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ARTIFICIAL INTELLIGENCE: ABA Guidance on AI Use for Lawyers

ccrockett@nlrg.com (Cassidy Crockett-Verba) — Thu, 27 Feb 2025 19:22:29 GMT

Lawletter Vol. 49. No. 4

ARTIFICIAL INTELLIGENCE: ABA Guidance on AI Use for Lawyers

The American Bar Association (ABA) has recently released Formal Opinion 512 addressing the increased use of Artificial Intelligence (“AI”) programs, specifically Generative AI or “GAI” in the legal profession.[1] A GAI tool that generates text is a “prediction tool[] that generate[s] a statistically probable output.”[2] The Opinion focuses on five major areas—competency, confidentiality, communication, supervisory responsibilities, and fee schedules, highlighting what lawyers can do to protect themselves and their clients.

Competence

Just as with the regular practice of law, there is no need to be an expert in AI to be competent in the meaning of Model Rule 1.1. However, lawyers do need to have an understanding of the capabilities and limitations of GAI, drawing on the guidance of others as needed. GAI lacks the ability to reason and is subject to mistakes. GAI tools can assist a lawyer in laying the groundwork for a case but the attorney is always fully responsible for all work done for a client. Especially while GAI is in its infancy, lawyers who use GAI tools must review the output as AI cannot replace the judgment and experience of a trained attorney.

Confidentiality

In all cases, lawyers must keep Model Rule 1.6, regarding confidentiality, in mind. GAI “learns” by culling data from the internet or proprietary data sources and those that are considered “self-learning” in that they learn from themselves as more data is incorporated. By their nature, “self-learning” tools risk disclosing confidential information to any later users. This potentially risks disclosure to those in the firm who may be prohibited from working on the case or to other unauthorized users. To properly understand the risks and who may have access to any information inputs, the attorney should read all terms of use, privacy policies, or other terms related to the tool that they will be using and consult with IT experts when necessary.

The ABA states that attorneys using GAI must assess the likelihood of disclosure and unauthorized access, the sensitivity of information, the difficulty of implementing safeguards, and whether safeguards will negatively impact the representation of a client. The client’s informed consent must be obtained prior to any information related to representation being input into a GAI tool—which requires more than just boilerplate language.[3] The attorney must provide the best judgment about why the GAI tool is being used, and the extent of and specific information about the risks and benefits.

Communication

Lawyers should be up-front with their clients about the use of AI without being prompted but disclosure is not always necessary. When determining if disclosure is necessary, attorneys should consider the importance of the tool to the task, the significance of the task to representation, how the tool will process the information, and whether a client’s knowledge that the attorney used GAI would affect the client’s confidence in the attorney’s work. Disclosure is not required when information relating to representation will not be shared with the GAI tool, such as using a tool for idea generation. If information relevant to the representation is input into a GAI tool or if a client asks about your use of AI, or if the use of an AI tool is relevant to the basis for a fee, you must disclose. Consultation with a client is always necessary where a GAI tool’s output will influence a significant choice—such as jury selection.

Attorneys also have a duty to the court and should check local rules to be sure they do not need to specifically disclose the use of AI tools. So far, courts have seen lawyers submit GAI-assisted products with citations to nonexistent opinions, inaccurate analysis of law, and misleading arguments.[4] Lawyers are always responsible for their submissions and must ensure that all citations, arguments, and information are accurate.

Supervisory Responsibilities

Supervising attorneys have a duty to ensure that all subordinate attorneys and non-attorneys are trained on the risks and benefits of GAI tools relevant to their work. This need not be a multiday affair to train every employee on every GAI tool, rather the training could focus on the basics of GAI technology, the limitations, ethical issues, and best practices for data security. We should analogize to earlier opinions—especially those regarding cloud computing—in determining best practices while GAI is still in its infancy. Supervisors should strive to ensure that the tools are configured to preserve security and confidentiality, that the lawyer will be notified of any breaches, and that the obligation is enforceable. The tools should be investigated for reliability, security, and policies and whether the tool retains information after services are discontinued.

Fees

Finally, the ABA advised attorneys that long-standing rules still apply—you can only bill as many hours as you have actually worked. If it takes you 15 minutes to input information and prompts into a GAI tool and complete the task, but it would usually take you three hours to complete the task on your own, you can only bill 15 minutes. Lawyers cannot charge a client for the time spent learning how to use these tools if they are incorporated into the practice. However, if a client explicitly requests that a specific GAI be used and the attorney is not yet knowledgeable, the time spent learning to use that tool may be billed.

The cost of GAI tools should generally be treated as overhead costs and subsumed into the general costs, just as you would for the cost of office space or printer ink. However, if using a third-party GAI tool that bills on a per-use basis, the actual cost may be passed on to the client. As an example, if you have paid for a GAI tool embedded in your word processing software that checks grammar, spelling, and tone of your work products, that is an overhead cost. If you are using a specialized legal AI company that bills you $100 per prompt or work product output, you may pass that cost along as you would any out-of-pocket expense.

Conclusion

While GAI is in its infancy, lawyers have already started to incorporate it into their practice with varying results. The current best practices are to review any and all work products generated by GAI tools, stay up-to-date on GAI tools and their benefits and limitations, keep all client information confidential (even if it means not using GAI until you are sure information won’t be shared), communicate your use of GAI, and bill only for the actual time you have worked. The current NLRG policy is to refrain from the use of any GAI tools; however, we are always reviewing new information and will continue to evaluate the reliability and uses of GAI tools in the future.

[1] ABA Standing Comm. on Ethics & Pro. Resp., Formal Op. 512 (2024).

[2] Id. at 1.

[3] Id. at 7.

[4] See D.C. Bar Op. 388 (2024).

CORPORATIONS: When Traditional Standing Rules Do Not Apply to Shareholder Derivative ActionsYour Blog Post Title Here...

cjhicks@nlrg.com (Charlene J. Hicks) — Fri, 15 Dec 2023 20:00:28 GMT

CORPORATIONS: When Traditional Standing Rules Do Not Apply to Shareholder Derivative Actions

Charlene J. Hicks—Senior Attorney

Standing, or the right to pursue a judicial action, is often viewed in black-and-white terms, that is, either a plaintiff does or does not have standing. In some situations, however, the plaintiff’s status cannot be so easily quantified. One notable grey area is found in shareholder derivative litigation.

Generally speaking, in order to maintain a shareholder derivative suit, an individual plaintiff must own stock in the corporation at the time the controlling shareholders or directors committed the wrongful act against the corporation that is the subject of the action, and the plaintiff must retain ownership of that stock for the entire duration of the lawsuit. If these stock ownership requirements are not satisfied throughout the entire course of litigation, the plaintiff lacks standing to maintain the derivative action on behalf of the corporation. This general rule is premised on the rationale that a former shareholder would not personally benefit from a recovery by the corporation; therefore, he/she “might be willing to accept an improper or inadequate settlement” to the detriment of the remaining shareholders. Noakes v. Schoenborn, 116 Or. App. 464, 470, 841 P.2d 682, 685 (1992).

Some courts, however, have recognized exceptions to this general rule of standing for shareholder derivative actions. The principal exceptions “have been codified by the American Law Institute in Principles of Corporate Governance (1992) (the Principles)” and adopted as state law. Loewen v. Galligan, 130 Or. App. 222, 232, 882 P.2d 104, 113 (1994); see also Cuker v. Mikalauskas, 547 Pa. 600, 613, 692 A.2d 1042, 1049 (1997).

Section 7.02(a)(2) of the Principles expresses the conclusion that “an otherwise eligible shareholder who has been involuntarily eliminated should be permitted to bring and continue the corporate cause of action if unjust enrichment otherwise seems likely to result.” Under this section, an individual who was once a shareholder may pursue a shareholder derivative action even after he loses his shares if his failure to hold the equity security “is the result of corporate action in which the holder did not acquiesce.” This may occur, for example, when a corporate merger eliminates the plaintiff’s ownership of the corporate stock. Workman v. Verde Wellness Ctr., Inc., 240 Ariz. 597, 604, 382 P.3d 812, 819 (Ct. App. 2016); Lewis v. Anderson, 477 A.2d 1040, 1047 (Del. 1984). In such cases, there is no danger that the plaintiff might be motivated to accept an improper or inadequate settlement on behalf of the corporation; therefore, the policy behind the general rule against standing is inapplicable. Noakes, 116 Or. App. at 470, 841 P.2d at 685-86.

In addition, for the former shareholder to retain derivative standing, he must be “better able to represent the interests of the shareholders than any other holder who has brought suit[.]” Principles, § 7.02(a)(2). To meet this requirement, the plaintiff “must not have or exhibit ulterior motives and must not be pursuing an external personal agenda.” Simmons v. Sutherland, No. 80-E, 1998 Pa. Dist. & Cnty. Dec. LEXIS 200, at *13 (Ct. Com. Pl. Nov. 12, 1998).

If a plaintiff who was a minority shareholder alleges that he was deprived of his equity interest in the company by the majority officers’ fraudulent actions, the plaintiff qualifies as “an otherwise eligible shareholder who has been involuntarily eliminated” within the meaning of the Principles, § 7.02(a)(2). In effect, where the controlling shareholders or directors committed fraud against the corporation and also stripped the plaintiff of his/her shares, the plaintiff is permitted to continue to pursue his/her shareholder derivative action on behalf of the corporation and against the controlling shareholders or directors.

This exception to the general rules of standing shows that principles of fairness and equity are important components of a shareholder derivative action. Particularly in the context of close corporations, the law does offer some protections to minority shareholders who have been forced out of the company but still wish to enforce the interests of the corporation as against the controlling shareholders or directors.

ChatGPT, LLMs, and Legal Research

bturner@nlrg.com (Brett R. Turner) — Thu, 26 Oct 2023 17:42:44 GMT

Lawletter Vol 48 No. 3

ChatGPT, LLMs, and Legal Research

Brett R. Turner—Senior Attorney

What Is ChatGPT? What Are LLMs?

ChatGPT is one particular brand of a large language model, or LLM. LLMs are a recent technological advance in how computers and humans communicate with one another. In one direction, LLMs parse plain-language instructions and convert them into language which a computer can understand. In the opposite direction, LLMs allow computers to translate their output into ordinary language for humans, including not only sentences but also entire written products, such as memos or briefs.

More specifically, LLMs work by starting with certain words (the prompt) and finding other words which are associated with those words in certain training material. An algorithm is then used to convert the chosen words into a product using ordinary human language.

ChatGPT has been analogized to the automatic chat bots found on many support websites. The software begins with a prompt, scans through a specific list of documents, and produces the content of those materials in ordinary human language.

The Cloud in the Silver Lining: False Authority

While ChatGPT is good at communicating with humans, at its core it is only a communications device. It finds words which are commonly associated with other words, but it does not actually understand the prompt or think for itself. It only reformats and reproduces words and sentences found in the training materials.

ChatGPT is capable of producing a written document which looks, to the casual eye at least, like a memorandum or brief. Upon careful examination, however, the document is nothing of the sort. It produces relevant sentences, cites authority in support of those sentences, and even provides copies of the cases. But the citations are very frequently false, and the cases provided are not those that have actually been decided by any court. Rather, they too are products of ChatGPT.

The Consequences of False Authority: Sanctions

Because ChatGPT makes up its own law, attorneys using the software blindly have found themselves in serious trouble. In Mata v. Avianca, Inc., No. 22‑cv‑1461 (PKC), 2023 U.S. Dist. LEXIS 108263 (S.D.N.Y. June 22, 2023), an attorney submitted to the court a brief written by ChatGPT. Upon request by the court, the attorney then provided copies of cases. Both the citations and the cases were invented entirely by the software. To make the situation worse, the attorney did not immediately admit ChatGPT's involvement, but rather he "did not begin to dribble out the truth" until almost three months after the brief was submitted. Id. at *3. The attorney and his law firm were found jointly liable for $5,000 in Rule 11 sanctions.

The sanctions in Mata may be only the tip of the iceberg. The attorney in that case could at least claim that he had no reason to suspect that ChatGPT would make up case law. The judge stated openly that he would have been more sympathetic if the attorney had been quicker to admit the use of ChatGPT. But ChatGPT has received a good amount of attention: as of this writing, Lexis shows that the term "ChatGPT" has been cited in no less than 260 law-related secondary sources. It is much less likely today that an attorney can plausibly claim to be unaware of ChatGPT's limitations—and ignorance will probably become even less defensible as the limitations of LLMs get more public attention. So the sanctions for using ChatGPT without supervision are likely to increase in the future.

Relying upon Mata, a federal judge in Texas issued a standing order that "[a]ll attorneys appearing before the Court must file on the docket a certificate attesting either that no portion of the filing was drafted by generative artificial intelligence (such as Chat GPT . . .) or that any language drafted by generative artificial intelligence was checked for accuracy, using print reporters or traditional legal databases, by a human being." https://www.txnd.uscourts.gov/judge/judge-brantley-starr.

The problems with ChatGPT are not by any means limited to case law. A federal bankruptcy judge asked ChatGPT to "prepare an essay about the evolution of social media and its impact on creating personas and marketing products." In re Vital Pharm., 652 B.R. 392, 398 n.12 (Bankr. S.D. Fla. 2023). The essay cited five sources. None of them actually existed. The judge gave up on ChatGPT and did his own research.

Note also that the use of ChatGPT may be easily detected. Among the more enthusiastic users of the software are college undergraduates, eager to submit the best possible essays to their professors with the least possible expenditure of time and effort. An assistant professor of history at North Carolina State, Bret Devereaux, reports that he has already received papers written by ChatGPT. But he also states that "ChatGPT responses seem to be actually pretty easy to spot once you know how to look for the limitations built into the system." Bret Devereaux, Collections: On ChatGPT (Feb. 27, 2023), https://acoup.blog/2023/02/17/collections-on-chatgpt/. If college professors can spot ChatGPT essays quickly, it seems likely that trial judges will be able to spot ChatGPT briefs quickly as well.

The Present Reality

Existing case law suggests a bottom-line lesson: do not ever, ever use ChatGPT or any other LLM to write any form of brief or memorandum without extremely close supervision. It may be possible to obtain some value from the software if the sources are checked closely. But a Florida bankruptcy judge found that citation of false sources was so common that, to fix the problem, he had to do the same work he would have done to write the product himself in the first place. It is, therefore, questionable whether, at present, there is much value in using ChatGPT itself to draft any court document.

Future Possibilities

To say that LLMs have very limited usefulness at present is not to say that they will never be useful at all. The software is a capable assembler of words. What is needed, above all, is a way to tell the software not to make up authority. This may be harder than it looks, because the software essentially looks for words that are used together in its source material. It is only a sophisticated word-association machine; it does not actually think or reason. A collection of words which are commonly used together in different contexts is not necessarily true. "Prior" may be commonly used with "case law," and "real" may be commonly used with "problem," but it is not at all true that all prior case law is a real problem. Indeed, experts have suggested that it may be impossible to completely prevent any LLM from relying on false authority. See Lucas Mearian, AI Deep Fakes, Mistakes, and Biases May Be Unavoidable, but Controllable, Computerworld (May 4, 2023), https://www.computerworld.com/article/3695508/ai-deep-fakes-mistakes-and-biases-may-be-unavoidable-but-controllable.html.

More generally, the main path to better software for helping attorneys make arguments may lie elsewhere. ChatGPT helps computers and humans communicate, but it does nothing to help computers to find helpful case law. Rather, ChatGPT avoids the issue by making up its own case law. By doing so, ChatGPT is running directly away from the core problem of legal research—finding real, actual, existing case law which helps an attorney make an argument.

At the National Legal Research Group, we have been using cutting-edge digital research tools for many years. Computers are an essential tool which our research attorneys use every day to find cases for our clients. But even the best computer software for legal research is no substitute for the reasoning and writing ability of the human brain. We are following developments in the LLM field closely, and we are committed to using computers in the most efficient and effective way possible. At present, however, LLMs in general and ChatGPT in particular, when used for legal research, create much more risk than benefit.

BANKRUPTCY: Eleventh Circuit Addresses Nuances in Preference Litigation

cjhicks@nlrg.com (Charlene J. Hicks) — Tue, 23 May 2023 20:01:49 GMT

Charlene Hicks, Senior Attorney, National Legal Research Group

Bankruptcy preference litigation involves situations in which the plaintiff (normally the trustee) tries to claw back substantial monetary payments debtors make to creditors within 90 days of filing for bankruptcy. Preference cases are deceptively simple in form. However, complications often arise, particularly in cases involving creditors that regularly do business with the debtor. Such creditors may invoke diverse sections of the Bankruptcy Code in an attempt to negate the trustee’s reimbursement claim against them.

In Auriga Polymers Inc. v. PMCM2, LLC, 40 F.4th 1273, 1277 (11th Cir. 2022), the Eleventh Circuit Court of Appeals recently analyzed the interplay between two such sections of the Bankruptcy Code. One of the eight preference defenses a creditor may raise is known as the subsequent new value defense and is set forth in 11 U.S.C. § 547(c)(4). Section 503(b)(9), in turn, contains an administrator expense claim that a creditor may obtain for payment in full for the value of goods sold to the debtor in the ordinary course of business within 20 days before the debtor files for bankruptcy. 11 U.S.C. § 503(b)(9). In an issue of first impression in the Eleventh Circuit and one which is unsettled in other circuits, the Auriga Polymers court addressed “whether post-petition transfers made under a 11 U.S.C. § 503(b)(9) request will reduce the creditor’s new value defense” under 11 U.S.C. § 547(c)(4). The trustee claimed that Auriga would effectively receive a “double payment” if it were allowed to obtain payment for its administrator expense claim and also to avoid repayment to the trustee under the preference defense of subsequent new value. Auriga Polymers, 40 F.4th at 1288.

The bankruptcy court ruled inthe trustee’s favor, and Auriga appealed directly to the Eleventh Circuit Court of Appeals. Id. at 1280-81. The Eleventh Circuit court first determined that the case turned on whether the funds the trustee had in reserve to pay Auriga’s § 503(b)(9) administrator expense claim represented an “‘otherwise unavoidable transfer’ that would offset Auriga’s preference defense to the extent of that amount.” Id. at 1282. The court concluded that “for purposes of § 547(c)(4)(B), ‘otherwise unavoidable transfers’ made after the debtor has filed for bankruptcy do not affect a creditor’s new value defense.” Id. at 1277. In effect, for an “otherwise unavoidable transfer” to occur, the debtor had to make the payment before filing for bankruptcy. Thus, “only pre-petition transfers will affect a creditor’s subsequent new value defense.” Id. at 1288. A § 503(b)(9) payment is issued to the creditor after the bankruptcy case is filed. Hence, it is not an “otherwise unavoidable transfer” that serves to reduce a creditor’s subsequent new value defense. Id.

The circuit court also rejected the trustee’s assertion that Auriga would receive a “double payment” if the subsequent new value defense were applied to reduce its preference liability and it was also permitted to receive payment for a § 503(b)(9) administrative expense claim. Id. The subsequent new value defense would prevent the return of payments already made on account of completely different goods than those delivered during the 20-day period immediately prior to the debtor’s filing of bankruptcy. As a factual matter, this would not result in a double payment to Auriga. Id.

Under Auriga Polymers, any business creditor that delivers goods to a debtor more than 20 days before the debtor files for bankruptcy should assert the subsequent new value preference defense set forth in 11 U.S.C. § 547(c)(4). Even if the creditor receives payment for administrative expenses under § 503(b)(9), it may still reduce its preference liability to the trustee under § 547(c)(4) for the value of deliveries made within the preference period.

EMPLOYMENT Disparate-Impact Cases Under the ADEA Are Not for the Faint of Heart

Nadine Roddy — Tue, 23 May 2023 19:59:10 GMT

Nadine Roddy, Senior Attorney, National Legal Research Group

In a most unusual case recently before the federal district court sitting in Nevada, Barnes v. Kijakazi, No. 3:18-cv-00199-MMD-WGC, 2023 WL 3007904 (D. Nev. Apr. 19, 2023), a pro se plaintiff asserted a claim of disparate-impact discrimination against the Social Security Administration (SSA) under the Age Discrimination in Employment Act (ADEA). It has been less than 20 years since the Supreme Court held in Smith v. City of Jackson, 544 U.S. 228 (2005), that disparate-impact claims are cognizable under the ADEA. The scope of disparate-impact liability is narrower under the ADEA than under Title VII, and the general requirement of statistical evidence to prove the elements of a disparate-impact case still applies. Thus, it is unusual for a pro se plaintiff to bring such a suit under the ADEA—even an attorney plaintiff.

The plaintiff in Barnes was a lawyer who had applied unsuccessfully for the position of attorney advisor in a soon-to-be-opened SSA hearing office in Reno, Nevada. She sued the agency through its Acting Commissioner and the hiring official who handled her application. She alleged that the official had recruited and hired five attorneys for the new office in a manner that had a disparate impact on older applicants such as herself. As part of his recruitment process, the official advertised the positions externally with an online job board maintained by the University of Nevada’s law school. He also recruited from the alumni branch of the Peace Corps.

Late in the recruitment period, the applicant contacted the SSA’s Human Resources Center to inquire whether the new office was hiring attorneys. The official then contacted her directly, described the application process, and told her that she should apply promptly because the recruitment period was closing. Unlike the law school and Peace Corps applicants, the official did not provide her with a copy of the job posting. Nevertheless, the applicant applied for the job, and the official confirmed that she met the minimum qualifications. She was granted an interview but ultimately was not hired. Of the five successful candidates, only one was age 40 or older.

The applicant’s theory of the case was that, despite the SSA’s facially neutral recruitment and hiring practices for attorney advisor positions, its officials violated the ADEA by advertising the open positions for the new office with two institutions that had populations well under age 40—practices that had a disproportionate and adverse impact upon the applicant and other job seekers age 40 and over. In support of her case, the applicant offered statistics on the median age of lawyers nationwide (47.1 in 2020 and 46.5 in 2021) and the average age of licensed attorneys in Nevada (47 in 2011). She also provided statistics tracking the ages of the 27 applicants and the five candidates hired for the positions in the new office. She asserted that only two of the 27 applicants (including herself) were over age 40, and that the average age of the five hired candidates was 33.2 years old—an age significantly lower than the Nevada and national lawyer averages.

In the court’s view, this evidence was insufficient to establish the element of causation for purposes of the applicant’s prima facie case. At best, it showed a mere correlation rather than a “direct nexus” between the official’s employment procedures and their disparate impact on applicants by virtue of their age. Additionally, there were “gaps and deficiencies” in other statistical evidence she presented. The court ultimately ruled that the applicant had not established the causation element of her prima facie case, and thus the defendants were entitled to summary judgment.

BANKRUPTCY: The Bankruptcy Court's Discretionary Authority Under Rule 1016 to Allow Further Administration of a Chapter 13 Case

ahemenway@nlrg.com (Anne B. Hemenway) — Fri, 05 May 2023 15:25:25 GMT

Anne Hemenway, Senior Attorney, National Legal Research Group, Inc.

It is not uncommon for a debtor who filed a Chapter 11 or 13 bankruptcy case to die or become incapacitated during the life of the bankruptcy proceeding. Under Fed. R. Bankr. P. 1016:

If a reorganization, family farmer's debt adjustment, or individual's debt adjustment case is pending under chapter 11, chapter 12, or chapter 13, the case may be dismissed; or if further administration is possible and in the best interest of the parties, the case may proceed and be concluded in the same manner, so far as possible, as though the death or incompetency had not occurred.

Interestingly, the rule is different where the debtor filed under Chapter 7. The death or incompetency of the debtor "shall not abate a liquidation case under chapter 7 of the Code." This is because the death of the debtor has no practical effect on the administration of a Chapter 7 which is in the hands of the Chapter 7 Trustee. See Hawkins v. Eads, 135 B.R. 380 (Bankr. E.D. Cal. 1991).

To avoid having a reorganization case dismissed upon the death of the debtor, an interested party must show that further administration of the case is in the best interest of the parties. The decision to proceed with the reorganization is entirely within the bankruptcy court's discretion. In re Querner, 7 F.3d 1199 (5th Cir. 1993). Most courts hold that in the Chapter 13 proceeding, if the debtor dies or becomes incapacitated after the Chapter 13 plan is confirmed, the case will not be dismissed but will proceed to its conclusion. See In re Perkins, 381 B.R. 530 (Bankr. S.D. Ill. 2007). The Rule does not preclude further administration where the Chapter 13 plan has not been confirmed prior to death, and it is possible under certain circumstances for the court to confirm a plan after the death of the debtor. In re Terry, 543 B.R. 173 (E.D. Pa. 2015).

In addition to seeking further administration, the deceased debtor's representative may seek a hardship discharge in a pending Chapter 13 case upon the death of the debtor. In In re Hoover, No. 09-71464, 2015 Bankr. LEXIS 924 (N.D. Cal. Mar. 24, 2015), the court held that the debtor need not be held accountable for his untimely death where the debtor died with just one payment left under his Chapter 13 plan. The court ordered a hardship discharge under 11 U.S.C. § 1328(b). See also In re Inyard, 532 B.R. 364 (Bankr. D. Kan. 2015).

Importantly, if a potential debtor dies prior to filing for bankruptcy protection, bankruptcy is not an option. A decedent's estate cannot be a debtor, and any attempt to seek protection under the Bankruptcy Code by the estate will be dismissed.

BANKRUPTCY: Exceptions to Bankruptcy Discharge for Fraudulently Incurred Debts

ldunham@nlrg.com (Lee P. Dunham) — Wed, 07 Dec 2022 14:19:05 GMT

Lee Dunham—Senior Attorney, National Legal Research Group

It can be frustrating for creditors when a debtor files for bankruptcy, especially when the creditor has put time and expense into successfully litigating a claim in court and obtaining a judgment. Nonetheless, with limited exceptions, even judgment debts are dischargeable in bankruptcy. Among these exceptions to discharge are exceptions that apply to certain fraudulently incurred debts. To claim the benefit of these exceptions, the creditor must bring a timely filed “adversary proceeding” (a suit filed in the Bankruptcy Court, under a separate case number but under the umbrella of the larger bankruptcy case) and plead and prove that a particular debt is nondischargeable under 11 U.S.C. § 523(a)(2)(A) or (B).

In nondischargeability actions brought pursuant to § 523(a)(2)(A), the plaintiff bears the burden of proving the elements of the claim by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 291 (1991); In re Ricker, 475 B.R. 445, 455 (Bankr. E.D. Pa. 2012); In re Witmer, 541 B.R. 769, 777 (Bankr. M.D. Pa. 2015).

A claim is nondischargeable under § 523(a)(2)(A) where the creditor proves each of the following: (1) the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or was made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiablyrelied on the false representation; and (4) its reliance was the proximate cause of loss. In re Rembert, 141 F.3d 277, 280-81 (6th Cir. 1998). Section 523(a)(2)(A) applies only to statements other than statements “respecting the debtor’s or an insider’s financial condition,” which fall under the narrower exception defined under § 523(a)(2)(B).

Justifiable reliance under § 523(a)(2)(A) is a subjective standard, and while a creditor must show that he or she actually relied upon a debtor's misrepresentation, the reliance need not be reasonable. Field v. Mans, 516 U.S. 59, 73 (1995). Moreover, the creditor is not required to show that he or she conducted an independent investigation into the truth or falsity of every representation. Id. However, the creditor is “required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation.” Id. at 71.

Most courts to consider the issue, including the First, Third, Sixth, Tenth, and Eleventh Circuits, have found that the intent to deceive can be inferred from the totality of the circumstances, including the debtor's reckless disregard for the truth. In re Cohn, 54 F.3d 1108, 1118-19 (3d Cir. 1995); Palmacci v. Umpierrez, 121 F.3d 781, 790 (1st Cir. 1997).

While a broken promise to repay a debt, without more, will not sustain a cause of action under § 523(a)(2)(A), such a promise made with scienter, or the lack of a present intent to repay the debt at the time the promise was made, is sufficient. See Field, 516 U.S. at 70-72.

A similar, but narrower, standard for an exception to discharge under § 523(a)(2)(B) applies to statements “respecting the debtor's or an insider's financial condition,” which can include, for example, representations that a particular asset will be used to pay the creditor. First, the statement must be “in writing.” The writing need not be particularly formal: an email can satisfy the requirement. See In re Owens, 549 B.R. 337, 351 (Bankr. D. Md. 2016); In re Hambley, 329 B.R. 382, 399 (Bankr. E.D.N.Y. 2005); In re May, 579 B.R. 568, 589 & n.79 (Bankr. D. Utah 2017). Second, the reasonableness of a creditor's reliance under § 523(a)(2)(B) is judged by an objective standard—the creditor must have exercised that degree of care that would be exercised by a reasonably cautious person in the same business transaction under similar circumstances. See Cohn, 54 F.3d at 1117-18.

These exceptions, while narrow, can be useful to protect a frustrated creditor who has not merely made a bad loan but who truly has been victimized by fraud.

ADMIRALTY: Statute of Limitations for Wrongful Death

fshackelford@nlrg.com (Alfred C. Shackelford III) — Thu, 27 Oct 2022 13:33:46 GMT

Fred Shackelford—Senior Attorney, National Legal Research Group

In a case of apparent first impression, the Ninth Circuit Court of Appeals has decided when a cause of action in admiralty for wrongful death accrues. In Deem v. William Powell Co., 33 F.4th 554 (9th Cir. 2022), a shipyard machinist contracted mesothelioma while employed in repairing naval vessels. His illness was diagnosed on February 20, 2015, and he died on July 3, 2015. His wife filed suit within three years of his death but more than three years after the illness was diagnosed. The federal district court ruled that the claim was time-barred because the three-year statute of limitations began to run at the time of the diagnosis.

The issue on appeal was succinctly stated: "When does a wrongful death claim accrue in a maritime case?" Id. at 559. To decide the question, the appellate court recognized that there is a fundamental distinction between survival actions and wrongful death actions under admiralty law. A survival action is for the benefit of the directly injured victim, while a wrongful death action benefits the decedent’s family members who are deprived of his presence when he dies.

Thus, the survival cause of action accrues at the time an injury occurs or is discovered. On the other hand, a wrongful death claim cannot arise before death occurs because one of the elements of the cause of action is death itself. Therefore, the court reasoned that the statute of limitations begins to run at death. The court posited an example to support its conclusion:

Consider a hypothetical case like this one, but where an illness from mesothelioma lingered on for more than three years after diagnosis but before death. In that hypothetical case, if one credited defendants' argument that there was discovery of injury from mesothelioma when illness was discovered, then any recovery for wrongful death would have been extinguished before the death even occurred. That result could not be reconciled with the Supreme Court's holding and reasoning in Moragne [v. States Marine Lines, Inc., 398 U.S. 375 (1970)], that the maritime law permits a claim for wrongful death for benefit of surviving family, distinct from the claim of the seaman for personal injury. Thus, we hold that the text of 46 U.S.C. § 30106 requires two separate accrual dates for the two separate claims. We hold that the uniform maritime three-year statute of limitations on a wrongful death claim begins to accrue on the date of the fulfillment of the condition precedent to bringing the wrongful death claim, i.e., a decedent's death. Where the cause of death is known at time of death, suit for wrongful death can be brought for three years thereafter.

Id. at 565.

CONTRACTS: Importance of Carefully Drafting Contractual Choice-of-Law Clauses

cjhicks@nlrg.com (Charlene J. Hicks) — Thu, 27 Oct 2022 13:21:30 GMT

Charlene Hicks—Senior Attorney, National Legal Research Group

It is common enough for an overworked attorney drafting a contract to regard a choice-of-law clause as boilerplate and therefore not in need of thoughtful consideration. However, the specific wording of such a clause may well alter the outcome of a future dispute between the contracting parties. Perhaps the most important consideration in this regard is whether the clause is worded broadly enough to encompass all potential causes of action that may arise in both contract and tort. In addition, specific language may be included to ensure that the chosen forum’s statute of limitations will also apply.

One recent illustrative case is ARKRAY America, Inc. v. Navigator Business Solutions, Inc., No. N20C-12-012 MMJ (2021) (CCLD), 2021 Del. Super. LEXIS 463 (June 9, 2021). There, the parties entered into two separate contracts, one for software and consulting services and one for a license. Both contracts contained nearly identical choice-of-law clauses except that one provided for Utah law to apply and the other for Delaware law. Both choice-of-law clauses utilized traditional language stating that the agreement shall be governed by and in accordance with the named state’s laws without reference to the state’s conflicts-of-law principles. Id. at *8. Although the ARKRAY parties agreed that the choice-of-law provisions applied to the plaintiff’s contractual claims, they disagreed as to whether those provisions also extended to the tort claims.

The court found that there was “divergent precedent in Delaware on this issue.” Id. Upon review, the court stated that a choice-of-law provision may be either narrowly worded so as to cover only contractual claims or it may be broadly worded to also include tort claims. To invoke a broad interpretation, the choice-of-law clause must include additional language beyond the traditional phrasing utilized in the ARKRAY contracts. To be effective, however, the additional language need not be extensive. The simple use of the phrase “arising out of or relates to” is sufficient to extend coverage to tort claims, including fraud. Id. at *11. Because the two choice-of-law provisions in the ARKRAY contracts did not include any expansive language, the court interpreted them narrowly as covering only the parties’ contractual claims. Id.

To ensure that a particular choice-of-law clause will broadly extend to both contractual and tort claims, a drafting attorney should take care to include expansive phrasing. For example, a choice-of-law provision will be broadly extended to tort claims where it states that it covers any disagreement or dispute “arising out of or relating to” the contract. Turtur v. Rothschild Registry Int’l, 26 F.3d 304, 309 (2d Cir. 1994).

To be safe, the drafter may also specify that to the extent allowable, the chosen state’s statute of limitations should also apply. See Gluck v. Unisys Corp., 960 F.2d 1168, 1179 (3d Cir. 1992) (“Choice of law provisions in contracts do not apply to statutes of limitations, unless the reference is express.”). Choice-of-law provisions normally cover only substantive matters, but statutes of limitations are often classified as procedural. Hence, the application of the chosen state’s statute of limitations is an issue that should be specially raised in the drafted choice-of-law contractual provision.

BANKING: Standing to Enforce UCC Midnight Deadline Rule

pferrer@nlrg.com (Paul A. Ferrer) — Wed, 13 Apr 2022 14:02:53 GMT

Paul Ferrer—Senior Attorney, National Legal Research Group

As part of the check collection process governed by Article 4 of the Uniform Commercial Code (“UCC”), the “midnight deadline” rule of § 4-302 requires that a payor bank pay or return an item, or send notice of its dishonor, before midnight of the next banking day following the banking day on which the bank receives the item. The rule imposes strict liability on a payor bank that fails to meet the midnight deadline requirement. But what if something happens to the payee while the check is being dishonored as part of the collection process? Who has standing to sue the payor bank to enforce the midnight deadline rule?

That was the unusual question decided by the Virginia Supreme Court in Stahl v. Stitt, ___ Va. ___, 869 S.E.2d 55 (2022). In that case, Ivory Markus had checking accounts at Branch Banking and Trust Company (“BB&T”) and MCNB Bank and Trust Company (“MCNB”). Markus’s niece, Sheree Stahl, was designated as the payable-on-death (“POD”) beneficiary on the BB&T account. On March 15, 2016, Stahl made an electronic request for a check transferring the $245,271.25 balance of the MCNB account to the BB&T account. On March 18, MCNB’s online banking system issued a check in that amount for mail-in deposit into the BB&T account. A BB&T branch received the check on March 21, and BB&T provisionally credited Markus’s account on that day. On March 22, the check was electronically presented to MCNB for payment. MCNB decided to dishonor the check and return it to BB&T but failed to do so until March 25, after MCNB’s midnight deadline. Markus died intestate on March 26.

Stahl sued MCNB, claiming that she owned the funds that were deposited in the BB&T account at the time of Markus’s death. Stahl argued that MCNB retained the check beyond the midnight deadline without paying or returning the item or sending notice of its dishonor and was therefore strictly liable for the payment of the check under UCC § 4-302. However, neither the trial court nor the Virginia Supreme Court reached the substantive issue, concluding that Stahl lacked standing to enforce the midnight deadline rule against MCNB. Section 4-302 of the UCC “confers standing upon a ‘limited class comprised of those involved in the collection and payment of the check at issue who may be directly harmed (but are not necessarily actually harmed) by the failure of the payor bank to adhere to the . . . midnight deadline.’” 869 S.E.2d at 59 (quoting Am. Title Ins. Co. v. Burke & Herbert Bank & Tr. Co., 813 F. Supp. 423, 428 (E.D. Va. 1993)).) Standing is thus based on the would-be plaintiff’s “potential reliance on payor bank action that arises once a check is actually presented” to the bank for payment. Id. (quoting Am. Title, 813 F. Supp. at 428).)

In the Stahl case, Markus was the party who initially presented the check for payment to MCNB on March 22 and could have relied on the prompt payment of the check and the resulting availability of the funds at issue. Stahl, by contrast, was only a POD beneficiary of the BB&T account on that date and could have been removed as the beneficiary by Markus after the check was presented for payment. Accordingly, Stahl was a crucial step removed from the transaction and did not have a vested interest in the check—that is, a right to rely on the prompt payment of the check—when MCNB failed to take action by its midnight deadline. Stahl thus lacked standing to enforce the midnight deadline rule.