Current Developments: March 2024 Review

From a new proposed rule that would require reports on nonfinanced transfers of residential real estate, to the reintroduction of the Supplemental Security Income Restoration Act in the US House of Representatives and a federal district court ruling that the Corporate Transparency Act is unconstitutional, we have recently seen significant legal developments. To ensure that you stay abreast of these changes, we have highlighted some noteworthy developments and analyzed how they may impact your estate planning, elder and special needs law, and business law practices.

Estate Planning

FinCEN Issues Proposed Rule Requiring Reports on Nonfinanced Transfers of Residential Real Estate to Legal Entities or Trusts

Anti-Money Laundering Regulations for Residential Real Estate Transfers, 89 Fed. Reg. 12424 (proposed Feb. 16, 2024).

On February 16, 2024, the Financial Crimes Enforcement Network (FinCEN) issued a proposed rule that would impose new nationwide reporting requirements on gifts and all-cash sales of residential real estate (single-family homes, townhouses, condominiums, cooperatives, and apartment buildings for one to four families) to a transferee entity or a transferee trust in the United States. Notably, transfers to individuals are outside the scope of the proposed rule. The proposed rule is designed to prevent gifts and all-cash sales of real estate in the United States from being used to facilitate money laundering and other illicit activities such as drug and human trafficking, corruption, and fraud that would otherwise avoid scrutiny required for bank-financed transactions under the Bank Secrecy Act. 

Reporting persons—generally, individuals involved in real estate closings and settlements—must submit a Real Estate Report identifying transferee entities and transferee trusts, beneficial owners of the transferee entity or trust, and certain individuals who sign documents on behalf of the transferee entity or trust, as well as information about the reporting person, the residential property being sold or transferred, the transferor, and payments made. The Real Estate Report must be filed within 30 days of the closing. Unlike the Corporate Transparency Act (CTA), the proposed rule would not require the reporting person to subsequently report changes in the beneficial ownership of transferee entities or trusts.

The proposed rule does not specify a minimum dollar amount that would trigger the application of the rule and is meant to apply to both sales and nonsale transfers, including gifts and transfers to trusts by a grantor. FinCEN anticipates that the proposed rule’s applicability to such transfers will be limited by exceptions for transfers of real estate that are financed and transfers of real estate due to death, including transfers by an executor of a grantor’s residential real estate to a testamentary trust.

The reporting person required to submit the report would be determined using a “cascading” approach (involving five cascading tiers) based on the functions performed. A reporting person is a real estate professional who performs a function described in the cascade where there is no other person who performs a function in a higher tier in the cascade. The tiers, from highest to lowest, are as follows:

1. Real estate professionals providing certain settlement services in the settlement process
2. The person who underwrites an owner’s title insurance policy for the transferee
3. The person that disburses the greatest amount of funds in connection with the reportable transfer (the proposed rule notes that such disbursements may be in any form, including from a trust account, a lawyer’s trust account, or an escrow account, which is frequently used to settle real estate transfers)
4. The person who prepares an evaluation of the title status
5. The person who prepares the deed (the proposed rule notes that a deed is typically prepared by an attorney)

A potential reporting person must determine if there is another potential reporting person who is in a higher tier in the cascade; however, they are not required to verify that the person filed the report. A real estate professional who would be the reporting person based on the reporting cascade may enter into a written agreement with another potential reporting person that obligates them to act as the reporting person. FinCEN noted that where an attorney who performs one of the functions that would impose a reporting obligation is concerned that attorney-client privilege would prevent them from reporting the information required under the proposed rule, they should agree to pass the obligation to another potential reporting person.

A transferee entity is generally defined as “any person other than a transferee trust or an individual” and may include “a corporation, partnership, estate, association, or limited liability company.” Anti-Money Laundering Regulations for Residential Real Estate Transfers, 89 Fed. Reg. 12424, 12431 (proposed Feb. 16, 2024). Like the reporting companies that are required to submit reports under the CTA, there are exceptions for entities that are already highly regulated.

A transferee trust is defined as “any legal arrangement created when a person (generally known as a settlor or grantor) places assets under the control of a trustee for the benefit of one or more persons (each generally known as a beneficiary) or for a specified purpose, as well as any legal arrangement similar in structure or function to the above, whether formed under the laws of the United States or a foreign jurisdiction.” Id. at 12434. A trust will be considered a transferee trust regardless of whether the residential real property is titled in the name of the trust itself or the name of the trustee in their capacity as trustee for the trust. There are exceptions for certain trusts that are already highly regulated.

Like the definition of beneficial owners under the CTA, the beneficial owner of a transferee entity is generally “any individual who, directly or indirectly, either exercises substantial control over the transferee entity or owns or controls at least 25 percent of the ownership interests of the transferee entity.” Id. at 12435.

Beneficial owners of transferee trusts are defined as any individual who, at the time of the transfer of residential real estate to the trust, meets the following requirements:

(1) is a trustee; 

(2) otherwise has authority to dispose of transferee trust assets, such as may be the case with a trust protector;

(3) is a beneficiary who is the sole permissible recipient of income and principal from the transferee trust or who has the right to demand a distribution of, or to withdraw, substantially all of the assets of the transferee trust; 

(4) is a grantor or settlor of a revocable transferee trust; or 

(5) is the beneficial owner of a legal entity or trust that holds one of the positions described in (1)–(4), taking into account the exceptions that apply to transferee entities and transferee trusts. 

Id. at 12434-35.

Takeaways: In contrast to the CTA, which requires the disclosure of information by all entities that fall within the definition of a reporting company, this proposed rule applies to a specific type of transaction—nonfinanced sales or gifts of residential real property to a transferee entity or trust. Although transfers resulting from death are outside the scope of the proposed rule, inter vivos gifts of residential real estate to a trust—a common estate planning strategy—are within its scope. This would place additional burdens and information disclosure requirements on most transfers of real estate to trust. Although the information disclosed to FinCEN would not be publicly available if the proposed rule becomes final, some of the anonymity that trust grantors and beneficiaries have enjoyed would be decreased. Public comments must be submitted by April 16, 2024.

Florida Supreme Court: Child Conceived by In Vitro Fertilization After Father’s Death Not Provided for in Will

Steele v. Comm’r of Soc. Sec., No. 20-11656, 2024 WL 630219 (Fla. Feb. 15, 2024)

Kathleen Steele, a surviving wife who successfully utilized in vitro fertilization to conceive a child using her late husband Philip’s cryopreserved sperm, filed a suit against the Commissioner of the Social Security Administration challenging the denial of the resulting child’s insurance benefits under the Social Security Act. During their marriage, the couple had conceived their first child through in vitro fertilization, and after the child’s birth, Philip had provided additional sperm, for storage and possible later use, to the fertility clinic.

Philip later prepared a will with the assistance of his estate planning attorney defining his family as his spouse, living children, and any adopted or “later-born” children. In the will, Philip devised all tangible personal property, homestead property, and the residue of his estate to his wife; if she predeceased him, his “then living” children would inherit his tangible personal property. Approximately a year and a half after executing his will, Philip died. Following his death, a child, P.S.S., was conceived via in vitro fertilization using the sperm that Philip had provided to the fertility clinic and was born to Kathleen.

Kathleen sought survivor benefits from the Social Security Administration (SSA) on behalf of P.S.S., asserting that P.S.S. was Philip’s child. The SSA denied the claim, contending that P.S.S., who was conceived and born after Philip’s death, was not Philip’s child under the relevant federal statutes. The United States District Court for the Middle District of Florida upheld the SSA’s decision and Kathleen appealed to the Eleventh Circuit Court of Appeals. 

The Eleventh Circuit certified two questions of first impression to the Florida Supreme Court regarding the meaning of Fla. Stat. § 742.17(4), which states that a “child conceived from the eggs or sperm of a person or persons who died before the transfer of their eggs, sperm, or preembryos to a woman’s body” can only take from a decedent’s estate if they are “provided for” in the decedent’s will: (1) Is P.S.S. “provided for” in Philip’s will within the meaning of Fla. Stat. § 742.17(4)(4), and (2) if the answer is yes, does Florida intestacy law authorize a posthumously conceived child who is provided for in the decedent’s will to inherit the decedent’s property?

The Florida Supreme Court, noting that “provided for” was not defined in Fla. Stat. § 742.17(4) or elsewhere in chapter 742, considered the objective meaning of the phrase, i.e., what a reasonable reader would have understood it to mean at the time the statute was issued. Based on prior case law in a related context (see Ganier’s Estate v. Ganier’s Estate, 418 So. 2d 256, 260 (Fla. 1982)), the court determined that “provided for” means that the testator “actually left something to the posthumously conceived child through the will . . . [and] as part of this requirement, the will must show that the testator contemplated the possibility of a child being conceived following his or her death.” Steele v. Comm’r of Soc. Sec., No. 20-11656, 2024 WL 630219, at *3 (Feb. 15, 2024). Because Philip’s will did not acknowledge the possibility of children being conceived after his death, and the mention of “later-born” children referred most naturally to children conceived before but born after his death, his will did not “provide for” P.S.S. within the meaning of the statute. Because the answer to the Eleventh Circuit’s first question was dispositive of the case, the Florida Supreme Court declined to address the second question.

Takeaways: The Steele case highlights the need for estate planning attorneys to ask clients about stored biological materials such as frozen sperm, eggs, or embryos and whether a survivor may utilize assisted reproductive technologies posthumously so those issues can be addressed in accordance with the applicable state law. To avoid unintentional disinheritance of a child, clients who use assisted reproductive technology may wish to specifically include posthumously conceived children in their estate plan. 

Video Recording by Estate Planning Attorney Used as Evidence of Decedent’s Incapacity

In re Estate of Scott, Nos. 360651; 360652; 360653; 360654; 2023 WL 8866471 (Mich. Ct. App. Dec. 21, 2023)

Matthew Scott, a Michigan resident, had two adult sons, Christopher and Tad. Matthew, who had major health problems, sometimes received treatment at the Mayo Clinic in Minnesota, which was near Christopher’s home. Matthew stayed with Christopher at Christopher’s house when he received treatment at the Mayo Clinic. In July 2019, during one of those stays, Matthew fell and suffered a traumatic brain injury that left him with significant physical and mental impairments. After months of care and rehabilitation, Matthew returned to an assisted living facility near his own home in Michigan, which he selected and approved with the help of family members. 

Phillip Sprague, a neighbor who had worked for Matthew until a falling out approximately ten years earlier, began visiting him frequently at the assisted living facility. Although Matthew initially seemed to enjoy living at the facility, his attitude changed over time, and he became paranoid about his living situation and family members, as well as aggressive and angry. Staff at the facility indicated that the change in Matthew’s feelings about the facility and his family members reflected hostile comments that Phillip had made about them. Phillip eventually moved Matthew out of the facility into Phillip’s home, thereby isolating Matthew from his family.

In December 2019, Phillip arranged a meeting for Matthew with an estate planning attorney, Joseph Barberi, to change his estate planning documents. Matthew executed estate planning documents in February and July 2020 (weeks before his death), including an amended trust naming Phillip as the successor trustee and a deed transferring his real property to the trust, with a trust provision that Phillip would receive the property upon his death. Matthew also executed a new will designating Phillip as the personal representative of Matthew’s estate and integrating the estate into the trust. In addition, the trust was amended to provide a distribution of money and some of the trust assets to Matthew’s grandchildren, his church, and Phillip, and several pieces of farm equipment were to be distributed to Christopher.

After Matthew’s death in July 2020, Phillip took possession of Matthew’s remains, property, and books and records. Christopher petitioned the probate court to set aside his will and trust and contest the validity of his estate planning documents. The jury entered a verdict that Matthew did not have the capacity to amend his estate planning documents and that they were the result of undue influence Phillip had exercised over him. Accordingly, the probate court entered judgment against Phillip and in favor of Christopher.

On appeal, the Michigan Court of Appeals, in a de novo review, found that the evidence at trial that Matthew had the capacity to make a will under Michigan law did not clearly preponderate in Phillip’s favor. Under Michigan law, to have the capacity to make a will, an individual must meet all of the following requirements:

(a) The individual has the ability to understand that he or she is providing for the disposition of his or her property after death.

(b) The individual has the ability to know the nature and extent of his or her property.

(c) The individual knows the natural objects of his or her bounty.

(d) The individual has the ability to understand in a reasonable manner the general nature and effect of his or her act in signing the will.

Mich. Comp. L. § 700.2501. 

The court found that the evidence at trial supported Christopher’s claim that Matthew did not have the required capacity to create a will when his estate planning documents were executed. Christopher’s evidence demonstrated Matthew’s traumatic brain injury, deterioration in his ability to rationally comprehend current and past events, and paranoid and delusional beliefs about aspects of his life and relationships with family and friends. Christopher’s evidence included both expert testimony and videos recorded by Matthew’s attorney Barberi over the course of several months. The videos revealed Matthew’s inability to focus his attention or know, remember, or understand the disposition of his property. One video, which was abruptly terminated by Barberi, was found to have particularly demonstrated Matthew’s confusion and incapacity. The videos also showed that Barberi often asked leading questions, supporting Christopher’s contention that Matthew was vulnerable to suggestion, manipulation, and lack of volition in his decision-making. 

In addition, the court held that the evidence could be reasonably interpreted by the jury to conclude that Phillip had exerted sufficient undue influence over Matthew—isolating him from his children and other family members over an extended period—to cause him to act against his inclination and free will and change his estate planning documents to benefit Phillip. Therefore, the court affirmed the trial court’s judgment based upon the jury’s verdict in favor of Christopher.

Takeaways: The Scott case reminds estate planners that video recording an estate planning meeting with a client to create evidence of their testamentary capacity can also be used by a family member or disappointed heir as evidence of the client’s lack of capacity. In this case, there was ample evidence of Matthew’s brain injury, memory loss, delusions, and confusion to support the jury’s verdict; however, even clients who are fully capable of understanding their estate plan may display discomfort being videotaped, appear awkward, or suffer from a momentary lapse that is memorialized on camera and used as evidence in support of a will contest. Other measures, such as a neutral attorney’s affidavit of a client’s understanding (often called a certificate of independent review) or a physician’s documentation of cognitive abilities based on an examination that is close in time to the signing of documents, may provide evidence of capacity without the risk of the evidence being used to support claims of incapacity in a will contest.  

Elder Law and Special Needs Law

Supplemental Security Income Restoration Act Reintroduced in the US House of Representatives

Supplemental Security Income Restoration Act of 2024, H.R. 7138, 118th Cong.

On January 30, 2024, the Supplemental Security Income Restoration Act of 2024 (SSI Restoration Act), was reintroduced in the US House of Representatives. The SSI Restoration Act would update the needs-based Supplemental Security Income (SSI) program, which provides financial assistance to seniors and disabled individuals. Many of the SSI program’s eligibility requirements have not been updated in decades, meaning recipients receive benefits that leave them well below the federal poverty level. If enacted, the SSI Restoration Act would increase the SSI benefit rate from 75 percent to at least 100 percent of the federal poverty level, with annual adjustments for inflation. Among the other changes, the Act would increase the following:

• The amount that recipients can receive from nonemployment sources from $20 to $149 
• The amount that can be earned from a recipient’s employment from $65 to $489 
• The amount that recipients can keep from $2,000 for an individual and $3,000 for a married couple to $10,000 for individuals and $20,000 for married couples

Further, the marriage penalty under current law would be eliminated, enabling each spouse to receive their full SSI benefit. Perhaps of most importance, however, might be the proposed exclusion of retirement accounts from countable resources. This would meaningfully expand the number of potential recipients throughout the country. 

Takeaways: The SSI Restoration Act has been introduced several times during past sessions of Congress. Despite the outdated SSI eligibility requirements, it is unclear if it will be brought for a vote during the 118th Congress. If passed, it would significantly increase benefit levels for SSI recipients, who have been impacted by high rates of inflation in recent years that diminish the real value of the existing benefits.

Insurance Policies Irrevocably Assigned to Funeral Home Not Countable Resources Under Ohio Medicaid Law

Shell v. Ohio Dept. of Job and Family Serv., No. 112448, 2024 WL 194807 (Ohio Ct. App. Feb. 27, 2024) 

On June 3, 2021, Dorothy Shell was admitted to Highland Pointe, a long-term care facility, to receive nursing care due to heart problems and blindness. Highland Pointe, as Dorothy’s authorized representative, applied for long-term care Medicaid benefits on her behalf with the county. Dorothy owned five life insurance policies having cash surrender values ranging from $582.70 to $1,743.99. She entered into a preplanned funeral contract with Calhoun Funeral Home that contained an irrevocable assignment of three of the insurance policies, and a subsequent letter stated that four of the policies were to be forwarded to it as beneficiary. Dorothy indicated that only one policy, with a cash surrender value of $587.25, remained in her name as of November 12, 2021.

On February 3, 2022, the county issued a notice of action stating that Dorothy’s countable resources exceeded the $2,000 resource limit and denying her application for long-term care Medicaid. After multiple unsuccessful appeals, Dorothy appealed to the Court of Appeals of Ohio.

On appeal, the court noted that Dorothy would be ineligible for coverage if her countable resources exceeded the $2,000 resource limit. Under Ohio’s former administrative code, resource limit meant “the maximum combined value of all resources an individual can have an ownership interest in and still qualify for medical assistance.” Former Ohio Admin. Code 5160:1-3-05(B)(8). Further, countable resources were the resources remaining after all exclusions were applied. Former Ohio Admin. Code 5160:1-3-05.1(C).

Although a life insurance policy is a countable resource if it generates a cash surrender value greater than $1,500, the court held that it is only a countable resource if an individual is the owner of the policy, regardless of whether the individual is also the insured. The court noted that if the consent of another person is needed to surrender a policy for its full cash surrender value, the policy is available as a resource. An individual is required to make a reasonable effort to obtain consent, but if consent cannot be obtained, the policy is not considered available. 

Dorothy asserted that the county’s February 3, 2022, notice of action was defective because it referenced a section of Ohio’s administrative code that did not exist at the time the notice was issued. Under 42 C.F.R. § 431.210(a) and (b), a state that elects to participate in Medicaid must provide a notice that contains both a statement of what action the skilled nursing facility intends to take, the effective date of such action, and “a clear statement of the specific reasons supporting the intended action.” In addition, “‘[t]he notice shall contain a clear and understandable statement of the action the agency has taken and the reasons for it,’ Ohio Admin. Code 5101:6-2-03(A)(1)(a), and the notice shall contain ‘citations to applicable regulations,’ Ohio Admin. Code 5101:6-2-03(A) (1)(b).” Shell v. Ohio Dept. of Job and Family Serv., No. 112448, 2024 WL 194807 at *5 (Ohio Ct. App. Feb. 27, 2024) (emphasis added). 

The court rejected the county’s argument that the error was harmless because Dorothy was still able to exercise her right to a hearing; rather, the court held that the word “shall” was not conditional but spelled out what was mandated, with no specific harm required for the notice to be deemed insufficient.

In addition, the court agreed with Dorothy’s assertion that her life insurance policies were not countable resources that were available to her and should not have been used as the basis for a denial of long-term care Medicaid. Specifically, the court ruled that under Ohio Medicaid law, an irrevocable assignment of an insurance policy means that the policy is excluded as a countable resource and that the three life insurance policies that Dorothy had irrevocably assigned to Calhoun Funeral Home were thus not among her countable resources. Because the cash surrender value of the remaining policies was $1,155.95—an amount less than $2,000, Dorothy qualified for long-term Medicaid. As a result, the court reversed the lower court’s ruling.

Takeaways: That such a basic spend-down strategy required multiple levels of appellate review to finally provide the correct answer—that Dorothy was eligible for benefits—highlights just how important advocacy can be. Elder law practitioners must continue to pursue meritorious claims on behalf of their clients despite setbacks.

Business Law

Federal District Court Rules CTA Unconstitutional

National Small Bus. United v. Yellen, No. 5:22-cv-1448-LCB, 2024 WL 899372 (N.D. Ala. Mar. 1, 2024)

On Friday, March 1, 2024, in National Small Bus. United v. Yellen, Judge Liles C. Burke of the United States District Court for the Northern District of Alabama ruled via memorandum opinion that the Corporate Transparency Act (CTA), enacted in 2021, is unconstitutional because Congress lacks the authority to require companies to disclose personal stakeholder information to the Financial Crimes Enforcement Network (FinCEN), the criminal enforcement arm of the US Department of the Treasury. The National Small Business Association (NSBA), an Ohio nonprofit organization representing more than 65,000 businesses from all 50 states, and Issac Winkles, an NSBA member and owner of two small businesses, brought suit against the US Department of the Treasury and Treasury Secretary Janet Yellen, alleging that the mandatory disclosure requirements imposed by the CTA exceeded Congress’s authority under Article I of the US Constitution and violated the First, Fourth, Fifth, Ninth, and Tenth Amendments. 

The court determined that the plaintiffs were entitled to summary judgment as a matter of law because the CTA could not be justified as an exercise of Congress’s enumerated powers, rejecting the argument that Congress had the power to enact the CTA under its foreign affairs powers, Commerce Clause authority, or as a necessary and proper exercise of its taxing power. It declined to address whether the CTA violates the First, Fourth, and Fifth Amendments. The court granted the plaintiffs’ motion for summary judgment and request for relief and entered a final declaratory judgment that the CTA is unconstitutional because it exceeds the limits imposed by the US Constitution on Congress’s power, permanently enjoining the defendants and any other agency or employee acting on behalf of the United States from enforcing the CTA against the plaintiffs. 

Takeaways: At this time, the CTA cannot be enforced against the particular plaintiffs in this particular case, but the decision (which will likely be appealed) could ultimately have far-reaching consequences. Business owners and their advisors should monitor the changing regulatory landscape as this case—and any others—travel through the appellate courts. WealthCounsel will continue to monitor developments related to the CTA and provide updates. On March 4, 2024, FinCEN issued a news release regarding the National Small Business United case.

IRS Provides 7 Warning Signs of Improperly Claimed Employee Retention Credits

The deadline to participate in the Internal Revenue Service’s (IRS) Employee Retention Credit (ERC) Voluntary Disclosure Program is March 22, 2024. This program allows employers that filed an ERC claim in error and received a payment to voluntarily repay only 80 percent of the claim. To assist businesses in determining whether they received a payment in error, on February 13, 2024, the IRS issued a list of seven suspicious signs that an ERC claim was improper:

1. Too many quarters being claimed
2. Government orders that do not qualify
3. Too many employees and wrong calculations
4. Business citing supply chain issues 
5. Business claiming ERC for too much of a tax period
6. Business did not pay wages or did not exist during eligibility period
7. Promotor says there is nothing to lose

Takeaways: Businesses eligible for the Voluntary Disclosure Program should immediately repay 80 percent of an ERC payment they now believe they received in error. Those that incorrectly received ERC payments after December 21, 2023, are not eligible for the program; if they received a payment, they should not cash or deposit the check but should return the check to avoid penalties and interest. Those who have submitted a claim they now believe was improper but have not received a payment may withdraw their claim to avoid future repayment, interest, and penalties. See the IRS’s frequently asked questions about the ERC webpage for general information.

Delaware Supreme Court: Forfeiture-for-Competition Provision in Limited Partnership Agreement Enforceable

Cantor Fitzgerald v. Ainslie, No. 162, 2023, 2024 WL 315193 (Del. Jan. 29, 2024)

Cantor Fitzgerald is a global financial services company formed under Delaware law. The plaintiffs were six former Cantor Fitzgerald limited partners (former limited partners) who signed and agreed to be bound by an Agreement of Limited Partnership (the Agreement). The Agreement included two mechanisms aimed at discouraging former partners from competing with Cantor Fitzgerald after withdrawing from the partnership: restrictive covenants and a conditioned payment device.

The restrictive covenants required partners to refrain from engaging in certain enumerated competitive activities for two years following withdrawal from Cantor Fitzgerald. Under the conditioned payment device, if a former partner breached the restrictive covenants, the partner would forfeit certain payments, including annual capital disbursements that they otherwise would be entitled to receive for four years following their withdrawal.

All six former limited partners engaged in competitive activities that breached the restrictive covenants in the Agreement within one year of voluntarily withdrawing from Cantor Fitzgerald. As a result, Cantor Fitzgerald withheld payments ranging from $100,000 to over $5 million from them.

The former limited partners filed suit in the Delaware Court of Chancery for breach of contract, alleging that the four-year noncompete provision was unenforceable because it was not appropriately limited in time or space, failed to protect a legitimate interest of Cantor Fitzgerald, and was oppressive. The Court of Chancery subjected the provisions to a reasonableness review and determined that the provision was unenforceable, primarily because the four-year duration was an unreasonable restraint of trade.

On appeal, the Delaware Supreme Court distinguished the case from one in which an employer sought to enforce a liquidated damages provision for a breach of a restrictive covenant in an employment agreement. In this case, the former limited partners had requested that a forfeiture-for-competition provision be found invalid under the same test applied to a traditional noncompete agreement. The court emphasized the difference between a noncompetition covenant that would preclude a former employee from earning a living in their field and potentially suffer serious financial hardship—a situation that justifies a review for reasonableness and a balancing of the equities—and a forfeiture-for-competition provision, which does not prohibit competition or preclude gainful employment.

Further, the court noted that the Delaware Revised Uniform Limited Partnership Act expressly states a public policy “to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements.” Although the common law disfavors forfeitures, this does not extend to limited partnership agreements, which are expressly permitted to contain consequences that would be “unavailable in a standard commercial contract, most notably penalties and forfeitures.” 6 Del. Ch. 17-306. Therefore, the court determined that the forfeiture provision should enjoy the court’s deference “on equal footing with any other bargained-for-term in a limited partnership agreement.” Cantor Fitzgerald v. Ainslie, No. 162, 2023, 2024 WL 315193 at *13 (Del. Jan. 29, 2024). In the present case, the former limited partners assumed the risk of the forfeiture because they had voluntarily entered into the agreement and competed with Cantor Fitzgerald following their withdrawal. 

The court concluded that the Court of Chancery had erred in subjecting the forfeiture-for-competition provision to a review for reasonableness. To the contrary, “[w]hen sophisticated parties agree in a limited partnership agreement that a partner, who voluntarily withdraws from, and then competes with, the partnership, will forfeit contingent post-withdrawal financial benefits, public-policy considerations weigh in favor of enforcing that agreement.” Id. 

Takeaways: Many states now prohibit or limit the use of traditional noncompetition agreements, particularly in the employment context. In addition, the Federal Trade Commission has issued a proposed rule that would ban most noncompetition agreements in the employment context. Although the forfeiture-for-competition provision in the Cantor Fitzgerald case was contained in a limited partnership agreement and expressly permitted by state law, this type of provision is likely to be used more frequently in attempts to discourage competition without running afoul of state law prohibiting or restricting traditional noncompetition provisions.

Ethics

Florida Bar Adopts Ethical Guidelines for Attorneys’ Use of Generative AI

Fla. Bar Board of Governors, Advisory Ethics Opinion 24-1 (Jan. 19, 2024)

On January 19, 2024, the Florida Bar’s Board of Governors approved Ethics Advisory Opinion 24-1, a nonbinding opinion recognizing that, although generative artificial intelligence (AI) has the potential to dramatically improve the efficiency of a lawyer’s practice and the use of reliable AI tools is not inherently improper, its use raises ethical concerns and potential pitfalls. 

In the opinion, the Florida Bar concluded that attorneys may use generative AI in their practices but must take steps to comply with existing ethical obligations to protect the confidentiality of client information, provide accurate and competent services, avoid improper billing, and comply with existing restrictions on advertising.

Confidentiality. Lawyers who use a third-party generative AI program must have a sufficient understanding of the technology to comply with ethical obligations. Specifically, attorneys must determine whether an AI program is self-learning, as the use of such a program could store confidential client information within the program that could be revealed in responses to future inquiries by third parties. In addition, attorneys should comply with recommendations set forth in previous opinions issued in the context of the use of cloud computing by (1) ensuring that a generative AI provider has an enforceable obligation to preserve the confidentiality and security of information and will notify the attorney in the event of a breach or service of process requiring the production of client information, (2) investigating the provider’s reputation, security measures and policies, and liability limitations, and (3) ascertaining whether the provider retains information an attorney submits before and after the discontinuation of service or asserts proprietary rights to information an attorney submits.

Accuracy and competency. Standards applicable to human nonlawyer assistants should be used as guidance when an attorney uses AI. Under existing ethical rules, attorneys must make reasonable efforts to ensure that their firms have policies to assure that the conduct of human nonlawyer assistants is compatible with the lawyer’s professional obligations. Similarly, attorneys who use generative AI for research, drafting, communication, and client intake should ensure its conduct is compatible with their professional obligations. In addition, attorneys are ultimately responsible for their work product and should review the work product of generative AI just as they would the work product of a human assistant. They should verify the accuracy and sufficiency of research performed by generative AI. Because these duties apply to nonlawyer assistants within and outside the law firm, the use of generative AI managed and operated by a third party does not excuse attorneys from ensuring their actions are consistent with the attorney’s professional and ethical obligations. Attorneys also must not delegate functions to generative AI that could constitute the practice of law; existing ethics opinions regarding tasks that attorneys are precluded from delegating to human nonlawyer assistants are instructive.

Legal fees and costs. Generative AI programs may enhance an attorney’s efficiency, but attorneys should not falsely inflate claims of time as a result of this increased efficiency. Contingent fee arrangements or flat billing rates may be adopted to ensure that both the attorney and the client benefit from gains in efficiency due to the use of generative AI. Attorneys should inform a client in writing if they intend to charge for the use of an AI service; such a charge should be reasonable and reflect the actual cost of its use, and should not be duplicative.

Lawyer advertising. Attorneys are prohibited from using misleading, unduly manipulative, or intrusive advertisements, including using voices or images creating the impression that a person speaking or shown is the advertising lawyer. Attorneys who use generative AI chatbots for advertising and intake are responsible for any misleading information or inappropriately intrusive or coercive communications they provide. Prospective clients should be informed that they are communicating with an AI program to avoid confusion or deception.

Takeaways: In its advisory ethics opinion, the Florida State Bar noted that lawyers should be cognizant that generative AI technology is still young and the concerns addressed in the opinion are not an exhaustive list. As generative AI continues to develop and change, more states will issue related guidance to ensure that attorneys’ uses of those programs are compatible with their professional and ethical obligations. In addition to Florida, California and New Jersey have recently issued guidance related to attorney use of generative AI in the practice of law.