The Supreme Court continued to accelerate its announcement of
granted cases, issuing its second round of grants nearly a week before the new
Term formally opens next Monday, October 4. The Court granted certiorari in ten
cases (two of them consolidated), three of which are of potential interest to
the business community. Under a special briefing schedule set by the Court,
amicus briefs in support of the petitioners are due on Friday, November 12,
1999, and amicus briefs in support of the respondents are due on December 13.
Any questions about this case should be directed to Donald Falk (202-263-3245)
or Eileen Penner (202-263-3242) in our Washington office.
1. ERISA — Breach of Fiduciary Duty — Managed Care —
Financial Incentives for Cost-Effective Care. Many health maintenance
organizations (HMOs) and other managed care plans provide participating
physicians with financial incentives to provide cost-effective care. The Supreme
Court granted certiorari in Pegram v. Herdrich, No. 98-1949, to
determine whether physician-administrators in HMOs with those incentives breach
fiduciary duties under the Employee Retirement Income Security Act of 1974, 29
U.S.C. § 1001 et seq. ("ERISA").
ERISA imposes fiduciary duties on persons with discretionary
authority over the management or administration of private employee benefit
plans. See 29 U.S.C. § 1002(21)(A). A fiduciary under ERISA has duties of care
and loyalty, and must act "solely in the interest of the [plan] participants and
beneficiaries and * * * for the exclusive purpose of: (i) providing benefits to
participants and their beneficiaries; and (ii) defraying reasonable expenses of
administering the plan * * * ." Id. § 1104. ERISA gives plans and plan
beneficiaries a federal cause of action for breach of these duties. See
id. § 1109(a), 1132(a).
Cynthia Herdrich was an ERISA health plan beneficiary whose
health plan contracted with a physician-owned HMO to provide medical care.
Herdrich's appendix ruptured while she waited eight days for an ultrasound
procedure — a delay she attributed to her HMO's requirement that she undergo the
procedure in a facility staffed by the HMO. Herdrich brought (and eventually
prevailed on) medical malpractice claims against the health care providers. She
also brought additional state-law claims focused on the operation of the HMO;
those claims were dismissed as preempted by ERISA, see 29 U.S.C. § 1144(a).
Herdrich then amended her complaint to allege that her doctor and HMO had
breached their fiduciary duties under ERISA by using cost-containment incentives
that could financially reward the doctors who operated the HMO. The district
court dismissed this cause of action for failure to state a claim.
A divided panel of the Seventh Circuit reversed. 154 F.3d 362
(1998). The court of appeals first determined that the doctor and HMO were
fiduciaries within the meaning of ERISA because, in its view, they exercised
discretionary authority in deciding disputed claims under the health plan.
Id. at 370-371. The Seventh Circuit then held that Herdrich had stated a
claim for a breach of the defendants' fiduciary duties under ERISA because she
had alleged that they had delayed in providing her with necessary treatment for
the sole purpose of receiving financial bonuses under the HMO's cost-cutting
incentives. Id. at 373. Although the majority recognized that ERISA
permits fiduciaries to maintain dual loyalties, ibid., it nevertheless
emphasized that a fiduciary breaches the duty of care when the fiduciary acts to
benefit its own interests, id. at 371. The majority also provided a long
disquisition on what it viewed as "the deleterious affects [sic] of managed care
on the health care industry." Id. at 375; see id. at 375-379.
Judge Flaum dissented, finding that the mere existence of
structural incentives to limit costs could not "give rise to a cause of action
for breach of fiduciary duty under ERISA." 154 F.3d at 381. In addition, Judge
Easterbrook (joined by Chief Judge Posner and Judges Flaum and Diane Wood)
sharply dissented from denial of rehearing en banc. 170 F.3d 683 (7th
Cir. 1999). Judge Easterbrook did not believe that the doctor and the HMO were
acting as fiduciaries of the ERISA plan when they chose a course of medical
treatment. He warned that the panel decision threatened the continued operation
of HMOs and other managed care plans. In particular, Judge Easterbrook noted,
the majority opinion "implies that the principal organizational forms through
which medical care is delivered today are unlawful," and that as a consequence
"the cost-saving achieved by managed care must be abandoned." Id. at
This case is of obvious interest to managed care plans and
providers. The case is of broader interest to the business community in light of
the prevalence of health and other benefits plans governed by ERISA, and the
widespread adoption by employers of managed care plans as part of their health
benefits packages. The Supreme Court's decision could alter the way in which
benefit plans are designed and administered, effectively precluding cost-saving
incentives and techniques.
2. State Taxation — Due Process — Commerce Clause —
Deduction Offsets for Dividends of Non-Unitary Subsidiaries. The Commerce
and Due Process Clauses of the Constitution limit the ability of States to tax
the income of corporations that operate in many States. In a nutshell, a State
may tax a proportionate share of an out-of-state corporation's income from its
"unitary" business (i.e., business related to its in-state activities). A
State may not tax income from out-of-state, non-unitary businesses owned by the
corporation. The California franchise tax (i.e., corporate income tax)
requires each nondomiciliary corporation to offset any deduction for business
interest expense with dividend income from non-unitary out-of-state subsidiaries
(see Cal. Rev. & Tax Code § 24344(b)) — income that California cannot
constitutionally tax. California corporations are not subject to the offset,
however, and dividend income from California subsidiaries also is exempt from
the offset requirement. The Supreme Court granted certiorari in Hunt-Wesson,
Inc. v. Franchise Tax Board, No. 98-2043, to decide whether that
practice violates the Due Process and Commerce Clauses.
Hunt-Wesson, Inc. is the successor to Beatrice Companies, Inc.,
a Delaware corporation domiciled in Illinois. Beatrice received dividends from
several foreign subsidiaries that were not part of Beatrice's unitary business.
Beatrice also incurred interest expenses on business loans that were not related
to the non-unitary foreign subsidiaries. Beatrice claimed these interest
expenses as deductions on its California franchise tax returns.
The California Franchise Tax Board disallowed Beatrice's
interest expense deduction by an amount equal to the dividend income received
from Beatrice's non-unitary subsidiaries during that year, and assessed a tax
deficiency against Beatrice. Beatrice paid the deficiency, and then
unsuccessfully sought a refund from the Board.
Hunt-Wesson, as Beatrice's successor, filed suit in California
state court seeking a refund. In an unpublished opinion, the trial court held
that the interest offset provision violated both the Due Process and Commerce
Clauses of the United States Constitution. The California court of appeal
reversed, also in an unpublished opinion. The court of appeal relied on
California Supreme Court precedent holding that the inclusion of nontaxable
dividends in the statutory offset computation does not constitute taxation of
the dividends themselves. See Pacific Telephone & Telegraph Co. v.
Franchise Tax Board, 498 P.2d 1030 (1972). The California Supreme Court
denied Hunt-Wesson's petition for review.
The decision of the California court of appeal appears to be in
tension with several Supreme Court decisions. First, the Court has held that a
State may not tax the dividends that a nondomiciliary corporation receives from
its non-unitary subsidiaries, e.g., ASARCO, Inc. v. Idaho State Tax
Commission, 458 U.S. 307 (1982) (due process); see also Allied-Signal,
Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992)
(clarifying that limitations on extraterritorial taxation rest on both the Due
Process and the Commerce Clauses). Second, the Court has made clear that a State
may not limit a tax benefit to its own domiciliaries or to those who invest in
corporations conducting in-state activity, e.g., South Central Bell Telephone
Co. v. Alabama, 119 S. Ct. 1180 (1999); Fulton v.
Faulkner, 516 U.S. 325 (1996).
Although this case is of obvious importance to corporations
that are taxed in California, the constitutional questions raised by this case
have substantial implications for all multistate taxpayers. By offsetting or
disallowing legitimate deductions where there is no relationship between the
disallowed expense and exempt income, California in effect indirectly taxes
income it cannot tax directly. If California prevails, other States may use
similar devices to impose what amounts to multiple taxation on non-unitary
out-of state income.
3. Appellate Procedure — Erroneously Admitted Evidence —
Grant of Judgment to Defense. The Supreme Court granted certiorari in
Weisgram v. Marley Co., 120 S. Ct. __ (2000) to determine whether
a court of appeals may order entry of judgment as a matter of law after
concluding that expert testimony was improperly admitted at trial and that the
remaining evidence does not raise a triable issue of fact.
Bonnie Jo Weisgram died in a fire. Her son and her home insurer
sued the manufacturer of one of her home's baseboard heaters, alleging that a
defect in the heater caused the fire. In support of their theory of causation,
the plaintiffs presented testimony from the fire captain who investigated the
fire, an electrician who styled himself a "fire investigator," and a
metallurgist. The district court rejected challenges to that testimony as
unreliable and inadmissible under Daubert v. Merrell Dow
Pharmaceuticals, Inc., 509 U.S. 579 (1993), and a jury awarded approximately
$600,000 to the plaintiffs.
A divided panel of the Eighth Circuit reversed. 169 F.3d 514
(1999). The majority found the testimony of the purported experts wholly
unreliable and concluded that the district court had abused its discretion in
admitting it. Without that testimony, the Eighth Circuit held, the evidence was
insufficient to prove the plaintiffs' case. 169 F.3d at 517, 521-522. The court
of appeals accordingly found that the defendant was entitled to judgment as a
matter of law. In a footnote, the Eighth Circuit explained that it was not
required to remand the case for a new trial to permit plaintiffs to present new
evidence in lieu of their belatedly rejected expert testimony. Id. at 517
n.2. The court explained that the case was close and that plaintiffs had already
had one "fair opportunity to prove their claim." Ibid. Judge Bright
dissented on the admissibility issue and on the ground that the appropriate
relief for any error was a new trial, not judgment as a matter of law.
Id. at 525-526.
The Eighth Circuit's decision conflicts with the decisions of
several other circuits holding that a motion for judgment as a matter of law
must be determined on the record as it stood at the close of trial and may not
be granted based on a belated ruling of inadmissibility. See, e.g., Sumitomo
Bank v. Product Promotions, Inc., 717 F.2d 215, 218 (5th Cir. 1983);
Schudel v. General Electric Co., 120 F.3d 991, 995 (9th Cir.
1997); Jackson v. Pleasant Grove Health Care Ctr., 980 F.2d 692,
695-96 (11th Cir. 1993).
This case is of substantial importance to the business
community. Many product liability cases turn on expert testimony alone. Under
the rule endorsed by the Weisgram majority, a defendant who challenges the
erroneous admission of such testimony can obtain a total victory on appeal,
terminating the litigation. The availability of that broad remedy would also
increase the bargaining power of defendants seeking to settle expert-dependent
product liability cases after a verdict and before a ruling on appeal.