April 2, 2018

Lit Alerts—April 2018, Vol. 1

A Publication of the Litigation Practice Group

Taxation: New Jersey Appellate Division Court Rules That Qui Tam Awards Are Taxable Under The New Jersey Gross Income Tax Act

In Kite v. Director, Division of Taxation, the Superior Court of New Jersey, Appellate Division, held that a taxpayer must pay state income taxes on a qui tam award under the New Jersey Gross Income Tax Act (Act), and that attorneys' fees and portions paid to co-plaintiffs were not deductible from this tax liability.

The plaintiff, a financial consultant, discovered fraudulent Medicare billing practices by some of his clients. After filing a qui tam action with two additional plaintiffs, he obtained a settlement with the hospital defendants. The federal government paid the qui tam award to the plaintiff's attorneys, who then distributed contractually agreed shares to themselves, the plaintiff's co-plaintiffs in the qui tam action, and the plaintiff himself.

The plaintiff did not report his qui tam recovery to the New Jersey Division of Taxation, and in 2012 the Division issued a tax deficiency notice. The plaintiff argued at trial that the qui tam award did not fall under the Act—which taxes prizes and awards—and that if it did, he was entitled to deduct the amounts he was contractually obligated to pay to his attorneys and co-plaintiffs. The trial and appellate courts both disagreed, stating that damages recovered in a lawsuit fall within the definition of "Award" in the Act, making them taxable as gross income. Both courts also refused to allow the plaintiff to deduct the portions of the award he paid to his attorneys for their services and to his co-plaintiffs in the qui tam action. The courts explained that the Act distinctly defines some income sources as gross income and others as net income, and that "awards" are defined as gross income. Therefore, the plaintiff was assessed taxes even on the portions of the qui tam award that went to his attorneys and co-plaintiffs.

Intellectual Property: Fourth Circuit Remands Closely Watched DMCA Case for Jury Instruction Errors

The Fourth Circuit recently raised the bar for one of the Digital Millennium Copyright Act (DMCA) safe harbor defenses in BMG Rights Management (US) LLC v. Cox Communications, Inc., No. 16-1972 (4th Cir. Feb. 1, 2018). BMG, which owns copyrights in musical compositions, alleged contributory copyright infringement by Internet service providers (ISPs) Cox Communications, Inc. and CoxCom, LLC (collectively "Cox").

The lower court held that Cox was not entitled to the safe harbor defense under Section 512(a) of the DMCA because Cox did not satisfy the conditions under Section 512(i)(1)(A). BMG Rights Mgmt. (US) LLC v. Cox Commc'ns, Inc., Case No. 1:14-cv-1611 (Aug. 8, 2016). That section requires ISPs seeking to avail themselves of the safe harbor defense to have "adopted and reasonably implemented . . . a policy that provides for the termination in appropriate circumstances of subscribers . . . who are repeat infringers." As we reported in August 2016, BMG won a $25 million jury verdict against Cox in this case.

On appeal, Cox argued it was entitled to the safe harbor provision "because 'repeat infringers' means adjudicated repeat infringers: people who have been held liable by a court for multiple instances of copyright infringement." Based on this narrow definition, Cox asserted it had complied with the safe harbor provision's requirement because BMG did not show Cox had failed to terminate any adjudicated infringers. The Fourth Circuit rejected Cox's narrow definition of "repeat infringer," however, and affirmed the lower court's denial of the safe harbor defense.

While doing so, the Fourth Circuit also reversed and remanded the case finding an erroneous jury instruction on contributory copyright infringement. Specifically, it found that the instructions permitted the jury to find Cox liable for contributing to copyright infringement if "it 'knew or should have known of such infringing activity,'" instead of requiring proof that Cox was at least willfully blind, a standard closer to actual knowledge. This ruling required remand for a new trial.

Class Actions: California District Court Denies Class Certification in Consumer Misbranding Suit

Judge Lucy Koh of the Northern District of California recently denied a plaintiff's motion to certify a class of consumers who alleged that Gerber's baby food product labels are unlawful, deceptive, and misbranded in violation of federal and California law." In Bruton v. Gerber Products Co., Case No. 12-CV-02412-LHK (N.D. Cal. Feb. 13, 2018), the plaintiff alleged Gerber's products are "misbranded" because (1) FDA does not authorize nutrient food content claims on foods intended for children under the age of two, yet Gerber made claims about the nutrient content of its products; and (2) Gerber failed to disclose that its products have a high caloric value. The plaintiff sought certification of a class seeking injunctive relief under Federal Rule of Civil Procedure 23(b)(2) and a class seeking restitution and damages under Rule 23(b)(3).

The Court declined to certify the Rule 23(b)(2) class, holding that the plaintiff lacked standing to pursue injunctive relief. Because Gerber had ceased using the challenged statements on its food products, the plaintiff "lacked the real and immediate threat of repeated injury necessary for [the plaintiff] to have standing to seek injunctive relief." The Court distinguished this case from Davidson v. Kimberly-Clark Corp., 873 F.3d 1103 (9th Cir. 2017), which holds that "a previously deceived consumer may have standing to seek an injunction against false advertising or labeling, even though the consumer now knows or suspects that the advertising was false at the time of the original purchase, because the consumer may suffer an 'actual and imminent, not conjectural or hypothetical' threat of future harm." In Davidson, the defendant continued to use the challenged statement on its products. Because Gerber's alleged mislabeling had ceased, there was no risk of actual or imminent future harm, and "nothing in Davidson suggests the Ninth Circuit created a freestanding right to seek injunctive relief based on conduct that has ended."

Denial of the Rule 23(b)(3) class was likewise appropriate, because the plaintiff had failed to set forth a viable damages model: the full refund model wrongly assumed consumers received no benefit from the products; the price premium model presumed that the entire price difference between Gerber food products and other brands was attributable to the challenged statements, and not to other factors "such as brand recognition or loyalty, ingredients, and product quality"; and the regression model "fail[ed] to satisfy Comcast [v. Behrend, 569 U.S. 27 (2013)] because . . . [it] did not show how the model 'controls for other variables affecting price.'"

© Arnold & Porter Kaye Scholer LLP 2018 All Rights Reserved. This newsletter is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

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