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The Sphinx on Skunk: Justice Thomas Speaks Out(!) on the Inconsistent Enforcement of Federal Cannabis Prohibition

July 21, 2021/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

They say that war makes for strange bedfellows. As it turns out, the war on drugs is no exception. In a recent opinion from the United States Supreme Court, conservative stalwart Justice Clarence Thomas rebuked the federal government’s “half-in, half-out” stance on state-legal cannabis, and strongly implied that said approach was untenable from a federalist perspective. This criticism of federal drug policy from the right—rather than the left—could be another omen that more cultural conservative objections to state-legal cannabis are yielding to federalism and economic concerns and could also signal a future bipartisan action to provide safer harbor to legal cannabis businesses.

In Standing Akimbo, LLC v. United States, 594 U.S. __ (2021), the Supreme Court, on June 28, 2021, denied certiorari to a medical cannabis dispensary in Colorado attempting to prevent disclosure of certain company records sought by the IRS. The dispensary was accused by the IRS of impermissibly using 280E of the Internal Revenue Code to deduct business expenses; as the law stands now, cannabis businesses, because they deal in a federally illegal substance, can only deduct the costs of goods sold.

However, in so doing, Justice Thomas took the opportunity to wag his finger at the inconsistency of federal enforcement of the illegality of cannabis: “[T]he Federal Government’s current approach to marijuana bears little resemblance to the watertight nationwide prohibition that closely divided Court found necessary to justify the Government’s blanket prohibition in Raich.” Id. A known advocate for federalist principles, he went on to note that “[i]f the Government is now content to allow States to act ‘as laboratories’ ‘and try novel social and economic experiments,’. . . then it might no longer have authority to intrude on ‘the States’ core policy powers . . . to define criminal law and to protect the health, safety, and welfare of their citizens.’” Id. (quoting Gonzales v. Raich, 545 U.S. 1, 42 (2005) (O’Connor, J., dissenting)).

Justice Thomas’s references to Raich (and Justice O’Connor’s dissent therein) is unsurprising given his own dissenting opinion in that case, in which he voiced similar concerns of federal commerce clause power overreach. Raich, 545 U.S. at 57 (Thomas, J., dissenting). In Raich, the majority held that the federal government had power under the commerce clause to regulate state-legal intrastate cannabis—that is, cannabis that is grown, distributed, and consumed within a state where it is legal. Id. at 22.

Justice Thomas opined that intrastate regulation in that context went beyond the federal government’s commerce clause powers, in that cultivation and consumption of medical cannabis entirely in California was not “commerce” nor interstate. Id. at 59. Moreover, although the majority substantially relied on Wickard v. Filburn, 317 U.S. 111 (1942) for the proposition that intrastate commerce that has a “substantial effect” on interstate commerce is within Congress’ regulatory power, Justice Thomas agreed with Justice O’Connor’s criticism of the majority’s reliance on Wickard. In Justice O’Connor’s dissent, she noted that, unlike Wickard, where the Court was presented with economic studies documenting the effects of personal intrastate wheat cultivation on the interstate wheat industry at large, there was no actual evidence that the small-scale medical cultivation and consumption by appellants had any “substantial effects” on interstate commerce. Id. at 53-54 (O’Connor, J., dissenting); id. at 67 (Thomas, J., dissenting). For his own part, Thomas criticized the majority’s apparent use of the Necessary and Proper Clause to hold that exercising federal police powers over intrastate legal cannabis cultivation was “necessary” to avoid a “gaping hole” in the Controlled Substances Act, id. at 21, reasoning that there was no evidence before the Court to suggest that failing to regulate intrastate cannabis cultivation and use would result in an inability to control interstate drug trafficking, id. at 63 (Thomas, J., dissenting), a criticism he alluded to in Standing Akimbo. 594 U.S. at __ (“A prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the Federal Government’s piecemeal approach.”).

Indeed, these statements—from an eminent conservative, no less—could be a wake-up call for activist litigation to challenge the ruling in Raich, or for Congress to act to provide some measure of legalization or safe harbor to state-legal cannabis operators. As I have written previously, even if an impact litigant were to challenge Raich on its own rationale—without delving into the more academic discourse of Thomas’s dissent—such a challenge might bear fruit.

In reaching its final holding that Congress had a rational basis for concluding that intrastate cannabis cultivation would have a “substantial effect” on its ability to regulate interstate cannabis commerce, the Court in Raich explicitly premised its decision upon (1) difficulties distinguishing between state-legal cannabis and illegal cannabis grown elsewhere and (2) “concerns about diversion [of state-legal cannabis] into illicit channels.” 545 U.S. at 22. As more and more states legalize cannabis in some fashion—36 states have legalized adult-use cannabis, medical cannabis, or both—both of points one and two become weaker and weaker. That is, as to point one, as legal cannabis packaging becomes more regulated and sophisticated, the visible difference between legal cannabis and illegal cannabis becomes more and more obvious. As to point two, as more and more states legalize, it becomes less and less likely for legal cannabis to be “diverted” into illicit channels. For example, nearly the entire Pacific bloc of states—California, Oregon, Washington, Nevada, Arizona, and Colorado—have legalized medical and adult-use cannabis. Leaving aside state law prohibitions, legal cannabis moved throughout this region is very unlikely to result in “diversion” of legal cannabis “into illicit channels.”

Although whether this shot across the bow of the federal government’s cannabis enforcement regime will result in or motivate any lasting change—either judicially or legislatively—remains to be seen, the cannabis industry will likely view this statement of support from a somewhat unexpected source as a moral victory.

Meet Ajay Gupta – Founder

July 20, 2021/in All Blog Posts/by The Gupta Evans & Ayres Team

All the law updates in the world aren’t going to help you understand who we are and how we practice as well as a conversations with us. WIth life as busy as ever, we thought it would be nice to take a few minutes and introduce ourselves and talk about why we do what we do.

Meet Ajay Gupta.

A Michigan native, Ajay came to San Diego in 2002. He lives in La Jolla with his beautiful wife, two boys, and cat. Ajay spends almost all his free time with his family. They enjoy hiking Torrey Pines, biking in Coronado, and Saturday mornings at the Little Italy Farmer’s Market. His sports of choice are basketball and golf. Ajay can be seen at poker night every third Friday of the month.

Ajay graduated from the University of Michigan in 1997 and the University of San Diego School of Law in 2005. He opened his practice in 2008 and has been involved in real estate law ever since. Ajay’s practice focuses on civil litigation with an emphasis on bankruptcy and real estate matters.

Mr. Gupta has been recognized by SuperLawyers from 2015 through 2018, which is reserved for the top 5% of lawyers in the country. In addition, Mr. Gupta is one of 13 certified bankruptcy specialists in San Diego County and widely regarded as an authority in the area of real estate and corporate law.

Ajay takes a hands-on, holistic approach to working with clients. He enjoys working to find solutions that address not only the financial concerns of his clients but solutions that address the emotional aspects of their case as well.

Beyond the standard CV we asked Ajay a few more… personal questions. Here are his answers:

What do you do when you’re not working?
When I’m not working, I enjoy playing basketball and Poker. I love watching football and movies, as well as meditating.

If you were to look back from the age of 80 and tell yourself anything what would it be?
Get your MBA, not a Law Degree.

What’s one fact about your education or upbringing that few people know?
I’m a redneck at heart. I grew up in rural Michigan and used to snowmobile to my neighbor’s house, go ice fishing /bow hunting, and take my oversized Dodge Ram mud bogging for fun.

What are two things on your bucket list?
1. Take two months off work and go to Katmandu, travel Northern India, possibly Tibet
2. Drive to Alaska and Denali National Park

Keep your eyes on this space for AJAY’s video interviews coming soon.

Famous Bankruptcy Cases

July 13, 2021/in All Blog Posts, Bankruptcy/by The Gupta Evans & Ayres Team

As Bankruptcy LItigation attorneys, we see people from all walks of life whose circumstances have caused them to need bankruptcy protection. We work with companies who are seeking to be made whole in cases where their debtor has declared bankruptcy and we support business owners and individuals whose cases are bankruptcy adjacent, meaning that the filing of Chapters 11 or 7 has tangentially affected the shared financial interests of our clients.

At Gupta Evans and Ayres, we pride ourselves on knowing quite a bit about bankruptcy filings, but we did not know quite how many celebrities have filed for bankruptcy. The one on this list that was most surprising? Ulysses S. Grant, though his bankruptcy filing is not related to his statue being toppled in San Francisco in 2020, it was the result of other bouts of poor judgement on his part.

Here is a list of some of the most surprising celebrities to have filed for bankruptcy throughout modern history (Grant is the outlier).

Cindy Lauper: Before she Wanted to Have Fun, her band went bankrupt. She made a hasty and stable recovery.

T-Pain declared bankruptcy in the 90’s after out-of-control spending. He recently appeared on and won the Masked Singer and his finances seem to be on the mend.

Before LArry King sat in front of the colorful iconic dots and hosted his famous talk show he was accused of stealing $5K from his business partner. The charges didn’t stick but the stigma did and he declared bankruptcy in the late ’70’s.

Burt Reynolds lost a fortune over his career partly due to an expensive divorce and all those toupees. He declared bankruptcy in the 90s but went on to make such cult favorites as Boogie Nights. He was still active in the movie industry until his death.

Nicholas Cage doesn’t just make movies in VEgas, he lives life on the edge. After wild spending and unpaid tax bills Cage declared bankruptcy in the early 200’s. He seems to be managing just fine now with an estimated net worth of over $20 million.

Mike Tyson has made some questionable choices (face tatoos, tigers, ears…) but poor spending choices and a pricey divorce caused the fighter to file for bankruptcy in the early 2000’s. He has since founded a marijuana company in California and seems to be solvent once again.

Looking at the retrospective of celebrities who have weathered bankruptcy may cause those of us touched by Chapter 7 or 11 filings to cringe more than the average person. The truth is, it’s no laughing matter. While bankruptcy filings can be strategic tools to protect assets in dire circumstances, those same filings can reserve funds from those who are owed money. At Gupta Evans and Ayres, we are bankruptcy litigation experts. The intricacies of filings are our forte. If you or someone you trust is impacted by bankruptcy, don’t hesitate to reach out.

Want to see how we work? READ ON…

Chapter 420, Part II: Closing the Book on Cannabis-Adjacent Bankruptcy

July 7, 2021/in All Blog Posts, Bankruptcy, Cannabis, Corporate Litigation/by Jake Ayres

In a previous article, I discussed the potential impacts of a then-forthcoming decision in the case of In re United Cannabis Corporation, which had the potential to widen access to federal bankruptcy relief to cannabis-adjacent hemp businesses.

However, the In re United Cannabis case ended not with a bang, but with a whimper. On January 12, 2021, after approximately eight months of consideration, Bankruptcy Judge Joseph G. Rosania, Jr. of the District of Colorado issued a one-page ruling dismissing[1] the bankruptcy petition “pursuant to 11 U.S.C. § 1112(b) and . . . finding good cause.” In so doing, he snuffed out any hope that the District of Colorado could become a hub for hemp businesses that dabble in cannabis to successfully pursue chapter 11 bankruptcy.

Because the ruling does not provide any substantive reasoning for the decision, industry observers are left to speculate. One can only assume that the court found the evidence offered by the U.S. Trustee—namely, that the debtor was not nearly as removed from the cannabis arena as it purported to be based on the debtor’s website and marketing materials—credible enough to justify dismissal on the grounds that a plan of reorganization could not be untainted by federally illegal cannabis money. In so doing, the court left the fundamental question of how the 2018 Farm Bill’s legalization of hemp affects the availability of bankruptcy to businesses that have toes in both the cannabis and hemp pools. For the time being, the safer route—and the route perhaps favored by conventional wisdom—for businesses is to completely segregate their cannabis and hemp businesses, both on a practical and corporate/legal level.

The Bankruptcy Court for the District of Colorado’s declination to decide the issue raised by Way to Grow only illuminates other quirks in the current state of affairs for bankruptcy in the cannabis context. In particular, the ruling in United Cannabis displays the tension between how different bankruptcy courts have construed section 1112 vis-à-vis section 1129(a)(3).

Section 1129(a)(3) provides that a bankruptcy plan shall only be confirmed where, inter alia, “[t]he plan has been proposed in good faith and not by any means forbidden by law.” On its face, this statute would seem to preclude plans funded by federally illegal cannabis, given that those funds would be derived from a “means forbidden by law.” However, the Ninth Circuit disagreed in Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019). In that case, the Ninth Circuit affirmed the Bankruptcy Court for the Western District of Washington’s confirmation of a chapter 11 plan for reorganization over the U.S. Trustee’s objection that one of the debtors was renting real property to a cannabis growing operation. Id. The Ninth Circuit parsed the language of section 1129(a)(3) quite narrowly, holding that that subsection “directs bankruptcy courts to policy the means of a reorganization plan’s proposal, not its substantive provisions.” Id.at 1033. The Ninth Circuit applied that interpretation to the case at bar, and found that although income funneled into the plan would ultimately be derived from a federally illegal source—the cannabis grower tenant—that had no bearing on whether the plan had been proposed in good faith. See id. at 1035-36. Importantly, the Ninth Circuit refused to rule on the argument that section 1112(b) mandated dismissal of the petition, concluding that “the Trustee waived the argument by failing to renew its motion to dismiss” after the Bankruptcy Court’s initial dismissal of a previous motion to dismiss with leave to renew at the plan confirmation hearing. Id. at 1033-34.

This literal interpretation of section 1129(a)(3) has been explicitly criticized in courts within other circuits. Indeed, the Bankruptcy Court for the Eastern District of Michigan sharply critiqued Garvin in dicta for its de facto affirmation of illegal conduct pursuant to a bankruptcy plan:

This Court does not necessarily agree with the Garvin court’s holding about § 1112(a)(3). And, respectfully, one might reasonably question whether the Garvin court should have refused to decide the § 1112(b) dismissal issue. That refusal, on waiver grounds, arguably is questionable, because it allowed the affirmance, by a federal court, of the confirmation of a Chapter 11 plan under which a debtor would continue to violate federal criminal law under the [Controlled Substances Act].

In re Basrah Custom Design, Inc., 600 B.R. 368, 381 n.38 (Bankr. E.D. Mich. 2019).

Moreover, the District Court of Colorado in In re Way to Grow, the very case that seemingly left the door open for United Cannabis in the first place, also criticized Garvin for unduly focusing on the “means forbidden by law” clause of section 1129(a)(3), rather than the “good faith” portion of the same. 610 B.R. 338.

As a result, there is an embryonic circuit split on the issue of interpreting section 1129(a)(3) as applied to cannabis business petitioners, with the Ninth Circuit in the minority and the Sixth and Tenth Circuits in the presumptive majority.

As fascinating as this may be on an academic level, for businesses in the cannabis industry, this circuit split will likely have little bearing on the ultimate issue of whether businesses that dabble in cannabis can obtain the benefits of federal bankruptcy. Reason being, section 1129(a)(3) is just one ground for dismissal on the basis of illegality. Garvin itself noted in its final paragraphs that there are plenty of other reasons to dismiss cannabis bankruptcies—not the least of which is section 1112(b). Garvin, 922 F.3d at 1036. Indeed, running an illegal business as part of a bankruptcy plan could conceivably run afoul of any number of the listed bases for “cause” under section 1112(b)(4), including but not limited to the “gross mismanagement of the estate” prong name checked by the court in Garvin.

The unceremonious dismissal of the petition in United Cannabis raises more questions than answers. Unless and until cannabis is descheduled, or some other form of federal reform occurs, the Bankruptcy Courts will be left to continue to battle it out over interpretations of section 1129(a)(3), comfortable in the knowledge that section 1112 provides a backstop for dismissing cannabis-funded petitions and plans. However, the issue raised in United Cannabis—whether a company that has cannabis-derived revenue can have a chapter 11 plan approved if the plan doesn’t require that revenue—remains tantalizingly unanswered for now.

[1] Curiously, the court styled the order as one “granting” the U.S. Trustee’s “Motion to Dismiss Chapter 11 Cases pursuant to 11 U.S.C. § 1112(b).” However, the U.S. Trustee never filed a Motion to Dismiss. Rather, the U.S. Trustee filed a response to the court’s own Order to Show Cause why the petition should not be dismissed—although, that response did raise section 1112(b) as a reason for dismissing the case.

Back to the Futile: California Court of Appeal Expands Breadth of “Futility Exception” to Prerequisites to Mandamus Claims in Land Use Cases

June 1, 2021/in All Blog Posts, Corporate Litigation/by Jake Ayres

A recent land use decision of the California Court of Appeal has eased one of the many burdens experienced by developers seeking to challenge a public entity’s permit denial. In an opinion by Judge Tangeman, the Second Appellate District reinforced the strength of the “futility exception” to the legal prerequisites in mandamus actions.

In Felkay v. City of Santa Barbara, 62 Cal. App. 5th 30 (2021), the Court of Appeal analyzed the futility exception and found it applicable under the circumstances to the judicial doctrines of ripeness and administrative exhaustion. The futility exception, generally speaking, is a doctrine that provides that where a decisionmaker has indicated that its mind is made up against the petitioner’s desired course of action, the normal procedural bars, such as administrative exhaustion, do not apply as they otherwise would.

In Felkay, petitioner and plaintiff Thomas Felkay purchased an oceanfront lot in the City of Santa Barbara (the “City”) located on top of a seaside bluff. Felkay wanted to develop a luxurious home on the property and applied for the relevant permits to the City’s planning commission (the “Commission”). Upon review by the Commission, it concluded that the proposed development was impermissible. Namely, because the bluff top’s elevation was deemed to be at 127 feet, the coastal restriction prohibited development at any elevation below that level (i.e. closer to the ocean), and the proposed development would take place below 127 feet, the project could not proceed as proposed. Moreover, the Commission also found that an alternative building site further uphill from the bluff top was untenable for geological reasons. Id. at 34-35.

Felkay then appealed the Commission’s decision to the City Council, while also arguing that the Commission’s decision amounted to a taking. The City upheld the Commission’s decision and found that there were other alternative uses to the property such that the Commission’s decision was not a taking. Id. at 35. Felkay filed a petition for administrative mandamus and complaint for inverse condemnation claims against the City. Id. at 36.

The court split the proceedings in two, starting with the writ proceeding and ending with the trial on the inverse condemnation claims. The court denied the writ, holding that the City’s decision was supported by substantial evidence and that Felkay had not introduced sufficient evidence to justify the City’s application of Public Resources Code section 30010, which authorizes development that would violate a coastal development restriction to avoid unconstitutional takings. As for the trial on the inverse condemnation claims, the court found that there had been a taking and awarded and the jury awarded Felkay $2.4 million in damages for the fair market value of the developed lot, along with a substantial attorney and expert fees. Id. at 36-38.

On appeal, the City challenged the trial court’s ruling on the inverse condemnation claims on three bases: (1) Felkay’s claim was not ripe; (2) Felkay had not exhausted his administrative remedies; and (3) Felkay waived his right to argue the section 30010 claims at trial because he did not raise them during the writ proceeding.

As for items 1 and 2 above, the court held that the futility exception applied to both. The City argued that, at a bare minimum, Felkay was obligated to submit an amended application for development before suing the City. However, according to the court, because the City had “made plain” that there was no way they would approve any development as envisioned because anything below or above the bluff top was unbuildable, Felkay was not obligated to submit an amended application. Id. at 40. As for the judicial exhaustion argument, the court held that because the parties had stipulated to try certain issues in the writ proceeding and reserve other issues for the inverse condemnation trial, the City’s argument failed. Indeed, the parties had agreed to reserve the section 30010 claim for the inverse condemnation trial, and any “failure” to raise that issue during the writ proceedings was by design. Id. at 41-43.

In short, the Felkay decision provides another example of when the futility expression excuses a project developer from having to go back to the drawing board before suing a public entity that denies development permit. That is, if there is “NO POINT [sic] in going back” to the decisionmaker with an amended application because it has “‘made plain’ it [will] not allow any development” on the relevant parcel, the prospective plaintiff’s claim is ripe and the exhaustion requirement is met.

Although the “futility exception” issue was the court’s focus in Felkay, perhaps the more interesting takeaway from it is that the trial court found—and the City apparently did not object to the finding—that Felkay had been deprived of “all economic use of the property” resulting in a “de facto taking,” even though the court acknowledged that the land was still usable for “recreation, parking, [and] views.” Id. at 35, 38. This suggests that “de minimis” economic uses of property do not negate a takings claim.

Similarly, another potential takeaway is that this underscores the lack of a due diligence component in inverse condemnation claims. The origin of the issue here is that Felkay originally thought the bluff top was at 51 feet, which opened up a greater area of his lot for development. Id. at 34. As it turns out, he was mistaken, and the City’s determination of the true bluff top elevation torpedoed his entire plan—although he ended up compensated handsomely for his trouble. This suggests that inverse condemnation claims do not take into account whether or not the plaintiff was mistaken, nor whether plaintiff could have reasonably discovered that mistake had he gotten a second opinion from a different surveyor prior to applying for his permit. Perhaps because of the constitutional nature of inverse condemnation claims, courts have never applied a judicial gloss to inverse condemnation claims to cut off rights to plaintiffs who could have discovered their lots were unbuildable prior to purchase.

At bottom, Felkay shows the risks for municipalities in uncompromising applications of their regulations to developers, and also shows the relatively deferential treatment inverse condemnation plaintiffs receive from courts with regard to the exhaustion requirement. Although any administrative law-flavored claim has hoops to jump through, Felkay has clarified the “futile” scenario where there is one less hoop.

Employer’s Liability for Independent Contractor’s Copyright Infringement

May 25, 2021/in All Blog Posts, Corporate Litigation/by John Ahn

You just hired a young web designer as an independent contractor to revamp your website. After struggling through the creative process, you and your web designer ultimately come to a decision on the final product, and you launch your site. However, a few months later, you receive a letter from the Law Office of Koppi & Wright, PC accusing you of infringing on its client’s intellectual property—specifically pointing to a few graphics and photographs scattered throughout your homepage. Koppi & Wright demands that you remove the graphics and photographs from your website or else it will file a lawsuit against you and your business for copyright infringement.

The main question is—did you do anything wrong? Are you liable if the pictures and graphics are actually protected by copyrights? After all, the web designer you hired placed the questionable graphics and photographs on the website—not you. The simple answer to each of these questions is a resounding “maybe” depending on a few key circumstances, of course.

Copyrights, In General

Copyrights are a type of intellectual property that grants the owner or originator certain exclusive rights including the right to reproduce, copy, distribute, and perform the work created. (17 U.S. Code § 106.) Specifically, copyrights protect original works of authorship including architectural, audiovisual, cartographic, choreographic, dramatic, graphic, literary, musical, pantomimic, pictorial, and sculptural creations. (copyright.gov.)

And to cover our bases, patents protect inventions and discoveries as opposed to works of authorship. (uspto.gov). On the other hand, trademarks generally protect names or logos that are associated with goods and/or services. (Id.).

As a general rule, if you want to use someone else’s property, you should probably ask for permission. The same principle applies for intellectual property, and in this case, copyrights. Once you receive permission from the owner or originator of the content or authored work, you should be able to use the work—such as a song or photograph—in your desired capacity. For instance, if you wanted to use a certain artist’s photograph as a backdrop on your website, you may do so with the permission of said artist. In another example, if you wanted to use the name and likeness of one of Disney’s fictional characters in your own business, you will need to get permission. Conversely, any time you decide to go rogue and use someone else’s authored work without that person’s permission, you are likely infringing on a Copyright.

Without getting too much into detail about fair use and other copyright exceptions (doing so would triple the length of this article), it is important to note that knowing when you are required to ask for permission can be a bit confusing. This is especially true if your “use” of the copyrighted work is more than simply copying or reproducing the work. For example, let’s say you wanted to take inspiration from a copyrighted work to create something of your own. Do you need to ask the author/originator of that copyrighted work to begin creating? The safe (albeit simplified) answer to that is “yes” unless you very clearly fall into an exception such as fair use. Rogers v. Koons is a notable case addressing this very issue. In Rogers, the court found that a sculptor’s faithfully copied sculpture of a copyrighted postcard photograph—which so blatantly copied the creative expression of the postcard photograph—did not fall under any fair use exceptions and therefore, constituted copyright infringement. (Rogers v. Koons (2d Cir. 1992) 960 F.2d 301, 307.) Although a sculptured version of a postcard photograph requires more work and transformation than simply photocopying, a faithful reproduction of an original copyrighted work can constitute copyright infringement.

Vicarious Liability of Copyright Infringement of Independent Contractors

We know that your direct actions can constitute infringement, but what happens when the infringement occurs due to a third party’s actions? For example, what if the third party is the independent contractor you hired to create your website?

In these instances, courts have held that anyone who has the “right and ability to supervise the infringing activity” of an independent contractor will be held vicariously liable for copyright infringement if he/she enjoys a “direct financial benefit from said infringing activity.” (See Rosen v. Martin. Cal. Apr. 19, 2013, No. CV 12-0657 ABC (Ex)) 2013 U.S.Dist.LEXIS 201985, at *12.)

In Rosen v. Martin, the court found the defendant had the ability to supervise the work of his independent contractors when they downloaded and uploaded copyrighted works without the Plaintiff’s permission. (Id.) Even though the defendant directed the independent contractors to not list these works again after the fact, the court still held the defendant vicariously liable for the independent contractors’ infringement. (Id.) In other words, even if your web designer is the one who actually infringed on an existing copyright, you could still be held accountable for the actions of your independent contractor.

The “What Ifs”

What if you completely unaware of the infringement? Could you try to make the argument that as the employer, you did not know your independent contractor would or could be infringing on intellectual property? The court in Hitek Software LLC echoed the ruling in Rosen but added that an employer who had the right to supervise the infringing activity would still be vicariously liable “even if the defendant initially lacks knowledge of the infringement.” (See Hitek Software LLC v. Timios, Inc., (C.D.Cal. June 18, 2012, No. CV 12-709 CAS (AJWx)) 2012 U.S.Dist.LEXIS 86560, at *11.) In Hitek Software LLC, the alleged infringement occurred when Timios, Inc. (the “Defendant”) employed an independent contractor computer specialist who installed software for the Defendant using an illegally generated product key and spoofing the software activation process. (Id. at 3.) However, the court determined that the Defendants had the right and ability to “oversee, govern, control, and direct” the independent contractor at all relevant times and was therefore liable for the independent contractor’s actions. (Id. at 13.) The idea here is that if you had the right and ability to supervise your independent contractor during employment, you should have known better and are not excused by your ignorance.

What if the independent contractor was simply negligent? Would employers be absolved of liability? As a general rule, employers will not be held vicariously liable for the negligent acts of their independent contractors. (See Secci v. United Independant Taxi Drivers, Inc. (2017) 8 Cal.App.5th 846, 859 [214 Cal.Rptr.3d 379].) This rule has a few caveats and exceptions like the peculiar risk doctrine, which states an employer can be held liable for an independent contractor’s negligence if the contractor was hired to perform work that is inherently dangerous, and the contractor’s negligence causes injury to others. (Privette v. Superior Court (1993) 5 Cal.4th 689, 691 [21 Cal.Rptr.2d 72, 854 P.2d 721].) However, assuming you haven’t hired an independent contractor for work that is inherently dangerous (and without getting into whether the court’s current view will continue to prevail) courts still generally view copyright infringement as a strict liability tort. (See Educational Testing Serv. v. Simon (C.D.Cal. 1999) 95 F.Supp.2d 1081, 1087.) Plaintiffs can merely show the defendant used their authored work without permission (e.g., copied, distributed, or performed) in order to prove a prima facie case of copyright infringement. This essentially means that you will likely be unable to use your independent contractor’s negligence as a defense to vicarious liability for your independent contractor’s infringement.

The takeaway here is simple: ask for permission. When you are dealing with situations where you encounter authored work that catches your eye, and you plan on using the copyrighted material in some shape or form, make sure to ask for the owner’s permission. Not all owners or originators of copyrights will ask for money. In fact, many just want credit and recognition for their hard work. If you don’t have the budget (or maybe you just don’t like talking to people), find something that is public domain including free stock images and try to make it work (because you don’t really have that many other legal options). As an employer, make sure your independent contractor is taking the same precautions to avoid letters from firms like Koppi & Wright, PC to save yourself the headache.

Checking In On The Status of Residential and Commercial Leases in California

May 4, 2021/in All Blog Posts, Corporate Litigation, Real Estate/by Chris Evans

Vaccines are being administered, indoor and outdoor activities are beginning to resume throughout California and it would appear that life is starting to get back to normal. Well, not quite. Before you get ahead of yourself, a litany of COVID-related protections remain in place, namely in the landlord-tenant arena. The below is a quick refresher on the state of landlord-tenant protections in California, all of which must be considered before you seek to return to business (and evictions) as usual.

SB 91 – COVID Eviction Protections Extended Through June 2021

Our last landlord-tenant summary focused primarily on California’s then recently passed Assembly Bill 3088, adopted at the end of August 2020 and formally known as the Tenant, Homeowner, and Small Landlord Relief and Stabilization Act of 2020 (“AB 3088”). In short, AB 3088 was designed to protect residential tenants—not commercial tenants—who faced, and continue to face, economic hardship due to COVID-19. With limited exceptions, the protections of AB 3088 apply to any tenant who is unable to pay all or part of their rent due to a COVID-19-related financial impact, so long as they provide an economic hardship declaration to the landlord within a specific period of time. A more detailed breakdown of AB 3088 can be found at our previous post here.

Currently, the protections of AB 3088 remain largely in place. Originally slated to protect residential tenants only through January 2021, the AB 3088 safeguards were extended by a second piece of legislation signed by Governor Newsom on January 29, 2021, known as Senate Bill (“SB 91”). The main thrust of SB 91 was to preserve the vast protections afforded by AB 3088 and extend its provisions another six months through June 2021. As a result of SB 91, no residential tenant can be evicted before June 30, 2021, if the basis of the eviction is rent that has been unpaid due to a COVID-19-related hardship and the tenant attests such fact under penalty of perjury. Additionally, if the tenant pays 25% of the rent owed from September 2020 through June 30, 2021, then the tenant cannot be evicted after the June 30, 2021 expiration. Landlords will be able to recoup the remaining rent balance owed after June 30, 2021, via a reconfigured small claims court. Alternatively, SB 91 also instituted a rental assistance program whereby residential landlords can apply to recover up to 80% of the unpaid rental balance through federal funds.

Also remaining in place and a key point to keep top of mind, among other things, is the expansion of the “just cause” eviction requirement. In essence, unless a tenant fails to attest to his or her COVID-related financial hardship, a residential tenant may only be evicted for either an “at-fault just cause” or “no-fault just cause.” In essence, unless a tenant fails to attest to his or her COVID-related financial hardship, a residential tenant may only be evicted for either an “at-fault just cause” or “no-fault just cause.” In other words, whereas “just cause” was previously only required if certain length of possession thresholds were met (see Civil Code section 1946.2), AB 3088 extended just cause to all tenancies and this protection has been extended via SB 91.

The foregoing is a relatively general and tremendously compressed explanation of SB 91 (and AB 3088), and a thorough review of the Bill’s intricacies is highly recommended. To assist in such review, our Firm has put together this simplified and updated version of our prior flowchart.

Again, What About Commercial Tenancies?

Like AB 3088 that came before it, SB 91 did not extend eviction protections to commercial tenants. As a result, commercial landlords and tenants should continue to look for guidance on whether a commercial eviction can proceed by turning their attention to the respective eviction moratoriums in place, if any, at the city and county levels.

The City of San Diego (the “City”), for instance, currently has its own eviction moratorium in place that sets forth the specific rules and regulations that would either permit or prohibit a commercial landlord from pursuing the eviction of a commercial tenant. The City of San Diego’s commercial eviction moratorium was re-adopted[1] on January 26, 2021 and will remain in place until June 30, 2021. Under the City’s commercial eviction moratorium, a commercial landlord cannot endeavor to evict (e.g. serving 3-day notices, filing unlawful detainer) a commercial tenant for nonpayment of rent if the tenant gives the landlord written notice of its inability to pay rent on or within seven days after the rent payment was due. The tenant’s notice must specify that the inability to pay is due to financial impacts related to COVID-19. The tenant will only be required to provide supporting documentation if the landlord asks for it within seven days of the tenant’s notice. If notice is sufficiently given by the tenant, the commercial tenant will have six months (or until December 30, 2021) to pay the unpaid rental balance due.

Our Firm has also put together a summary flowchart of the City of San Diego’s commercial eviction moratorium to help commercial landlords and tenants through avoid likely pitfalls.

Whereas the above only pertain specifically to the City of San Diego, if a commercial eviction moratorium is in place at your city or county levels, such moratoriums typically apply exclusively to the non-payment of rent scenario; but, landlords and tenants should carefully review each particular moratorium for the specific provisions, prerequisites and/or deadlines included in their respective moratorium, if any. As of the date of this posting, eviction moratoriums are currently in place in Southern California in, among other places, Carlsbad, Los Angeles County, and San Bernardino County. Notably, San Diego County does not have an overarching eviction moratorium in place; but, rather, such moratoriums, if any, are unique to the specific cities within the County.

Conclusion

As we near the end of the COVID-19 pandemic and begin to get back to business as usual, it is important to be cognizant of the fact that many COVID-related legislative actions and changes, particularly in the landlord-tenant space, will likely remain in place for months, if not years, to come. The landscape will continue to shift, and landlords and tenants should continue to look for the most recent updates with respect to how best to proceed, or not proceed, in the context of evictions.

The materials available at this web site are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this web site or any of the e-mail links contained within the site do not create an attorney-client relationship. The opinions expressed at or through this site are the opinions of the individual author and may not reflect the opinions of the firm or any individual attorney.

[1] Oddly, the City of San Diego’s prior commercial eviction moratorium expired on September 30, 2020, and many commercial evictions were able to move forward given the gap in protection between October 1, 2021 through January 25, 2021.

Bid Protests and Damages Availability

February 26, 2021/in All Blog Posts, Corporate Litigation/by Jake Ayres

You’re a seasoned litigator and an aggrieved, hardworking contractor comes into your office (or your Zoom room). His recent proposal to the City, which was prepared with painstaking detail and offered the lowest bearable price, was rejected—unfairly, the contractor says. Instead, the City awarded the contract to the contractor’s bitter rival, Dewey/Cheatham, who appears to have a cozy relationship with the City manager. The contractor got second place.

After poring through the evaluation, it’s clear to you that the award process was far from fair, if not downright biased toward Dewey/Cheatem. Your potential client is incensed—the contractor wants to file a lawsuit to give those so-and-sos down at City hall a piece of his mind—and to recover the profits he anticipated receiving under the contract. He asks you: can he recover lost profits damages in bid protest litigation?

You respond in typical, equivocal fashion: probably not. But also maybe.

A disappointed bidder who responded to either a request for proposals or an invitation for bids is not in a contractual relationship with the government entity requesting bids or proposals, which rules that claim out as a basis for recovering lost profit damages. Moreover, because bid documents always allow for the government entity to reject all bids, tort claims, such as fraud, are also ruled out. The case law in California has recognized this quirk, instead sanctioning claims by disappointed bidders on promissory estoppel theories—but only allowing damages for the costs of preparing the bid or proposal. See Kaijima/Ray Wilson v. Los Angeles County Metro. Trans. Auth., 23 Cal. 4th 305, 314 (2000) (“Because the MTA was authorized to reject all bids, Kajima did not know at this point whether the contract would ever be awarded. Nor, because of the secrecy of the bidding process, did Kajima know whether it was indeed the lowest responsible bidder. Therefore . . . bid preparation costs, not lost profits, were the only costs reasonably incurred.”); Eel River Disposal & Resource Recovery, Inc. v. Cnty. of Humboldt, 221 Cal. App. 4th 209, 240 n.12 (2013) (“[A] bidder deprived of a public contract, by the wrongful misaward of that contract, has neither a tort nor a breach of contract action against the public agency.”).

Although Kajima and its progeny have spoken fairly authoritatively on this issue, there remains a glimmer of hope for disappointed bidders that is yet to be conclusively addressed in California courts: whether the presence of bad faith on the part of the government entity entitles a disappointed bidder to recover lost profits damages. The court in Kajima held that lost profit damages were not allowed in the case at bar, noting that it was a “distinctly minority position” to allow lost profits as damages, and that the courts that had done so awarded those damages where bad faith was shown on the part of the government entity. Kajima, 23 Cal.4th at 320. The daylight in Kajima is that while the court in that case said that lost profits were not available to the plaintiff (who had not shown or alleged bad faith), it did not affirmatively say that lost profits damages would not be reachable if bad faith had been shown by the plaintiff. See id. In other words, Kajima was taking the broader position that, generally speaking, lost profits damages are not available to a disappointed bidder under a promissory estoppel theory. It did not speak to the more specific issue of whether lost profits damages are available when bad faith can be demonstrated.

Nonetheless, while the California Supreme Court did not foreclose this possibility completely, the branding of that strand of persuasive authority as “a distinctly minority position” would seem not to bode well for disappointed bidders bringing those arguments in the future. However, the case can be made that although the court in Kajima pointed out that the policy of competitive bidding statutes is to protect the public rather than the expectations of a disappointed bidder, awarding damages to a disappointed bidder who is a victim of bad faith actions by a government entity, which in turn damages the public by potentially awarding the public contract to a more expensive or less qualified contractor, could serve those same public policies by deterring government chicanery and cronyism. See id. at 318-20.

The availability of lost profits damages for disappointed bidders will likely remain a desolate frontier until an optimistic litigant tries to wedge itself into the crevice left by Kajima’s dicta regarding bad faith. In the meantime, disappointed bidders will have to content themselves with bid preparation costs as their only remuneration for unjustly unsuccessful bids.

MORE Legislation, MORE Problems: The MORE Act to Legalize Cannabis Passes the House

December 17, 2020/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

On December 4, 2020,¹ the United States House of Representatives made history and voted to federally legalize cannabis for the first time by voting to pass the Marijuana Opportunity Reinvestment and Expungement Act (the “MORE Act”). Although the MORE Act still has to pass the historically cannabis-unfriendly United States Senate, the House’s quick action to pass a sweeping legalization bill in a time of presidential transition could signal greater legislative efforts to resolve the federal-state tension over state-legal cannabis.

The key provision of the MORE Act would be to federally deschedule cannabis and thereby remove it from the purview of the Controlled Substances Act. The MORE Act also would enact a 5% federal tax—which would step up by a point each year after the first two years after enactment up to 8%—on cannabis products and earmark those tax revenues to fund various social justice measures via a trust fund (the “Opportunity Trust Fund”). The Opportunity Trust Fund’s money would help fund the Community Reinvestment Grant Program (the “CRGP”), also established by the statute. The CRGP, administered by the newly created Cannabis Justice Office, would be responsible for “provid[ing] eligible entities with funds to administer services for individuals adversely impacted by the War on Drugs, including (1) job training; (2) reentry services; (3) legal aid for civil and criminal cases, including expungement of cannabis convictions; (4) literacy programs; (5) youth recreation or mentoring programs; and (6) health education programs.”

The MORE Act also has several other social justice measures embedded within it. First, it prohibits the denial of any “Federal public benefit”—e.g., welfare benefits, etc.—on the basis of any cannabis-related conduct. Second, the MORE Act would also explicitly authorize SBA loans to legal cannabis businesses. Third, and perhaps most potently, the MORE Act would provide for an automatic expungement process for nonviolent cannabis convictions, where each Federal district would initiate the process without any affirmative steps by the convicted person.

Importantly, despite the proposed sweeping federal changes, the MORE Act would preserve the current federalist contours—that is, individual states can still decide on whether to legalize or prohibit cannabis.

Although the House’s passage of the MORE Act is a watershed moment for cannabis in the United States, it is difficult for the industry to maintain too much excitement given the current United State Senate’s propensity for killing bills, or at least allowing them to die in that chamber. Even putting aside the sweeping legalization measures, the social justice strands of the MORE Act may be the dealbreakers for Congressional republicans, some of whom have already said as much publicly. Of course, if both Georgia Senate seats flip to democrats in the January runoff elections, the 50/50 split in the Senate, then the bill is teed up to have Vice President (and MORE Act Senate sponsor) Harris pushing the bill over the hump.

If that Senate scenario does not come to pass, the likely outcome seems to be that the extremity of the MORE Act may make more incremental cannabis legalization—like the STATES Act, which would federally deschedule cannabis without any other attendant social justice measures—more appealing to a recalcitrant Senate. Even more likely may be the SAFE Banking Act, which would not federally deschedule cannabis, but would provide safe harbor to the financial industry (among other service providers) who service the cannabis industry. Of course, if the MORE Act were to be enacted, it would presumably eliminate the financial industry’s objections to banking for and lending to state-legal cannabis businesses.

In the meantime, cannabis industry participants and onlookers will eagerly watch how this bill fares as the canary in the Senatorial coal mine.

¹ Appropriately enough, the date of the House’s vote was Jay Z’s birthday. However, Jay himself did not identify as a heavy cannabis user, preferring to consume “once in a blue when there’s nothing to do/And the tension gets too thick for [his] sober mind to cut through.” That being said, Jay is ostensibly pro-legalization, having recently introduced his own brand of cannabis and cannabis accessories. Chris Gardner, Jay-Z Debuts Product Line for Cannabis Brand Monogram, The Hollywood Reporter (Dec. 10, 2020), available at https://www.hollywoodreporter.com/rambling-reporter/jay-z-debuts-product-line-for-cannabis-brand-monogram

Contracting Around the Discovery Rule? Don’t be SOL

December 17, 2020/in All Blog Posts, Corporate Litigation/by Dylan Contreras

In legal practice, all lawyers stress about blowing deadlines. Perhaps the most popular deadline that keeps lawyers up at night is the statute of limitations. The statute of limitations is a legal principle that requires parties to file their legal claims within a specific time. An exception to the statute of limitations is the discovery rule. The discovery rule provides that the statute of limitations for a legal claim does not begin to accrue (or start) until the injured party either (1) discovers their injury or (2) should have discovered their injury through reasonable diligence. In short, the discovery rule is an effective counter to the statute of limitations defense.

Often, attorneys insert specific clauses into a contract that shortens the statute of limitations otherwise provided by law. It is an effective tactic because it further restricts the amount of time the potentially injured party can bring a claim related to that contract. As further discussed below, parties are permitted to shorten the limitations period through a contract, albeit certain requirements must be met. However, what is often overlooked is the issue of how these contractual provisions impact California’s discovery rule. In other words, does including a contractual provision that shortens the statute of limitations eliminate the application of the discovery rule?

This blog article explores the case law on this distinct issue and provides a brief synopsis on the statute of limitations, the delayed discovery rule, and what requirements must be met for a court to uphold a shortened statute of limitations clause in a contract.

The Statute of Limitations

The statute of limitations operates to limit the amount of time an injured party can bring their legal claim in court. An essential point that is regularly overlooked by litigators, law students, and laypersons is that the statute of limitations begins to accrue (or starts running) from the date all elements of the claim are satisfied. (See Grisham v. Philip Morris U.S.A., Inc. (2007) 40 Cal.4th 623, 634; Civ. Proc. § 312.) For most legal claims sounding in tort or contract, the statute of limitations accrues from the date the party suffers its injury, whether it be physical or monetary. (See Naftzger v. American Numismatic Society (1996) 42 Cal.App.4th 421, 428.)

California’s Discovery Rule

The discovery rule modifies the rule that the statute of limitations accrues on the date of injury. In essence, the discovery rule postpones the accrual of the statute of limitations until the plaintiff actually discovers their injury or the cause of their injury, or should have discovered their injury, had they exercised reasonable diligence. (See April Enterprises, Inc. v. KTTV (1983) 147 Cal.App.3d 805, 832.) The discovery rule operates as an equity-based exception as it protects parties who are ‘ignorant’ of their cause of action through no fault of their own and allows these parties to pursue their claims in court. (Id.) To assert the discovery rule, the plaintiff must show: “(1) the time and manner of discovery and (2) the inability to have made earlier discovery despite reasonable diligence.” (Fox v. Ethicon Endo-Surgery, Inc. (2005) 35 Cal.4th 797, 808.)

The discovery rule frequently applies to cases in which a fiduciary relationship exists between the parties and/or it is difficult to detect the breach, such as Fox v. Ethicon Endo-Surgery, Inc.

In Fox, the plaintiff underwent gastric bypass surgery, but suffered complications and required further hospitalization after the surgery. Plaintiff commenced a medical malpractice suit against the performing doctor and the hospital. During the performing doctor’s deposition, it was revealed that the stapler the doctor used to seal the plaintiff’s incisions might have caused the plaintiff’s injuries. Thereafter, the plaintiff filed an amended complaint asserting a product liability action against the manufacturer of the stapler. However, the amended complaint was challenged by the manufacturer because the statute of limitations for a product liability action was one year from the injury date, and the plaintiff filed the amended complaint two years after suffering the injury.

The court found that the plaintiff timely filed her amended complaint asserting the product liability cause of action because, prior to the doctor’s deposition, the plaintiff had no reason to suspect the stapler was the cause of her injuries. The performing doctor’s reports did not mention the stapler malfunction or misfired. During post-surgical care, the performing doctor never stated that the stapler may have caused the plaintiff’s injuries or had caused similar injuries to other patients in the past. Additionally, the doctor’s deposition was taken only a short time after the complaint was filed, which illustrates that the plaintiff was diligently investigating the causes of her injuries. With these facts in mind, the court found that, under the discovery rule, there was no cognizable reason for the plaintiff to suspect the stapler was the ultimate cause of her injury when she filed her first complaint. For these reasons, the court held the statute of limitations for the products liability action began to accrue on the doctor’s deposition date, and the plaintiff timely filed her amended complaint.

The Fox case demonstrates when it is difficult for the plaintiff to detect the cause of the injury. In these rare situations, the plaintiff has suffered an injury but cannot determine the ultimate cause of the injury. As illustrated above, if the plaintiff was diligent in their investigation, the court will likely apply the discovery rule. The next phase of this article discusses the requirements that must be met for a court to uphold a contractual clause that shortens the statute of limitations.

Shortening the Statute of Limitations Through Contract

Through contract negotiations, attorneys strive to limit their client’s potential liability, among other things. An easy way to achieve this goal is to insert a provision in the contract that shortens the statute of limitations provided by statute. This tactic further restricts the amount of time the potentially injured party can bring a legal claim related to the contract. California courts have upheld this practice by hanging their hat on freedom of contract principles, holding that contractual “parties [have] substantial freedom to modify the length of the statute of limitations.” (Hambrecht & Quist Venture Partners v. American Medical Internat., Inc. (1995) 38 Cal.App.4th 1532, 1548.) The only caveat to this broad rule is that the limitation must be ‘reasonable.’ (See Moreno v. Sanchez (2003) 106 Cal.App.4th 1415, 1430.) A provision shortening the statute of limitations is reasonable “if it provides sufficient time to effectively pursue a judicial remedy.” (Id.)

The common theme in California is that the shortened limitations period is reasonable if the legal claim is obvious to the plaintiff. In other words, the plaintiff learns of their legal claim immediately after the wrongful event occurred.

For instance, in Capehart v. Heady (1962) 206 Cal.App.2d 386, a lease agreement shortened the statute of limitations for a breach of contract claim from four years to three months. The plaintiff sued for breach of written lease seven months after the alleged breach, which was then challenged by the landlord as being untimely. The plaintiff argued that the costs he incurred in relocating his business prevented him from bringing this lawsuit within the shortened limitation period. The court sided with the landlord, holding that such costs were natural and expected business expenses, and the tenant should have considered these potential expenses when negotiating the lease and agreeing to the shortened limitation period.

Similarly, in Tebbets v. Fidelity and Casualty Co. (1909) 155 Cal. 137, the life insurance policy stipulated that any action to recover under the policy had to be brought within six months from the date of death. The aggrieved party did not file the claim until after the limitation period expired. The court found that the shortened limitation period was reasonable because, akin to Capehart, the triggering event was evident because it was the death date, and plaintiffs should have asserted their claim within the limitation period provided in the policy.

The underlying denominator in these cases is that the breach was straight-forward and readily apparent. The breach was not hard to detect and was not done in secret. Instead, the breach had a ‘triggering event,’ which helped the court find the limitations period ‘reasonable.’ This leads to the discussion of the discovery rule and whether it is effectively terminated in contracts where the limitations period is shortened.

The Discovery Rule & Contracts That Limit the Statute of Limitations

The discovery rule and contracts that limit the statute of limitations are in direct competition with each other. The discovery rule allows parties to pursue their legal claims after the statute of limitations would have otherwise expired. On the other hand, parties that mutually agree to a shortened limitation period know precisely when they must bring their legal claims related to that contract. The holdings in Moreno and Brisbane Lodging, L.P. are perhaps the two leading cases that split this hair on when the discovery rule applies to cases in which the parties have mutually agreed to a shortened limitation period.

In Moreno v. Sanchez (2003) 106 Cal.App.4th 1415, the plaintiff home-buyers sued the defendant home inspector after discovering the inspector did not disclose defects in the property. The contract between the plaintiffs and the inspector limited the statute of limitations to one year from the inspection date. The plaintiffs filed suit against the inspector approximately 14 months after the inspector completed his inspection. The issue on appeal was whether the contract eliminated the discovery rule.

In a 2-1 decision, the court held that eliminating the discovery rule in contracts entered into between laypersons and professionals in which the contract shortened the statute of limitations period violated California’s public policy. In reaching this broad conclusion, the court emphasized that the discovery rule is founded on crucial public policy considerations and is appropriate in instances where a fiduciary relationship exists. (Id. at 1429.) As touched on above, the court reasoned that in the context of fiduciary relationships, the fiduciary’s breach of the agreement and/or the injury caused is difficult to discover.

Armed with this principle, the court held that a fiduciary relationship existed between the plaintiff and the inspector. The inspector, albeit not the ordinary professional, was a tradesman and possessed specialized skills and knowledge to analyze a residence’s structural and component parts. Furthermore, the plaintiffs trusted the inspector to disclose any property defects, so the plaintiffs could decide to purchase the property. For these reasons, the court concluded that the discovery rule equally applied to home inspectors as it did to other professionals, such as doctors, lawyers, and engineers.

The court then concluded that the discovery rule could not be terminated through a contractual provision that shortened the limitations period. Central to the court’s holding was that the discovery rule was a judicially created exception to the statute of limitations enacted by the Legislature. And if the laws enacted by our Legislature had to yield to the judicially made discovery rule, so too did contractual clauses that provided a shortened statute of limitations. Moreover, the court held that the cases that upheld contractually created limitation periods were cases in which the breach or injury was readily apparent to the plaintiff. Those cases, such as the ones touched on above—Tebbets and Capehart—were instances in which the plaintiff knew of their injury exactly when it occurred, and no fiduciary relationship existed between the parties. The court noted that these cases were strikingly different from the one at hand wherein the plaintiffs did not learn of the inspector’s breach until well after his inadequate inspection of the property. For these reasons, the court concluded that the discovery rule applied to cases in which there existed a fiduciary relationship between the parties, regardless of whether the contract stipulated for a shorter limitations period. [1]

Moreno is the first case to decide that shorter limitations periods in contracts do not abrogate the discovery rule in the context of a fiduciary relationship between the parties. However, in Brisbane Lodging, L.P. v. Webcor Builders, Inc. (2013) 216 Cal.App.4th 1249, the court distinguished Moreno and ruled that when there are sophisticated parties, who possess equal bargaining power, the shorter limitation period terminates the discovery rule.

In Brisbane, the developer-plaintiff entered into a contract with the builder-defendant to construct a hotel in San Francisco, California. Through their lawyers, agents, and other representatives, the parties engaged in extensive contract negotiations, evidenced by the numerous revisions made to the contract at issue. As part of the negotiations, the parties mutually agreed that the statute of limitations for any claim related to the project’s construction began to accrue upon completion of the project. The project was completed in July 2000, and the statute of limitations for breach of written contract was (and still is) four years, which meant any claim related to the project had to be filed by or before July 2004. After discovering multiple defects with the project, the plaintiff filed suit in 2008. The plaintiff argued that the contract eliminated the discovery rule and that such provision violated California’s public policy, as articulated in Moreno.

The court disagreed and held that the discovery rule did not apply to the contract at issue. Central to the court’s holding was the sophistication of the parties. Different from Moreno, the parties were professionals and were represented by lawyers and agents who exchanged multiple iterations of the contract and understood the potential consequences of the contractual provisions they agreed to. Additionally, in Moreno, a fiduciary relationship existed between the parties, which was vital to that court holding that the contractual provision did not eliminate the discovery rule. In this case, no fiduciary relationship existed between the parties, and the parties negotiated the contract at arm’s length and on equal footing. [2]

Together, the holdings in Moreno and Brisbane teach us that the discovery rule will likely continue in full force when there is a fiduciary relationship between the parties, regardless of whether the contract stipulates for a shorter limitations period. On the other hand, when the parties are sophisticated and bargain on equal footing, a contractual provision that shortens the limitations period terminates the discovery rule, per the ruling in Brisbane.

In closing, the distinction between Moreno and Brisbane is essential for laypeople and attorneys to understand when they are faced with a contract that shortens the statute of limitation ns period. For attorneys especially, they must be careful not to shorten the limitations period to an extent that it harms their client down the road.

The materials available at this website are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this web site or any of the e-mail links contained within the site do not create an attorney-client relationship. The opinions expressed at or through this site are the opinions of the individual author and may not reflect the opinions of the firm or any individual attorney.

[1] Reaffirmed in William L. Lyon & Associates, Inc. v. Superior Court (2012) 204 Cal.App.4th 1294, 1310 (finding that the delayed discovery rule applied to a broker-buyer contract that limited the statute of limitations to two years and in which the broker was a dual agent and helped the sellers conceal defects in the property sold to plaintiff-buyers).

[2] The holding in Brisbane was affirmed in Wind Dancer Production Group v. Walt Disney Pictures (2017) 10 Cal.App.5th 56, 73 (holding that the contractually agreed 24 months statute of limitations was not inherently unreasonable because the contracting parties negotiated the agreement with equal bargaining power as they were represented by attorneys and other professionals).