tM...with workouts, foreclosures and servicing issues involving loan syndications and participations, senior/subordinate and mortgage/ mezzanine arrangements. I also represent asset

Winter 2009

From Consumer-Driven to struCtureD FinanCe: Covering the range oF FinanCial serviCes litigation With John Doherty, Frank Hirsch and Matt McGuire

Déjà vu all over again: Bank oFFiCers anD DireCtors PrePare For a rePlay oF litigation that FolloweD the savings anD loan Crisis

By Mary C. Gill, Mark C. Kanaly and Robert R. Long

how CaliFornia’s green Chemistry initiative will Change the gloBal Consumer eConomy

By Maureen F. Gorsen and Colin K. Kelly

Ricci v. DeStefano: what Does the suPreme Court’s DeCision mean For emPloyers?By Jesse M. Jauregui and Erin L. Connolly

CaliFornia aPPellate Court DeParts From ninth CirCuit By aPPlying the FeDeral government ContraCtor DeFense to state ProDuCts liaBility Claims Brought against manuFaCturers oF government-ProCureD non-military equiPment

By Stephanie A. Jones and J. Andrew HowardAtlanta · Charlotte · Dallas · Los Angeles · New York · Research Triangle · Silicon Valley · Ventura County · Washington, D.C.

www.alston.com

in Litigation trendstM

• • •

In Trends, we seek to highlight developments in the law and Alston & Bird’s litigation practice. This edition covers both topics. Financial institutions faced unprecedented challenges this year. Our first two pieces in this edition of Trends address how we are assisting our clients in this arena. First, there is an interview with important new additions to the Alston & Bird team—John Doherty, Frank Hirsch and Matt McGuire—concerning their cutting edge financial institution practices and the evolving state of the relevant law. Next, Mary Gill, Mark Kanaly and Robert Long examine the potential challenges that bank directors and officers face in light of the financial crisis.

The remaining three articles are also timely. Maureen Gorsen and Colin Kelly analyze the effect of California’s green chemistry initiative on consumer trends and anticipated regulatory enforcement. Jesse Jauregui and Erin Connolly examine the recent landmark U.S. Supreme Court case concerning Title VII and the City of New Haven Firefighters. Finally, Stephanie Jones and Andy Howard examine how the California appellate court’s interpretation of the federal government contractor defense in product liability cases differs from that of the U.S. Court of Appeals for the Ninth Circuit.

We hope you enjoy Trends and, as always, we value your comments.

Peter Kontio Todd R. David

Peter Kontio Co-Chair

Litigation [email protected]

Todd R. DavidCo-Chair

Litigation [email protected]

2

From Consumer-Driven to struCtureD FinanCe: Covering the range oF

FinanCial serviCes litigation

l l l

In light of the complex and volatile issues facing the financial services industry, Alston & Bird has expanded its capacity in this arena. With the addition of John Doherty to our New York office, and Frank Hirsch and Matt McGuire to our North Carolina practice, we have added top flight talent with deep experience in all aspects of financial services. Todd David, co-chair of the firm’s litigation practice, spoke recently with John, Frank and Matt about the legal landscape.

Todd David:

Alston & Bird has historically had great strength in its financial services practice, but we knew in the current economic environment it was a good time to increase our bench strength. We are pleased you decided to join A&B.

First, John, let me start with you—tell us about your practice.

John Doherty:

I’m a commercial litigator. In the financial sector, I regularly handle matters concerning structured finance, structured products, derivatives and other related investment products. I have handled a broad cross-section of disputes involving almost every type of market player in the securitization, asset class and securitization structure. In addition, I represent commercial lenders and special servicers for both securitized and portfolio loans in connection with workouts, foreclosures and servicing issues involving loan syndications and participations, senior/subordinate and mortgage/mezzanine arrangements.

I also represent asset managers. Most of these have a hedging arrangement, and I represent parties to credit default swaps and other hedging arrangements.

Todd:

Frank and Matt, can you describe your practice?

John P. Doherty, PartnerLitigation & Trial Practice [email protected]

Frank A. Hirsch, Jr., PartnerLitigation & Trial [email protected]

Trend

3

Frank Hirsch:

Here in North Carolina, we have more of a consumer-driven practice, focused on home mortgage litigation, credit card litigation, unsecured consumer lending and the defense of class-actions. We also have commercial lending litigation experience, but not to the extent John does, because New York tends to be the hub of those cases.

Matt McGuire:

In addition, we deal a lot with the federal “alphabet soup” claims—the Truth in Lending Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, Home Ownership Equity Protection Act—the entire panoply of consumer regulatory schemes developed over the past 30 to 40 years.

Recently, we’ve seen a spike in state law claims—for example, unfair and deceptive trade practice claims—because most plaintiffs’ lawyers want to avoid federal court.

Todd:

Years ago, the business community was relatively satisfied with the state of the law regarding lender liability. It sounds like there are some initiatives to make new law by certain claimants or debtors. Is that a trend?

Matt:

Absolutely. We’re seeing it on two levels. Sophisticated lenders have figured out how to originate loans within the guidelines mandated by state and federal governments. Although claims arising out of the initial lending decision have declined, two types of claim theories have increased. One is based on predatory servicing—some time after the loan closed, things went wrong on the servicing end. This litigation often occurs under the guise of wrongful foreclosure actions, brought to stop or slow down foreclosure proceedings.

The other trend is newer and more dangerous for our clients. This is the notion of structural unfairness or unsuitability—a way of circumventing the federal regulatory schemes and looking at lenders’ activities from a different perspective. Essentially, this theory posits that it doesn’t matter whether you complied with the governing regulations because lenders have a fiduciary duty

Matthew P. McGuire, PartnerLitigation & Trial Practice [email protected]

4

to make sure that the loan products are suitable for borrowers and are structurally fair. That’s a radical concept—it’s essentially an attempt by the plaintiffs’ bar to superimpose a totally different paternalistic regulatory scheme on lenders.

Frank:

That’s right. These claim theories are being litigated across the country. There’s not much set law, but the concepts of suitability and structural fairness are cropping up more often, creating the battleground upon which consumer-driven lending litigation will be fought over the next decade.

Todd:

With that in mind, what big-picture advice can you offer members of the financial services industry regarding risk prevention and management?

Frank:

In the future, we will see a much greater focus on compliance. If the Consumer Financial Protection Agency comes to pass, as advocated by President Obama, the regulatory environment for financial institutions will be more aggressive.

John:

Whether it’s among note holders in a securitization, within an investment bank, among co-lenders or in the context of a foreclosure action on behalf of a collateralized debt obligation and an investment bank—the legal concepts of confidentiality and privilege are vitally important. My advice for any financial institution is to improve its understanding of how to keep things confidential and privileged, and when to involve a lawyer. Developing sound practices for these two concepts will reduce both costs and exposure.

Todd:

John, what led you to conclude Alston & Bird was an appropriate platform for your practice?

John:

I was impressed with every aspect of the firm. Alston & Bird has a sophisticated financial institutions practice, exceptional litigation

•••The other trend is newer

and more dangerous for our clients. This is the notion of structural unfairness or unsuitability—a way of circumventing the federal regulatory schemes and

looking at lenders’ activities from a different perspective.

•••

5

capability and a national footprint. I’ve been handling credit crisis litigation since late 2006, and I could see that Alston & Bird was uniquely positioned to service clients in that area. Since 2008, and in particular in 2009, the needs of financial institutions have undergone a shift that reflects the changing nature of the client’s business. The loan and securitization origination platforms have been transformed into distressed asset and workout groups, and special servicers of commercial loans have seen a significant uptick in defaults and workouts. I could see that my practice would mesh quite well within the firm. Also, on a personal level, I knew I would feel comfortable here. I met 40 partners before I came here and was favorably impressed. The Alston & Bird people across the table were good, decent people, and impressive in their own right. And when you combine that with the depth of talent, specifically in my area, I knew this would be a great fit.

Frank:

We felt the same thing. Our previous firm did not have either the RMBS or CMBS experience, so that was really important to us. And we held the class action expertise within Alston & Bird in high esteem—Mark Vasco, Cari Dawson, Mike Kenny, Candace Smith, Steve Collins, Johnny Stephenson, Chris Riley and others—all great people.

Matt:

We were also attracted to the national platform and capability that Alston & Bird offered. In today’s business environment, many financial services companies are looking to consolidate their legal work in firms that operate in more places. The ability to project ourselves into California, New York, Texas, D.C. and around the country was really critical. It was just such a natural fit. It’s been a great experience so far.

Todd:

Talk a little bit more broadly about the things you’ve done outside of financial services.

Frank:

We’re involved in general complex commercial litigation as well. Whether it’s a business tort or unfair competition matter, Matt and I have a good bit of experience and a sizable practice. We

•••In the future, we will

see a much greater focus on compliance.

•••

6

•••The firm has a

sophisticated financial institutions practice, exceptional litigation

capability and a national footprint.

•••

also deal with complex commercial disputes, sometimes in the arbitration setting and sometimes in the North Carolina Business Court setting, and we handle a lot of litigation in the soft IP space. This isn’t as specialized as our financial services work, but it’s an important aspect of our practice.

Matt:

That’s right. In North Carolina, we’ve developed a general complex business litigation practice that runs a wide gamut. Over the past five years, for example, roughly 20 percent of my work has been in telecommunications litigation. In addition, my practice involves commercial foreclosures, guaranty litigation, very high-dollar trust and estate litigation and insurance coverage claims.

John:

In addition to finance litigation, I also practice in the areas of securities, insurance, construction, aviation, and oil and gas litigation. Being in New York requires an international focus as well, including international arbitration under the ICC. The crash of the Concorde, for example, involved matters in Germany and France. We were also recently retained by a Belgian industrial company in connection with a lawsuit brought in New York by the Republic of Iraq. I’ve worked on a number of suits out of London involving structured investment vehicles and derivatives, and complex, cross-border privilege issues. And, in South America, I’ve been involved in oil and gas disputes between Chile and Argentina, and an international arbitration dispute involving a U.S. pharmaceutical company and its operations in Colombia.

Todd:

Obviously our clients will benefit greatly from your presence at Alston & Bird. Thanks for talking with me today.

7

Déjà vu all over again: Bank oFFiCers anD DireCtors PrePare For a rePlay oF litigation that FolloweD the savings anD loan Crisis

l l l

The current financial crisis is unparalleled since the savings and loan crisis, when 1,813 financial institutions failed.1 There have been 123 bank failures to date in 2009, in addition to the 26 bank failures in 2008, with projections indicating that hundreds more bank failures may be on the horizon.2 Recent figures suggest that the current financial crisis may ultimately overshadow the experience 20 years ago.3

In most instances, the failure of a bank is preceded by a variety of regulatory mandates. These include heightened supervisory initiatives, such as a board resolution or a memorandum of understanding, as well as more substantive formal enforcement initiatives, such as a cease and desist order that mandates steps the bank must take to attain financial soundness and prompt corrective actions if the bank continues to fail to comply. In general, these directives impose additional requirements on the banks to raise capital and place restrictions on lending activity. As a director of a distressed bank, navigating through these troubled waters can be treacherous and, unfortunately, the risk of litigation is high.

The officers and directors of a failing or failed bank face scrutiny by one or more regulators, but the most likely threat of litigation is from the Federal Deposit Insurance Corporation (FDIC). When a federally insured bank is closed, the FDIC is appointed as conservator or receiver. The FDIC may then pursue a claim against directors or officers of the failed financial institutions in an effort to recoup losses to the bank. Of the financial institutions that failed in the period between 1985 and 1992, the FDIC initiated claims against the former officers and directors of 24 percent of those institutions.4

According to an FDIC Policy Statement, claims will not be brought against officers and directors “who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable business judgments on a fully informed basis and after proper deliberation.”5 In general, actions were brought against officers

Trend

Mark C. Kanaly, PartnerFinancial Services & Products

[email protected]

Mary C. Gill, PartnerSecurities Litigation

[email protected]

Robert R. Long, PartnerSecurities Litigation

[email protected]

8

and directors during the savings and loan crisis where the FDIC believed that there was evidence of (i) dishonest conduct or abusive insider transactions; (ii) violations of internal policies, law or regulations that resulted in a safety or soundness violation; or (iii) failure to establish, monitor or follow proper underwriting procedures, or heed warnings from regulators or advisors.6

In a replay of the earlier crisis, the FDIC has begun to investigate many of the failed banks and to make pre-litigation demands for payment of civil damages against officers and directors of some failed banks for losses incurred by the bank. There is no public source of information regarding the number of investigations or subpoenas that have been issued by the FDIC. It is also too early to determine how aggressive the FDIC will be in filing civil actions against officers and directors of failed banks. As noted in the FDIC Policy Statement, however, “the FDIC brings suits only where they are believed to be sound on the merits and likely to be cost effective.” Accordingly, in order to determine the ability of an individual to respond to a claim, if successful, it is routine for the FDIC to seek personal financial information from the officers and directors as part of the investigation. In addition, the FDIC typically sends its demand for payment of civil damages directly to the D&O insurance carrier to provide the requisite notice under the policy to trigger insurance coverage as a potential source of recovery if liability is established.

A further source of litigation risk for officers and directors of banks or holding companies are shareholder lawsuits. The number of shareholder class actions filed against financial institutions in 2008 was at an all-time high, accounting for 54 percent of the market cap of all such lawsuits filed against S&P 500 companies.7 This is the highest percentage of any business sector, by a wide margin, in the past eight years. Moreover, financial institutions were defendants in 67 percent of the shareholder class action filings in the first half of 2009.8 The shareholder plaintiffs typically allege that the company’s stock price was inflated by falsely disclosed financial reports that overestimated the value of real-estate-backed assets, and that once the truth was revealed, it caused the stock price to fall to the shareholders’ detriment.

With the heightened risk of litigation in the financial sector, there are certain steps that counsel for bank officers and directors may take to prepare for claims or litigation that may follow. Meeting with the board members and reviewing the examination reports

•••The number of shareholder class actions filed against

financial institutions in 2008 was at an all-time high, accounting for 54 percent of the market cap of all such lawsuits filed against S&P 500

companies.

•••

9

and other documents available while the bank remains open will provide insight into the specific issues that confront the board of directors and management. It is important that documents pertaining to the bank are preserved and counsel may give guidance on specific document preservation procedures.

In this environment, it is especially important for bank officers and directors to have a clear understanding of the scope and potential limitations of their D&O insurance policies. There are a variety of clauses that may impact the availability of insurance coverage in these cases. In the wake of the savings and loan crisis, insurance carriers began to include regulatory exclusions in D&O policies, in an effort to reduce exposure to claims for civil damages and/or penalties sought by the regulators.9 Bank directors and officers will want to know whether their policy contains such limitations and have sought legal counsel regarding the practical impact of the limitations. Other provisions of the insurance policy may require that certain action be taken to afford coverage. For example, many policies require that the insureds furnish a “Notice of Circumstances” under the policy, which is typically prepared by counsel and provides a description of potential claims that may be brought against the insureds. Such notices may provide coverage under the policy that the directors and officers otherwise would not have. Accordingly, directors and officers should seek counsel to consider whether a Notice of Circumstances is warranted.

The waves of litigation from the financial crisis will undoubtedly continue. Counsel for bank officers and directors can take steps now to prepare for claims or litigation that may follow, including (i) gaining an understanding of the particular issues confronting the bank, through a review of the examination reports and other documents available while the bank remains open; (ii) a review of the D&O policies; and (iii) the preparation of a Notice of Circumstances. There may be other steps that are also appropriate at this juncture, depending upon the particular facts and circumstances of the bank.

Endnotes1 Between 1988 and 1992, there were 794 bank failures and 1,019 savings and

loan failures. Testimony of Donna Tanoue, FDIC Chairman, On Recent Bank Failures and Regulatory Initiatives, Before The Committee on Banking and Finan-cial Services, U.S. House Of Representatives, February 8, 2000.

•••The waves of litigation from the financial crisis

will undoubtedly continue.

•••

10

2 The FDIC announced on August 27, 2009, that the number of financial institutions on the “Problem List” had increased from 305 to 416 by the second quarter of 2009. See FDIC Quarterly Banking Profile, Second Quarter 2009, June 30, 2009.

3 According to a recent article relying upon statistics from the MIT Center for Real Estate, commercial real estate has experienced a 39 percent decline in prices from the peak period two years ago, which is much higher than the 27 percent real estate decline from the prior savings and loan crisis of the late 1980s and early 1990s. “Commercial Real Estate Crisis Threatens Recovery,” Atlanta Journal-Constitution, September 15, 2009.

4 FDIC Financial Institution Letter (FIL-87-92), December 3, 1992.

5 Id.

6 Id.

7 Cornerstone Research, Securities Class Action Filing, 2008: A Year in Review.

8 Cornerstone Research, Securities Class Action Filings, 2009 Mid-Year Assessment.

9 The terms of these “regulatory exclusions” vary between policies and the specific terms of the policy should be reviewed carefully.

AbouT The AuThorS

l l l

Mary C. Gill, Mark C. Kanaly and Robert R. Long are partners in the firm’s Atlanta office and are part of its dedicated Officers & Directors of Distressed Financial Institutions team, a cross-disciplinary group comprised of members with substantial experience in representing the financial services sector on transactional and regulatory issues, as well as in matters involving bank officers and directors in regulatory, securities and other corporate governance disputes. The team has recently advised more than 20 distressed banks and represents well over 100 bank officers and directors in regulatory and shareholder matters, including in over 30 claims by the FDIC brought after bank failures.

In addition to Ms. Gill and Messrs. Kanaly and Long, the team includes John L. Latham, Tod J. Sawicki and Dwight C. Smith, III.

11

Maureen F. Gorsen, PartnerEnvironmental &

Land [email protected]

Colin K. Kelly, PartnerProducts Liability

[email protected]

Trend

how CaliFornia’s green Chemistry initiative will Change the gloBal Consumer eConomy

l l l

In the fall of 2008, the California Environmental Protection Agency (Cal/EPA) developed its Green Chemistry Initiative, a six-point program with the audacious goal of fundamentally transforming global consumer product manufacturing. Thus far, only two of the six program points have been enacted into law, but some observers think that Governor Arnold Schwarzenegger will seek to solidify his green chemistry legacy and lead the passage of the remaining four initiatives during his final term in office.

As with any significant new regulatory program, industry watchers are also interested in whether potential legal challenges will emerge upon adoption of the initiative’s implementing regulations. Among the issues are potential due process concerns that arise from reliance on chemical information obtained from other nations, governments and authoritative bodies; interstate commerce concerns related to the program’s efforts to regulate the chemical industry beyond California’s geographic boundaries; and the scope of liability and enforcement with regard to manufacturers, suppliers and retailers, both in and outside of California.

Why Is California Leading the Green Chemistry Revolution?

In the last decade, an extensive canon of thought and literature has been developed, focusing on a single theme—that we can design a new and safer way to make the products we all use. These authors all say, in essence, that if companies think more strategically about the ingredients, the molecules and the design of their products, then there will not be as pressing of a need for environmental laws to ward off toxins in the air, water, land and people because the products will be “benign by design.” California, true to its reputation as an early adopter, is the first state to embrace these ideas in policy and in law through the Green Chemistry Initiative.

At its heart, green chemistry seeks to head off the drumbeat of consumer angst about the increasing number of public health and environmental problems associated with ingredients in everyday consumer products. The Green Chemistry Initiative seeks to

12

gather information and provide tools that can help companies accelerate the switch to safer substitute materials in their products. Alzheimer’s, autism, cryptochordism, infertility and certain cancers have risen at alarming rates over the last decade. Experts disagree about the various causes behind the dramatic rise of these conditions, but to the extent that a chemical or group of chemicals becomes a factor in the harm, the initiative will eliminate its use in favor of a safer substitute. Prior to the initiative, California’s efforts to ban certain toxic substances created several unintended consequences. California’s ban on lead in gasoline led to the wide-spread substitute MTBE, a potential human carcinogen. This “regrettable substitution” caused California to trade in its air pollution problem for a far worse water pollution problem.

What Does the California Green Chemistry Initiative Call For?

The California Green Chemistry Initiative calls for six main policy and law changes:

1. Expand pollution prevention and product stewardship programs to more business sectors, to refocus additional resources on prevention rather than clean up.

2. Develop green chemistry workforce education and training, research and development and technology transfer through new and existing educational programs and partnerships.

3. Create an online product ingredient network to disclose chemical ingredients for products sold in California, while protecting trade secrets.

4. Create an online toxics clearinghouse—an online database of chemical toxicity and hazards populated with the guidance of a green ribbon science panel to help prioritize chemicals of concern and data needs.

5. Accelerate the quest for safer products, creating a systematic, science-based process to evaluate chemicals of concern and alternatives to ensure product safety and reduce or eliminate the need for chemical-by-chemical bans.

6. Move toward a cradle-to-cradle economy to leverage market forces to produce products that are “benign-by-design,” in part by establishing a California green products registry to develop green metrics and tools (e.g., environmental

•••In the last decade, an extensive canon

of thought and literature has been developed, focusing

on a single theme—that we can design a new and

safer way to make the products we all use.

•••

13

footprint calculators, sustainability indices) for a range of consumer products and encourage their use by businesses.

Initiatives four and five have moved from policy to law with the passage of two bills signed by Governor Schwarzenegger in September 2008. Cal/EPA is busy creating the templates and requirements for an online toxics clearinghouse—a “Facebook” for chemicals. The department within Cal/EPA assigned to implement the program—the Department of Toxic Substances Control (DTSC)—is busy developing the alternatives analysis regulations that it will require of product manufacturers selling goods in California. Both efforts can be followed at www.dtsc.ca.gov.

How Will You Know If Your Product Is “Green” and How Will That Knowledge Give You a Market Advantage?

Advertisements are filled with pictures of leaves, trees, windmills and the ubiquitous picture of two hands cupping a tiny sprout. Many companies are making bold claims that they are “green.” Consumer and environmental groups have been threatening companies with lawsuits if they make false claims about the “greenness” of their products and/or manufacturing processes—referred to as “greenwashing.” Will switching from petroleum-based ingredients to citrus-based ingredients qualify a consumer product company as being green? Right now there is no objective way to measure whether a company or its products are in fact green. The advantage of California’s Green Chemistry Initiative is that it helps to level the playing field for companies who sell/import products in California by creating an objective “environmental footprint criteria” for products based on the lifecycle of the product. Companies that have already made investments in sustainable practices or environmental improvements will be rewarded with a lower environmental footprint score than companies that have not made those investments. It will also give claims of greenness an objectively verifiable measurement system and, hence, a competitive advantage similar to the LEED system for green buildings.

How Do You Prepare and Get Ahead of the Green Chemistry Wave?

Know the ingredients in your products. To the extent that you already know all the various chemical ingredients in your products, you are way ahead of the game. If you do not, then you should look at your

•••The advantage of

California’s Green Chemistry Initiative is that it helps to level the playing

field for companies who sell/import products in

California by creating an objective “environmental footprint criteria” . . .

•••

14

supplier agreements and push for a full disclosure of ingredients. If you do not spend the time now to find out what materials are being used along your supply chain, someone else will and a mandatory race to find an acceptable substitution may be expensive.

Stay abreast of emerging chemicals of concern. There are many Web sites, blogs and listservs you can join to learn about emerging chemicals of concern. For instance, a weekly perusal of Web sites for the Environmental Working Group, the Environmental Defense Fund, the Breast Cancer Fund and Environmental Health News should alert you to chemicals that are concerning these groups.

Regularly test your products for emerging chemicals of concern and always be on the lookout for safer alternatives. This may be a chemical substitution or it may be a product design or materials change that eliminates the need for the chemical. To the extent that you do not know your ingredients, are not aware of potential concerns and have not investigated alternatives, you may become an early guinea pig for Cal/EPA under its new green chemistry regulatory authorities.

AbouT The AuThorS

l l l

Maureen F. Gorsen, the former director of the California Department of Toxic Substances Control and former general coun-sel of the California Environmental Protection Agency, is a partner with Alston & Bird and focuses her practice on environmental law.

Colin K. Kelly is a partner in the firm’s Products Liability and Litigation and Trial Practice Groups in Alston & Bird’s Atlanta office. Mr. Kelly has defended multiple Fortune 500 companies in connection with a variety of products liability, toxic tort and complex commercial litigation matters and has prepared more than 100 cases for trial in more than 10 different states. Mr. Kelly has also spoken and written on a variety of toxic tort and product liability issues nationally.

•••To the extent that you

do not know your ingredients, are not aware of potential concerns and

have not investigated alternatives, you may

become an early guinea pig for Cal/EPA under its new green chemistry regulatory authorities.

•••

15

Trend

Jesse M. Jauregui, PartnerLabor & Employment

[email protected]

Erin L. Connolly, PartnerLabor & Employment

[email protected]

Ricci v. DeStefano: what Does the suPreme Court’s DeCision mean For emPloyers?

l l l

In Ricci v. DeStefano, 129 S. Ct. 2658 (2009), the United States Supreme Court addresses and attempts to reconcile what the majority of the Court views as the inherent tension between the disparate treatment and disparate impact provisions of Title VII, 42 U.S.C. § 2000e, et seq. Since it was issued on June 29, 2009, the Court’s opinion has garnered a great deal of attention not only because it reversed the ruling of then-pending Supreme Court nominee Sonia Sotomayor and her colleagues on the Second Circuit Court of Appeals, but also because it left many open questions as to how the principles underlying the opinion will be applied, and potentially expanded, in the future. This article explores the Court’s opinion and examines the uncertainties employers now face in applying the Court’s ruling to their employment practices.

Factual Background

In 2003, New Haven firefighters took standardized written and oral examinations to determine eligibility for promotions to lieutenant and captain. The city had hired a third-party company to develop the exams, assemble the exam assessors and process the results. With respect to the captain’s exam, the results demonstrated large disparities in performance along racial lines, with the black applicants’ pass rate at approximately 37.5 percent while the white applicants’ pass rate was approximately 64 percent. On the lieutenant’s exam, the black applicants’ pass rate was approximately 31.6 percent while the white applicants’ pass rate was approximately 58.1 percent. Under the city’s “Rule of Three,” which provided that it could only promote from those applicants with the three highest scores on the exam, no black applicants could be considered for immediate promotion to either lieutenant or captain.

As a result of the statistical disparity in the pass rates of white and minority firefighters, a heated public debate arose as to whether the exam results should be certified or discarded. Ultimately, New Haven’s Civil Service Board deadlocked in a 2-2 vote and refused to certify the results based on a concern that the exam had a disparate impact on minorities and, therefore, would expose the city to potential liability under Title VII.

16

•••In arriving at its decision, the Court applied a new “strong basis in evidence”

standard to determine when an employer may engage in intentional disparate treatment in

order to remedy a perceived disparate impact violation.

•••

Seventeen white firefighters and one Hispanic firefighter who were to be considered for promotion based on the exam results sued the city. They claimed that by discarding the results, the city had discriminated against them in violation of the disparate treatment provisions of Title VII and the Equal Protection Clause of the 14th Amendment. The city prevailed on summary judgment at the District Court level, and the Second Circuit Court of Appeals affirmed. The firefighters then appealed the case to the United States Supreme Court.

The Supreme Court Decision

In a 5-4 ruling, the Supreme Court reversed the rulings of the lower courts and held that New Haven’s decision to discard the test results violated Title VII.1 In arriving at its decision, the Court applied a new “strong basis in evidence” standard to determine when an employer may engage in intentional disparate treatment in order to remedy a perceived disparate impact violation. Ricci, 129 S. Ct. at 2675-76. Specifically, the Court explained that in order to justify discarding the exam results—i.e., to engage in the disparate treatment of the white and Hispanic firefighters—the city must have had a “strong basis in evidence” to believe that had it not done so, it would have faced liability under Title VII’s disparate impact provisions. Id.

Justice Kennedy, writing for the majority, ruled that the city’s rejection of the exam results based solely on the statistical disparity could not satisfy the new standard. The Court pointed out that there was no genuine dispute as to whether the exams were job-related and consistent with business necessity, nor was there sufficient evidence that the city had refused to adopt an equally valid, less discriminatory alternative that served the city’s business needs. Id. at 2678-79. According to the Court, “[f]ear of litigation alone cannot justify an employer’s reliance on race to the detriment of individuals who passed the examinations and qualified for promotions.” Id. at 2681.

In the dissent, written by Justice Ginsburg on behalf of herself and Justices Stevens, Souter and Breyer, Ginsburg noted that the Court left out important facts in determining whether the city met the “strong basis in evidence” standard, emphasizing evidence of multiple flaws in the exams, as well as expert testimony that there were other better, less-discriminatory selection methods that the city could have utilized. Id. at 2690. Additionally, though they

17

•••. . . although the Ricci case did not involve an

affirmative action program, many have characterized

it as an affirmative action case . . .

•••

believed that the city had met the newly articulated standard, the dissenting justices also believed that the standard was too strict and that a less strict “good cause standard” was more appropriate. Id. at 2702. Ultimately, Justice Ginsburg opined that the Court’s decision would not have “staying power.” Id. at 2690.

Justices Alito and Scalia wrote separate concurring opinions. In Justice Scalia’s concurrence, he noted that even though the Court did not have to address the Equal Protection Clause issue, it inevitably would face the question of whether, or to what extent, the disparate impact provisions of Title VII are consistent with the Constitution’s guarantee of equal protection. In Justice Alito’s concurrence, with which Justices Scalia and Thomas joined, he addressed some of the dissent’s major points by arguing that even if the city had met the “strong basis in evidence” standard, the firefighters likely would have had a strong argument that the city’s asserted reason for discarding the exam results was a pretext for discrimination based on certain evidence of record in the case, including evidence that an influential community leader lobbied city administration to scrap the test results and the city did so to placate a politically important racial constituency. Id. at 2684-88.

Prospective Application of Ricci

The Court’s Ricci decision constitutes a significant development in employment discrimination law, and going forward, it is likely that its application and impact will reach beyond the narrow issue of employee testing expressly addressed in the opinion.

One area of employment law that may be impacted by the Ricci decision involves voluntary affirmative action programs. Indeed, although the Ricci case did not involve an affirmative action program, many have characterized it as an affirmative action case because New Haven engaged in race conscious actions to achieve further diversity in its workforce. In its decision, the Supreme Court seemingly recognized the potential impact of its ruling on affirmative action plans and stated as follows: “We do not question an employer’s affirmative efforts to ensure that all groups have a fair opportunity to apply for promotions and to participate in the process by which promotions will be made. But once that process has been established and employers have made clear their selection criteria, they may not then invalidate the test results, thus upsetting an employee’s legitimate expectation not to be judged on the basis of race[.]” Id. at 2677.

18

Thus, in the immediate aftermath of Ricci, it appears that employers may continue to develop policies and programs aimed at promoting diversity in their workforces; however, if those policies and programs as implemented result in the disparate treatment of a particular racial group, employers should be prepared to face a more stringent standard of review in justifying the necessity of the policies and programs. Accordingly, now more than ever, it is imperative that employers carefully examine all types of remedial measures they use or intend to use to obtain a diverse work environment, and that they document not only their implementation of those measures, but also the reasons why they feel those measures are necessary.

The scope of the Ricci decision’s impact also may extend to reduction-in-force (RIF) analyses. Often employers faced with the difficult task of laying off employees attempt to reduce exposure to discrimination claims by engaging in pre-RIF statistical testing, which is used to determine whether there will be any unfavorable statistical disparities among protected groups. If such disparities are discovered, the employers may choose to reconfigure their selection criteria to obtain a more favorable statistical result.

In the wake of Ricci, however, employers should be mindful that if statistical analysis yields unfavorable results against a protected group, they may expose themselves to liability if they reconfigure their criteria to obtain a more desirable result. In order to justify such a reconfiguration, Ricci suggests that employers must be able to demonstrate that they had “a strong basis in evidence” to believe that the initial selection was unlawful and disparately impacted a protected group—and presenting evidence of the results of the statistical analysis alone may not suffice.2

Conclusion

Many people will be watching the development of the Ricci jurisprudence over the next several years to see whether it is expanded as contemplated above, or whether it indeed lacks “staying power” as Justice Ginsburg surmised. While the Ricci decision favored the firefighter-employees, the decision’s immediate impact is to provide employers with greater guidance and arguably greater protection against disparate impact claims. In the meantime, however, the best advice for employers is to make certain that all employment-related decisions are carefully analyzed, well-documented and premised upon specific and precise job-related criteria. If and when unanticipated disparities arise

•••. . . it is imperative

that employers carefully examine all types of

remedial measures they use or intend to use to obtain a diverse work

environment . . .

•••

19

as a result of an employment test or some other selection device, being armed with evidence of a well-documented, well-reasoned decision will be imperative.

Endnotes1 Because the resolution of the Title VII issue granted the firefighters the relief

they sought, the Court did not reach the Equal Protection Clause issue.

2 It is worth noting that the “strong basis in evidence” standard is taken from a reduction-in-force case applying the Equal Protection Clause of the Four-teenth Amendment. See Wygant v. Jackson Bd. of Education, 476 U.S. 267 (1986).

AbouT The AuThorS

l l l

Jesse Jauregui is a partner in the Los Angeles office and focuses his practice on employment law and litigation as well as telecommunications law. Mr. Jauregui has significant experience handling employment matters for both private and public entities and provides advice and counsel to both. Mr. Jauregui is a former city attorney and has been special counsel to various municipalities in Southern California. Mr. Jauregui was recently named a Southern California “Super Lawyer” for 2010 and is a member of the Labor and Employment section of the State Bar of California. Mr. Jauregui was a recent co-presenter for a BNA Webinar on the Ricci v. City of New Haven decision and its implications for employers.

Erin Connolly, a partner in the firm’s Los Angeles office, focuses her practice on labor and employment law. In addition to litigating both single-plaintiff and class-action employment claims, Ms. Connolly has substantial experience in prosecuting and defending actions involving claims for breach of restrictive covenants, breach of fiduciary duties and duties of loyalty, tortious interference with business relations, unfair competition and trade secret misappropriation. Ms. Connolly also regularly assists clients in connection with the drafting and negotiation of employment agreements, separation agreements and restrictive covenant agreements.

20

Trend

Stephanie A. Jones, PartnerConstruction &

Government Contracts [email protected]

J. Andrew Howard, PartnerConstruction &

Government Contracts [email protected]

CaliFornia aPPellate Court DeParts From ninth CirCuit By aPPlying the FeDeral

government ContraCtor DeFense to state ProDuCts liaBility Claims Brought against manuFaCturers oF government-ProCureD

non-military equiPment

l l l

On April 27, 1983, United States Marine David Boyle died when the helicopter he was co-piloting crashed off the Virginia coast during a training exercise. While Mr. Boyle survived the impact of the crash, he drowned because he could not open the escape hatch—which swung outward from the airframe—due to the surrounding water pressure as the helicopter sank. His father sued the helicopter manufacturer, alleging, among other things, that the escape hatch had been defectively designed and should have opened inward, rather than outward. This allegedly defective design, however, had been approved by the government and incorporated into the helicopter’s specifications.

The case made its way to the United States Supreme Court. There, a majority of the Court held that liability for design defects in military equipment cannot be imposed upon the government’s civilian manufacturers or suppliers where (1) the United States approved reasonably precise specifications; (2) the equipment conformed to those specifications; and (3) the manufacturer warned the government of any dangers in the use of the equipment that were known to the manufacturer but not the United States. Boyle v. United Technologies Corp., 487 U.S. 500 (1988). This case is regarded as the seminal case outlining the requirements for what is commonly referred to as the government contractor defense to state law product liability actions.

While the factual circumstances in Boyle caused the Supreme Court to frame the parameters of the defense in terms suggesting its application only to manufacturers of military equipment, most courts that have subsequently considered it draw no distinction between manufacturers of military and non-military equipment. These courts reason that the underlying rationale for the rule applies equally to both. In other words, federal procurement

21

•••While the vast majority of courts to consider the government contractor defense apply it equally to military and non-

military manufacturers and suppliers alike, the U.S. Court of Appeals

for the Ninth Circuit has departed from the majority by resisting expansion of

the doctrine to non- military procurements.

•••

policies take precedence over state products liability claims in certain circumstances where the allegedly defective product was manufactured pursuant to government-approved specifications. Accordingly, for all intents and purposes, the manufacturer or supplier of such products is cloaked with the government’s sovereign immunity and shielded from state tort liability.

While the vast majority of courts to consider the government contractor defense apply it equally to military and non-military manufacturers and suppliers alike, the U.S. Court of Appeals for the Ninth Circuit has departed from the majority by resisting expansion of the doctrine to non-military procurements. However, in a recent case styled Oxford v. Foster Wheeler LLC, 177 Cal.App.4th 700 (2009), the California Court of Appeal diverged from Ninth Circuit precedent by applying the federal government contractor defense to products liability claims originating from equipment not exclusively manufactured for the military.

In Oxford, defendant Foster Wheeler LLC manufactured boilers for the U.S. Navy during WWII pursuant to naval specifications that required the use of asbestos. Plaintiff Oxford was exposed to asbestos while performing repairs to those boilers, which were installed in naval vessels in the mid-1960s. In 2005, Oxford was diagnosed with mesothelioma and died later that year. In 2006, Oxford’s heirs sued Foster Wheeler, alleging products liability claims.

The jury in the trial court found in favor of the Oxford heirs on one of their products claims, but also found that Foster Wheeler had proved the elements of the federal government contractor defense set forth in Boyle. The Oxford heirs appealed, asserting that the boilers in question did not qualify as military equipment for purposes of the government contractor defense even though they were installed in Navy vessels. Their argument was based in large part on the Ninth Circuit’s decision in In re Hawaii Federal Asbestos Cases, 960 F.2d 806 (9th Cir. 1992), where that court concluded that the concerns sought to be protected under the government contractor defense, as proscribed in Boyle, do not exist with respect to products readily available commercially. The Oxford heirs argued that, under In re Hawaii Federal Asbestos Cases, the fact that Foster Wheeler also sold similar boilers commercially precluded application of the government contractor defense to their products liability claim.

22

The California Court of Appeal disagreed, instead relying upon an earlier California appellate decision that refused to find the commercial availability of a product determinative on the appropriateness of applying the government contractor defense. Further, the Court of Appeal held that the trial court properly recognized that the availability of the government contractor defense, as articulated in Boyle, does not depend upon the distinction between military and non-military products or parties, but instead depends on whether the state law claim touches upon a uniquely federal interest resulting in a significant conflict with federal policy. In the end, the court in Oxford rejected the Ninth Circuit’s constrained application of the government contractor defense, concluding that Foster Wheeler would not be precluded from raising the defense when the case was remanded for retrial.

The California Court of Appeal also adopted a test formulated by the U.S. Court of Appeals for the Sixth Circuit for determining the application of the government contractor defense to state law claims for negligent failure to warn. Under current California law, a contractor’s successful establishment of the three-part government contractor defense will—in the appropriate case—insulate it from design defect claims, but does not, by itself, also insulate the contractor from claims for failure to warn. As to these latter claims, to avail itself of the defense, a government contractor must prove the following: (1) the government exercised its discretion and approved the warnings at issue, if any; (2) the contractor provided warnings that conformed to the warning approved by the government; and (3) the contractor warned the government of the dangers inherent in the equipment’s use about which the contractor knew, but the government did not.

It is not often that a state court sitting within the jurisdictional boundaries of a federal Circuit Court of Appeal departs from the federal appellate court’s pronouncements on issues of federal common law. Nevertheless, the court in Oxford extended the federal government contractor defense to apply in cases alleging state products liability claims for products not manufactured exclusively for the military. Going forward, a government contractor sued in a California state court for claims alleging product defects would be well advised to think twice before removing the case to federal court, because Oxford suggests that litigating the matter in state court may provide broader defenses than those available in federal court.

•••Going forward, a

government contractor sued in a California state court for claims alleging product defects would be

well advised to think twice before removing the case to

federal court . . .

•••

23

AbouT The AuThorS

l l l

Stephanie Jones is a partner in the Construction & Government Contracts Group in the firm’s Los Angeles office. She also maintains a substantial Products Liability practice. She is a graduate of the University of California and the University of San Diego Law School. Ms. Jones has extensive experience with complex products liability matters relating to manufacturing, chemical and building products, as well as large scale claims litigation, on behalf of project owners, developers and subcontractors, in both state and federal courts. Ms. Jones also regularly advises her construction industry clients on all manner of construction matters, including bid disputes, claims avoidance and early resolution of disputes through mediation and other alternative dispute mechanisms.

Andy Howard is a member of the firm’s Construction & Government Contracts Group, where he specializes in helping companies do business with federal, state and local governments. Mr. Howard’s experience includes counseling clients on compliance with, and in negotiation of, government contracts, representing them in pre- and post-award bid protests and assisting them in pursuing or responding to open records requests, and in the prosecution and defense of claims involving federal, state and local agencies. In addition to his government contracts practice, Mr. Howard regularly advises owners, developers and contractors in all manner of construction matters, including mediation, arbitration and litigation in the state and federal courts. Mr. Howard is a frequent author and lecturer in the fields of construction and government contracts, and is an active member of the American Bar Association’s Public Contract Law Section and Forum on the Construction Industry, where he serves on the Steering Committee for Division II.

Winter 2009

From Consumer-Driven to struCtureD FinanCe: Covering the range oF FinanCial serviCes litigation With John Doherty, Frank Hirsch and Matt McGuire

Déjà vu all over again: Bank oFFiCers anD DireCtors PrePare For a rePlay oF litigation that FolloweD the savings anD loan Crisis

By Mary C. Gill, Mark C. Kanaly and Robert R. Long

how CaliFornia’s green Chemistry initiative will Change the gloBal Consumer eConomy

By Maureen F. Gorsen and Colin K. Kelly

Ricci v. DeStefano: what Does the suPreme Court’s DeCision mean For emPloyers?By Jesse M. Jauregui and Erin L. Connolly

CaliFornia aPPellate Court DeParts From ninth CirCuit By aPPlying the FeDeral government ContraCtor DeFense to state ProDuCts liaBility Claims Brought against manuFaCturers oF government-ProCureD non-military equiPment

By Stephanie A. Jones and J. Andrew HowardAtlanta · Charlotte · Dallas · Los Angeles · New York · Research Triangle · Silicon Valley · Ventura County · Washington, D.C.

www.alston.com

in Litigation trendstM

• • •