intentionally both broad and general:
“A partner in a law firm, and a lawyer who individually or together with other lawyers possesses comparable managerial authority in a law firm, shall make reasonable efforts to ensure that the firm has in effect measures giving reasonable assurance that all lawyers in the firm conform to the Rules of Professional Conduct.”[vii]
RPC 5.1(b), in turn, addresses the responsibilities of a direct supervisor—regardless of the lawyer’s position within the firm involved:
“A lawyer having direct supervisory authority over another lawyer shall make reasonable efforts to ensure that the other lawyer conforms to the Rules of Professional Conduct.”
Similarly, the Idaho Supreme Court in Stephen v. Sallaz & Gatewood, Chtd., 150 Idaho 521, 527, 248 P.3d 1256,1262 (2011), emphasized that a law firm is responsible for any malpractice committed by its lawyers:
“Idaho’s corporate code applies here and it is clear that a corporation is liable for the negligent or wrongful act of employees acting on behalf of the corporation.”
Although neither of these regulatory or corporate codes address lawyer impairment specifically, both make clear that client work must be undertaken competently and within the standard of care. RPC 1.1 defines the former:
“A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.”[viii]
Case law defines the latter:
“As a matter of law, an attorney owes his client a duty to use and exercise reasonable care, skill, discretion, and judgment in the representation.”[ix]
The comments to RPC 5.1 counsel that firms should take proactive steps that reasonably anticipate common risks and that they cannot “turn a blind eye” when problems arise.
For its part, Comment 2 gives examples of proactive steps firms should generally take to address common risks: “Such policies and procedures include those designed to detect and resolve conflicts of interest, identify dates by which actions must be taken in pending matters, account for client funds and property and ensure that inexperienced lawyers are properly supervised.”
And Comment 3 notes the reality that problems may occur and cannot simply be ignored: “In any event, the ethical atmosphere of a firm can influence the conduct of all its members and the partners may not assume that all lawyers associated with the firm will inevitably conform to the Rules.”
Although these are comments to a regulatory rule, then-Justice Jim Jones, in his concurring opinion in a legal malpractice case, acknowledged the practical relationship between the regulatory rules and the standard of care: “The contours of an Idaho lawyer’s duty of care are generally spelled out in the Idaho Rules of Professional Conduct[.]”[x]
Given better documentation of lawyer impairment issues and the more robust resources now available for law firms in this area, firms will likely be increasingly expected to implement policies and procedures for identifying and assisting firm lawyers to both prevent and mitigate impairment-related issues. The comments to RPC 5.1 suggest that such policies and procedures may be tailored to a firm’s particular circumstances, with Comment 3 observing: “In a small firm of experienced lawyers, informal supervision and periodic review of compliance with the required systems ordinarily will suffice . . . [while] [i]n a large firm . . ., more elaborate measures may be necessary.”
In sum, the increasing recognition of the problem of impairment within the legal profession means that law firms should incorporate protocols appropriate for firm size and practice into their risk management plans. With the increasing recognition of the problem has also come the availability of resources for firms of all sizes from national organizations such as the ABA and local ones such as the Idaho Lawyers Assistance Program. Malpractice carriers are also another source of practical tools. Just as law firms cannot ignore conflict checks or cyber security risks, they need to frankly acknowledge and address the issue of lawyer impairment.
RPC 8.3(a) states a lawyer’s duty to report professional misconduct:
“A lawyer who knows that another lawyer has committed a violation of the Rules of Professional Conduct that raises a substantial question as to that lawyer’s honesty, trustworthiness or fitness as a lawyer in other respects, shall inform the appropriate professional authority.”
Comment 3 to RPC 8.3 outlines the contours of the reporting requirement:
“If a lawyer were obliged to report every violation of the Rules, the failure to report any violation would itself be a professional offense. Such a requirement existed in many jurisdictions but proved to be unenforceable. This Rule limits the reporting obligation to those offenses that a self-regulating profession must vigorously endeavor to prevent. A measure of judgment is, therefore, required in complying with the provisions of this Rule. The term ‘substantial’ refers to the seriousness of the possible offense and not the quantum of evidence of which the lawyer is aware. A report should be made to the bar disciplinary agency unless some other agency, such as a peer review agency, is more appropriate in the circumstances. Similar considerations apply to the reporting of judicial misconduct.”
The ABA in Formal Opinion 03-429 (2003) wrestled with the interplay between addressing impairment issues internally and reporting under ABA Model Rule 8.3—on which Idaho’s variant is based. In what can be a gray area, the opinion offers prudent and practical guidance.
Formal Opinion 03-429 divides the duty to report—or not—into three broad categories. First, the opinion counsels that there is no duty to report if the impairment has not resulted in a violation of the professional rules. The opinion puts it this way: “[I]f the firm reasonably believes that it has succeeded in preventing the lawyer’s impairment from causing a violation of a duty to the client by supplying the necessary support and supervision, there would be no duty to report under Rule 8.3(e).”[xi] For example, if a firm lawyer raised—or was confronted with—an issue that had the potential to impair the lawyer’s representation of a client but no harm to the client resulted, then there would be no duty to report. Even if there is no duty to report, however, the firm should still take whatever remedial steps are appropriate to assist the lawyer and to protect any clients affected.
Second, the opinion concludes that there is no duty to report if the condition that has caused impairment has resolved. The opinion uses the following example: “[I]f partners in the firm and the supervising lawyer reasonably believe that the previously impaired lawyer has resolved a short-term psychiatric problem that made the lawyer unable to represent clients competently and diligently, there is nothing to report.”[xii] The logic in this scenario is that the lawyer has regained the requisite fitness to practice law moving forward. Although this may alleviate the need to report the lawyer to a regulatory authority, the firm would still have a duty under the “communication rule”—RPC 1.4—to inform current clients impacted by any material errors the lawyer made during the transitory period of impairment. Another ABA opinion—Formal Opinion 481 (2018)—addresses this duty in considerable detail. Depending on the circumstances, Formal Opinion 03-429 suggests the firm may also have a duty to monitor the lawyer’s work for at least a reasonable period going forward to assure that the impairment has not reoccurred.
Third, the opinion finds that if a lawyer’s impairment renders the lawyer unable to competently represent clients but the lawyer insists on doing so anyway, the firm must report.[xiii] In this situation, the opinion concludes that the firm cannot simply replace the lawyer without telling the clients affected—although it suggests there is a balance to be struck between informing clients and respecting the privacy of the lawyer involved. The opinion suggests in this regard: “In discussions with the client, the lawyer must act with candor and avoid material omissions, but to the extent possible, should be conscious of the privacy rights of the impaired lawyer.[xiv] The opinion also finds that, again depending on the circumstances, management and supervisory lawyers may have an obligation to take appropriate steps to mitigate the consequences.
Formal Opinion 03-429 strikes a balance between helping impaired lawyers and protecting clients. The opinion offers firms practical guidance in navigating what is always a difficult situation.
With the increasing recognition of impairment issues within the legal profession and the corresponding availability of resources to address them, law firms should incorporate protocols for dealing with impairment issues appropriate for firm size and practice into their risk management plans.
Mark J. Fucile of Fucile & Reising LLP handles professional responsibility, regulatory, and attorney-client privilege matters for lawyers, law firms, and legal departments throughout the Northwest. He is a member of the Idaho State Bar Litigation and Professionalism & Ethics Sections. He also teaches legal ethics as an adjunct for the University of Oregon School of Law’s Portland campus. He can be reached at 503.224.4895 or email@example.com.
[i] See, e.g., Patrick R. Krill, Ryan Johnson and Linda Albert, The Prevalence of Substance Use and Other Mental Health Concerns Among American Attorneys, 10, No. 1 J. Addict. Med. 46 (2016); Christine Simmons, Law Firms Face Malpractice Risk Over Substance Abuse, Poor Mental Health, available at www.propertycasualty360.com, Dec. 4, 2018.
[ii] See, e.g., ABA Working Group to Advance Well-Being in the Legal Profession, Report 105 to the 2018 Mid-Year Meeting of the House of Delegates (Feb. 2018); Idaho Lawyer Assistance Program, available at https://isb.idaho.gov/member-services/programs-resources/lap/.
[iii] See, e.g., Matter of Tway, 123 Idaho 59, 62, 844 P.2d 688, 691 (1992) (personal and emotional problems led to issues underlying imposition of lawyer discipline); National Union Fire Ins. Co. of Pittsburgh, PA v. Wuerth, 540 F. Supp.2d 900 (S.D. Ohio 2007) (legal malpractice claim painted against backdrop of lawyer impairment issues).
[iv] Although this article focuses on supervision of lawyers, law firms are also generally responsible for supervising non-lawyer employees. See generally Matter of Jenkins, 120 Idaho 379, 816 P.2d 335 (1991) (discussing regulatory responsibility for non-lawyers under RPC 5.3); Stephen v. Sallaz & Gatewood, Chtd., 150 Idaho 521, 248 P.3d 1256 (2011) (discussing malpractice liability for law firm employees).
[v] ABA Formal Opinion 03-431 (2003) addresses issues surrounding the duty to report a non-firm lawyer’s impairment.
[vi] Black’s Law Dictionary (11th ed. 2019), for example, defines “impairment” as: “The quality, state, or condition of being damaged, weakened, or diminished; a condition in which part of a person’s mind or body is damaged or does not work well[.]”
[vii] Idaho RPC 5.1 is patterned on ABA Model Rule 5.1.
[viii] RPC 1.3 addresses the related concept of “diligence.”
[ix] Sun Valley Potatoes, Inc. v. Rosholt, Robertson & Tucker, 133 Idaho 1, 4, 981 P.2d 236, 239 (1999).
[x] Bishop v. Owens, 152 Idaho 616, 622, 272 P.3d 1247, 1253 (2012)
[xi] ABA Formal Op. 03-429, supra, at 7.
[xii] Id. at 5.
[xiv] Id. at 5-6.
By David E. Kerrick
This morning I realized I have been in the business of the practice of law for 40 years. I graduated from the University of Idaho College of Law in December 1979. It has been an amazing journey! I wonder what the next 40 years will look like.
Many things have changed in four decades. But the people are still basically the same – the clients, the co-workers, the adversaries, and the professional colleagues. What has changed and what has driven change is technology.
In the beginning of my practice, my day would start by getting the mail at the post office. Letters and court pleadings would arrive, all with the necessary postage. Legal research was done in a law library with large impressive books. I would respond to the phone messages written up by the secretary with the use of a black desk phone. Mountain Bell was the only carrier available and calling Boise was a long-distance call.
My secretary could take my dictation in shorthand and would type my words up on a fancy IBM Selectric typewriter. My scheduling calendar was a spiral notebook, month-at-a-glance format, with 18 months’ worth of capacity.
To do research on my clients or the opposing party was a mysterious process of interviews and detective work finding records at various locations. Client files would grow and grow. When the files were closed, they were placed in a dead file storage unit. The dead files grew like a cancer. The physical office itself was where all the work had to be done. When I was away from the phone, I was away. Back then the life of George Jetson seemed farfetched.1
As time has passed, communication has changed. Paper letters have all but gone the way of the dinosaur. Now, the only things I find when I go to the post office are a few bills and a bunch of junk mail. Email is now the preferred method of communication by most. In the mid-1990s, I had heard of the internet but did not have a clue as to what it was or how it worked. When I purchased my first laptop computer, my nine-year-old daughter taught me how to use Windows. My first cell phone was the size of a brick and had an antenna. There was no camera in it.
I am not yet there, but many lawyers are now putting their files in the cloud. Recently, I have started keeping my calendar on an app that I can look at with my cell phone. Before I see a new client now, I usually have a stack of information that my assistants print from the internet, such as property records, obituaries, court repositories, Facebook profiles, news articles, etc.
Legal research has also become quicker with the internet. In fact, I can find an Idaho statute quicker through Google than I can find it through the index in my Idaho Code set.
These days it is difficult to find a secretary who knows shorthand. I put my last IBM Selectric on Craigslist for free. It took over a month to find a taker.
I am amused now when I go to a conference. The speaker is standing up front giving a PowerPoint presentation and everyone in attendance is looking at their phone or their tablet checking their email or surfing the internet. And it isn’t even considered rude. It’s just normal multitasking in the 21st Century.
Every new device that automates something or makes our work faster and more efficient simultaneously increases our workload. The expectation now seems to be that I sit at my computer all day long, including nights and weekends, and respond instantly to one email after another. How I miss the days when I could rely on the mail to give me at least an excused three-day delay.
The challenge today, and into the future, will be mastering this endless transition of new technology.
What will the law office of the future look like? Even today, people can telecommute, and many people are capable of working “remotely.” Like George Jetson talking to his boss, Mr. Spacely, on the videophone, 2062 has already arrived! Our staff members do not need to be in the same location anymore. The secretary with shorthand is now replaced by an app on your phone that will do voice-to-text.
I can see the future now. My office will soon be contained entirely in my phone. All of my files and law books will be stored in the cloud. I will meet and talk with everyone – employees, clients, colleagues, the court – in real-time, face-to-face on my phone without leaving my house. Most mornings I won’t even need to put on my pants.
David E. Kerrick is a sole practitioner in Caldwell where he has been engaged in private civil practice since 1980. He graduated from Caldwell High School, attended the College of Idaho, received a B.A. from the University of Washington, and a J.D. from the University of Idaho College of Law.
- George Jetson is the lead character in a television cartoon series that first aired in 1962. George and his family lived 100 years in the future, that is 2062. The Jetsons talk on telephones which have a TV screen picture of the other person on the call. George’s boss is Mr. Spacely, owner of Spacely Space Sprockets. A videophone call from Mr. Spacely typically starts with him yelling at George for some work performance issue.
By Major Stephen A. Stokes
Members of the 116th Cavalry Brigade Combat Team (CBCT) Brigade Legal Section (BLS), Idaho Army National Guard, deployed to the U.S. Army National Training Center in Fort Irwin, California from May 24, 2019, to June 20, 2019. The Legal Section was part of a much larger exercise, which saw over 4,000 Soldiers and Airmen and over 2,000 pieces of equipment travel to California for a large-scale, simulated-combat experience.[i]
The rotation at the National Training Center was a culminating training event for the 116th CBCT as it prepares for deployment in the spring of 2020. This article will briefly describe the National Training Center (NTC), the Brigade Legal Section’s composition and role in a training exercise like NTC, and what is next for the legal section.
The National Training Center, which has an area roughly the size of Rhode Island, is the U.S. Army’s premier training center. NTC rotations “incorporate a complex scenario design laden with social, ethical, and moral dilemmas; the goal of which is to develop leaders while exposing them to multifaceted problems. Units training at NTC today face a complex hybrid threat. Units must face a near-peer opposing force, while taking on an insurgent force.”[ii]
The National Training Center allows units to “train under the most war-like conditions available.”[iii] It was under these conditions that the 116th CBCT honed its craft.
The BLS consisted of Major Steve Stokes, Brigade Judge Advocate, Captain Michael Winchester, Trial Counsel, Captain Nate Peterson, Operational Law Attorney, First Lieutenant Anil Kimball, Chief of Administrative Law, Staff Sergeant Peter Scheri, Paralegal NCOIC, and Sergeant Kenneth Kalim, Paralegal Soldier. In addition, each of the nine battalions making up the 116th CBCT deployed with a Paralegal Specialist.
The legal team is of vital importance to a commander in the field. War plans, initiatives, and decisions can have far-reaching strategic and policy implications in complex operational environments.[iv] The Brigade Legal Section honed its skills by advising on a wide array of legal issues including the law of armed conflict, rules of engagement, lethal and nonlethal targeting, treatment of detainees and noncombatants, fiscal law, foreign claims, contingency contracting, international rule of law, the conduct of military investigations, and military justice.[v] Members of the BLS also served as staff officers on boards, centers, cells, and working groups, where they fully participated in the military planning process.[vi]
The 116th CBCT BLS reflect the diversity of experience inherent in the National Guard; More than two-thirds of the Soldiers and Airmen in the Idaho National Guard are part-time citizen-soldiers. These Soldiers and Airmen have the triple burden of excelling in their civilian careers, serving their State and Nation, and upholding their commitments to their families.
The 116th BLS exemplifies this can-do spirit: CPT Nate Peterson is a busy and successful private practitioner in Boise; CPT Mike Winchester is a deputy prosecuting attorney serving the people of Jefferson County; 1LT Anil Kimball recently passed the Idaho bar examination and is beginning his civilian career after completing his military education, and SSG Peter Scheri is an electrician in Meridian.
Through the crucible of the 2019 NTC rotation, the BLS came together as a team, learned best practices from the best legal trainers in the U.S. Army, and gained new Soldier skills and determination that the members will bring home to their civilian employers and communities.
Next spring, the 116th CBCT will participate in an exercise called Defender 2020, which will include a month-long deployment to Germany.[vii] One purpose of Defender 2020 is to show that an armored brigade combat team can deploy from the United States, draw equipment, and rapidly build combat forces in Europe.[viii] During the exercise, the brigade will also conduct training in a high-intensity European scenario fight.[ix] The BLS will be a vital part of this deployment, ensuring that the 116th CBCT follows the rule of law and executes its mission in a legal and ethical manner.
“Stokes Photo 1” Cutline – The 116th CBCT Brigade Legal Section in action. From left to right: CPT Nate Peterson, Operational Law Attorney, CPT Mike Winchester, Trial Counsel, MAJ Steve Stokes, Brigade Judge Advocate, 1LT Anil Kimball, Chief of Administrative Law, and SGT Kenneth Kalim, Paralegal Soldier. Not Pictured, SSG Peter Scheri, Brigade Paralegal NCOIC. Photo Credit: 1LT Anil Kimball.
Major Stephen A. Stokes is the full-time Staff Judge Advocate, Idaho National Guard. After clerking, he worked in private practice in Pocatello from 2006 until 2014, when he joined the Idaho National Guard full-time. Stokes was commissioned as a Judge Advocate in 2009 and deployed to Iraq in 2010-2011 with the 116th Cavalry Brigade Combat Team. He has served in a wide variety of local and state bar activities. He is a 2014 graduate of the Idaho Academy of Leadership for Lawyers. Currently, he is President of the Fourth District Bar Association and immediate Past-Chair of the Idaho Military Legal Alliance.
[i] Steve Dent, Idaho National Guard finishes off a Successful NTC Rotation at Fort Irwin, KIVI Boise, www.kivitv.com (last visited on September 3, 2019).
[iii] Lt. Col. Chris Borders, 116th Soldiers Return Home after Month-Long Exercise, Clearwater Tribune, www.clearwatertribune.com (last visited September 3, 2019) (“Borders Article”).
[iv] U.S. Army Field Manual 1-04, Legal Support to the Operational Force, Paragraph 1-1.
[vii] Borders Article.
By Mellisa D. Maxwell and Claire C. Rosston
If your business clients haven’t already asked you about the California Consumer Protection Act (CCPA),[i] expect that they will soon. The CCPA is the first data privacy and security act in the United States with expansive protections for data that can identify or is directly or indirectly linked to particular individuals. Even though the CCPA applies to the personal information of California residents only, its reach will extend well beyond the borders of California.
Idaho businesses that collect or have access to personal information of California residents will fall within the CCPA’s purview. The CCPA also imposes stiff penalties of up to $2,500 for each violation, which increases to $7,500 if the violation is intentional. Moreover, it gives California residents a civil right of action for injunctive or declaratory relief as well as monetary damages against businesses that fail to implement reasonable security measures to protect their personal information.
Given the liability for noncompliance and the likelihood that the CCPA will become the standard for best practices in privacy and data protection unless preempted by federal law or another state adopts more rigorous requirements, Idaho business lawyers need to understand the basic components of the CCPA to serve their clients well. This article outlines the components of the CCPA that every business lawyer should know, with the caveats that some interpretation challenges still exist and that additional amendments and regulatory guidance may be issued prior to the January 1, 2020 effective date.
Broad Application of the CCPA
In order to understand how the CCPA could apply to Idaho clients, it is important to recognize the broad group of entities that are within its scope. First and foremost, the CCPA applies to any for-profit business (regardless of where it is located) that controls personal information of California residents and satisfies at least one of the following criteria: (i) generates gross revenues above $25 million; (ii) annually receives or shares for commercial purposes or buys or sells personal information of at least 50,000 California residents, households, or internet-connected devices; or (iii) derives at least 50% of its annual revenue from selling California residents’ personal information.
A business controls California residents’ personal information if it determines the purposes and means of processing the personal information that is collected by it or on its behalf. As a result, a business can be covered by the CCPA even if it does not itself collect and store California residents’ personal information. For example, your client hires a consulting firm to survey its California employees about their job satisfaction, and in doing so, instructs the consulting firm which questions to ask and how it wants the results communicated in charts and summaries that de-identify the data. Despite not directly collecting, processing, or storing the personal data, your client is the controller of the data.
In addition, the CCPA covers more than just businesses that control personal information. All businesses that are controlled by or share common branding with a business covered by the CCPA must comply with the CCPA, regardless of whether such businesses independently satisfy the criteria for covered businesses.
Finally, the CCPA also applies to any service providers or other individuals and entities (regardless of location) who purchase or receive personal information of California residents for a business purpose. Therefore, while your clients may not be businesses as described above, the CCPA may affect them based on what the regulation identifies as a “service provider” or a “third party.”
A service provider is a for-profit entity that processes information on behalf of a CCPA-covered business. If your client operates under a business-to-business model, requirements may be pushed down to your client pursuant to a written contract. On the flip side, if your client is a covered business, it will want its vendor contracts to contain certain restrictions and obligations because the regulation may offer some protections to the business if its contracts contain the required terms.
Unlike a business or a service provider, the regulation defines a “third party” in the negative. Because of some subtle nuances, this results in a number of interpretive challenges. In short, however, a third party is any person or entity that is not a business or service provider. However, a situation could arise when a client is a service provider (i.e., a vendor to a business) but is not a “service provider” as defined under the CCPA.
It is crucial to understand the relationships within the organizational ecosystem, the data involved, and the contractual terms in place among entities because the obligations and requirements under the regulation will vary. Falling into one category over another could impact your clients’ ability to conduct business or add administrative burdens they may or may not be able to carry out.
The broad scope of the CCPA is largely derived from the key definitions of “personal information,” “processing,” and “selling.” When it comes to consumers as individuals, they may have different ideas on what is considered private or personal. Simply asking clients or business owners if they are receiving, collecting, or storing personal information is problematic because each individual you are asking will likely attribute his or her own understanding as opposed to how the term is defined under the regulation.
Under the CCPA, personal information is any information that identifies, relates to, describes, is capable of being associated with, or could reasonably be linked, directly or indirectly, with a particular consumer or household. Section 1798.140(o) of the CCPA provides an illustrative, but not exclusive, list of the categories of information within the definition of personal information. The categories include the expected identifiers, such as name, address, or SSN. However, identifiers also include IP address, email address, account names, and other similar identifiers.
Other categories that may not intuitively seem like personal information include commercial information; internet/electronic network activity information; audio, electronic, visual, thermal, olfactory, or similar information; professional or employment-related information; or inferences from any information that could create a profile about a consumer.
Fortunately, a few exceptions have been carved out from this very broad definition. One exception is “publicly available” information as defined under the regulation. There are also exceptions for information that is de-identified or aggregated in accordance with the regulation. Medical information is also excluded to the extent it is protected under the California Confidentiality of Medical Information Act. Similarly, protected health information (PHI) as defined and governed under Health Insurance Portability and Accountability Act (HIPAA) is also excluded. While these carve-outs are helpful in theory, in practice it could be a large technical feat for clients to segregate data that is subject to HIPAA as PHI from information that is personal information under the CCPA.
The CCPA also uses the expansive terms “processing” and “selling.” Even if your client is not directly covered by the CCPA because it does not control how personal data is collected and used, it may still be a service provider by virtue of processing personal data for another business. Service providers are required to comply with certain requirements of the CCPA that controllers of personal data contractually obligate them to do. The CCPA defines “processing” to mean any operation performed on personal data, regardless of whether it is by automated means. Something as simple as linking one piece of personal data with a customer identifier is sufficient to process the data.
The CCPA contains many restrictions related to the selling of personal information, including giving California residents the right to opt-out of the sale of their personal information. Under the CCPA, the word “sell” and its variations are defined broadly to mean any disclosure, transfer, or make available personal information of California residents for monetary or other valuable consideration. Consequently, two businesses with a data-sharing agreement are selling personal data to each other under the regulation by virtue of the exchange of the data, which has value, for other data.
Inventorying data collected and stored by a business is the foundation of its compliance with CCPA. It is not possible for your clients to comply with the CCPA without knowing what personal data they collect, how the various pieces of personal data are linked to one another, and the purpose of collecting and storing the data. For this reason, the first step towards CCPA compliance is for your clients to inventory their data.
It is most likely that all employees of a business collect personal data in some form or another, even if this is done merely by storing contact information and signature cards in an employee’s email account. Your clients should identify all data collection points and detailed information about the data collected. This can be done by asking each employee to answer a questionnaire about the data the employee collects and stores. This questionnaire should also ask specific information about the data in order to accurately categorize the data and how it is used.
Through this exercise, your clients should be able to answer the following questions about each type of data they collect:
- Is the data personal information?
- Within which category (e.g., biometric or financial) does the data fit?
- Is the data encrypted?
- What is the source of the data?
- How is the data used?
- How is the data linked/tracked/connected with other data?
- Is the data sold? If yes, to whom?
- Is the data disclosed? If yes, to whom and for what purpose?
- How long is the data retained?
- Is the data discarded by destruction or de-identification?
With this information, a business can then prepare an easy-to-use reference illustrating the life cycle of all of the personal data it collects and stores and to which other data the personal data is linked. This reference can then be used for your client to consider whether it can change any of its personal data collection practices in order to lessen its CCPA compliance burden. It costs money to collect and store data. If your client doesn’t need particular types of personal data, it can improve its bottom line and minimize its CCPA compliance burden by reducing what data it collects and how long the data is kept.
Updating Policies and Procedures
In order to demonstrate compliance with the CCPA, organizations must develop, implement, and maintain appropriate policies and procedures and other measures necessary to comply with the requirements of the law. Consumers must be offered at least two methods to submit requests, and procedures must be implemented to process all requests in the manner and time frame prescribed. Some of these processes and procedures may be easy to implement; however, others may require significant changes depending on your client’s business and past efforts to comply with data privacy and security laws.
The mechanisms employed and evidence used to demonstrate compliance with the following consumer rights may vary depending on the nature and size of your client. One of the largest compliance burdens is for businesses to be ready to respond to the consumer rights granted by CCPA. The basic consumer rights covered under the regulation are: (1) the right of access; (2) the right to erasure; (3) the right to not be subject to discrimination; (4) the right to data portability; (5) the right to object; and (6) the right to be informed.
The less technical implementations include providing consumers with full visibility of the data the organization has about them. This means each consumer has the right to obtain details, and even copies, of such data. A process must be in place to handle all requests in the manner and time frame prescribed.
In addition, consumers have a right to request deletion of their personal information free of charge (although there are times when a fee may be requested). Also, if incentives are offered for the collection, sale, or deletion of information, then policies and procedures must be in place to provide consumers with notice of the financial incentives, and consumers must expressly opt-in to any such incentive programs. This ties into the requirement that consumers may not be discriminated against for opting out of the sale of their personal information.
When it comes to the data portability requirement, consumers have a right to obtain access to their data in a format that allows the transmission of the data to someone of their choice without hindrance or cost. Your clients must have mechanisms in place to validate the identity of individuals requesting this information. More technical compliance requirements include a “Do Not Sell My Personal Information” link and extensive employee training.
Updating Privacy Policies
Additionally, the CCPA requires notice of the rights the CCPA gives California residents with respect to their personal information and how they may exercise these rights by making requests to a business about their personal information. Your clients also need to make sure that their websites contain multiple ways for the individuals to exercise their rights, including, at a minimum, a toll-free telephone number and a website address.
At the end of the day, even though the CCPA applies only to businesses with customers or employees who are California residents, businesses will likely find it cumbersome to maintain separate processes for California residents. Given the shift on the national stage regarding privacy, all of your clients should consider implementing these requirements as best practices sooner rather than later, recognizing that the CCPA will likely become the standard for U.S. residents everywhere.
Mellisa D. Maxwell is the Associate General Counsel and Privacy Officer at Healthwise, Incorporated and an Adjunct Professor at Concordia University School of Law. She currently serves as the Executive Director to Initium Law, Inc. where she also volunteers her time to provide legal services to small businesses, startups, and nonprofits. When not being a lawyer she is roaming around the wilderness with her adventure dog, a Staffy rescue.
Claire C. Rosston is a business attorney at Holland & Hart LLP who counsels clients in data privacy and security and commercial transactions, including business acquisitions and secured financings.
[i] Stats. 2018, c. 55 (A.B.375), § 3, eff. Jan. 1, 2019, operative Jan. 1, 2020, as amended by Stats. 2018, c. 735 (S.B.1121). The CCPA, as amended, has not been codified. The CCPA is expected to be codified as Sections 1798.100 to 1798.199 of the California Civil Code. The CCPA’s definitions are set forth in what is expected to be codified as Section 1798.140. The consumer rights granted by the CCPA are set forth in what is expected to be codified as Sections 1798.100, 1798.105, 1798.110, 1798.115, 1798.120, and 1798.125.
By Kelsey J. Nunez
Social entrepreneurs believe that a for-profit business model can improve environmental quality, community health, and worker well-being while also earning profits. As there is no one-size-fits-all approach to focusing on a triple bottom line (people, planet, and profits), this article provides thoughts to consider when helping social entrepreneur clients decide whether to become a benefit corporation (a legal entity form), a Certified B Corporation (a third-party certification), both, or neither.
Entity selection involves analysis of many issues, including ease of formation, flexibility in management, limitation of owner liability, transferability of ownership, characterization, and allocation of profits and losses, ability to fundraise, and tax considerations. This article focuses on how creating social or environmental benefit fits into this conversation. The idea is to help a client achieve its purpose-driven goals while putting itself in the best legal box(es) for other goals.
Benefit corporations have different rules
In 2010, Maryland became the first state to create a new type of corporation called a benefit corporation. Currently, 34 states have benefit corporations, including Idaho.[i] Idaho benefit corporations are governed by both the Idaho Benefit Corporation Act (Idaho Code §§ 30-2001 et seq.) and the Idaho Business Corporation Act (Idaho Code §§ 30-29-101 et. seq). Chapter 20 imposes requirements that are in addition to, or in lieu of, the general business corporation laws in Chapter 29.[ii] The most significant additions and distinctions in Chapter 20 relate to corporate purpose, standards of conduct, accountability, transparency, and enforcement.
This corporate form was created in response to shareholder primacy litigation.[iii] Strong precedent and philosophical force supported the rule that corporate boards must justify decisions in terms of creating shareholder value. Directors who made choices based upon impacts on the environment, workers, or community, or who chose to reduce or delay profits to help non-shareholders, were getting fired and sued. This legal framework discouraged entrepreneurs from using the corporate form if their business model was centered around creating positive impacts on external stakeholders and non-shareholders.[iv]
Prior to any benefit corporation legislation, many states changed the common law rule of shareholder primacy by enacting “constituency statutes,” which permit consideration of other constituencies, i.e., non-shareholders, in certain situations.[v]
Constituency statutes allow – but do not mandate – consideration of non-shareholders.
Idaho has two constituency statutes. Both the Business Combination Act and the Control Share Acquisition Act state, “[A] director, in considering the best interests of the corporation, shall consider the long-term as well as the short-term interests of the corporation and its shareholders including the possibility that these interests may be best served by the continued independence of the corporation. In addition, a director may consider the interests of Idaho employees, suppliers, customers and communities in discharging his duties.”[vi] Notably, these constituency statutes do not require directors to consider non-shareholders when combining with another business or selling/acquiring a controlling share, and shareholders remain at the top of the hierarchy.
Advocates for social entrepreneurship were not satisfied with constituency statutes because they were limited in scope and permissive in nature. So, they created a new corporate form, the benefit corporation, which made it mandatory to pursue public benefits and consider impacts on non-shareholders.
Benefit corporations opt-in to new statutory duties
Recall that a benefit corporation is subject to the same statutes and case law that govern general business corporations unless the Idaho Benefit Corporation Act provides a different rule. There are many reasons why a social entrepreneur would want to form a corporation, including a defined and well-regulated mechanism for raising money. Assuming your client is already leaning toward a for-profit corporate entity, the question becomes: “should the client be a benefit corporation or a regular corporation?” While there is plenty of overlap, the distinctions are profound.
For example, a benefit corporation’s very purpose distinguishes it from a regular corporation. “A benefit corporation shall have the purpose of creating general public benefit,” which means “a material positive impact on society and the environment, taken as a whole, as assessed under a third-party standard, resulting from the business and operations of a benefit corporation.”[vii]
Benefit corporations may also commit to “specific public benefits,” such as (i) providing low-income or underserved individuals or communities with beneficial products or services; (ii) promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business; (iii) protecting or restoring the environment; (iv) improving human health; (v) promoting the arts, sciences, or advancement of knowledge; (vi) increasing the flow of capital to entities with a purpose to benefit society or the environment; or (vii) conferring any other particular benefit on society or the environment.[viii]
This corporate purpose is a key element in eliminating shareholder primacy constraints. In a benefit corporation, creating value beyond shareholder profits is the point.
Assessing the performance of a benefit corporation requires the use of a third-party standard. Idaho Code does not mandate the use of a particular third-party assessment, but it establishes requirements that narrow the field of options.
The assessment must be “a recognized standard for defining, reporting and assessing corporate social and environmental performance.”[ix] It must also be: (i) comprehensive in how it assesses the business and its impacts on shareholders and external stakeholders; (ii) developed by an entity that is not controlled by the benefit corporation; (iii) credible, in that it was developed by an entity qualified to assess overall corporate social and environmental performance and uses a balanced multi-stakeholder approach to develop the standard, including a reasonable public comment period; and (iv) transparent in that information about the standard is publicly available, including information about the criteria and weighting of such criteria, the identity of those who developed and revised the standard, an accounting of the revenue of sources of financial support used to develop the standard, and disclosures of any potential conflicts of interest.[x]
Benefit corporations are most likely to choose the Certified B Corporation as their third-party standard because it meets all of these requirements. This is by design, as the entity that created that standard, B-Lab, also drafted the model benefit corporation legislation.[xi]
A benefit corporation’s standard of conduct also distinguishes it from a general business corporation. General business corporations have a standard of conduct for directors and officers—they must act in good faith, in a manner that the director reasonably believes to be in the best interests of the corporation, and with the care that a person in a like position would reasonably exercise under similar circumstances.[xii]
The Idaho Benefit Corporation Act goes further by mandating an analytical process when determining what is in the best interests of the corporation.
In a benefit corporation, the directors and officers shall consider the effects on: (i) the shareholders; (ii) the employees; (iii) the subsidiaries and suppliers; (iv) the interests of customers as beneficiaries of the general public benefit or specific public benefit purposes; (v) community and social factors, including those of each community in which offices or facilities of the benefit corporation, or its subsidiaries, or its suppliers are located; (vi) the local and global environment; (vii) the short-term and long-term interests of the benefit corporation, including benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation; and (viii) the ability of the benefit corporation to accomplish its general public benefit purpose and any specific benefit purpose.[xiii]
For some investors, this shift in how shareholders and profits are prioritized presents unacceptable risks because the managers entrusted with the investors’ capital are not constrained by conventional limits on their discretion and the non-financial results are not as easy to measure.[xiv]
The corporate purpose and standard of conduct requirements for benefit corporations are given teeth by reporting and enforcement mechanisms. Benefit corporations must prepare an annual benefit report that discusses its pursuit of public benefits (including anything that went wrong or did not succeed), explains the third-party assessment used, and discloses compensation and conflicts of interest.[xv]
The statute also creates the Benefit Enforcement Proceeding, the exclusive forum to sue for failure to pursue or create public benefit or for violating the duties or standards of conduct.[xvi] This enforcement mechanism, including how to prevent or prevail in one, is examined in the August 2019 issue of The Advocate.[xvii]
Another option is to become a Certified B Corporation
For a benefit corporation to be the right choice for a client, it must first be the right choice for the client’s entity to be a for-profit corporation. Then, the company must decide if it is ready and willing to commit to a wide range of stakeholders, submit to the judgment of a third-party standard, be transparent in its reporting, and be subject to civil litigation if it fails to pursue or achieve its goals.
Shareholders investing in a benefit corporation must understand that they are not assured of shareholder primacy at any stage of the corporation’s life (operation, merger, sale, etc.). Benefit corporations certainly aren’t for everyone! For those unwilling or unable to utilize a benefit corporation, there are other options.
Any legal entity form can apply to become a Certified B Corporation[xviii]. This process is inspiring and humbling. It sets high standards for practices relating to governance, workers, environment, community, and customers. The “B Impact Assessment” is used by a company to measure its impacts, set goals, learn best practices, and shine as an example of “using business as a force for good.”[xix] Anyone can use this tool to analyze one’s practices (it’s free).
However, it is only companies that get enough points on the assessment that can submit it for review to qualify for certification. During review, staff will verify the responses with data requests. Once verified, the company can sign a contract committing to B-Lab’s high standards. Only then can the company market itself as part of this growing network of gold-star social entrepreneurs. Payment is required each year, recertification happens every two years, and the assessment keeps getting harder as the bar continues to rise.
If your client will form its company as a benefit corporation, it will need to select a third-party assessment, which could be the Certified B Corporation. Note that a benefit corporation is not legally required to achieve certification, but it must use a standard to assess its performance.
If your client will form as an LLC or other non-corporate for-profit entity, and it wants to formally commit to social and environmental benefits, becoming a Certified B Corporation is a bold move. It’s not easy, and it takes a lot of work to make it through the assessment and remain certified every year. But it’s the best option to publicly declare a commitment and stay accountable for showing results. I am not paid to advertise for B-Lab, so I will keep my cheerleading to a minimum. But I do encourage companies to at least take the assessment and see what it illuminates.
Any entity can use the B Impact Assessment to examine how it can improve its triple bottom line.
Other entities must prioritize goals
If your client does not want to form a benefit corporation or earn a Certified B Corporation designation, what then? I suggest having meaningful conversations about goals, intentions, and strategies. Clients must determine what they are willing and able to commit to. They can insert self-created standards into their operating agreements or implement policies or programs to act on their values. Many companies already do this (e.g., worker wellness programs, volunteer days, nonprofit sponsorships, flexible work hours, etc.). In these situations, the company won’t earn the accolades or benefit from the marketing opportunities of the certification, but it can still do good work.
Deciding how to operate one’s business is complex. As legal counselors, we have the opportunity to get to know our clients and help them analyze the costs and benefits of their options. Some businesses are willing to opt in-to extra rules to prove their commitment to social and environmental benefits, and some are not. This article should help your clients identify where on the spectrum they feel most comfortable.
Kelsey J. Nunez’s boutique practice is dedicated to social entrepreneurs and collaborative culture. She is available to consult with fellow attorneys who have clients interested in integrating these new tools and models. In addition to lawyering, Kelsey owns The Vervain Collective, a plant-based apothecary with a natural health treatment room in Garden City.
[i] See State by State Status of Legislation, BenefitCorporation.net,https://benefitcorp.net/policymakers/state-by-state-status (last visited August 30, 2019). Most states have deviated from the model legislation (especially Delaware), so readers should review the statute of the desired state of incorporation.
[ii] Idaho Code § 30-2001(4).
[iii] I have addressed this topic in previous issues of The Advocate. See Kelsey Jae Nunez & Mark Buchanan, New Corporate Form Provides More Options for Social Entrepreneurs, 60 The Advocate 42 (Aug. 2017); Kelsey Jae Nunez, Enforcing the Benefit Part of Benefit Corporations, The Advocate (Aug. 2019). For a well-rounded analysis of case law, legislative history, and academic literature that inspired the creation of the benefit corporation, see generally Frederick H. Alexander, Benefit Corporation Law and Governance: Pursuing Profit with Purpose (2018) (especially Part 1: Shareholder Primacy and Its Discontents). See also FAQs, BenefitCorporation.net, https://benefitcorp.net/faq (last visited August 30, 2019).
[iv] Many authors have argued that existing corporate law was sufficient and a new entity was not required. For example, see Janet E. Kerr, Sustainability Meets Profitability: The Convenient Truth of How the Business Judgment Rule Protects a Board’s Decision to Engage in Social Entrepreneurship, 29 Cardozo L. Rev 623 (2007) (I was a student research assistant on this article). The argument still has merit, although the benefit corporation provides clearer protection than the Business Judgment Rule.
[v] Chapter 9 of Benefit Corporation Law and Governance: Pursuing Profit with Purpose, analyzes constituency statutes and case law governing their applications in various fact patterns.
[vi] Idaho Code §§ 30-1602, -1702.
[vii] Id. §§ 30-2006(1), -2002(5).
[viii] Id. § 30-2002(9).
[ix] Id. § 30-2002(11).
[xi] B Lab, bcorporation.net, https://bcorporation.net/about-b-lab (last visited August 30, 2019).
[xii] Idaho Code §§ 30-29-830(a)-(b), -842(a).
[xiii] Id. §§ 30-2007, -2009. Other factors may also be considered, and none of the factors have to be prioritized over the others. Id.
[xiv] Several authors have written about the real and perceived downsides of benefit corporations. See Ronald J. Columbo, Critiques of the Benefit Corporation, Law of Corp. Offs. & Dirs.: Rts., Duties & Liabs. § 22:20 (2018); Sarah Dunn, What is the Benefit of Benefit Corporations? 9 Hous. L.R. 82 (2019); Kennan Khatib, The Harms of a Benefit Corporation, 65 Am. U. L. Rev. 151 (2015).
[xv] Idaho Code §§ 30-2012, -2013.
[xvi] Id. § 30-2011.
[xvii] Kelsey Jae Nunez, Enforcing the Benefit Part of Benefit Corporations, The Advocate (Aug. 2019). This article also discusses various methods used to measure return on investments into social and environmental impacts.
[xviii] See Certified B Corporation, https://bcorporation.net/ (last visited August 30, 2019).
[xix] See B Impact Assessment, https://bimpactassessment.net/ (last visited August 30, 2019).. “Using business as a force for good” is a trademarked phrase of B-Lab. B Lab, bcorporation.net, https://bcorporation.net/about-b-lab (last visited August 30, 2019).
By Barbara Zanzig Lock
How do you advise your business clients on which entity is best for their closely-held business? Because most choices offer the desired limited liability, tax consequences are frequently the deciding factor. Those consequences changed with the 2017 Tax Cuts and Jobs Act (TCJA).[i]
Before the TCJA, the choice-of-entity landscape was fairly settled. Most small businesses chose a pass-through entity,[ii] usually an LLC or an S corporation. Then, with the White House promising a system that “encourages companies to stay in America, grow in America, spend in America, and hire in America,”[iii] Congress passed the TCJA. This act decreased the top corporate tax rate from 35 percent to 21 percent. This was the biggest corporate tax cut in U.S. history.
So why didn’t practitioners advise their clients to immediately start forming C corporations to take advantage of the savings? They might well have, but before the TCJA passed, owners of pass-through entities pushed for a comparable cut for their own businesses. The result was the show-stealing section 199A.[iv] This complex and arbitrary provision allows an unprecedented 20 percent business income deduction for owners of pass-through entities.
How significant is section 199A? While the TCJA reduced the top individual ordinary income tax rate from 39.6 to 37 percent, the top rate for income eligibility for the section 199A deduction is 29.6 percent. That’s significant. The bottom line: although the TCJA’s hallmark was the C corporation tax rate cut, the action for the closely-held business is in section 199A.
Section 199A: Overview, mechanics, limits
What is the Section 199A deduction? For tax years 2018—2025, any taxpayer other than a corporation or employee, may deduct up to 20 percent of “qualified business income” (QBI)[v] from a “qualified trade or business.”[vi] The deduction is available for income from businesses operated as sole proprietorships, partnerships, LLCs, S corporations, trusts, and estates.
A “qualified trade or business” includes every trade or business other than that of being an employee and certain businesses designated as a “specified service trade or business” (SSTB).[vii] A taxpayer may deduct income from an SSTB, but the deduction phases out once the taxpayer’s household income exceeds a threshold amount.[viii] This SSTB limit and the exclusion of wage income from the deduction are intended to restrict the deduction to business rather than personal service income.
Section 199A and the final regulations provide a list of businesses they characterize as SSTBs. Architecture and engineering were omitted from the list of SSTBs. In addition, there is a de minimis exception to SSTB classification for a business with gross receipts less than $25 million.[ix] Such business is not an SSTB if 10 percent or less of its gross receipts are attributable to services performed in a disqualified field.
Businesses Characterized as SSTBs
- Actuarial science
- Performing arts
- Financial services
- Brokerage services
- Investing and investment management
- Dealing in securities, partnership interests, or commodities
- Any trade or business where the principal asset is the reputation or skill of one or more of its employees.
Not surprisingly, the SSTB has proven difficult to define. For example, the brokerage services category includes stockbrokers, but not real estate and insurance brokers.[x] Investment management does not include real estate management.[xi] Financial services includes investment banking and retirement advising, but not taking deposits or making loans.[xii] What if a bank offers investment banking services? Is the bank an SSTB?
A second restriction on the deduction phases in as the taxpayer’s household income exceeds a threshold amount. This income threshold is the same as that for the SSTB limitation.[xiii] The second restriction limits the taxpayer’s deduction based either on W2 wages the business pays or on a combination of W2 wages paid and the original cost of the business’s depreciable property.[xiv] The depreciable property limit was added to appease rental property owners, who often pay management fees rather than wages. It allows them to take advantage of the deduction without rearranging their businesses.
Because the deduction has limits based on the taxpayer’s household income, taxpayers take it on their form 1040. It is a below-the-line deduction available in addition to the standard deduction or itemized deductions. [xv]
So how does the deduction work? Let’s start with a basic scenario, where section 199A’s application is fairly straightforward. Assume Jane is a single attorney with a solo practice. She earns $150,000 from her law practice, and this is her only income. Jane may deduct 20 percent of her QBI, or $30,000. Although Jane’s business is an SSTB, her deduction is not subject to the SSTB limit or to the W2 wage limitation because her household income does not exceed the threshold amount, which is $160,725 in 2019 ($321,450 for married filing jointly (MFJ)).[xvi]
Now let’s add a complicating factor. Jane is married to Hank, who earns wages of $300,000 working as a physician employed by a hospital. Hank does not qualify for a section 199A deduction, because wages are not QBI. But his wages count toward household income, affecting Jane’s entitlement to a Section 199A deduction. The couple’s household income is $450,000, which exceeds the phase-out ceiling. Because Jane works as an attorney, which is an SSTB, she loses her section 199A deduction.
Now let’s add one more twist. Suppose Hank still earns $300,000 wages, but Jane makes $150,000 as a self-employed real estate broker instead of an attorney. The couple’s household income still exceeds the threshold, but Jane’s business is not an SSTB. So is Jane entitled to a Section 199A deduction? It depends. If Jane’s business has no depreciable assets, Jane’s deduction is limited to 50 percent of the W2 wages the business pays employees. If she pays her assistant $30,000 in 2019, Jane may take a $15,000 section 199A deduction.
Maximizing the Section 199A Deduction
What to do with all of this? This article cannot give more than a superficial overview of the section 199A deduction. But here are a few things to take away.
The deduction gets very complicated very quickly. Consider that Congress recently released a 274-page document containing both final regulations explaining section 199A and explanations of those final regulations. But, despite its complexity, any practitioner advising a client about business formation should still be aware of its existence and potential impact.
The deduction offers incentives to reevaluate. Section 199A creates an incentive to run otherwise non-business income through a business to qualify for the deduction. For example, suppose Frank’s hobby is refurbishing guitars and selling them on eBay. If he sells enough guitars, and he sells them consistently enough, his hobby may rise to the level of business and he may qualify for the 20 percent deduction. But section 199A and its regulations do not define trade or business and, in fact, Treasury and IRS declined requests for a bright-line test in the final regulations. The definition of trade or business for tax law remains a facts and circumstances one based on the taxpayer’s profit motive and level of activity.[xvii]
The deduction also encourages employees to become independent contractors. Of course, independent contractor status has its disadvantages, such as increased payroll taxes and the loss of employment benefits, but section 199A changes the equation by creating a 20 percent deduction for the independent contractor.
The deduction poses traps for the unwary. Suppose Jim owns a small plumbing business as an LLC. Jim has no employees, does all the plumbing work himself, and earns $150,000 in 2019 from his labor. Jim’s wife, Kate, earns $300,000. Ignoring the depreciable asset limit, Jim’s section 199A deduction will be $0. Why? Jim’s household income is above the ceiling amount and he pays no W2 wages—an LLC member’s compensation is not W2 income. How can Jim remedy this result? He can “check the box”[xviii] to have the LLC taxed as an S corporation, in which case Jim’s compensation will count as W2 income.
Or suppose instead Jim’s partner is Julia, a famous chef, and their business consists of a restaurant and adjacent shop that sells cookware and utensils bearing the chef’s name. Jim manages both the restaurant and the shop. Is the business’s principal asset Julia’s skill or reputation, making it an SSTB for all owners, including Jim?
The final regulations say the skill or reputation limitation applies only to fact patterns where one receives compensation for appearances, for endorsing products or services, or for licensing the person’s identity.[xix] According to the final regulations, Julia has two businesses: one is being a chef and owning restaurants, which is not an SSTB, and the other is the business of receiving endorsement income, which is an SSTB.[xx] Query what this means for Jim, Julia’s minority partner?
And what about consulting businesses? They are section 199A SSTBs. But don’t virtually all businesses involve consulting? According to the final regulations, consulting means providing professional advice and counsel, but not training and educational courses, to clients. It also does not include providing consulting services ancillary to the sale of goods or performance of services on behalf of an otherwise non-SSTB, such as typical services provided by a building contractor, if there is no separate payment for the consulting services.[xxi] Such distinctions promise to be difficult, if not impossible, to apply consistently.
The deduction does not treat all pass-through entities alike. In theory, it does. But, in practice, a business owner with less than the threshold household income might be better off as an LLC or sole proprietor, while one with income exceeding the threshold might be better off as an S corporation. Why? Assume two single-owner businesses each earn $100,000 net business income and distribute $80,000 to their respective owners as compensation for services. The LLC’s entire $100,000 is QBI potentially eligible for the section 199A deduction. But the S corporation must pay its shareholder-employee a reasonable salary, and that reasonable salary is not QBI. Assuming the $80,000 is the shareholder’s reasonable salary, the S corporation will have only $20,000 of QBI.
Now suppose the businesses each earn $300,000, and each distributes $200,000 to its owner as compensation. The LLC has no section 199A deduction because it pays no W2 wages.[xxii] An LLC owner’s compensation is by definition not W2 income.[xxiii] The S corporation, on the other hand, has paid $200,000 in W2 wages. The shareholder’s potential section 199A deduction is $100,000, or 50 percent of the W2 wages paid, assuming the $300,000 qualifies as reasonable compensation.
S corporations still maintain the self-employment tax savings advantage over LLCs and other pass-through entities. Now that advantage can be combined with the section 199A deduction.
An S corporation’s earnings exceeding the reasonable salaries it must pay its shareholder-employees are not subject to self-employment tax.[xxiv] This quirk gives the S corporation a tremendous tax advantage over the LLC, where every dollar earned is self-employment income. But, as we just saw, S corporation shareholder salaries are not Section 199A QBI, so they reduce the corporation’s deductible income, thereby reducing the deduction itself.
So how can an S corporation achieve Pareto optimality, maximizing its section 199A deduction while sacrificing as little self-employment tax savings as possible? Not surprisingly, this question has been asked and answered. When the corporation pays approximately 28 percent of its income in salaries—which may or may not be reasonable—it optimizes the combination of section 199A deduction and self-employment tax savings.
If it pays more in salary, the shareholders forfeit their self-employment tax savings and pay too much in Medicare and Social Security. If it pays less in salary, the shareholders forfeit section 199A deduction because of the too-low W2 wages cap. The optimal point is where those limits equal each other, which is when salaries are approximately 28 percent of earnings.
Consider, for example, Sam, the sole shareholder whose S corporation earns $100,000, but whose household income makes him subject to W2 limits. If the corporation pays Sam a $20,000 salary, assuming 7.5 percent employer payroll tax, Sam has a potential $15,700 deduction, but the W2 limit caps his deduction at $10,000. At a $50,000 salary, the W2 cap is $25,000 but his deduction is limited to $9,250, or 20 percent of income. Finally, when his salary is 28 percent, his potential $14,000 deduction is capped at $13,980. The deduction is maximized.
The deduction offers planning opportunities: Section 199A encourages “cracking” and “packing,” i.e., strategies that qualify an SSTB’s income for the deduction.[xxv] For example, a law firm, which is an SSTB, buys its office building through an LLC. The LLC rents the office to the law firm, which deducts the rental payments as a business expense. Can the lessor entity qualify for the section 199A deduction? The final regulations say no if the businesses share 50 percent or more common ownership. But what if they don’t? There is plenty of room for planning to maximize the section 199A benefit.
Conclusion. While the TCJA added a significant player to the team in the form of section 199A— one which business lawyers should be aware of— it did not change the winner of the game. The TCJA effectively retained the tax advantage for pass-through entities, particularly S corporations, while adding some tax-saving opportunities and potential traps. Section 199A’s unprecedented business income deduction, together with its complexity and sheer arbitrariness, make it worth some study. The bottom line is, entity choice still requires a facts and circumstances analysis of your client’s particular situation, but section 199A is now likely to be a major part of that analysis.
Barbara Zanzig Lock is an associate clinical professor and director of the federal income tax clinic at the University of Idaho College of Law in Boise. She has taught for the College of Law since it welcomes its first Boise third-year class in 2010. She teaches federal income tax and wills, trusts, and estates.
[i] Pub. L. No. 115-97.
[ii] A pass-through entity is not a separate taxpayer. Rather, it passes its income through to its owners, and the income is taxed only at the owner level. Examples of pass-through entities are sole proprietorships, partnerships, LLCs, and S corporations. In contrast, a C corporation is a separate taxpayer from its owners. Corporate income is taxed to the corporation when earned, and then again to the shareholders when distributed.
[iv] 26 U.S.C. §199A.
[v] QBI is the net amount of qualified items of income, gain, deduction, and loss with respect to a qualified trade or business. 26 U.S.C. §199A(c).
[vi] 26 U.S.C. §199A(c)(1). Section 199A does not define trade or business. But, solely for the purposes of § 199A, a safe harbor exists for individuals and pass-through entity owners with respect to a rental real estate enterprise. See IRS Notice 2019-07. Rental real estate that does not meet the requirements of the safe harbor may still be treated as a trade or business for purposes of the QBI deduction if it qualifies as a §162 trade or business.
[vii] 26 U.S.C. § 199A(d)(2), referencing 26 U.S.C. §1202(e)(3)(A).
[viii] 26 U.S.C. § 199A(d)(3)(B).
[ix] 26 C.F.R. § 1.199A-5(c)(1).
[x] 26 C.F.R. § 1.199A-5(b)(2)(x).
[xi] 26 C.F.R. § 1.199A-5(b)(2)(xi).
[xii] 26 C.F.R. § 1.199A-5(b)(2)(ix).
[xiii] 26 U.S.C. § 199A(b)(3)(B).
[xiv] Sec. 199A(b)(2)(B)(i) & (ii). Above the income ceiling, the QBI deduction for a non-SSTB is limited to the greater of the taxpayer’s share of 50% of W-2 wages paid to employees during the tax year and properly allocable to QBI, or the sum of the individual’s share of 25% of such W-2 wages plus the individual’s share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property, usually its original cost. Qualified property means depreciable tangible personal property.
[xv] To prevent taxpayers from taking the §199A deduction for income already taxed at preferential rates, the deduction is further limited to the amount by which the taxpayer’s QBI exceeds net capital gain for the year. §199A(a)(2), (b)(1), (2).
[xvi] §199A, Rev. Proc. 2018-57.
[xvii] In Commissioner v. Groetzinger, 480 U.S. 23 (1987), the Supreme Court stated, “[w]e conclude that if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the statutes with which we are here concerned.”
[xviii] 26 CFR § 301.7701-3. The “check the box” regulations permit certain business entities to choose their classification for U.S. federal income tax purposes by checking the box.
[xix] 26 C.F.R. § 1.199A-5(b)(2)(xiv).
[xx] 26 C.F.R. §1.199A-5(b)(3), ex. 15.
[xxi] 26 C.F.R. §1.199A-5(b)(2)(vii).
[xxii] This example, again, ignores the depreciable assets (UBIA) portion of the W2 wages test.
[xxiii] In Rev. Rul. 69-184, 1969-1 C.B. 256, the IRS classified partners as independent contractors rather than employees.
[xxiv] In Rev. Rul. 59-221, 1959-1 C.B. 225, the IRS rules that S shareholders’ distributive shares are not subject to self-employment tax. To prevent abuse of this rule, the IRS requires S corporations to pay reasonable compensation to shareholder-employees.
[xxv] For more on cracking and packing, see David Kamin et al., The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the 2017 Tax Legislation, 103 Minn L. Rev. 1439 (2018).
By Jennifer A. Hearne
We spend up to one-third of our lives at work. For some of us, this means we will spend up to 90,000 hours at work during our lifetime. By developing a workplace culture that fosters camaraderie and fun, those 90,000 hours can be spent increasing the quality of employees’ life.
Investing in employee success and workplace fun is analogous to investing in the future of your business. Indeed, countless studies, newspaper articles, and blogs have touted the benefits of employee engagement, which include increased productivity, decreased turnover, and reduced absenteeism.[i] Internal case studies from Apple, Microsoft, Google, and Netflix show a direct link between employee engagement and increased profits.[ii]
At the same time, however, there are potential pitfalls to incorporating fun into a workplace.
Drawing from my experience as House Counsel and Director of Human Resources for a college that emphasized incorporating fun into the workplace, I have a series of ideas about how to foster this without running into trouble.
Why It Works
The above initiatives and ideas only work if there is buy-in from the top. Here are the key ways to achieve that buy-in:
Lead by Example. Senior and mid-level leaders should be actively involved in fun initiatives, with participation included on all manager job descriptions as a “required” job function. For example, leadership could author regular articles in the employee newsletter to promote fun initiatives.
Training. Managers should receive regular training on how to coach and encourage employees, rather than discipline them.
Sincerity. Efforts to help employees feel valued must be perceived as genuine. One way to accomplish this is to make those efforts deliberate and thoughtful rather than “one size fits all.”
Investment. The business must demonstrate its long-term commitment to fun initiatives by allocating significant financial resources toward the development of personalized job descriptions, employee perks, and hiring a dedicated ambassador.
Measuring Results. How employees feel about work is difficult to measure. One effective (but also expensive) way to measure success is through the administration of employee satisfaction surveys. These surveys should be completed on a regular time schedule so that companies can measure whether employee satisfaction is going up or down over time. Tracking employee turnover, employee performance, and absenteeism rates over time can also provide useful metrics.[vi]
Tips to Avoid Pitfalls
There is a risk that, when fun is introduced into the work environment, some employees will interpret this as a license to tell jokes or discuss issues that others may find offensive. Companies should establish clear boundaries to avoid unintentionally creating an environment that breeds harassment or discrimination of any kind.
Simple guidance to supervisors and employees might include the following:
- Poke fun at events, not people;
- Steer clear of discussions about religion and politics;
- Never compromise safety; and
- Don’t lose sight of the work that needs to be done.
A second risk is that, by seeking to introduce fun into the workplace, the business fails to account for the diversity of its employees, thus excluding or alienating some employees. For example, dietary restrictions should be taken into account when planning group meals.
A Worthwhile Investment
As long as a company’s efforts are thoughtful, non-discriminatory and consistent, it’s hard to find a good reason not to pour energy and resources into developing a fun and positive workplace culture. Employees who genuinely feel valued and appreciated are more productive, are absent less often, and are more loyal to your business. Regardless of how many of those 90,000 hours you’ve got left, it’s never too late to start having fun at work. Now seriously, go have fun!
Jennifer A. Hearne’s legal practice with J.A. Hearne Law, PLLC is centered around employment and labor law. When she is not defending clients, drafting employee handbooks, and developing training, Jennifer enjoys boating, skiing, and biking with her family and friends.
[i] Gallup, “Employee Engagement On the Rise in the U.S.” by Jim Harter, August 26, 2018, published in Economy, https://news.gallup.com/poll/241649/employee-engagement-rise.aspx; Harvard Business Review, “Engagement Does More Than Boost Productivity” John Baldoni, July 2013 https://hbr.org/2013/07/employee-engagement-does-more
[ii] Questions and Answers About Fun at Work: https://pdfs.semanticscholar.org/3b34/9a3cd0fad79c80e14b295780409a4b48ce78.pdf ; Non Profit HR, “An Apple is an Apple is an Apple. Employee Engagement: Does Benchmarking Really Have Value?” http://www.nonprofithr.com/wp-content/uploads/2013/02/An-Apple-is-an-Apple-is-an-Apple.pdf; “Steve Jobs’ Legacy: 360 Degree Engagement” http://www.incentivemag.com/Strategy/Engagement/Steve-Jobs–Legacy–360-Degree-Engagement/
[iii] Solving the Puzzles of Teamwork: https://drclue.com/paper-airplanes-for-teambuilding/
[iv] LaughterYoga.org: https://laughteryoga.org/laughter-yoga/application/laughteryoga-in-business/
[v] 25 Ways to Have Fun at Work: https://daringtolivefully.com/have-fun-at-work
[vi] Top 39 Human Resources (HR) Metrics & How to Calculate Them: https://fitsmallbusiness.com/hr-metrics/
By Jessica Kinslow
The SEC recently adopted Regulation Best Interest (“Reg BI”), which changes the regulatory landscape for broker-dealers and investment advisers.[i] Although the SEC staff had recommended a uniform fiduciary standard applicable to both broker-dealers and investment advisers, Reg BI does not go so far. However, Reg BI does narrow the gap between the duties owed by broker-dealers and investment advisers. This article summarizes the regulatory landscape pre-Reg BI, clarifies what aspects of that landscape remain intact, explains the changes that Reg BI makes, and identifies unanswered questions that remain.
The Landscape Before Reg BI
Traditionally, there was a vast difference in the duties owed by registered investment advisers (“RIAs” and broker-dealers (“BDs”). RIAs owe their clients a fiduciary duty to “act in the best interest of their clients and to make such recommendations as will best serve such interest.”[ii] This fiduciary duty includes the duty to avoid conflicts of interest, but such conflicts can be mitigated by making disclosure of such conflict, and obtaining the client’s “informed consent to such dealings.”[iii] This fiduciary duty also requires RIAs to make “full and frank disclosure of [their] practice of trading on the effect of [their] recommendation.”[iv]
BDs, on the other hand, have traditionally not owed a fiduciary duty to their clients, instead owing the lesser duty to recommend “suitable” securities to their clients.[v] BDs were treated as salespeople, offering a range of investment products and services to pick and choose from, rather than acting as fiduciaries.
Over time, however, product offerings and services of both BDs and RIAs became more complex, and the distinctions between the two different roles became murky. BDs and RIAs began to compete with each other for business. BDs focused on assets under management and fee-based accounts, while RIAs began referring management of assets to third parties and collecting a fee. Some firms became dually registered in order to offer even more options to their customers, and with the introduction of industry certifications with names such as Financial Adviser and Financial Planner, further confusion of the roles and their duties became apparent.
Against this backdrop, the Dodd-Frank Act required the SEC to conduct a “Study on the Effectiveness of Legal and Regulatory Standards of Care for Broker Dealers and Investment Advisors.”[vi] The SEC staff’s resultant study recommended that “[t]he SEC should make rules specifying a uniform fiduciary standard of conduct applying to both broker-dealers and investment advisors when providing personal advice about securities to retail investors, that is no less stringent than the current standard required of investment advisors.”[vii]
What Reg BI Does Not Do
Contrary to the SEC staff’ recommendation, Reg BI does not create a uniform fiduciary standard applicable to BDs and RIAs, but it does narrow the gap between the duties owed by BDs and RIAs. The SEC explained that it had “chosen not to apply the existing fiduciary standard under the Advisers Act to [BDs] in part because of concerns that such a shift would result in fewer [BDs] offering transaction-based services to retail customers, which would in turn reduce choice and may raise costs for certain retail customers,” and because it “would discard decades of regulatory and judicial precedent.”[viii]
Instead, the SEC chose to enhance existing obligations for BDs when making recommendations to retail customers.[ix] These enhanced suitability standards and disclosure requirements more closely align the nature of BD and RIA relationships with their clients.
What Reg BI Does
The primary purpose of Reg BI is to establish more transparency about the relationship between BDs, RIAs, and their retail customer clients. Reg BI, and the companion Form CRS and Adviser’s Act Interpretations adopted at the same time, accomplish this with two key changes: (1) a new “best interest” standard applicable to BDs, which encompasses four additional obligations; and (2) a new requirement that BDs and RIAs provide a relationship summary to retail clients.
The New “Best Interest” Standard
Reg BI requires BDs and their associated persons to act in the “best interest” of their retail clients when making a recommendation.[x] Reg BI does not define “best interest” as a term, but it instead states that “acting in the best interest means”[xi] complying with four additional obligations—the “disclosure obligation,” the “care obligation,” the “conflict of interest obligation,” the “compliance obligation”—and adhering to a “recordkeeping” requirement.[xii]
The purpose of the “disclosure obligation” is to facilitate the retail customer’s awareness of certain key information about the relationship with the BD or RIA. This prong of the rule is designed to work in concert with Form CRS, which must be delivered by all BDs and RIAs to their retail customers upon opening of an account. Form CRS contains high-level disclosures about the nature of the relationship, services to be provided, fees, charges, compensation, and conflicts of interest.
In addition, in order to reinforce the distinction between BDs and RIAs, BDs may not use the terms “adviser,” or “advisor,” unless they are dually registered as such. Although most of the disclosures required by Reg BI can be made through Form CRS, certain additional disclosures, such as material conflicts related to recommendations about a specific product, will likely need to be made at the point-of-sale,[xiii] because they would be unknown at the time of opening an account where ongoing sales are expected to occur.[xiv]
The intention of the “care obligation” is to incorporate and enhance existing suitability requirements that are applicable to BDs, while also imposing a “best interest” requirement, that the BD shall not put its own interests ahead of the retail customer’s interest when making recommendations.
The care obligation requires a BD, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, to exercise reasonable diligence, care, and skill to do the following: (a) understand the potential risks, rewards, and costs associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers (reasonable basis suitability); (b) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer (customer specific suitability); and (c) have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in the light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer, or such natural person making the series of recommendations ahead of the interest of the retail customer (quantitative suitability).[xv]
The purpose of the “conflict of interest obligation” is to enhance the disclosure of conflicts of interest in order to educate retail customers about those conflicts and to help them evaluate recommendations received from BDs. Reg BI imposes an obligation on BDs to not only disclose, but also mitigate, conflicts of interest arising from financial incentives associated with their recommendations. Common conflicts include compensation arrangements, as well as the BD acting as a principal in the sale of certain proprietary products.
The reason for the “compliance obligation” is to create a holistic, affirmative obligation with respect to Reg BI, while maintaining sufficient flexibility to allow BDs to establish and implement their own compliance procedures, thus accommodating a broad range of business models.[xvi] Thus, Reg BI does not enumerate specific requirements that BDs must include in their policies and procedures. Instead, when adopting policies and procedures, BDs should consider the nature of that firm’s operations and how to design such policies and procedures to prevent violations from occurring, to detect violations that have occurred, and to correct promptly any violations that have occurred.
The New Relationship Summary Requirement
Reg BI also requires BDs and RIAs to provide a brief relationship summary to retail investors[xvii] and to inform retail investors of the types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interests, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm.[xviii]
As a companion to Reg BI, the SEC also adopted a Form CRS Relationship Summary,[xix] which requires RIAs and BDs to provide a concise, plain English summary detailing the nature of the relationship, including the standard of care provided to the customer through the services, products, and relationship.[xx]
Reg BI leaves a number of unanswered questions, including whether it preempts state law and how it applies to dual-registrants.
Preemption of State Law. Some states have implemented, or have proposed implementing, fiduciary standards or expanded standards of care for BDs that go beyond those imposed by Reg BI. Many commentators urged the SEC to either preempt or avoid preempting state fiduciary rules.[xxi] However, the SEC decided to “retain the overall structure and scope”[xxii] without stating whether Reg BI preempts state fiduciary rules.[xxiii]
Dual-Registration. In the Proposing Release, the SEC stated Reg BI would apply only when a dual-registrant representative had its BD hat on, and whether or not additional disclosure or obligations would apply to dual-registrant firms would be based on a “facts and circumstances test.”[xxiv]
However, unanswered questions still remain. For instance, for dual-registrant firms, is there a conflict of interest when offering the same product, such as variable annuities, under either the BD or RIA models? Does Reg BI dictate under which model the firm should sell the investments to the client? Are dual-registrants required to disclose that a product could be sold under both models and provide a side-by-side comparison?
Although many critics have expressed that Reg BI does nothing more than preserve the status quo for BDs, while failing to increase protection for retail investors, the “best interest” standard, coupled with a more stringent regime for disclosure of material conflicts, achieves a more harmonized standard of care and disclosure for both RIAs and BDs, even if it falls short of imposing a uniform fiduciary standard.
Jessica Kinslow graduated from the University of Idaho College of Law in 2013. Jessica lives in Portland, Oregon and has worked as in-house counsel and compliance specialist for dual-registrant firms throughout her career. Jessica enjoys racing sailboats and playing with her Scottish Terrier, Duffy.
[i] Release 34-86031 (June 5, 2019) (hereafter “Release”), available at: http://bit.ly/2KbhJE8.
[ii] In re Arleen Hughes, Exchange Act Release No. 4048, 27 S.E.C. 629 (Feb. 18, 1948).
[iv] SEC v. Capital Gains Research Bureau, 375 U.S. 180 (1963).
[v] See FINRA, FINRA Rule 2111 (SUITABILITY).
[vi] Dodd-Frank Act, Section 913.
[vii] Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (“913 Study”) at 8-12, available at www.sec.gov/news/studies/2011/913studyfinal.pdf (discussing the range of brokerage and dealer services provided by broker-dealers).
[xi] See Release at p.35.
[xii] Rule 15l-1(a)(1) under the Exchange Act.
[xiii] See Proposing Release at 21605.
[xiv] See Release at 234.
[xv] See Release at 253.
[xvi] See generally Release atSection II.C.4, Compliance Obligation.
[xvii] 17 CFR Parts 200, 240, 249, 275, and 279, p.1.
[xix] Release 34-86032 (June 5, 2019) (the “CRS Release”), available at: http://bit.ly/2XIK1Jl.
[xx] The SEC also issued an interpretation reaffirming and clarifying the fiduciary duty that RIAs owe to their clients under the Investment Advisers Act of 1940 (Advisers Act) and an interpretation of the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act, both of which are addressed in a separate Client Alert.
[xxi] See Release at p. 32.
[xxii] See Release at p. 33.
[xxiii] Id. Any express preemption would arise under 15(i)(1) of the Exchange Act, prohibiting states from establishing certain differing requirements already established under the Securities Laws.
[xxiv] See Release at p. 127.
By Michael R. Christian and Sydney Sears
The following scenario is repeating itself across the country: A business operating a website receives a letter from a law firm in a distant venue. The letter claims that the website is insufficiently accessible by the firm’s visually impaired client. The letter invites the business to engage in a process to remedy the situation. However, it also threatens suit under Title III of the Americans with Disabilities Act of 1990 (“ADA”) in that distant venue if an acceptable resolution is not reached. Faced with this scenario, businesses, attorneys, and courts are struggling to determine (1) whether website or mobile applications are covered by Title III of the ADA; (2) if so, how to comply with the ADA; and (3) whether a business can be forced to defend itself against these claims in a distant jurisdiction.
Is a website or mobile application a “place of public accommodation” covered by Title III of the ADA?
The ADA is revered as an important piece of civil rights legislation. However, in recent years a small number of visually impaired plaintiffs and their attorneys have used the statute, along with its fee-shifting provision, to create a cottage industry of demands and litigation directed toward the owners of websites and mobile applications. Initially, large corporations like Nike, Amazon, Facebook, and Dominos were the focus of Title III plaintiffs. More recently, smaller businesses, often ill-equipped to litigate across the country, have become targets. Website accessibility lawsuits filed in federal court under Title III skyrocketed from 262 in 2015 and 2016 combined, to 814 in 2017, to 2,258 in 2018. Title III creates possible exposure for “businesses of every shape and size” that operate on the Internet—meaning the majority of businesses in the United States. 
The problem for businesses is that the statute does not adequately address website accessibility. Aggressive plaintiffs have used the current lack of clarity surrounding Title III application to websites to generate revenue by extracting settlements. Because of their lack of resources and the risk of a large fee award, small business owners are often forced to settle quickly rather than litigate.
Title III of the ADA provides: “No individual shall be discriminated against on the basis of disability in the full and equal enjoyment of the goods, services, facilities, privileges, advantages, or accommodations of any place of public accommodation by any person who owns, leases (or leases to), or operates a place of public accommodation.” The statute sets forth a list of twelve categories of “private entities” that are considered to be “public accommodations.” The categories themselves include exhaustive lists of specific physical places and refer to either “places” or “establishments,” both of which seem to connote physical locations.
Absent from these categories are websites and mobile applications. When Congress passed the ADA, the World Wide Web was just taking on recognizable form, and mobile applications were an idea of the future. Now, the Internet is an engine of commerce. Close to 80% of small businesses use at least one digital platform to provide information to customers.
Under President Obama’s administration, the Department of Justice (“DOJ”) issued an Advanced Notice of Proposed Rulemaking (“ANPRM”) to address the application of ADA Title III to websites. After a series of delays and a change in administration, on December 26, 2017, the DOJ published a “Notice of Withdrawal of Four Previously Announced Rulemaking Actions,” including the ANPRM regarding website accessibility.
Federal circuit courts are split over the question of whether Title III applies to websites. They clash over whether a website or mobile application must have a nexus to a physical (“brick and mortar”) business location—such that it is at least related to a “place of public accommodation”—in order to be subject to Title III.
Within the First, Second, and Seventh Circuits, enterprises that are Internet-only businesses—without any physical location—can face Title III liability based on alleged website inaccessibility. Plaintiffs in those circuits “must show only that the website falls within a general category listed under the ADA.” Those circuits conclude that the inclusion of “travel service” in the list of codified service establishments meant that Congress “contemplated that ‘service establishments’ include[d] providers of services which do not require a person to physically enter an actual physical structure.” Thus, in those circuits, websites offering goods or services to the public are considered public accommodations.
In contrast, the Third, Sixth, Ninth, and Eleventh Circuits hold instead that a website must have a “nexus” to a brick-and-mortar location of a business to be subject to Title III. These circuits focus on whether a particular means of access, including a website or mobile application, impedes overall access to the benefits of a physical, public accommodation. These circuits rely on the principle of noscitur a sociis (“known by its associates”), concluding that because “[e]very term listed in § 12181(7) and subsection (F) is a physical place open to public access,” a place of public accommodation must be or have a connection with, a physical place. In other words, web-only businesses with no physical location for customers to access are not subject to Title III application to their websites or mobile applications.
This issue may be reviewed during the United States Supreme Court’s next term. In Robles v. Domino’s Pizza, the Ninth Circuit held that, because Domino’s Pizza’s website and mobile application provide connectivity between customers and the resulting goods and services of its physical restaurants, each method of ordering those goods and services (e.g., pizza) must be accessible to customers with disabilities. Thus, the decision imposed ADA applicability on websites and mobile applications that offer access to companies’ in-store goods and services. Domino’s Pizza submitted a petition for certiorari to the Supreme Court on June 13, 2019, stating the question presented as follows: “Whether Title III of the ADA requires a website or mobile application that offers goods or services to the public to satisfy discrete accessibility requirements with respect to individuals with disabilities.” Domino’s Pizza argues that Congress “passed a statute to apply only to places of public accommodation, which must be physical locations, and only to ensure adequate overall access to the benefits of those locations,” arguing that a change in that policy “is up to Congress, not the judiciary.” Robles argues that all circuits agree that Title III applies at least where a physical nexus exists.
If the ADA applies to a website or mobile application, what steps are necessary to comply?
Presumably, business owners have no interest in discriminating against individuals with disabilities. However, they do need to know how to comply. Because it does not explicitly address websites or mobile applications, the ADA itself provides no answer. Having abandoned rulemaking in the area, the DOJ is of little help. With such little direction, many plaintiffs argue that websites and mobile applications must comply with Web Content Accessibility Guidelines (“WCAG”). These are voluntary website accessibility standards developed by the World Wide Web Consortium. While the DOJ has yet to formally adopt these private standards, it has pursued enforcement actions against businesses for website accessibility, seeking to apply WCAG guidelines. Compliance with these voluntary standards can be time-intensive and expensive, particularly for small businesses.
WCAG standards have been through multiple revisions. In June 2018, WCAG published an updated accessibility criterion in version 2.1. Businesses need guidance to determine which version will produce compliance with the ADA. Small businesses may not be able to afford compliance, potentially resulting in the discontinuation of their websites. Moreover, small businesses also risk litigation over their website at least if associated with a brick-and-mortar establishment.
Where can a business be forced to defend itself against an ADA complaint?
Claims regarding website or mobile application accessibility further raise issues of jurisdiction. Websites and mobile applications, by their nature, are accessible anywhere the Internet can be accessed. Plaintiffs sue, or threaten to sue, where they live rather than where a website operator is headquartered.
Courts exercise two types of personal jurisdiction over defendants: general and specific. General jurisdiction exists when a defendant is domiciled in the forum state or its “affiliations with the state are so ‘continuous and systematic’ as to render the entity essentially at home in the forum State.” Specific jurisdiction requires: (a) a non-resident defendant must have “purposefully directed” activities to the forum state or its residents, or have performed “some act by which he purposefully avails himself of the privilege of conducting activities in the forum, thereby invoking the benefits and protections of its laws”; (b) the claim must “arise out of” the defendant’s forum-related activities; and (c) the exercise of jurisdiction must be fair and reasonable. In Walden v. Fiore, the Supreme Court held that in order to create specific personal jurisdiction, the defendant’s “suit-related conduct must create a substantial connection with the forum State,” and clarified that the “‘minimum contacts’ analysis looks to the defendant’s contacts with the forum state itself, not the defendant’s contacts with persons who reside there.”
No court has found general jurisdiction over a defendant solely as a result of the operation of a generally available website or mobile application. Likewise, the mere maintenance of a website or mobile application outside a forum state, but accessible to residents within it, likely does not subject the owner of the application to special jurisdiction there. The Ninth Circuit has held that a mere internet presence in a forum state cannot confer jurisdiction over foreign parties because, if that were the case, “[t]he eventual demise of all restrictions on personal jurisdiction of state courts would be the inevitable result.” However, if a business makes significant sales to residents of a state via its website, that may be enough to confer specific jurisdiction there. Thus, a business operating in Idaho but engaging in sufficient sales to residents of another state could find itself hauled into a court on the other side of the country and subject to potential liability under Title III.
What is the best way for a business to avoid the pitfalls and uncertainty of these types of accessibility claims? Unless the Supreme Court decides websites are not subject to the ADA, the answer is to provide accessibility. The unfortunate reality is that what “accessible” means remains unclear. It seems clear, however, that doing nothing is no longer an option. Attorneys can advise their clients regarding the issues and risks, but it will be the rare attorney who can implement changes needed to make a website WCAG 2.1 compliant or otherwise compatible with screen-reader technology. Consulting a qualified web design expert with experience in screen reader compatibility is a highly recommended next step.
Michael R. Christian is an attorney at Smith + Malek with 30 years of experience in business, real estate, natural resources, and administrative law. He represents a broad range of businesses and has litigated disputes across a wide variety of subjects. He is a graduate of the University of Washington and Northwestern University.
Sydney Sears is an intern at Smith + Malek while completing her final year at the University of Idaho College of Law. She serves as the chief symposium editor for the Idaho Law Review and holds degrees in finance and accountancy from Boise State University. She hopes her practice will focus on business law.
 See 42 U.S.C. § 12101, et seq.
 42 U.S.C. § 12205.
 Cedric Bishop v. Amazon.com Inc.,No. 1:18-cv-00973 (S.D.N.Y. Feb. 04, 2018); Mendizabal v. Nike, Inc., 1:17-cv-09498 (S.D.N.Y. Dec. 4, 2017); Robles v. Domino’s Pizza, LLC, Case No. 17-55504 (9th Cir., Jan. 25, 2019); Young v. Facebook, Inc., 790 F. Supp. 2d 1110, 1115 (N.D. Cal. 2011).
 Kristina M. Launey & Melissa Aristizabal, Website Accessibility Lawsuit Filing Still Going Strong, Title III Access, Aug. 22, 2017, https://www.adatitleiii.com/2017/08/website-accessibility-lawsuit-filings-still-going-strong/; Mimh N. Vu, Kristina M. Launey & Susan Ryan, Number of Federal Website Accessibility Lawsuits Nearly Triple, Exceeding 2250 In 2018, Title III Access, Jan. 31, 2019, https://www.adatitleiii.com/2019/01/number-of-federal-website-accessibility-lawsuits-nearly-triple-exceeding-2250-in-2018/.
 Letter from Congressman Ted Budd to Attorney Gen. Jeff Sessions (June 20, 2018) https://www.cuna.org/uploadedFiles/Advocacy/Priorities/Removing_Barriers_Blog/ADA%20Final_06212018.pdf.
 See Helia Garrido Hull, Vexation Litigants and the ADA: Strategies to Fairly Address the Need to Improve Access for Individuals with Disabilities, Cornell J. of L. and Pub. Pol’y, Vol. 26:71, 82 (2016).
 42 U.S.C. §§ 12181–89.
 42 U.S.C. § 12181(7); Jankey v. Twentieth Century Fox Film Corp., 14 F. Supp. 2d 1174, 1178 (C.D. Cal. 1998); see ADA Title III Technical Assistance Manual Covering Public Accommodations and Commercial Facilities, ADA.GOV, https://www.ada.gov/taman3.html (last visited Jul. 16, 2019).
 See, e.g., 42 U.S.C. § 12181(7)(A)-(F).
 The first iPhone was released in 2007.
 U.S. Chamber of Commerce, Morning Consult, Facebook, Examining The Impact of Technology on Small Business 3 (Jan. 18, 2018) https://www.uschamber.com/sites/default/files/ctec_sme-rpt_v3.pdf.
 Nondiscrimination on the Basis of Disability; Accessibility of Web Information and Services of State and Local Government Entities and Public Accommodations, 75 Fed. Reg. 43,461 (July 26, 2010).
 Nondiscrimination on the Basis of Disability; Notice of Withdrawal of Four Previously Announced Rulemaking Actions, 82 Fed. Reg. 60,932 (Dec. 26, 2017).
 Nat’l Ass’n of the Deaf v. Harvard Univ., No. 3:15-CV-30023-KAR, 2019 WL 1409302, at *6 (D. Mass. Mar. 28, 2019).
 Carparts Distribution Ctr., Inc. v. Auto. Wholesaler’s Ass’n of New Eng., Inc. 37 F.3d 12,19 (1st Cir. 1994); Morgan v. Joint Admin. Bd., Ret. Plan, 268 F.3d 456, 459 (7th Cir. 2001); Pallozzi v. Allstate Life Insurance Co., 198 F.3d, 28, 33 (2nd Cir. 1999).
 Nat’l Ass’n of the Deaf v. Netflix, Inc., 869 F. Supp. 2d 196, 200–01 (D. Mass. 2012).
 Carparts, 37 F.3d at 19. Accord Pallozzi, 198 F.3d at 32–33; Mut. of Omaha Ins. Co., 179 F.3d at 558–59.
 E.g., Robles v. Domino’s Pizza, LLC, 913 F.3d 898, 905 (9th Cir. 2019); Young v. Facebook, Inc., 790 F. Supp. 2d 1110, 1115 (N.D. Cal. 2011); Peoples v. Discover Financial Services, Inc., 387 F. App’x 179, 183 (3d Cir. 2000).
 See Harvard Univ., 2019 WL 1409302, at *6.
 The Supreme Court denied certiorari in an order on October 7, 2019.
 913 F.3d at 905-06.
 Domino’s Pizza LLC v. Robles, Petition for a Writ of Certiorari, at 2.
 Id. at 34.
 See Domino’s Pizza LLC v. Robles,Brief in Opposition ofPetition for a Writ of Certiorari.
 Shawn Lawton Henry, W3C Accessibility Standards Overview, W3C Web Accessibility Initiative, https://www.w3.org/WAI/standards-guidelines/#intro (last updated Mar. 13, 2019).
 See Press Release, Justice Department Enters into a Settlement Agreement with Peapod to Ensure that Peapod Grocery Delivery Website is Accessible to Individuals with Disabilities, The United States Department of Justice (Nov. 17, 2014), https://www.justice.gov/opa/pr/justice-department-enters-settlement-agreement-peapod-ensure-peapod-grocery-delivery-website.
 Shawn Lawton Henry, Web Content Accessibility Guidelines (WCAG) Overview, W3C Web Accessibility Initiative, https://www.w3.org/WAI/standards-guidelines/wcag/#versions (last updated June 22, 2018).
 Daimler AG v. Bauman, 571 U.S. 117, 126-27 (2014).
 Schwarzenneger v. Fred Martin Motor Co., 374 F.3d 797, 803 (9th Cir. 2004).
 Walden v. Fiore, 571 U.S. 277, 284-85 (2014).
 CollegeSource, Inc. v. AcademyOne, Inc., 653 F.3d 1066, 1075 (9th Cir. 2011) (internal quotations removed).
 Walden, 571 U.S. at 285-86.
By Donald F. Carey
We may often hear or even say, “They are a good lawyer,” when speaking of one of our colleagues in the bar. Have you considered what qualities or behaviors make someone a good lawyer? Does being a good lawyer include full compliance with the rules of professional conduct? A person who is knowledgeable in the law and capable? One who is diligent, courteous, and, above all else, honest and trustworthy? I think we could all agree that these qualities are at least a good starting point for one to be considered a good lawyer.
So, what does it take to be a great lawyer? Or maybe a better question to ask is: What does it take to stand out among very capable lawyers? I want to suggest that to stand out as a great lawyer one should develop a legacy of service outside the practice of law. Using a legacy of service as the criterium, I conclude that the greatest lawyer I know is Paul Harris.
Harris was born on April 19, 1868, in Racine, Wisconsin.[i] Twenty years later he moved to Des Moines, Iowa and began his apprenticeship in law. After completing his apprenticeship, he studied law at the University of Iowa. He graduated with a Bachelor of Law in June 1891.[ii] Harris began his law practice in 1896 in Chicago’s main business district. After establishing his law practice, Harris began to consider the benefits of the formation of a social organization for local professionals. So, in 1905, Harris organized the first Rotary Club with three clients and local businessmen, Silvester Schele, Gustavus Loehr, and Hiram Shorey. The initial goal was to create a club of professionals and businessmen for friendship and fellowship. Not long thereafter, Harris realized that Rotary needed a greater purpose.
In 1907, Harris’s Rotary Club initiated its first public service project, the construction of public toilets in Chicago. This step transformed Rotary into the world’s first Service Club. By 1910, at least 15 new clubs had begun in major cities. That August, the existing 16 Rotary Clubs held a national convention in Chicago. There, they unanimously chose to unify as the National Association of Rotary Clubs. Eventually, the organization became the International Association of Rotary Clubs, now known as Rotary International.
Today, Rotary has over 35,000 clubs worldwide and over 1,200,000 members.[iii] Its focus is on service, as defined broadly within six distinct areas of focus. The needs are profound. For example, it is estimated that 6,000 people die each day, more than 2.2 million each year, from waterborne pathogens. (We take potable water for granted, and even use it to flush our waste.) Rotary works to construct clean wells and filtration systems, both fixed and portable, to prevent at least some of these unnecessary deaths.
One of Rotary’s greatest achievements, and what remains a bit of unfinished business, is the fight to eradicate the wild poliovirus worldwide. In 1988, Rotary and the World Health Organization launched the Global Polio Eradication Initiative for the eradication of polio worldwide. At that time there were an estimated 350,000 cases of polio worldwide, in 125 endemic countries.[iv] In contrast, there were only 33 new cases of polio reported worldwide in 2018, and now there are only three endemic countries – Afghanistan, Nigeria and Pakistan. It is estimated that 88% of children ages one year or older have now been vaccinated against polio, with over 2.5 billion children worldwide having been immunized to date.[v]
In Idaho, there are Rotary Clubs in almost every town. These clubs serve their local communities with any number of service projects and they participate in international projects by way of boots on the ground and financial contributions. Rotarians are some of the busiest people you will ever know. We are fortunate to have many lawyers and judges who are current members of Rotary. They serve their communities, their state, their nation, and the world quietly, effectively, and without fanfare.
Circling back, because Paul Harris had a vision, “Service Above Self,” which is the Rotary motto, and because of the legacy of Rotary International and all the good work it does, Paul Harris is the greatest lawyer I know.
What will be your legacy of service? Rotary is only one avenue to serve and certainly isn’t for everyone. Still, I encourage you to find a way to serve your Bar, your town, your state, and indeed, your world in a consistent and meaningful manner. I trust you will find more joy in those acts of service than you can imagine. Live well!
Donald F. Carey is a 1991 graduate of the University of Wyoming College of Law. He is a founding partner in the Idaho Falls-based law firm of Carey Romankiw. He is a certified mediator. His practice includes general litigation and alternative dispute resolution. When he is not in the office you may find him running ridiculous distances in the mountains of eastern Idaho and western Wyoming.
[i] Rotary’s Founder – The Paul Harris Story.
[ii] Wikipedia – Paul Harris
[iii] Rotary International web site.
[iv] World Health Organization web site.