Hold Your Horses – Cannabis Rescheduling Hearings Stayed, Pending Appeal
In the latest development in a road to rescheduling cannabis from Schedule I to Schedule III under the Controlled Substances Act (“CSA”), on January 13, 2025, in the Matter of Schedules of Controlled Substances: Proposed Rescheduling of Marijuana, DEA Docket No. 1362 Hearing Docket No. 24-44, Chief Administrative Law Judge (“ALJ”) John Mulrooney cancelled the January 21, 2025 hearing on the merits of the Drug Enforcement Agency’s (“DEA”) proposal to reschedule cannabis from Schedule I to Schedule III.
After a request by two private movants (the “Movants”) to remove the DEA from its role as proponent of the proposed reclassification rule was denied, the Movants filed a motion for the ALJ to reconsider its denial of this request. On January 13, 2025, ALJ Mulrooney (i) denied the motion for reconsideration but (ii) granted leave for the Movants to file an interlocutory appeal on the merits of ALJ Mulrooney’s refusal to remove the DEA as proponent of the reclassification. While this Order opens the door on appeal to potentially enable to a private actor to replace the DEA as proponent of the reclassification, the January 13 Order will surely cause further delay in the process of potential rescheduling, evidenced by ALJ Mulrooney’s ordering the Movants and the Government to provide a joint status update 90 days from the issuance of the Order, and every 90 days thereafter.
For those hoping that cannabis would be reclassified before the Trump administration enters office, this is a major disappointment. For those who have been paying attention, this is no surprise, and more of the same.
In a constantly evolving and [still – very] nascent industry like the cannabis industry, one truth has remained: it is a fools errand to try to predict if, when, and how regulatory changes and developments will occur at the federal level. For years, there have been similar questions floated and discussed amongst advisors, operators, and investors in the cannabis industry: “when will cannabis be legalized?”,“when will the SAFE act pass”, “surely Congress will do something, right?”.
Federal action is largely an issue of legislative and regulatory priorities (or, as we have seen, a lack-thereof). Folks can talk and pontificate all they want, but the reality has remained the same: States (at this point, 39 in total, having already passed laws allowing medical marijuana use) are left to fend for themselves, as are the businesses trying to operate with one (if not two) arms tied behind their back.
When President Biden requested in October 2022 for the U.S. Department of Health and Human Services (“HHS”) to “initiate the administrative process to review expeditiously how marijuana is scheduled under federal law”, there was tepid excitement. Hey – the White House is asking HHS to look into this… progress! Then, in August 2023, HHS issued a recommendation to the DEA that cannabis be reclassified from Schedule I to Schedule III under the CSA. At this point, industry participants started to cautiously buy in – maybe – just maybe – this will be the time something actually happens. After all, for business operators, a reclassification to Schedule III under the CSA, would have potentially huge implications – potentially rendering §280E of the tax code inapplicable to cannabis businesses, opening the door for cannabis businesses to deduct various business expenses like any other businesses complying with their state and local laws. And yet, here we are, almost two and a half years later, and the industry is still hoping for change at the federal level.
For operators and investors alike, the reality is simple. Now is not the time to focus on what could happen – or what we hope will happen – at the federal level. Industry participants must continue to focus on what they control: increasing operational efficiency to achieve and maintain profitability.
US Department of Justice Announces US$2.9 Billion in Fiscal Year 2024 False Claims Act Recoveries
On 15 January 2025, the US Department of Justice (DOJ) published its report (Report) announcing civil recoveries under the False Claims Act (FCA) for Fiscal Year (FY) 2024. The recoveries for FY 2024 exceeded US$2.9 billion, approximately US$1.7 billion of which involved the health care industry. The US government has now collected over US$78 billion in recoveries under the FCA since the statute was amended in 1986 to allow for treble damages and increased incentives for whistleblowers. Notably, the 979 qui tam lawsuits filed in FY 2024 marked the highest number in a single year; and the 558 settlements and judgments trailed only just behind the record number set in FY 2023.
As with FY 2023, qui tam cases comprised the largest portion of recoveries, with over 83% (US$2.4 billion) stemming from whistleblower actions. The government paid over US$400 million to whistleblowers in relation to these FY 2024 recoveries. Of the record-setting 979 qui tam suits that were filed in FY 2024, 370 were health care focused.
DOJ also highlighted its “key enforcement priorities” for FY 2024 and provided representative examples. The enforcement priorities included health care fraud, military procurement fraud, pandemic fraud, and cybersecurity fraud. As with prior years, health care fraud was the principal source of FCA recoveries, which included recoveries relating to Medicare Advantage fraud, billing for unnecessary services and substandard care, opioid epidemic-related fraud, kickback schemes, and Stark Law violations.
Health Care Fraud
With Medicare Advantage, also known as Medicare Part C, having become the largest component of the Medicare program, the government continued its focus on Medicare Advantage fraud. In FY 2024, the government secured a substantial recovery from a provider that allegedly paid kickbacks to third-party insurance agents in exchange for recruiting senior citizens to the provider’s primary care clinics. DOJ also highlighted that it is continuing to litigate a number of cases against Medicare Advantage Organizations.
DOJ obtained substantial recoveries from providers who allegedly improperly billed for medically unnecessary services and substandard care. Additionally, the government has continued to focus on opioid crisis-related fraud, with several substantial recoveries against pharmaceutical companies and individual physicians.
In a carry-over from FY 2023, some of the largest health care recoveries in FY 2024 resulted from alleged unlawful kickback schemes and Stark Law violations. The kickback schemes ranged from payments to purportedly induce referrals of dialysis patients, to medical directorships that were intended to induce patient referrals. As to the Stark Law, DOJ highlighted a US$345 million settlement to resolve allegations that a health care network paid compensation to certain physician groups far above fair market value and awarded bonuses tied to referral volume.
Other Enforcement Priorities
In addition to health care-specific recoveries, the government recovered significant funds stemming from military procurement fraud, pandemic fraud, and cyber fraud. The military procurement fraud recoveries included a US$70 million settlement against a contractor to resolve allegations that they overcharged the US Navy for spare parts and materials needed to repair and maintain aircraft used to train naval aviators. Of note, military procurement fraud recoveries could have been much higher in FY 2024, however, a US$428 million settlement with a defense contractor occurred on 16 October 2024, putting that recovery in FY 2025.
The government also resolved an estimated 250 cases, totaling over US$250 million, in connection with pandemic-related fraud. As with FY 2023, the pandemic fraud largely stemmed from the submission of inaccurate information in PPP loan applications, though the DOJ also highlighted a US$12 million recovery that resolved allegations of false claims for COVID-19 testing that were billed to the Health Resources and Services Administration’s Uninsured Program.
In October 2021, DOJ announced its Civil Cyber-Fraud Initiative with the goal of pursuing companies who receive federal funds while failing to follow required cybersecurity standards. In FY 2024, the government entered into several recoveries under the Civil Cyber-Fraud Initiative. DOJ also highlighted a complaint-in-intervention that was filed against a research institution alleging that the defendants had failed to meet cybersecurity requirements in connection with Department of Defense contracts.
Whistleblower Suits
Given the record-setting number of qui tam cases filed in FY 2024, it will be important to continue to monitor developments regarding the constitutionality of the qui tam provisions. On 30 September 2024, a judge in the US District Court for the Middle District of Florida held that the qui tam provisions of the FCA violate the Appointments Clause of Article II of the US Constitution. This first-of-its-kind decision has sparked a wave of filings by the defense bar. With the Middle District of Florida’s decision on appeal, there are sure to be many developments on this issue in the coming months.
The FY 2024 settlements and judgments provide an insight into the government’s enforcement priorities and potential future enforcement areas. The firm’s forthcoming article The False Claims Act and Health Care: 2024 Recoveries and 2025 Outlook will provide an in-depth analysis of the 2024 recoveries, as well as some key enforcement areas to look out for in 2025.
Department of Education Warns NCAA Schools That NIL Deals May Implicate Title IX Obligations
The U.S. Department of Education warned National Collegiate Athletic Association (NCAA) schools that payments to athletes for the use of their names, images, and likenesses (NIL) implicate the gender equal opportunity requirements of Title IX of the Education Amendments, even if from outside sources.
Quick Hits
The U.S. Department of Education released a fact sheet that provides guidance on educational institutions’ Title IX obligations with NIL compensation for college athletes.
The guidance confirms the Department of Education’s view that NIL compensation from schools constitutes “athletic financial assistance” covered by Title IX’s equal opportunity requirements.
The guidance comes amid a changing landscape in college sports with NIL compensation and the prospect of potential revenue-sharing between schools and college athletes.
On January 16, 2024, the Department of Education’s Office for Civil Rights (OCR) released a nine-page fact sheet, titled, “Ensuring Equal Opportunity Based on Sex in School Athletic Programs in the Context of Name, Image, and Likeness (NIL) Activities,” providing long-awaited guidance on schools’ obligations with respect to Title IX in the context of NIL.
The fact sheet confirms that the department views NIL compensation provided by a school as “athletic financial assistance,” which Title IX requires to be distributed in a nondiscriminatory manner under Title IX.
The guidance comes years after the NCAA lifted restrictions on college athletes’ ability to earn compensation for their NIL. This has led to the formation of so-called NIL collectives, organizations typically comprised of boosters, fans, alumni, and businesses, to facilitate NIL deals for athletes.
Further, the NCAA and major conferences have reached a proposed settlement in litigation that will pay nearly $2.8 billion in back pay to former athletes over the next ten years and establish a revenue-sharing framework in which schools will be allowed to share more than $20 million annually with their athletes.
Title IX regulations require schools to provide equal athletic opportunity, regardless of sex, including with “athletic financial assistance” that schools award to college athletes.
According to the OCR fact sheet, the Department of Education “does not view compensation provided by a third party (rather than a school) to a student-athlete for the use of their NIL as constituting athletic financial assistance awarded by the school.” However, the fact sheet warns that the OCR has “long recognized that a school has Title IX obligations when funding from private sources, including private donations and funds raised by booster clubs, creates disparities based on sex in a school’s athletic program or a program component.”
“The fact that funds are provided by a private source does not relieve a school of its responsibility to treat all of its student-athletes in a nondiscriminatory manner,” the Department of Education said in the fact sheet. “It is possible that NIL agreements between student-athletes and third parties will create similar disparities and therefore trigger a school’s Title IX obligations.”
The department noted the variety and evolving nature of NIL agreements in college athletics and specified that the application of Title IX “is a fact-specific inquiry.” Further, and in recognition of the continued evolution of college athletics, the department noted that “Title IX regulations assume that the receipt of financial assistance does not transform students, including student-athletes, into employees,” and the fact sheet, thus, operates under the same assumption. The Department of Education stated that it would “reevaluate” this position should the legal landscape around that issue change.
Next Steps
The fact sheet comes just days before the presidential administration changeover, which is anticipated to impact the federal government’s response to NIL pay and make systemic changes to college sports, including regarding the question of employee status. Still, the fact sheet indicates that schools may face risks under Title IX with the distribution of NIL compensation even if third parties are providing that money.
EnforceMintz — Scienter, Causation, and Constitutional Questions: 2024’s Three Key FCA Litigation Issues
In 2024, federal courts issued a number of important decisions in False Claims Act (FCA) cases that are particularly noteworthy for the health care and life sciences industries. We focus here on decisions that further develop the FCA scienter standard addressed in 2023 by the Supreme Court in its important SuperValu decision. We also look at decisions that have accepted the invitation of three Supreme Court justices to reexamine the constitutionality of the FCA’s qui tam provisions. Finally, a circuit split on the interpretation of “causation” for FCA suits based on alleged violations of the Anti-Kickback Statute (AKS) remains unresolved, pending a decision from the First Circuit.
Post-SuperValu Developments Concerning the FCA’s Scienter Standard
An essential element of any FCA claim is “knowledge” that the submission of claims was “false or fraudulent.” By statute, the FCA defines “knowledge” to mean that a person acted with (i) actual knowledge, (ii) deliberate ignorance, or (iii) reckless disregard with respect to the truth or falsity of the information at issue. This is the FCA’s intent or scienter standard. Last year, in SuperValu, the Supreme Court held that the FCA’s “knowledge” element is based on subjective intent and not, as a number of circuits had previously held, on a defendant’s “objectively reasonable” interpretation of an ambiguous legal or regulatory issue.1 We previously discussed the SuperValu case (here and here) and analyzed the decision’s implications in last year’s issue of EnforceMintz.
The Supreme Court explained that the FCA’s scienter requirement could be met by showing (i) “deliberate ignorance,” meaning that a defendant had knowledge of a “substantial risk” that its statements were false but “intentionally avoid[ed]” a relevant legal or regulatory requirement; or (ii) “reckless disregard,” meaning that a defendant understood that there was a “substantial and unjustifiable risk” that its claims were false but submitted the claims anyway. While the Supreme Court did not define how lower courts might determine which risks are “substantial” or “unjustifiable,” these two new glosses on “deliberate ignorance” and “reckless disregard” offer some guidance to providers and companies seeking to avoid exposure to FCA liability through well-designed compliance programs.
SuperValu may have been initially understood as a clear-cut victory for the United States and private whistleblowers who bring actions under the qui tam provisions of the FCA. Generally speaking, in litigation, a defendant’s subjective knowledge is often a question of fact, which makes it difficult for defendants to win a motion to dismiss on the basis of whether a complaint adequately alleges knowledge. But as decisions from the past year demonstrate, that is not the full story, for two reasons.
First, even after SuperValu, courts have been willing to grant motions to dismiss on scienter grounds. For example, in August 2024, a federal district court granted a pharmaceutical manufacturer’s motion to dismiss an FCA complaint for failure to adequately allege scienter.2 In US ex rel. Sheldon v. Forest Laboratories, LLC, the relator alleged that Forest Laboratories overcharged the government in violation of the FCA because it did not include certain price concessions in calculating “best price,” as that term was defined by statute. The court found the “best price” definition “no more informative than the hypothetical instruction in [SuperValu] to drive at a ‘reasonable’ speed.”3 As such, the court found that the defendant’s alleged familiarity with such vague instructions did not provide a basis to attribute a culpable mental state to the drug manufacturer.
Second, in June 2024, the Supreme Court decided Loper Bright Enterprises v. Raimondo, ending the era of “Chevron deference” in which courts deferred to an agency’s interpretation of an ambiguous statute.4 This decision may lend support to FCA defendants in cases where the conduct at issue allegedly violated an ambiguous statutory or regulatory requirement. Often in FCA cases, the United States or a private relator attempts to establish scienter by showing an FCA defendant’s knowledge of statutory or regulatory requirements or agency guidance. After Loper Bright, a provider or company facing ambiguous or complex statutory or regulatory requirements can now demonstrate that it subjectively believed it was not taking “substantial and unjustifiable risk” that its claims were false based on the controlling statutory text, without undue deference to an agency’s interpretation. For example, analyzing Stark Law compliance often requires a review of layers of exceptions to complex statutory or regulatory prohibitions. Loper Bright may help provide a defense as to both scienter and falsity where theories of liability are premised on noncompliance with a web of statutory requirements, regulations, and complex agency guidance.
As we previously discussed (here), these case law developments highlight three implications for health care and life sciences companies seeking to minimize FCA exposure or to defend against an FCA investigation or litigation:
Providers and companies should seek to minimize potential FCA exposure by documenting interpretations of ambiguous legal requirements or regulations based on all available advice, communications with agencies or payors, and any other information when making business decisions that involve claims to federal programs or federal funds.
In the event of an FCA investigation, strong compliance functions and a clear record showing the entity’s lack of a subjective belief that it was submitting false or fraudulent claims, or taking an unjustified risk of doing so, may help persuade the government to decline to intervene in an FCA lawsuit.
As Sheldon demonstrates, once in litigation, a scienter-based motion to dismiss argument as well as summary judgment opportunities may still be available, despite SuperValu’s subjective intent holding.
While scienter issues often raise disputed factual questions, that is not always the case, as demonstrated by developments in FCA case law since SuperValu.
Successful Constitutional Challenges in FCA Cases Under Article II and the Eighth Amendment
For the first time in two decades, the issue of the constitutionality of the FCA’s qui tam provisions is squarely before the federal courts. In 2024, defendants raised successful constitutional challenges in cases involving large FCA penalties. Given these results, constitutional questions will likely remain a hot-button issue in 2025, particularly in cases where the government declines to intervene.
Zafirov and the Constitutionality of the FCA’s Qui Tam Provisions
In September 2024, a federal district court held in US ex rel. Zafirov v. Fla. Med. Assocs., LLC that the FCA’s qui tam provisions violate the Appointments Clause of Article II of the Constitution.5
Public officials who exercise “significant authority” under federal law and “occupy a continuing position established by law” are “Officers” who must be appointed consistent with the requirements of Article II, Section 2. In considering whether FCA relators are “Officers”, the court observed that “[a]n FCA relator’s authority markedly deviates from the constitutional norm.” The court explained that the qui tam provisions permit anyone “wherever situated, however motivated, and however financed” to perform a “traditional, exclusive [state] function by appointing themselves as the federal government’s avatar in litigation.”6 The court thus concluded that arrangement violates the Appointments Clause because it permits unaccountable, unsworn private actors to exercise core executive power with substantial consequences for the public. Finding the relator in Zafirov was unconstitutionally appointed, the court granted the defendants’ motion for judgment on the pleadings and dismissed the case with prejudice.
In our prior discussion (here), we explained how Zafirov followed from Justice Thomas’s dissent in US ex rel. Polansky v. Executive Health Resources, which noted the “substantial arguments” that the FCA’s qui tam provisions may be “inconsistent with Article II.” Two other justices agreed with Justice Thomas’s suggestion that the Court should consider the constitutional question in an appropriate case.
The United States and the relator appealed the Zafirov decision to the Eleventh Circuit. As of the date of this publication, briefing is in progress. The government made four particularly noteworthy arguments in its opening brief. First, the government argued that qui tam relators pursue “private interests” assigned by the FCA but do not exercise executive power. Second, the government argued that the qui tam provisions are not subject to the Appointments Clause because relators are not a part of the federal government. Third, even if the Appointments Clause applies, the government argued that relators (i) do not exercise “significant authority” because they are not part of the government workforce and the government retains supervisory authority over declined FCA cases; and (ii) do not “occupy a continuing position established by law” because the role of a qui tam relator is time-limited, case-specific, and involves interests that are personal in nature. Finally, the government argued that, even if the district court’s ruling in Zafirov is affirmed, the decision should be limited only to declined cases and should not extend to matters where the government has intervened or is considering whether to intervene. The defendants’ brief will be filed in the first quarter of 2025 and a decision is expected by the end of 2025.
If Zafirov is affirmed, that would create a circuit split on the constitutionality of the qui tam provisions, which would greatly increase the odds of Supreme Court review. In cases decided between 1993 and 2002, the Second, Fifth, Sixth, Ninth, and Tenth Circuits rejected Article II constitutional challenges to the FCA’s qui tam provisions, so Zafirov’s impact may be limited in those jurisdictions. But in circuits where the issue has not been decided, and to preserve the argument in circuits that previously rejected Article II challenges, defendants are raising the constitutional arguments via motions to dismiss, motions for judgment on the pleadings, and in affirmative or general defenses.
For example, in one recent declined FCA lawsuit pending in a federal district court within the Eleventh Circuit, a defendant Medicare Advantage Organization moved to dismiss, leading its brief with the argument that such relator-driven qui tam suits violate Article II of the Constitution.7 Defendants have made similar arguments in other jurisdictions as well.8
The success of these arguments remains to be seen. FCA defendants raising the constitutional argument should be aware of the notice requirements of Federal Rule of Civil Procedure 5.1, which requires that a party filing a pleading or motion drawing into question the constitutionality of a federal statute promptly file a “notice of constitutional question” with the court and serve that notice on Attorney General of the United States.
In response to FCA defendants’ emerging reliance on Zafirov, the United States has not hesitated to step in to defend the constitutionality of the FCA’s qui tam provisions in previously declined cases. For example, in US ex rel. Gill v. CVS Health Corp., DOJ initially declined to intervene in an FCA lawsuit involving over $200 million in alleged damages from overpayments and over-billing federal programs and commercial payors.9 After Zafirov was decided, the CVS defendants filed a Rule 5.1 notice of constitutional challenge, arguing that the FCA qui tam provisions violated separation of powers principles and Article II of the US Constitution. The CVS defendants also asserted those defenses in their answer to the complaint. The CVS defendants’ Rule 5.1 notice prompted the government to reverse course and intervene “for the limited purpose of defending the constitutionality of the qui tam provisions” of the FCA.
These Article II challenges to the qui tam provisions could significantly impact FCA cases, especially qui tam litigation where the United States previously declined to intervene. We will continue to monitor this issue as it develops in 2025.
Eighth Amendment Challenges to Excessive FCA Penalties
In July, the Eighth Circuit vacated a roughly $6.5 million FCA award, holding that the amount violated the Eighth Amendment’s Excessive Fines Clause.10 In Grant ex rel. US v. Zorn, a medical practitioner filed a qui tam action against the co-owner of a sleep disorders center, alleging that the defendant overbilled federal and state programs for patient visits and engaged in a kickback scheme. After trial, the district court determined that the 1,050 false claims the defendant had submitted to the government resulted in roughly $86,000 in actual damages, which was then trebled to about $259,000. Then, the court imposed a per-claim civil penalty, which added almost $7.7 million to the total award.
Citing the Eighth Amendment’s Excessive Fines Clause and the Supreme Court’s prior invalidation of punitive damages awards that far outpace actual damages, the district court reduced the penalties to $6.47 million. The district court thus endorsed a ratio in which the penalty amounts were 25 times greater than actual damages.
On appeal, however, the Eighth Circuit in Grant vacated the punitive damages award, holding that the application of both treble damages and per-claim civil penalties violated the Eighth Amendment’s Excessive Fine Clause. The court reasoned that the punitive sanction was “grossly disproportional” to the conduct at issue and that the Eight Circuit had previously rejected double-digit multipliers where there was a small economic loss and no evidence of danger to health and safety.
The Grant decision bolsters defendants’ arguments for lower penalty awards in FCA cases where the penalties imposed far exceed actual damages. These arguments are more likely to succeed in cases where the only harm alleged is purely economic.
The Unresolved Circuit Split on the Causation Standard for AKS-Based FCA Claims
As we discussed in last year’s edition of EnforceMintz, a significant circuit split is developing on the causation standard applicable to FCA claims based on violations of the AKS. Specifically, section (g) of the AKS states that “a claim that includes items or services resulting from a violation of [the AKS] constitutes a false or fraudulent claim for purposes of [the FCA].”11 The issue in this circuit split is whether the submission of a claim to the government “result[s] from” a kickback only if it would not have been submitted “but for” the kickback.
In July 2024, the First Circuit heard oral argument on the FCA-AKS causation issue in United States v. Regeneron Pharmaceuticals, Inc.12 As of the date of publication of this article, the First Circuit’s decision is pending.
In Regeneron, the government appealed the district court’s holding that a standard of “but for” causation applied to FCA lawsuits premised on AKS violations. The district court’s holding was consistent with recent decisions from the Sixth and Eighth Circuits (which we previously discussed here) applying the plain language of section (g) of the AKS to require a showing of “but for” causation. On appeal, the government argued that a broader proximate cause standard applies, requiring only “some sort of causal connection.” That view, which has been endorsed by the Third Circuit, is based on the legislative history of the 2010 amendment that added the “resulting from” language in section (g) of the AKS.
At oral argument in Regeneron, Judge Kayatta challenged the government’s expansive view of the causation standard based on legislative intent. Judge Kayatta asked whether causation would be met in a situation where a hospital sent a vendor 10,000 claims in one year, then received a kickback, and then sent fewer claims in the following year. In response, the government argued that each and every claim in year two would be tainted by a kickback, even though the volume of claims decreased post-kickback. Perhaps tellingly, Judge Kayatta found that to be an “odd” outcome.
However the First Circuit rules, the circuit split will deepen, thereby increasing the likelihood that the causation standard question will rise to the Supreme Court. In the meantime, health care and life science entities facing FCA scrutiny based on AKS theories should closely monitor this emerging area. The applicable causation standard can have major implications on FCA exposure and potential damages.
ENDNOTES
[1] US ex rel. Schutte v. SuperValu Inc., 143 S. Ct. 1391, 1399 (2023).
[2] US ex rel. Sheldon v. Forest Laboratories, LLC, No. 1:14-cv-02535, 2024 US Dist. LEXIS 129331, at *79-80 (D. Md. July 23, 2024), appeal filed, No. 24-1793 (4th Cir. Aug. 21, 2024).
[3] Id. at 63.
[4] Loper Bright Enters. v. Raimondo, 603 US ___, 144 S. Ct. 2244 (2024).
[5] US ex rel. Zafirov v. Fla. Med. Assocs., LLC, C.A., No. 8:19-cv-01236-KKM, 2024 US Dist. LEXIS 176626 (M.D. Fla. Sept. 30, 2024).
[6] Id. at *58-59 (internal quotations omitted).
[7] See Gonite v. UnitedHealthCare of Ga., Inc., et al., No. 19-246 (M.D. Ga. Oct. 11, 2024), ECF 69.
[8] See, e.g., US ex rel. Kenly Emergency Med. Corp. v. SCP Health, No. 3:20-cv-3274 (N.D. Cal. Dec. 13, 2024), ECF 74; Omni HealthCare Inc., et al v. North Brevard Cty. Hosp. Dist., et al., No. 6:22-cv-00696 (M.D. Fla. Nov. 28, 2024), ECF 87; US ex rel. Sullivan, et al. v. Murphy Med. Ctr., Inc., et al., No. 1:21-cv-219-MR (W.D.N.C. Oct. 25, 2024), ECF 85; US ex rel. Eckert v. Sci Tech. Inc and Sanmina Corp., No. 20-cv-1443 (D.D.C. Oct. 7, 2024), ECF 34-1.
[9] US ex rel. Gill v. CVS Health Corp., et al., No. 1:18-cv-06494 (N.D. Ill. Feb. 25, 2022), ECF 31.
[10] Grant ex rel. US v. Zorn, 107 F.4th 782 (8th Cir. 2024).
[11] 42 USC § 1320a-7b(g) (emphasis added).
[12] United States v. Regeneron Pharms., Inc., No. 23-2086 (1st Cir. filed Dec. 22, 2023).
SCOTUS: No Heightened Standard of Proof Required for FLSA Exemption Defense
In E.M.D. Sales, Inc. v. Cabrera, issued on January 15, 2025, the Supreme Court held that the “preponderance of the evidence” standard—and not the more difficult-to-satisfy “clear and convincing evidence” standard—applies when an employer seeks to demonstrate that an employee is exempt from the minimum wage and/or overtime pay provisions of the Fair Labor Standards Act.
In an FLSA dispute, plaintiffs bear the burden to prove all elements of their claims. But if the employer is defending on the ground that an exemption applies, the employer has the burden of proof on the exemption. The issue before the Supreme Court in Cabrera was the level of proof required.
In 1938, when Congress passed and President Franklin D. Roosevelt signed the FLSA, the default standard of proof in American civil litigation was the “preponderance of the evidence” standard. That standard—which allows both parties to “share the risk of error in roughly equal fashion,” in the Court’s words—remains the default standard of proof in American civil litigation today.
In civil litigation, the Supreme Court has deviated from the default preponderance standard in three main circumstances:
where a statute expressly requires a heightened standard of proof;
where the Constitution requires a heightened standard of proof; and
in “uncommon” cases where Supreme Court precedent holds that a heightened standard of proof is appropriate, including where the government seeks to take action “more dramatic than entering an award of money damages or other conventional relief” against an individual (e.g., revocation of citizenship).
With none of these circumstances present, the Court held that the default preponderance standard governs when an employer seeks to prove that an employee is exempt under the FLSA. The Court quickly disposed of the plaintiff-employees’ policy arguments, noting that “[i]f clear and convincing evidence is not required in Title VII cases, it is hard to see why it would be required in [FLSA] cases.”
Environmental Developments to Watch in California in 2025
Contaminants of Concern
Perfluoroalkyl and polyfluoroalkyl substances (PFAS)
In September 2024, California’s legislature enacted two new bills restricting the use of PFAS in consumer products.
AB 347 – This statute gives California’s Department of Toxic Substances Control (DTSC) enforcement authority over existing PFAS restrictions on textile articles (AB 1817), juvenile products (AB 652), and cookware and food packaging (AB 1200) (the “covered products” under the “covered PFAS restrictions”). AB 347 also requires manufacturers of covered products to submit a registration to DTSC by July 1, 2029, pay a registration fee, and submit a statement of compliance to DTSC confirming that each covered product complies with the covered PFAS restriction on the sale or distribution of the product that contains regulated PFAS. DTSC will begin enforcing this legislation after July 1, 2030. Given DTSC is the enforcement authority for the above-mentioned covered products, we expect DTSC to release guidance on interpreting AB 1817, AB 652, and AB 1200 in the future.
AB 2515 – This statute prohibits companies from manufacturing, selling, or distributing menstrual products that contain regulated PFAS. “Regulated PFAS” means PFAS “intentionally added to a product” as of January 1, 2025, and will mean “PFAS in a product at or above a limit determined by the department” beginning January 1, 2027. Like AB 347, AB 2515 requires manufacturers to register with DTSC by July 1, 2029, pay a registration fee, and submit a statement of compliance confirming that menstrual products do not contain regulated PFAS.
We expect DTSC to initiate the rulemaking process for both statutes, which would include regulations regarding accepted testing methods for PFAS levels in menstrual products and third-party laboratory accreditations, and regulations to implement, interpret, and enforce the statutes. Both statutes require DTSC to adopt these regulations before January 1, 2029.
Proposition 65
California’s Safe Drinking Water and Toxic Enforcement Act of 1986, Health & Safety Code Section 25249.5 et seq. (“Proposition 65”) prohibits persons in the course of doing business from knowingly and intentionally exposing individuals to certain listed chemicals above a safe harbor level, where one exists, without first providing a “clear and reasonable” warning to such individuals. (Health & Safety Code § 25249.6). The law applies to consumer product exposures, occupational exposures, and environmental exposures that occur in California. Presently, there are approximately 900 listed chemicals known by the State of California to cause cancer, reproductive harm, or both.
In 2025, we will continue to see developments in the implementation and enforcement of this law, of which manufacturers and retailers selling products in California should be aware.
Vinyl Acetate
On December 19, 2024, the Office of Environmental Health Hazard Assessment’s (OEHHA) Carcinogenic Identification Committee (CIC) voted to list vinyl acetate as a carcinogen under Proposition 65. Vinyl acetate is primarily used in glues, plastics, paints, paper coatings, and textiles. Exposure to the chemical can occur through dermal contact, inhalation, or ingestion.
Vinyl acetate was listed despite industry groups claiming that none of the recognized Proposition 65 authoritative bodies consider the chemical to be a carcinogen. OEHHA published evidence of the carcinogenicity of vinyl acetate, which was used by the CIC to support the listing.
Once listed, businesses have 12 months to provide any required warnings.
Warning Labels
Safe harbor regulations provide examples of long-form and short-form warnings deemed “clear and reasonable,” which, if followed, offer businesses an affirmative defense in the event of enforcement. On December 6, 2024, OEHHA amended Proposition 65 to require companies to add at least one chemical name—or the name of two chemicals, if the warning covers both cancer and reproductive toxicity, unless the same chemical is listed for both endpoints—to the short-form warning on the product label for products manufactured and labeled after January 1, 2028. For example:
“[the warning symbol] WARNING: Cancer risk from exposure to [name of chemical]. See www.P65Warnings.ca.gov.”
OEHHA has authorized the continued used of the earlier short-form warning template (that does not name the chemical) for products manufactured and labeled before January 1, 2028:
“[the warning symbol] WARNING: Cancer – www.P65Warnings.ca.gov.”
Manufacturers and retailers selling products in California containing listed chemicals should review their product labeling protocols, as non-compliance may result in an enforcement action. Some manufacturers have employed generic short-form warnings to forestall enforcement actions without determining whether their products actually exposed consumers to listed chemicals. This practice will not be effective after 2027.
Amended Acrylamide Warning Label
On January 1, 2025, OEHHA’s amendments to acrylamide warning label requirements took effect. The new regulation provides:
Warnings must now contain either:
“WARNING”
“CA WARNING”; or
“CALIFORNIA WARNING.”
The warning must be followed by either:
“Consuming this product can expose you to acrylamide;” or
“Consuming this product can expose you to acrylamide, a chemical formed in some foods during cooking or processing at high temperatures.”
The warning must also be followed by at least one of the following:
“The International Agency for Research on Cancer has found that acrylamide is probably carcinogenic to humans;”
“The United States Environmental Protection Agency has found that acrylamide is likely to be carcinogenic to humans;” or
“The United States National Toxicology Program has found that acrylamide is reasonably anticipated to cause cancer in humans.”
The warning may be followed by one or more of the following:
“Acrylamide has been found to cause cancer in laboratory animals”;
“Many factors affect your cancer risk, including the frequency and amount of chemical consumed”’ or
“For more information including ways to reduce your exposure, see www.P65Warnings.ca.gov/acrylamide.”
The newly amended warning language comes after years of ongoing litigation alleging that the previous warning mandate violated the First Amendment (California Chamber of Commerce v. Rob Bonta (2:19-cv-2019 DJC JDP)). Challengers allege that the warning remains unconstitutional as the state has failed to show that the warnings are purely factual and uncontroversial. As described below, the First Amendment is proving to be an effective defense in some circumstances.
Litigation Update: The Personal Care Products Council vs. Rob Bonta
In recent years, the First Amendment has served as a powerful tool for companies subject to Proposition 65 labeling requirements. A 2025 ruling in The Personal Care Products Council vs. Rob Bonta (2:23-cv-01006) will determine the legality of warning labeling requirements regarding titanium dioxide in consumer products. In 2025, the U.S. District Court for the Eastern District of California is poised to rule on the parties’ motions in the case. If the Court grants the Personal Care Products Council’s (PCPC) summary judgment motion, the ruling will have far-reaching impacts on the enforcement of Proposition 65, bolstering the First Amendment defense to Proposition 65 claims where there is a reasonable scientific debate about the hazards of the listed chemical.
The action was brought in 2023 by PCPC a non-profit association of businesses in the cosmetic and personal care products industry, which sued California Attorney General Rob Bonta in his official capacity.
On June 12, 2024, the District Court issued an Order granting PCPC’s request for a preliminary injunction enjoining Bonta and all private enforcers of Proposition 65 from filing new lawsuits to enforce the law’s warning requirement for exposures to titanium dioxide. The District Court agreed with PCPC that the “Prop 65 warning requirements for Listed Titanium Dioxide are not purely factual because they tend to mislead the average consumer” since the warnings may convey a “false and/or misleading message that Listed Titanium Dioxide causes cancer in humans or will increase a consumer’s risk of cancer.” This, according to the District Court, renders PCPC likely to prevail on the merits of its First Amendment claim under Zauderer v. Off. of Disciplinary Couns. of Supreme Ct. of Ohio, 471 U.S. 626 (1985) (government may compel commercial speech so long as it is reasonably related to substantial governmental interest, purely factual, noncontroversial, and not unjustified or unduly burdensome).
PCPC’s pending summary judgment motion was filed on September 10, 2024. If granted, this will be the third case successfully challenging Proposition 65 warnings on First Amendment grounds, with previous cases involving designated glyphosate and acrylamide. See Nat’l. Assoc. of Wheat Growers v. Bonta, 85 F.4th 1263 (9th Cir. 2023); Cal. Chamber of Comm. v. Bonta, 529 F. Supp. 3d 1099 (E.D. Cal. 2021).
Here, the District Court’s June 12, 2024 ruling dramatically halted the prosecution of countless pending claims against cosmetic companies and retailers of cosmetics. A favorable ruling for PCPC in 2025 may embolden companies subject to Proposition 65 requirements to bring an array of constitutional challenges with respect to other designated chemicals, specifically businesses selling products containing a designated chemical where the underlying scientific basis for its designation is controversial. The District Court’s language strongly casts doubt on the constitutionality of “misleading” Proposition 65 labels that lack an adequate scientific basis.
Extended Producer Responsibility (EPR) and Recycling
California continues to pave the way for EPR laws that affect various products. Rulemaking efforts will continue through 2025.
AB 863 – Carpets
Governor Newsom approved AB 863 on September 27, 2024, governing carpet recycling in California. California enacted its first carpet stewardship law in 2010 and has since amended it multiple times. The latest law maintains several basic facets and updates the governance structure of California’s current carpet stewardship program but nominally converts it to a carpet producer responsibility program following the expiration of the current 2023-2027 five-year carpet stewardship plan. The new law punts many specifics of the new program to the discretion of CalRecycle, including performance standards and metrics, key definitions, deadlines, and grounds for approving or revoking an approved plan. CalRecycle must adopt implementing regulations effective no earlier than December 31, 2026. The law purports to deem CalRecycle’s adopted “performance standards” as immune from judicial review under the California Administrative Procedure Act. The law also calls for certain amendments to the existing carpet stewardship plan to be proposed and adopted sooner.
The new law requires all carpet producers doing business in California to form and register with a single producer responsibility organization (PRO). The law requires the PRO to develop a producer responsibility plan for the collection, transportation, recycling, and safe and proper management of covered products in California, along with related public outreach regarding the plan; review the plan at least every five years after approval; and submit annual reports to CalRecycle. An approved plan must be in place within 24 months of the effective date of CalRecycle’s regulations under the new law, which may result in a deadline as early as December 31, 2028. All reports and records must be provided to CalRecycle under penalty of perjury. The law restricts public access to certain information collected for the purpose of administering this program.
The PRO must establish and provide a covered product assessment to be added to the purchase price of a covered product sold in the state by a producer to a California retailer or wholesaler or otherwise sold for use in the state. Each retailer and wholesaler is then required to add the assessment to the purchase price of all covered product sold in the state. This assessment of carpet sales in California parallels existing law. The new law does not specify any other available funding methods for implementing its requirements. The new law also requires the PRO to pay fees to CalRecycle, not to exceed CalRecycle’s actual and reasonable regulatory costs to implement and enforce the program. It further newly requires all carpet sold in California to contain 5% of post-consumer recycled carpet content by 2028, and grants CalRecycle authority to set new rates for 2029 and beyond.
Additionally, the new law requires carpet producers to provide additional information to CalRecycle regarding California carpet sales and compliance with the requirements of an approved plan. CalRecycle must post on its website a list of producers that are in compliance with the requirements of the program. The existing carpet stewardship plan must be amended to allocate 8% of collected assessments to unions for apprenticeship program grants. Compared to current law, penalties for violations increase from $5,000 per day to $10,000 per day, and from $10,000 per day to $25,000 per day if the violation is intentional, knowing, or negligent. CalRecycle may audit a carpet stewardship organization and individual producers annually The law also clarifies that a carpet stewardship organization cannot delegate decision-making responsibility regarding a carpet stewardship plan to a person who is not a member of the organization’s board.
SB 707 – Textiles
In September 2024, California’s legislature enacted the first, and only current, statewide EPR textile program in the U.S. with the Responsible Textile Recovery Act of 2024. The Act requires qualified producers of apparel or textile articles to form and join a PRO that CalRecycle will approve by March 1, 2026. All eligible producers must join the PRO by July 1, 2026. Once formed, the PRO must submit a statewide plan for the collection, transportation, repair, sorting, recycling, and the safe and proper management of covered clothing and textiles to CalRecycle for review. Once the plan is approved, retailers, importers, distributors, and online marketplaces will not be permitted to sell, distribute, offer for sale, or import a covered product into the state unless the producer of the covered product is listed as in compliance. The PRO will charge each participant-producer annual fees for its operation.
By July 1, 2030, or upon approval of the plan, whichever occurs first, noncompliant producers of covered products will be subject to administrative civil penalties up to $50,000 per day.
The Act directs CalRecycle to adopt regulations to implement its provisions with an effective date of no earlier than July 1, 2028. The rulemaking process will be carried out in accordance with California’s Administrative Procedure Act, which provides opportunities for the public, including industry representatives, to shape the policy going forward. Rulemaking efforts associated with SB 707 are not yet listed on CalRecycle’s website, but given the short deadlines imposed by the Act, we can expect updates in the near future.
AB 187 – Mattresses
California’s legislature established the Used Mattress Recovery and Recycling Act (Mattress EPR Act) in 2013 and most recently updated it in 2019. The Mattress EPR Act, which CalRecycle administers, applies to manufacturers, renovators, distributors, and retailers that sell, offer for sale, or import a mattress into California. At least once every five years, the mattress recycling organization reviews the plan for the recovery and recycling of used mattresses and determines whether amendments are necessary. Each year, CalRecycle, through the Mattress Recycling Council, posts lists of compliant manufacturers, renovators, and distributors on its website. If the manufacturer, brand, renovator, or distributor is not on this list, no retailer or distributor may sell a mattress in the state until the department affirms they are in compliance.
CalRecycle may impose an administrative civil penalty of not more than $500 per day on any manufacturer, mattress recycling organization, distributor, recycler, renovator, or retailer violating the Mattress EPR Act. However, if the violation is intentional, knowing, or reckless, the department may impose an administrative civil penalty of not more than $5,000 per day.
SB 551 – Beverage Containers
SB 551, or the California Beverage Container Recycling and Litter Reduction Act, took effect on September 29, 2024 as an urgency statute, necessary for the immediate preservation of the public peace, health, or safety within the meaning of Article IV of the California Constitution. Plastic beverage containers sold by a beverage manufacturer must contain a specified average percentage of post-consumer recycled plastic per year. Manufacturers of beverages sold in a plastic beverage container subject to the California Redemption Value fee must report to CalRecycle certain information about the amounts of virgin plastic and post-consumer recycled plastic used for those containers for sale in California in the previous calendar year. The law authorizes certain beverage manufacturers to submit a consolidated report to CalRecycle with other beverage manufacturers, in lieu of individual reports, if those beverage manufacturers share rights to the same brands or the products of which are distributed, marketed, or manufactured by a single reporting beverage manufacturer. This consolidated report must be submitted under penalty of perjury and pursuant to standardized forms prescribed by CalRecycle.
SB 54 – Plastics and Packaging
At the start of this year, CalRecycle was required to adopt any necessary regulations to implement and enforce its Plastic Pollution Prevention and Packaging Producer Responsibility Act (SB 54). SB 54 imposes EPR on “producers” of packaging materials for achieving the source reduction, recyclability or composability, and recycling rates for their products. Producers may comply with SB 54’s requirements by either joining the Circular Action Alliance (CAA), the PRO selected by the state to administer SB 54, or through assuming individual responsibility for compliance.
CalRecycle met its regulation deadline under SB 54 by publishing the Source Reduction Baseline Report on December 31, 2024, followed by updates to the list of Covered Material Categories regulated by SB 54 on January 1, 2025. The updates to the Covered Material Categories include an increase in materials considered to be “recyclable” or “compostable” while the Source Reduction Baseline Report establishes a baseline measurement for the Department and CAA to define source reduction targets, develop plans and budgets, and the track progress of SB 54’s implementation.
On January 1, 2025, SB 54’s prohibition on the sale, distribution, or importation of expanded polystyrene (EPS) food service items—unless the producer can demonstrate that all EPS used in the state meets a recycling rate of least 25%—went into effect. EPS food service producers may now be subject to notices of violation from CalRecycle and enforcement of penalties for noncompliance of up to $50,000 per violation, per day. Recycling rate mandates for plastic-covered materials do not go into effect until 2028.
SB 1143 – Paint
In September 2024, California enacted SB 1143, which expands the state’s existing Architectural Paint Recovery Program to include a wider range of paint products. “Paint product” is now defined to include interior and exterior architectural coatings, aerosol coating products, nonindustrial coatings, and coating-related products sold in containers of five gallons or less for commercial or homeowner use.
The law tasks CalRecycle with administering the program and approving a stewardship plan for the newly covered paint products. Retailers, importers, distributors, and online marketplaces will be prohibited from selling, offering for sale, or importing these products in California unless the producers are in compliance with the stewardship plan. Producers may comply with SB 1143 requirements by either joining PaintCare, the only recognized paint stewardship organization representing paint manufacturers in California, or through assuming individual responsibility for compliance.
All eligible products must comply with the new requirements by January 1, 2028, or an earlier date set by an approved stewardship plan. By July 1, 2030, or upon approval of the plan, whichever comes first, noncompliant producers will face administrative civil penalties up to $50,000 per day.
Climate Regulation
SB 261 and SB 253
After a year of uncertainty driven by budget constraints, California seems poised to implement its climate disclosure laws (SB 261 and SB 253) that were first passed in 2023. In September 2024, the Legislature passed SB 219, which granted the California Air Resources Board (CARB) a 6-month extension to issue the requisite rules that must be adopted by no later than July 1, 2025. CARB is responsible for administering SB 261 and SB 253.
On December 16, 2024, CARB posted an Information Solicitation that calls for public comments on the implementation of the laws and related issues. The Information Solicitation also invites input on key aspects of the climate disclosure framework that have been subject to speculation since the laws were enacted, such as the definition of “entity that does business in California” (clarifying the cohort within the scope of the laws); the methods for measuring and reporting scope 1, scope 2, and scope 3 emissions; and third-party verification and assurance requirements. The deadline to submit comments through CARB’s website is February 14, 2025.
Cal Chamber v. CARB
On January 30, 2024, the U.S. Chamber of Commerce and other business groups filed Chamber of Commerce of the United States of America et al. v. California Air Resources Board (CARB) et al., No. 2:24-cv-00801 (C.D. Cal. 2024) challenging SB 253 and SB 261 for violation of the First Amendment, the Supremacy Clause, and the U.S. Constitution’s limitations on extraterritorial regulation, including the dormant Commerce Clause.
Regarding the First Amendment facial challenge, the Plaintiffs alleged the laws “compel companies to publicly express a speculative, noncommercial, controversial, and politically-charged message that they otherwise would not express.” Concerning the Supremacy Clause, they argued that by requiring companies to make speculative public statements about emissions and climate-related financial risk, the laws enable “activists and policymakers to single out companies,” pressuring them to reduce emissions within and outside California. As for the constitutional claims, the Plaintiffs alleged that California lacks authority to regulate greenhouse gas emissions outside of the state and that the laws are invalid under the U.S. Constitution’s limitations on extraterritorial regulation because they heavily intrude on Congress’s authority to regulate interstate and foreign commerce.
To expedite the District Court’s ruling, the Plaintiffs moved for summary judgment on the First Amendment challenge. Simultaneously, CARB moved to dismiss the Plaintiffs’ Supremacy Clause and extraterritorial regulation claims. On November 5, 2024, the District Court denied the Plaintiffs’ motion. The Court held that the First Amendment applied to SB 253 and 261; however, it concluded that the constitutional challenge involves factual questions that go beyond pure legal analysis and thus, completing a “fact-driven task” was necessary to decide which of the laws’ applications violate the First Amendment. It held that further discovery is required to complete this “fact-driven” task.
The District Court indicated that it would address CARB’s motion to dismiss in a separate order. That motion is pending as of the date of this publication.
SB 1383 – Organic Waste & Food Collection
Since CalRecycle adopted regulations implementing SB 1383, California communities have made progress in diverting and reducing the disposal of organic waste and thereby reducing the amount of methane emissions from landfills. According to California’s Short-Lived Climate Pollutant Reduction Strategy, 93% of jurisdictions with requirements for collection reported having residential organics collection, and 100% of California communities expanded programs to send still-fresh, unsold food to Californians in need, reducing the waste large food businesses send to landfills every year. Through SB 619, 126 jurisdictions have been granted additional time to comply with SB 1383 regulations.
While progress has been made, local jurisdictions continue to struggle to meet the law’s mandates (namely, reduce organic waste disposal by 75% and reduce edible food waste by 20% by 2025). Rather than revising those mandates or pausing the implementation of SB 1383 to ensure jurisdictions weren’t sanctioned for missing implementation deadlines, the legislature enacted a number of laws to address some of the concerns raised by the regulated community. These include SB 2902, AB 2346, and SB 1046.
SB 2902 extends the rural jurisdiction exemption to comply with organics collection and procurement requirements until January 1, 2027. AB 2346 allows jurisdictions to count specified compost products toward their goals and adopt a five-year procurement target instead of annual goals, and SB 1046 directs CalRecycle to create a programmatic environmental impact report for small to medium composting facilities, aiding local governments and composters by streamlining permitting.
Although CalRecycle initiated formal enforcement actions in 2024, there is no indication that the agency has fined or sanctioned any jurisdiction for non-compliance. As the 2025 target date has now passed, expect enforcement efforts to increase in the months and years ahead.
Energy Efficiency Standards
As covered in our December 10, 2024 news alert, manufacturers and sellers of consumer products in California should be aware that the California Energy Commission continues to bring more enforcement actions and assess large civil penalties for violations of its Title 20 Appliance Efficiency Program. At a time when federal appliance efficiency standard enforcement is expected to recede due to the recent presidential election and imminent transition, California enforcement is likely to continue to grow. Regulated businesses, therefore, should pay increasing attention to Title 20 compliance, not only to avoid large fines but also to ensure continued access to their products in the lucrative California market.
Stationary Source Regulation
AB 1465 – Air Quality Management Districts (AQMDs) Granted Authority to Seek Triple Penalties
For years, the penalty ceilings in California’s Health & Safety Code have limited the ability of California’s regional AQMDs to collect civil penalties for rule violations. Starting January 1, 2025, AB 1465 tripled these ceilings. For example, the typical maximum penalty for strict liability violations—previously $12,090 per violation—has escalated to $36,270 per violation. The new law also requires that air districts (or a court) consider items like health impacts and community disruptions when evaluating penalty amounts (in addition to other factors required to be considered by law). These elevated ceilings only apply to stationary sources that have a Federal Clean Air Act Title V permit and emit certain defined compounds. How air districts will wield this new authority has yet to be seen, but we expect to see increasing penalties for many sources as a result.
Indirect Source Rules Will Continue to be a Hot Topic
While regional air districts are generally limited in their legal authority to regulate mobile sources (that authority is reserved for California’s state air regulator, CARB), indirect source rules (regulation of stationary sources that attract emissions from mobile sources) have received renewed attention as a means by which air districts seek to curb air pollution. With the incoming Trump administration signaling its intent to limit California’s ability to regulate mobile sources, air districts will likely be incentivized to find creative ways to indirectly regulate mobile sources within their districts.
In 2024, the South Coast AQMD received U.S. Environmental Protection Agency (EPA) approval to include such an indirect source rule (ISR) for warehouses as part of its state implementation plan. South Coast AQMD also adopted an ISR in 2024 applicable to rail yards and has been working on a rule applicable to ports for years, which it promises to bring before its board for approval in 2025.
Perhaps observing the South Coast AQMD’s recent ISR adoptions, the Bay Area AQMD also included an ISR in its 2025 rulemaking forecast. However, exactly what such a rule for this district might look like or what source it might seek to regulate remains to be seen.
New National Ambient Air Quality Standard for PM 2.5 Will Likely Drive Rulemaking Activity
California’s major regional air quality districts (the Bay Area AQMD, the South Coast AQMD, and the San Joaquin Valley Air Pollution Control District) have jurisdiction over areas considered to be in non-attainment of national standards regarding particulate matter (PM) 2.5. Areas in persistent non-attainment status risk federal sanctions and the loss of federal highway funding. In early 2024, EPA tightened the PM 2.5 standards even further. As a result, some air districts may consider rulemakings designed to reduce PM2.5 pollution within their jurisdictions. Given that mobile sources are a major contributor of this pollutant, ISR options may become even more appealing in 2025 and beyond.
Mobile Source Regulation
The Clean Air Act preempts states from adopting their own emission standards for new motor vehicles and new motor vehicle engines. However, Section 209 of the Clean Air Act allows California to set its own emissions standards if EPA grants a waiver from the federal preemption or EPA authorizes California to enforce its own standards despite the preemption. In the past year, CARB submitted requests for waiver or authorization for several regulations.
Advanced Clean Fleets Regulation – This regulation applies to trucks performing drayage operations at seaports and railyards; fleets owned by State, local, and federal government agencies; and high-priority fleets that are entities that own, operate, or direct at least one vehicle in California and that have either $50 million or more in gross annual revenue, or that own, operate, or have common ownership or control of a total of 50 or more vehicles. The regulation imposes restrictions on purchasing internal combustion engines, requires fleet owners to phase in zero-emission vehicles (ZEVs) or near-ZEVs beginning in 2024, and imposes reporting and recordkeeping requirements on fleet owners and operators. On January 13, 2025, CARB withdrew the request for waiver and authorization. In a response letter, EPA stated that it, therefore, “considers the matter closed.”
In-Use Locomotive Standards – The regulation has four primary, interrelated components: (1) imposes restrictions on the operation of any locomotive that is “23 years or older” from the original engine build date unless the locomotive exclusively operates in zero-emission configuration within California; (2) requires railroads to make annual deposits into a “Spending Account” based on the locomotive’s emissions in California in the prior year and imposes restrictions on the use of funds in the “Spending Account”; (3) imposes idling requirements that would regulate a locomotive’s function and maintenance; and (4) imposes registration, reporting, and recordkeeping requirements, including the requirement to annually report emissions information for non-zero emissions locomotives. On January 13, 2025, CARB withdrew the request for waiver and authorization. By response letter, EPA stated it therefore “considers this matter closed.”
Amendments to the Small Off-Road Engines Regulations – The amendments include improvements to evaporative emissions certification procedures, revise the compliance testing procedure, update the evaporative emissions certification test fuel to represent commercially available gasoline, and align aspects of the regulation requirements with the corresponding federal requirements. EPA granted the authorization request on December 19, 2024.
The “Omnibus” Low NOx Regulation – The regulation establishes the next generation of exhaust emission standards for nitrogen oxides (NOx), PM, and other emission-related requirements for new 2024 and subsequent model year on-road medium- and heavy-duty engines and vehicles. EPA granted the authorization request on December 17, 2024.
Advanced Clean Cars II Program – The regulations amend the Zero-emission Vehicle Regulation to require an increasing number of ZEVs and amends the Low-emission Vehicle Regulations to include increasingly stringent particulate matter, Nox, and hydrocarbon standards for gasoline cars and heavier passenger trucks to continue to reduce smog-forming emissions. EPA granted the authorization request on January 6, 2025.
Amendments to California’s In-Use Off-Road Diesel-Fueled Fleets regulation – The amendments will require fleets to phase out use of the oldest and highest polluting offroad diesel vehicles in California, prohibit the addition of high-emitting vehicles to a fleet, and require the use of R99 or R100 renewable diesel in off-road diesel vehicles. EPA granted the authorization request on January 3, 2025.
If the current EPA administration does not grant the pending waiver requests, then it is unclear how EPA under the Trump administration will decide on the waiver requests. Our November 6, 2024 news alert discusses these waiver issues in more detail.
CARB also enacted the zero-emission forklift regulation on August 2, 2024. The regulation accelerates the transition towards zero-emission forklifts by restricting fleet operators/owners from owning, possessing, and operating Large Spark Ignition (LSI) forklifts starting on January 1, 2026, and requiring fleet operators to phase out Class IV LSI forklifts of any rated capacity, as well as Class V LSI Forklifts with rated capacity less than 12,000 pounds according to the compliance schedule in the Regulation. These forklifts will need to be phased out by January 1, 2038.
Cal/OSHA Developments
Cal/OSHA Lead Exposure Regulations
The California Division of Occupational Safety and Health’s (Cal/OSHA) updated lead standards, which were approved on February 15, 2024, and went into effect on January 1, 2025. These apply to both general and construction worksites and replace standards that are decades old, based on data from over 40 years ago. The amended standards modify the permissible exposure limit (PEL), action level (AL), workplace hygiene practices, and medical surveillance requirements relating to lead in the workplace.
The reduction of the PEL and AL is significant; the threshold that triggers various regulatory requirements is now considerably lower. Many new industries will likely be covered. The PEL is now 10 µg/m3 (8-hour-time weighted average), an 80% reduction from the earlier PEL (50 µg/m3). The AL is now 2 µg/m3, a 93% drop from the prior AL (30 µg/m3).
Regulations for General Industry now define certain tasks as “Presumed Significant Lead Work” (PSLW). Until employers perform an employee exposure assessment, they are required to provide employees performing PSLW with interim protections.
For the construction industry, the regulations also define various “trigger tasks” levels, which assume a certain level of employee exposure. These “triggers” require protective measures for employees performing these tasks until an employee exposure assessment is completed.
Cal/OSHA Silica Emergency Temporary Standard
Cal/OSHA stated that California is experiencing a “silicosis epidemic” among artificial stone fabrication workers. In December 2023, the Occupational Safety and Health Standards Board (OSHB) approved the Emergency Temporary Standard (ETS) on Respirable Crystalline Silica (RCS) in response to these circumstances. The ETS intends to protect employees working with artificial and natural stone containing more than 10% crystalline silica. Additional protections apply to workers performing “high exposure trigger tasks.”
On December 19, 2024, OSHB voted unanimously to make the Silica ETS permanent. The decision is a step towards making these emergency measures permanent. The current proposal continues the protections the ETS has introduced, with some changes. These include a new medical removal subsection and updates to the medical surveillance subsection.
The proposed medical removal provisions provide protections to employees when a physician or other licensed healthcare professional (PLHCP) recommends that they be removed from a job assignment or that the job be modified to reduce exposure to RCS. The proposed updates to the medical surveillance provisions include specific medical procedures to be conducted for the required initial and periodic examinations. PLCHPs and specialists would also be required to submit certain information to the California Department of Public Health for each silica medical examination conducted.
The Office of Administrative Law has 30 days to approve or deny the proposal. We expect a decision in mid-January 2025.
Cal/OSHA Increases Staffing for Its Bureau of Investigations Unit
In August 2024, Cal/OSHA announced that it had increased staffing for its Bureau of Investigations (BOI) unit. Cal/OSHA says this would “allow BOI to tackle more cases and ensure that the most negligent of employers are held accountable.”
The BOI is responsible for investigating employee fatality and serious injury cases, and preparing and referring cases to local and state prosecutors for criminal prosecution. Cal/OSHA was criticized in early 2024 for the short-staffed status of BOI. Given the recently enhanced staffing, employers should expect that BOI investigations will likely increase in 2025.
Bird Flu
On December 18, 2024, Governor Newsom declared a state of emergency for Avian influenza (H5N1) (“bird flu”) in California. On December 27, 2024, the Division of Workers’ Compensation (DWC) advised employers and healthcare professionals to look for occupational cases of bird flu. There have been no cases of human-to-human transmission in California—nearly all affected persons had exposure to infected cattle. In light of DWC’s recommendations, employers should nevertheless review Cal/OSHA’s guidance on bird flu for employers.
Water Rights, Tribal Issues, Public Lands, Endangered Species
Threatened Species Listing of Monarch Butterfly
On December 12, 2024, the U.S. Fish and Wildlife Service (FWS) proposed listing the monarch butterfly as a threatened species with a special section 4(d) rule under the Endangered Species Act (ESA). The special 4(d) rule would provide very narrow exemptions to the ESA’s broad prohibition on unauthorized take for certain types of activities that may otherwise impact the species. FWS also proposed designating nearly 4,500 acres in California as critical habitat that would extend from the California Bay Area’s Marin County down the state’s western coast to Ventura County north of Los Angeles.
If finalized as proposed, this listing would stand as the largest listing decision in ESA history, affecting the entire lower forty-eight states. FWS is receiving public comment through March 12, 2025.
Central Valley Project and State Water Project
The U.S. Bureau of Reclamation (Reclamation)’s Central Valley Project (CVP), which is operated jointly with the California Department of Water Resources’ State Water Project (SWP), manages the collection, storage, and transport of many millions of acre-feet of water through the Central Valley for delivery to irrigators and municipalities and to meet state and federal ecological and species requirements. In 2018, California finalized revisions to its Water Quality Control Plan for the San Francisco Bay and San Joaquin-Sacramento River Delta (Bay-Delta) to require that more flows from the San Joaquin and Sacramento Rivers would reach the Bay-Delta for water quality and fish and wildlife enhancement, accordingly reducing water supplies for agricultural irrigators. In 2019, the previous Trump administration responded by committing to increasing CVP water supplies for agricultural users through changes to long-term operations of the CVP, pursuant to a 2019 ESA biological opinion or “BiOp.”
These ESA changes were promptly challenged by California and environmental organizations as insufficiently protective of Bay-Delta salmon and smelt populations, habitats, and spawning activities. They were first enjoined by federal court and later remanded to the National Marine Fisheries Service (NMFS) and FWS under the Biden administration. The cases were stayed during NMFS and FWS’s reconsideration of new CVP and SWP operating rules, in favor of an interim operations plan (IOP), which was extended through December 2024 to allow for the issuance of new CVP and SWP BiOps. See March 28, 2024 Order in Pacific Coast Federation of Fishermen’s Associations v. Raimondo, Civ. Nos. 20-00426, -00431 (E.D. Cal.). On December 20, 2024, on the verge of another change in administration, Reclamation issued its Record of Decision for the “Long-Term Operation of the Central Valley Project and State Water Project” based on 2024 BiOps, to mixed reviews from environmentalists and water users alike. It is likely that these new “California water rules” will spark new rounds of both litigation challenges and regulatory reconsideration in 2025.
Yurok Tribe v. Klamath Water Users Association
In this appeal before the Ninth Circuit (Nos. 23-15499 and 23-15521, consolidated), the Klamath Water Users Association (KWA) and Klamath Irrigation District (KID) sought review of a 2023 federal district court decision holding that an Oregon Water Resources Department (OWRD) order prohibiting Reclamation from releasing stored water subject to adjudicated irrigation rights from Upper Klamath Lake to protect and restore endangered fish species was preempted by the ESA. KWA and KID had sought declaratory relief that the ESA does not authorize Reclamation to release water from Upper Klamath Lake, arguing that the case does not involve any issue of preemption, because Reclamation does not have authority under its enabling act to appropriate rights to use water in violation of Oregon law, and the ESA does not expand these Reclamation authorities. OWRD subsequently withdrew its order.
The Ninth Circuit heard oral argument on June 12, 2024, but the court, just prior to the hearing, indicated that it perceived potential jurisdictional issues due to the OWRD withdrawal having mooted the initial challenge to its order. At oral argument, KID urged the court to certify key questions to the Oregon Supreme Court concerning Reclamation’s authority to use and control the use of water under Oregon law, arguing that Oregon’s water rights and laws governing the use and control of water in Upper Klamath Lake were established long before the ESA was enacted, that Section 8 of the Reclamation Act mandates compliance with state water law and water rights, and that controlling precedent makes clear that state law governs whether Reclamation has authority or discretion to meet its ESA obligations using stored irrigation water subject to adjudicated water rights. Therefore, these state law questions should be addressed independently of the federal question of Reclamation’s ESA obligations and their preemptive consequences. Briefing on KID’s motion for certification continued into December 2024, so a Ninth Circuit ruling on the merits, or as to whether the questions will proceed for now in state or federal court, can be expected in 2025.
Water
On November 20, 2024, EPA Region 9 published in the Federal Register its Final Designation of formerly unregulated stormwater discharges from commercial, industrial, and institutional (CII) properties for required National Pollutant Discharge Elimination System (NPDES) stormwater permitting. The designation applies to CII facilities consisting of five or more acres of impermeable surfaces (in the case of unpermitted facilities) or five or more total acres (in the case of unpermitted portions of facilities already holding a NPDES permit and no exposure certificate, and in the case of non-notice of non-applicability (NONA) covered portions of facilities with a NONA) in two watersheds in the Los Angeles County area. This expansion of stormwater regulation is a joint effort between EPA Region 9 and the Los Angeles Regional Water Quality Control Board. The Water Board prepared the corresponding draft CII General Permit and is expected to hold a public hearing on the draft permit now that EPA’s designation is final.
The incoming Trump administration may reevaluate the Final Designation and consider rescinding it, but it may take some time for new EPA staffers to address this action. In the interim, it will be critical for parties adversely affected by the Final Designation to expeditiously seek judicial review—and a stay or preliminary injunction—to protect their interests.
Additional Authors: Gary J. Smith, Patrick J. Redmond, Leticia E. Duarte, Sara M. Eddy, Gabriela Espir, Jeremy D. Faulkner, Nicole L. Garson, Ragini Gupta, Lauren M. Lankenau, Sharon Mathew, Claire S. McLeod Ruiz, Lauren M. Murvihill, and Megan V. Unger
Ceramtec GMBH v. Coorstek Biocermanics LLC
This case examines the application of trademark functionality doctrine in the medical device industry, specifically addressing whether the pink color of ceramic hip components can be protected as a trademark. The case provides important guidance on how courts evaluate functionality claims and the intersection between patent and trademark protection for product features.
Background
Ceramtec manufactures artificial hip components using zirconia-toughened alumina (“ZTA”) ceramic material containing chromium oxide (chromia). The chromia gives their products, marketed under the name “Biolox Delta,” a distinctive pink color. Prior to seeking trademark protection, Ceramtec held U.S. Patent 5,830,816 covering their ceramic composition, which expired in January 2013.
In January 2012, Ceramtec applied for two trademarks claiming protection for the color pink used in ceramic hip components. The marks were registered on the Supplemental Register in April 2013, covering both a “hip joint ball” and an “acetabular shell or fossa.”
Coorstek, a competitor in the medical implant market, manufactures two different ZTA ceramic materials: CeraSurf-p, which contains chromia and is pink, and CeraSurf-w, which does not contain chromia and is white. On March 3, 2014, Coorstek filed both a lawsuit in the District of Colorado and a cancellation petition with the Trademark Trial and Appeal Board (TTAB), arguing that the pink color was functional and therefore ineligible for trademark protection.
The TTAB ruled in favor of Coorstek, finding that the pink color was functional and cancelling Ceramtec’s trademark registrations. The Board based its decision on evidence from Ceramtec’s expired patent and their technical publications showing that chromia provided material benefits to the ceramic components. Ceramtec appealed this decision to the Federal Circuit, challenging both the Board’s functionality finding and its handling of the unclean hands defense.
Issue(s)
Whether the pink color of Ceramtec’s ceramic hip components is functional and thus ineligible for trademark protection.
Holding
The Federal Circuit affirmed the TTAB’s decision canceling Ceramtec’s trademarks, finding that the pink color was functional and therefore not eligible for trademark protection.
Reasoning
The Federal Circuit’s analysis centered on the Morton-Norwich factors, a four-part test established in In re Morton-Norwich Products, Inc. that courts use to determine whether a product feature is functional. These factors examine: (1) the existence of a utility patent disclosing the utilitarian advantages of the design; (2) advertising materials in which the originator of the design touts its utilitarian advantages; (3) the availability to competitors of functionally equivalent designs; and (4) facts indicating the design results in a comparatively simple or cheap method of manufacturing.
Applying these factors to Ceramtec’s case:
The court found that Ceramtec’s expired patent disclosing the use of chromia in ZTA ceramics provided strong evidence that the pink color was functional, as it resulted from a feature that provided material benefits.
The court considered Ceramtec’s advertising materials and public communications, which disclosed that chromia provides material benefits to the ZTA ceramics, further supporting functionality.
Regarding the availability to competitors, the court found no evidence that alternative designs would work as well, making this factor neutral in the analysis.
The court determined that evidence about manufacturing costs and methods was inconclusive and treated this factor as neutral.
Particularly significant was the relationship between Ceramtec’s expired patent and their trademark claims. The court emphasized that features previously protected by a patent cannot later be protected through trademark law if they are functional, as this would effectively extend patent protection indefinitely.
The court also rejected Ceramtec’s argument that the Board improperly applied the “unclean hands” doctrine, finding that the Board properly considered the public interest in removing registrations for functional marks from the trademark register.
Through this decision, the Federal Circuit reinforced the principle that functional product features, even if they create a distinctive appearance, cannot be protected as trademarks when they serve a utilitarian purpose essential to the product’s use or manufacture.
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(US) Fifth Circuit Puts Serta Simmons Uptier Transaction to Bed
On December 31, 2024, the U.S Court of Appeals for the Fifth Circuit issued a unanimous decision reversing the bankruptcy court’s ruling that allowed an uptier transaction entered into by Serta Simmons Bedding, LLC (“Serta Simmons”) in 2020 (the “2020 Uptier”). The appellate court also held that plan provisions requiring the indemnification of the lenders who participated in the 2020 Uptier (“Prevailing Lenders”) were impermissible under the U.S. Bankruptcy Code and should be excised from the plan.
The use of uptier transactions by distressed borrowers has increased dramatically over recent years, spurred by the marked increase in distressed companies during the COVID-19 pandemic. The 2020 Uptier was one of the first major uptier transactions and was controversial from its inception because it resulted in the subordination of a majority of creditors’ interests. Typically, in an uptier transaction, a borrower will issue new superpriority debt under an existing credit facility, consented to by the majority of lenders, in exchange for giving those lenders’ debt superior status. Such transactions earned their name because new debt is “uptiered,” subordinating the existing debt of lenders who were not party to the uptier transaction. This is what occurred with the 2020 Uptier—the Prevailing Lenders were able to uptier their loan, with the remaining lenders (“Excluded Lenders”) recovering little on their claims in the restructuring.
Background
Serta Simmons is the world’s leading producer of mattresses and other bedding products. It entered into a 2016 credit agreement with certain lenders which provided it with a $1.95 billion first lien term loan credit facility (“2016 Agreement”). Among the various provisions, the 2016 Agreement mandated pro rata sharing among the lenders, a background norm in corporate finance that requires a borrower to proportionately allocate its repayments based on the lenders’ percentage interest in the outstanding debt. The 2016 Agreement included exceptions to the ratable sharing provision that “any lender may, at any time, assign all or a portion of its rights and obligations under this Agreement in respect of its Term Loans to any Affiliated Lender on a non-pro rata basis (A) through Dutch Auctions[1] open to all Lenders holding the relevant Term Loans on a pro rata basis or (B) through open market purchases, in each case with respect to clauses (A) and (B), without the consent of the Administrative Agent.” The term “open market purchase” was not defined in the 2016 Agreement.
Later, facing liquidity issues during the COVID-19 pandemic, Serta Simmons entered into the 2020 Uptier with its Prevailing Lenders holding first-lien and second-lien debt. The 2020 Uptier: (i) provided Serta Simmons with $200 million in new financing in exchange for $200 million first-out superpriority debt; and (ii) traded $1.2 billion of first-lien and second-lien loans for $875 million in second-out superpriority debt. To facilitate the 2020 Uptier and to deal with anticipated future litigation, Serta Simmons amended the 2016 Agreement in order to allow it to issue new priming debt, labeled the 2020 Uptier an “open market purchase” within the meaning of section 9.05(g) of the 2016 Agreement, and agreed to indemnify the Prevailing Lenders for all losses, claims, damages, and liabilities in connection with their participation in the 2020 Uptier (“Prepetition Indemnity”).
Despite the 2020 Uptier, Serta Simmons’ financial condition continued to deteriorate. Subsequently, on January 23, 2024, Serta Simmons and 13 affiliated debtors (together, the “Debtors”) filed for chapter 11 protection in the Bankruptcy Court for the Southern District of Texas (“Bankruptcy Court”). The Bankruptcy Court entered an order confirming the Debtors’ Second Amended Joint Chapter 11 Plan (“Plan”) on June 14, 2023. The Plan was subject to a number of objections, including objections to an indemnity provision that baked the provisions of the Prepetition Indemnity into the plan (“Plan Indemnity”), but was ultimately confirmed and went effective on June 29, 2023.
The 2020 Uptier Was Not a Valid Open Market Purchase
The 2020 Uptier was met with resistance from Excluded Lenders and other creditors. In response, the Debtors and Prevailing Lenders filed an action for declaratory relief on January 24, 2023, seeking the Bankruptcy Court’s approval of the 2020 Uptier through a declaration that it did not violate the pro-rata sharing provisions in the 2016 Agreement and did not violate the implied covenant of good faith and fair dealing.[2] On February 24, 2023, the Debtors and Prevailing Lenders each filed a motion for summary judgment, arguing inter alia that: (i) the term “open market purchase” under the 2016 Agreement included debt exchanges in which not all lenders are invited to participate; (ii) the inclusion of “non-pro rata” in section 5.09(g) of the 2016 Agreement reflects an intention that open market purchases need not be open to all; (iii) the Debtors undertook a robust marketing process to obtain the best price possible; and (iv) therefore, the 2020 Uptier was a valid open market purchase under the 2016 Agreement.[3]
Former Bankruptcy Judge David Jones granted partial summary judgment in favor of the Debtors and the Prevailing Lenders, finding that the 2020 Uptier was an open market purchase and permitted under the 2016 Agreement. In so finding, Judge Jones found that there was no ambiguity in the meaning of “open market purchase” in section 9.05(g) of the 2016 Agreement, and that the 2020 Uptier fit within the definition because there was no evidence of any coercion or manipulation in the transaction.
On appeal, the Fifth Circuit reversed the Bankruptcy Court’s decision, finding that the 2020 Uptier was not a permitted open market purchase under the 2016 Agreement. The appellate court rejected the expansive definition of “open market purchase” proffered by the Debtors, because its application would mean that short of coercing one of the lenders, the Debtors could call any arms-length transaction an open market purchase.[4] Additionally, according to the Fifth Circuit, an open market is “a specific market that is generally open to participation by various buyers and sellers.”[5] This means that an open market purchase takes place on the market relevant to the purchased product, in this case being the secondary market for syndicated loans.[6] Instead of purchasing the loans on the secondary market, Serta Simmons privately engaged individual lenders outside of the secondary market, taking the 2020 Uptier outside the protection of section 9.05(g).[7]
The Bankruptcy Code Does Not Permit the Indemnification of Prevailing Lenders
The Excluded Lenders and a creditor, Citadel Equity Fund Ltd. (“Citadel”), objected to the Plan Indemnity, arguing that it allowed the Prepetition Indemnity to pass through the Plan in violation of sections 502(e)(1)(B) and 509(c) of the Bankruptcy Code.[8] Together, they argued, these provisions were enacted to ensure that a non-debtor co-obligor’s reimbursement claim could not be recovered prior to the full payment of the primary claim.[9] The Debtors’ Plan ran afoul of this legislative intention by allowing the contingent claims of co-obligors to pass through bankruptcy at the expense of the Excluded Lenders’ claims that would be discharged for almost no value.[10]
However, Judge Jones found that the Plan Indemnity was given to the Prevailing Lenders as part of a “basket of consideration” in exchange for the equitization of almost $1 billion in secured claims and the provision of DIP Financing.[11] According to Judge Jones, because the Plan Indemnity dealt with potential liability connected to participation in the 2020 Uptier, it was unsurprising that the Plan Indemnity’s language was virtually identical to that of the Prepetition Indemnity.[12] Therefore, the Plan Indemnity was valid as part of a plan settlement pursuant to section 1123(b)(3) of the Bankruptcy Code.
The Fifth Circuit reversed Judge Jones’ ruling, holding that the plan provisions that required the Debtors to indemnify the Prevailing Lenders were impermissible under the Bankruptcy Code. Initially, the court found that the issue was not equitably moot since the Plan Indemnity could simply be excised from the Plan without threatening the success of the Debtors’ reorganization.[13] Additionally, it was unclear which third parties would be harmed by excision, and while the Excluded Lenders and Citadel had been denied a stay of the confirmation order, such failure did not mandate finding an appeal equitably moot.[14]
Turning next to the merits, the Fifth Circuit found that the Plan Indemnity was “an impermissible end-run” around the Bankruptcy Code.[15] The court began its analysis with section 502(e)(1)(B) of the Bankruptcy Code, which requires bankruptcy courts to disallow contingent prepetition indemnification claims.[16] The Debtors attempted to avoid the section 502(e)(1)(B) ban by characterizing the Plan Indemnity as a valid settlement indemnity under section 1123(b)(3)(A). The Fifth Circuit rejected this argument because section 1123(b)(3)(A) only allows for a plan to settle or adjust certain claims or interests and does not expressly allow for “the back-end resurrection of claims already disallowed on the front end.”[17] The Plan Indemnity mirrored the terms of the Prepetition Indemnity and sought to protect the same group of lenders. On this basis, the Bankruptcy Court’s acceptance of the validity of the resurrected Prepetition Indemnity in the form of the Plan Indemnity was a “mistake.”[18]
Takeaways
The Fifth Circuit’s decision may potentially chill the market for uptier transactions as it takes a swing at a once-reliable option for struggling companies which relied on the general acceptance of open market purchase provisions. As for the rejected plan indemnities, interested lenders may be discouraged by the increased risks associated with uptier transactions. Litigation risk will now shift from debtors to lenders because equitable mootness under these circumstances will no longer provide an effective back-stop to litigation, and at least in the Fifth Circuit, the use of settlement indemnities containing terms identical or substantially similar to prepetition indemnities provided in uptier transactions will not be approved.
On the other hand, however, the market for uptier transactions may not be so strongly impacted because the decision is only binding in the Fifth Circuit, and it is unknown whether other jurisdictions will follow suit. Distressed companies and interested lenders may also get creative with the language in credit agreements moving forward to allow for such transactions. For example, in the Ocean Trails CLO VII v. MLN Topco Ltd. decision that was also handed down on December 31, 2024, the New York Appellate Court blessed an uptier transaction because it found that the terms of the credit agreement allowed for the purchase of loans on a non-pro-rata basis.[19] While the Fifth Circuit put the 2020 Uptier to bed, it remains to be seen whether other courts will follow suit.
[1] A Dutch auction is an auction in which property is initially offered at an excessive price that is gradually lowered until the property is sold. See Dutch Auction, Black’s Law Dictionary (12th ed. 2024).
[2] See Adversary Complaint(ECF No. 1), Serta Simmons Bedding, LLC, et al. v. AG Centre Street Partnership L.P. (In re Serta Simmons Bedding, LLC), Case No. 23-09001, (Bankr. S.D. Tex. Jan. 24, 2023).
[3] See Serta Simmons Bedding, LLC’s Motion for Summary Judgment(ECF No. 69), p. 18, Serta Simmons Bedding, LLC, et al. v. AG Centre Street Partnership L.P. (In re Serta Simmons Bedding, LLC), Case No. 23-09001, (Bankr. S.D. Tex. Feb. 24, 2023); Lender Plaintiffs’ Motion for Summary Judgment (ECF No. 73), pp. 3-4, Serta Simmons Bedding, LLC, et al. v. AG Centre Street Partnership L.P. (In re Serta Simmons Bedding, LLC), Case No. 23-09001, (Bankr. S.D. Tex. Feb. 24, 2023).
[4] Opinion (ECF No. 233), p. 33, Excluded Lenders v. Serta Simmons Bedding, LLC, (In re Serta Simmons Bedding, LLC), Case No. 23-20181, (5th Cir. Dec. 31, 2024)(“Opinion”).
[5] Id. at 29.
[6] Id.
[7] Id. at 32.
[8] In re Serta Simmons Bedding, LLC, Case No. 23-90020, 2023 WL 3855820, at *10 (Bankr. S.D. Tex. Jun. 6, 2023).
[9] Objection of the Ad Hoc Group of First Lien Lenders to the First Amended Joint Chapter 11 Plan of Serta Simmons Bedding, LLC and Its Affiliated Debtors(ECF No. 824), pp. 2, 13-16, In re Serta Simmons Bedding, LLC, Case No. 23-90020, (Bankr. S.D. Tex. May 11, 2023).
[10] Id.
[11] Id.
[12] Id.
[13] Opinion, at 40, 42-43.
[14] Id. at 41-42.
[15] Id. at 46.
[16] Id.
[17] Id. at 48.
[18] Id. at 47.
[19] Case No. 2024-00169 (N.Y. App. Div., 1st Dept., Dec. 31, 2024).
Considerations for Avoiding Waiving Contractual Rights to Collect Liquidated Damages
Liquidated damages clauses are inserted into contracts to establish a pre-determined amount of compensation to the non-breaching party where the damages may be difficult to calculate. A variety of circumstances may trigger liquidated damages, including when (1) a party fails to deliver goods on time (thereby causing a delay in production and/or lost sales); (2) a party abandons a lease before its expiration (thereby causing the owner to suffer lost rents and other costs until it obtains a replacement tenant); and (3) a contractor fails to complete a project on time (thereby delaying a new business location’s opening and causing the owner to incur lost profits).
Like all contract provisions, the non-breaching party’s words and/or conduct can waive liquidated damages provisions. To determine if a party has waived their ability to seek liquidated damages, courts consider (1) the contract’s terms and whether the moving party provided notice of the event that triggered the liquidated damages (if the contract requires notice), (2) the parties’ conduct, (3) contractual compliance for extensions, and (4) evidence of extension agreements.
The case U.S. Pipeline, Inc. v. N. Nat. Gas Co., 930 N.W.2d 460 (Neb. 2019) discusses the circumstances that can result in a waiver of rights to collect liquidated damages. In that case, the owner sought liquidated damages from the contractor after the contractor failed to complete the natural gas pipeline construction by the date of substantial completion specified in the contract. Rather than notify the contractor of its intent to enforce the liquidated damages clause, the owner worked with the contractor to develop a new schedule and directed the contractor to perform additional work after the deadline to achieve substantial completion. Importantly, however, the owner failed to provide the revised plans for the extra work for several weeks, thereby delaying the start of the extra work and causing further delays. The contractor performed the extra work and ultimately completed the project several months after the original deadline.
The owner sued the contractor for its delay in completing the project and sought to recover liquidated damages based on the total number of days the project was delayed (which an expert calculated to be a total of 141 days after the substantial completion date). The trial court denied the owner’s claim for liquidated damages, explaining that the owner waived its right to liquidated damages. The Supreme Court of Nebraska affirmed the trial court’s ruling, explaining that the owner’s decision to request the contractor to perform extra work after the date of substantial completion, combined with the owner’s failure to inform the contractor of its intent to seek liquidated damages, demonstrated that the owner intended to waive its right to these damages.
The court’s ruling serves as a powerful reminder that parties can waive their right to recover liquidated damages. Parties seeking to enforce their rights to collect liquidated damages should consider immediately sending written notice of their intent to collect liquidated damages to the other party after it has breached the contract. However, subsequent communications between the parties concerning requests from the owner to the contractor to perform extra work, or about steps the breaching party plans to take to cure the default and/or to mitigate the non-breaching party’s damages should be carefully drafted to avoid a claim that liquidated damages have been waived.
Tickled Pink No More – Federal Circuit Affirms Cancellation of CeramTec’s Trademarks for Pink Ceramic Hip Implants
Color trademarks have traditionally been difficult to obtain. Of the over 4 million trademark registrations, there were less than 1000 color trademarks as of 2019.[1] To be eligible for trademark registration, a color must have acquired distinctiveness and must not be functional. Recently, the Federal Circuit examined the functional component of the analysis and explained why it presents such a hurdle to registration—particularly when a party also obtains patent protection.
On January 3, 2025, the U.S. Court of Appeals for the Federal Circuit upheld the Trademark Trial and Appeal Board (TTAB) decision canceling trademarks claiming protection for the pink color of ceramic hip components.
CeramTec, a manufacturer of ceramic components for artificial hip implants, developed zirconia toughened alumina (ZTA) containing chromia, which imparts pink color and increased hardness. This material was protected under CeramTec’s U.S. Patent No. 5,830,816, which expired in January 2013. In 2012, CeramTec sought trademark protection for the pink color of its ceramic components. CoorsTek, a competitor, successfully petitioned the TTAB to cancel the trademarks, arguing that the pink color was functional.
On appeal, the Federal Circuit affirmed the TTAB decision, emphasizing that trademarks are not registrable or enforceable if the design is functional. The court analyzed the TTAB’s application of the Morton–Norwich factors to determine functionality:
the existence of a utility patent disclosing the utilitarian advantages of the design;
advertising materials in which the originator of the design touts the design’s utilitarian advantages;
the availability to competitors of functionally equivalent designs; and
facts indicating that the design results in a comparatively simple or cheap method of manufacturing the product.
CeramTec GmbH v. Coorstek Bioceramics LLC, No. 2023-1502, 2025 WL 29252 (Fed. Cir. Jan. 3, 2025).
The court also considered TrafFix Devices, Inc. v. Mktg. Displays, Inc., 532 U.S. 23 (2001), which establishes that utility patents are strong evidence of functionality. The Federal Circuit noted that the functionality doctrine ensures the public is free to use innovations after a patent expires.
Based on these findings, the court affirmed that CeramTec’s pink trademarks are functional and therefore ineligible for protection.
[1] Wang, Xiaoren, Should We Worry about Color Depletion? An Empirical Study of USPTO Single-color Trademark Registrations (January 18, 2022). Available at SSRN: https://ssrn.com/abstract=4011677 or http://dx.doi.org/10.2139/ssrn.4011677
Beachfront Boundaries: Regulatory Takings Clarified
Jones v. Town of Harwich involved a dispute over the application of the Wetland Protection Bylaw and Regulations in Harwich, Massachusetts (“Wetland Protection Regulations”). In 1958, Lois H. Jones (“Jones”) purchased two distinct lots separated by a private driveway. The lots were known as 5 and 6 Sea Street Extension (“5 Sea Street” and “6 Sea Street”). 5 Sea Street was, and remains, a vacant lot that abuts the ocean. 6 Sea Street is improved with a four-bedroom house. In 1999, Jones sold 6 Sea Street. The record in the case indicated that Jones long intended to construct a single-family dwelling on 5 Sea Street.
In 2011, Jones filed a Notice of Intent with the Harwich Conservation Commission, proposing construction of a single-family residence on 5 Sea Street. In 2012, the Commission issued a denial Order of Conditions. Later that year, the Massachusetts Department of Environmental Protection issued a Superseding Order of Conditions, denying the project under the Massachusetts Wetlands Protection Act. In 2013, the Town of Harwich changed the tax assessment designation associated with 5 Sea Street to “unbuildable” and reduced the assessed valuation from $1,434,500 to $24,000. In 2015,1 the DEP, Jones, and some abutters, reached a settlement, which included a Final Order of Conditions. Nonetheless, the Harwich Conservation Commission maintained its position that Jones’s proposed construction would violate the Wetlands Protection Regulations, as well as the state wetlands regulations, and denied approval.
Jones filed suit against the Town of Harwich in the U.S. District Court for the District of Massachusetts, alleging that the application of the Wetland Protection Regulations to 5 Sea Street constituted a regulatory taking, entitling her to compensation. The Town argued that Jones could only recover if the Wetland Protection Regulations were the “but for” cause of 5 Sea Street being unbuildable. The Town argued that since state wetlands regulations also precluded developing 5 Sea Street, the local Regulations could not be the but for cause of Jones’s harm, and therefore, she could not recover from the Town. The District Court rejected this argument on summary judgment because the record contained evidence that the DEP’s 2015 decision could be amended, and the project might be allowed under state wetland regulations.
Next, the Court applied the cornerstone Penn Central test to determine whether or not the Town’s application of the Wetlands Regulation could constitute a regulatory taking. Penn Central Transportation Co. v. City of New York, 438 U.S. 104, 124 (1978). The factors applied by the Court include: economic impact of the Regulations on the Plaintiffs; the extent to which the Regulations have interfered with distinct investment-backed expectations; and the character of the governmental action.
The District Court found that the significant decrease in the property’s value supported a substantial economic impact as a result of the Town’s Regulations. Additionally, the extent to which the Regulations interfered with investment-backed expectations was not appropriate for summary judgment because the parties presented competing arguments and evidence as to Jones’ intention to develop the property, and the alleged “windfall” that her estate would receive from development. Id., at 6. Finally, the District Court held that the character of the governmental action could be equivalent to a typical taking because the Regulations prevent any structure on the lot despite being generally applicable to all property.
Jones is a helpful reminder that application of local regulations may constitute a regulatory taking.
1 Jones passed away in 2014, but her estate continued her efforts to develop 5 Sea Street.
Appeals Court Shines Light on Solar Panel Protections
Kearsarge Walpole LLC v. Zoning Board of Appeals of Walpole involved a dispute over where a large-scale solar array could be placed in Walpole, Massachusetts. In Kearsarge, a solar developer (Kearsarge), along with Norfolk County Agricultural High School (Norfolk Aggie), and Norfolk County, entered into an agreement to construct a solar facility on the Norfolk Aggie campus, which is located in Walpole’s rural residential zoning district.
Kearsarge applied to the Walpole building commissioner for a building permit. The commissioner denied the permit, deeming the project a nonconforming use under Walpole’s zoning bylaw. The Walpole Planning Board upheld the commissioner’s decision, finding that the project was a nonconforming use and did not qualify for any exception from the Walpole zoning bylaw, which established that large-scale solar facilities be located within certain overlay districts. Kearsarge appealed to the Land Court, arguing that the project was exempt from Walpole’s restrictions pursuant to the “Solar Energy Provision” of G. L. c. 40A, § 3.1 Kearsarge also argued that the project was exempt under the “Education Provision” of G. L. c. 40A, § 3.2
The Land Court granted summary judgment in favor of Kearsarge, reasoning that the board’s decision indeed violated the Solar Energy Provision. However, the Land Court rejected Kearsarge’s assertion that the project constituted an educational use.
The Appeals Court affirmed the Land Court, applying the doctrine set forth in Tracer Lane II Realty, LLC v. Waltham, 489 Mass. 775, 781 (2022). Under Tracer Lane, the Court’s determination hinged on “whether the interest advanced by the ordinance or bylaw outweighs the burden placed on the installation of solar energy systems.” In Tracer Lane, the Court of Appeals ruled that Waltham’s near total ban on solar facilities (except in “one to two” percent of the city’s land area) constituted a violation of the Solar Energy Provision.
Here, Walpole argued that its zoning bylaw (which also restricted solar facilities to less than 2% of the town) was different than Waltham’s law given that the Waltham bylaw amounted to a blanket ban on solar facilities while the Walpole law allowed for expansion of the overlay districts wherein solar facilities were permitted. The Court rejected this argument holding that a town need not impose a blanket ban on solar facilities to violate the Solar Energy Provision. Rather, the Solar Energy Provision prohibits local ordinances that “unduly restrict . . . solar energy systems.” Walpole’s bylaw, by requiring “discretionary zoning relief” in order to construct solar facilities in all but 2% of the city constituted such an undue restriction – especially where expansion of the overlay districts would require an applicant to “petition to amend the Walpole zoning bylaws [by] submit[ing] their proposed amendment to a public hearing and town vote.” This, in the Court’s view was “a significant hurdle.” The Court also rejected Walpole’s argument that the interests advanced by its bylaw (protecting agriculture) promoted public health, safety, and welfare sufficient to justify that significant burden on solar development. According to the Court, “[t]he record . . . [did] not support a conclusion that a bylaw this stringent is necessary to protect the public health, safety, or welfare interests that Walpole seeks to promote.”
Kearsarge is another instance where the Appeals Court makes clear that Massachusetts courts will not hesitate to reign in local authority in the interest of enforcing the Solar Energy Provision.
1 Pursuant to Mass. Gen. Laws Ann. c. 40A, § 3, Ninth Paragraph, “[n]o zoning ordinance or by-law shall prohibit or unreasonably regulate the installation of solar energy systems or the building of structures that facilitate the collection of solar energy, except where necessary to protect the public health, safety or welfare.”
2 Under Mass. Gen. Laws Ann. c. 40A, § 3, Second Paragraph, “[n]o zoning ordinance or by-law shall regulate or restrict the interior area of a single-family residential building nor shall any such ordinance or by-law prohibit, regulate or restrict the use of land or structures for religious purposes or for educational purposes . . .”