On May 21st, Jacob Ayres moderated a panel discussion on the cutting-edge topic of insolvency in the cannabis industry along with Ajay Gupta and other thought leaders in the burgeoning field. In case you missed this thought-provoking one-hour chat, it has been recorded in its entirety and is now available to view here!
In a previous article, I discussed the ultimately doomed effort by United Cannabis, a cannabis-affiliated company, to maintain its chapter 11 bankruptcy petition in the face of the Bankruptcy Court for the District of Colorado’s sua sponte challenge on the basis of the plan requiring administration of federally illegal cannabis activity. Although that case did seem to further shut the door to cannabis businesses seeking the protections of bankruptcy, at least in the Tenth Circuit, it also indirectly highlighted the growing gap in treatment of bankruptcy cases between the Ninth Circuit and others. In a recent case, In re The Hacienda Company, LLC, No. 2:22-bk-15163-NB, 2023 Bankr. LEXIS 2359 (Bankr. C.D. Cal. Sept. 20, 2023), the Ninth Circuit has doubled down on its liberal treatment of cannabis bankruptcy cases. Specifically, Bankruptcy Judge Neil W. Bason of the Central District confirmed the debtor’s chapter 11 plan of reorganization and denied the U.S. Trustee’s motion to dismiss the petition on the grounds that federally illegal cannabis activity was funding the reorganization.
Debtor in the case, the Hacienda Company, was at one point an active California cannabis cultivator and distributor. However, it fell on hard times in 2021 and sold its assets to Lowell Farms, Inc., a Canadian, company, in exchange for shares of Lowell Farms stock. Eventually, Hacienda declared bankruptcy and proposed, as part of its plan of reorganization, to sell off the Lowell Farms shares and distribute the proceeds to its creditors.
The U.S. Trustee objected, and filed a motion to dismiss under section 1112(b) of the bankruptcy code, which prohibits the confirmation of any plan of reorganization for “cause.” Although “cause” under section 1112(b) has somewhat of a malleable definition, the U.S. Trustee argued that good cause was present because Hacienda was still (technically) involved in federally illegal cannabis business activities—specifically, a “conspiracy” to violate the Controlled Substances Act via its assets-for-stock transaction with Lowell Farms.[1]
Judge Bason disagreed, denying the U.S. Trustee’s motion to dismiss and, in a companion order, confirming the plan of reorganization over the U.S. Trustee’s objections. The court’s reasoning, put briefly, was that evidence of illegal activity by a debtor as part of a proposed plan of reorganization does not, ipso facto, mandate dismissal. Specifically, the court pointed out that Congress did not explicitly list “illegal activity” as one of the grounds for “cause” under section 1112(b). It also pointed out several famous examples of confirmed plans of reorganization where past or ongoing illegal activity was present—such as the Enron and PG&E bankruptcies. Lastly, the court also pointed out that the plan it was approving resulted in the same remedy that would have resulted had the debtor been criminally prosecuted under anti-money laundering statutes: liquidation of the assets for the benefit of creditors.
The court went a step further, and also held that even if there was “cause” for dismissal arising from the illegal activity, the “unusual circumstances” exception of section 1112(b)(2) would also justify denial of the motion to dismiss. The court applied the two-part test for “unusual circumstances,” finding first that there were unusual circumstances such that dismissal was not in the best interests of creditors because dismissal would mean that the debtor’s shares in Lowell Farms would sit on the shelf rather than be liquidated to pay the unsecured creditors. The court then found the plan also met the second prong of the unusual circumstances test in that (1) the plan could be confirmed in a reasonable amount of time and (2) that the resulting ability to pay off the debtor’s creditors in full provided “reasonable justification” for the liquidation of the Lowell Farms stock and would also cure any residual illegal activity by eliminating the last cannabis-connected asset of the company.
Implications and Takeaways
The holding in Hacienda should embolden both cannabis businesses and their service providers in that it has left the door to bankruptcy protection slightly ajar. Of course, the unique factual circumstances of this case likely limit its applicability, but it is notable for the court’s noting that illegal activity—read: involvement in cannabis business—does not automatically disqualify a business from bankruptcy protection and the ability to reorganize under chapter 11. Other would-be cannabis debtors that are winding down their operations, but may have other assets, such as intellectual property, they may want to parlay into another venture will likely take advantage of this rather liberal reading of the Bankruptcy Code. That said, for other cannabis businesses, the juice may not be worth the squeeze in terms of the barriers to entry for bankruptcy, and may elect to pursue dissolution or receivership under state law, as has been the trend.
Aside from Hacienda’s impact on its own terms, it further highlights a growing divide between Bankruptcy Courts inside of different circuits, specifically regarding the application of section 1112(b) for dismissal or conversion of chapter 11 petitions and section 1129(a) for chapter 11 plan confirmation.
As you may recall from my prior article, there is a circuit split between the Ninth Circuit on one hand, and Sixth and Tenth Circuits on the other, regarding the interpretation of section 1129(a)(3). That particular subsection requires that, for a plan of reorganization to be confirmed, that it must be “proposed in good faith and not by any means forbidden by law.” The Ninth Circuit, in Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019), interpreted this clause to mean that the plan must be “proposed . . . not by any means forbidden by law,” not that the plan itself must not contain any illegal activity. The Hacienda court followed this precedent in its order confirming the debtor’s plan. In re Hacienda Co., LLC, 2023 Bankr. LEXIS 2359, at *7-9. In contrast, the Sixth and Tenth Circuits have taken the opposite view and looked at the substantive terms of the plan and, specifically, whether the debtor’s plan consists of any ongoing involvement with federally illegal cannabis business, to determine whether it meets the requirements of section 1129(a)(3). See, e.g., In re Basrah Custom Design, Inc., 600 B.R. 368, 381 n.38 (Bankr. E.D. Mich. 2019); In re Way to Grow, Inc., 610 B.R. 338, 345-47 & n.3 (D. Colo. 2019). Practically speaking, this means that cannabis businesses can have plans confirmed in the Ninth Circuit, but because of the federally illegal nature of their business, the Sixth and Tenth Circuits prevent plan confirmation because the illegal activity prevents a finding that the plans are proposed “in good faith.”
Apart from reinforcing this split, Hacienda answers a lingering question from Garvin. As liberal as the Garvin court was in confirming the plan of reorganization, the court did note that opponents of cannabis business chapter 11 plans could always invoke the section 1112(b) to dismiss the bankruptcy, even if it meets the “proposal” requirements for confirmation under 1129(a), specifically invoking the “gross mismanagement” prong of “cause” for dismissal under that subsection. Garvin, 922 F.3d at 1036. The Hacienda court noted that illegal activity might constitute “gross mismanagement” in the abstract, and impliedly found that the illegal activity by the debtor was not gross mismanagement, although it does not appear that the U.S. Trustee argued that point. One can assume that the relatively “clean” nature of the plan to liquidate the Lowell Farms shares to pay off the creditors left little room for a mismanagement argument. More significantly, the Hacienda court has shown that to constitute cause for dismissal under 1112(b), a movant must show that the illegal activity provides cause for some other reason than its own illegal status. This furthers the divide between the Ninth and Sixth Circuits; although the United Cannabis court did not explicitly say why it was finding good cause under 1112(b) to dismiss the debtor’s petition, one can presume that the “illegal activity” rationale played a role in the good cause finding.
In short, Hacienda’s holding has made the bankruptcy courts of the Ninth Circuit friendlier to cannabis businesses on the issues of cause for dismissal and plan confirmation. Until federal legalization happens, these circuit splits will likely deepen, and is perhaps predictable, if not appropriate, that bankruptcy courts located in the Pacific region—historically the vanguard in cannabis legalization—are providing a more hospitable environment for cannabis business debtors.
[1] Significantly, the U.S. Trustee and Court noted that although Lowell Farms was wholly legal in Canada, including its public trading on the Canadian Stock Exchange, it likely had operations in the United States that violated federal law.
In my first article on this topic, I discussed the blurred line between permissible prelitigation communications and constitutionally unprotected extortionate demands. In a subsequent article, I discussed that without payment by the extortionist to the victim, there is no claim for civil extortion.
A relatively recent case has shed additional light on the blurry line discussed in Part I of this series. Specifically, the new precedent clarifies the importance of a key issue in the civil extortion analysis—the relatedness of the information threatened to be revealed and the underlying wrong. It also bridges the gap between the seminal authorities of Flatley v. Mauro, 39 Cal. 4th 299 (2006)and Malin v. Singer, 217 Cal. App. 4th 1283 (2013) (previously discussed in Part I).
Case Analysis:
In Flickinger v. Finwall, 85 Cal. App. 5th 822 (2022) (“Flickinger II”), decided November 30, 2022, Jason Flickinger (“Plaintiff”), through counsel, made a demand on Robert Pendergrast, a contractor he hired to remodel his home, for presumably the cost of finishing the remodeling work. Id. at 828. Pendergrast, through his counsel, Gordon Finwall (“Finwall”), rejected the demand in a December 2016 letter (the “December 2016 Letter”), wherein he wrote, “I suggest you discuss with [Plaintiff] how such litigation may result in Apple opening an investigation into [Plaintiff’s] relationships with vendors.” Id. at 829. In so doing, Finwall was apparently alluding to Plaintiff’s alleged receipt of kickbacks from Chinese vendors while liaising with them on behalf of Apple, Plaintiff’s employer.
The first case, Flickinger I, began when Plaintiff sued Pendergrast. While Flickinger I was still pending, Plaintiff filed another case in what is known as Flickinger II.
In the case that preceded Flickinger II, Flickinger I, Plaintiff asserted a breach of contract cause of action against Pendergrast. Id. While Flickinger I was pending, Plaintiff filed Flickinger II, naming both Pendergast and Finwall as defendants, based on allegations that Finwall “used threats, intimidation, and coercion” in the December 2016 Letter “to prevent [p]laintiff from filing [Flickinger I].”. Id. at 831. The trial court denied Finwall’s anti-SLAPP motion to strike Plaintiff’s causes of action, holding that it was extortionate and illegal as a matter of law and thus unprotected activity; Finwall appealed. Id.
The Court of Appeal found that the December 2016 letter was protected under Section 425.16 because it was “written in response to a prelitigation demand from Plaintiff’s counsel and previewed Pendergrast’s litigation posture.” Id. at 833. “Section 425.16 protects any conduct in furtherance of the exercise of the constitutional right of petition.” Id. at 832. The Court also found that the Flatley exception did not apply because “Defendant’s letter bears no resemblance to the “extreme” conduct in Flatley which warranted a “narrow” exception to the protections ordinarily accorded petitioning activities under section 425.16.” Id. at 836. The Court reasoned that Flatley permitted a “finding of extortion as a matter of law only where an attorney’s threats fall wholly outside the bounds of professional norms.” Id.
Moreover, the Court reconciled that while the Malin court found that the “allegations of Malin’s sexual activity Singer threatened to disclose in [that] litigation [were] ‘inextricably tied’ to the underlying causes of action,” the court also suggested a standard that only required them to be reasonably connected to be protected under 425.16. Malin, 217 Cal. App. 4th at 1299. Therefore, the Court stated that “[a] threat that is ‘entirely unrelated’ to the merits of the disputed claims is not ‘reasonably connected’ to the actionable conduct. But a threat does not have to be ‘inextricably tied’ to the merits to avoid a finding it is “entirely unrelated.” Flickinger II, 85 Cal. App. 5th at 838. Therefore, the Court found that Finwall’s implied threat to publicize that Plaintiff engaged in an illegal kickback scheme was reasonably connected to the dispute. Id. Specifically, the underlying dispute about the incomplete remodel ultimately arose from Pendergrast’s failure to obtain permits, which, in turn, arose from Plaintiff’s alleged instruction to Pendergrast not to obtain permits to avoid any public record of Plaintiff spending above his means, implicating the alleged cash kickback payments. Id. at 838-39. As a result, the December 2016 Letter was not illegal as a matter of law and was entitled to protected activity status as prelitigation communications in connection with the constitutional right of petition under section 425.16(e)(4). Id. at 832-33.
Unlike previous cases, the Flickinger Court had the occasion to go past the first prong of the anti-SLAPP analysis (the “protected activity” inquiry). Having determined that the December 2016 Letter was protected activity, the Court moved on to the second step of the anti-SLAPP analysis, wherein the burden shifted to the Plaintiff to show that it had a “likelihood of success” on the merits of his civil extortion claim. The Court held that Plaintiff could not show a likelihood of success on his civil extortion cause of action because the cause of action was barred by the litigation privilege of Civil Code Section 47(b), which rather broadly protects communications made in connection with judicial proceedings, including pre- and post-litigation communications. Id. at 840. The Court, applying largely the same logic as in the first step of its analysis, held that the litigation privilege applied to Defendant’s December 2016 Letter because it was related to Plaintiff’s threatened litigation against Defendant’s client. Id. In so doing, the Court reversed the trial court’s denial of the anti-SLAPP motion, finding that the trial court should have stricken Plaintiff’s civil extortion claim.
What about the holdings in Stenehjem or Mendoza?
Although the Flickinger Court largely focuses on the “reasonably related” test for extortion that it establishes, that test does not fully explain other courts’ prior decisions regarding whether various prelitigation communications were illegally extortionate as a matter of law.
Specifically, the court does not directly address the cases of Mendoza v. Hamzeh, 215 Cal. App. 4th 799 (2013) or Stenehjem v. Sareen, 226 Cal. App. 4th 1405 (2014)–both of which are discussed in greater detail in Part I of this series.
However, in both of those cases, the crimes/disgraces threatened to be revealed by the sender of the challenged communication are at least arguably reasonably related to the underlying wrongdoing. Specifically, the threat to report plaintiff in Mendoza to various agencies for fraud in its business practices is ostensibly related to the underlying claim for the “same” “fraud, conversion, and breaches of contract” allegedly perpetrated by the plaintiff against the attorney defendant’s client, plaintiff’s former employee. Mendoza, 226 Cal. App. 4th at 802-03. Similarly, plaintiff in Stenehjem’s threat to initiate a qui tam action against his former employer is also ostensibly related to his underlying claim for wrongful termination based on alleged retaliation against him for reporting the same conduct that would form the basis for the qui tam action. Although the court in Stenehjem does expressly state that it found the qui tam threat to be unrelated to the underlying wrongful termination claim. However, that analysis seems suspect given that the alleged illegal activity by the former employer is what plaintiff alleges led to his termination. If anything, that conduct is more related to the underlying claim than the money laundering of Flickinger II is to the breach of contract. Indeed, the court in Flickinger II seems to have taken the non-moving party’s theory of the case at face value in its analysis, while the Stenehjem court took a more critical approach.
Perhaps the way to square the circle in both of these cases is by referring to the explicitness of the threat. Although not spelled out in any of these cases, the unspoken factor of explicitness balances out the relatedness “prong” of the civil extortion test. For example, the threat in Flickinger II is in the Malin “just stating facts” mode that suggests that unpleasant information might be revealed if the case did not settle. On the other hand, the demand letter in Mendoza openly threatens to report the plaintiff to a laundry list of agencies. Although subtler, the plaintiff in Stenehjem was also more direct about filing the qui tam claim than the oblique threat of exposure in Flickinger II. Indeed, although not expressly “weighed” against the relatedness analysis, the Flickinger court does take note of the lack of express threats in the December 2016 Letter:
[Finwall’s] only express ‘threat’ was that his client . . . would ‘aggressively defend himself in litigation. The statement from which plaintiff and the trial court implied a further threat [regarding the potential exposure of the money laundering to Apple] is not a threat that Pendergrast would report plaintiff to prosecuting authorities, and does not lie so far outside the bounds of professional communication to amount to criminal extortion as a matter of law.
Flickinger, 85 Cal. App. 5th at 837.
Takeaways
So what does this mean for litigators and their clients? Although lawyers still must take care not to cross an often blurry line, it behooves them to make sure (1) that whatever “threat” is issued is related to the underlying claim and (2) to avoid express threats. These best practices are rooted in the reality, illuminated by Flickinger, that courts are less inclined to find that a demand is extortionate as a matter of law if your threat (implied or not) to report a violation/crime or reveal a “disgrace” is related to the underlying claim that you are leveraging the threat to recover money on. Adhering to these general guidelines will minimize the chances that any prelitigation demand will be considered extortionate and thus not entitled to constitutional protection. Of course, attorneys would appreciate the Court of Appeal addressing head-on how the “relatedness” and “explicit threat” factors relate to each other in making the extortion determination, but until that day comes, practitioners at least have this newly published case that adds a not insubstantial gloss on the established Flatley/Malin analysis.
Part I of this article discussed the “threshold” issues to be analyzed when a business is on the receiving end of a negative, and potentially defamatory, online review. In so doing, Part I covered the quasi-legal options of proceeding via the online review platform’s dispute resolution process, and established the framework for a defamation claim—in particular, the preliminary issues of unmasking an anonymous reviewer, personal jurisdiction, and fact versus opinion statements. Part II of this discussion will address the next step in the analysis: whether a business’s online review defamation claim can withstand the inevitable challenge of an anti-SLAPP motion.
Your Claim on the Merits – The Anti-SLAPP Analysis
California—along with many other states—have employed a statutory strategy to reinforce the First Amendment by discouraging the filing of lawsuits based on protected speech: the anti-SLAPP (Strategic Lawsuit Against Public Participation) statute. In other words, it’s a statutory device that allows a defendant, sued for claims arising from “protected activity” (read: speech or other expressive conduct), to strike the plaintiff’s complaint and—drumroll please—obtain an award of attorney’s fees for drafting, filing, and arguing the anti-SLAPP motion. As is too often the case, it is the fee provision that makes the world go round, and what should make every potential defamation plaintiff pause and think before suing an online reviewer for defamation.
The anti-SLAPP statute in California mandates a two-step analysis to determine whether the complaint can be stricken: (1) do the claims arise from “protected activity,” and (2) if they do, does the plaintiff have a probability of prevailing on the merits of their claim? Kim v. R Consulting & Sales, Inc., 67 Cal. App. 5th 263, 270-71 (2021). This analysis is a burden-shifting framework where defendant has the burden on prong one of the above analysis, and if that burden is met, the burden then shifts to defendant to prove prong two. Id.
Protected Activity
The California anti-SLAPP statute outlines four categories of protected activity, but for the purposes of online defamation in the context of negative reviews, only two of the four categories are potentially applicable. California Code of Civil Procedure section 425.16(e)(3) provides that “[s]tatements made in a place open to the public or a public form in connection with an issue of public interest” constitute protected activity. Subsection (e)(4) is a “catchall” category, which provides protection for “[a]ny conduct in furtherance of First Amendment rights in connection with a public issue or an issue of public interest.”
For subsection (e)(3), as applied to negative online reviews, the first element—a place open to the public or a public forum—is usually easily met. That is, because websites like Google and Yelp are publicly accessible, they are considered public forums. However, grey areas arise when negative statements are made not on public review sites, but on “private” social media pages that may restrict access to certain users. See Turnbull v. Lucerne Valley Unified School District, , 535 (2018).
As for the second element of (e)(3), the “public issue/interest” element, that is also usually easily met for a negative review. To the extent the reviewer is opining about the quality of your services or character, those issues are typically fair game in the sense that “warning” other potential consumers about a business’s shortcomings is considered an issue of public interest. See Chaker v. Mateo, 209 Cal. App. 4th 1138, 1146 (2012) (“The statements posted to the Ripoff Report Web site about [plaintiff’s] character and business practices plainly fall within the rubric of consumer information about [plaintiff’s] ‘Counterforensics’ business and were intended to serve as a warning to consumers about his trustworthiness.”).
Even if the statement is made on a private web page or group, the catchall category of (e)(4) can still render the conduct protected if the statement concerns a “public issue or an issue of public interest.” Practically speaking, the analysis is very similar to the second element of subsection (e)(3), and is thus likely to be met by a similar “warning” about a business’s services. However, if the audience for the disparaging review or post are people that are unlikely to patronize the business in the first place, then it’s questionable whether the issue becomes one of public concern when the statement is made by one person to a private collection of individuals.
Lastly, as a final note, if the negative review is actually comparative advertising masquerading as a negative consumer review, that speech is not protected. That is, said “review” is actually commercial speech that falls outside of the protected activities under section 425.16(e). See Code Civ. Proc. § 425.17(c); Xu v. Huang, 73 Cal. App. 5th 802, 813 (2021) (citations omitted) (“The purpose of [the commercial speech exemption of section 425.17(c) from the anti-SLAPP statute] is straightforward: A defendant who makes statements about a business competitor’s goods or services to advance the defendant’s business cannot use the anti-SLAPP statute against causes of action arising from those statements.”). Thus, in a scenario where a negative review of a dry cleaner suspiciously names a competing dry cleaner as superior, and assuming the prospective plaintiff has reason to believe it was posted by someone at that competitor, it may merit pursuing the defamation claim as the defendant could fail to meet its burden on the first step of the anti-SLAPP motion.
In short, because of the very nature of online reviews, unless the review is about something utterly unrelated to your business and your character (which seems unlikely given the breadth of Chaker), then you will likely have the burden of proving a probability of prevailing on the merits on an anti-SLAPP motion.
Probability of Prevailing
Elements of Defamation
Because of the nature of negative online reviews, several elements of defamation are usually presumptively met. Defamation requires proof of (1) publication of the statement to a third party, (2) the audience reasonably understanding that the statement is about plaintiff, (3) the audience reasonably understanding the statement to have a meaning damaging to the plaintiff’s reputation, (4) the falsity of the statement, and (5) depending on several factors, a certain quantum of intent regarding the falsity of the statement.
For a negative online review, elements 1 through 3 above are pretty much always met—the review identifies the plaintiff, the audience understands it to be about the plaintiff as it is on their only Yelp or Google reviews page, and the negative nature of the review is presumptively damaging to the plaintiff’s business reputation. As for falsity, the most frequent pitfall for a prospective plaintiff is the fact versus opinion issue referenced above—that is, if a statement is one of opinion, it cannot be proven false.
The final element is the deepest. The nature of whether the plaintiff is a private or public figure, and whether the issue about which the speech is concerned controls whether a plaintiff must prove that the defendant published the defamatory statement with actual malice—to wit, whether the defendant made the statement with knowledge of its falsity, or reckless disregard as to its falsity. See CACI 1700-1705. In the context of an online review, it is debatable whether the business being reviewed would be considered a public figure.
For example, in Vegod Corporation v. American Broadcasting Company, 25 Cal. 3d 763, a company liquidating a historic San Francisco department store sued ABC for a news broadcast stating that they were selling of inferior goods at inflated prices. ABC argued that plaintiff, by virtue of stepping in to liquidate a famous department store, had rendered itself a public figure. The California Supreme Court disagreed, holding that “criticism of commercial conduct does not deserve the special protection of the actual malice test” and that “a person in the business world advertising his wares does not necessarily become part of an existing public controversy.” Id. at 770. Moreover, the court also noted that “[m]erely doing business with parties to a public controversy does not elevate one to public figure status.” Id. at 769. In short, under Vegod, in many online reviews, the reviewed business would not likely be deemed a public figure simply because of its status as a business open to the public.
On the other hand, it is not difficult to imagine a scenario where an online review of a business is in the context of a broader public controversy into which the business has more or less willingly inserted itself, which would result in application of the public figure label and the actual malice test to online reviews. For example, the Los Angeles Bar “Schwartz & Sandy’s,” featured extensively on the Bravo reality television show “Vanderpump Rules,” recently found itself on the receiving end of a massive review-bombing campaign by fans of the show apoplectic over the infidelity of one of the bar’s co-owner’s, Tom Sandoval. Although that review-bombing incident was resolved via the Terms of Service recourse discussed in the part I of this article, it is not difficult to imagine that the business entity that owns the bar would be held to be a public figure due to the actions of its principals in seeking extensive media exposure through the show, had push come to shove.
Affirmative Defenses
Litigation Privilege
Even if a defamation plaintiff can show a likelihood of success on the merits of the elements of defamation, the plaintiff must also overcome any purported affirmative defenses advanced by defendant. However, despite the quirks of the anti-SLAPP burden-shifting framework, the defendant bears the initial burden of establishing the defenses of privilege—affirmative defenses commonly advanced in defamation cases. See Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP, 133 Cal. App. 4th 658, 676 (2005) (“[A]lthough section 425.16 places on the plaintiff the burden of substantiating its claims, a defendant that advances an affirmative defense to such claims properly bears the burden of proof on the defense.”). That said, if the defendant meets that burden of establishing the existence of a privilege, the plaintiff then bears the burden of showing that they can overcome that claim of privilege. See Blanchard v. DIRECTV, Inc., 123 Cal. App. 4th 903, 922 (2004) (“[P]laintiff’s showing failed to demonstrate prima facie that they could overcome the litigation privilege. By contrast, [defendant] demonstrated that the privilege does apply.”).
The most significant of these privilege defenses is the litigation privilege of Civil Code section 47(b). The litigation privilege is very broad, almost shockingly so, in that it completely immunizes a defamation defendant from liability for any statements made “in connection” with litigation, which often includes pre-litigation communications such as demand letters. See, e.g., Blanchard, 123 Cal. App. 4th at 919-22 (2004).Because of the breadth of the litigation privilege, negative online reviews that closely precede a lawsuit could be within the ambit of the litigation privilege and thus totally defeat any defamation claims arising from it. This is the case regardless of the falsity of the statement, and regardless of malice. See, e.g., Quidel Corp. v. Siemens Med. Solutions USA, Inc., No. 16-cv-3059-BAS-AGS, 2019 U.S. Dist. LEXIS 167363,at *24 (S.D. Cal. Sept. 27, 2019) (quoting Butler v. Resurgence Fin., LLC, 521 F. Supp. 2d 1093, 1095 (C.D. Cal. 2007) (“Even if it is alleged that a party ‘made misrepresentations in the complaint, false statements in sworn discovery responses . . . and false allegations,’ the conduct is all covered by the litigation privilege.”); compare Civ. Code § 47(b) with Civ. Code § 47(c).
However, negative online reviews are often an end unto themselves; negative reviewers scratch the itch to strike at the business that has apparently wronged them in a quicker and dirtier fashion than the civil justice system can offer. Moreover, in an unpublished case, the Ninth Circuit Bankruptcy Appellate Panel recently upheld a ruling that rejected the application of the litigation privilege to negative online reviews that were premised solely on self-serving declarations stating that the reviewers were “contemplating” litigation at the time they were posted. Dickens v. Bradley (In re Dickens), No. CC-21-1202-FSG, 2022 Bankr. LEXIS 2277 (Aug. 17, 2022). Accordingly, at least some courts are wise to defense attorneys overplaying their hands in an attempt to hide behind the broad shield of the litigation privilege.
Common Interest Privilege
The common interest privilege, on the other hand, has a narrower application that is nonetheless better suited to online reviews. The common interest privilege as codified in Civil Code section 47(c) protects speakers from liability for statements made to a person with an interest common to the speaker, or who has requested said information from the speaker, “without malice.” Online reviews are presumptively geared toward those with common interests: the prospective use of the goods or services of the business being reviewed. However, assuming malice is already required if the business is deemed to be a public figure, the proof of malice necessary to show a likelihood of success on the merits would also defeat any claims of common interest privilege. The importance of the common interest privilege grows exponentially if the business is a private figure, in which case the plaintiff could meet its burden of showing a likelihood of success without showing malice, the defendant could in turn raise the defense of the common interest privilege which would require the defendant to prove an absence of malice. Byzantine, we know.
Conclusion
A defamation claim is a proverbial hornets’ nest even outside of the context of a potentially anonymous online review. Inside that context, numerous legal issues and pitfalls exist such that any business contemplating a defamation claim should think long and hard before pursuing one, especially given the draconian penalty of paying the other side’s attorneys’ fees for unsuccessfully opposing an anti-SLAPP motion. All that being said, businesses would do well to be fully informed about their legal options to combat unfairly negative online reviews, from the quasi-legal options covered in Part I, to the legal options covered in Part II herein. Of course, from a business perspective, the best option is usually engaging with the review, answering it thoughtfully, and working out a resolution with the customer. But there may be reviews that are genuinely false and done with bad intent that may merit pressing the big, blinking red button of a defamation action.
AB 1200 – Client Update
If there’s one thing lawyers love, it’s reporting on new laws that go into effect on January 1 of each new year—ourselves included. But one January 1 change that may have flown under the radar for many is the effective date of the first part of California Assembly Bill 1200 (“AB 1200”)—a new California law that imposes extensive disclosure requirements on manufacturers of cookware and food packaging items that contain listed chemicals with toxic properties.
Food Packaging
The food packaging requirements are the smaller portion of AB 1200 and easier to parse. As of January 1, 2023, no “food packaging” in California may contain “regulated perfluoroalkyl or polyfluoroalkyl substances or PFAS.” Cal. Health & Saf. Code § 109000(b). “Food packaging” is broadly defined to include any food or beverage storage item such as take out containers, wrappers, utensils, straws, and so on. See id. § 109000(a)(1). “Regulated . . . PFAS” is defined as organic chemicals containing at least one fully fluorinated carbon atom where the manufacturer has “intentionally added” it to the product in question, or where the product has more than 100 parts per million of PFAS.
The stated legislative purpose was to bring food packaging requirements into congruence with pre-existing law that prohibits bisphenol A in baby bottles and cups and pre-existing (but not yet effective) law that prohibits PFAS in cosmetic products.
Cookware
This is where it gets interesting. The cookware portion of AB 1200 imposes two distinct requirements: internet disclosure requirements and product label requirements. The former went into effect on January 1, 2023, the latter will not go into effect until a year later. Id. § 109011-109012.
Internet Posting
The internet posting rules require that manufacturers of any “cookware” sold in California that contains any intentionally added chemicals that appear on the list of candidate chemicals published by the California Department of Toxic Substances Control (“DTSC”) in the “cookware surface” or “handle” of the cookware product to provide a written warning on the “internet website for the cookware.” Id. § 109012. That written warning must contain the names of all listed chemicals, the names of the “authoritative lists” from which the DTSC candidate list pulls the listed chemicals, and a link to the websites for each authoritative list. Id. § 109012(a)-(c). “Cookware” is broadly defined to mean “durable houseware items” used to “prepare, dispense, or store food, foodstuffs, or beverages.” “Cookware surface” is any part of the cookware that touches the food or beverage. “Handle” is undefined, but presumably has its ordinary meaning to include the handles of pots, pans, and utensils.
Product Labeling
As for product labeling requirements, going into effect January 1, 2024, the triggering mechanism is the same as for internet posting: the presence of an intentionally added candidate chemical in the cookware surface that comes into contact with food or beverages or the product handle. Id. § 109011(a). If said chemical is present, the manufacturer must provide a warning on the product label that provides (1) a list of the candidate chemicals the product contains; (2) a hyperlink to the website that provides the internet posting requirement information under section 109012, with a short preamble in both English and Spanish, and (3) a QR code that links directly to the internet posting requirement information. Id. This information also must be visible on the “product listing for online sales.” Id. § 109011(b). “Product label” is defined as “a display of written, printed, or graphic material that appears on, or is affixed to, the exterior of a product, or its exterior container or wrapper that is visible to a consumer, if the product has an exterior container or wrapper.”
The statute also provides a small exemption for cookware that either lacks enough surface area to ft a product label of two square inches, or does not have exterior packaging or a tag with information about the cookware. Id. § 109011(c). Products exempt from the physical product labeling requirement must still provide the required information on the online listing for the product under section 109011(b).
Enforcement
Unlike other consumer protection “right to know” statutes related to toxic chemicals, such as California’s Proposition 65, AB 1200 currently has no statutory private right of action. Even regarding public enforcement, AB 1200 also contains no provisions for statutory damages, penalties, or attorneys’ fees. In fact, the only gesture toward enforcement provides simply that cookware not in compliance with the posting/labeling requirements “shall not be sold, offered for sale, or distributed in the state.” Id. § 109014. This begs the question of what happens if a manufacturer violates the cookware provisions—would a shipment of noncomplying cookware to the Port of Los Angeles be seized? Would cookware in violation be sent back to its point of origin? Would it be destroyed? Who is the agency in charge of enforcing compliance? Does “offered for sale . . . in the state” encompass websites that are visible in California that would be subject to blockage if not in compliance with the posting requirements? These are all open questions in this newborn statute, and only time will tell how the State of California will enforce its provisions.
Open Issues
The ambiguities inherent in this statute will likely lead to litigation over when chemicals are “intentionally added” to the handle or cookware surface. The DTSC candidate chemical list is nothing if not overinclusive. Numerous basic elements, such as iron and chromium, are listed candidate chemicals, the two of which just so happen to be the key components of stainless steel, a popular material in pots and pans. Does using stainless steel, a common material, in the handle of a pot or pan require an internet posting under the statute? Or is it exempt as iron and chromium were not “intentionally added” because their inclusion is incidental to the usage of stainless steel? The statute’s definition of “intentionally added chemical” leaves plenty of room for argument and interpretation: “a chemical that a manufacturer has intentionally added to a product that has a functional or technical effect in the product, including the components of intentionally added chemicals and intentional breakdown products of an added chemical that also have a functional or technical effect in the product.” Id. § 109010(c).
Going one level deeper, the breadth of the DTSC candidate chemical list as applied to cookware—particularly “handles” thereto—is also subject to challenge. For example, iron is only listed as a candidate chemical because it is a pollutant under the Clean Water Act. No one would argue that iron is safe to have in drinking water, but it is dubious that the prohibition of iron in drinking water should be extended such that iron is viewed as a toxic chemical when ensconced in the alloy structure of stainless steel in the handle of a saucepan. The “piggybacking” of AB 1200 on the DTSC candidate list without any nuances or carveouts, may be subject to court challenge by manufacturers.
Conclusion
AB 1200 imposes significant labeling burdens on manufacturers of cookware sold in California. Although the consequences for noncompliance are ill-defined at this point in time, manufacturers would do well to comply as much as possible with the statute until those consequences are clarified. That said, manufacturers that are not yet in compliance can take some comfort in the fact that the plaintiffs’ bar does not yet have a reason (or a right) to pursue civil lawsuits for violations of the statute.
If you are a cookware manufacturer with questions about AB 1200 compliance, please reach out to our office to discuss.
You are a hardworking business owner. You cherish your sterling reputation in the community—including your 4.5 star average on Yelp and Google reviews. But one morning you are woken up by the chime of your email notification on your phone and, to your infinite dismay, someone has left a scathing review of your business on Yelp. Not only is the review uniformly negative and one-sided—it’s completely false too. What do you do?
There is no easy answer to this question. This is a situation that many business owners find themselves in and, unfortunately for them, there is a large obstacle to bringing the hammer down on reviewers—online or otherwise—that smear your reputation: the First Amendment. The rules governing when a false statement is legally actionable is Byzantine, and the analysis is only complicated when the false statements are made online—doubly so when the reviewer is anonymous. Regardless of these often-labyrinthine rules this article—part one of a two-part series–will lay out a framework of legal strategies for how to respond to negative online reviews. Part two will analyze the same issue from the opposite perspective—that of the negative reviewer.
The First Line of Defense: Quasi-Legal – Terms of Service (TOS) Violations
As discussed below, immediately pulling trigger on a defamation lawsuit is fraught with danger for the plaintiff. Accordingly, more often than not, the best legal strategy for dealing with negative reviews is to attempt to have the review removed for violating the applicable platform’s terms of service (TOS). The TOS are binding on all users and reviewers, and the platform will typically not hesitate to remove a review if its content fits neatly into one of the TOS’s prohibitions.
For example, Glassdoor.com prevents a given user from reviewing the same employer more than once in a year. For some employers, a common fact pattern is a disgruntled former employee “review bombing” the company with negative reviews with slightly different usernames. Although the employer/business may have some difficulty proving it is the same person to justify application of the policy to remove the review, this policy at least gives the business some measure of damage control over the negative reviews of a given former employee.
Somewhat similarly, Yelp has a policy in its TOS that prohibits using a third party’s full name in a review. As can sometimes be the case, if the negative review is targeting a particular employee or representative and the reviewer, in a fit of pique, names that particular person, that is grounds for the removal of the review. That said, the Yelp policy only says that it prohibits the use of someone’s “full name,” which, on its face, means that using someone’s first name or first name and last initial, likely is not enough for Yelp to remove the review.
Regardless of the exact contours of the TOS, it is wise to check the applicable TOS first when dealing with a bad online review. If there is a basis for removal, invoking the TOS is often the quickest and cheapest way of dealing with a bad review.
Legal Option – Defamation/Speech Tort Claims
Threshold Inquiries
Who Is the Speaker?
As is often the case with the internet, the issue of anonymity often bears heavily on the online defamation claims analysis. That is, if you want to sue the online reviewer, but you don’t know who they are, how do you sue them?
The reality is that a business owner can often deduce the identity of the negative reviewer based on the content of the review, even if the reviewer is anonymous on the face of the review. However, if you genuinely do not know the identity of the speaker, your options are limited. Internet service providers (ISPs) or online platforms often zealously protect the identities of their users. See, e.g., United States v. Glassdoor, Inc. (In re Grand Jury Subpoena), 875 F.3d 1179 (2017) (“[Glassdoor] . . . argues that ‘anonymity is an essential feature of the Glassdoor community,’ and that ‘if employees cannot speak anonymously, they often will not speak at all,’. . . [and that] forcing Glassdoor to comply with the grand jury’s subpoena subpoena duces tecum will chill First Amendment-protected activity.”).
The recipient of a bad review from an anonymous reviewer seeking to bring a civil defamation-type claim thus has two options. First, the business owner can see if the ISP or platform, on the off chance, does have some kind of unmasking policy for anonymous users, but that is doubtful. The second, and more viable course of action, is to file the complaint against a “Doe Defendant”—meaning a defendant that is subject to identification at a later date after discovery. That said, if your only source of identification of the user is the ISP or the platform, even if your complaint makes it to the discovery stage, the ISP/platform may ultimately stymie your ability to gather information about the identity of the reviewer at all through privacy objections that may outweigh your right to the information. See, e.g., Awtry v. Glassdoor, No. 16-mc-80028-JCS, 2016 U.S. Dist. LEXIS 44804 (N.D. Cal. Apr. 1, 2016) (holding that plaintiff employer’s interest in obtaining identifying information of anonymous reviewer was “significantly outweighed” by the reviewer’s—and the review platform’s—First Amendment interest in maintaining anonymity). This continues to be an intractable problem for business owners on the receiving end of anonymous speech, but it is reflective of a deeper bargain struck between the First Amendment—which courts have held includes the right to anonymous speech —and the comparatively weaker rights of civil litigants fighting over a few fistfuls of filthy lucre. Compare Krinsky v. Doe 6, 159 Cal. App. 4th 1154 (2008) (holding that libel plaintiff seeking discovery of anonymous speaker’s identity must make a prima facie showing of all elements of defamation) with Glassdoor, 875 F.3d at 1191-92 (affirming denial of motion to quash subpoena to Glassdoor regarding identifying information in criminal grand jury proceeding because, under applicable Branzburg test, Glassdoor had not shown that the grand jury was acting in bad faith or a “tenuous connection” between the criminal probe and information sought).
Do You Have Jurisdiction?
If you are able to identify your negative reviewer, you may be faced with another obstacle: is your negative reviewer even within the jurisdiction of the court you might want to sue in—or even within the jurisdiction of any court within the United States?
It’s a cliché at this point to invoke the world-shrinking powers of the internet, but those powers are on full display in the context of negative online reviews. That is, it is incredibly easy for someone in a different state, country, or continent to negatively review a business—especially now that e-commerce and associated logistical and communications technology has made it easy for even a small business to provide their goods and services across the globe. In that scenario, where the negative reviewer is located in another state or country, the business owner must analyze whether the speaker has sufficient contacts with the forum state—not the plaintiff/business owner who happens to be in the forum state—such that the court may exercise jurisdiction over the out-of-state (or country) reviewer defendant. See Axiom Foods, Inc. v. Acerchem Int’l, Inc., 874 F.3d 1064, 1070 (9th Cir. 2017) (citing Walden v. Fiore, 571 U.S. 277, 287-88 (2014) (noting that the Supreme Court in Walden rejected the theory that “‘knowledge of the plaintiffs’ strong forum connections,’ plus the ‘foreseeable harm’ the plaintiffs suffered in the forum, comprised sufficient minimum contacts under the purposeful direction test).
More specifically, the business owner must apply the “purposeful direction” test—the subspecies of the law-school-famous International Shoe minimum contacts test—which applies to tort claims (as opposed to the “purposeful availment” test applicable to contract claims). Williams v. Kula, No. 20-CV-1120 TWR (AHG), 2020 U.S. Dist. LEXIS 244769, at *6-7 (S.D. Cal. Dec. 29, 2020). “Purposeful direction ‘requires that the defendant have (1) committed an intentional act, (2) expressly aimed at the forum state, (3) causing harm that the defendant knows is likely to be suffered in the forum state.’” Id. at *7 (quoting Schwarzenegger v. Fred Martin Motor Co., 374 F.3d 797, 803 (2004)). Of course, leaving a bad review easily meets element one of this test. The trick is meeting element two, commonly known as the “express aiming” requirement, and to a lesser extent, element three. That is, most of the time, the conduct is aimed at the target of the review, not the forum state itself—after all, on a website like Yelp, theoretically anyone with internet access can view that review, not just people within the forum state.
On the other hand, the California Court of Appeal in Burdick v. Superior Court, 233 Cal. App. 4th 8 (2015), has provided a framework which victims of online defamation can use to determine whether personal jurisdiction exists over the online reviewer defendant(s). In Burdick, the Illinois-resident principal of a skin care company (defendants), upon receiving a skeptical review by plaintiff doctors, began a campaign of online defamation, including several disparaging posts on his personal Facebook page. Id. at 14-15. The court held that although the Facebook page was publicly available and that it was directed at a California resident, there was not personal jurisdiction over the Illinois defendant in light of Walden. Id. at 25 (“[M]erely posting on the Internet negative comments about the plaintiff and knowing that the plaintiff is in the forum state are insufficient to create minimum contacts. . . . Walden emphasize[s] the difference between conduct directed at the plaintiff and conduct directed at the forum state itself . . . .”). However, the Burdick court did list some factors that could have supported a finding of purposeful direction:
Plaintiffs did not produce evidence to show Burdick’s personal Facebook page or the allegedly defamatory posting was expressly aimed or intentionally targeted at California, that either the Facebook page or the posting had a California audience, that any significant number of Facebook ‘friends,’ who might see the posting, lived in California, or that the Facebook page had advertisements targeting Californians.
Id.
This verbiage is instructive in an online review context. If your business has a physical presence in a given area—say, southern California, and your clientele is overwhelmingly Californian, even if your negative reviewer is in Florida, there would likely be personal jurisdiction under the Burdick factors above. See Russell v. Samec, No. 2:20-cv-00263-RSM-JRC, 2020 U.S. Dist. LEXIS 226125, at *12-15 (W.D. Wash. Oct. 8, 2020) (exercise of jurisdiction proper where defendant posted comments on social media referencing the location in Washington of plaintiff’s business); Gallgher v. Maternitywise Int’l, LLC, No. 18-00364 LEK-KJM, 2019 U.S. Dist. LEXIS, at *17-18 (D. Haw. Feb. 27, 2019) (holding personal jurisdiction existed where there was proof that defendant had been informed of location of plaintiff’s business in Hawaii and thereafter posted defamatory comments on plaintiff’s Facebook business page). On the other hand, a negative Google review of a large national company does not necessarily imply the same level of forum state targeting. See Smart Energy Today, Inc. v. Hoeft, No. CV 15-8517 DSF (AJWx), 2016 U.S. Dist. LEXIS 187571, at *4-5 (C.D. Cal. June 20, 2016) (negative posts on Yelp and AngiesList where plaintiff did not allege that there was any aiming at California was insufficient to find personal jurisdiction).
Is the Review a Non-Actionable Statement of Opinion?
Although the issue of whether the disparaging statement is one of opinion or fact is part of the general defamation claims analysis and not a prerequisite like defendant identification and personal jurisdiction, in the context of online reviews—which are often directly related to matters of opinion—it behooves the prospective plaintiff to perform the analysis as it if were a prerequisite. An actionable defamatory statement must be one of fact, not opinion. CACI 1707. It sounds simple enough, but the line between opinion and fact in defamation cases is razor thin, if not completely porous.
For example, a California jury recently found that business tycoon Elon Musk’s tweet that Vernon Unsworth, one of the diving rescuers of the Thai boy scouts that became stuck in a cave in that country, was a “pedo guy”—an insult flung at him after Mr. Unsworth criticized Mr. Musk’s attempts to insert himself into the efforts to rescue the scouts—was a statement of opinion (or insult) rather than fact. In a less sensational case, the Court of Appeal in Chaker v. Mateo, 209 Cal. App. 4th 1138 (2012), showed a similarly blasé attitude toward inflammatory statements made on the internet. In that case, the Court characterized defendant’s statements, made on plaintiff’s business’s page on the Ripoff Report website, that the plaintiff was a “criminal and a deadbeat dad” and that he was patronizing prostitutes as “exaggerated or insulting criticisms” that constituted a “negative, but nonactionable opinion” that plaintiff was a “dishonest and scary person.” Id. at 1149. Despite the seemingly black-and-white factual nature of these statements, the court went further to say that “it is difficult to conclude [defendant’s] alleged embellishments, to the effect [plaintiff] picks up streetwalkers and homeless drug addicts and is a deadbeat dad, would be interpreted by the average internet reader as anything more than the insulting name calling—in the vein of ‘she hires worthless relatives,’ ‘he roughed up patients,’ or ‘he’s a crook’—which one would expect from someone who had an unpleasant personal or business experience with [plaintiff] and was angry with him rather than as any provable statement of fact.” Id.
In short, California courts (and juries) are very quick to dismiss heated speech on the internet as just that—name-calling or insults. So if you receive a negative review that blasts your business as “full of cheats” or “a ripoff” or “run by criminals out to steal from you,” think twice before running to the courthouse.
Conclusion
This is merely the first part of the analysis of a defamation-type claim arising from an online review. As one can see, the process is positively fraught with potential pitfalls in bringing your claim to fruition. Accordingly, any prospective defamation plaintiff should use extreme caution before embarking on the path to the courthouse.
In Part 2, we will examine the critical (and often dreaded) next phase in the claims analysis if the threshold issues can be met—the two-step anti-SLAPP analysis.
Gupta Evans & Ayres was successfully able to secure a release of a bank loan that was erroneously accounted for as due when the bank had previously discharged the loan years prior. All it took was a simple and effective demand letter, saving our client time and money.
Our client obtained a $50,000 loan from Union Bank in early February 2006. A little over ten years later, Union Bank sent our client a notice of cancellation stating that the remaining balance on the loan had been discharged. Shortly thereafter and to fulfill IRS requirements, Union Bank sent our client a 1099-C Form titled “Combined Tax Statement for Year 2016” which stated and confirmed that the loan had indeed been discharged. Relying on this 1099-C Form, our client promptly paid the taxes on the discharged debt to the IRS.
Around mid-June of 2020, our client sought to secure a loan to purchase real estate and performed a title search. Much to our client’s surprise, the preliminary report included the 2006 loan for $50,000. To sort out this confusion, our client contacted Union Bank directly multiple times requesting access to our client’s bank records and any records of communications or correspondence between our client and Union Bank. However, and unsurprisingly, Union Bank’s representatives’ responses had largely been the same—that the Loan was still showing as due.
GEA stepped in and drafted a demand letter to Union Bank which included documents sent by Union Bank themselves telling our client that the 2006 loan had been discharged, and alluded to Union Bank’s potential violations of the Rosenthal Act given the inaccurate accounting on the loan and Union Bank’s inaction in investigating the errors. In response, Union Bank agreed to release and reconvey the deed of trust on the loan, fully clearing the 2006 loan from our client’s name. As a result, our client was able to freely secure the mortgage loan he was seeking and avoid potential litigation costs and expenses.
On February 3, 2022, the Subchapter 5 plan for Eminent Cycles, LLC (Case #21-01006-CL11 filed in the Southern District of California) was confirmed over objection from the main secured creditor. The Debtor in this instance had financing ready but could not move forward because the secured creditor’s interest was substantially more than the value of the company.
In a highly contested Chapter 11, the Debtor’s plan effectuated a cramdown of the primary secured creditor allowing the company to continue operations as a going concern while forcing the creditors to restructure their liabilities. The valuation of the business was contested in addition to the plan, however, the Court ultimately held that the plan was proposed in good faith and was in the best interests of the creditors.
There are couple take aways from this process. First and foremost, despite the attempt to streamline the Subchapter 5 process, a Subchapter 5 is still very expensive. A contested Subchapter 5 bankruptcy is much more than a glorified Chapter 13 and debtor’s counsel should plan on a budget that respects the time that it will take to get a plan to completion.
Second, you can confirm a Subchapter 5 without a consenting class of creditors if the plan is fair and equitable. There are two major additions to the code that make a Subchapter 5 easier to confirm than a traditional Chapter 11. The abolition of the absolute priority rule for Subchapter 5 bankruptcies allows access to a restructuring under Chapter 11 that previously was not available to most small businesses. While we did not need that rule in our case, the other major addition which we were able leverage allows a plan to be confirmed without a consenting class of as long as the plan does not discriminate unfairly and is fair and equitable. (11 USC 1191(b))
We are not aware of any specific contested cases that were approved prior to ours, but the UST’s office said there may be another one out there. In any case, if you have any questions or concerns about your Subchapter 5 whether it is a creditor or a debtor matter, we’d be happy to look at it for you and get you some guidance.
Gupta Evans and Ayres is proud to announce they were able to secure another resounding victory and six-figure verdict for their client after over four years of litigation and a hard-fought jury trial in San Diego County.
GEA represented a purchaser of a home in Oceanside that the purchaser later discovered to be littered with an assortment of undisclosed defects and faulty repairs. The Firm began representing the client in early 2017, which would begin what would become a marathon of litigation and include a litany of hotly contested issues, complete with extensive discovery and motion practice (and, of course, a global pandemic). Although the case concluded as a trial between a buyer and seller of residential real estate, the case began with three times the parties and several cross-complaints and competing defenses, all of which had to be resolved before trial.
Finally, after over four years of litigation, and a seven-day jury trial before Judge Blaine Bowman in the North County branch of San Diego Superior Court, the Firm established that the sellers of the home were liable to the client-buyer for breach of contract, fraud (intentional and negligent misrepresentation) and engaging in work as an unlicensed contractor. After establishing such liability, the jury returned a six-figure verdict in favor of the firm’s client.
As the prevailing party at trial, the Firm was then also able to succeed on a post-judgment motion for attorneys’ fees and costs incurred by their client throughout the course of the litigation, in part by successfully arguing the “intertwinement” of the tort and contract causes of action.
After resolving claims against parties other than the seller pre-trial, and upon the successful jury verdict and attorneys’ fees motion, the client was granted a total award of approximately $540,000, inclusive of punitive damages. Congratulations to trial counsel Ajay Gupta and Chris S. Evans for bringing this case across the finish line and obtaining a victory for the Firm’s client!
This is a three-part article that explores whether private student loans are excepted from discharge under Section 523 (a)(8) of the Bankruptcy Code. Section 523 (a)(8) includes three categories of non-dischargeable student loan debt. Part I of the blog article discussed Section 523 (a)(8)(A)(i) and can be accessed here. Part II of the blog article discussed Section 523 (a)(8)(A)(ii) and can be accessed here. This is Part III of the blog article and explores the last category of non-dischargeable student loan debt, Section 523 (a)(8)(B).
Section 523 (a)(8)(B) — “Qualified Education Loan”
The last non-dischargeable exception states that “any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986 incurred by a debtor who is an individual” is non-dischargeable unless repaying the debt would impose an undue hardship on the debtor and their dependents. 11 U.S.C.S. 523 § (a)(8)(B) (emphasis added). Section 523 (a)(8) leads the reader through a statutory trail and, therefore, requires a detailed explanation of each section mentioned in the statute.
Section 221 (d)(1) of the Internal Revenue Code (“IRC”) states that a “qualified education loan” is any indebtedness incurred by the taxpayer solely to pay for “qualified higher education expenses.” The term “qualified higher education expenses” in Section 221 (d)(1) of the IRC means any expenses used to fund the student’s education, such as tuition, books, supplies, room and board, and other related expenses. See 26 U.S.C.S. § 221 referring to 20 U.S.C.S. § 1087ll. Moreover, the “qualified higher education[al] expenses” must be directed towards an “Eligible Educational Institution.” See 26 U.S.C.S. § 221 referring to 26 U.S.C.S. § 25A. Whether private, non-profit, or government-funded, most accredited universities are “Eligible Educational Institutions.”[i]
Despite the complexity of Section 523 (a)(8)(B), Bankruptcy Courts throughout the country appear to agree that Section 523 (a)(8)(B) encompasses private student loans. For instance, in Conti v. Arrowood Indem. Co. (In re Conti), 982 F.3d 445 (6th Cir. 2020), the debtor received loans from CitiBank to fund her college education and then later sought to discharge the private debt through a Chapter 7 bankruptcy. There was no dispute that the loan proceeds were for the debtor, the debtor was an eligible student when she incurred the debt, and the loan funds were directed to an accredited institution. The sole issue on appeal was whether the overall purpose of the loan was to fund the debtor’s education. See In re Conti, 982 F.3d at 446-47.
The Circuit Court held that the purpose of the loan proceeds can be “centrally discerned from the lender’s agreement with the borrower.” Id. at 448-49. The Circuit Court found that the promissory notes explicitly stated that the loan was for educational expenses at the named institution and even specified that the loan proceeds were intended to pay for the debtor’s tuition. Id. Accordingly, the Appellate Court held that the private student loan was a “qualified education loan” and, thus, was non-dischargeable under Section 523 (a)(8)(B).
The Bankruptcy Court in the District of Alaska reached a similar conclusion in the case of Rizor v. Acapita Educ. Fin. Corp. (In re Rizor), 553 B.R. 144 (Bankr. D. Alaska 2016). In that case, the debtor took out a private student loan to fund his attendance at a private, for-profit veterinary school located in Grenada. Unlike In Re Conti, the primary issue was whether the veterinary school was an eligible educational institution (“EEI”). In re Rizor, 553 B.R. 144. The Bankruptcy Court held that the institution was an EEI because Section 1002 of the U.S. Education Code provided a carve-out for specific, off-shore veterinary schools. Id.
At first blush, Section 523 (a)(8)(B) appears to provide a safe haven for private student loans. However, it is important to note that Section 523 (a)(8)(B) is extremely dense and statutorily driven. Part III of article only touched on this subsection’s most important and relevant parts. The cases cited above offer guidance to Bankruptcy Courts on the innerworkings of Section 523 (a)(8)(B), but do not flush out each moving-part of this exception. Needless to say, wise attorneys on both sides of the aisle will continue to uncover other legal issues that will undoubtedly make this subsection more difficult to navigate.
Conclusion
This three-part blog article touched on each non-dischargeable student loan debt category in Section 523 (a)(8) of the Bankruptcy Code. Part I of the blog article, which can be accessed here, focused on Section 523 (a)(8)(A)(i) and concluded that the term “funded” takes on many definitions, depending on the type of loan program at play. Part II of the blog article can be accessed here and was focused on Section 523 (a)(8)(A)(ii), which does not provide a safe haven for private lenders. There appears to be a consensus amongst the Circuit Courts that Section 523 (a)(8)(A)(ii) is not focused on loans at all; instead, the sub-section is aimed at non-conditional grants, such as stipends and scholarships. Part III of the article was discussed above and examined the intricate statutory trail created by Section 523 (a)(8)(B) of the Code.
Analyzing all three non-dischargeable exceptions under Section 523 (a)(8), it appears that private student loans are non-dischargeable in two instances. Under Section 523 (a)(8)(A)(i), a private student loan is excepted from discharge if a non-profit entity was part of a loan program that facilitates loans to students in need of financial assistance, and the non-profit entity guaranteed the loan or purchased the loan from the original lender. Section 523 (a)(8)(B) is also a safe haven for private lenders. The threshold issue under Section 523 (a)(8)(B) is that the private student loan must be a “qualified education loan,” which requires the proponent to jump through multiple statutory hurdles.
This is Part III of a three-part blog article. Part I of this three-part blog article can be accessed by clicking on this link. Part II of this blog article can be accessed by clicking on this link.
[i] The IRS website specifically states: Eligible Educational Institutions “include[] most accredited public, non-profit and privately-owned–for-profit postsecondary institutions.”
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